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MODULE 13 PACKET
AE 15 and ELEC 1 – INTERMEDIATE ACCOUNTING
MODULE 13 METHODS OF DEPRECIATION

Welcome to Module 13
In this module, we will understand the concept of depreciation and its specific causes. At the end of this
module, you will be answering multiple choice questions and straight problems.

CONSULTATION HOURS:
Virtual time: During your class schedule (either Monday or Tuesday)
Phone or Messenger: Every Thursday from 8am to 11am and 1pm to 4pm

MODULE 13 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Identify the factors involved in determining depreciation
2. Compute depreciation using straight line, service hours and production method.
3. Compute depreciation using sum of years’ digit, declining balance and double declining balance.
4. Know the proper accounting treatment for change in estimated useful life and in depreciation method

COURSE CONTENT FOR MODULE 13:

ACTIVITY DESCRIPTION TIME TO COMPLETE

Straight line and variable method

Assigned Reading 2 hours
Sum of years’ digit and declining balance

ACTIVITY 13 Problem Solving and Discussions 2.5 hours

Summative quiz for module 13 (to be

Quiz 1.5 hours
announced)

Answers to ACTIVITY 13 will be due on NEO LMS

, 2020 thru Google Classroom or
Facebook Group. Correct answers will be posted thereafter for your reference.

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ASSIGNED READING

13. 1 Depreciation

The role of depreciation is to allocate the cost of a PPE asset (except land) over the accounting periods
expected to receive benefits from its use. Depreciation begins when the asset is in the location and
condition necessary for it to be put to use. Depreciation continues even if the asset becomes idle or is
retired from use, unless it is fully depreciated. Land is not depreciated, as it is assumed to have an unlimited
life.

Depreciation is an application of the matching principle.

According to generally accepted accounting principles, a company should select a method of depreciation
that represents the way in which the asset’s future economic benefits are estimated to be used up.

There are many different ways to calculate depreciation. The most frequently used methods are usage-
based and time-based. Regardless of depreciation method, there are three factors necessary to calculate
depreciation:
• cost of the asset
• residual value is the estimated worth of the asset at the end of its estimated useful life
• estimated useful life or productive output. Useful life is the length of time that a long-lived asset is
estimated to be of benefit to the current owner. This is not necessarily the same as the asset’s
economic life. If a company has a policy of replacing its delivery truck every two years, its useful
life is two years even though it may be used by the next owner for several more years. Productive
output is the amount of goods or services expected to be provided. For example, it may be
measured in units of output, hours used, or kilometers driven.

Methods of depreciation

Equal or uniform charge methods Variable charge or use-factor or activity method

a. Straight line a. Working hours or service hours
b. Composite b. Output or production method
c. Group method

Decreasing charge or accelerated or diminishing Other methods

a. Sum of years’ digits a. Inventory or appraisal
b. Declining balance b. Retirement method
c. Double declining c. Replacement method

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Straight Line

The following data relate to an equipment at the beginning of the first year:
Equipment P105,000 Residual Value P5,000 Useful life 5 years

Depreciable Amount = Cost minus residual value or salvage value

Annual Depreciation = Depreciable Amount / Useful life in years

Depreciation 20,000 Depreciation Accum Depn Carrying Amount

Accumulated Depreciation 20,000 Acquisition cost 105,000
Yr 1 – Depn 20,000 20,000 85,000
Balance Sheet Presentation: Yr 2 – Depn 20,000 40,000 65,000
Equipment 105,000 Yr 3 – Depn 20,000 60,000 45,000
Yr 4 – Depn 20,000 80,000 25,000
Accumulated Depreciation (20,000)
Yr 1 – Depn 20,000 100,000 5,000
Carrying amount 85,000

Composite and Group Method

Under the composite method, assets that have different physical characteristics and vary widely in useful
life are grouped and treated as a single unit.

Under the group method, all assets that are similar in nature and in estimated useful life are grouped and
treated as a single unit.

The computation are essentially the same. The average useful life and the composite or group rate are
computed, and the assets in the group are depreciated on that basis.

Procedures:
1. Depreciation is reported in a single accumulated depreciation account. The accumulated
depreciation is NOT related to any specific asset account.
2. The composite or group rate is multiplied by the total cost of the assets in the group to get the
periodic depreciation.
3. When an asset in the group is retired, no gain or loss is reported. The asset account is credited for
the cost of the asset retired and the accumulated depreciation is debited for the cost minus salvage
proceeds.
4. When the asset retired is replaced by a similar asset, the replacement is recorded by debiting the
asset account and crediting cash or other appropriate account.
Composite or group rate x Balance of asset account = Periodic Depreciation

Asset Cost Residual value Depreciable amount Useful Life Annual Depreciation
Building 650,000 50,000 600,000 15 40,000
Machinery 220,000 20,000 200,000 8 25,000
Equipment 130,000 30,000 100,000 4 25,000

