Engineering Economy
Chapter 7: Depreciation
1
The objective of Chapter 7 is to
explain how depreciation affects
economic decision making.
Depreciation is an important
element in finding after-tax cash
flows.
Depreciation is the decrease in value of
physical properties with the passage of
time.
It is an accounting concept, a non-cash cost,
that establishes an annual deduction against
before-tax income.
It is intended to approximate the yearly
fraction of an asset’s value used in the
production of income.
Property is depreciable if
it is used in business or held to produce
income.
it has a determinable useful life, longer than
one year.
it is something that wears out, decays, gets
used up, becomes obsolete, or loses value
from natural causes.
it is not inventory, stock in trade, or
investment property.
Depreciable property is
tangible (can be seen or touched;
classified into: personal or real property)
or intangible (such as copyrights, patents,
or franchises).
depreciated, according to a depreciation
schedule, when it is put in service (when
it is ready and available for its specific
use).
1.Straight line (SL): constant amount of
depreciation each year over the depreciable
life of the asset.
N = depreciable life BVk = book value at
B = cost basis
end of k
SVN = salvage value
dk = depreciation in k
Pause and solve
Acme purchased a coordinate measurement
machine (CMM). The cost basis is $120,000 and it
has a seven-year depreciable life. Acme estimates a
salvage value of $22,000 at the end of seven years.
Determine the annual depreciation amounts using
SL depreciation. Tabulate the annual depreciation
amounts and book value of the CMM at the end of
each year.
Solution
B = $120,000 SV = $22,000 N = 7 years
Year Depreciation Ending Book Value
1 $14,000 $106,000
2 $14,000 $92,000
3 $14,000 $78,000
4 $14,000 $64,000
5 $14,000 $50,000
6 $14,000 $36,000
7 $14,000 $22,000
2.Declining-balance (DB): a constant-
percentage of the remaining BV is
depreciated each year.
The constant percentage (or depreciation rate) is
determined by R, where R = 2/N when 200%
declining balance is being used (what is the rate of
SL method), and R = 1.5/N when 150% declining
balance is being used.
TABLE 7-1 The 200% DB Method with Switchover
to the SL Method (Example 7-2)
The 3.units-of-production method can be
used when the decrease in value of the
asset is mostly a function of use, instead of
time. The cost basis is allocated equally
over the number of units produced over
the asset’s life. The depreciation per unit of
production is found from the formula
below.
Suggested Questions
1, 2, 3, 4, 6, 8, 9,
11, 13, 14, 17
12
Supplementary
13
The 4.Modified Accelerated Cost
Recovery System (MACRS) is the
principle method for computing
depreciation for property in
engineering projects. It consists of
two systems, the main system called
the General Depreciation System
(GDS) and the Alternative
Depreciation System (ADS).
When an asset is depreciated using MACRS,
the following information is needed to
calculate deductions.
Cost basis, B
Date the property was placed into
service
The property class and recovery period
The MACRS depreciation method
(GDS or ADS).
With MACRS:
SVN is zero
In general: ADS provides longer recovery period
and uses only SL method
Property needs to be qualified to be depreciated
under the ADS method
Real property is classified into: residential and
nonresidential with recovery periods different
between GDS and ADS.
Mainly, GDS uses DB with switching to SL method
while ADS uses the SL method mainly.
Half-year time convention is applied
Using MACRS is easy!
1. Determine the asset’s recovery period (Table
7-2).
2. For GDS, use the appropriate column from
Table 7-3 that matches the recovery period
to find the recovery rate, rk, and compute the
depreciation for each year as
TABLE 7-2 MACRS Class Lives and
Recovery Periods
TABLE 7-2 (continued) MACRS Class Lives and
Recovery Periods
TABLE 7-3 GDS Recovery Rates (rk) for the Six
Personal Property Classes
TABLE 7-3 GDS (continued) Recovery Rates (rk)
for the Six Personal Property Classes
TABLE 7-4 MACRS (GDS) Property Classes and Primary
Methods for Calculating Depreciation Deductions
TABLE 7-4 (continued) MACRS (GDS) Property Classes and
Primary Methods for Calculating Depreciation Deductions
Figure 7-1 Flow Diagram for Computing Depreciation
Deductions under MACRS
MACRS Spreadsheet
Figure 7-2 GDS Recovery Rate for 5-year Recovery Period Spreadsheet
Comprehensive example
Figure 7-3 BV Comparisons for Selected Methods of
Depreciation in Example 7-7 (Note: The bus is assumed to be sold
in year six for the MACRS-GDS method.)
