UNIVERSITY OF NUEVA CACERES COLLEGE OF ENGINEERING AND ARCHITECTURE

Week 11 & 12: Depreciation

I. Introduction
The decline in the efficiency of asset is due to its constant use-the wear and tear. When an asset
losses its efficiency, its value goes down and depreciation arises. This is true in case of tangible assets
like plant and machinery, building, furniture, tools and equipment used in the factory. Also, The
value of asset may decrease due to the passage of time even if it is not in use. There are some
intangible fixed assets like copyright, patent right, and lease hold premises which decrease its value
as time elapse. Changes in fashion are external factors which are responsible for throwing out of
assets even if those are in good condition. For example black and white televisions have become
obsolete with the introduction of color TVs, the users have discarded black and white TVs although
they are in good condition. Such as loss on account of new invention or changed fashions is termed
as obsolescence. Interestingly, there are some assets that not subject to depreciation, which means
that its value increases with the passage of time. Land, jewelry and antique materials are some of
the example these kind of assets.

II. Objectives
At the end of this module, you should be able to:
1. Articulate the need for allocating depreciation costs in fixed assets
2. Conclude what types of depreciation are applicable for a given problem
3. Solve problems on depreciation
4. Master the four methods of computing depreciation

III. Depreciation

DEPRECIATION – is the reduction in value of an asset or physical property during the course of its
working life and due to the passage of time. It can be calculated using a variety of methods.

TYPE OF DEPRECIATION:

1. Physical Depreciation is due to the reduction of the physical ability of the equipment or asset to
produce results.

2. Functional Depreciation is due reduction in the demand for the function that the equipment or
asset was designed to render. This type of depreciation is often called obsolescence.

Symbols used to compute the depreciation

d annual depreciation charge

dm depreciation charge during the mth year
Dm total depreciation after m year
Co First cost
Cn Salvage value after nth year
Cm Book value after the mth year
n expected depreciable life of the asset
m number of years before n
K rate of depreciation for DBM

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METHODS OF COMPUTING DEPRECIATION:

A. STRAIGHT LINE METHOD

In this method of computing depreciation, it is assumed that the loss in value is directly
proportional to the age of the equipment or asset

Annual depreciation charge, d

��−��
�= �
where: Co = first cost
Cn = cost after “n” years (salvage or scrap value)
n = life of the property

Book value at the end of “m” years using, cm

�� = �� − �� where: Dm = total depreciation after “m” years

�� = �(�)

B. SINKING FUND METHOD

In this method of computing depreciation, it is assumed that a sinking fund is established in which
funds will accumulate for replacement purposes.

Annual depreciation charge, d

(��−��)(�)
�= (�+�)� −�
where: Co = first cost
Cn = cost after “n” years (salvage or scrap value)
n = life of the property

Book value at the end of “m” years using, cm

�� = �� − �� where: Dm = total depreciation after “m” years

�[(�+�)� −�]
�� = �

C. DECLINING BALANCE METHOD

In this method of computing depreciation, it is assumed that the annual cost of depreciation is a
fixed percentage of the book value at the beginning of the year. This method is sometimes known
as constant percentage method or the Matheson Formula

� �� � ��
�=�− ��
or �=�− ��

The value K is the constant percentage. Hence K must be decimal and a value less than 1. In this
method, the salvage or scrap value must not be zero.

D. SUM-OF-YEARS’ DIGIT (SYD) METHOD

Assumes that the depreciation charge vary directly to the number of years and inversely to the
sum of the year’s digit.

Respective depreciation charges:

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�
First Year: �� = (�� − ��)( �����
)

�−�
Second Year: �� = (�� − ��)( �����
)

�−�
Third Year: �� = (�� − ��)( �����
) so on…..

Book value at the end of “m” years using, cm

�� = �� − (�1 + �2 + . . . ��)

Sum of year’s digit, �����

�(�+�)
����� = �
COMPARISON BETWEEN THE DIFFERENT METHODS OF DEPRECIATION:

In order to establish the comparison between the depreciation methods mentioned above, let us
consider the following data:

First cost, �� = 10,000

Salvage value, �� = 500
Life of property, n = 5 years

A. Using straight line method:

�0 − ��
�=
�
10,000−500
�= 5
� = 1,900

Tabulation of book value:

PERIOD DEPRECIATION BOOK VALUE

0 10,000.00
1 1,900.00 8,100.00
2 1,900.00 6,200.00
3 1,900.00 4,300.00
4 1,900.00 2,400.00
5 1,900.00 500.00

B. Using sinking fund method:

Assume 10% interest rate

(�0 − ��)�
� = (1+�)� −1
(10,000−500)(0.10)
�= (1+0.10)5 −1
� = 1,556.076

�1 = � = 1,556.076

� 1+� 2 −1 1,556.076 (1+0.1)2 −1

�2 = = 0.1
= 3,267.7596
�

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� 1+� 3 −1 1,556.076 (1+0.1)3 −1

