What’s the half-year depreciation convention?

The half-year convention involves depreciating all property purchased during the year as if acquired in the middle of the year. Only half of the full-year depreciation is permitted in the first year, and the rest is removed in the final year or when the property is sold. The half-year depreciation convention applies to all methods.

Understand the Half-Year Depreciation Convention

In U.S. GAAP, the matching concept aims to align costs with revenue periods. Depreciation is an accounting rule that aligns fixed asset costs with revenue during their useful lives.

A corporation records an item as a fixed asset at the time of acquisition if it exceeds a capitalization requirement and will add value over time. Depreciation lets a corporation deduct a percentage of an asset’s cost during its useful life instead of the whole cost in the year of purchase. The corporation subtracts cumulative depreciation from its historical cost for asset book value.

Buying an asset mid-year allows corporations to depreciate half of the average yearly depreciation expenditure in year one, better matching revenues and expenses. This applies to all depreciation types, including straight-line, double-declining, and sum-of-years’-digits.

Use the mid-quarter convention instead of the half-year convention if at least 40% of fixed assets bought in a year were placed into service in the final three months.

Half-Year Convention Example

Suppose a corporation buys a $105,000 delivery vehicle with a $5,000 salvage value and a 10-year lifespan. Divide the difference between the truck’s cost and salvage value by its projected life to compute straight-line depreciation costs. This example uses $105,000 minus $5,000 divided by 1 year, or $10,000 a year. The corporation typically spends $10,000 in years 1–10.

However, if the corporation buys the vehicle in July rather than January, the half-year convention is more realistic to line equipment costs with value. The half-year convention depreciates $5,000 in year one instead of $10,000. The corporation spends $10,000 in years 2–10 and $5,000 in year 11. Although the half-year norm prolongs asset depreciation, it improves expense-revenue matching.

What Assets Use Half-Year Convention?

The half-year convention applies to all property except residential rental property, nonresidential real property, railroad gradings, and tunnel bores unless the mid-quarter convention applies.

Use the half-year convention when?

If the mid-quarter convention does not apply, use the half-year convention. If your tax year’s last three months’ property basis exceeds 40% of all property basis, the mid-quarter convention applies.

Imagine installing a $2,000 machine in January, a $500 desk in April, and a $2,000 computer in November. Computers installed in the last three months of the year account for 44.4% of all property bought that year. All three assets must employ a mid-quarter convention.

Depreciation Types That Use the Half-Year Convention?

The half-year convention works with all depreciation methodologies. The Internal Revenue Service (IRS) MACRS has two depreciation systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS), which taxpayers must choose until necessary.

MACRS offers three GDS and one ADS depreciation technique. GDS allows the 200% declining balance, 150% declining balance, and straight-line methods; however, ADS only allows the straight line.

Bottom Line

The half-year standard for depreciation treats assets bought during the year as if purchased mid-year. It may be necessary to employ the mid-quarter convention. These standards help companies match revenues and costs in the year they occur.

Conclusion

• The half-year depreciation convention uses half the average yearly expenditure in the first and last years of an asset’s useful life.
• According to the matching principle, the half-year convention aligns costs with asset revenues in the same accounting period.
• The half-year convention applies to all depreciation types, including straight-line, double-falling balance, and sum-of-years’ digits.