Depreciation

Introduction
The difference between the original cost of a
property and any remaining value when it is
retired or worn out is an expense that should be
distributed to the periods during which the asset
is used.

The portion that is allocated to expense in a

particular period is referred to by three different
terms namely:
A. Depreciation
B. Depletion
C. Amortization
 Concept of Depreciation
Depreciation is defined as the systematic
allocation of the depreciable amount of an
asset over the useful life.

Depreciation is a matter of cost allocation in

recognition of the exhaustion of the useful life
of an item of property, plant, and equipment.

The objective of depreciation is to have each

period benefiting from the use of the asset
bear an equitable share of the asset cost.
 Depreciation in the Financial
Statements
Depreciation expense may be a part of the
cost of goods manufactured or an
operating expense.

Except for non exhaustible land, all

property shall be depreciated on a
systematic basis over the useful life of the
asset irrespective of the earnings of
the entity.
 Depreciation Period
Depreciation of an asset begins when it is
available for use, meaning, when the
asset is in the location and condition
necessary for it to be capable of operating
in the manner intended by management.

Depreciation ceases when the asset is

derecognized.
 Kinds of Depreciation
1. Physical depreciation
2. Functional or Economic
depreciation
 Physical Depreciation
Physical depreciation is related to the
depreciable asset’s wear and tear and
deterioration over a period.
Physical depreciation may be caused by:
A. Wear and tear due to frequent use
B. Passage of time due to non use
C. Action of the elements such as
wind, sunshine, rain or dust
D. Casualty or accident such as fire,
flood, earthquake and other natural
disaster
E. Disease or decay – applicable to
animals and wooden buildings
 Functional or Economic
Depreciation
Functional or economic depreciation arises
from inadequacy, supersession and
obsolescence.
Inadequacy arises when the asset is no longer
useful to the entity because of an increase in the
volume of operations.

Supersession arises when a new asset becomes

available and the new asset can perform the same
function more efficiently and economically or for
substantially less cost.

Obsolescence arises when there is no future

demand for the product which the asset produces. It
encompasses inadequacy and supersession.
 Factors of Depreciation
1. Depreciable amount
2. Residual value
3. Useful life
 Depreciable Amount
Depreciable amount or depreciable
cost is the cost of an asset or other
amount substituted for cost, less the
residual value.
 Residual Value
Residual value is the estimated net
amount currently obtainable if the asset is
at the end of the useful life.
 Useful Life
Useful life is either the period over which
an asset is expected to be available for use
by the entity, or the number of production
or similar units expected to be obtained
from the asset by the entity.

The useful life of an asset is expressed as:

A. Time periods as in years
B. Units of output or production
C. Service hours or working hours
 Factors in Determining Useful
Life
A. Expected usage of the asset – usage is
assessed by reference to the asset’s expected
capacity or physical output.
B. Expected physical wear and tear – depends
on the operational factors such as the number of
shifts the asset is used, the repair and maintenance
program, and the care and maintenance while the
asset is idle.
C. Technical or commercial obsolescence –
this arises from changes or improvements in
production, or changes in the market demand for
the product output of the asset.
D. Legal limits for the use of the asset –
expiry date of the related lease.
 Depreciation Method
The depreciation method shall reflect the
pattern in which the future economic
benefits from the asset are expected to be
consumed by the entity.

The method shall be changed if there is a

significant change in the expected pattern of
future economic benefits.

Such change in depreciation method shall be

accounted for as change in accounting
estimate.
 Methods of Depreciation
1. Equal or uniform charge methods
A. Straight line
B. Composite method
C. Group method

2. Variable charge or use-factor or activity

methods
A. Working hours or service hours
B. Output or production method
3. Decreasing charge or accelerated or
diminishing balance methods
A. Sum of years’ digits
B. Declining balance method
C. Double declining balance

4. Other methods

A. Inventory or appraisal
B. Retirement method
C. Replacement method
 Straight Line Method
The annual depreciation charge is calculated
by allocating the depreciable amount equally
over the number of years of estimated useful
life.

Annual depreciation = Cost minus residual

life
 Useful life in years

Cost minus residual value equals depreciable

amount.
 Straight Line Rate
The straight line rate is determined by
dividing 100% by the life of the asset
in years.