�3 = �
= 0.1
= 5,150.6116

� 1+� 4 −1 1,556.076 (1+0.1)4 −1

�4 = = = 7,221.7487
� 0.1

� 1+� 5 −1 1,556.076 (1+0.1)5 −1

�5 = = 0.1
= 9,500.00
�

Tabulation of book value:

PERIOD DEPRECIATION BOOK VALUE

0 10,000.00
1 1,556.08 8,443.92
2 3,267.76 6,732.24
3 5,150.61 4,849.39
4 �, ���. �� 2,778.29
5 9,500.00 500.00

C. Using declining balance method:

� ��
�=1− ��
5 500
�=1− 10,000
� = 1 − 0.5493
� = 0.4507

Tabulation of book value:

PERIOD DEPRECIATION BOOK VALUE
0 10,000.00
1 0.4507 10,000 = 4,507.00 5,493.00
2 0.4507 5,493 = 2,475.69 3,017.30
3 0.4507 3,017.30 = 1,359.90 1,657.40
4 �. ���� �, ���. �� = ���. �� ���. ��
5 0.4507 910.41 = 410.32 500.09

Note: Slight difference is a result of rounding off of values.

D. Using SYD method:

(�)(�+1)
���� = 2
(5)(5+1)
���� = 2
= 15

� 5
�1 = �� − �� ����
= 10,000 − 500 15
= 3,166.67
�−1 4
�2 = �� − �� ����
= 10,000 − 500 15
= 2,533.33
� 3
�3 = �� − �� ����
= 10,000 − 500 15
= 1,900.00
� 2
�4 = �� − �� ����
= 10,000 − 500 15
= 1,266.67

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� 1
�5 = �� − �� ����
= 10,000 − 500 15
= 633.33

Tabulation of book value:

PERIOD DEPRECIATION BOOK VALUE

0 10,000.00
1 3,166.67 6,833.33
2 2,533.33 4,300.00
3 1,900.00 2,400.00
4 �, ���. �� 1,133.33
5 633.33 500.00
SUMMARY TABLE

Formula to compute Formula to compute

Method Depreciation During Book Value During where
��� year ��� year

SLM �� − �� �� = �� − �� �� = �(�)
�=
�

SFM �[(1 + �)� − 1] �� = �� − �� (�� − ��)(�)

�� = �=
� (1 + �)� − 1

SYD �� = �� − �� [
������� �����
��� �� �����
] �� = �� − �� �� = [ �� − ��
����� �� ������� �����
��� �� �����
]

�� = ��(1 − �)�−1 �
� ��
DBM �� = ��(1 − �)� �=1−
��

Example:
If n = 5
1 5
2 4
3 3
4 2 reverse digit of 4
5 1
Thus,
If m = 4
Reverse of digit = 2

Total of reverse digits = 5+4+3+2 = 14

Total of digit = 1+2+3+4+5 = 15

EXAMPLE:
1. An Asset was purchased for 10,000 and expected to have a salvage value of 500 at the end of 5
years.
A. Compute the depreciation and book during the 4th year using SLM
B. Compute the book value during the 4th year using SLM

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2. An Asset was purchased for 10,000 and expected to have a salvage value of 500 at the end of 5
years.
A. Compute the depreciation and book during the 4th year using SYD
B. Compute the book value during the 4th year using SYD

3. An Asset was purchased for 10,000 and expected to have a salvage value of 500 at the end of 5
years.
A. Compute the depreciation and book during the 4th year using SFM
B. Compute the book value during the 4th year using SFM

4. An Asset was purchased for 10,000 and expected to have a salvage value of 500 at the end of 5
years.
A. Compute the depreciation and book during the 4th year using DBM
B. Compute the book value during the 4th year using DBM

IV. SAMPLE PROBLEMS

1. A VOM has a selling price of 400. If its selling price is expected to decline at a rate of 10% per
annum due to obsolescence, what will be its book value after 5 years?

2. A machine costs 8,000 and an estimated life of 10 years with a salvage value of 500. What is its
book value after 8 years using straight line method?

3. A machine has an initial cost of 50,000 and a salvage value of 10,000 after 10 years. What is the
book value after 5 years using straight line depreciation?

4. A machine has an initial cost of 50,000 and a salvage value of 10,000 after 10 years. What is the
straight line method depreciation rate as a percentage of the initial cost?

5. A machine costing 45,000 is estimated to have a book value of 4,350 when retired at the end of 6
years. Depreciation cost is computed using a constant percentage of the declining book value.
What is the annual rate of depreciation in %?

6. An asset is purchased for 9,000. Its estimated economic life is 10 years after which it will be sold
for 1,000. Find the depreciation in the first three years using straight line method.

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