GEAL201:

Engineering Economy

Engr. Michael M. Real

CEA Department
Ateneo de Naga University
Definition of Terms

 Depreciation – it is the decrease in the value of

a fixed asset, or the value of physical property,
with the passage of time.
 Value – is the present worth of all the future
profits that are to be received through the
ownership of a particular property.
 Market Value of a Property – is the amount,
which a willing buyer will pay to a willing seller
for the property where each has equal
advantage and is under no compulsion to buy
and sell.
Definition of Terms

 Utility or Use Value of Property – is what the

property is worth to the owner as an operating unit.
 Fair Value – is the value which is usually
determined by the disinterested third party in order
to established a price that is fair to both seller and
buyer.
 Book Value – is the worth of the property as shown
in the accounting records of an enterprise. It is
sometimes called as depreciated book value.
 Salvage or Resale Value – is the price that can be
obtained from the property after it has been used.
Salvage Year is the year when scrap value is equal
to book value.
 Scrap Value or Junk Value – is the price that can
be recovered if an asset is disposed as a junk.
Purposes of Depreciation

1. To provide for the recovery of capital

which has been invested in physical
property.

2. To enable the cost of depreciation

to be charged to the cost of producing
products or services that results from
the use of property.
Causes of Depreciation

 Physical Depreciation – it is due to wear and

tear of the asset.
 Functional Depreciation – it is due to the
obsolescence of the asset.
 Depletion – refers to the decrease in the value
of a property due to the gradual extraction of
its contents.
 Monetary Depreciation – depreciation due to
changes in price level.
Physical and Economic Life

 Physical Life of a Property – is the

length of time during which it is capable
of performing the function for which it
was designed and manufactured.

 Economic Life or Useful Life – is the

length of time during which the property
may be operated at a profit.
Methods Used to
Determine Depreciation

1. Straight Line Method

2. Declining Balance Method
3. Double Declining Balance Method
4. Sum-of-Years’ Digit Method
5. Sinking Fund Method
6. Service Output Method
Straight Line Method

The straight line method is the simplest way in

computing for depreciation. In this method, the
depreciation each year is constant and the interest
rate is being neglected.

Where:
𝐬
V = original cost/value
VS = salvage value, value at the end
Va = book value
𝐚 d = depreciation
D = total depreciation after n years
n = economic life
a = depreciable year
SEATWORK #__
•Problem no. 1: An electronic
balance costs P90,000 and has an
estimated salvage value of P8,000 at
the end of its 10 years life time.
What would be the book value after
three years, using the straight line
method in solving for the
depreciation?
9
SEATWORK #__
•Problem no. 2: Equipment bought
for Php60,000 is expected to last for
30 years. If the book value after
20 years is Php20,000, how much
is the depreciation each year? Find
the book value after 10 years.

10
Sinking Fund Method

Sinking fund method presents the idea of

annuity in computing for the depreciation. The
interest rate for the worth of money is being
considered so as to have the depreciable value.

𝐚
𝐬 𝐧 𝐬 𝐧
SEATWORK #__
•Problem no. 3: A broadcasting corporation
purchased an equipment for P53,000 and paid
P1,500 for freight and delivery charges to the
job site. The equipment has a normal life of 10
years with a trade-in value of P5,000 against
the purchase of a new equipment at the end of
its life.
•(a) Determine the annual depreciation cost by
the straight line method.
•(b) Determine the annual depreciation cost by
the sinking fund method. Assume interest at 6-
1/2% compounded annually.
12
Declining Balance Method or
Reducing Balance Method

In this method, the net book value at the end of

each period can be simply computed by
multiplying the original market price by a fix
percentage repeatedly until it reaches the
salvage value. This method is also called
Matheson’s Formula.

𝐚 𝟏 𝐚
𝐚 𝐚

𝐧
𝐬
Where:
k = depreciation factor or rate
SEATWORK #__
•Problem no. 4: A certain type of
machine loses 10% of its value each
year. The machine costs P2,000.00
originally. Make out a schedule
showing the yearly depreciation, the
total depreciation and the book
value at the end of each year for 5
years.
14
SEATWORK #__
•Problem no. 4: A certain type of
machine loses 10% of its value each
year. The machine costs P2,000.00
originally. Make out a schedule
showing the yearly depreciation, the
total depreciation and the book
value at the end of each year for 5
years.
15
SEATWORK #__
•Problem no. 5: Equipment bought
for Php60,000 is expected to last for
20 years. If the scrap value after that
is Php20,000, how much is the
depreciation for year 10?

