Friday, February 17, 2012

Depreciation using ACRS/MACRS

The Economic Recovery Tax Act of 1981 established the Accelerated Cost Recovery System (ACRS) for property placed in service after 1980 and the Tax Reform Act of 1986 established the Modified Accelerated Cost Recovery System (MACRS) for property placed in service after 1986. Under ACRS and MACRS, the cost of most tangible, depreciable property are recovered over predetermined periods generally unrelated to and shorter than useful lives. The recovery deduction for each year is determined by applying a percentage specified in the law to the unadjusted basis of the property. By now, there are probably not too many assets around that predate the MACRS methodology.

Contractors need to keep in mind that ACRS/MACRS was created for income tax purposes and not financial reporting purposes. It would be very unusual to find ACRS/MACRS depreciation methods used in any audited financial statements. FAR 31.205-11(c) ties the allowability of depreciation for Government contract costing purposes to "financial reporting" purposes. It provides that ACRS/MACRS is acceptable for contract costing if the method is used for financial accounting purposes.

Many small Government contractors do not prepare audited financial statements and therefore have no benchmark for determining the depreciation method applicable to their contract(s). Some simply pluck the amount from the most convenient source and that source is the tax return. The tax return however is focused on minimizing tax liability and not the realistic useful lives of assets.

In reviewing forcasted or actual indirect expense rates, auditors will usually make inquiries into the depreciation methodology used, if depreciation expense is a significant element of the indirect cost pool being reviewed. Contractors who are using ACRS/MACRS for Government contract costing purposes need to adjust their practices to comply with FAR 31.205-11.

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