Depreciation
Depreciation
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Depreciation is defined as the decrease in
the value of a property, such as machinery,
equipment, building or other structure, due to
the passage of time.
Depreciation
Value – preset worth of all future profits that
are to received through ownership
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
Depreciation
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Utility or use of property – is what the
property is worth to the owner as an
operating unit
Fair value – the value which is determined by
a disinterested third party in order to
establish a price that is fair to both seller and
buyer.
Depreciation
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Book value (depreciated book value) – worth of
a property as shown on the accounting records
of an enterprise
Salvage (resale) value – is the price that can be
obtained from the sale of property after it has
been used
Scrap value – amount the property would sell for
if disposed off as junk
Purposes of Depreciation
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To provide for the recovery of capital which
has been invested in physical property
To enable the cost of depreciation to be
charged to the cost of producing products or
services that results from the use of the
property
Types of Depreciation
Normal depreciation
Physical
Functional
Depreciation due to changes in price levels
Depletion
Depreciation Cost
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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 – is the length of time during
which the property may be operated at a profit
Requirements of a Depreciation Method
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It should be simple.
It should recover profit.
The book value will be reasonably close to
the market value at any time.
The method should be accepted by the
Bureau of Internal Revenue.
Depreciation Methods
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Straight Line Method
Sinking Fund Formula
Declining Balance Method
Double Declining Balance (DDB) Method
Sum of the Years’ Digits (SYD) Method
Service Output Method
Straight Line Method
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Straight Line Method assumes that the loss
in value is directly proportional to the age of
the property.
Straight Line Method
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Example 1
An electronic balance costs P90,000 and has
an estimated salvage value of P8,000 a the
end of its 10 years life time. What would be
the book value after three years, using the
straight line method?
Example 2
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A tax and duty free importation of a 30HP
sandmill (for paint manufacturing) cost
P360,000, CIF Manila. Bank charges, arrastre
and brokerage cost P5,000. Foundation and
installation costs were P25,000. Other
incidental expenses amounted to P20,000.
salvage value of the mill is estimated to be
P60,000 after 20 years. Find the appraisal value
of the mill, using straight line depreciation , at
the end of (a) 10 years and (b) 15 years.
Example 3
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A certain company makes it the policy that
for any new piece of equipment the annual
depreciation cost should not exceed 10% of
the original cost at any time with no salvage
or scrap value. Determine the length of
service life necessary if the depreciation
method used is straight line formula.
Sinking Fund Formula
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This method assumes that a sinking fund is
established in which funds will accumulate
for replacement.
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.
Sinking Fund Formula
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Example 4
A broadcasting corporation purchased
equipment worth P53,000 and paid P1,500
for freight and delivery charges to the site.
The equipment has a normal life of ten years
with a trade-in value of P5,000 against the
purchase of new equipment at the end of life.
Determine the book value at the end of 7
years using sinking fund method at 6%
interest.
Example 5
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Power to a remote transmitting station is
provided by a Diesel-electric generator unit.
The original cost of the unit is P65,000. it
costs P2,000 to ship the unit to the job site.
An additional cost of P3,000 was incurred for
installation. If the unit has an expected life of
10 years and a salvage value P5,000,
determine:
Example 5
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a. the annual depreciation cost by the straight
line method;
b. the annual depreciation cost by the sinking
fund method (Assume that the annual charge
for depreciation was deposited in a fund
drawing compound interest at the rate of 5%.)
Declining Balance Method (DBM)
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It is sometimes called the constant
percentage method or the Matheson Formula.
In this method, it is assumed that the annual
cost of depreciation is a fixed percentage of
the salvage value at the beginning of the
year
Declining Balance Method
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Declining Balance Method
Example 6
A certain type of machine loses 10% of its
value each year. The machine costs P2,000
originally. Make out a schedule showing the
yearly depreciation, the total depreciation
and the book value at the end of each year
for 5 years.
Book value at Depreciation Total
Book value at
Year beginning of during the depreciation at
end of year
year year 10% end of year
Double Declining Balance (DDB)
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Method
This method is very similar to the declining
balance method except that the rate of
depreciation k is replaced by 2/L.
Double Declining Balance Method
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Example 6
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.
Sum-of-the-Years’-Digits (SYD)
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Method
Sum-of-the-Years’-Digits (SYD)
Method
Service-Output Method
In this method, it is assumed that the total
depreciation that has taken place is directly
proportional to the quantity of the output of
the property up to that time.
Service-Output Method
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Example 7
An asphalt and aggregate mixing plant
having a capacity of 50 cu.m. every hour
costs P2,500,000. It is estimated to process
800,000 cu.m. during its life. During a certain
year, it processed 60,000 cu.m. if its scrap
value is P100,000, determine the total
depreciation during the year and the
depreciation cost chargeable to each batch
of 50 cu.m. using the service-output method.
Example 8
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A contractor imported a bulldozer for his job, paying
P250,000 to the manufacturer. Freight and insurance
charges amounted to P18,000; customs’, broker’s fees
and arrastre services, P8,500; taxes, permits and other
expenses, P25,000. If the contractor estimates the life of
the bulldozer to be 10 years with a salvage value of
P20,000, determine the book value at the end of 6 years,
using the (a) straight line formula, (b) sinking fund at 8%,
(c) Matheson formula, (d) double declining balance
method and (e) SYD method.
Example 9
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A machine costs P7,000, last 8 years and
has a salvage value at the end of life of P350.
Determine the depreciation charge during the
4th year and the book value at the end of 4
years by the (a) straight line method, (b)
declining balance method, (c) SYD method,
and (d) sinking fund method with interest at
12%.
Example 10
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A machine which costs P10,000 was sold as
scrap after being used for 10 years. If the
scrap value was P500, determine the
depreciation charge during the fifth year and
the book value at the end of 5 years using (a)
constant percentage method, (b) double
declining balance method, (c) SYD method
and (d) straight line formula.
