DEPRECIATION

DEPRECIATION
Depreciation is the decrease in the value of physical property with the passage of
time. The method used to depreciate an asset is a way to account for the
decreasing value of the asset to the owner and to represent the diminishing value
(amount) of the capital funds invested in it.
❖ Value is the present worth of all future profits that are to be received through
ownership of a particular property.
❖ Fair value is the value which is usually determined by a disinterested third
party in order to establish a price that is equitable to both buyer and seller.
❖ Book value represents the remaining, undepreciated investment after the total
amount of depreciation charges to date have been removed.
❖ Salvage or resale value the estimated trade-in or market value at the end of the
asset’s depreciable life.
 DEPRECIATION
Purpose 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 the property
Types of depreciation
1. Normal depreciation
2. Depreciation due to changes in price levels
3. Depletion
 STRAIGHT LINE METHOD
Straight line is considered the standard against which any depreciation method is
compared. It derives its name from the fact that the book value decreases linearly
with time.
Annual cost of depreciation
𝐹𝐶 − 𝑆 𝐶𝑜 − 𝐶𝑛
𝑑= 𝑜𝑟 𝑑 =
𝑛 𝑛
Total depreciation after 𝑚 years
𝐷𝑚 = 𝑚𝑑
Book value after 𝑚 years
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
Where
𝐶𝑜 , 𝐹𝐶 = first cost or initial cost
𝐶𝑛 , 𝑆 = book value at the end of life, n years (salvage value or scrap value)
n = useful life of the property in years
m = age of the property at any time less than or equal to n (m≤n)
𝐷𝑚 =accrued or total depreciation up to age m years
 SINKING FUND METHOD
A sinking fund formula establishes funds that will accumulate for replacement.
The total depreciation that has taken place up to any given time is assumed to be
equal to the accumulated amount in the sinking fund at that time.
Annual cost of depreciation
𝑖
𝑑 = 𝐹𝐶 − 𝑆
1+𝑖 𝑛−1
Total depreciation after 𝑚 years
𝑚
1+𝑖 −1
𝐷𝑚 = 𝑑
𝑖
1+𝑖 𝑚−1
𝐷𝑚 = 𝐹𝐶 − 𝑆 𝑛−1
1+𝑖
Book value after 𝑚 years
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
Where
𝐹𝐶 = first cost or initial cost
𝑆 = salvage value
 DECLINING BALANCE METHOD
The Declining Balance (DB) method is assumed that the annual cost of
depreciation is a fixed percentage of salvage value at the beginning of the year. This
method is also known as fixed percentage or uniform percentage method. The ratio
of the depreciation in any year to the book value at the beginning of that year is
constant throughout the life of the property. This method does not apply if the
salvage value is zero.
Rate of depreciation
𝑛 𝑆
𝑘 =1−
𝐹𝐶
Depreciation charge or depreciation at year 𝑚
𝑑𝑚 = 𝐹𝐶 1 − 𝑘 𝑚−1 𝑘

Book value after 𝑚 years

𝐵𝑉𝑚 = 𝐹𝐶 1 − 𝑘 𝑚

Total depreciation after 𝑚 years

𝐷𝑚 = 𝐹𝐶 − 𝐵𝑉𝑚
 DOUBLE DECLINING BALANCE METHOD
The Double Declining Balance (DDB) takes into account the maximum annual rate
that is twice the straight line rate.
Rate of depreciation
2
𝑘=
𝑛

Depreciation charge or depreciation at year 𝑚

𝑚−1
𝑑𝑚 = 𝐹𝐶 1 − 𝑘 𝑘
Book value after 𝑚 years
𝐵𝑉𝑚 = 𝐹𝐶 1 − 𝑘 𝑚

Total depreciation after 𝑚 years

𝐷𝑚 = 𝐹𝐶 − 𝐵𝑉𝑚
 SUM-OF-YEAR’S DIGIT METHOD
The SYD method is the first historical accelerated depreciation technique that can
remove over 40% of the first cost in the first 25% of a 20-year recovery period.
This technique may be used in an engineering economy analysis in the book
depreciation of multiple-asset accounts (group and composite depreciation).
𝑛 𝑛+1
Sum of the years =SUM = 𝑆𝑈𝑀/⅀𝑦𝑒𝑎𝑟𝑠 =
2

For any year m, m≤ the annual depreciation charge is:

2(𝑛 − 𝑚 + 1)
𝑑𝑚 = 𝐹𝐶 − 𝑆
𝑛(𝑛 + 1)
Total depreciation after 𝑚 years
𝑚 2𝑛 − 𝑚 + 1
𝐷𝑚 = 𝐹𝐶 − 𝑆
2 ∙ 𝑆𝑈𝑀
Book value after 𝑚 years
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
 Example Problems
• 1.) The original cost/ first cost of a certain piece of equipment is P150,00 and it
is depreciated by a 10% sinking fund method. Determine the annual
depreciation charge if the book value of the equipment after 10 years is the same
as if it had been depreciated at P14,000 each year by straight -line method.
Given: Co/FC = P150,000;
i=10%;
n=10 years
Depreciation every year = P14,000
Required: d
Solution:
The total depreciation in 10 years by the straight line formula
= 10(P14,000)=P140,000
Therefore the Salvage value=P150,000-P140,000=P10,000
𝑖
By the sinking fund formula: 𝑑 = 𝐹𝐶 − 𝑆
1+𝑖 𝑛 −1

