Depreciation

Lecture 4
Basic Aspects of Depreciation
Lesson 1

ENGR. RJGRUDA-BAYOR
Depreciation
• Depreciation is the decrease in value of physical properties with the
passage of time and use.
• It is a way to account for the decreasing value of the asset to the owner
and to represent the diminishing value of the capital funds invested in it.
• Depreciation is a noncash cost intended to “match” the yearly fraction
of value used by an asset in the production of income over the asset’s
life.
• Depreciation is also an accounting concept that will be used to
calculate the tax-deductible income business expense to help businesses
recover the cost of an asset.

Buildings are assets that depreciate over time. Building tax (ex. houses) is
calculated differently from land tax. Buildings depreciate over time while
land does not.
ENGR. RJGRUDA-BAYOR
Definitions of Value
Value – The present worth of all future profits that are to be received through
ownership of a particular property

Market Value of a Property – 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 or sell. The estimated amount realizable
if the asset were sold on the open market.

Fair Value of a Property – The value which is usually determined by a

disinterested party in order to establish a price that is fair to both seller and
buyer

Utility or Use Value of a Property – What the property is worth to the owner
as an operating unit
ENGR. RJGRUDA-BAYOR
Definitions of Value
Book Value – Sometimes called Depreciated Book Value. The worth of a property
as shown on the accounting records of an enterprise

Salvage or Resale Value– The price that can be obtained from the sale of the
property after it has been used

Scrap Value – The amount the property would sell for if disposed off as junk

ENGR. RJGRUDA-BAYOR
 Market Value Book Value
Value depends on how much the Value is determined based on
market is willing to pay for it depreciation
Value may increase or decrease Value will always decrease
Applicable to any type of property Not applicable for land, gold, etc.
Market value is considered for Book value is considered for account
valuation books in company
Depends on supply, demand, Value depends only the passage of time
development of area, etc. and is not dependent on demand and
supply

Commercial building tends to increase in market value, but the book value will
decrease as depreciation charges are taken.

Cellphones may have a market value much lower than the book value
because of newer models or other brands offering the same product.
ENGR. RJGRUDA-BAYOR
Depreciable Property
Depreciable property is property for which depreciation is allowed under
federal, state, or municipal income tax laws and regulations.
Example: Buildings, motor vehicles, equipment

It must be used in business or held to produce income.

It must have a determinable useful life, and the life must be longer
than one year.

It must be something that wears out, decays, gets used up,

becomes obsolete, or loses value from natural causes.

It is not inventory, stock in trade, or investment property.

ENGR. RJGRUDA-BAYOR
Types of Depreciable Property
Depreciable property can either be intangible or tangible.

Tangible property can be seen,

touch, and felt.

Types:
• Real – Land, anything that is
erected on (ex. Buildings),
Real property
growing on (trees), or
attached to land.
• Personal – equipment,
furnishings, vehicles, office
machinery, or not defined as
real property.
ENGR. RJGRUDA-BAYOR

Personal property
Intangible Property
Intangible property has value but cannot be seen or touched, examples
include patents, copyrights, and trade marks.

Goodwill - That element of value which a business has earned through

favorable consideration and patronage of its customers arising from its well-
known and well conducted polices and operations

Franchise - An intangible item of value arising from the exclusive right of a

company to provide a specific product or service in a stated region of the
country

Going Value -An intangible value which an actually operating concern has due
to its operation

Organization Cost - The amount of money spent in organizing a business and

arranging for its financing and building ENGR. RJGRUDA-BAYOR
Purpose of Using Depreciation
Book Depreciation – Used by a corporation or business for internal
financial accounting to track the value of an asset or property over its life.
➢ Helps in pricing decisions.
➢ In calculating net income to be reported to investors/stockholders

Tax Depreciation – Used by a corporation or business to determine taxes

due based on current tax laws of the government entity (country, state,
province, etc.).
➢ In calculating income taxes for the BIR
➢ To help recover the cost from investing in the property

ENGR. RJGRUDA-BAYOR
Types of Depreciation
1. Normal Depreciation
a) Physical – due to lessening physical ability of a property to produce
results (wear and tear)
b) Functional – due to the lessening of demand for the function the
property was designed to render (obsolescence)

2. Depreciation due to changes in price level

This is affected by external factors such as economic performance, inflation
and deflation, and others. It is almost impossible to predict and is not
considered in economy studies.

3. Depletion
This depreciation refers to the decrease in value of a property due to the
gradual extraction of its contents. This is usually used by individuals who
engage in extraction of natural resources such as miners, loggers, etc.

ENGR. RJGRUDA-BAYOR
Factors Considered in Depreciation

Physical life of a property - The length of time during which it is capable for
performing the function for which it was designed and manufactured

Economic life - The length of time during which the property may be operated
at a profit

ENGR. RJGRUDA-BAYOR
Requirements of a Depreciation Method
1. It should be simple
2. It should recover capital
3. The book value will be reasonably close to the market value at any time
4. The method should be accepted by the Bureau of Internal Revenue

Note: It is the taxpayer who initially determines the method of depreciation.

However, change of depreciation method would require an approval of the BIR.

ENGR. RJGRUDA-BAYOR

*[Link]
Notations

𝐿 = 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒 𝑜𝑓 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠 𝐶0 = 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝐶𝑛 = 𝑡ℎ𝑒 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 𝑜𝑓 𝑛 𝑦𝑒𝑎𝑟𝑠

𝑑 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐷𝑛 = 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑢𝑝 𝑡𝑜 𝐶𝐿 = 𝑣𝑎𝑙𝑢𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑙𝑖𝑓𝑒,

𝑎𝑔𝑒 𝑜𝑓 𝑛 𝑦𝑒𝑎𝑟𝑠 𝑠𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒
(𝑖𝑛𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑔𝑎𝑖𝑛 𝑜𝑟 𝑙𝑜𝑠𝑠 𝑑𝑢𝑒 𝑡𝑜 𝑟𝑒𝑚𝑜𝑣𝑎𝑙)

𝑑𝑛 = 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑐ℎ𝑎𝑟𝑔𝑒 𝑇 = 𝑡𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑄𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓

𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑛𝑡ℎ 𝑦𝑒𝑎𝑟 𝑜𝑢𝑡𝑝𝑢𝑡 𝑢𝑝 𝑡𝑜 𝑒𝑛𝑑 𝑜𝑓 𝑙𝑖𝑓𝑒 𝑜𝑢𝑡𝑝𝑢𝑡 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑛𝑡ℎ 𝑦𝑒𝑎𝑟
𝑘 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

ENGR. RJGRUDA-BAYOR
Straight-Line Method
Lesson 2

ENGR. RJGRUDA-BAYOR
Straight-Line Method
SL depreciation is the simplest depreciation method. It assumes that a
constant amount is depreciated each year over the depreciable (useful) life
of the asset.

Formula:

Annual cost of depreciation, d

𝐶𝑜 − 𝐶𝐿
𝑑=
𝐿
Depreciation up to age n years, 𝐷𝑛
𝑛(𝐶𝑜 − 𝐶𝐿 )
𝐷𝑛 =
𝐿
Book value at the end of n years, 𝐶𝑛
𝐶𝑛 = 𝐶0 − 𝐷𝑛

ENGR. RJGRUDA-BAYOR
Example
An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at
the end of life of ₱5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years using the straight-line method.