Composite Life = Total depreciable amount / total annual depreciation = 900,000 / 90,000 = 10 yrs
Composite Rate = total annual depreciation / total cost = 90,000 / 1,000,000 = 9%

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Building 650,000
To record the depreciation for the current year:
Machinery 220,000
Equipment 130,000
Depreciation 90,000 Total 1,000,000
Accum. Depreciation 90,000 Accum. Depreciation (90,000)
Carrying Amount 910,000

If the equipment is retired after four years and If the equipment is retired after four years with no
sold for P20,000, the journal entry: proceeds:
Cash 20,000 Accum. Depreciation 130,000
Accum. Depreciation 110,000 Equipment 130,000
Equipment 130,000

After the retirement of the equipment, the remaining cost of the assets in group is P870,000 (1M -130k).
The depreciation is no longer P90,000 but will be P78,300 (P870,000 x 9% composite rate).

Supposing the retired equipment was replaced by a similar asset costing P160,000, the total cost of the
assets in the group is now P1,030,000, hence annual depreciation is P92,700 (P1,030,000 x 9%)

Depreciation shall be discontinued when the same would result to a carrying amount of the assets in the
group which is below the residual value of the assets in the group.

Variable Depreciation

Working hours method and output or production method provide depreciation based on function of use
rather than passage of time. They are found to be appropriate for assets such as machineries.

Assets depreciate more rapidly if they are used full time or overtime. There is direct relationship between
utilization of assets and realization of revenue. If assets are used more intensively in production, greater
revenue is expected. It may, however, be difficult to estimate units of output or service hours.

Machinery, at cost 500,000 Service Hours Output

Residual value 20,000 Year 1 25,000 80,000
Estimated useful life 4 yrs Year 2 20,000 60,000
Service Hours 80,000 hours Year 3 18,000 40,000
Output 200,000 units Year 4 17,000 20,000

Rate/hour = 500,000 – 20,000 / 80,000 hrs = P6 Rate/unit = 500,000 – 20,000 / 200,000 units = P2.40
Yr Depreciation Accum. Depn. Carrying Amount Yr Depreciation Accum. Depn. Carrying Amount
500,000 500,000
1 150,000 150,000 350,000 1 192,000 192,000 308,000
2 120,000 270,000 230,000 2 144,000 336,000 164,000
3 108,000 378,000 122,000 3 96,000 432,000 68,000
4 102,000 480,000 20,000 4 48,000 480,000 20,000

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Sum of Years’ Digit (SYD)

Provides for depreciation that is computed by multiplying the depreciable amount by a series of
fractions:

SYD = Life Life + 1

2

Equipment 450,000 Residual value 50,000 Useful life 4yrs

Syd = 4(4+1)/2 = 4 (2.5)
Depreciation Accum. Depreciation Carrying Amount
Acquisition Cost 450,000
Year 1 4 /10 x 400,000 160,000 160,000 290,000
Year 2 3 /10 x 400,000 120,000 280,000 170,000
Year 3 2 /10 x 400,000 80,000 360,000 90,000
Year 4 1 /10 x 400,000 40,000 400,000 50,000

Double declining balance method

A fixed rate is multiplied by the declining carrying amount of the asset to arrive at the annual depreciation.
This is also known as 200% declining balance method.

Equipment 200,000 Residual value 20,000

Useful life 5yrs Straight Line Rate (100%/5yrs) = 20% Double declining rate 40%

Depreciation Accum. Depreciation Carrying Amount

Acquisition Cost 200,000
Year 1 40% x 200,000 80,000 80,000 120,000
Year 2 40% x 120,000 48,000 128,000 72,000
Year 3 40% x 72,000 28,800 156,800 43,200
Year 4 40% x 43,200 17,280 174,080 25,920
Year 5 25,920 – 20,000 5,920 180,000 20,000

The residual value is ignored in the first year of computation of depreciation. In the last year, the fixed
rate of 40% is no longer multiplied by the carrying amount, but depreciation = carrying amount less the
residual value.

150% declining balance method

The straight line rate is also computed and multiplied by 1.5 instead of 2 (as in the case of double declining).
Hence, the rate is 30% under this method is (20% x 1.5) multiplied by P200,000, the carrying amount.
Depreciation in the first year will be P60,000.

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Inventory method

The inventory method consists of merely estimating the value of the asset at the end of the period. The
difference between the balance of the asset account and the value at the end of the year is then
recognized as depreciation for the year.

In recording depreciation, no accumulated depreciation account is maintained since depreciation is

credited directly to the asset account.

This is usually used for small and relatively inexpensive assets such as hand tools or utensils.

Tools account, January 1 100,000 Sale of used tools, at residual value 3,000
Acquisition at cost 80,000 Inventory of tools on Dec 31, at cost 125,000

To record the acquisition To record the sale of used tools To record depreciation of tools
Tools 80,000 Cash 3,000 Depreciation 52,000
Cash 80,000 Tools 3,000 Tools (100+80-3-125) 52,000

Retirement and replacement method

No depreciation is recorded until the asset is retired or retired and replaced. If the asset retired is not
replaced, the original cost of the asset retired is recognized as depreciation.

