DEPRECIATION

- It is the decrease in the value of physical

property with the passage of time
 Definitions of Value

• 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 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
 Definitions of Value

• Fair value is the value which is usually determined by a

disinterested third party in order to establish a price that
is fair to both seller and buyer.
• Book value, sometimes called depreciated book value, is
the worth of the 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 if
disposed off as a junk.
Purpose of Depreciation

1. To provide for the recovery of capital which has

been invested in physical property

2. To enable the cost of depreciation to be charged to

the cost of producing products or services that
results from the use of the property.
 Types of Depreciation

• Normal depreciation
a) Physical depreciation – is due to the lessening of the physical
ability of a property to produce results (wear and deterioration)
b) Functional depreciation – is due to the lessening in the demand
for the function which the property was designed to render
(inadequacy, changes in styles, more efficient machines are
produced)
• Depreciation due to changes in price levels – is impossible to predict
and therefore is not considered in economy studies
• Depletion – refers due to the decrease in the value of a property due
to the gradual extraction of its contents
Physical and Economic Life

• Physical life of a property is the length of time

during which it is capable of performing the
function for which it was designed and
manufactured.

• Economic life is the length of time during which the

property may be operated at a profit.
Requirements of a Depreciation Method

1. It should be simple.
2. It should recover capital.
3. The book value will be reasonably close to the
market value at any time.
4. The method should be accepted by the Bureau of
Internal Revenue.
Symbols to be used for the different
depreciation methods:

• 𝑳 = 𝒖𝒔𝒆𝒇𝒖𝒍 𝒍𝒊𝒇𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒑𝒓𝒐𝒑𝒆𝒓𝒕𝒚 𝒊𝒏 𝒚𝒆𝒂𝒓𝒔

• 𝑪𝒐 = 𝒕𝒉𝒆 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
The 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
The Straight Line Method

Ex: An electronic balance costs P90,000 and has

an estimated salvage value of P8,000 at the end
of its 10 years life time. What would be the book
value after three years?
The Sinking Fund Method

• This method assumes that a sinking fund is

established in which funds 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.
The Sinking Fund Method

𝑪𝑶 −𝑪𝑳 𝒊
•𝒅 =
𝟏+𝒊 𝑳 −𝟏

𝒅 𝟏+𝒊 𝒏 −𝟏
• 𝑫𝒏 = 𝒊

• 𝑪𝒏 = 𝑪𝑶 − 𝑫𝒏
The Sinking Fund Method

Ex: A broadcasting corporation purchased an equipment

for P53,000 and paid P1,500 for freight and delivery
charges to the job site. The equipment has a normal life
of 10 years with a trade-in-value of P5,000 against the
purchase of a new equipment at the end of the life.
a) Determine the annual depreciation cost by the
straight line method.
b) Determine the annual depreciation cost by the sinking
fund method .Assume interest at 6.5% compounded
annually.
Declining Balance Method

• Sometimes called the percentage method or the

Matheson Formula, it is assumed that the annual
cost of depreciation is a fixed percentage of the
salvage value at the beginning of the year.
• The ratio of the depreciation in any year to the
book value at the beginning of that year is
constant throughout the life of the property and is
designated by k, the rate of depreciation.
Declining Balance Method

Year Book value at beginning Depreciation during Book value at the end of year
of year the year
1 𝑪𝑶 𝒅𝟏 = 𝒌𝑪𝑶 𝑪𝟏 =𝑪𝑶 − 𝒅𝟏 =𝑪𝑶 𝟏 − 𝒌
2 𝑪𝑶 𝟏 − 𝒌 𝒅𝟐 = 𝒌𝑪𝟏 𝑪𝟐 =𝑪𝟏 − 𝒅𝟐 =𝑪𝑶 𝟏 − 𝒌 𝟐

