What is the ‘Half-Year Convention For Depreciation’
When it comes to depreciation, the half-year convention refers to the depreciation schedule that considers all property purchased throughout the year as if it were bought precisely at the halfway point of the year. The result is that only half of the total full-year depreciation is permitted in the first year, with the remaining balance being deducted in the last year of the depreciation schedule, or the year in which the property is sold, whichever comes first. For the purpose of computing depreciation, the half-year convention is used for both modified accelerated cost recovery systems and straight-line depreciation schedules.
Explaining ‘Half-Year Convention For Depreciation’
Accounting conventions are many and are designed to match revenues and costs to the year in which they are incurred. The term “depreciation” refers to one of these conventions. When a corporation purchases an item that will provide value to the company for more than one year, depreciation enables the firm to expense just a part of the cost of the asset in the year it is acquired. Accountants can keep track of the worth of an asset by recording cumulative depreciation; however, what happens if a corporation acquires an item in the middle of the year and does not record the depreciation?
Half-year Convention
In addition, by depreciating just half of the depreciation expenditure during year one if an asset is acquired in the middle of the year, corporations are able to better align sales and expenses to their respective years of occurrence. This is true for all types of depreciation, including straight-line and double-declining balances, as well as accelerated depreciation. Additionally, if the aggregate depreciable base of new property is larger than 40% and the property is placed in operation during the final three months of the year, the mid-quarter convention may be employed instead of a half-year convention to reduce the amount of tax due.
Half-year Convention Example
Consider the following scenario: a firm acquires a $105,000 delivery truck with a salvage value of $5,000 and a projected life of ten years, and the vehicle is in good condition. In the straight-line technique of calculating depreciation expenditure, the amount of depreciation expense is determined by dividing the difference in cost between the vehicle and its salvage value by the truck’s projected useful life. In this case, the solution is $105,000 minus $5,000 divided by ten years, which is 10,000 dollars.
Normally, the company would incur a $10,000 charge in each of the first through tenth years. If, on the other hand, the firm acquires the truck in July rather than January, it is more appropriate to apply the half-year approach in order to better line the cost of the equipment with the time period during which the vehicle is of value to the company. As an alternative to depreciating the whole $10,000 in the first year, the half-year convention only depreciates half of the computed depreciation expenditure (or $5,000). Company costs total $10,000 in years two through ten, and the last $5,000 in year eleven, with the remaining $5,000 coming from outside sources. The half-year convention increases the number of years that an asset is depreciated, but the increase in accuracy is offset by the increase in length of time.
Half-Year Convention For Depreciation FAQ
What is the mid-month convention for depreciation?
What exactly does the phrase 'mid-month convention' imply in the context of depreciation? Depreciation is calculated according to the mid-month convention, which implies that an asset taken into service during a particular month is considered to have been placed into service in the middle of that month.
When can I use half-year convention?
Using the half-year convention is required if you put property into service between January and September (the first nine months of the year). However, even if the property was put in service at the beginning of the year, this convention implies that it was placed in service in the middle of the year.
Further Reading
- The Effect of Inflation-Adjusted Depreciation on Project and Firm Risk – heinonline.org [PDF]
- PERFORMING CORPORATE TAX AND TAXATION IN UZBEKISTAN IN ORDER TO SUPPORT ECONOMIC GROWTH – journals.researchparks.org [PDF]
- An economic evaluation model for advanced manufacturing systems – www.tandfonline.com [PDF]
- The new economics of accelerated depreciation – www.nber.org [PDF]
