Accelerated cost recovery system


By

Dr. Parimalendu Bandhyopadhya
Sr. Lecturer
Department of Business Administration
Bengal College of Engineering & Technology
Durgapur

Joydeep Chowdhury
Former Lecturer
Department of Computer Application
B.B. College
Asansol
 


1.How Accelerated cost recover system introduce:

Paying taxes is becoming a routine job for the people of almost all the nation. The employee of government and the private firms, businessmen and the people related to other occupation use to converse with the issue-"How to reduce the rate of amount pay for the tax".

People are becoming. The are buying the things which are imported or some precious things such as fancy cars, jewelries etc. For these, they also have to pay taxes. The product we buy, every year by year lost its value in amount of cash(we used to call it Buy value).This loosing of value is called Depreciation. In the, word of finance, Depreciation is:  "A non-cash expense that provides a source of free cash flow. Amount allocated during the period to amortize the cost of acquiring Long term assets over the useful life of the assets" Depreciation tax shield is used to for the value of the tax write-off on depreciation of plant and equipment.

Some time, we can assume that the depreciation of any asset is smooth or in financial term it is linear. When we purchase any asset we consider a depreciation rate(some time following some schedule that is market value, demand, supply and  obviously response of people, usages and some future aspects of that asset.NB:1 illustrate it). Some time we simply consider some value by our own. But, it is not a good practice. Some time in certain period of time the asset can go through a vast depreciation or less depreciation of its value what we have expected. But, in the above two approaches this vast change in depreciation remain under curtain.

To recover this amount of money we need Accelerated cost recovery system .Any depreciation method that produces larger deductions for depreciation in the early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule allowed for tax purposes, is one such example.

In the other word we can say Schedule of depreciation rates allowed for tax purposes.

2.How it works:

The Accelerated Cost Recovery System (ACRS) is a method of depreciating property for tax purposes that allows individuals and businesses to write off capitalized assets in an accelerated manner. Adopted by the U.S. Congress in 1981 as part of the Economic Recovery Tax Act, ACRS assigns assets to one of eight recovery classes—ranging from 3 to 19 years—depending on their useful lives. These recovery classes are used as the basis for depreciation of the assets.

The idea behind ACRS was to increase the tax deduction for depreciation of property and thus increase the cash flow available to individuals and businesses for investment.

The Accelerated Cost Recovery System (ACRS) established by the Economic Recovery Tax Act of 1981, along with the modifications in 1986 (MACRS), provide a radical departure from previously acceptable tax depreciation methods. A system that was once closely allied to the financial accounting concept of depreciation was changed to a mechanical computation that ignores such time-honored accounting concepts as useful life and salvage value.

For example, office equipment is depreciated with a class life of seven years, and water vessels are depreciated over ten years. Each MACRS class has a predetermined schedule, which determines the percentage of the asset's cost which is depreciated each year (see tables). Specifically, to calculate the depreciation charge for recovery tax year six of a Municipal sewage treatment plant that had an original cost of Rs/- 200000:

1. Look up its property class (GDS class life): 15-Year property
2. Trace down the percentage table along 15-Year property to year 6: 6.23%
3. Multiply the original cost by the value found in the table: 0.0623 * 200,000 = 124,60
4. The depreciation charge is 124,60 Rs/-

Example - Determining Class Lives of Personally:

For the current tax year, taxpayer buys and places in service in the taxpayer's trade or business: office desks, a mini computer, a heavy-duty truck, a single purpose horticultural structure, and an over-the-road tractor. Under the Table of Class Lives (reproduced in the Depreciation Tables section), these properties have class lives (in years) and are assigned to asset classes as follows:

Property

Asset Class

Class Life

Office desks

00.11

10

Mini Computer

00.12

6

Heavy-duty truck

00.242

6

Single purpose hort. Structure

01.4

15

Over-the-road tractor

00.26

4


Under MACRS, the office desks and the single-purpose horticultural structure are 7-year MACRS property; the mini computer and the heavy-duty truck are 5-year property; and the over-the-road tractor is 3-year MACRS property.

