Half-year convention

Half-year convention assumes the property is placed in service midyear no matter when it was actually placed in service. 

Straight-line depreciation rates (half-year convention)... 

Land for the project is available at 300,000. The fixed capital investment was estimated to be 12,000,000. A working capital of 1,800,000 is needed initially for the venture. Start-up expenses based upon past experience are estimated to be 750,000. The project qualifies under IRS guidelines as a 5-year class life investment. The company uses MACRS depreciation with the half-year convention. At the conclusion of the prmect, the land and working capital are returned to management. Develop a cash flow analysis for this project, using a cumulative cash position table (Table 9-25). 

In general, ACRS allowed one-half of a full year s deduction for property in the year it was placed in service and no deduction in the year when the property was anticipated to be disposed of, although special month-by-month rules could be applied for some cases. Similarly, this so-called half-year convention applied for MACRS as one-half of a full year s deduction for property in the year it was placed in service, but it also allowed one-half of a full year s deduction during the year of disposal. Thus, the years of depreciable values equaled the class years for ACRS and equaled one more than the class years for MACRS. 

For MACRS, the statutory percentages were based on a 200-percent declining balance for class lives of 3, 5, 7, and 10 years and a 150-percent declining balance for class lives of 15 and 20 years with a switch to straight-line depreciation at the time appropriate to maximize the deduction. The half-year convention applied for the first year when property was placed in service and also for the year of disposal. Salvage value was taken as zero. 

Details, such as shown in Tables 3 and 4, are presented annually as part of the United States Federal Income Tax Regulations. Tables are also given with conventions other than the half-year conventions for MACRS, such as mid-... 

For the first year, with the half-year convention, the investment is considered as being made at the midpoint of the year. Thus, the f which applies for the first year is (2X1100/22,000) = 0.10. 

Calculate the percentage factors for a class life of 10 years as presented in Table 3 of this chapter for the Accelerated Cost Recovery System (ACRS). Note that ACRS is based on a HO-percent declining balance with switch to straight-line depreciation at the time appropriate to maximize the deduction. It is also based on salvage value being zero. The half-year convention in the first year applies, but the last half-year deduction cannot be claimed as such. Use an initial property value of 22,000 to permit comparison to Fig. 9-4 and Example 2. 

Half-year convention, 286-290 Handling of materials, 101-102 Handrails, cost of, 711 Harmonic mean, 742... 

Other details of MACRS depreciation are not discussed here, and at the time of writing, the tax law also allows assets to be depreciated by the straight-line method (over the class life, not the recovery period and still following the half-year convention). The tax law is revised frequently and the most recent version of IRS publication... 

Note that the depreciation for a 7-year asset is spread over an 8-year period. It is assumed that full benefit will not be received during the first year of the life of an asset. So a half-year convention is adopted, and the remaining recovery is made in the eighth year. 

The current depreciation system is the Modified Accelerated Cost Recovery System (MACRS), and chemical industries are in the seven-year life category. The rates for years one through eight are 14.29, 24.49, 17.49, 12.29, 8.93, 8.92, 8.93, and 4.46, respectively. The depreciation is spread over an eight-year period for a seven-year asset. It is assumed that, during the first year of the life of the asset, full benefit will not be received from the asset. Therefore, a half-year convention is adopted, and the remaining recovery is made in the eighth year. 

The current federal tax law is based on MACRS, using a half-year convention. All equipment is assigned a class life, which is the period over which the depreciable portion of the investment may be discounted. 

---