(Tribal drum music.)
-: The diminishing value method
for calculating the decline in value
for a capital allowance deduction
is set out in Section 40-72 of the ITAA 1997.
We can use the diminishing value method
to calculate the decline in value
for assets held post 9th of May 2006.
Noting that assets held prior to this date
may be eligible under Section 40-70.
The method is not available for intangible assets
except for copyright in a film.
For example, in house software or intellectual property.
Let's consider Glenn and his small sheet metal business,
Metal by Hand.
In the income year just ended
Metal by Hand purchased an item of machinery
with an effective life of 10 years.
On the first of September this income year ended
the machinery was installed.
The purchase cost was $90,000
and this is the first element cost.
On the first of May
capital improvement works were undertaken
at a cost of $10,000.
The formula to use for the diminishing value method
is set out in Section 40-72 subsection 1,
and is the base value
multiplied by the number of days held in the year
divided by 365
multiplied by 200%
divided by the effective life.
What this is
is a reducing balance method without a residual value.
The 200% factor means twice the rate of decline
in the first year, compared with the prime cost method.
However, the size of the decline reduces in subsequent years
as the balance gets smaller.
No more than the cost is recovered over time.
In our example, the base value in the first year is $90,000
being the purchase price.
Plus the $10,000 capital improvement
which is a second element cost.
Cost is $100,000.
In subsequent years
the base value is the opening adjustable value
plus second element costs for that year.
In the first income year
the base value is equal to the purchase cost of $90,000
plus the $10,000 capital improvement cost.
The days held is the number of days
from installation on the 1st of September to 30th of June
which is 304 days, which we divide by 365.
Note, that leap days must be included
in the days held if we're in a leap year.
And then we multiply by 200%
divided by the effective life of 10 years.
This gives us a decline in value of $16,657.
We then deduct this from the base value
to give us the adjustable value of $83,343
at the 30th of June.
Now in the next income year
we have a further capital improvement made
on the first of August costing $5,000.
But we also have a review of the effective life
and based on rapidly changing technology
the effective life is reviewed downwards
from 10 years to 5 years on the first of June.
For the second income year
our base value is the opening adjustable value of $83,343
plus the $5,000 second element cost which is $88,343.
The asset was in service for the full year
so we multiply the base value by 365 divided by 365
and then multiply by 200% divided by five.
Note, that we've changed the effective life to five
for the calculation for the entire income year
even though the review did not take place
until the first of June.
So, the decline in value is $35,337
and our new adjustable value
at the end of the second income year is $53,006.
To recap, some of the key points for you to note
are that most intangibles are not eligible
to use the diminishing value method.
Second element costs are not depreciated separately
they form part of the base value in the formula
used to calculate the decline in value
at the end of the income year.
And any changes to the effective life during a year
affects the calculation from that year onwards
regardless of when the change occurs.
That is that there is no pro-rata decline calculation
for part of the year.