--- name: depreciation-amortization description: Calculate, record, and manage depreciation and amortization for all fixed assets and intangible assets using appropriate methods and useful lives. Use when setting up depreciation schedules, selecting depreciation methods, recording monthly depreciation, handling asset disposals with gain/loss calculation, performing impairment reviews, or preparing fixed asset reports for auditors. Triggers on phrases like "depreciation schedule", "amortization", "depreciation method", "useful life", "asset disposal", "book value", "accumulated depreciation", "impairment test", "MACRS", "capital allowance", "fixed asset depreciation". --- # Depreciation & Amortization Systematically allocate the cost of tangible and intangible assets over their useful lives using appropriate methods, ensuring accurate expense recognition and compliance with accounting standards. ## Workflow 1. **Categorize the asset**: Classify as tangible fixed asset (depreciation) or intangible asset (amortization); determine if it has a finite or indefinite useful life. 2. **Determine depreciable base**: Asset cost less salvage/residual value (for tangible assets) or less any residual value (for intangibles, typically $0). 3. **Assign useful life**: Based on asset class, industry standards, company policy, and expected usage pattern — reference IRS Class Lives (US) or local tax authority guidelines. 4. **Select depreciation/amortization method**: Choose between straight-line, declining balance, units of production, or sum-of-years-digits based on usage pattern and financial statement objectives. 5. **Set up in fixed asset register**: Record asset details, cost, acquisition date, useful life, method, salvage value, and depreciation schedule. 6. **Run monthly depreciation**: Automate the calculation and GL posting; verify amounts for reasonableness against prior months. 7. **Handle mid-year acquisitions and disposals**: Apply appropriate conventions (half-year, mid-month, mid-quarter) for partial-year depreciation. 8. **Review useful lives periodically**: Ensure assigned lives remain appropriate; change accounting estimate if patterns change. 9. **Test for impairment**: When triggering events occur, compare carrying amount to recoverable amount; recognize impairment loss if carrying value exceeds recoverable amount. 10. **Prepare fixed asset roll-forward**: Generate monthly/quarterly roll-forward report for management review and audit. ## Depreciation Methods ``` METHOD 1: STRAIGHT-LINE (Most Common) ──────────────────────────────────── Annual Depreciation = (Cost − Salvage Value) / Useful Life Example: Machine costing $100,000, salvage $10,000, life 10 years Annual depreciation = ($100,000 − $10,000) / 10 = $9,000/year Schedule: Year Cost Depr Accum Depr Book Value 1 $100,000 $9,000 $9,000 $91,000 2 $100,000 $9,000 $18,000 $82,000 3 $100,000 $9,000 $27,000 $73,000 ... 10 $100,000 $9,000 $90,000 $10,000 Best for: Buildings, furniture, assets with uniform usage pattern Financial statement impact: Smooth, predictable expense METHOD 2: DECLINING BALANCE (Accelerated) ───────────────────────────────────────── Annual Depreciation = Book Value at Beginning of Year × Depreciation Rate Depreciation Rate = (2 / Useful Life) for Double-Declining Balance Example: $100,000 machine, 10-year life, DDB method (rate = 20%) Year Book Value Depr (20%) Accum Depr Ending BV 1 $100,000 $20,000 $20,000 $80,000 2 $80,000 $16,000 $36,000 $64,000 3 $64,000 $12,800 $48,800 $51,200 4 $51,200 $10,240 $59,040 $40,960 ... Switch to straight-line when SL produces higher expense Best for: Technology, vehicles, assets that lose value faster early Financial statement impact: Higher expense early, lower later METHOD 3: UNITS OF PRODUCTION (Activity-Based) ─────────────────────────────────────────────── Depreciation per Unit = (Cost − Salvage) / Estimated Total Units Period Depreciation = Units Produced × Depreciation per Unit Example: $100,000 machine, estimated total production 500,000 units Depreciation per unit = ($100,000 − $10,000) / 500,000 = $0.18/unit Year 1: 75,000 units × $0.18 = $13,500 Year 2: 80,000 units × $0.18 = $14,400 Year 3: 60,000 units × $0.18 = $10,800 Best for: Manufacturing equipment, vehicles by mileage Financial statement impact: Expense follows production METHOD 4: SUM-OF-YEARS-DIGITS (Accelerated) ──────────────────────────────────────────── SYD = n(n+1)/2 where n = useful life Year 1 Depreciation = (n/SYD) × (Cost − Salvage) Example: $100,000, 5-year life, $10,000 salvage SYD = 5×6/2 = 15 Year Fraction Depr Accum Depr Book Value 1 5/15 $30,000 $30,000 $70,000 2 4/15 $24,000 $54,000 $46,000 3 3/15 $18,000 $72,000 $28,000 4 2/15 $12,000 $84,000 $16,000 