Depreciation = Original cost – salvage proceeds

This method is suitable for a large number of similar items employed by the entity and the items are
constantly being retired and replaced such as poles, lines, meters and telephone receivers.

Balance, Jan 1 (1,000 units @ P50) P 50,000 Retirement of tools 1,200 units
Acquisition (2,000 units @ P70) 140,000 Proceeds from retirement of tools P8,000

Retirement Method
To record the acquisition To record the retirement Cost of tools retired (FIFO)
Tools 140,000 Cash 8,000 1,000 units x 50 = 50,000
Cash 140,000 Depreciation 56,000 200 units x 70 = 14,000
Tools 64,000 TOTAL 64,000

Replacement Method
To record the acquisition To record replacement of tools retired Replacement cost
Tools 56,000 Depreciation 76,000 of tools retired
Cash 56,000 Cash 76,000 1,200 units x 70 = 84,000
(2,000–1,200=800units xP70) Proceeds fr retirement (8,000)

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Change in useful life and depreciation method

Unexpected physical deterioration or technological improvement may indicate that the useful life of the
asset is less than that originally estimated.

Improved maintenance procedures or revision of operating procedures may prolong the useful life of the
asset beyond the original estimate.

The useful life of an item of property, plant and equipment shall be reviewed at least each financial year-
end and if expectations are significantly different from previous estimate, the change shall be accounted
for as a change in accounting estimate.

Past depreciation is not corrected. The depreciation charge for the current and future periods shall be
adjusted. It is computed by allocating the remaining carrying amount of the asset over the remaining
revised useful life.

The carrying amount of the asset subject to change in useful life or depreciation method shall be
determined before effecting the change.

A depreciable asset costing P400,000 is originally estimated to have useful life of 5 years. At the beginning
of the 3rd year, the original useful life is revised to 8 years. Thus, the asset has a remaining useful life of 6
years.
Cost 400,000 Annual depreciation starting the 3 rd yr
Accum. Depreciation (400,000/5 x 2yrs) (160,000) 240,000 / 6 remaining yrs = P40,000
Carrying amount – beginning of 3rd yr 240,000

When a change in depreciation method is necessary, the change is accounted as a change in accounting
estimate and the depreciation charge for the current and future periods shall be adjusted.

An asset was acquired on January 1, 2017 at P200,000 with a useful life of 4 years. An entity decided to
change from SYD to the straight line method of depreciation on January 1, 2019.
Cost – Jan. 1, 2017 200,000
Depreciation:
2017 (4/10 x 200,000) 80,000 60,000 / 2 remaining years
2018 (3/10 x 200,000) 60,000 140,000 = P30,000 new depreciation
Carrying amount 60,000

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ACTIVITY 13 – Submit your handwritten answers through Google Classroom

Problem 1: Tree Company purchased machinery with a useful life of 10 years for P470,000 on June 30,
2020. It is estimated to have a residual value of P20,000, production of 100,000 units and working hours
of 50,000.

The machinery was used for 5,000 hours in 2020 and 4,000 hours in 2021. It produced 9,000 units in 2020
and 7,000 units in 2021.

Compute depreciation for 2020 and 2021: straight line, working hours and output method.

Problem 2: Snowy revealed the following straight-line depreciation policy on equipment:

A full year depreciation is taken in the year of acquisition
No depreciation is taken in the year of disposition
Useful life is 5 years
On July 1, 2020, the entity sold for P230,000 the equipment acquired in 2017 for P420,000. Estimated
residual value was P60,000. What amount of gain or loss on disposal should be recorded in 2020?

Problem 3: Compute for the composite life and composite rate of Delsy based on the following schedule
of property, plant and equipment:
Asset Cost Residual value Useful Life
Warehouse 590,000 90,000 20
Machinery 230,000 50,000 15
Equipment 80,000 10

Problem 4: Equipment acquired in 2020 costs P1,200,000 with residual value of P150,000 with useful life
of 6 years. Compute for the depreciation for 2020 and 2021 using the:
a. Sum of Years’ Digits
b. Double Declining Balance

Problem 5: Purchased machinery on January 1, 2016 for P720,000 with a useful life of 10 years with no
residual value. It was depreciated using the straight line method until January 1, 2019 when the
depreciation method was changed to sum of year’s digits. The estimated life and residual value remained
unchanged. What is the depreciation for 2019?

Problem 6: Bought machinery on January 1, 2018 for P1,000,000 with a useful life of 8 years with
P100,000 residual value and depreciated using the straight line method. In January 1, 2020, the entity
estimated that the asset’s useful life from the date of acquisition should have been 4 years and the residual
value is P40,000. What is the accumulated depreciation on December 31, 2020?

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