The half-year convention for depreciation is an accounting schedule that treats all property purchased during a year as if it was acquired exactly in the middle of that year. This approach allows only half of the full-year depreciation in the first year, deferring the remaining balance to the final year of the asset’s life or the year the property is sold. The convention can be used across different depreciation methods, enhancing alignment of expenses and revenues.
Key Takeaways
- The half-year convention permits half of the annual depreciation expense in both the first and the concluding years of an asset’s useful life.
- Its primary aim is to better match expenses with the revenues generated by the asset, adhering to the matching principle in accounting.
- It is applicable to all depreciation methods, such as straight-line, double declining balance, and sum-of-the-years\u2019 digits.
Understanding the Half-Year Convention for Depreciation
Depreciation helps match the cost of a fixed asset with the revenues it generates over its useful life, as per the matching principle adopted in U.S. generally accepted accounting principles (GAAP). When an item exceeding a company’s capitalization threshold is purchased, it is recorded as a fixed asset rather than a full expense in the year of acquisition.
With the half-year convention, companies depreciate only half of the typical annual expense in the first year if the asset is purchased mid-year. For example, in methods like the straight-line, double-declining balance, and sum-of-the-years\u2019 digits, the half-year convention smoothly integrates into the calculation process.
Example of the Half-Year Convention
Consider a company purchasing a $105,000 delivery truck with a salvage value of $5,000 and an expected life of 10 years. If using the straight-line method:
- Calculation for straight-line depreciation: ($105,000 - $5,000) / 10 years = $10,000 annually.
Ordinarily, the company would expense $10,000 each year from year one to ten. However, if the truck is bought in July instead of January, the half-year convention ensures that only $5,000 is expensed in the first year. $10,000 is then expensed annually from years two through ten, with a final $5,000 in year eleven. This approach offers a more precise expense-revenue matching.
What Assets Can Use the Half-Year Convention?
This convention applies to all forms of property except residential rental property, nonresidential real property, railroad gradings, and tunnel bores, unless the mid-quarter convention applies.
When Can I Use the Half-Year Convention?
You can employ the half-year convention if the mid-quarter convention doesn’t apply. The mid-quarter convention is used when 40% or more of the aggregate basis of all properties acquired within a year are placed in service in the last three months of that year.
For instance, if you acquire a machine for $2,000 in January, a desk for $500 in April, and a computer for $2,000 in November, the computer constitutes over 40% of total annual purchases: $2,000 / ($2,000 + $500 + $2,000) = 44.4%. Hence, the mid-quarter convention should be adopted.
What Forms of Depreciation Can Use the Half-Year Convention?
This convention is compatible with various depreciation methods permitted under the Internal Revenue Service (IRS) Modified Accelerated Cost Recovery System (MACRS), which includes the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).
MACRS enables three depreciation methods under GDS (200% declining balance, 150% declining balance, and straight-line) and one under ADS (straight-line only).
The Bottom Line
The half-year convention ensures that assets bought during the year are treated as if purchased mid-year for depreciation purposes. This accounting method, along with the possible application of the mid-quarter convention, provides a more accurate matching of expenses and revenues, benefiting a company\u2019s financial accuracy.
Related Terms: GAAP, Fixed Assets, Book Value, Accumulated Depreciation, Historical Cost.
References
- Internal Revenue Service. “Publication 946 (2021), How to Depreciate Property”.
- Internal Revenue Service. “2021 Instructions for Form 4562”, Page 9.
- Cornell. “Applicable Conventions - Half Year and Mid-Quarter Conventions”.
