DEBRE MARKOS UNIVERSITY

INSTITUTE OF TECHNOLOGY
DEP’T OF CIVIL ENGINEERING

Engineering Economics
By; Dejene M.
Augest, 2019

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 CHAPTER-4

Depreciation
 1-A) Depreciation cost

Depreciation can mean

– a decrease in market value,
– a decrease in the value to the owner.

Important reasons for depreciation include

– deterioration,
– obsolescence.

Accountants define depreciation as follows:

the systematic allocation of the cost of an asset over its useful, or
depreciable life.
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 Depreciation: Requirements
In general business assets can only be depreciated if
they meet the following basic requirements:

 The property must have a useful life that can be

determined, and this life must be longer than one
year
 The property must be an asset that decays, gets
used up, wears out, becomes obsolete, or loses
value to the owner due to natural causes

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 Depreciation Calculation Fundamentals
Example.
Year Depreciation Book Value
A PC costs 1,800. Its annual (dt ) (BVt )
depreciation charges are 800, 600, 0 1,800
and 350 for three years.
1 800 1,000
2 600 400
3 350 50
 1,800 is called the cost, initial cost, or cost basis.
 dt denotes the depreciation deduction in year t.
 Thus d1 = 800, d2 = 600, d3 = 350.
 BVt denotes the book value at the end of year t.

BV0 = cost basis (e.g., 1,800)

BV1 = BV0 – d1 = cost basis – d1 (e.g., 1,000)
BV2 = BV1 – d2 = cost basis – (d1 + d2) (e.g., 400)
BV3 = BV2 – d3 = cost basis – (d1 + d2 + d3) (e.g., 50)

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 Depreciation Calculation Fundamentals
BVt = cost basis – (d1 + d2 + … + dt)
This equation is used to compute the book value of an asset at the end
of any time t.

Book value can be viewed as the remaining unallocated cost of an asset:

Book value = Cost – Depreciation charges made to date

Note:
If the item has a salvage value then the final book value will be the
salvage value.

Example:
The book value of the PC declines during the useful life from a value of

B = 1,800 at time 0 in the recovery period, to a value of S = 50 at time 3

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 Depreciation Methods

Some of the common methods used to calculate deprecation;

 Straight line,

 Sum-of-the-years digits, and

 Declining balance.
Each method requires estimates of the asset’s useful
life and salvage value.

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 Straight Line (SL) Depreciation
Year Initial Book Depr. EOY Book
Value Charge Value
Example 0 900
An asset has a cost of B = 900, 1 Cost = 900 166 734
a useful life of N = 5 years, and 2 734 166 568
an EOL salvage value of S = 70. 3 568 166 402
4 402 166 236
With straight line depreciation, 5 236 166 Salvage Value
we would compute the following: 70
Total Depr.: 830
Annual depreciation charge: Initial
di = (B-S)/N Book Value Cost
900
= 830/5 = 166.
Salvage
The book value of the asset Value
decreases by $166 each year
70

1 2 3 4 5 N
Useful Life 8
 Sum-Of-Years Digits (SOYD) Depreciation
Example
An asset has a cost of B = 900, a useful life of N = 5 years, and an EOL salvage
value of S = 70. With SOYD depreciation, we would compute the following

Year Life Multiplier B-S Depreciation Charge EOY Book Value

0 900
1 5 5/15 830 277 623
2 4 4/15 830 221 402
3 3 3/15 830 166 236
4 2 2/15 830 111 125
5 1 1/15 830 55 70

15 1 830

The product of the multiplier and B-S for the year is the depreciation charge
for the year. Note the multipliers add to 1.

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 Declining Balance Depreciation
For straight line depreciation with N years, the rate of decrease each year is 1/N.
Declining balance depreciation uses a rate of either 150% or 200% of the straight-
line rate.
Since 200% is twice the straight-line rate, it is called double declining balance (DDB).
The DDB equation for any year is

DDB depreciation dt = (2/N) ( Book value)

Book value = Initial cost – total charges to date,
So,
DDB deprec. dt = (2/N) (Initial cost – total charges to date)
It can be shown for DDB, that the depreciation schedule in year t is given by:
DDB depreciation in year t = (2B/N)(1 – 2/N)t-1
For 150% declining balance depreciation, the depreciation in year t is given by:
DDB depreciation in year t =(1.5 B/N)(1 – 1.5/N)t-1.
we just replace each “2” in the DDB formula by “1.5”.

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 Declining Balance Depreciation: Example
Example
An asset has a cost of B = 900, a useful life of N = 5 years, and an EOL salvage
value of S = 70. With DDB depreciation, we would compute the following

Year Multiplier Cost – Depreciation EOY

depreciation Charge Book
charges to date Value
0 900
1 2/5 900 360 540
2 2/5 540 216 324
3 2/5 324 130 194
4 2/5 194 78 116
5 2/5 116 46 70
830

If the salvage value of this example had not been 70, a modification of DDB would be
necessary.
Several possibilities exist:
• stop further depreciation when the book value equals the salvage value;
• “switch over” from DB depreciation to straight line.
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