DEPRECIATION

DEPRECIATION
Decrease in value of physical properties
due to the passage of time and use
Accounting concept: establishing annual
deduction against before-tax income
- to reflect effect of time and use on assets
value in firms financial statements

- to match yearly fraction of value used by asset

in production of income over assets
economic life

PURPOSES OF DEPRECIATION
Because property decreases in value, it is
desirable to consider the effect that this
depreciation has on engineering projects.
Primarily, it is necessary to consider
depreciation for two reasons
1. To provide for the recovery of capital that
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. Depreciation cost is
deducible in computing profits on which
income taxes are paid.

PROPERTY IS DEPRECIABLE IF
IT MUST :
be used in business or held to produce
income
have a determinable useful life which is
longer than one year
wear out, decay, get used up, become
obsolete, or lose value from natural causes
not be inventory, stock in trade, or
investment property

WHEN DEPRECIATION STARTS

AND STOPS
Depreciation starts when property is placed
in service for use in business or for
production of income
Property is considered in service when
ready and available for specific use, even if
not actually used yet
Depreciation stops when cost of placing it
in service is removed or it is retired from
service

Types of Depreciation
Physical property depreciation
deterioration due to the effects of
various chemical and mechanical factors on
the material composing the property.
Functional depreciation due to the
decrease in the demand for the function of
the equipment for which it was designed.
Changes in the price level of a similar
property it is the capital that depreciated
not the property.

DEPRECIATION CONCEPTS
Depreciation Cost depends upon the physical or
economic life of the equipment and its first cost.
Physical Life length of time which it is capable of
performing the function for which it was designed
and manufactured.
Economic life length of time of an equipment
which it will operate at a satisfactory profit.
First Cost includes the original purchase price,
freight and transportation charges, installation
expenses, initial taxes, permits to operate and other
expenses needed to operate the equipment.

DEPRECIATION CONCEPTS
Salvage Value the amount for which the
equipment or machine can be sold as a second
hand.
Scrap or Junk Value the amount that equipment
can be sold for, when disposed off as a junk.
The equipment/property cannot be used anymore.

Book Value (BV) - Worth of depreciable property

as shown on accounting records.
Original cost basis of property, including adjustments,
less allowable depletion or depreciation deductions

Methods used for the Determination

of Depreciation Cost
Straight Line Formula
Sinking Fund Formula
Matheson formula (Constant/Fixed % method,
Declining Balance method or Diminishing balance
method).
Sum-of-the-Years Digit method
Service-Output or Production-Units method

Notations on Depreciation
The following terms are used in the classical
(historical) depreciation method equations:
n = useful life/depreciable life of the asset (in years)
m = age of property at any time < n
d m = annual depreciation cost in year m (1< m < n)
D m = accrued or total depreciation through year m
CO = original or first cost of the property
Cm = book value of the property at the end of m years
Cn = book value at the end of useful life.
K = the ratio of depreciation in any one year to the BV at the
beginning of the year

STRAIGHT-LINE (SL) METHOD

Simplest depreciation method
Assumes constant amount is depreciated each year
over depreciable (useful) life; gives uniform annual
charge.
Does not take into account the interest rate on the
accumulated depreciation fund.
This method requires an estimate of the final SV ( also
the final book value at the end of year N )
dm = (CO - Cn ) / n
Dm = m x d (for 1 < m < n)
Cm = CO - Dm

 Example (7- 6/p.334)

EOY
(m)

dm

Dm

Cm

11,000

11,000(1) = 11,000

120,000 11,000 = 109,000

11,000

11,000(2) = 22,000

120,000 22,000 = 98,000

11,000

11,000(3) = 33,000

87,000

11,000

11,000(4) = 44,000

76,000

11,000

11,000(5) = 55,000

65,000

11,000

11,000(6) = 66,000

54,000

11,000

11,000(7) = 77,000

43,000

11,000

11,000(8) = 88,000

32,000

11,000

11,000(9) = 99,000

21,000

10

11,000

11,000(10) = 110,000

10,000

 Example 2.
A company purchased a machine for P30,000,
used it for 5 years and then sold it for P10,000.
If the capital worth is at 8% determine the
annual cost of depreciation using straight-line
method.
d = (30,000-10,000) / 5
= (20,000 / 5)
= $ 4,000/year

The Sinking Fund Formula

In this method it is assumed that a sinking fund is
established in which funds will accumulate for
replacement purposes and will beat interest. The
total depreciation which has occurred up to any
given time is assumed to equal the amount in
the sinking fund at that time.
Also gives a uniform annual charge
dm = (CO Cn) ( A/F, i %, N)
Dm

= (CO Cn) [(F/A, i%, m)/(F/A, i%, n)

= (CO Cn) [((1+i)m-1)/((1+i)n-1)]

Cm

= C O Dm

 Example # 3
A civil engineer bought a crane used to erect tall buildings.
It will be invoiced from Vietnam, CIF (cost, freight, &
insurance) Manila at P250,000. Brokerage fees, arrastre
fees, customs, duties, permits, etc. amounts to P120,000.
At the end of 10 years, he expects to sell it for P50,000.
Prepare a depreciation schedule for the crane. Use i =
12%.

Soln:
Co = 370,000
Cn = 50,000

n = 10 years

d = (370,000-50,000) [ 0.12 / ((1.12)^10 1))

= P 18,234.93

 Example
EOY (m)

dm

Dm

Cm

18,234.93

18,234.93

351,765.07

18,234.93

38,658.05*

331,341.95

18,234.93

61,531.97**

308,468.03

18,234.93

87,150.72

282,849.28

18,234.93

18,234.93

18,234.93

18,234.93

18,234.93

10

18,234.93

* D2 = 320,000*[((1.12)2-1)/((1.12)10-1)] = 38,658.05

**D3 = 320,000*[((1.12)3-1)/((1.12)10-1)] = 61,531.9653

SUM-OF-THE-YEARS-DIGITS (SYD) METHOD

1. Number for each permissible year of life are listed in
reverse order
2. The depreciation factor for any year is the corresponding
number from the reverse order listing divided by the sum
of those digits, or the following
2 (n - m + 1 )
df = ----------------n(n+1)
3. Depreciation for any year is the product of that years SYD
depreciation factor and the difference between First Cost
and the final estimated BV at end of useful life.
d m = (CO Cn) df
4. Enables a very rapid depreciation during the early years of
life.

SUM-OF-THE-YEARS-DIGITS (SYD) METHOD

a. Determine the sum of years.
years = (n / 2)( n + 1)
b. Determine the loss in value due to depreciation
CO Cn

c. Compute annual depreciation charges

d1 = (CO Cn) (n / years )
d2 = (CO Cn) (n-1 / years)
d3 = (CO Cn) (n-2 / years)

dn = (CO Cn) (1/ years )

Cumulative depreciation through year n is:
D1 = d1
D2 = d1 + d2
D3 = d1 + d2 + d3

 Reworking example # 3
years = (n / 2)( n + 1) = (10/2)(10+1) = 55 years
Year

Dm

Book Value @ EOY n

320,000(10/55) =
58,181.82

58,181.82

370,000 - 58,181.82
= 311.818.18

320,000(9/55) =
52,363.64

58,181.82+52,363.64 =
110,545.46

370,000 110,545.46 = 259,454,54

320,000(8/55) =
46,545.45

110,545.46+46,545.45
= 157,090.91

370,000 157,090.91 = 212,909.09

320,000(7/55) =

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