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Half-Year Convention for Depreciation

A depreciation rule that assumes the depreciation on a fixed asset is halved for the first and additional last year

What is the Half-Year Convention for Depreciation?

The half-year convention for depreciation is a depreciation rule that assumes fixed assets have been in service for one-half of its first year. In simpler terms, depreciation on a fixed asset is split in half during the first year of purchase, regardless of the purchase date.

 

Half-Year Convention for Depreciation

 

The other half of the depreciation does not go unnoticed; rather, it is allocated as an extra year of depreciation that proceeds the fixed asset’s useful life. The half-year convention for depreciation applies to all forms of depreciation. It applies to methods such as straight-line depreciation, sum-of-the-years digits, modified accelerated cost recovery systems, and double-declining balance.

 

Summary

  • The half-year deprecation convention is a depreciation rule that assumes the depreciation on a fixed asset is halved for the first and additional last year.
  • It is crucial to remember that deprecation is halved in the first year, with the remainder of that depreciation being added to an additional last year.
  • Rules created by the U.S. Internal Revenue Service (IRS) aims to prevent unethical deductions on fixed assets that use the half-year convention to calculate depreciation.

 

Half-Year Convention for Depreciation Example

The allocation of depreciation for half-year convention can be difficult to grasp. To get a better understanding, an example of a half-year convention with a depreciation schedule is shown below.

Example: Company A purchases a manufacturing machine for $25,000 on March 1, 2020. The manufacturing machine’s useful life is five years. With the application of a half-year convention, the depreciation schedule is as follows:

  • Straight-line Depreciation = Cost of Asset / Useful Life = ($25,000 / 5) = $5,000 per year.
  • Application of Half-year Convention = ($5,000 / 2) = $2,500 for first and additional year.
  • Depreciation Schedule:

 

Half-Year Convention for Depreciation - Sample Table

 

As the table shows, the first year of depreciation is halved due to the half-year convention. To make up for it, an extra year is added to the end of the depreciation schedule.

 

What is the Depreciation Convention?

A depreciation convention is a rule that is used to determine four different criteria:

  • The deprecation method you can use
  • The depreciation schedule you can use, dependent on the useful life
  • The amount of deprecation that can be claimed once the fixed asset is disposed of
  • The amount of depreciation that can be claimed in the first and last year of the fixed asset’s recovery period

As a whole, depreciation conventions govern when and how depreciation is calculated.

 

Types of Depreciation Conventions

As for the types of depreciation conventions, nine conventions govern when and how depreciation is calculated. The conventions are listed and discussed below:

  • FM = Full Month: The fixed asset receives a full month of depreciation during the month when it is placed in service. It does not receive depreciation for the month of disposal.
  • HM = Modified Half Month: If the fixed asset is put into service during the first half of the month, it receives a full month of deprecation. If it is put into service during the second half of the month, the calculation of depreciation begins the preceding month.
  • MM = Mid-Month: The fixed asset receives half a month of depreciation for the month it was placed into service and half a month of deprecation when disposed of.
  • NM = Next Month: Deprecation for the fixed asset begins one month after it is placed into service and receives one month of depreciation when disposed of.
  • HY = Half-Year: Depreciation is halved for the first and last year once it is in service.
  • MY = Modified Half-Year: If put into service before the midpoint of the year, the fixed asset receives a full year of depreciation for the first year, but none on the last. If put into service after the midpoint of the year, depreciation is calculated the following year. Also, a full year of depreciation is received once disposed of.
  • FY = Full Year: The fixed asset received a full year of depreciation when put into service and when it is disposed of.
  • AD = Actual Days: The fixed asset receives depreciation every day it is in service during a company’s fiscal year.
  • MQ = Mid-Quarter: The fixed asset receives half of one quarter’s depreciation for the quarter that it was placed into service. Same situation for disposal.

 

Tax Implications

How and when depreciation is calculated directly affects an organization’s tax status. A half-year convention does not require taxpayers to prove when the fixed asset was placed into service. Instead, the U.S. Internal Revenue Service (IRS) created a rule that assumes fixed assets are placed into service on July 1st of the year it was actually placed in service.

The IRS created the rule because taxpayers would be enticed to purchase fixed assets in the second half of the year and unethically claim full depreciation deductions. As for taxpayers, the rule eliminates the hassle of keeping records that prove when a fixed asset was put into service. It would be assumed to be put into service on July 1st.

 

Related Readings

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Day-Count Convention
  • Depreciated Cost
  • Double Declining Balance Depreciation
  • Depreciation Methods Template

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