Depreciable amount multiplied by the

straight line rate of depreciation gives
the amount of annual depreciation.
 Rationale for Straight
Line
The straight line approach considers
depreciation as a function of time rather
than as a function of usage.
 Illustration
The following data relate to an equipment
acquired at the beginning of the first year:
Equipment
P105,000
Residual value
5,000
Useful life 5
years
 Depreciation Table – Straight Line
 (a) (b) (c)
 Accumulated
Carrying
 Year Particular Depreciation depreciation
amount
 Acquisition cost
105,000
1 Depreciation for first year 20,000 20,000
85,000
2 Depreciation for second year 20,000 40,000
65,000
3 Depreciation for third year 20,000 60,000
45,000
4 Depreciation for fourth year 20,000 80,000 25,000
5 Depreciation for fifth year 20,000 100,000 5,000
 100,000
 Journal Entry
Depreciation 20,000
 Accumulated depreciation
20,000
 Statement Presentation
When a statement of financial position is
prepared at the end of the first year, the
equipment account is classified as
property, plant and equipment.
Equipment
105,000
Accumulated depreciation
(20,000)
Carrying amount
85,000
 Composite and Group
Method
Two methods of depreciating various
individual assets as a single asset are
composite method and group method.
 Under the composite method, assets that are
dissimilar in nature or assets that have different
physical characteristics and vary widely in useful
life, are grouped and treated as a single unit.

 Under the group method all assets that are

similar in nature and in estimated useful life are
grouped and treated as a single unit.

 The average useful life and the composite or

group rate are computed, and the assets in the
group are depreciated on that basis.
 Accounting Procedures
 A. Depreciation is reported in a single accumulated
depreciation account.
 B. The composite or group rate is multiplied by the
total cost of the assets in the group to get the
periodic depreciation.
 C. When an asset in the group is retired, no gain or
loss is reported.
 D. When the asset retired is replaced by a similar
asset, the replacement is recorded by debiting the
asset account and crediting cash or other
appropriate account. The composite or group rate
is multiplied by the balance of the asset account
to get the periodic depreciation.
 Composite Method
 The following computation is necessary in determining the composite
life and composite rate:
 (a) (b) (a
+b)
 Residual Depreciable Useful life
Annual
 Asset Cost value amount in years
depreciation
 Building 650,000 50,000 600,000 15
40,000
 Machinery 220,000 20,000 200,000 8
25,000
 Equipment 130,000 30,000 100,000 4
25,000
 1,000,000 100,000 900,000
90,000
The composite life is determined by
dividing the total depreciable amount
by total annual depreciation.

The composite rate is determined by

dividing the total annual depreciation
by the total cost.
 The annual depreciation for the current year is reported as
follows:
 Depreciation 90,000
 Accumulated depreciation 90,000

 A statement of financial position prepared at the end of the

current year would report property, plant and equipment as
follows:
 Building 650,000
 Machinery 220,000
 Equipment 130,000
 Total 1,000,000
 Accumulated depreciation (90,000)
 Carrying amount 910,000
Retirement of Asset in the
Group
 If the equipment is retired after four years and sold for
P20,000, the journal entry is:
 Cash 20,000
 Accumulated depreciation 110,000
 Equipment 130,000

 If there are no proceeds from the retirement of the

equipment, the journal entry is:
 Accumulated depreciation 130,000
 Equipment 130,000
The annual depreciation starting the fifth
year would be P78,300, computed by
multiplying the composite rate of 9% by the
remaining cost of P870,000.
 Retirement and Replacement of
Asset
 Upon the retirement of the equipment, the same is
replaced by a similar asset costing P160,000.
 The total cost of the assets in the group is now
P1,030,000.
 The annual depreciation starting the fifth year should be
9% times P1,030,000 or P92,700.
 Variable Charge Or Activity
Methods
The variable or activity methods assume
that depreciation is more of a function of
use rather than passage of time.

The useful life of the asset is considered in

terms of the output it produces or the
number of hours it works.
Two variable methods:
A. Working hours method
B. Output or production method
 Rationale for Variable
Depreciation
The use of the variable methods is based
on the following:
A. Assets depreciate more rapidly if they
are used full time or overtime.
B. There is a direct relationship between
utilization of assets and realization of
revenue.
 Illustration
 Machinery, at cost 600,000
 Residual value None
 Estimated useful life:
 Years 5 years
 Service hours 60,000 hours
 Output 150,000 units

 Actual operations Service hours

Output
 First year 14,000 34,000
 Second year 13,000 32,000
 Third year 10,000 25,000
 Fourth year 11,000 29,000
 Fifth year 12,000 30,000
 60,000 150,000
 Working Hours Method
Under this method, a depreciation rate
per hour is computed by dividing the
depreciable amount by the estimated
useful life in terms of service hours.

The depreciation rate per hour is

multiplied by the actual hours worked
in one period to get the depreciation for
that period.
 Depreciation Table – Working Hours
Method
 Accumulated
Carrying
 Year Particular Depreciation depreciation amount

600,000
1 14,000 x 10 140,000 140,000
460,000
2 13,000 x 10 130,000 270,000
330,000
3 10,000 x 10 100,000 370,000
230,000
4 11,000 x 10 110,000 480,000
120,000
5 12,000 x 10 120,000 600,000 --
 600,000
 Output or Production
Method
A depreciation rate per unit is
computed by dividing the depreciable
amount by the estimated useful life in
terms of units of output.