3 𝑪𝑶 𝟏 − 𝒌 𝟐 𝒅𝟑 = 𝒌𝑪𝟐 𝑪𝟑 =𝑪𝟐 − 𝒅𝟑 =𝑪𝑶 𝟏 − 𝒌 𝟑

… … … …
n 𝑪𝑶 𝟏 − 𝒌 𝒏−𝟏 𝒅𝟏 = 𝒌𝑪𝒏−𝟏 𝑪𝒏 =𝑪𝒏−𝟏 − 𝒅𝒏 =𝑪𝑶 𝟏 − 𝒌 𝒏

… … … …
L 𝑪𝑶 𝟏 − 𝒌 𝑳−𝟏 𝒅𝑳 = 𝒌𝑪𝑳−𝟏 𝑪𝑳 =𝑪𝑳−𝟏 − 𝒅𝑳 =𝑪𝑶 𝟏 − 𝒌 𝑳
Declining Balance Method
𝒏−𝟏
• 𝒅𝒏 = 𝑪𝑶 𝟏 − 𝒌 𝒌

𝒏
𝒏 𝑪𝑳 𝑳
• 𝑪𝒏 = 𝑪𝑶 𝟏 − 𝒌 = 𝑪𝑶
𝑪𝑶

• 𝑪𝑳 = 𝑪𝑶 𝟏 − 𝒌 𝑳

𝒏 𝑪𝒏 𝑳 𝑪𝑳
•𝒌 =𝟏− =𝟏−
𝑪𝑶 𝑪𝑶
Declining Balance Method

• This method does not apply, if the salvage value

is zero, because k will be equal to 1 and 𝒅𝟏
= 𝑪𝑶 .
Declining Balance Method

Ex: A certain type of machine loses 10% of its value

each year. The machine costs P2,000 originally. Make
out a schedule showing the yearly depreciation, the
total depreciation and the book value at the end of
each year for 5 years.
 Double Declining Balance (DDB) Method

• This method is very similar to the declining balance method

𝟐
except that the rate of depreciation k is replaced by .
𝑳
𝟐 𝒏−𝟏 𝟐
• 𝒅𝒏 = 𝑪𝑶 𝟏 −
𝑳 𝑳

𝟐 𝒏
• 𝑪𝒏 = 𝑪𝑶 𝟏 −
𝑳

𝟐 𝑳
• 𝑪𝑳 = 𝑪𝑶 𝟏 −
𝑳
Double Declining Balance (DDB) Method

• When the DDB method is used, the salvage value should

not be subtracted from the first cost when calculating
the depreciation charge.
Double Declining Balance (DDB) Method

• Determine the rate of depreciation, the total

depreciation up to the end of the 8th year and the
book value at the end of 8 years for an asset that
costs P15,000 new and has an estimated scrap value
of P2,000 at the end of 10 years by (a) the declining
balance method and (b) the double declining balance
method
The Service-Output Method

• This method assumes that the total depreciation that

has taken place is directly proportional to the quantity
of output of the property up to that time. This method
has the advantage of making the unit cost of
depreciation constant and giving low depreciation
expense during periods of low production.
 The Service-Output Method

• Let T = total units of output up to the end of life

• 𝑸𝒏 = 𝐭𝐨𝐭𝐚𝐥 𝐧𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐮𝐧𝐢𝐭𝐬 𝐨𝐟 𝐨𝐮𝐭𝐩𝐮𝐭 𝐝𝐮𝐫𝐢𝐧𝐠 𝐭𝐡𝐞 𝐧𝐭𝐡 𝐲𝐞𝐚𝐫
𝑪𝑶 −𝑪𝑳
• Depreciation per unit of output =
𝑻
𝑪𝑶 −𝑪𝑳
• 𝒅𝒏 = 𝑸𝒏
𝑻
 The Service-Output Method

• A television company purchased machinery for P100,000

on July 1, 1979. It is estimated that it will have a useful
life of 10 years; scrap value of P4,000, production of
400,000 units and working hours of 120,000.
The company uses the machinery for 14,000 hours in 1979
and 18,000 hours in 1980. The machinery produces 36,000
units in 1979 and 44,000 units in 1980. Compute the
depreciation for 1980 using each method given below:
a) Straight line b) Working hours c) Output method
Sum-of-the-Years’-Digits (SYD) Method

• A higher expense is incurred in the early years and

lower expense in the latter years of the asset’s useful
life
𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕
• Let 𝒅𝒏 = 𝑪𝒐 − 𝑪𝑳
𝒔𝒖𝒎 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓𝒔 𝒅𝒊𝒈𝒊𝒕
Sum-of-the-Years’-Digits (SYD) Method

Ex. A structure costs P12,000 new. It is estimated to

have a life of 5 years with a salvage value at the end
of life of P1,000. Determine the book value at the
end of each year of life.