16
Double Declining Balance Method

This is the same as declining balance method except

that k is replaced by 2/n.
SEATWORK #__
•Problem no. 6: Determine the rate of
depreciation, the total depreciation up
to the end of the 8th year and the
book value at the end of 8 years for an
asset that costs P15,000 and has an
estimated scrap value of P2,000 at the
end of 10 years by (a) the declining
balance method and (b) the double
declining balance method.
18
SEATWORK #__
•Problem no. 7: A plant bought a
calciner for Php220,000 and used it for
10 years, the life span of the
equipment. What is the book value of
the calciner after 5 years of use?
Assume a scrap value of Php20,000 for
straight-line method; Php22,000 for
declining balance method and
Php20,000 for double-declining
balance method.
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Sum-of-Years’ Digit Method

This method uses the year’s digit (in reverse

order) in computing for the depreciation.

𝐚 𝐬

𝐬
𝐚 𝐬

Where: SYD = sum-of-years’ digit

SEATWORK #__
•Problem no. 8: An industrial plant bought a
generator set for Php90,000. Other expenses
including installation amounted to Php10,000.
The generator set is to have a life of 17 years
with a salvage value at the end of life at
Php5,000. Determine the depreciation charge
during the 13th year and the book value at the
end of 13 years by:
(a) Declining balance method
(b) Double declining balance method
(c) Sum-of-Years’ digit method

21
Service Output method

Similar to the hour output method, this method

based its computation on how much the asset
has been used.

𝐚
𝐚 𝐬 𝐚 𝐚

Where:
Q = total amount that the asset can give
service
Qa = amount of the asset has been used
PROBLEM SET #5

1. An electronic balance costs P90,000 and has an estimated

salvage value of P8,000 at the end of its 10 years life time.
What would be the book value after three years, using the
straight line method in solving for the depreciation?
2. Equipment bought for Php60,000 is expected to last for
30 years. If the book value after 20 years is Php20,000,
how much is the depreciation each year? Find the book
value after 10 years.
3. A broadcasting corporation purchased an equipment for
P53,000 and paid P1,500 for freight and delivery charges to
the job site. The equipment has a normal life of 10 years
with a trade-in value of P5,000 against the purchase of a
new equipment at the end of its life. (a) Determine the
annual depreciation cost by the straight line method. (b)
Determine the annual depreciation cost by the sinking fund
method. Assume interest at 6-1/2% compounded annually.
PROBLEM SET #5

4. A certain type of machine loses 10% of its value each year. The
machine costs P2,000.00 originally. Make out a schedule showing
the yearly depreciation, the total depreciation and the book value at
the end of each year for 5 years.
5. Equipment bought for Php60,000 is expected to last for 20
years. If the scrap value after that is Php20,000, how much is the
depreciation for year 10?
6. Determine the rate of depreciation, the total depreciation up to
the end of the 8th year and the book value at the end of 8 years for
an asset that costs P15,000 and has an estimated scrap value of
P2,000 at the end of 10 years by (a) the declining balance method
and (b) the double declining balance method.
7. A plant bought a calciner for Php220,000 and used it for 10
years, the life span of the equipment. What is the book value of the
calciner after 5 years of use? Assume a scrap value of Php20,000
for straight-line method; Php22,000 for declining balance method
and Php20,000 for double-declining balance method.
PROBLEM SET #5

8. Delivery jeeps purchased by KH Company cost Php180,000

each. Past records indicate that jeeps should have an economic life
of 10 years. They can be sold from an average of Php50,000 each
year after 10 years of use. The company receives 9% interest on
investment funds. Using straight line method, determine: a. the
depreciation charge during 3 years, b. the depreciation reserve
accumulated at the end of 3 years & c. book value at the end of
3 years.
9.
10.
11.