Chapter 4

DEPRECIATION

At the end of the chapter, the student shall be able to:

 Know and understand depreciation and its different types,
 And calculate the depreciation of machinery, buildings and other equipment’s using
the different method..

Depreciation is the decrease in the value of physical property with the passage of time.

Passage of time

L=?
Brand new Salvage Value

Definition of Value
Value in a commercial sense, is the present worth of all future profits that are to be
received through ownership of a particular property.

Market value of property is the amount which a willing buyer will pay to a willing seller
for the property where each has equal advantage and is under no compulsion to buy or sell.

Utility or Use value of a property is what the property is worth to the owner as an
operating unit.

Fair value is the value which is usually determined by a disinterested third party in order
to established a price that is fair to both seller and buyer.

Book value, sometimes called depreciated book value, is the worth of a property as
shown on the accounting records of an enterprise.

Salvage, or resale value is the price that can be obtained from the sale of the property
after it has been used .

Scrap value is the amount the property would sell for if disposed off as junk.

Purpose of Depreciation
1. To provide for the recovery of capital which has been invested in physical property.

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 2. T enable the cost of depreciation to be charged to the cost of producing products or
services that results from the used of the property.

Types of Depreciation
1. Normal depreciation
a. physical
b. functional
2. Depreciation due to changes in price levels
3. Depletion

Physical depreciation is due to the lessening of the physical ability of a property to

produce results. Its common causes are wear and deterioration.

Functional deterioration is due to the lessening in the demand for the function which the
property was designed to render. Its common causes are inadequacy, changes in styles,
population centers shift, saturation of markets or more efficient machines are produces.
Depreciation due to changes in price levels is almost impossible to predict and therefore
is not considered in economy studies.

Depletion refers to the decrease in the value of a property due to the gradual extraction of
its contents.

Physical and Economic Life

Physical life of a property is the length of time during which it is capable of performing
the function for which it was designed and manufactured.
Economic life is the length of time during which the property may be operated at a profit.

Requirements of a Depreciation Method

1. It should be simple.
2. It should recover capital.
3. The book value will be reasonably close to the market at any time.
4. The method should be accepted by the Bureau of Internal revenue.

Depreciation methods
We shall use the following symbols for the different depreciation methods.

L = useful life of the property in years

Co = the original cost
CL = the value at the end of the life, the scrap value (including gain or loss due to removal).
d = the annual cost of depreciation
Cn = the book value at the end of n years
Dn = depreciation up to age n years

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1. The Straight line method
This method assumes that the loss in value is directly proportional to the age of the
property.

d = Co - CL
L

Dn = n (Co - CL )
L
Cn = Co - Dn

Ex. A digital weighing scale cost P90,000 and has a estimated salvage value of P8,000 at
the end of its 10 years lifetime. What would be the book value after three years, using the straight
line method in solving for the depreciation.

Solution:

Co = P90,000 CL = P8,000 L = 10 n =3

d = = P8,200.00

D3 = (n) (d) = (3) (P8200) = P24,600.00

C3 = Co – D3 = P90,000 – P24,600 = P65,400

2. The Sinking Fund formula

This method assumes that a sinking fund is established in which fund 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.

Dn Co - Cl

0 1 2 3 n
n -------

d d d d d

–
d =
⁄

Dn = d (F/A, i%, n)
Cn = Co – Dn

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Example
GMA broadcasting corporation purchased an equipment for P53,000 and paid P1,500 for
freight and delivery charges to the job site. The equipment has a normal life of 10 years with
trade-in value of P5,000 against the purchase of a new equipment at the end of the life.
a. Determine the annual depreciation cost by the straight line method.
b. Determine the annual depreciation cost by the sinking fund method. Assume interest
at 6.5% compounded annually.

Transport &
Purchased delivery charge
Equipment Freight P1,500
P53,000

Solution:
Co = P53,000 + P1,500 = P54,500
CL = P5,000
i = 6.5 % = 0.065
n = 10 yrs

a.) d = = = P4,950

b.) d =
⁄
= = = P3,668.19
[ ]

3. Declining Balance Method

In this method, sometimes called the constant percentage method or the Matheson
formula, it is assumed that the annual cost of depreciation is a fixed percentage of the salvage
value at the beginning of the year. 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 and is designated by k,
the rate of depreciation.

dn = Co (1- k)n – 1 (K)

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 Cn = Co(1 – k)n = [ ]

CL = Co(1 – k )L

K= 1- √ = 1- √

Note: This method does not apply, if the salvage value is zero, because k will be equal to one
and d1 will be equal to Co

Example

A machining equipment loses 10% of its value each year. The machine cost P5,000.00
originally. Make out a schedule showing the yearly depreciation, the total depreciation and the
book value at the end of each year for 10 years.

