Construction Equipment

Management
Part three
3. Cost of Owning and Operating Construction Equipment
Modified Accelerated Cost Recovery
System (MACRS)
• MACRS consists of two systems that determine how you depreciate
your property.
1. General Depreciation System (GDS) – main system, generally uses
the declining balance method over a shorter recovery period.
2. Alternative Depreciation System (ADS) uses only the straight line
method over a generally longer recovery period.
GDS
GDS
• However, where the depreciation calculated using the above formula
is lower than depreciation under straight line method, the straight
line depreciation for the previous year is taken as the relevant
depreciation deduction for the rest of the recovery period.
• Alternatively, tables provided by IRS can be used. Following table
(taken from IRS website) shows rates for 200% declining balance
method using half-year convention:
 Depreciation Rate in % for Recovery Period
Year
3-year 5-year 7-year 10-year 15-year 20-year
1 33.33 20.00 14.29 10.00 5.00 3.750
2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.81 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52 12.49 11.52 7.70 6.177
5 11.52 8.93 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55 5.90 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12 5.90 4.461
13 5.91 4.462
14 5.90 4.461
15 5.91 4.462
16 2.95 4.461
17 4.462
18 4.461
19 4.462
20 4.461
21 2.231
GDS
• Calculating depreciation under MACRS involves the following steps:
1. Figure out the class of the property: Machines fall under 3, 5, 10, and 15-year
property classifications. Cars and light duty trucks (<13,000 lb unloaded) now
classed as 3-year items. Most other construction machines classified as 5-year
property.
2. Figure out the required depreciation convention: to simplify the calculation, the
IRS has prescribed whether an asset should be treated as acquired at the quarter
or the year. These conventions are called mid-quarter and half-year conventions
respectively.
3. Determine the depreciation method to be applied: depreciation is charged on
the cost based on 3 different depreciation methods: 150% declining balance,
200% declining balance and straight-line method.
For more information please visit the following site :
https://www.irs.gov/publications/p946/ch04.html#en_US_2012_publink1000107555
Example
• Use MACRS method to compute the depreciation in each year of the
equipment’s useful life for each of the above depreciation methods
for the following bucket loader:
• Initial cost: $148,000 includes delivery and other costs
• Tire cost: $16,000
• a 5 year property.
• half-year convention.
Solution
• Depreciation for the first year = $(148,000-16,000) × 1/5 × 200% (declining
balance method) × 1/2 (for half-year convention) = $26,400
• Depreciation for the first year can also be calculated using rates given in table.
For 5 year property with half-year convention and 200% declining balance
method, rate for the first year is 20% as given in Table A-1 of Appendix A.
• Depreciation for first year using Table A-1 is $(148,000-16,000) × 20% =
$26,400
• Depreciation for the second year= $ (148,000-16,000 - 26,400) × 1/5 × 200% =
42,240
• Depreciation in 2010 using Table = $ (148,000-16,000 - 26,400) × 32% =
$42,240
Solution

BOOK VALUE USING DIFFERENT METHODS

100000 SL
80000 SOYD
60000 DDB
40000 MARCS
20000
0
0 1 2 3 4 5 6 7
# OF YEARS
INVESTMENT (OR INTEREST) COST
• Investment (or interest) cost represents the annual cost (converted
into an hourly cost) of capital invested in a machine.
• If borrowed funds are utilized for purchasing a piece of equipment,
the equipment cost is simply the interest charged on these funds.
• However, if the equipment is purchased with company assets, an
interest rate that is equal to the rate of return on company
investment should be charged.
• Therefore, investment cost is computed as the product of interest rate
multiplied by the value of the equipment, which is then converted
into cost per hour of operation.
INVESTMENT (OR INTEREST) COST
• The average annual cost of interest should be based on the average
value of the equipment during its useful life. The average value of
equipment may be determined from the following equation:

• Where IC is the total initial cost, P the average value, S the salvage
value, and n the useful life (years).
EXAMPLE
• Consider a unit of equipment costing $50,000 with an estimated
salvage value of $15,000 after 5 years. Find the average value of
equipment?
• Solution
INSURANCE TAX AND STORAGE
COSTS
• Insurance cost represents the cost incurred due to fire, theft,
accident, and liability insurance for the equipment.
• Tax cost represents the cost of property tax and licenses for the
equipment.
• Storage cost includes the cost of rent and maintenance for equipment
storage yards, the wages of guards and employees involved in moving
equipment in and out of storage, and associated direct overhead.
INSURANCE TAX AND STORAGE
COSTS
• The cost of insurance and tax for each item of equipment may be known
on an annual basis. In this case, this cost is simply divided by the hours of
operation during the year to yield the cost per hour for these items.
• Storage costs are usually obtained on an annual basis for the entire
equipment fleet.
• Insurance and tax costs may also be known on a fleet basis. It is then
necessary to assign these costs to each item as a percentage.
• By doing so, the rate for insurance, tax, and storage may simply be added
to the investment cost rate for calculating the total annual cost of
investment, insurance, tax, and storage
INSURANCE TAX AND STORAGE
COSTS
• The average rates for interest, insurance, tax, and storage found in the
literature are listed in the below Table. These rates will vary according
to related factors such as the type of equipment and location of the
job site.
TOTAL OWNERSHIP COST
• Total equipment ownership cost is calculated as the sum of
depreciation, investment cost, insurance cost, tax, and storage cost.
• As mentioned earlier, the elements of ownership cost are often
known on an annual cost basis. However, while the individual
elements of ownership cost are calculated on an annual cost basis or
on an hourly basis, total ownership cost should be expressed as an
hourly cost.
• After all elements of ownership costs have been calculated, they can
be summed up to yield total ownership cost per hour of operation.
Example
• Calculate the hourly ownership cost for the second year of operation
of a 465 hp twin-engine scraper. This equipment will be operated 8
h/day and 250 days/year in average conditions. Use the sum-of-years’-
digits method of depreciation as the following information:
o Cost delivered = $152,000
o Tire cost = $12,000
o Estimated life = 5 years
o Salvage value = $16,000
o Depreciation method = sum-of-the-years'-digits
o Investment (interest) rate = 10%
o Tax, insurance, and storage rate = 8
Solution
• Depreciation cost:
D2 = 4/15 × (152,000 - 16,000 - 12,000) = $33,067
• Depreciation = 33,067/2000 =$16.53/h
• Investment, tax, insurance, and storage cost:
Cost rate =Investment + tax, insurance, and storage
= 10 + 8 = 18%
• Average Investment = (152 000 + 16 000)/2
= $84,000
• Investment, tax, Insurance, and storage = (84000 × 0.18)/2000
= $7.56/h
• Total owning cost = 16.53 + 7.56 =$24.09/h