Handling US Tax Depreciation in SAP (Part 1): The Basics

In the capital accounting area that we specialize in, there are a few different business groups that we routinely deal with.  Customer’s usually have a capital planning or strategic planning group that is in charge of maintaining the capital budget as well as administer the process of approving appropriation requests (AFEs).  On the project side most customers have, at a minimum, individual accountants that manage projects.  Most of the larger companies go so far as to have a centralized project management group.  This centralized group is often in charge of project creation and most of the month end close steps for Project Systems.  For fixed assets, there’s always a property accounting group that handles the asset records, retirements, and depreciation postings at month end.  That’s what I sometimes refer to as the ‘Big 3’ in the capital accounting space.

 

And the Fourth?

The other group that we spend a lot of time interfacing with is the tax department.  US taxes are a key accounting concern in the capital accounting area for a few different reasons.

First, the dollars maintained here are large.  We’re not talking about indirect purchasing or simple admin expenses at a plant office.  I’d estimate that even a small SAP customer will have an annual capital spend of at least $100 million USD.  The largest customer we worked with had to maintain an annual capital spend of approximately $30 billion USD.  If I had to average, the large customers usually fall somewhere in the $4-10 billion range.  Relative to traditional SG&A spending, capex spending is definitely much higher.  With figures that large, there are obvious tax consequences that the tax department needs to carefully monitor.  Below are some examples from some different industries.

 

Apple — Technology (Source: MarketWatch)

Harley Davidson — Automobiles (Source: MarketWatch)

Johnson & Johnson — Pharmaceuticals (Source: MarketWatch)

The GAP — Retail (Source: MarketWatch)

ExxonMobil — Oil&Gas (Source: MarketWatch)

 

Secondly, it’s not just the amount that is important but the strategic importance of how those funds impact the customer’s objectives.  Re-allocating funds from one project to another can help take advantage of market factors, maximize cost efficiency, and preserve or expand a companies market position.  Capex spending also tends to be irreversible because they can’t cancel the spending without taking immediate loses.  Taxes play a role in decisions such as these particularly when they involve different tax jurisdictions.

Lastly, accurate tax depreciation on a companies fixed asset base represents a significant impact on earnings.  The depreciation that is calculated represents a direct reduction on the earnings that taxes are based on.  Reducing the net income amount reduces the tax owed.

I’d estimate that about half of our consulting business comes from the tax side.  We’ve worked with them for over 25 years on a range of issues that, quite frankly, haven’t changed much.  It seems that they’re still dealing with some of the same issues here in 2020 that we first dealt with back in the mid 1990’s.

With this blog series I’d like to focus on several of those items…  and I’ll start off with the most important one.

 

What’s the Most Often Mis-Implemented Area of Fixed Assets in SAP?

As you can probably guess, the answer is everything that has to do with taxes.  The depreciation area setup, the tax calculations themselves, basis adjustments, and reporting… basically everything.  Name me an area in FI-AA and I can give you an example of how someone mis-implemented it as it relates to taxes.

Why is that?  Most of the time it seems that the tax department doesn’t get the attention that the other finance areas get during an SAP implementation.  In terms of staffing, the tax department is consistently under-represented on the project and there is rarely a dedicated consultant who is handling this area.  Just like in regular accounting, the consulting world doesn’t like to work with taxes and does the bare minimum to pass the test case, then they move on.

Secondly, I think the tax group itself is slow to engage.  Yes, they are usually dealing with prior year’s data so it’s normal for them to lag the day-to-day business flow… but sometimes it seems that they are more reactive than proactive.  This has major implications during an SAP project when you’re designing processes that can have tax implications yet there isn’t enough involvement from those responsible for it.

Over the years, this has led to a general misconception amongst some IT and/or Finance managers that SAP can’t handle US tax requirements.  For fixed assets that means that they don’t expect for FI-AA to handle US tax depreciation calculations and reporting.  They assume that most customers instead just extract the data from the corporate book depreciation area and handle the tax part offline.  This is 100% false.  Let’s dive into some examples.

 

Basic US Tax Depreciation Calculations

Below is one of the tables published by the IRS.  This one shows the MACRS rates when using the mid-year convention.  You’ll notice that for a 5 year asset, the rates are 20%, 32%, 19.20%, 11.52%, 11.52%, and 5.76%.  I’ve also highlighted the 10 year rates for a second example below.

 

In SAP, I’ve created an asset and posted a simple $10,000 acquisition to it.  The posting was made today on November 23, 2020.  Below are the details from the Asset Explorer.

Note: The screenshots below are from an S/4HANA 1909 OP system but all of this functionality goes back to SAP R/3 and ECC.

 

If I go to the Comparison tab I can view the asset’s values over a range of years.  For this 5 year asset, I see the depreciation figures and resulting net book value.  Notice anything?  Those amounts tie to the rates from above.

  • Year 1:  10,000  X  20.00%  =  $2,000 in depreciation expense
  • Year 2:  10,000  X  32.00%  =  $3,200 in depreciation expense
  • Year 3:  10,000  X  19.20%   =  $1,920 in depreciation expense
  • Year 4:  10,000  X  11.52%    =  $1,152 in depreciation expense
  • Year 5:  10,000  X  11.52%    =  $1,152 in depreciation expense
  • Year 6:  10,000  X   5.76%    =  $576 in depreciation expense

You can see that even though the asset was acquired in period 11, it still received the full half-year of depreciation in year 1 (correct).  The total depreciation also lasts over 6 calendar years (also correct).

 

Below is a similar asset. The only difference is that it has a 10 year useful life. The depreciation figures, again, tie to what was shown above for the MACRS depreciation rates.

 

What About AMT?

Let’s go back to the previous record and look at the AMT depreciation area.  It has the same 5 year useful life but uses a 150% declining balance depreciation key.

 

Looking at the rates on the IRS website and we find the following…  Yep, those tie out too!

 

MACRS Straight Line and Mid-Period?

For real property we have to depreciate using straight line and mid-period.  Below is another new asset… for demo purposes I’ve set the useful life to 10 years just so I can easily show the first and last year of the depreciation forecast.

 

Since the acquisition was made on November 23rd, it should get half of November and all of December for the depreciation.  Here’s the math:

Cost:  $10,000

Useful Life:  120 periods

Depreciation per (full) period:  $83.33

Depreciation per (half) period:  $41.67

2020 Depreciation:  41.67 + 83.33 = $125

 

The above schedule shows $125 in year 1 (The 1.5 periods for a mid-November start date), an even 10% per year for a 10 year useful life asset in years 2-10, and the remaining 10.5 periods in year 11.  120 total periods and 10,000 in depreciation…  all correct.

 

Conclusion

This is just a quick overview but it starts to show that SAP can easily handle the basic US tax depreciation requirements.  Mid-year, mid-period, or mid-quarter.  150% or 200% declining balance, or straight line.  Bonus or non-bonus.  In my opinion, all of it is just a variation on the same theme and just requires a configuration change for each item.

On to the next blog!

Blog Series:
Handling US Tax Depreciation in SAP (Part 1): The Basics
Handling US Tax Depreciation in SAP (Part 2): Separate Books
Handling US Tax Depreciation in SAP (Part 3): Basis Adjustments
Handling US Tax Depreciation in SAP (Part 4): Prior Year Adjustments