The half-year convention is used to calculate depreciation for tax purposes and states that a fixed asset is assumed to have been in service for one-half of its first year, irrespective of the actual purchase date. The remaining half-year of depreciation is deducted from earnings in the final year of depreciation.
What is Half-Year Convention for Depreciation?
When you use the six-month depreciation convention, the system uses the acquisition year or the year that the asset was placed in service, then calculates five years of depreciation from that year, and then adds six months. To illustrate this process, consider an asset that was acquired for the price of 50,000, and placed in service in April 2020. Also, assume that the asset has a five-year service life.
The first year of service will conclude in December 2020, which means the end of the asset’s five-year service life will be December 2024. The half-year depreciation convention will add six months to the asset’s life, which means its service life will end in June 2025.
Explaining the Half-Year Convention for Depreciation Depreciation, in a way, is the Accounting convention that assists match related revenues and expenditure. If an item is competent enough to bring value to the company for several upcoming years, it gets recorded as the Fixed Asset during the time of purchase.
Depreciation enables a company to expense a specific amount of the cost of the asset in every year of the asset’s life. The company then tracks the Book Value of the asset by deducting the accumulated depreciation from the historical cost of the company.
Thus, the half-year convention for depreciation enables companies to match expenses and revenue in the year as they incurred by depreciating just half of the basic annual depreciation expense that occurred in the first year in case the asset was purchased in the mid-year.
What is a Depreciation Convention?
A depreciation convention is a rule that is used to determine four different criteria:
- The depreciation method you can use
- The depreciation schedule you can use, is dependent on the useful life
- The amount of depreciation that can be claimed once the fixed asset is disposed of
- The amount of depreciation that can be claimed in the first and last year of the fixed asset’s recovery period
As a whole, depreciation conventions govern when and how depreciation is calculated.
Types of Depreciation Conventions
As for the types of depreciation conventions, nine conventions govern when and how depreciation is calculated. The conventions are listed and discussed below:
- FM = Full Month: The fixed asset receives a full month of depreciation during the month when it is placed in service. It does not receive depreciation for the month of disposal.
- HM = Modified Half Month: If the fixed asset is put into service during the first half of the month, it receives a full month of depreciation. If it is put into service during the second half of the month, the calculation of depreciation begins the preceding month.
- MM = Mid-Month: The fixed asset receives half a month of depreciation for the month it was placed into service and half a month of depreciation when disposed of.
- NM = Next Month: Depreciation for the fixed asset begins one month after it is placed into service and receives one month of depreciation when disposed of.
- HY = Half-Year: Depreciation is halved for the first and last year once it is in service.
- MY = Modified Half-Year: If put into service before the midpoint of the year, the fixed asset receives a full year of depreciation for the first year, but none on the last. If put into service after the midpoint of the year, depreciation is calculated the following year. Also, a full year of depreciation is received once disposed of.
- FY = Full Year: The fixed asset received a full year of depreciation when put into service and when it is disposed of.
- AD = Actual Days: The fixed asset receives depreciation every day it is in service during a company’s fiscal year.
- MQ = Mid-Quarter: The fixed asset receives half of one quarter’s depreciation for the quarter that it was placed into service. Same situation for disposal.