0.10
𝑑 = 𝑃150,000 − 𝑃10,000
1 + 0.10 10 − 1
𝑑 = 𝑃8,784.36
• 2.) A certain company makes it a policy that for any new piece of equipment
the annual depreciation cost should not exceed 10% of the original cost at
any time with no salvage or scrap value. Determine the length of service life
necessary if the depreciation method used is a) the straight line formula, b)
the sinking fund formula at 8%, and c) the SYD method.

Given: S= 0; 𝑑 = 0.10𝐹𝐶
Required: n?
• Solution:
𝐹𝐶−𝑆
a) Straight-line formula: 𝑑= 𝑛
𝐹𝐶−0
0.10𝐹𝐶 = 𝑛 ; n= 10 years
b) Sinking fund formula at 8%
𝑖
𝑑 = 𝐹𝐶 − 𝑆 1+𝑖 𝑛 −1
0.08
0.10𝐹𝐶 = (𝐹𝐶 − 0) 1+0.80 𝑛 −1
(1.08)𝑛 − 1.08 = 0.8
(1.08)𝑛 = 1.8 ; n=7.64 years say 8 years
• c)SYD Method:
𝑛
d = (𝐹𝐶 − 𝑆)
⅀𝑦𝑒𝑎𝑟𝑠

𝑛
0.10𝐹𝐶 = (𝐹𝐶 − 0) 𝑛
(𝑛+1)
2
2
0.10 = (𝑛+1)
𝑛 = 19 𝑦𝑒𝑎𝑟𝑠
• 3.) A contractor imported a bulldozer for his job, paying p250,000 to
the manufacturer. Freight and insurance charges amounted to
P18,000; customs, broker’s fees and arrastre services, P8,500; taxes,
permits, and other initial expenses, P25,000.
If the contractor estimates the life of the bulldozer to be 10
years with a salvage value of P20,000, determine the book value at the
end of 6 years, using the straight-line method, b) sinking fund method
at 8%, c.)Matheson method or double declining method d)SYD
method.
Given:
FC=P250,000+P18,000+P8,500+P25,000 = P301,500
S=P20,000;
n=10 years
m=6 years
Required:
BV=?
• Solution:
a.) Using the Straight–line Method
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
where 𝐷𝑚 = 𝑚𝑑
𝐹𝐶−𝑆 𝐶𝑜 −𝐶𝑛
𝑑 = 𝑛 𝑜𝑟 𝑑 = 𝑛
𝑃301,500−𝑃20,000
𝑑 = = 𝑃28,150.00
10
Substitute to:
𝐷𝑚 = 6 𝑃28,150 = 𝑃168,900
Therefore:
𝐵𝑉𝑚 = 𝑃301,500 − 𝑃168,900 = 𝑃132,600.00
• b.) Using Sinking Fund Method at 8%
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
Solving for Dm:
1+𝑖 𝑚 −1
𝐷𝑚 = 𝐹𝐶 − 𝑆 1+𝑖 𝑛 −1

1 + 0.08 6 − 1
𝐷𝑚 = 𝑃301,500 − 𝑃20,00
1 + 0.08 10 − 1

𝐷𝑚 = 𝑃142,550.31
Therefore:
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
𝐵𝑉6 = 𝑃301,500 − 𝑃142,550.31
𝐵𝑉6 = 𝑃158,949.69
• C.) Using Double Declining Method or
Matheson Formula
𝐵𝑉𝑚 = 𝐹𝐶 1 − 𝑘 𝑚
Where:
𝑛 𝑆
𝑘 =1−
𝐹𝐶

10 𝑃20,000
𝑘 =1−
𝑃301,500
𝑘 = 0.2376
Therefore:
𝐵𝑉𝑚 = 𝐹𝐶 1 − 𝑘 𝑚
6
𝐵𝑉6 = 𝑃301,500 1 − 0.2376
𝐵𝑉6 = 59,201.33
• d.) Using SYD Method:
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚

Where:
𝑛 𝑛+1 10(10+1)
𝑆𝑈𝑀/⅀𝑦𝑒𝑎𝑟𝑠 = 2
= 2 = 55

𝑚 2𝑛−𝑚+1
𝐷𝑚 = 𝐹𝐶 − 𝑆 2∙𝑆𝑈𝑀
6 2𝑥10−6+1
𝐷𝑚 = 𝑃301,500 − 𝑃20,000 2𝑥55
=𝑃230,318.18
Therefore:

𝐵𝑉𝑚 = 𝑃301,500 − 𝑃230,318.18

𝐵𝑉6 = 𝑃71,181.52