Module 4

DEPRECIATION

Engr. Gerard Ang

School of EECE
 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. Hour Output Method
7. 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:
𝐕 − 𝐕𝐬
𝐝= V = original cost/value
𝐧
VS = salvage value
Va = book value
𝐕𝐚 = 𝐕 − 𝐚 × 𝐝 d = depreciation
D = total depreciation after n years
𝐃=𝐝×𝐧 n = economic life
a = depreciable year
 Sample Problems
on Straight Line Method
1. Prepare a depreciation table for an asset which was
bought at Php15,000 and useful for a period of 7 years.
Estimated salvage value is 10% of its original cost.
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 machine which costs Php10,000 was sold as scrap
after being used for 10 years. If the scrap value was
Php500, determine the total depreciation and book value
at the end of the 5th year.
 Sample Problems
on Straight Line Method
4. 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.
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.

𝐝𝐚 = 𝐤𝐕(𝟏 − 𝐤)𝐚−𝟏 𝐕𝐚 = 𝐕(𝟏 − 𝐤)𝐚

𝐧 𝐕𝐬 Where:
𝐤=𝟏− k = depreciation factor or rate
𝐕
 Sample Problems on
Declining Balance Method
1. A machine worth Php800,000 is bought from China.
Freight charges amount to Php200,000. If the scrap
value of the machine is Php50,000 that occurs at
the end of 17 years. Compute (a) the depreciation
and (b) book value at the end of 11 years.
2. Equipment bought for Php60,000 is expected to last
for 30 years. If the scrap value after 20 years is
Php20,000. How much is the depreciation for year
10?
 Double Declining
Balance Method
This is the same as declining balance method except that
k is replaced by 2/n.
𝟐
𝐤=
𝐧

Sample Problem on Double Declining Balance Method

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.
 Sum-of-Years’ Digit Method
This method uses the year’s digit (in reverse order) in
computing for the depreciation.

𝐧+𝟏−𝐚 𝐧(𝐧 + 𝟏)
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐒𝐘𝐃 =
𝐒𝐘𝐃 𝟐

𝐚 𝟐𝐧 + 𝟏 − 𝐚 𝒂 𝟏
𝐃= (𝐕 − 𝐕𝐬 ) 𝐚 𝐧− +
𝐧(𝐧 + 𝟏) 𝐕𝐚 = 𝐕 − 𝟐 𝟐 (𝐕 − 𝐕 )
𝐬
𝐒𝐘𝐃

Where: SYD = sum-of-years’ digit

 Sample Problem on
Sum of Years’ Digit Method
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
 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.

𝐢 (𝟏 + 𝐢)𝐚 −𝟏
𝐝 = (𝐕 − 𝐕𝐬 ) 𝐃 = (𝐕 − 𝐕𝐬 )
(𝟏 + 𝐢)𝐧 −𝟏 (𝟏 + 𝐢)𝐧 −𝟏
 Sample Problem
on Sinking Fund Method
A broadcasting company purchased an equipment for
Php53,000 and paid Php1,500 for freight and delivery
charges to the job site. The equipment has a normal life
of 10 years with a trade-in value of Php5,000 against the
purchase of a new equipment at the end of the life.
Determine the annual depreciation cost using:
(a) straight line method
(b) sinking fund method assuming interest is
6% compounded annually
 Hour Output method
In this method, the functionality period and the period
the machine has been used is considered.
Depreciation is computed based on the wear and tear
of the machine.

𝐡𝐚
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐕𝐚 = 𝐕 − 𝐝𝐚
𝐇

Where:
H = total hours of economic life
ha = number of hours the asset has been used
 Service Output method
Similar to the hour output method, this method based
its computation on how much the asset has been
used.
𝐐𝐚
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐕𝐚 = 𝐕 − 𝐝𝐚
𝐐

Where:
Q = total amount that the asset can give service
Qa = amount of the asset has been used
 Sample Problems on
Service and Hour Output Method
1. An electric bulb bought for Php100 is guaranteed to be
useful for 50 hours. A certain company uses the said
bulb for 10 hours a day. If there is no scrap value for the
bulb. Compute the daily depreciation and create the
depreciation table throughout its economic life.
2. A tire bought for Php1,000 is expected to be useful in
traveling 100 km after which it can be sold as scrap for
Php50. (a) If the pedometer displays a value of 85 km,
what is the book value of the tire? (b) How much did the
owner need to travel for the tire to amount to Php80?