What Is Depreciation?

Depreciation is the decrease of in the value of physical property with the passage
of time.
DEFINITION OF TERMS
Value, in a commercial sense, is the present worth of all future profits that are to be
received through ownership of a particular property.
The market value of a property is the amount which a willing buyer will pay to a willing
seller for the property where each has an equal advantage and is under no compulsion to
buy or sell.
The Utility or use value of a property, is what the property is worth to the owner as an
operating unit.
Fair Value is the value which is usually determined by a disinterested third party in order
to established a price that is fair to both seller and buyer.
Book Value, sometimes is called depreciated book value, is the worth of a property as
shown on the accounting records of an enterprise.
Salvage, or resale, value is the price that can be obtained from the sale of the property
after it has been used.
Scrap value is the amount the property would sell for its disposed off as junk.
PURPOSE OF DEPRECIATION
1. To provide for the recovery of capital which has been invested in physical
2. To enable the cost of depreciation to be charged to the cost of producing product or
services that result from the use of the property.
TYPES OF DEPRECIATION
1. Normal depreciation
a) Physical
b) functional
2. Depreciation due to changes in price levels
3. Depletion
Physical depreciation is due to the lessening of the physical ability of the property to
produce results. Its common causes are wear and deterioration.
Functional depreciation is due to the lessening in the demand for the function which
the property was designed to render. Its common causes are inadequacy, changes in
styles, population center shifts, saturation of markets or more efficient machines are
produced.
Depreciation due to changes in price level is almost impossible to predict and
therefore is not considered in economy studies.
Depletion refers to the decrease in the value of a property due to the gradual
extraction of its contents.
Types of Depreciation With Calculation Examples
There are a number of methods that accountants can use to depreciate capital assets.
They include straight-line, sinking fund, declining balance, double-declining balance, sum-
of-the-years' digits, and unit of production. We've highlighted some of the basic principles
of each method below, along with examples to show how they're calculated

DEPRECIATION METHODS
We shall use the following symbols for the different depreciation methods.

L Useful life of the property in years

Co Original cost

CL The value at the end of the life, the scrap

value (including gain or loss due to removal)
d The annual cost of depreciation

Cn The book value at the end of n years

Dn Depreciation up to age n years

STRAIGHT LINE METHOD

This method assumes that the loss in value is directly proportional to the age of the
property.
𝐶𝑜 − 𝐶𝑙
𝑑=
𝐿

𝑛(𝐶𝑜 − 𝐶𝑙)
𝐷𝑛 =
𝐿
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛

EXAMPLE NO.1
An electronic balance costs Php 90,000 and has estimated salvage value of Php 8,000 at
the end of its 10 years lifetime. What would be the book value after three years, using
straight method in solving for the depreciation

L Useful life of the property in years

𝐶𝑜 − 𝐶𝑙
=
Co Original cost 𝐿
CL The value at the end of the life, the
scrap value (including gain or loss 𝑛(𝐶𝑜 − 𝐶𝑙)
due to removal) 𝐷𝑛 =
d The annual cost of depreciation 𝐿
Cn The book value at the end of n years
Dn Depreciation up to age n years
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
EXAMPLE NO.2
An asset is purchased for Php 500,000. The salvage value in 25 years is Php 100,000.
What are depreciation in the first three years using straight line method.

L Useful life of the property in years

𝐶𝑜 − 𝐶𝑙
𝑑=
Co Original cost 𝐿
CL The value at the end of the life, the
scrap value (including gain or loss 𝑛(𝐶𝑜 − 𝐶𝑙)
due to removal) 𝐷𝑛 =
d The annual cost of depreciation 𝐿
Cn The book value at the end of n years 𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Dn Depreciation up to age n years

EXAMPLE NO3.
The cost of equipment is Php 500,000 and the cost of installation is PHp 30,000. If the
salvage value is 10 % of the cost of equipment at the end of 5 years, determine the book
value at the end of the fourth year.

L Useful life of the property in years

Co Original cost
CL The value at the end of the life, the
scrap value (including gain or loss
due to removal)
d The annual cost of depreciation

Cn The book value at the end of n years

Dn Depreciation up to age n years
SINKING FUND METHOD
This method assumes that a sinking fund is established in which fund 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.
𝐶𝑜 − 𝐶𝑙 𝐶𝑜 − 𝐶𝑙
𝑑= =
𝐹 (1 + 𝑖)𝐿 − 1
, 𝑖%, 𝐿 ( )
𝐴 𝑖
𝐹 (1 + 𝑖)𝑛 − 1
𝐷𝑛 = 𝑑 ( , 𝑖%, 𝑛) = 𝑑 ( )
𝐴 𝑖
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛

EXAMPLE NO1.
A broadcasting corporation purchased an equipment for Php 53,000 and paid Php 1,500
for freight and delivery charges to the job site. The equipment has a normal life of 10
years with a trade-in value of Php 5,000 against the purchase of a new equipment at the
end of the life.Determine the annual depreciation cost by the sinking fund method.
Assume interest at 6-1/2% compounded annually.

L Useful life of the property in years 𝐶𝑜 − 𝐶𝑙 𝐶𝑜 − 𝐶𝑙

𝑑= =
𝐹 (1 + 𝑖)𝐿 − 1
Co Original cost , 𝑖%, 𝐿 ( )
𝐴 𝑖
CL The value at the end of the life, the
scrap value (including gain or loss 𝐹 (1 + 𝑖)𝑛 − 1
due to removal) 𝐷𝑛 = 𝑑 ( , 𝑖%, 𝑛) = 𝑑 ( )
d The annual cost of depreciation 𝐴 𝑖
Cn The book value at the end of n years
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Dn Depreciation up to age n years
EXAMPLE NO 2
A unit of welding machine cost Php 45,000 with an estimated life of 5 years. Its salvage
value is Php 2,500 find its depreciation rate if sinking fund method. Assuming that will
deposit the money to a bank giving 8.5%. solve for the annual depreciation.

L Useful life of the property in years 𝐶𝑜 − 𝐶𝑙 𝐶𝑜 − 𝐶𝑙

𝑑= =
𝐹 (1 + 𝑖)𝐿 − 1
Co Original cost , 𝑖%, 𝐿 ( )
𝐴 𝑖
CL The value at the end of the life, the
scrap value (including gain or loss 𝐹 (1 + 𝑖)𝑛 − 1
due to removal) 𝐷𝑛 = 𝑑 ( , 𝑖%, 𝑛) = 𝑑 ( )
d The annual cost of depreciation 𝐴 𝑖
Cn The book value at the end of n years
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Dn Depreciation up to age n years

EXAMPLE NO 3
A certain machinery cost Php 50,000, last 12 years with a salvage value of Php5,000.
Money is worth 5%. If the owner decides to sell it after using it for 5 years. What is the
book value of the machine? Using sinking fund method.

L Useful life of the property in years 𝐶𝑜 − 𝐶𝑙 𝐶𝑜 − 𝐶𝑙

𝑑= =
𝐹 (1 + 𝑖)𝐿 − 1
Co Original cost , 𝑖%, 𝐿 ( )
𝐴 𝑖
CL The value at the end of the life, the
scrap value (including gain or loss 𝐹 (1 + 𝑖)𝑛 − 1
due to removal) 𝐷𝑛 = 𝑑 ( , 𝑖%, 𝑛) = 𝑑 ( )
d The annual cost of depreciation 𝐴 𝑖
Cn The book value at the end of n years
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Dn Depreciation up to age n years
EXAMPLE NO4
A php 110,000 chemical plant had an estimated life of 6 years and projected scrap value
of Php 10,000. After 3 years of operation an explosion made it a total loss. How much
money would have to be raised to put up a new plant costing Php 150,000, If a
depreciation reserved have been maintained during its 3 years of operation by sinking
fund method. assume 6% interest

L Useful life of the property in years 𝐶𝑜 − 𝐶𝑙 𝐶𝑜 − 𝐶𝑙

𝑑= =
𝐹 (1 + 𝑖)𝐿 − 1
Co Original cost , 𝑖%, 𝐿 ( )
𝐴 𝑖
CL The value at the end of the life, the
scrap value (including gain or loss 𝐹 (1 + 𝑖)𝑛 − 1
due to removal) 𝐷𝑛 = 𝑑 ( , 𝑖%, 𝑛) = 𝑑 ( )
d The annual cost of depreciation 𝐴 𝑖
Cn The book value at the end of n years
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Dn Depreciation up to age n years