Four Factors Necessary to Compute MACRS

The Four Factors Necessary to Compute MACRS

Four factors are necessary to determine cost recovery deductions under the MACRS procedure. These are:

(1) Class life :

In general, the MACRS rules (referred to as the general depreciation system) classify property into the two broad categories of personality (six different classes) and realty (two different classes). The six recovery classes of personality are divided into 3, 5, 7, 10, 15, or 20-year categories.. The notation class life generally refers to the former midpoint life of the asset under the Asset Depreciation Range (ADR) System, a procedure instituted in 1971 under the old depreciation rules.

(2) Depreciable basis after credit reduction:

The MACRS rules provide for two depreciation classes of realty: residential and nonresidential realty. Residential realty is always assigned a recovery period of 27.5 years, and commercial realty is assigned a recovery period of either 39 years (if placed in service after May 12, 1993) or 31.5 years (if placed in service after 1986 and on or before May 12, 1993). Residential realty is defined as any building or structure if at least 80% of the gross rental income of the building is derived from dwelling units (e.g., a residential apartment complex). All other realty is classified as non-residential realty (e.g., commercial buildings, such as office buildings and factories).

Example
XYZ Corporation purchased an old office building during the year for 30000 Rs/-, and incurred 40000 Rs/- of renovation expenses that qualify for a 10%  as credit, or 4000. XYZ's adjusted basis in the building will be 66000 Rs/-, the total expenditure of 70000 Rs/- less 100% of the 4000 Rs/- rehabilitation credit.

(3) Acquisition year assumption:

The general acquisition year assumption for personality is the half-year convention, which assumes that the personality was placed into service in the middle of the tax year. Thus, one-half year's depreciation is allowed in the year of acquisition, and one-half year will also be allowed in the year following the last full year of cost recovery under MACRS. Likewise, one-half year is allowed in the year of disposing the property, if during the MACRS life.

Example:
"X" is a company, a calendar-year corporation, places in service Rs/- 200,000 of computers (5-year MACRS personality) on March 1, 2008. In applying the MACRS half-year convention, "X" company will deduct one-half year of depreciation in 2008, a full year's depreciation in the years 2008-2012, and one-half year in the year 2013. If "X" company were to sell the asset in 2011, they would deduct one-half year of depreciation on their 2011 return.

(4) Recovery method:

The cost of depreciable property placed in service after 1986 is recovered using one of three permissible recovery methods:

1. The 200% declining-balance method (available for the 3-, 5-, 7-, and 10-year personality recovery classes)
2. The 150% declining-balance method (available for the 15- and 20- year personality classes), and
3. The straight-line method (required for both residential and nonresidential realty).

Salvage value is ignored under MACRS, and the cost recovery computations are to reflect the applicable acquisition year assumption (half-year, mid-quarter, or mid-month convention). When the accelerated method is used (i.e., for personality), a switch to the straight-line method is made at the optimum point.

Conclusion:

As ACRS introduce some people said that – "the system would create a lack of information in entire environment. And, the system will provide such a scenarios that does not map with real world because real world have lots of issues that can't be adjust in tax calculation and recovery method".

It is adoptable that ACRS had some problem and that's why MACRS has come. Now, It is not satisfying the people need, but also providing information more that expected which help them to manage business in a well manner.

Some people expressed concern that the change would spur consumption at the expense of investment and thus end the period of economic recovery and growth. Others worried that the frequency of changes would unnecessarily complicate the tax code. After all, taxpayers were required to use the useful life method to depreciate property put in service prior to 1981, the ACRS method for property put in use between 1981 and 1986, and the MACRS method for property put in use after 1986.

MACRS actually encompasses two different depreciation methods, called the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). GDS is used for most types of property. ADS applies only to certain types of property—that which is used for business purposes 50 percent of the time or less, is used predominantly in the while world, or is used for tax-exempt purposes, for example—but can also be used if the taxpayer so chooses.

Reference:

1. The Future of Depreciation Rules." Nation's Business. February 1986.
2. IRS Publication 946: How to Depreciate Property. Internal Revenue Service, 2000.
3. Kaplan, Elizabeth. "Wall Street Zeroes in on Cash Flow." Dun's Business Month. July 1985.
 


Dr. Parimalendu Bandhyopadhya
Sr. Lecturer
Department of Business Administration
Bengal College of Engineering & Technology
Durgapur

Joydeep Chowdhury
Former Lecturer
Department of Computer Application
B.B. College
Asansol
 

Source: E-mail May 27, 2008

          

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