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Depreciation Is A Term Used Reference To The

Depreciation is the allocation of the cost of an asset over its useful life. Assets lose value over time due to physical decomposition, changes in technology, and other factors. Depreciation is calculated by dividing the initial cost minus salvage value by the number of years of useful life. Common depreciation methods include straight-line, declining balance, and sum of the years' digits. These methods allocate depreciation differently but all aim to match the cost of an asset to the periods it benefits the company.

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Muzammil Iqbal
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80 views

Depreciation Is A Term Used Reference To The

Depreciation is the allocation of the cost of an asset over its useful life. Assets lose value over time due to physical decomposition, changes in technology, and other factors. Depreciation is calculated by dividing the initial cost minus salvage value by the number of years of useful life. Common depreciation methods include straight-line, declining balance, and sum of the years' digits. These methods allocate depreciation differently but all aim to match the cost of an asset to the periods it benefits the company.

Uploaded by

Muzammil Iqbal
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Depreciation

Depreciation is a term used reference to the


fact that assets with finite lives lose value over
time. Depreciation is associated with:

Physical
decomposition
Changing in trend and technology
Change of economic & etc.

Depreciation corresponds to the historical or


purchase cost of an asset across its useful life,
roughly corresponding to normal wear and tear.
For example, if a company buys a piece of
equipment for RM31000 and expects it to have
a useful life of 10 years, it will be depreciated
over 10 years. Every accounting year, the value
of the asset will decrease and in the end after
10 years the value becomes RM1000. At this
value the equipment can be considered as scrap
equipment. Therefore the depreciation is RM
30000 in 10 years period. Practically, the RM
30000 can be considered as cost of usage of the
equipment in 10 years.
Glossary
1. Life period (service life/ useful life); N usage
of an asset which is still valuable
2. Salvage value: Value of an asset which is sold in
total after the end of its life period, F.
3. Scrap value: value of an asset which sold as
parts (eg. Spare parts) after the end of its life
period.
4. Initial value of asset, P.
5. Book value, BV: BV = P (depreciation value
on that particular period)(actual price of the
equipment)
Depreciation Method
1. Straight Line method:
The simplest and most commonly used,
assuming that the value of an asset is decreasing
linearly with time, the same value of
depreciation is imposed yearly through the
whole period of life of the asset.
Straight line depreciation is calculated by taking
the purchase or acquisition price of an asset
subtracted by the salvage value divided by the
total productive years the asset can be
reasonably expected to benefit the company
[useful life].
Example:You buy a new equipment approximately
RM50000 (P). The salvage value is RM4000 (F). The
useful life of the equipment is expected in 20 years (N).
Using that information, the depreciation can be
determined:
P-F
d= = RM 2300 per year
N
d1
Depreciation rate, k =
P
RM 2300
=
RM 50000
= 0.046
= 4.6% per year

D n Depreciation value till 'n'th-year


BVn = Book value in the end of 'n'th- year
n
Dn = (P - F)
N
n
BVn = P- (P - F)
N
2. Declining Balance (Fixed Percentage)
Method
BV1 = P(1- k )1
BV2 = P(1- k ) 2
BVn = P(1- k ) n
k is fixed for the whole life period of the asset.

At the end of the life period, N


BVn = P(1- k ) n = F
1
F N
Therefore, k = 1-
P
This is called Text-Book Formulae or Matheson Formulae
Total depreciation value at the final 'n'th year ;E
d n = kBVn-1
Matheson Formulae cannot be used when F=0.
2
For this condition, k= is used.
N

Economist assumed that 2/3 of the depreciation value is accumulated in the


first half of the life period.
Example : N= 10 years

0 5 10

First of life
3. Double-Declining Balance Method
k = 2 ( the minimum rate of straight line )
d
=2
P straight line

P-F
where, d = (straight line method)
N

This method is usually used when salvage value = 0


4. Sum of the Year Digits Method (SYD)
Cost of new equipment, P = RM 20000
Period of life, N = 5 years
Salvage Value, F = RM 2000
Year Balance of Year SYD
Remaining depreciation factor
1 5 5/15
2 4 4/15
3 3 3/15
4 2 2/15
5 1 1/15
15 15/15
d1 = (P-F)(5/15)
= (20000-2000)(5/15)
= RM 6000

d 2 = 18000(4/15) = RM 4800

d 3 = 18000(3/15) = RM 3600

or

2(N-n+1)
d n = (P-F)
N(N+1)

(18000)2(5 1 1)
d1 =
5(5 1)
= RM 6000

NOTE
For BV, this method is similar with the Declining Balance Method

BVn P(1- k) n
5. Sinking Fund Method

A
d = (P - F) , i %, N
P

F
d n = d , i %, n -1
P

A F
D n = (P - F) , i %, N , i %, n
F A

A F
(BV) n = P - (P - F) , i %, N , i %, n
F A
Example :
P = RM 40000
F=0
N= 10
a) Determining d5 using Double Declining-Balance Depreciation
Method
d
k = 2
P straight line


P - F
= 2
N

P

40000 0
= 2
10

40000
= 0.2

d 5 = kBV4 where

BV4 = P(1 - k) 4
= 40000(1- 0.2) 4
= RM 16384.00

Therefore, d 5 = (0.2)(16384)
= RM 3276.80
b) Determining d 5 by using 'Sum of the Year Digits Depreciation' Method
2(N-n+1)
d n (P - F)
N(N+1)
2(10-5+1)
d 5 = (40000 - 0)
10(10+1)
= RM 4363.64

c) Determine the percentage of payback of the initial investment for an asset


in its first half life period by using 'Double-Declining Balance' Method
From (a)
k =0.2
BVn = P(1-k) n
BV5 = 40000(1-0.2)5
= RM 13107.20

D5 = P- BV5
= 40000 - 13107.20
= RM 26892.80
(or D5 = d1 + d 2 + d 3 + d 4 + d 5
D10 = P- F
= 40000 - 0
= RM 40000

D5 26892.80

D10 40000
= 0.6723 = 67.23%

d) Determine D5 / D10 by using the 'Sum of the Year Digits' Method

2(N-n+1)
d n = (P - F)
N(N+1)
2(10 1 1)
d 5 = (40000 - 0)
10(10 1)
= RM 7272.73
d 2 ___________ d 4 ___________
d 3 ___________ d 5 ___________
Therefore, D5 = d1 d 2 d 3 d 4 d 5

D10 = P- F = 40000- 0 = RM 40000


D5
x 100 = 72.73%
D10

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