The depreciation rate per unit is

multiplied by the yearly output to get
the annual depreciation.
 Depreciation Table – Output Method
 Accumulated
Carrying
 Year Particular Depreciation depreciation
amount

600,000
1 34,000 x 4 136,000 136,000
464,000
2 32,000 x 4 128,000 264,000
336,000
3 25,000 x 4 100,000 364,000
236,000
4 29,000 x 4 116,000 480,000
120,000
5 30,000 x 4 120,000 600,000 -
 600,000
 Decreasing Charge or Accelerated
Methods
The decreasing charge or accelerated
methods provide higher depreciation in the
earlier years and lower depreciation in the
later years of the useful life of the asset.

These methods result in a decreasing

depreciation charge over the useful life.
 Rationale for Accelerated
Depreciation
The accelerated depreciation is on the
philosophy that new assets are generally
capable of producing more revenue in the
earlier years than in the later years.
 Sum of Years’ Digits
The sum of years’ digits method provides for
depreciation that is computed by multiplying
the depreciable amount by a series of
fractions whose numerator is the digit in
the useful life of the asset and whose
denominator is the sum of the digits in
the useful life of the asset.

The fractions are developed by getting the

sum of the digits in the useful life of the asset.
Alternate formula:
SYD = Life ( Life + 1 )
 2
 Sum of Half Years’ Digits
 If the useful life of the asset is 2 ½ years, the procedure
is to multiply the useful life by 2 in order to get the
useful life of the asset in half years.

 Thus, the useful life of the asset in half years would be 5

(2 ½ years x 2). The sum of half years’ digits would be
15 or 1 + 2 + 3 + 4 + 5.

 First year – Two fractions: 5/15 and 4/15 (each fraction

pertaining to half year or six months)
 Second year – Two fractions: (3/15 and 2/15)
 Third year – One fraction: 1/15
 Illustration – Sum of
Years’ Digits
Machinery 430,000
Residual Value
30,000
Estimated useful life 4
years

SYD = 4 ( 4 + 1 ) = 10
 2
 Depreciation Table – Sum of Years’
Digits
 Accumulated
Carrying
 Year Particular Depreciation depreciation
amount

430,000
1 4/10 x 400,000 160,000 160,000
270,000
2 3/10 x 400,000 120,000 280,000
150,000
3 2/10 x 400,000 80,000 360,000
70,000
4 1/10 x 400,000 40,000 400,000
30,000
 400,000
 Fractional Depreciation – Sum of
Years’ Digits
Cost of asset
300,000
Residual value
None
Date of acquisition
April 1. 2020
Estimated useful life
3 years

SYD = 1 + 2 + 3 = 6
 Depreciation for Each Year of the
Useful Life
 From April 1, 2020 to March 31, 2021 ( 3/6 x P300,000)
150,000
 From April 1, 2021 to March 31, 2022 ( 2/6 x P300,000)
100,000
 From April 1, 2022 to March 31, 2023 (1/6 x P300,000)
50,000

300,000
 Computation of Depreciation –
Calendar Period
 Depreciation for 2020:
 P150,000 x 9/12 ( April 1, 2020 to December 31, 2020) 112,500
 Depreciation for 2021:
 P150,000 x 3/12 ( January 1 to March 31, 2021 ) 37,500
 P100,000 x 9/12 ( April 1 to December 31, 2021) 75,000
 112,500
 Depreciation for 2022:
 P100,000 x 3/12 ( January 1 to March 31, 2022) 25,000
 P 50,000 x 9/12 (April 1 to December 31, 2022) 37,500
 62,500
 Depreciation for 2023:
 P50,000 x 3/12 (January 1 to March 31, 2023) 12,500
Double Declining Balance
Method
A fixed rate is multiplied by the
declining carrying amount of the asset to
arrive at the amount of depreciation.

Under the double declining balance method,

the straight line rate is doubled to get
the fixed rate.

The double declining balance method is also

known as “200% declining balance
method”.
 Illustration
Cost of asset
500,000
Date of acquisition January
1, 2020
Residual value
50,000
Estimated useful life 5
years
Straight line rate ( 100%/5 years) 20%
Double declining rate ( 20% x 2 ) 40%
 Accumulated
Carrying
 Year Particular Depreciation depreciation
amount
 Acquisition cost
500,000
 2020 40% x 500,000 200,000 200,000 300,000
 2021 40% x 300,000 120,000 320,000 180,000
 2022 40% x 180,000 72,000 392,000 108,000
 2023 40% x 108,000 43,200 435,200 64,800
 2024 64,800 – 50,000 14,800 450,000 50,000
 450,000
 150% Declining Balance
Under the 150% declining balance method,
the fixed rate is 150% of the straight
line rate.
 Illustration
Cost of asset 500,000
Residual value 50,000
Date of acquisition January 1,
2020
Useful life 5 years
Straight line rate (100%/5 years) 20%
Fixed rate (150% x 20%) 30%

Depreciation for 2020:

( 30% x 500,000 ) 150,000
 Inventory Method
 The inventory method consists of estimating the value
of the asset at the end of the period.

