DEPRECIATION

Prepared by Frances Angela G. Monton, BSIE

Content
01 Introduction 03 Depreciation Methods

02 Additional Definitions
Depreciation
Depreciation is the decrease in value of physical properties with the passage
of time and use.

It is the book method (noncash) to represent the reduction in value of a

tangible asset.
Value
In a commercial sense, it is the present worth of all future profits that are to
be received through ownership of a particular property.
Market Value
Utility Value
Fair Value
Book Value
Salvage Value
Scrap Value
 Definitions of Value
Market Utility Fair
Value Value Value
It is the amount which Also known as Use It is the value which is
a willing buyer will pay Value, it is what the usually determined by
to a willing seller for the property is worth to the a disinterested third
property where each owner as an operating party in order to
has equal advantage unit. establish a price that is
and and is under no fair to both the seller
compulsion to buy or and the buyer.
sell.
 Definitions of Value
Book Salvage Scrap
Value Value Value
Sometimes referred to Also known as resale It is the amount the
as depreciated book value, it is the price property would sell for
value, it is the worth of that can be obtained if disposed off junk.
a property as shown from the sale of the
on the accounting property after it has
records. been used.
Depreciable Property
In general, property is depreciable if it meets the following basic requirements:

1. It must be used in business or held to produce income.

2. It must have a determinable useful life, and the life must be longer than one
year.
3. It must be something that wears out, decays, gets used up, becomes obsolete,
or loses value from natural causes.
4. It is not inventory, stock in trade, or investment property.
Depreciable Property
Tangible
can be seen or touched
personal property (equipment) or real
property (on land, houses)

Intangible
personal property such as copyrights, patents,
or franchises
Purpose 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 result from the use of the property.
Types of Depreciation
1. Normal Depreciation
a. physical — decreased physical performance
b. functional — decreased demand for the function
2. Depreciation due to changes in price levels
3. Depletion — decrease of value due to continuous extraction
of contents
Physical and Economic Life
The 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 is the length of time during which the property may be
operated at a profit.
DEPRECIATION METHODS
Requirements of
Depreciation Methods
1. It should be simple.
2. It should recover capital.
3. The book value will be reasonably close to the market value
at any time.
4. The method should be accepted by the Bureau of Internal
Revenue.
Depreciation Variables
 Depreciation Methods

Straight Line Method

This method assumes that the loss of value is directly proportional to the age of
the property.
Example: Straight Line Method
An electronic balance costs P90,000 and has an estimated salvage value of
P8,000 at the end of its 10-year lifetime. What would be the book value after
three years, using the straight line method in solving for the depreciation?
 Depreciation Methods

Sinking Fund Formula

This method assumes that a sinking fund is established in which funds will
accumulate for replacement. The total depreciation that has taken place up to
any given time is assumed to be equal to the accumulated amount in the sinking
fund at that time.
Example: Sinking Fund Formula
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 the 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.
 Depreciation Methods

Declining Balance Method

Also known as the constant percentage method or the Matheson formula, it is
assumed that the annual cost of depreciation is a fixed percentage of the
salvage value at the beginning of the year. The ratio of the depreciation in any
year to the book value at the beginning of that year is constant throughout the
life of the property and is designated by k, the rate of depreciation.
 Depreciation Methods

Declining Balance Method

 Depreciation Methods

Declining Balance Method

This method does not apply if
the salvage value is zero
because k will be equal to one
and d1 will be equal to C0.
Example: Declining Balance Method
A certain type of machine loses 10% of its value each year. The machine costs
are P2,000 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.
 Depreciation Methods

Double Declining Balance Method

This method is very similar to the declining balance method except that the rate
of depreciation k is replaced by 2/L. When the DDB method is used, the salvage
value should bot be subtracted from the first cost when calculating the
depreciation charge.
Example: Double Declining Balance
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 new
and has an estimated scrap value of P2,000 at the end of 10 years.
a. Use the declining balance method.
b. Use the double declining balance method.
 Depreciation Methods

Service Output Method

This method assumes that the total depreciation that has taken place is directly
proportional to the quantity of output of the property up to that time. This
method has the advantage of making the unit cost of depreciation constant and
giving low depreciation expense during periods of low production.
Example: Service Output Method
A Television Company purchased machinery for P100,000 on July 1, 1979. It is
estimated that it will have a useful life of 10 years, scrap value of P4,000,
production of 400,000 units, and working hours of 120,000.
The company uses the machinery for 14,000 hours in 1979 and 18,000 hours in 1980.
The machinery produces 36,000 units in 1979 and 44,000 units in 1980. Compute
the depreciation for 1980 using each method given below:
a. Straight line
b. Working hours
c. Output method
 Depreciation Methods

SYD Method
The Sum of the year's digits method of depreciation is one of the accelerated
depreciation techniques which are based on the assumption that assets are
generally more productive when they are new and their productivity decreases as
they become old.
Example: SYD Method
For example, for a property whose life is 5 years.
Example: SYD Method
A company purchases an asset for P10,000.00 and plans to keep it for 20 years. If
the salvage value is zero at the end of the 20th year, what is the depreciation in
the third year? Use SYD method.
Example: SYD Method
A structure costs P12,000 new. It is estimated to have a life of 5 years with a
salvage value at the end of life of P1,000. Determine the book value at the end of
each year of life
 REFERENCES
Blank, L., & Tarquin, A. (2020). Basics of Engineering Economy (3rd ed.). McGraw-
Hill Higher Education (International)

Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall.