DEPRECIATION

Depreciation • The loss of value

• Can involve deterioration and
obsolescence
• a reduction in the value of an
asset with the passage of
time, due in particular to wear
and tear.
• It is the decline in assets value
over time
 Depreciation
Accounting
• The main function is to account for the cost of fixed assets in a
pattern that matches their decline in value over time.
• Capitalized Assets
Their cost are distributed by subtracting them as expenses
from gross income. One part at a time over a number of periods.
The systematic allocation of the initial cost of an asset in parts
over a time, known as its depreciable life in means accounting
depreciation or more commonly named as ASSET DEPRECIATION.
 The process 1. What is the cost of the
of asset?
depreciation 2. What is the depreciable
life of the asset?
3. What is the asset’s value at
the end of it’s useful life?
4. What method of method
will be used?
 What is a • A property for which a firm may take
depreciation deductions against
depreciable income.
asset? • Any depreciable property must be
1. Be used in business or held for the
production of income
2. Have a definite service life, which
must be longer than one year.
3. Be something that wears out,
decays, gets used-up, becomes
obsolete, or loses value from
natural causes.
Depreciable • Includes buildings, machinery,
equipment, vehicles and some
property intangible properties.
• Intangible property is property that has
value but cannot be seen or touched.
Example are
1. Copyrights and patents
2. Customer and subscription lists
3. Design and patterns
4. Franchises
 The cost • Represents the total cost that is claimed
as an expense over an asset’s life.
basis of an • The sum of the annual depreciation
asset expenses
• Includes the actual cost of the asset and
any incidental cost.
• What are incidental cost
• Examples are
– Freight
– Site Preparation
– Installation
 Example • Raymond Stamping Services purchased a
stamping machine priced at $21,500. The
Cost of the New Machine $22,700 firm ahs to pay a sales tax of $1,200 on
Freight $525 this purchase. Raymond also paid the
Installation Labor $1,350
inbound transportation charges of $525 on
Site Preparation $2,125
Cost of Machine (Cost $26,700
the new machine, as well as labor cost of
Basis) $1,350 to install the machine in the
factory. In addition, Raymond had to
prepare the site before installation at a
cost of $2,125. Determine the cost basis
for the new machine for depreciation
purposes.
Useful Life •How long will the
asset be useful to
the company?
Salvage • An asset’s estimated
Value value at the end of it’s
life.
Depreciation 1. Book Depreciation Method
Methods - a depreciation methods
for usage in financial reports.
(Balance Sheet or Income
Statement)
2. Tax Depreciation Method
- intended for the IRS/BIR
for the purpose of calculating
taxes.
 Book • Enables the firms to report
Depreciation depreciation to stockholders
and other significant
outsiders on the basis of the
matching concept. Therefore,
accounting loss of value of
the assets is generally
reflected.
 Tax • Allows firms to benefit from
Depreciation tax advantages of
depreciating assets more
quickly than would be
possible under the matching
concept.
• Tax depreciation allows firms
to defer paying income taxes.
 Book Depreciation Methods
1. Straight Line Method
2. Declining Balance Method (Matheson)
3. Sum 0f the Years Digit Method
4. Service Output Method
5. Sinking Fund Method
 Straight • Interprets a fixed asset as an
line method asset that provides its service
in a uniform fashion.
(SL)
• The asset provide an equal
amount of service in each
year of its useful life.
• Depreciation rate is 1/N,
where N is the depreciable
life.
Straight
Line
Method
 Example • Consider the following data on
an automobile:
Cost basis of the Asset - $10,000
Useful Life – 5 Years
N Dn Bn Estimated Salvage Value -
0
$2,000
1
2 Compute for the annual
3
4
depreciation value, and book
5 value.
 Example
N Dn Bn
0 $10,000
1 $1,600 $8,400
2 $1,600 $6,800
3 $1,600 $5,200
4 $1,600 $3,600
5 $1,600 $2,000
Declining • Recognizes that the stream of services provided
by a fixed asset may decrease over time.

Balance • The stream may be greatest in the first year of an

Method
asset’s service life and least on its last year.
• This pattern occurs because mechanical efficiency
of an asset tends to decline with age, or because
of the increasing likelihood that better equipment
will become available and make the original asset
obsolete.
• “ charges a larger fraction of the cost as an
expense of the early years than of the later years”
• α = (1/N)(multipier)
Formula
 Example • Consider the following
accounting information
Cost basis of the asset - $10,000
N Dn Bn
0 Useful Life - $5 years
1
2 Estimated Salvage Value - $2,000
3
4
Multiplier = 150%
5 Determine the Book value and
depreciation cost at the end of
each year
Example
N Dn Bn
0 $10,000
1 0.3($10,000) = $3,000 $7,000
2 0.3($7,000) = $2,100 $4,900
3 0.3($4,900) = $1,470 $3,430
4 0.3($3,430) = $1,029 $2,401
5 0.3($2,401) = $720.30 , $401 $2,000
Total $8,000
 Double • is a form of an
accelerated depreciation
Declining method in which the asset value is
Balance depreciated at twice the rate it is
done in the straight-line method.
Method Since the depreciation is done at
a faster rate (twice to be precise)
of the straight-line method it is
called accelerated depreciation.
• It is depreciation that is 200% vs
the straight line method.
 Example • Consider the following
accounting information
N Dn Bn
Cost basis of the asset - $10,000
0
Useful Life - $5 years
1
2 Estimated Salvage Value - $2,000
3
4 Multiplier = 200%
5
Determine the Book value and
depreciation cost at the end of
each year
Example
N Dn Bn
0 $10,000
1 0.4($10,000) = $4,000 $6,000
2 0.4($6,000) = $2,400 $3,600
3 0.4($3,600) = $1,440 $2,160
4 0.4($2,160) = $864 , $160 $2,000
5 0 $2,000
Total $8,000

• Tax law dos not permit to depreciate the

assets below their salvage value.
 Sum if the • The sum of years' digits
method is a form of accelerated
Years Digit depreciation that is based on the
Method assumption that the productivity
of the asset decreases with the
passage of time. Under
this method, a fraction is
computed by dividing the
remaining useful life of the asset
on a particular date by the sum
of the year's digits.
 Example • Consider the following
accounting information
N Dn Bn
Cost basis of the asset - $10,000
0 Useful Life - $5 years
1
2 Estimated Salvage Value - $2,000
3
4 Determine the Book value and
5 depreciation cost at the end of
each year
Example
N Dn Bn
0 $10,000
1 $8,000(5/15) = $2,666.67 $7,333.33
2 $8,000(4/15) = $2,133.33 $5,200.00
3 $8,000(3/15) = $1,600 $3,600.00
4 $8,000(2/15) = $1,066.67 $2,533.33
5 $8,000(1/15) = 533.33 $2,000
Total $8,000
Service • Units of Production Depreciation Method,
also known as Units of Activity and Units
Output of Usage Method of Depreciation,
calculates depreciation on the basis of
Method expected output or usage.
• For example, a machine may be
depreciated on the basis of output
produced during a period in proportion to
its total expected production capacity.
Therefore, useful life of an asset under
Units of Production Method is stated in
terms of production output or usage
rather than years of service.
Example • A truck for hauling coal has an estimated
net cost of $55,000 and is expected to give
service for 250,000 miles, resulting in a
$5,000 salvage value. Compute the
allowed depreciation amoung for the
truck usage of 30,000 miles.
• I - $55,000
• S - $5,000
• Total Service Units – 250,000 miles
• Usage for the year – 30,000 miles
• Dn = Service Units Consumed This Year * (I-
S) / Total Service Units
Example • Dn =
(30,000/250,000)*($55,000
- $5,000)
• Dn = $6,000

• Book Value = $55,000-

$6,000 = $49,000
 Declining
Balance Method
Straight
Double Declining
Line
Balance Method
Method
Declining
Sinking Balance Matheson
Fund Method Formula
Method

Depreciation
Methods

Service-
Output Sum-of-the-
Method Years-Digit
Method
Formulas
Straight Line Method
• Dn = (Cost – Salvage value) / Useful life
• Bn = (Cost – Dn)
Declining Balance Method
• Dn = α(I)(1-α)n-1
• Bn = I(1- α)n
Double Declining Balance Method
• Dn = α(I)(1-α)n-1
• Bn = I(1- α)n
Sum of Year Digit
• Dn = (Remaining Life / SYD) *(I-S)
• Bn = I - Dn
Units-of-production Depreciation
• Dn = (Units Produced / Capacity in Units) * (I-S)
• Bn = (Total Units Consumed / Capacity in Units) * (I-S)