 The difference between the balance of the asset

account and the value at the end of the year is
recognized as depreciation for the year.

 In recording depreciation, no accumulated depreciation

is maintained. The depreciation is credited directly to
the asset account.

 This depreciation approach is applied generally to assets

which are small and relatively inexpensive such as
hand tools and utensils.
 Illustration – Inventory
Method
An entity uses the inventory method to account
for numerous small tools.
The following transactions concerning small tools
occurred during the current year.
Tools account, January 1
100,000
Acquisition, at cost
90,000
Sale of used tools, at residual value
2,000
Inventory of tools on December 31, at cost
125,000
 Journal Entries
 1. To record the acquisition:
 Tools 90,000
 Cash 90,000
 2. To record the sale of used tools at residual value:
 Cash 2,000
 Tools 2,000
 3. To record the depreciation of tools:
 Depreciation 63,000
 Tools 63,000
 Balance of tools account
188,000
 Inventory of tools – December 31
125,000
 Depreciation
63,000
 Retirement and Replacement
Method
 Under the retirement method of
depreciation, no depreciation is recorded until
the asset is retired.

 The amount of depreciation is equal to the

original cost of the asset retired minus
salvage proceeds.
Under the replacement method, no
depreciation is recorded until the asset is
retired and replaced.

The amount of depreciation is equal to the

replacement cost of the asset retired,
minus salvage proceeds.
If the asset is retired and not replace, the
original cost of the asset retired but
not replaced is recognized as
depreciation.

The retirement and replacement methods

are suitable when a large number of
similar items are employed by the entity
and the items are constantly being retired
and replace.
 Illustration
The following data relate to the tools
account for the current year:
Balance – January 1, 1,000 units at P50 per
unit 50,000
Acquisition – 2,500 units at P70 per unit
175,000
Retirement of tools – 1,200 units
Proceeds from retirement of tools
5,000
 Retirement Method
 1. To record the acquisition:
 Tools 175,000
 Cash 175,000

 2. To record the retirement:

 Cash 5,000
 Depreciation 59,000
 Tools 64,000
 Cost of tools retired (FIFO):
 1,000 units x 50 50,000
 200 units x 70 14,000
 1,200 64,000
 Replacement Method
 1. To record the acquisition of tools in excess of the
retirement (2,500 – 1,200 equals 1,300):
 Tools ( 1,300 x 70 ) 91,000
 Cash 91,000

 2. To record the replacement of the tools retired:

 Depreciation 79,000
 Cash 79,000

 Replacement cost of tools retired (1,200 x 70) 84,000

 Proceeds from retirement (5,000)
 Depreciation
79,000
 Change in Useful Life
 Unexpected physical deterioration or
technological improvement may indicate
that the useful life of the asset is less than
that originally estimated.

 On the other hand, improved maintenance

procedures or revision of operating
procedures may prolong the useful life of the
asset beyond the original estimate.
 Illustration
 A depreciable asset costing P500,000 is originally estimated
to have a useful life or 5 years.
 At the beginning of the third year, the original useful life is
revised to 8 years. Thus, the asset has a remaining useful
life of 6 years.

 Annual depreciation starting the third year:

 Cost 500,000
 Accumulated depreciation (500,000/5 x 2) 200,000
 Carrying amount – beginning of third year 300,000

 Annual depreciation starting the third year

(300,000/6) 50,000
 Change in Depreciation
Method
 Depreciation method used shall reflect the
pattern in which the asset’s economic
benefits are expected to be consumed by the
entity.

 The depreciation method shall be reviewed at

least at each financial year end and if there
has been a significant change in the expected
pattern of economic benefits embodied in the
asset, the method shall be changed to reflect
the new pattern.
 Illustration
 An entity decided to change from SYD to the straight line method of
depreciation on January 1, 2020.
 The asset is acquired on January 1, 2018 at a cost of P1,000,000 and
has an estimated useful life of 4 years.

 Carrying amount of the asset on January 1, 2020:

 Cost – January 1, 2018 1,000,000
 Accumulated depreciation:
 2018 (4/10 x 1,000,000) 400,000
 2019 (3/10 x 1,000,000) 300,000 700,000
 Carrying amount – January 1, 2020
300,000
 The depreciation for 2020 is as follows:
 Depreciation (300,000/2) 150,000
 Accumulated depreciation 150,000
 End of
Presentation