DEPRECIATION

COLLEGE OF ENGINEERING, ARCHITECTURE, AND TECHNOLOGY

Subject: Quantitative Management
Depreciation Concepts
Topic: Introduction to Operations Research/LP (Graphical Method)
Lecturer: Engr. Ma. Estrella Natalie B. Pineda

• Depreciation is the decrease in the value of physical

property due to physical or economic reasons. Physical
property shall include both tangible and intangible
business property with the exception of real estate.

*Tangible – may be seen or touched (furniture,

machinery, office equipment, etc.)
*Intangible – includes copyright , franchise, or patent.
 Types of Depreciation
1. Physical Depreciation
 Results in the decrease in the ability of a physical
property to perform its intended service which is
caused by corrosion, abrasion, decay, impact, heat,
stress, and vibration.
2. Functional Depreciation
 Results from obsolescence or inadequacy of the
property to meet the demand required, which occurs
when new and better equipment is available that is
more efficient and less expensive to operate.
3. Accident
 Results when the property becomes a casualty of fire,
flood or any accident.
 Purpose of Depreciation Studies

1. To provide for the replacement of

tangible property.
2. To provide for the recovery of invested
capital.
3. To enable the cost of depreciation to be
charged to the cost of manufacturing
products or services rendered.
 Terminologies
• Value - Is the measure of the worth that an individual
ascribes to a property or service.
• Market Value - Is the amount that a willing buyer pays a
willing seller for the purchase of his property, where
neither buyer nor seller is compelled to buy or sell.
• Fair value - Is the worth of a property to a disinterested
third party, in order to establish a price that is fair to both
buyer and seller.
• Book Value - Is the worth of a property at a given time as
reflected in the accounting records of a business. It is the
acquisition cost of the any adjustments, property, plus any
adjustments, less the accumulated depreciation charges for
a given period.
 Terminologies
• Assessed Value - Is the reported value used for
property tax purposes. It is usually obtained by
appraisal.
• Salvage value - Is the price of a property when it can
no longer operate at a profit. It is the estimated worth
of the property at the end of its productive life.
• Scrap Value - Is the value of the property after it can no
longer perform its intended function. It is the price that
the property can command if it is sold as junk.
• Physical Life - Is the period in which a given property is
able to perform the function for which it was designed
for.
 Terminologies
• Economic or Useful Life - The period during Is also
referred to as the property's depreciable life. It is which
a property may be operated at a profit.
• Acquisition Cost - Is also referred to as first cost, it
includes the purchase the property price of plus any
expenses incurred (shipping, installation, improvement
and repair) prior to initial service operation of the
property.
• Yearly Depreciation Charge - Is the depreciation charge
for a given year of the property.
• Accumulated Depreciation - Is the total depreciation
expense charged to a property after n years of service.
 Terminologies
• Depreciation Table - Is a tabulated depreciation schedule
showing the yearly and accumulated depreciation charges,
together with the book value at the end of each year of the
property's useful life.
• Wearing Cost - Is the accumulated depreciation of a
property at the end of its useful life.
• Depreciation Funds - Are funds that are set aside out of
profit so that capital is available for replacing essential
equipment at the time of retirement.
• Depreciation Rate - Is the decrease in property value for a
given year expressed as a percentage.
• Recovery Period - Is the time period required for capital
cost recovery. This period is usually shorter than the
economic life of the property in order to encourage capital
investment and improve productivity.
 Depreciation Methods
• Straight-Line Method (SLM)
The SLM is the simplest and most commonly
used depreciation method. It assumes that
the loss of value is directly proportional to
the age of the property so that the annual
depreciation charge, d, and the depreciation
rate, k, is constant. Hence, the book value,
BV, of the property decreases each year at a
uniform rate.
 Depreciation Methods
• Sinking Fund Method or Formula
The SFF assumes that a sinking fund
earning interest is created for
replacement purposes. The fund is
established by depositing equal
amounts at the end of each year for
L years at an interest rate of i% per
year.
 Depreciation Methods
• Declining Balance Method or Matheson
Method (DBM)
This method is also referred to as the constant
percentage method. The DBM assumes that
the depreciation charge for a given year is a
