DEPRECIATIONBy: Eliseo E. Larena

The worth of an item most often decreases over the years.

This decrease in worth is due to what is called

The most common methods of depreciation are:

depreciation.

I. Straight-line methodII. The units-of-production methodIII. The sum-of-years-digits methodIV. The declining-balance methodV. The modified accelerated cost-

recovery system method (MACRS)

THE STRAIGHT-LINE METHOD

Often used because it is the easiest one to compute.

This method assumes that the items will depreciate by the same amount each year.

It involves four factors: 1. The of the item – This cost

is the actual price that the business paid for the item plus any shipping costs and installation costs.

2. The of the item – This could be stated by the number of years the item can be used or the number of hours of operation an item is used, such as

a) machineryb) number of miles a vehicle is driven over

its lifetime as in the case of a delivery van.

original cost

estimated lifetime

3. The or of an item – When the item is no longer useful to the company, it may be sold to another company or even to a salvage dealer who can cut it up for its scrap value.

4. The of an item for a specific year, number of miles, hours, etc. of operation is the value of an item after depreciation is calculated.

scrap resale value

book value

In order to compute the yearly depreciation amount of an item, subtract the scrap value for the item from the original cost, and then divide the answer by the value of its estimated lifetime.

The original cost minus the scrap value is calleddepreciable amount.

Example 1. A factory machine was purchased for $15,000 and has an estimated lifetime of 5 years. If the scrap value at the end of 5 years is estimated at $3000, find the amount of the depreciation for each year.

 Example 2. Find the book value at the end of 4 years of a digital video camera costing $24,000 with an expected lifetime of 6 years. The scrap value at the end of its lifetime is $3000.

A depreciation schedule can be made to keep track of an item’s depreciation over its lifetime.

The depreciation schedule should consist of four items.

The year The depreciation during the year The accumulated depreciation The value of the item at the end of the year

Example 3. Make a straight-line depreciation schedule for a heating unit that costs $900, has an estimated lifetime of 4 years, and a scrap value of $100.

Step 1. Find the depreciable amount

Step 2. Find the book value of the unit at the of the first year by subtracting the depreciation amount from the original cost.

Step 3. For the next year, subtract the depreciation amount from the book value of the unit for the previous year to get the book value for that year.

Step 4. Repeat step 3 for the remaining years.

Step 5. Find the accumulated depreciation for each year by adding the depreciation for that year to the sum of the depreciation for the previous years.

Step 6. Make a table.

PRACTICE:

1. Find the yearly depreciation, using the straight-line method of 10 security uniforms costing $200 each and having a lifetime of 4 years. There is no scrap value.

2. A file cabinet costs $700. If it has an expected lifetime of 10 years, find the yearly depreciation using the straight-line method. The scrap value is $100.

3. Find the yearly depreciation of a lawn tractor costing $1800. It has an expected lifetime of 5 years and a scrap value of $200. Use the straight-line depreciation method.

4. Find the book value at the end of 60,000 miles of a bus costing $80,000 if it has an expected lifetime of 100,000 miles and a scrap value of $8000. Use the straight-line method.

5. Find the yearly depreciation of 15 table and chair sets for a restaurant costing a total of $60,000. The scrap value is $4000 and the expected lifetime is 8 years. Use the straight-line method. Make a depreciation schedule for the table and chair sets.

SUM-OF-THE-YEARS-DIGITS METHOD

Assumes that the amount of the depreciation of an item is the largest in the first year and then gets smaller each year at a proportional rate.

Example 1. A computer system costing $32,000 has an expected lifetime of 5 years. The scrap value is estimated to be $2000. Find the depreciation for each year using the sum-of-the-years-method.

Step 1. Find the depreciable amount.

Step 2. Find the sum of the number of each year for the expected lifetime or the sum of the digits.

Step 3. Make a fraction using the year numbers in reverse order over the sum and multiply by the depreciation amount.

Example 2. A small truck costing $18,000 has an expected lifetime of 4 years and a scrap value of $2000. Find the amount of depreciation for each of the 4 years.

PRACTICE:

1 An automobile service center purchases an emission-testing machine for $44,000. Its expected lifetime is 7 years. The estimated scrap value is $2000. Find the yearly depreciation and the book value for the first 2 years using the sum-of-the-years-digits method.

2. A bank purchases 10 safety deposit boxes at a cost of $250 each. If the lifetime of the boxes is 20 years, find the depreciation for the first 3 years using the sum-of-the-years-digits method and the book value at the end of the third year. The estimated scrap value of each box is $10.

3. A library purchases some books for a total cost of $800. If the estimated lifetime value of the books is 4 years and the scrap value is $50, find the annual depreciation using the sum-of-the-years-digits method.

4. An x-ray machine used at an airport costs $75,000 when new. It has an estimated lifetime of 5 years. The scrap value is $5000.

5. A short-line railroad purchases a used switch engine for $48,000. It has an estimated lifetime of 6 years. The scrap value is $6000. Find the yearly depreciation using the sum-of-the-years-digits method. Make a depreciation schedule.

DECLINING-BALANCE METHOD Similar to sum-of-the-years-digits method.

Assumes that the largest amount of depreciation occurs during the first year then deceases for each succeeding year

Example 1. A cleaning company purchases 10 vacuum cleaners at a total of $4000. The expected lifetime of the vacuum cleaners is 4 years. The scrap value is $250. Using the double-declining method, find the yearly depreciation.

Step 1. Find the depreciation rate and double it.Step 2. Find the depreciation for the first year.Step 3. Find the book value.

 Example 2. A delivery van costs $22,000 and has an estimated lifetime of 5 years. Its scrap value in 5 years is $2500. Find the depreciation using the double-declining method.

PRACTICE

1. A soundboard for a theater’s sound system costs $1500. Its estimated lifetime is 3 years. Its scrap value is $50. Find the annual depreciation using the double-declining method.

2. A photographer purchases a digital video camera for $24,000. Its estimated lifetime is 4 years. The scrap value is $1400. Find the annual depreciation using the double-declining balance method. Make a depreciation schedule for the item.

3. A large hotel chain purchases carpeting for its new building in Harrisburg. The cost and installation is $96,000. The estimated lifetime is 7 years. Its scrap value is $4000. Find the depreciation for the first 2 years using the double-declining balance method.

4. The same hotel chain purchases 80 beds with springs and mattresses for a total cost of $56,000. The estimated lifetime is 10 years. The scrap value is $600. Find the depreciation for the first 3 years using the double-declining method.

5. A bank purchases a security system costing $24,000 (including installation). The lifetime of the system is 12 years. Its scrap value is $1000. Find the depreciation for the first 2 years using the double-declining method.