Depreciation

Engr. Charity Hope Gayatin

DEPRECIATION

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.


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.


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.


PERSONAL PROPERTY, one of the two types of property

for which depreciation is allowed is the income-

producing, 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.


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 = ( CO 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


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


CO - original cost





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 ( CL / CO)

*not applicable if salvage value is zero because K = 1


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


CO - original cost





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



CO - original cost





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



CO - original cost




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-of-

the-years-digit method.

Documents

Depreciation