fixed percentage of the book value at the start
of the year, such that, the depreciation charge
decreases as the property nears the end of its
useful life.
 Depreciation Methods
• Double Declining Balance
Method, DDBM
In this method, the depreciation rate,
k, is computed as 200%/L, such that k is
replaced by the value 2/L. For this
method, the estimated useful life of the
property must exceed 2 years so that
k<1.
 Depreciation Methods
• Sum of the Years-Digit Method, SYD
This method requires that the digits
corresponding to the number of each
year of the property life first be listed in
reverse order. The depreciation rate for a
given year is found by taking the
corresponding number from the reversed
listing and dividing it by the sum of the
years digits, y.
 Depreciation Methods
• Units-of-Production Method
The units-of-production method is used to
determine the depreciation of property not as a
function of time, in years, but as a function of use.
In this method, depreciation is charged in
proportion to units of production, or time of use,
or the amount of work performed.
The depreciation rate per unit(d) in this method is
constant and the accumulated depreciation
charge, Dn, is proportional to the rate of
production.
 Depreciation Methods
• Problems:
1. An electronic balance costs P 90,000 and
has an estimated salvage value of P 8,000 at
the end of its 10 yrs lifetime. What would be
the book value after three years, using the
SLM in solving for the depreciation?
2. A broadcasting corporation purchased an
equipment for P 53,000 and paid P 1,500 for
freight and delivery charges to the job site.
 Depreciation Methods
• Problems:
The equipment has a normal life of 10yrs
with a trade-in value of P 5,000 against the
purchase of a new equipment at the end of
the life.
a. Determine the annual depreciation cost
by SLM.
b. Determine the annual depreciation cost
by SFM. Assume interest at 6-1/2% annually.
 Depreciation Methods
• Problems:
3. A firm bought an equipment for P 56,000.
Other expenses including installation
amounted to P 4,000. The equipment is
expected to have a life of 16 yrs with a
salvage value of 10% of the original cost.
Determine the book value at the end of 12
yrs., by (a) SLM and (b) SFM at 12% interest.
 Depreciation Methods
• Problems:
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 8yrs for
an asset that costs P 15,000 new and has an
estimated scrap value of P 2,000 at the end of
10 yrs by (a) DBM and (b) DDBM
5. A plant bought a calciner for P 220,000 and
used it for 10 yrs, the life span of the
equipment. What is the book value of the
 Depreciation Methods
• Problems:
calciner after 5 yrs of use? Assume a scrap
value of P 20,000 for SLM; P 22,000 for DBM
and P 20,000 for the DDBM.
6. A structure costs P 12,000 new. It is
estimated to have a life of 5 yrs with a
salvage value at the end of life of P 1,000.
Determine the book value at the end of each
year of life.
 Depreciation Methods
• Problems:
7. A television company purchased
machinery for P 100,000 on July 1, 1979. It is
estimated that it will have a useful life of 10
years; scrap value of P 4,000, a production of
P 400,000 units and working hours of P
120,000. The company uses the machinery
for P 14,000 hours in 1979 and 18,000 hours
in 1980. The machinery produces 36,000
 Depreciation Methods
• Problems:
units in 1979 and 44,000 units in 1980.
Compute the depreciation for 1980 using the
methods, SLM; SFM at 10% interest; SOM;
WHM.
8. A machine costs P 7,000 last 8 years and
has a salvage value at the end of life of P 350.
Determine the depreciation charge during
the 4th year and the book value at the end of
 Depreciation Methods
• Problems:
of 4 years by the SLM; SYD; DBM and DDBM.
9. The original cost of a certain machine is P
150,000, has an economic life of 8 years; with
a salvage value of P 9,000 at that time. If the
depreciation of the first year is equal to P
44,475, what method is used in the
calculation of the depreciation?
 Depreciation Methods
• Problems:
10. A telephone company is contracted for
the purchase and installation of a fiber optic
cable at a total cost of P 960M. This amount
includes freight and installation charges
estimated at 10% of the above contract price.
If the cable shall be depreciated over a period
of 15 years with zero salvage value: a. What
is the annual depreciation charge given the
 Depreciation Methods
• Problems:
sinking fund deposit factor of 0.0430 at 6%
interest where n=15. b. what is the
depreciation charge during the 8th year using
the sum of the years digits method?
11. In the purchase of a rice cooker, a buyer
pays P 200 as an advance fee. He will
discharge the balance, principal and interest
included at 18% payable monthlyon the
 Depreciation Methods
• Problems:
unpaid balance by payments of P 75 at the
end of each month for a year. Find the cash
value of the rice cooker.