Given: Find:
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 Depreciation charge during the 13th year, 𝑑13
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Book value at the end of 13 years, 𝐶13
Useful life, 𝐿 = 17 𝑦𝑒𝑎𝑟

Solution:
𝑛(𝐶 −𝐶 )
Solve for 𝐷𝑛 = 𝑜𝐿 𝐿
13(100000 − 5000)
𝐷13 = = 𝟕𝟐, 𝟔𝟒𝟕. 𝟎𝟔
17
Therefore, 𝐶𝑛 = 𝐶0 − 𝐷𝑛
𝐶13 = 100,000 − 72,647.06 = 𝟐𝟕, 𝟑𝟓𝟐. 𝟗𝟒
ENGR. RJGRUDA-BAYOR
Example

ENGR. RJGRUDA-BAYOR
Sinking-Fund Method
Lesson 3

ENGR. RJGRUDA-BAYOR
The Sinking Fund Method
• A technique for depreciating an asset while generating enough money to replace it at the
end of its useful life. Assumes that a sinking fund is established in which funds will
accumulate for replacement
• These funds sit in a sinking fund account and generate interest
• The total depreciation that has taken place up to any given time is assumed to be equal
to the accumulated amount in the sinking fund at that time

Formula: Recall:
F=A(F/A,i%,n)
Annual depreciation, d 1+𝑖 𝑛−1
𝐶0 − 𝐶𝐿 𝐹=𝐴
𝑑= 𝑖
𝐹 Τ𝐴 , 𝑖%, 𝐿
Depreciation during the nth year, 𝑑𝑛
𝑑𝑛 = 𝐷𝑛 − 𝐷𝑛−1
Depreciation up to age n years, 𝐷𝑛
1+𝑖 𝑛−1
𝐷𝑛 = 𝑑 𝐹 Τ𝐴 , 𝑖%, 𝑛 = 𝑑
𝑖
ENGR. RJGRUDA-BAYOR
Book value at the end of n years, 𝐶𝑛
𝐶𝑛 = 𝐶0 − 𝐷𝑛
Example
An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at
the end of life of ₱5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years using the sinking fund method at 12%.

Given: Find:
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 Depreciation charge during the 13th year, 𝑑13
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Book value at the end of 13 years, 𝐶13
Useful life, 𝐿 = 17 𝑦𝑒𝑎𝑟
Rate of interest, i=12
Solution:
Solve for d
100000 − 5000
𝑑= = 𝟏𝟗𝟒𝟑. 𝟑𝟗
1 + 0.12 17 − 1
0.12
1+𝑖 𝑛 −1
Solve for 𝐷𝑛 = 𝑑
𝑖
1 + 0.12 13 − 1
𝐷13 = 1943.39 = 𝟓𝟒, 𝟒𝟕𝟏. 𝟒𝟕
0.12
Therefore, 𝐶𝑛 = 𝐶0 − 𝐷𝑛 ENGR. RJGRUDA-BAYOR

𝐶13 = 100,000 − 54,471.47 = 𝟒𝟓, 𝟓𝟐𝟖. 𝟓𝟑

Example

ENGR. RJGRUDA-BAYOR
Declining-Balance Method
Lesson 4

ENGR. RJGRUDA-BAYOR
Declining Balance Method
• Sometimes called the constant-percentage method or the Matheson formula
• it is assumed that the annual cost of depreciation is a fixed percentage of the book value
at the beginning of the year
• A fixed asset as providing its service in a decreasing fashion
• This method cannot be used if salvage value is zero.

Formula:
Depreciation during the nth year, 𝑑𝑛
𝑑𝑛 = 𝐶0 1 − 𝑘 𝑛−1 𝑘

Rate of depreciation, k
𝑛 𝐶𝑛 𝐿 𝐶𝐿
𝑘 = 1− =1−
𝐶0 𝐶0
Depreciation up to age n years, 𝐷𝑛
𝐷𝑛 = 𝐶0 − 𝐶𝑛
Book value at the end of n years, 𝐶𝑛
𝑛
𝑛
𝐶𝐿 𝐿
𝐶𝑛 = 𝐶0 1 − 𝑘 = 𝐶0
𝐶0 ENGR. RJGRUDA-BAYOR

