Depreciation Depreciation Concepts Depreciation is the decrease in the value of physical property due to physical or economic reasons. Physical property shall include both tangible and intangible business property. Property which may be seen or touched such as transportation, machinery, furniture and office equipment, are classified as tangible. Intangible property on the other hand, includes franchise, copyright or patent. This chapter gives emphasis only on the depreciation of tangible property since engineering projects usually include this type of Property. Amortized cost which Is the accounting viewpoint for depreciation considers depreciation as the cost of a useful property which is periodically charged as an operating expense over its useful life, as such, depreciation charges are deductible from gross income before income taxes are paid. In general, a given property is considered subject to depreciation if it meets the following requirements: it must be used in business and not for personal use it must have a determinable useful life that is longer than one year. it is not product inventory, stocks, bonds or other assets of investment. it must be a property that loses its value due to deterioration, obsolescence and other natural causes, AONE Types of Depreciation 1. Physical Depreciation results in the decrease in the ability of a physical property to perform its intended service which is caused by corrosion, abrasion, decay, impact, heat, stress, and vibration. 2. Functional Depreciation results from obsolescence or inadequacy of the property to meet the demand required, which occurs when new and better equipment is available that is more efficient and less expensive to operate. This also occurs when the property can no longer satisfy the current or anticipated demand or when demand no longer exists. 3 Accident results when the property becomes a casualty of fire, flood or any acadent.Purpose of Depreciation Studies 1. To provide for the replacement of tangible property. 2 To provide for the recovery of invested capital. % To enable the cost of depreciation to be charged to the cost of manufacturing products or services rendered. Terminologies Value Is the measure of the worth that an individual ascribes to a property or service. Market Value Is the amount that a willing buyer pays a willing seller for the purchase of his property, where neither buyer nor seller is compelled to buy or sell. Fair Value Is the worth of a property to a disinterested third party, in order to establish a price that is fair to both buyer and seller. Book Value, BY Is the worth of a property at a given time as reflected in the accounting records of a business. It is the acquisition cost of the property, plus any adjustments, less the accumulated depreciation charges for a given period. Assessed Value Js the reported value used for property tax purposes. It is usually obtained by appraisal. Salvage Value, $ Is the price of a property when it can no longer operate at a profit. [t is the estimated worth of the property at the end of its productive life. Scrap Value, S Is the value of the property after it can no longer perform its intended function. It is the price that the property can command if it is sold as junk. Physical Life Is the period in which a given property is able to perform the function for which it was designed for.Economic or Useful Life, L Is also referred to as the property's depreciable life. It is the period during which a property may be operated at a profit. Acquisition Cost, P Is also referred to as first cost, it includes the purchase price of the property plus any expenses incurred (shipping, installation, improvement and repair) prior to initial service or operation of the property. Yearly Depreciation Charge, d, Is the depreciation charge for a given year of the property. Accumulated Depreciation, D, Is the total depreciation expense charged to a property after n years of service. Depreciation Table Is a tabulated depreciation schedule showing the yearly and accumulated depreciation charges, together with the book value at the end of each year of the property's useful life. Wearing Cost, (P-S) Is the accumulated depreciation of a property at the end of its useful life. Depreciation Funds ‘Are funds that are set aside out of profit so that capital is available for replacing essential equipment at the time of retirement. Recovery Period Is the time period required for capital cost recovery. This period is usually shorter than the economic life of the property in order to encourage capital investment and improve productivity.Depreciation Methods © Straight-Line Method (SLM) The SLM Is the simplest and most commonly used depredation method. It assumes that the loss of value is directly proportional to the age of the property so that the annual depreciation charge, d, and the depreciation rate, k, is constant. Hence, the book value, BV, of the property decreases each year at 2 uniform rate. Equations: A machine costs P8000.00 and has an estimated life of 10 years with a salvage value of P500.00. What is its bock value after 8 years using straightine method. Solution: P = P8000.00; L = 10 years; S = P500.00; n = 8 years Using SLM: Ds = Ze -s)= Hpleao00 -P500)| = P6000.00 BV, = P-D, = (P8000-P6000)=P2000.00An engineer bought an equipment for P500 000.00. Other expenses induding installation arnounted to P30 000.00, At the end of its estimated useful life of 10 years, the salvage value will be 10% of the first cost. Using straight line method of depreciation, what is the book value after five years? Solution: P = P500 000 + P30 000 = P530 000.00 $ = 0.1 (P530 000) = 753 000.00 L= 10 years; n= Syears Using SLM b, =2(p-s)- Zes%0 000-P53 000) =P47 700.00 BY, = P-D, = P530 000 -P47 700 BY, = P291 500.00 Based on its purchase price, a machine is expected to depreciate at uniform rate of 18% annually until it has zero salvage value. What is the useful life of the machine using SLD method? Solution:AA pick-up truck costs P960 000.00 and is expected to be used for 10 years after which it wil have a salvage value of P160 000.00. Find the book value at the end of the third year using a) Straight Line Depreciation Solution: P = P960 000.00; L~ 10 years; S~ P160 000.00; n ~ 3 years a) Using SLM n D, =-(P-S) rP-s) D, = 4 (P960 000 -P160 000) = P240 000.00 BY, =P -D, = (P960 000-240 000) BY, = P720000