W12_IN_Depreciation Methods for PSC New Project

1. Problem Recognition

The faster/earlier the return of investment (cost recovery), the more interesting the project is (Depreciation Acceleration).

In order to choose and invest on Project XYZ, a PSC company shall conduct economic evaluations prior requesting for Financial Investment Decision. One of which how project are considered economic might be seen by assessing the ability to return capital expenditure from cost recovery using appropriate depreciation method.

2. Feasible Alternatives

Referring to 2017 IRS Depreciation publication this blog post will use 200% declining balance, straight line and a couple other methods

12.2a

  1. Double Declining Balance (DDB)
  2. Sum of The Year Digits (SYD)
  3. Straight Line (SL)
  4. Units of Production (UOP)

Company will choose which depreciation methods that will gives best project economic (indicate by High NPV of Cost of Capital return).

In PSC, Depreciation of Capital Expenditure use assumption 0 MMUS$ at year six and Capex Depreciation is part of cost recovery method for cost of capital (Asset) that will be given to Contractor. PSC depreciation will be calculated started from the beginning year in which the assets is Placed into Service (PIS) with a full year depreciation allowed the initial year.

3. Outcomes

Assuming capital investment for project XYZ is $2,000m with MARR 8.6% (per week 9 blog) using 4 depreciation methods results as follows:

4. Selection of criteria

Selection of preferable alternatives would be based on depreciation method that produces high NPV (fastest recovery of capital expenditure)

5. Analysis & comparison

12.5

12.6

Based on the comparison above Sum of Year Digit have highest NPV compared to others. In this case there’s no need to pick method that provide earlier cash flow spread due to PSC contract still not due in the near future.

6. Selection of preferred alternative

Sum of Year Digit (SYD) result in highest NPV compared to other depreciation models.

7. Performance monitoring

The Depreciation calculation above can be used when proposing new project to reflect project economic which can be used for project portfolio where higher NPV of capex return means that the project is more economic using SYD and could get faster recovery.

Reference

  1. Internal Revenue Service (IRS). Which Depreciation Method Applies. Retrieved from: https://www.irs.gov/pub/irs-pdf/p946.pdf
  2. Unit of Production Depreciation
    https://www.accountingtools.com/articles/2017/5/17/units-of-production-depreciation
  1. Units of Production Depreciation
    https://fitsmallbusiness.com/units-of-production-depreciation/
  2. Wagner, Ralph. Scheduling Best Practice pp 2 – 4. Retrieved from
    http://warnercon.com/wp-content/uploads/2012/07/Article-9-Handling-Out-of-Sequence-Progress1.pdf
  3. Sullivan, William G., Wicks, Elin M. & Koelling, C. Patrick. Engineering Economy, 6th Global Edition.
  4. Determine Appropriate Depreciation Method on PSC of PT ABC
    https://garudaaace2015.wordpress.com/2015/07/26/w19_hmip_-determine-appropriate-depreciation-method-on-psc-of-pt-abc/
Advertisements

One thought on “W12_IN_Depreciation Methods for PSC New Project

  1. Another 5 star posting Bu Innar!! And this is one you are almost SURE to see on your CCP or DRMP exams.

    AACE loves to ask questions about depreciation but to be candid, as a project manager or project controls manager, I never dealt with depreciation as that is NORMALLY built into the charge rate of the equipment, either as an internal billing if the company owns their own equipment or built into the rental or lease rate if you source the equipment from outside of the company.

    But you did a great job on this…

    BR,
    Dr. PDG, Jakarta

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s