General Depreciation System - GDS

  

You buy a car for $25,000. The minute you drive the car off the lot, it begins to lose value. Your car depreciates at a rate of 15% every year. The depreciation deduction for the first year would be $3,750. Your car lost $3,750 in value in one year, making it now worth $21,250.

The value of depreciation is compared against the value of the car each year. The next year, instead of your car being worth $25,000, it is now worth $21,250, which will make the deduction for the second year $3187.50, and so on and so forth.

Knowing that your car loses value each year by 15%, you can figure out how much it will be worth in 5 or 10 years.

Related or Semi-related Video

Finance: How Does Depreciation Affect Ta...40 Views

00:00

- a la shmoop. how does depreciation affect taxes? okay you're a waffle maker

00:08

maker. ironically named waffle- even though you're not. last year you use [man grins on screen]

00:13

manual labor to make your waffle makers and made a hundred million dollars in

00:18

profits pre-tax you paid 30% in taxes and showed net income of 70 million

00:24

bucks .but then the Union came to town threatened to strike wanting raises for [equation]

00:28

all and for you to hire a lot more people than you need, so ticked off you

00:33

bought a robot waffle maker making factory for three hundred million

00:38

dollars. well that factory is expected to last

00:41

twenty years before you can sell it for scrap for a hundred million dollars. you [equation]

00:45

apply straight-line depreciation. when you think about accounting for the

00:48

decline in value of the factory you've lovingly called the Union replacer, that

00:52

means that each year you will depreciate the same amount of value to the factory

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until you sell it 20 years after you bought it. during that time it will [100 dollar bill]

01:02

depreciate in value two hundred million dollars declining from the three hundred

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you paid for it to the hundred you'll sell it for got--it's that's a decline

01:11

of two hundred dollars over twenty years or a depreciation amount of ten million

01:14

dollars applied over that time each year. you have a decent year next year and

01:18

make the same hundred million dollars in pre-tax profits you did last year only [man gives presentation]

01:22

this time you have ten million dollars of depreciation you can apply to your

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costs or expenses. you paid three hundred million dollars up front for that

01:30

equipment but you don't lose three hundred million dollars in that one year.

01:34

rather you account for a decline in that value one year at a time. so you can [balance sheet]

01:40

depreciate ten million dollars against your hundred million dollars of profits

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and pay taxes on the remaining ninety million of taxable profits. at thirty

01:50

percent you pay twenty seven million dollars in taxes. well the

01:54

depreciation you took that ten million dollars each year saved you three

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million dollars in taxes, or made you an extra three million dollars in earnings. [equation]

02:03

did your cash profits change? well you kept three million more cash dollars

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because you saved that amount in taxes you'd have had to pay otherwise.

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but other than that, nothing changed. except now you have a whole lot fewer [man speaks to robot]

02:16

workers to give you grief about your lousy curried coffee and a shiny new set

02:21

of robots to hang out with and beat you at chess. so the math above is derived by

02:25

applying straight-line depreciation. but in real life if you just paid 300

02:30

million dollars for a new factory and one year later wanted to sell it well [2 smiling men]

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you'd be lucky to get a lot more than half the price you paid for it. and

02:37

factories depreciate way worse than cars

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you know like one hour after you drive that new factory off the lot blammo it's

02:43

worth a lot less. so what if you used more of a market value approach to the [man drives red sports car]

02:48

depreciation you're applying. and in year one you depreciated the value of the

02:53

factory to be eighty million dollars less holding it now at a Book value than

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to be worth only two hundred twenty million dollars after year one. well

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remember that hundred million dollars of pre-tax profits, and we're ignoring the [man speaks to camera]

03:05

depreciation up to this point to get that hundred million. if you depreciated

03:09

80 million dollars against those profits well you'd show only 20 million dollars

03:14

as taxable profits in year one after you bought the factory. and all those union

03:20

people would be crowing. in reality however nothing changed other than the

03:25

way you are accounting for things. you still earn the hundred million dollars

03:29

in cash you still owe taxes but instead of paying taxes of 30 million against a [equation]

03:35

hundred million in pre robot factory day profits. this time in year 1 you show

03:40

only 20 million dollars in taxable profits and you pay 30 percent on that

03:45

number or 6 million dollars in total taxes to show net income of 14 million

03:50

bucks. your real cash profits well you made a

03:53

hundred million dollars in cash profits and you paid 6 million in taxes and Wow

03:58

now you have 94 million dollars in cash profits even though from an accounting [equation]

04:03

perspective you show earnings or net income of just 14 million dollars. the

04:08

downside in depreciating a lot of the factory up front well? you have fewer tax

04:13

deductions from its depreciation in the future but the value of having that cash

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handy dandy today is a lot to most companies so they don't mind having a [robots standing around man in a pile of cash]

04:22

notionally high tax Eric a decade in the future. most of the

04:25

management will be retired by then anyway, and worried a lot more about

04:29

their putting and wedge game and you know staying out of sand traps made with

04:33

old robot waffle maker makers. [golf ball in sand]

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