𝑳
𝑪𝑳 = 𝑪𝟎 𝟏 − 𝒌
Example
An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at
the end of life of ₱5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years using declining balance method.
Given: Find:
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 Depreciation charge during the 13th year, 𝑑13
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Book value at the end of 13 years, 𝐶13
Useful life, 𝐿 = 17 𝑦𝑒𝑎𝑟

Solution:
𝑛 𝐶𝑛 𝐿 𝐶𝐿
Solve for k, 𝑘 = 1 − =1−
𝐶0 𝐶0

17 5000
𝑘 =1− = 0.1616
100000
Solve for 𝑑13 , 𝑑𝑛 = 𝐶0 1 − 𝑘 𝑛−1
𝑘
13−1
𝑑13 = 100000 1 − 0.1616 0.1616 = 1949.74
𝑛
𝐶𝐿 𝐿
Therefore,𝐶𝑛 = 𝐶0 1 − 𝑘 𝑛
= 𝐶0
𝐶0
13 ENGR. RJGRUDA-BAYOR

50000 17
𝐶𝑛 = 100000 = 𝟏𝟎, 𝟏𝟏𝟖. 𝟎𝟎
100000
Example

ENGR. RJGRUDA-BAYOR
Double Declining-Balance
Method
Lesson 5

ENGR. RJGRUDA-BAYOR
Declining Balance Method
• Very similar to the declining balance method but k is replaced by 2/L.
• A fixed asset as providing its service in a decreasing fashion

Formula:
Depreciation during the nth year, 𝑑𝑛
𝑛−1 𝑘
𝑑𝑛 = 𝐶0 1 − 𝑘
Rate of depreciation, k
2
𝑘=
𝐿
Depreciation up to age n years, 𝐷𝑛
𝐷𝑛 = 𝐶0 − 𝐶𝑛
Book value at the end of n years, 𝐶𝑛
𝐶𝑛 = 𝐶0 1 − 𝑘 𝑛
𝑪𝑳 = 𝑪𝟎 𝟏 − 𝒌 𝑳

ENGR. RJGRUDA-BAYOR
Example
An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at
the end of life of ₱5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years using double-declining balance method.

Given: Find:
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 Depreciation charge during the 13th year, 𝑑13
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Book value at the end of 13 years, 𝐶13
Useful life, 𝐿 = 17 𝑦𝑒𝑎𝑟

Solution:
2
Solve for k, 𝑘 =
𝐿
2
𝑘= = 0.1176
17
Solve for 𝑑13 , 𝑑𝑛 = 𝐶0 1 − 𝑘 𝑛−1
𝑘
13−1
𝑑13 = 100000 1 − 0.1176 0.1176 = 2619.93
Therefore,𝐶𝑛 = 𝐶0 1 − 𝑘 𝑛

𝐶𝑛 = 100000 1 − 0.1176 13 = 𝟏𝟗, 𝟔𝟒𝟗. 𝟒𝟓 ENGR. RJGRUDA-BAYOR

Example

ENGR. RJGRUDA-BAYOR
Sum-of-the-Years-Digits (SYD)
Method
Lesson 6

ENGR. RJGRUDA-BAYOR
SYD Method
• Similar to the concept of DB but with a decreasing depreciation rate
• Charges a larger fraction of the cost as an expense of the early years than of later years.

Formula:
Depreciation during the nth year, 𝑑𝑛
𝑑𝑛 = 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑓𝑎𝑐𝑡𝑜𝑟 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡𝑠
𝑑𝑛 = (𝐶 − 𝐶𝐿 )
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 0
Where
reverse digits= number of years of estimated life remaining as of the beginning of the year
Sum of digits= sum of the years

Depreciation up to age n years, 𝐷𝑛

𝑛 2𝐿 − 𝑛 + 1
𝐷𝑛 = (𝐶0 − 𝐶𝐿 )
𝐿 𝐿+1
Book value at the end of n years, 𝐶𝑛
𝐶𝑛 = 𝐶0 − 𝐷𝑛
ENGR. RJGRUDA-BAYOR
Example
An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at
the end of life of ₱5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years using sum-of=the-years-digits method.

