Module 4
DEPRECIATION
Engr. Gerard Ang
School of EECE
Definition of Terms
⮚ Depreciation – it is the decrease in the value of a fixed
asset, or the value of physical property, with the
passage of time.
⮚ Value – is the present worth of all the future profits that
are to be received through the ownership of a particular
property.
⮚ Market Value of a 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 and sell.
Definition of Terms
⮚ Utility or Use Value of Property – is what the property
is worth to the owner as an operating unit.
⮚ Fair Value – is the value which is usually determined by
the disinterested third party in order to established a price
that is fair to both seller and buyer.
⮚ Book Value – is the worth of the property as shown in
the accounting records of an enterprise. It is sometimes
called as depreciated book value.
⮚ Salvage or Resale Value – is the price that can be
obtained from the property after it has been used.
Salvage Year is the year when scrap value is equal to
book value.
⮚ Scrap Value or Junk Value – is the price that can be
recovered if an asset is disposed as a junk.
Purposes of Depreciation
1. To provide for the recovery of capital
which has been invested in physical
property.
2. To enable the cost of depreciation to be
charged to the cost of producing
products or services that results from
the use of property.
Causes of Depreciation
⮚ Physical Depreciation – it is due to wear and tear of
the asset.
⮚ Functional Depreciation – it is due to the
obsolescence of the asset.
⮚ Depletion – refers to the decrease in the value of a
property due to the gradual extraction of its contents.
⮚ Monetary Depreciation – depreciation due to
changes in price level.
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 or Useful Life – is the length of time
during which the property may be operated at a
profit.
Methods Used to
Determine Depreciation
1. Straight Line Method
2. Declining Balance Method
3. Double Declining Balance Method
4. Sum-of-Years’ Digit Method
5. Sinking Fund Method
6. Hour Output Method
7. Service Output Method
Straight Line Method
The straight line method is the simplest way in
computing for depreciation. In this method, the
depreciation each year is constant and the interest
rate is being neglected.
Where:
V = original cost/value
VS = salvage value
Va = book value
d = depreciation
D = total depreciation
after n years
n = economic life
a = depreciable year
Declining Balance Method or
Reducing Balance Method
In this method, the net book value at the end of each
period can be simply computed by multiplying the
original market price by a fix percentage repeatedly
until it reaches the salvage value. This method is also
called Matheson’s Formula.
Where:
k = depreciation factor or rate
Double Declining
Balance Method
This is the same as declining balance method except that
k is replaced by 2/n.
Sum-of-Years’ Digit Method
This method uses the year’s digit (in reverse order) in
computing for the depreciation.
Where: SYD = sum-of-years’ digit
Sinking Fund Method
Sinking fund method presents the idea of annuity in
computing for the depreciation. The interest rate for
the worth of money is being considered so as to have
the depreciable value.
Hour Output method
In this method, the functionality period and the period
the machine has been used is considered.
Depreciation is computed based on the wear and tear
of the machine.
Where:
H = total hours of economic life
ha = number of hours the asset has been
used
Service Output method
Similar to the hour output method, this method based
its computation on how much the asset has been
used.
Where:
Q = total amount that the asset can give
service
Qa = amount of the asset has been used