Half-Year Convention for Depreciation

What Is the Half-Year Convention For Depreciation?

The half-year convention for depreciation assumes assets are used for half of the first year, allowing half of the annual depreciation amount in the first and last years.

In other words, only half of the full-year depreciation is recognized in the first year, and the same is done in the final year of the asset's life or the year in which the investment is being sold.

The half-year convention for depreciation can be applied to straight-line depreciation schedules and other accelerated depreciation methods, such as the diminishing balance method or the double declining balance method.

This convention recognizes half-year depreciation in the first and last year of depreciation schedules. The half-year convention for depreciation aims to match the expenses related to a particular asset in line with its revenues.

Using the half-year convention does not increase the total number of years for which depreciation is charged to the asset. Instead, it adjusts the depreciation amount in the first and last years.

Understanding the Half-Year Convention for Depreciation

The Matching accounting principle that US GAAP principles have accepted aims to match expenses and revenues to a particular period. Thus, a half-year convention for depreciation helps relate costs and revenues for a specific period.

A fixed asset is an item recorded in a company's accounts if it adds value to a company for many years. Depreciation helps a company recognize a part of the fixed asset cost as an expense over the asset's useful life.

The company would keep a record of the book value of the fixed assets by subtracting their accumulated depreciation from an asset's historical cost.

This convention of half-year depreciation allows a company to match its revenues and expenses of particular periods more accurately by depreciating only half of that year's depreciation expense if the asset has been purchased in the middle of the year.

This convention can be applied to all types of depreciation, such as the sum of the years' digits, straight-line, and double declining balance. 

Along with the half-year convention, there is also a mid-quarter convention that can be used only if at least 40% of the cost of fixed assets acquired in the year was used in the last three months.

Types Of Depreciation Conventions

There are nine types of depreciation conventions helping in deciding when and how the depreciation will be calculated, which have been explained below:

• Full Year (FY): When calculating depreciation using this convention, depreciation is charged for the whole year at the time of its purchase and disposal
• Half-Year (HY): Depreciation is charged for half a year in the years of its disposal, and the year it was put to use
• Modified Half-Year (MY): If the fixed asset is used during the first half of the year, depreciation is charged for the full year, whereas no depreciation is charged in the disposal year
• Mid-Quarter (MQ): Depreciation is charged equal to half of the quarter's depreciation amount in which it was put to use and the quarter in which it is disposed of
• Full Month (FM): Depreciation is charged for the full month in which it was put to use; however, the same does not happen in the disposal month, as no depreciation is charged in the month of disposal
• Modified Half Month (HM): Depreciation is charged for the full month if the asset is used during the first half of the month. Otherwise, it is not charged for the month
• Mid-Month (MM): Depreciation is charged in an amount equal to half-month depreciation in both the month of disposal and the month when it was put to use
• Next Month (NM): Depreciation is charged after the asset has been used for a month, which is compensated for by charging one month of depreciation at the time of disposal
• Actual Days (AD): Depreciation is based on the days the fixed asset has been used during the financial year

Example of the Half-Year Convention

For example, company X has purchased a $500,000 combination of furniture items for its newly constructed office space, which is expected to be sold off for $157,000 at the end of 20 years. 

Now, we calculate the depreciation expense using the straight-line method. In that case, it is obtained by dividing the difference between the purchase price and the salvage value by the number of years of its useful life.

Therefore, according to the straight-line method, the depreciation for the year would be : 

Depreciation Expense each year = ($500,000 - $157,000)/ 20 = $17,150

However, suppose the furniture items had been purchased in July rather than January. In that case, it is advisable to use the half-year convention to align the cost of the furniture items to different periods.

Now, with the half-year convention, only half of the depreciation expense in the first year is recognized. As a result, only $8,575 is recorded as depreciation in the first year. 

$17,150 is recognized in years 2 to 20. However, the remaining $8,575 to be depreciated is recognized in the second year.

This method extends the number of years for which the asset is depreciated. However, it helps to better match revenues with expenses, also known as the matching principle. 

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accumulated Depreciation
• Allowed Depreciation
• Capital Lease
• Depreciation Expense
• PP&E (Property, Plant and Equipment)