Given: Find:
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 Depreciation charge during the 13th year, 𝑑13
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Book value at the end of 13 years, 𝐶13
Useful life, 𝐿 = 17 𝑦𝑒𝑎𝑟

Solution:
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡𝑠
Solve for 𝑑𝑛 = (𝐶0 − 𝐶𝐿 )
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠
5
𝑑𝑛 = 100000 − 5000 = 3,104.58
153
𝑛 2𝐿−𝑛+1
Solve for 𝐷13 , 𝐷𝑛 = (𝐶0 − 𝐶𝐿 )
𝐿 𝐿+1
13 2 17 − 13 + 1
𝐷13 = 100000 − 5000 = 𝟖𝟖, 𝟕𝟗𝟎. 𝟖𝟓
17 17 + 1
Therefore,𝐶𝑛 = 𝐶0 − 𝐷𝑛 ENGR. RJGRUDA-BAYOR

𝐶13 = 100000 − 88,790.85 = 11,209.15

Example

ENGR. RJGRUDA-BAYOR
ENGR. RJGRUDA-BAYOR
The Service-Output Method
Lesson 7

ENGR. RJGRUDA-BAYOR
Service-Output Method
• Assumes that the total depreciation that has taken place is directly proportional to the
quantity of output of the property up to that time
• Has the advantage of making the unit cost of depreciation constant and giving low
depreciation expense during periods of low production

Formula:
➢ Depreciation based on output, 𝒅𝒏
𝐶0 − 𝐶𝐿
Note:
𝑑𝑛 = 𝑄𝑛 𝐶0 − 𝐶𝐿
𝑇 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑢𝑡𝑝𝑢𝑡 =
Where 𝑇
T= total units of output up to end of life
Qn= total number of units of output during the nth year

➢ Depreciation based on working hours, 𝒅𝒏 Note:

𝐶0 − 𝐶𝐿
𝑑𝑛 = 𝐻𝑛 𝐶0 − 𝐶𝐿
𝐻 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 ℎ𝑜𝑢𝑟 =
Where 𝐻
Hn= total number of working hours during the nth year
H= total working hours up to end of life
ENGR. RJGRUDA-BAYOR
Example
A television company purchased machinery for ₱100,000 on July1, 1979. It is estimated that it will have a
useful life of 10 years; scrap value of ₱4,000, production of 400,000 units and working hours of 120,000.
The company uses the machinery for 18,000 hours in 1980 and produces 44,000 units. Compute the
depreciation for 1980 using each method given below:
1)Straight-Line Method
2)Working Hours
3)Output Method

Given: Straight-Line Method

100000 − 4000
Initial Cost, 𝐶𝑜 = 𝑃100,000.00 𝑑80 = = 𝑃9.600.00
10
Scrap value, 𝐶𝐿 = 𝑃5,000.00 Working Hours
Useful life, 𝐿 = 10 𝑦𝑒𝑎𝑟 100000 − 4000
Production, 𝑇 = 400,000 𝑢𝑛𝑖𝑡𝑠 𝑑80 = 18000 = 𝑃14,400.00
120000
Working hours, 𝐻 = 120,000 Output Method
Production in 1980, 𝑄80 = 44000 100000 − 4000
Working hours in 1980, 𝐻80 = 18000 𝑑80 = 44000 = 𝑃10,560.00
400000
Find 𝒅𝟖𝟎
ENGR. RJGRUDA-BAYOR
References:
Chapter 7 (Sullivan, Wicks & Koelling)
Chapter 16 (Blank & Tarquin)
Chapter 4 (Sta. Maria)

ENGR. RJGRUDA-BAYOR