5 1/15 $6,000 $90,000 $10,000 Best for: Assets with front-loaded utility, tax acceleration goals ``` ## Useful Life Guidelines ``` RECOMMENDED USEFUL LIVES BY ASSET CLASS: TANGIBLE ASSETS: ─────────────── Asset Class GAAP Life Tax Life (MACRS) Notes ───────────────────────────────────────────────────────────────────── Land N/A N/A Not depreciated Buildings 30–40 yrs 39 yrs (non-res) Excludes land value Building improvements 10–15 yrs 15–39 yrs ROUs, renovations Machinery/Equipment 5–15 yrs 5–7 yrs Varies by type Computers 3–5 yrs 5 yrs Hardware only Software (purchased) 3–5 yrs 5 yrs Not custom development Vehicles 5–8 yrs 5 yrs Cars, trucks, fleet Furniture/Fixtures 7–15 yrs 7 yrs Office furniture Leasehold improvements Lesser of 15 yrs Lesser of useful life lease term or remaining lease INTANGIBLE ASSETS: ────────────────── Asset Class Amortization Life Notes ────────────────────────────────────────────────────────────── Patents Legal life or Lesser of remaining legal life economic life or economic benefit period Trademarks Indefinite If indefinite → no amortization, (if indef.) annual impairment test only Copyrights 15–25 yrs Economic life Customer relationships 5–15 yrs Based on attrition rate analysis Non-compete agreements Term of agreement Typically 2–5 years Software (developed) 3–7 yrs Economic useful life Goodwill Indefinite No amortization; annual impairment Trade names 10–20 yrs Or indefinite if perpetual value Licenses/Permits Term of license Remaining contractual term Developed technology 5–10 yrs Based on obsolescence rate RULE: Useful life = shorter of economic life and legal life Review lives annually; change is a change in estimate (prospective, not retroactive) ``` ## Partial-Year Depreciation Conventions ``` CONVENTIONS FOR MID-YEAR ACQUISITIONS/DISPOSALS: HALF-YEAR CONVENTION (MACRS default): ───────────────────────────────────── Asset placed in service anytime during year → 6 months depreciation in first year Asset disposed anytime during year → 6 months depreciation in last year Example: $100,000 machine, 10-year SL, acquired June 15 Year 1 (half-year): $9,000 × 6/12 = $4,500 Year 2–10: $9,000 per year Year 11 (half-year): $9,000 × 6/12 = $4,500 (if held through year 11) MID-MONTH CONVENTION (Buildings, MACRS): ────────────────────────────────────── Asset acquired mid-month → 17.5 days of that month (half-month) Example: $500,000 building, 39-year SL, acquired March 15 Month of acquisition: 17.5/365 of annual depreciation Annual depr = $500,000 / 39 = $12,821 Year 1: $12,821 × (10.5 months / 12) = $11,218 MID-QUARTER CONVENTION (MACRS trigger): ────────────────────────────────────── Triggered when > 40% of assets placed in service in Q4 Assets depreciated from midpoint of quarter of placement Example: 3 of 5 assets placed in Q4 → mid-quarter convention applies to ALL assets Q4 assets: 1.5 months depreciation (half of Q4) GAAP vs. TAX: ──────────── • GAAP: Company chooses convention (half-year common for simplicity) • Tax (US): MACRS conventions are prescribed by IRS • Book-tax differences tracked in deferred tax accounts ``` ## Asset Disposal Accounting ``` ASSET DISPOSAL — RECORDING THE TRANSACTION: When an asset is sold, retired, or disposed: 1. DETERMINE CARRYING AMOUNT: Carrying Amount = Original Cost − Accumulated Depreciation 2. STOP DEPRECIATION: Depreciate through the disposal date (or convention-appropriate period) 3. RECORD DISPOSAL: Dr. Accumulated Depreciation [$accum depr] Dr. Cash/Proceeds [$proceeds] Dr. Loss on Disposal [$if proceeds < carrying amount] Cr. Fixed Asset [$original cost] Cr. Gain on Disposal [$if proceeds > carrying amount] EXAMPLE — SALE: Machine: Cost $100,000 | Accum Depr $63,000 | Carrying Amount $37,000 Sold for: $45,000 Gain = $45,000 − $37,000 = $8,000 Dr. Accumulated Depreciation $63,000 Dr. Cash $45,000 Cr. Fixed Asset (Machinery) $100,000 Cr. Gain on Asset Sale $8,000 EXAMPLE — RETIREMENT (no proceeds): Equipment: Cost $50,000 | Accum Depr $42,000 | Carrying Amount $8,000 Loss = $0 − $8,000 = ($8,000) Dr. Accumulated Depreciation $42,000 Dr. Loss on Asset Retirement $8,000 Cr. Fixed Asset (Equipment) $50,000 TAX CONSIDERATIONS: • Gain on depreciable property: May be Section 1231 gain (preferential rate) or Section 1245 recapture (ordinary income to extent of depreciation taken) • Loss on disposal: Generally deductible as ordinary loss • Like-kind exchange (Section 1031): Defers gain on real property exchanges ``` ## Impairment Testing ``` IMPAIRMENT TEST — WHEN AND HOW: TRIGGERING EVENTS (test when these occur): ⚠ Significant decline in market value ⚠ Physical damage or obsolescence ⚠ Adverse changes in legal/regulatory environment ⚠ Asset will be disposed earlier than planned ⚠ Operating losses + cash flow losses using the asset ⚠ Restructuring affecting the asset TWO-STEP TEST (US GAAP — Finite-Life Assets): ───────────────────────────────────────────── STEP 1: Recoverability Test Compare: Carrying Amount vs. Undiscounted Future Cash Flows If Carrying Amount > Undiscounted Cash Flows → Impairment exists → Go to Step 2 If Carrying Amount ≤ Undiscounted Cash Flows → No impairment → Stop STEP 2: Measurement Impairment Loss = Carrying Amount − Fair Value Fair Value = Market price (if available) OR discounted cash flow OR appraisal Record: Dr. Impairment Loss [$loss] Cr. Accumulated Impairment [$loss] EXAMPLE: Production Line: Carrying Amount $2,000,000 Undiscounted future cash flows: $1,800,000 → Fail recoverability test ($2M > $1.8M) Fair value (discounted): $1,500,000 Impairment loss: $2,000,000 − $1,500,000 = $500,000 Dr. Impairment Loss $500,000 Cr. Accumulated Impairment $500,000 ANNUAL TEST — Indefinite-Life Intangibles & Goodwill: ───────────────────────────────────────────────────── Test at least annually (typically fiscal year-end) Compare: Carrying amount vs. Fair value If Carrying > Fair value → Impairment loss recognized immediately ``` ## Edge Cases - **Asset with no salvage value**: Use full cost as depreciable base; common for technology assets - **Fully depreciated asset still in use**: Continue on fixed asset register at zero book value; depreciate no more; test for impairment if condition deteriorates further - **Component depreciation**: When an asset has major components with different lives (e.g., building structure + HVAC + elevator), depreciate each component separately - **Revaluation model** (IFRS only): IAS 16 permits revaluation to fair value; revaluation surplus goes to OCI, not P&L; subsequent depreciation based on revalued amount - **Construction in progress (CIP)**: Not depreciated until placed in service; move to appropriate asset class when completed - **Asset exchange/trade-in**: Derecognize old asset, recognize new asset at fair value; calculate gain/loss on old asset disposal - **Capital vs. repair judgment**: Betterment/improvement = capitalize (add to asset basis); maintenance/repair = expense; use the "betterment test" — does it extend life, increase capacity, or improve quality? ## Output ### Fixed Asset Roll-Forward Report ``` FIXED ASSET ROLL-FORWARD — January 2025 ========================================== CATEGORY: MACHINERY & EQUIPMENT (in thousands) Beg Balance Additions Disposals Transfer In Transfer Out End Balance ────────────────────────────────────────────────────────────────────────────────────────────────────── Gross Cost $4,200 $180 ($45) $25 ($10) $4,350 Accumulated Depr. ($2,800) ($12) $38 — $8 ($2,766) ────────────────────────────────────────────────────────────────────────────────────────────────────── Net Book Value $1,400 $168 ($7) $25 ($2) $1,584 ────────────────────────────────────────────────────────────────────────────────────────────────────── SUMMARY — ALL ASSET CATEGORIES: Category Gross Cost Accum Depr NBV Depr Expense (MTD) ────────────────────────────────────────────────────────────────────────────── Buildings $12,500 ($3,750) $8,750 $88 Machinery & Equipment $ 4,350 ($2,766) $1,584 $28 Computers & IT $ 2,100 ($1,680) $420 $15 Vehicles $ 800 ($600) $200 $5 Furniture & Fixtures $ 650 ($455) $195 $5 Leasehold Improv. $ 950 ($665) $285 $9 ────────────────────────────────────────────────────────────────────────────── Total Tangible $21,350 ($9,916) $11,434 $150 Intangibles: Software $ 1,200 ($600) $600 $10 Patents $ 500 ($200) $300 $3 Customer Rel. $ 800 ($400) $400 $5 Goodwill $2,000 $0 $2,000 $0 ────────────────────────────────────────────────────────────────────────────── Total Intangible $4,500 ($1,200) $3,300 $18 GRAND TOTAL $25,850 ($11,116) $14,734 $168 KEY METRICS: Depreciation rate (annualized): 4.9% of gross tangible assets Average asset age: 6.2 years Assets fully depreciated but in use: $320K (2.5% of gross) Impairment losses YTD: $0 Capital expenditure YTD: $180K (M&E additions) ``` ## Integration Points - Fixed asset modules (SAP FI-AA, Oracle Assets, NetSuite FA): Asset register, depreciation engine - ERP/GL: Monthly depreciation journal entries, disposal postings - Procurement systems: Asset capitalization from POs and invoices - Tax software: MACRS schedules, book-tax difference tracking, Form 4562 preparation - Impairment testing tools (Sigma, Refinitiv): Fair value estimation, DCF models - Physical asset management (Hou.Ki, Cheqroom): Tagging, location tracking, physical verification - BI tools: Fixed asset dashboards, depreciation forecasts, capital planning - Audit management platforms: Depreciation testing workpapers, audit evidence