# Depreciation - Prime Cost or Diminishing Value method ?

#### fredo

Depreciation

I have just had a depreciation schedule completed on an IP in QLD

Do I use the straight line method of the deminishing method what are the pros and cons of each

Regards Fredo

Fredo,

An interesting question. It raised questions in my mind, so I did a little research.

I'm not sure if I have my rates correct. The ato site (http://www.ato.gov.au/content.asp?doc=/content/Individuals/22284.htm&page=6#P215_25397) gives a formula for the depreciation rate which gives a higher rate for diminishing value as against straight line.

Their formula for diminishing value rate is

base value * (days held / 365) * (150% / asset's effective life).

So if an asset has an effective life of 10 years, the diminishing value percentage is 15% pa for every full year.

Their formula for Prime cost rate is

base value * (days held / 365) * (100% / asset's effective life).

So if an asset has an effective life of 10 years, the Prime Cost percentage is 10% pa for every full year.

So, there's a higher rate for reducing balance in earlier years using reducing balance, and a lower rate afterwards- but the number of years you can claim is longer.

For something worth \$10,000 with a life of 10 years, you would claim (using diminishing value):
Year 1 \$1500
Year 2 \$1275
Year 3 \$1083.75
Year 4 \$921.19

etc.

(After 20 years, you would be claiming \$68.40- assuming you had not disposed of the asset).

Using straight line, you would claim \$1000 pa every year for 10 years. It would then be completely written down.

My preference would certainly be to use the diminishing value method, to claim the most you can as early as you can.

Once you add the "real" value of the money (allowing for inflation) and the opportunity costs, the diminishing value method seems even more attractive.

Geoff,

Your analysis misses out on the low value pool (depreciate new items worth less than \$1000 at 18.75% in the first year and 37.5% thereafter, and roll in items that have been depreicated by diminishing cost (but NOT prime cost) method into the pool when their written down value first drops below \$1000. This is another advantage with diminishing cost, but for me the clincher is the time value of money (ie. big payments up front when you want them).

Cheers,

Bob

HI

As a rule of thumb, we always use the diminishing value method as, just as Bob mentions, there are bigger tax deductions in the earlier years than there are in the later years.

In theory, they should both work out the same over time anyway.

Have fun

Dale

In theory, they should both work out the same over time anyway.
Probably over a long time, using historical cost accounting, they will give the same results.

In the 10 year effective life example, it's round about seven years before the total deductions using both methods match up. After that, (eg,in year 10), the total deductions for the period are higher using straight line. That's excluding the low value pool as mentioned by Bob.

Now, here's one scenario for favouring the straight line method (just to be perverse)

If you had a property, and you were on alower tax rate- and perhaps earlier in your career- you might choose to get loser deductions now, in the knowledge that the income from your property will probably rise over time,and you may well be moving into a higher tax bracket in your career. In this situation, higher deductions in years 3+ might be of much more benefit than deductions now.

Originally posted by geoffw
Now, here's one scenario for favouring the straight line method (just to be perverse)

If you had a property, and you were on alower tax rate- and perhaps earlier in your career- you might choose to get loser deductions now, in the knowledge that the income from your property will probably rise over time,and you may well be moving into a higher tax bracket in your career. In this situation, higher deductions in years 3+ might be of much more benefit than deductions now.

Hi Geoff

That is a very real and worthwhile strategy. Thank you.

Dale

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