Methods of working out decline in value
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You generally have the choice of two methods to work out the decline in value of a depreciating asset: the prime cost method or the diminishing value method.
You can generally choose to use either method for each depreciating asset you hold. Once you have chosen a method for a particular asset, you cannot change to the other method for that asset.
In some cases, you do not need to make the choice because you can claim an immediate deduction for the asset-for example, certain depreciating assets which cost $300 or less see Immediate deduction for certain non-business depreciating assets costing $300 or less.
In other cases, you do not have a choice of which method you use to work out the decline in value:
- for some intangible depreciating assets-in-house software, certain items of intellectual property, spectrum licences and datacasting transmitter licences-you must use the prime cost method
- if you acquire a depreciating asset from an associate who has deducted or can deduct amounts for the decline in value of the asset see Depreciating asset acquired from an associate
- if you acquire a depreciating asset but the user of the asset does not change or is an associate of the former user (for example, under sale and leaseback arrangements) see Sale and leaseback arrangements
- if there has been roll-over relief see Roll-over relief.
Both the diminishing value and prime cost methods are based on a depreciating asset's effective life-the rules for working out an asset's effective life are explained in Effective life.
By working out the decline in value you determine the adjustable value of a depreciating asset. A depreciating asset's adjustable value at a particular time is its cost (first and second elements) less any decline in value up to that time see The cost of a depreciating asset for information on first and second elements of cost. Adjustable value is similar to the concept of undeducted cost used in the former depreciation rules. The opening adjustable value of an asset for an income year is generally the same as its adjustable value at the end of the previous income year.
The decline in value and adjustable value of a depreciating asset are calculated from the asset's start time independently of your use of the depreciating asset for a taxable purpose. However, your deduction for the decline in value is reduced to the extent your use of the asset is not for a taxable purpose see Decline in value of depreciating asset used for non-taxable purpose. Your deduction may also be reduced if the depreciating asset is a leisure facility or boat even though the asset is used, or installed ready for use, for a taxable purpose see Decline in value of leisure facilities and boats.
The diminishing value method assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time. The formula is:
Base value × (days held ÷ 365) × (150% ÷ asset's effective life)
For the income year in which an asset's start time occurs, the base value is the asset's cost. For a later income year, the base value is the asset's opening adjustable value plus any amounts included in the asset's second element of cost for that year.
Example: Base value (ignoring any goods and services tax [GST] impact)
Leo purchased a computer for $6,000. The computer's base value in its start year would be its cost of $6,000. If the computer's decline in value for that year is $1,500 and no amounts are included in the second element of the computer's cost, its base value for the next income year would be its opening adjustable value of $4,500. This amount is the cost of the computer of $6,000 less its decline in value of $1,500.
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Days held is the number of days you held an asset in an income year on which you used it or had it installed ready for use for any purpose. If the income year is the one in which the asset's start time occurs, you work out days held from its start time. If a balancing adjustment event occurs for the asset during the income year (for example, if you sell it), you work out days held up until the day the balancing adjustment event occurred see What happens if you no longer hold or use a depreciating asset? for information about balancing adjustment events.
Diminishing value method (ignoring any GST impact)
Laura purchased a photocopier on 1 July 2002 for $1,500. The asset started to be used on the day of its purchase and has an effective life of five years. Laura chose to use the diminishing value method to work out the decline in value of the photocopier. The decline in value of $450 for the 2002–03 income year is worked out as follows:
$1,500 × (365 ÷ 365) × (150% ÷ 5)
If Laura used the photocopier wholly for taxable purposes in that income year, she would be entitled to a deduction equal to the decline in value. The adjustable value of the asset at 30 June 2003 would be $1,050. This is the cost of the asset ($1,500) less its decline in value up to that time ($450).
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The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. The formula for the prime cost method is:
Asset's cost × (days held ÷ 365) × (100% ÷ asset's effective life)
Example: Prime cost method (ignoring any GST impact)
Using the facts of the previous example, if Laura chose to work out the decline in value of the photocopier using the prime cost method, the decline in value for the 2002–03 income year would be $300. This is worked out as follows:
$1,500 × (365 ÷ 365) × (100% ÷ 5)
If Laura used the photocopier wholly for taxable purposes in that income year, she would be entitled to a deduction equal to the decline in value. The adjustable value of the asset at 30 June 2002 would be $1,200. This is the cost of the asset ($1,500) less its decline in value up to that time ($300).
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If there has been roll-over relief and the transferor used the prime cost method to work out the asset's decline in value, the transferee should replace the asset's effective life in the prime cost formula with the asset's remaining effective life-that is, any period of the asset's effective life that is yet to elapse when the transferor stopped holding the asset see Roll-over relief.
An adjusted prime cost formula must be used if:
- you recalculate the effective life of an asset see Effective life
- an amount is included in the second element of cost of an asset's cost after the income year in which the asset's start time occurs see The cost of a depreciating asset
- an asset's opening adjustable value is reduced by a debt forgiveness amount see Commercial debt forgiveness
- you reduced the opening adjustable value of a depreciating asset which is the replacement asset for an asset subject to an involuntary disposal see Involuntary disposal of a depreciating asset, or
- an asset's opening adjustable value is modified due to GST increasing or decreasing adjustments, input tax credits in relation to the acquisition or importation of the asset or input tax credits for amounts included in the second element of cost of an asset see GST input tax credits.
The adjusted prime cost formula must be used from an income year in which any of these changes are made (a 'change year'). The formula is:
Opening adjustable value for the change year plus any second element of cost for that year × (days held ÷ 365) × (100% ÷ asset's remaining effective life)
where the asset's remaining effective life is any period of its effective life that is yet to elapse at the start of the change year.
The prime cost formula must also be adjusted for certain intangible depreciating assets you acquire from a former holder see Effective life of intangible depreciating assets.
Last modified: 01 Jun 2005QC 27453