Module 4
DEPRECIATION
Engr. Gerard Ang
School of EECE
De nition of Terms
Depreciation – it is the decrease in the value of a
xed asset, or the value of physical prope y, with the
passage of time.
Value – is the present wor th of all the future prof its
that are to be received through the ownership of a
pa icular prope y.
Market Value of a Proper ty – is the amount, which a
wil l ing buyer wil l pa y to a wil l ing s el l er for the
proper ty where each has equal advantage and is
under no compulsion to buy and sell.
De nition of Terms
Utility or Use Value of Proper ty – is what the proper ty
is wo h to the owner as an operating unit.
Fair Value – is the value which is usually determined
by the disinterested third pa y in order to established
a price that is fair to both seller and buyer.
Book Value – is the wor th of the proper ty as shown in
th e ac c o u n ti n g re c o rd s o f an e n te rp ri s e . I t i s
sometimes called as depreciated book value.
Salvage or Resale Value – is the price that can be
obtained from the proper ty 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 recover yof capital
which has been invested in physical
prope y.
2. To enable the cost of depreciation to
be charged to the cost of producing
products or ser v i ces that results
from the use of prope y.
Causes of Depreciation
Physical Depreciation – it is due to wear and tear
of the asset.
F u n c t i o n a l D e p re c i a t i o n – i t i s d u e t o t h e
obsolescence of the asset.
Depletion – refers to the decrease in the value of a
prope r ty due to the gradual ex traction of its
contents.
Monetar yDepreciation – depreciation due to
changes in price level.
Physical and Economic Life
Physical Life of a Proper ty – is the length of time
during which it is capable of per fo rming the
function for which it was de signe d and
manufactured.
Economic Life or Useful Life – is the length of
time during which the proper ty may be operated
at a pro t.
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. Se ice Output Method
Straight Line Method
T he 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 = original cost/value
VS = salvage value
Va = book value
d = depreciation
D = total depreciation after n years
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. D eli v er yjeep s p urc h a s ed by KH C o m p a n y c o st
Php180,000 each. Past records indicate that jeeps
should have an economic life of 10 years. T h ey can
be sold from an average of Php50,000 each year after 10
years of use. T he c o m p a n y rec ei v es 9 % i n t erest o n
investment funds. Using straight line method:
Determine:
a. the depreciation charge during 3 years
b. the depreciation reser v
e 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
e ach pe riod can be simpl y compu te d by
multiplying the original market price by a f ix
percentage repeatedly until it reaches the salvage
value. T hi s method is also called Matheson’s
Formula.
Where:
k = depreciation factor or rate
Sample Problems on
Declining Balance Method
1. A machine wor th 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
T h
is is the same as declining balance method except
that k is replaced by 2/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;
P h p22,000 for declin in g balan ce m et h od an d
Php20,000 for double-declining balance method.
Sum-of-Years’ Digit Method
is method uses the year’s digit (in reverse order)
in computing for the depreciation.
Where: SYD = sum-of-years’ digit
Sample Problem on
Sum of Years’ Digit Method
An in du strial pl an t bo u gh t a ge n e rato r se t f o r
Php90,000. Other expenses including installation
amounted to Php10,000. T h e 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. T h e interest
rate for the wo h of money is being considered so
as to have the depreciable value.
Sample Problem
on Sinking Fund Method
A broadcasting company purchased an equipment for
Php53,000 and paid Php1,500 for freight and delive
charges to the job site. T h
e 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.
Where:
H = total hours of economic life
ha = number of hours the asset has been
used
Se ice Output method
Similar to the hour output method, this method
based its computation on how much the asset has
been used.
Where:
Q = total amount that the asset can give se ice
Qa = amount of the asset has been used
Sample Problems on
Se ice and Hour Output Method
1. An electric bulb bought for Php100 is guaranteed to be
useful for 50 hours. A ce ain 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?
