DEPRECIATION

Engr. Charity Hope Gayatin

Learning Outcome
Use depreciation or depletion methods to reduce
the book value of a capital investment in an asset
and natural resource.

Purposes of Depreciation
1. To provide for the recovery of capital which has
been invested in physical property.
2. To enable the cost o f depreciation to be charged
to the cost producing products or services that
results from the use of the property.
3. Depreciation is a tax-allowed deduction included
in tax calculations.
Taxes = (income deductions)(tax rate)

Depreciation Terminologies
DEPRECIATION is a book method to represent the
reduction in value of a tangible asset. (Amortization used
to reflect the decreasing value of intangible assets)
FIRST COST P OR UNADJUSTED BASIS B is the
delivered and installed cost of the asset including
purchase price, delivery and installation fees, and other
depreciable direct costs incurred to prepare the asset for
use. The term unadjusted basis , or simply basis , is used
when the asset is new, with the term adjusted basis
used after some depreciation has been charged.

Depreciation Terminologies
BOOK VALUE BV represents the remaining,
undepreciated capital investment on the books after the
total amount of depreciation charges to date has been
subtracted from the basis.
RECOVERY PERIOD n is the depreciable life of the asset
in years. Often there are different n values for book and
tax depreciation. Both of these values may be different
from the assets estimated productive life.

MARKET VALUE MV a term also used in replacement

analysis, is the estimated amount realizable if the asset
were sold on the open market.

Depreciation Terminologies

SALVAGE VALUE SV is the estimated trade-in or market

value at the end of the assets useful life.
DEPRECIATION RATE OR RECOVERY RATE d is the
fraction of the first cost removed by depreciation each
year. This rate may be the same or different each year.

Depreciation Terminologies
PERSONAL PROPERTY, one of the two types of property
for which depreciation is allowed is the incomeproducing, tangible possessions of a corporation used to
conduct business.
REAL PROPERTY
includes real estate and all
improvementsoffice
buildings,
manufacturing
structures, test facilities, warehouses, apartments, and
other structures. Land itself is considered real property,
but it is not depreciable.

Depreciation Terminologies

PHYSICAL LIFE length of time during which the property

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

Depreciation
TYPES OF DEPRECIATION
1. Normal Depreciation

a. PHYSICAL DEPRECIATION- is due to the

lessening of the physical ability of a property to
produce results
b. FUNCTIONAL DEPRECIATION- is due to the
lessening in the demand for the function which
the property was designed to render.

Depreciation
TYPES OF DEPRECIATION

2. Depreciation due to changes in price levels

3. DEPLETION- this refers to the decrease in the
value of a property due to the gradual extraction
of its contents.

Depreciation Methods
1. STRAIGHT LINE METHOD
assumes that the loss in value is directly
proportional to the age of the property
d = ( C O CL ) / L
Dn = n ( CO CL ) / L
Cn = CO Dn
where
d - annual cost of depreciation
L
- useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Depreciation Methods
2. SINKING FUND
assumes that the funds will accumulate for
replacement
d = ( CO CL ) / (F/A, i%, L)
Dn = d ( F/A, i%, n)
Cn = CO Dn
where
d - annual cost of depreciation
L
- useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Depreciation Methods
3. DECLINING BALANCE METHOD
percentage method or Matheson Formula
assumes 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 through out the life of the property and
is designated by K, the rate of depreciation.
K = 1 n ( Cn / CO)
= 1 L ( C L / C O )
*not applicable if salvage value is zero because K = 1

Depreciation Methods
3. DECLINING BALANCE METHOD
Cn = CO ( 1 K ) n
CL = CO ( 1 K ) L
dn = KCO ( 1 K ) n 1
where
dn - depreciation charge during the nth year
L
- useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Depreciation Methods
4. DOUBLE DECLINING BALANCE METHOD
similar to the declining balance method except
that the rate of depreciation K is equal to 2/L.
Cn = CO ( 1 K ) n
CL = CO ( 1 K ) L
dn = KCO ( 1 K ) n 1
where
dn - depreciation charge during the nth year
L
- useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Depreciation Methods
5. SUM OF THE YEARS DIGIT METHOD
assumes that the funds will accumulate for
replacement
dn = (Reverse Digit/Sum of Digit) * (CO CL)
dn = (depreciation factor) * (total depreciation)
where
dn - depreciation charge during the nth year
L - useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Problem
1. An electronic balance costs P90,000 and has an
estimated salvage value of P8000 at the end of
its 10years lifetime. What would be the book
value after 3years using the straight line method
in solving for the depreciation?

2. A firm bought equipment for P560,000. Other

expenses including installation amounted to
P4000. The equipment is expected to have a life
of 16years with a salvage value of 10% of the
original cost of the equipment. Determine the
book value at the end of 12years by sinking fund
method at 12% interest.

Problem
3. A certain type of machine loses 10% of its value
each year. The machine costs P20,000 originally.
Make out a schedule showing the yearly
depreciation, the total depreciation and the
book value at the end of each year for 5years.

4. Determine the rate of depreciation, the total

depreciation up to the end of the 8th year and
the book value at the end of 8 years for an asset
that costs P15,000 new and has an estimated
scrap value of P2,000 at the end of 10 years by
(a) the declining balance method and (b) the
double declining balance method.

Problem
5. A structure costs P120,000. It is estimated to
have a life of 5years, with a salvage value at the
end of its life of P1000. Determine the book
value at the end of each year of life. Use sum-ofthe-years-digit method.