Half-Year Convention For Depreciation

What is the 'Half-Year Convention For Depreciation'

The half-year convention for depreciation is the depreciation schedule that treats all property acquired during the year as being acquired exactly in the middle of the year. This means that only half of the full-year depreciation is allowed in the first year, with the remaining balance is deducted in the final year of the depreciation schedule, or the year that the property is sold. The half-year convention for depreciation applies to both modified accelerated cost recovery systems and straight-line depreciation schedules.

BREAKING DOWN 'Half-Year Convention For Depreciation'

Accounting is full of conventions to match sales and expenses in the year they are incurred. One convention is referred to as depreciation. Depreciation allows a company to only expense a portion of the cost of an asset in the year it is purchased if the asset will give value to the company in more than one year. Accountants can keep track of the value of the asset by tracking accumulated depreciation, but what if the company purchases the asset in the middle of the year?

Half-year Convention

The half-year convention for depreciation allows companies to better match sales and expenses in the year they are incurred by depreciating only half of the depreciation expense in year one if the asset is purchased in the middle of the year. This applies to all forms of depreciation, including straight-line and double-declining balances. There is also a mid-quarter convention that can be used instead of the half-year convention, if the aggregate depreciable base of new property is greater than 40% and is used in service sometime during the last three months of the year.

Half-year Convention Example

As an example, assume a company purchases a $105,000 delivery truck with a salvage value of $5,000 and an expected life of 10 years. The straight-line method of depreciation expense is calculated by dividing the difference between the cost of the truck and the salvage value by the expected life of the truck. In this example, the answer is $105,000 minus $5,000 divided by 10 years, or $10,000. Ordinarily, the firm would expense $10,000 in years one through year 10. If the company purchases the truck in July rather in January, however, it is more accurate to use the half-year convention to better align the cost of the equipment with the time period in which the truck provides value. Instead of depreciating the full $10,000 in year one, the half-year convention expenses half of the calculated depreciation expense, or $5,000. In years two through 10, the company expenses $10,000, and then in year 11, the company expenses the final $5,000. The half-year convention extends the number of years the asset is depreciated, but the extension provides a more accurate calculation.