Solution

Year Book value at the Depreciation during Total Book value at

beginning of year the year 10% depreciation at end of year
end of year
1 P5,000.00 P500.00 P500.00 P4,500.00
2 4,500.00 450.00 950.00 4,050.00
3 4,050.00 405.00 1,355.00 3,645.00
4 3,645.00 364.50 1,719.50 3,280.50
5 3,280.50 328.05 2,047.55 2,952.45
6 2,952.45 295.25 2,342.80 2,657.21
7 2,657.21 265.72 2,608.52 2,391.48
8 2,391.48 239.15 2,847.66 2,152.34
9 2,152.34 215.23 3,062.90 1,937.10
10 1,937.10 193.71 3,256.61 1,743.39

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4. Double Declining Balance (DDB) Method
This method is very similar to the declining balance method except that the rate of
depreciation k is replaced by 2/L

–
dn = Co [ ]

Cn = Co[ ]

CL = Co[ ]

Note: when the DDB is used, the salvage value should not be subtracted from the
first cost when calculating the depreciation charge

Example

Determine the rate of depreciation, the total depreciation up to the end of 10th year and
the book value at the end of 10 years for a tricycle that cost P20,000.00 new and has an estimated
scrap value of P3,000.00 at the end of 15 years by (a) the declining balance method (b) double
declining balance method

Solution

Co = P20,000.00 CL = P3,000.00 L = 15 yrs n= 10

a. Declining Balance Method

k= 1- √ = 1- √ = 0.1188 = 11.88%

C10 = Co(1 – k)n = P20,000 (1- 0.1188)10 = P,646.44

D10 = Co - C10 = P20,000 – 5,646.44 = P14,353.56

b. Double Declining Balance Method

Rate of Depreciation = = = 0.1333 = 13.33%

C10 = Co[ ] = P20,000[ ] = P4,781.35

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 D10 = Co – C10 = P20,000 – P4,781.35 = P15,218.65

5. The Sum of the Years’ Digits (SYD) Method

Let dn = depreciation charge during the nth year

dn = (depreciation factor) ( total depreciation)

dn = = (Co – CL)

Example

For a property or equipment whose life is 5 years

Year Year in Depreciation Depreciation during Book value

reverse order factor the year
1 5 5/15 5/15 (Co – CL) C1 = Co - D1
2 4 4/15 4/15 (Co – CL) C2 = C1 - D2
3 3 3/15 3/15 (Co – CL) C3 = C2 – D3
4 2 2/15 2/15 (Co – CL) C4 = C3 – D4
5 1 1/15 1/15 (Co – CL) C5 = C4 – D5
∑

Example

A Rice milling machine costs P50,000, last 9 years and has a salvage value at the end of
life of P3,000.00. Determine the depreciation charge during the 5th year and the book value at the
end of 5 years by the (a) straight line method, (b) declining balance method , (c) SYD Method,
and (d) Sinking fund method with interest at 12%

Solution

Co = P50,000.00 CL = P3,000.00 L = 9 yrs n = 5 years

a. Straight Line method

d = = = P5,222.22 annual
depreciation

D5 = d (n) = P5,222.22 (5) = P26,111.11

C5 = Co - D5 = P50,000.00 – P26,111.11 = P23,888.90

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b. Declining Balance method

K= 1- √ = 1- √ = 0.2684

d5 = Co (1- k)n – 1 (K) = P50,000 (1 – 0.2684)5-1 (0.2684) = P3,830.24

C5 = Co (1- k)5 = P50,000 (1 – 0.2684)5 = P10,479.45

c. SYD method

1 9
Sum of digit = = 45
2 8
3 7 d5 = (5/45)(P50,000 – P3,000) = P5,222.22
4 6 D5 = (35/45) (50,000 -3000) = P36,555.56
5 5
6 35 C5 = (Co – D4) = 50,000 – 36,555.56 = P13,444.44
7
8
9
45

Year Year in Depreciation Depreciation Book value

reverse factor during the (Php)
order year (Php)
1 9 0.20 9400.00 40600.00
2 8 0.18 8355.56 32244.44
3 7 0.16 7311.11 24933.33
4 6 0.13 6266.67 18666.67
5 5 0.11 5222.22 13444.44
6 4 0.09 4177.78 9266.67
7 3 0.07 3133.33 6133.33
8 2 0.04 2088.89 4044.44
9 1 0.02 1044.44 3000.00
45 45

6. The Service Output Method

This method assumes that the total depreciation that has taken place is directly
proportional to the quantity of output of the property up to that time. This method has the
advantage of making the unit cost of depreciation constant and giving low depreciation expense
during the periods of low production

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 Let T = total units of output up to the end of life
Qn = total number of units of output during the nth year

Depreciation per unit of output =

dn = (Qn)

Example

A factory purchased a canning machine for P95,000.00 on January 1, 2015. It is estimated

to have a useful life of 3 years; scrap value cost P5,000.00, production of 1,500,000 canned
goods and working hours 7,488 hours.

The factory used the machine in 2015 for 2300 hours, and 2200 hours in 2016. The
machinery produces 460,737 units and 360,577 units for 2016. Determine the depreciation for
2016 using the following method:

a. Straight line method

b. working hours
c. Service out put method

Solution

Co = P95,000 CL = P5,000 L = 3 yrs

T = 1,500,000 H = 7,488 hours

a. Straight line Method

d = = = P30,000.00

b. Working hours

d16 = = 2200 = P26,442.31

c. Service output method

d16 = == 360,577 = P21,634.62

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