Chapter 28 - Depreciation 1.

Inadequacy arises when the asset is no longer useful

because of an increase in the volume of operations. 1. Equal or uniform charge methods.
• Depreciation refers to property, plant, and equipment, 2. Supersession arises when a new asset becomes available, a. Straight line method
depletion of wasting an asset, and amortization to an and the new asset can perform the same function more b. Composite method
intangible asset. efficiently and economically or for substantially less cost. c. Group method
• Depreciation is defined as ‘’the systematic allocation of 3. Obsolescence is the catchall for economic or functional
2. Variable charge or use-factor or activity methods
the depreciable amount of an asset over its useful life. ‘’ depreciation.
a. Working hours or service hours
• Depreciation is not so much of a valuation as it is a b. Output or production method
matter of cost allocation in the exhaustion of the useful Factors of Depreciation 3. Decreasing charge or accelerated or diminishing balance
life of an item of property, plant, and equipment. method
1. Depreciable Amount – the cost of an asset or other a. Sum of years’ digits
Depreciation in the financial statements amount substituted for cost, less the residual value. b. Declining balance method
• Depreciation is an expense. It may be part of the cost of 2. Residual Value – the estimated amount currently c. Double declining method
goods manufactured or an operating expense. obtainable if the asset is at the end of its useful life. 4. Other methods
3. Useful Life – it is either the period in which an asset is a. Inventory method
Depreciation Period expected to be available for use by the entity or the b. Retirement method
number of production or similar units expected to be c. Replacement method
• Depreciation of an asset begins when it is available for obtained from the asset by the entity.
use, meaning when the asset is at the location and
1. Straight line method
condition necessary for it to be capable of operating in Useful life of an asset is expressed as • The annual depreciation charge is calculated by
the manner intended by the manager. a. Time periods as in years allocating the depreciable amount equally over the
• Depreciation ceases when the asset is derecognized and b. Units of output or production number of years of estimated useful life.
when the asset is classified as held for sale. c. Service hours or working hours • Straight line method is constant charge over the useful
Kinds of Depreciation Service life of an asset should be distinguished from physical life. life of the asset.

• Physical depreciation is related to the depreciable asset's Service life is the period of time an asset shall be used by an Straight line formula:
wear and tear and deterioration over a period. entity. The service life is the equivalent of a useful life.

1. Wear and tear due to frequent use Physical life refers to how long the asset shall last.
2. Passage of time due to nonuse Straight line rate
3. Action of the elements such as wind, sunshine, rain Depreciation method
or dust • The depreciation method shall reflect the pattern in
4. Casualty or accident such as fire, flood, earthquake
which the future economic benefits from the asset are
and other natural disaster
expected to be consumed by the entity. The depreciable amount multiplied by the straight line rate of
5. Disease or decay is a physical cause applicable to
• Reviewed at least every year-end. depreciation also gives the amount of annual depreciation.
animals and wooden buildings.
• Any change is accounted for accounting estimate.
• Functional or economic depreciation arises from
inadequacy, supersession, and obsolescence.
 Accounting Procedures - Composite / Group Method
Rationale for straight line method a. Depreciation is reported in a single accumulated
depreciation account.
• Straight line method is adopted when principal cause of b. The composite or group rate is multiplied by the total
depreciation in passage of time. cost of the assets in the group to get the periodic
• Straight line approach considers depreciation as function depreciation.
Cash 20,000
of time rather than function as usage. c. When an asset in the group is retired, no gain or loss is
Accumulated depreciation 110,000
• Straight line method is widely used in practice because reported. The asset account is credited for the cost of the
Equipment 130,000
of simplicity. asset retired and the accumulated depreciation account
is debited for the cost minus salvage proceeds.
If there are no proceeds from the retirement:
d. When an asset retired is replaced by a similar asset, the
Accumulated depreciation 130,000
replacement is recorded by debiting the asset account
Equipment 130,000
and crediting cash or other appropriate account.
What is the depreciation starting on the fifth year?
2. Composite method
- 9% × P870,000
• Assets that are dissimilar in nature or assets that have
- P783,000
different physical characteristics and vary in useful life,
are grouped and treated as a single unit. Retirement and replacement of asset
If upon the retirement of the equipment, the same is replaced by a
Journal entry for annual depreciation. similar asset costing P160,000

Depreciation 20,000 Total cost of asset after replacement = 1,030,000

Annual depreciation starting on the 5th year = 92,700
Accu. Depre. 20,000
Variable charge or activity methods
At the end of the first year, the equipment account is classified as • Assume that depreciation is a function of use rather than
property, plant, and equipment. passage of time.
• Useful life of the asset is considered in terms of the
Composite life: 10 years (Total dep. amount/ Ann. Dep) output it produces or the number of hours it works.
Composite rate: 9% (Total Ann. Dep./ Total Cost) • Based on the following:
Equipment 105,000
- Assets depreciate more rapidly if they are used full-time
Depreciation 90,000 or overtime.
Accu. Depre. (20,000)
Annual Dep. 90,000 - There is a direct relationship between the utilization of
Carrying amount 85,000 To record annual depreciation. assets and the realization of revenue.

3. Group method Major objection: units of output or service hours may be difficult
• All assets that are similar in nature and in estimated to estimate
useful life are grouped and treated as a single unit. Two methods:
a. Working hours method
Retirement of assets in the group b. Output or production method
If the equipment is retired after four years and sold for P20,000:
 Depreciation rate per hour is computed by dividing the • In an argument, the use of decreasing charge method is
Rationale for variable depreciation depreciable amount by the estimated useful life in terms the cost of using an assets includes not only depreciation
• The variable methods are adopted if the principal cause of service hours. Thus, 600k / 60k = 10 but also repairs.
of depreciation is usage. To get the annual depreciation, the depreciation rate per • Cost of using an asset includes depreciation AND repairs
The use of these methods is based on the following: hour is multipied by the actual hours worked in the on such asset.
1. Assets depreciate more rapidly if they are used period. • Repair cost should be allocated over the useful life of the
full time or overtime. asset on a systematic and uniform basis.
2. There is a direct relationship between 5. Output or production
Three Decreasing Charge Method:
utilization of assets and realization of revenue. The output or production method results in a charge
Sum of years' digits
If assets are used more intensively in based on the expected use or output.
Declining balance
production, greater revenue is expected. Double declining balance
Under this method, a depreciation rate per unit is
The variable methods are found to be appropriate for computed by dividing the depreciable amount by the
6. Sum of years’ digits
assets such as machineries. estimated useful life in terms of units of output.
• Provides for depreciation that is computed by
Major objection: units of output or service hours may be multiplying the depreciable amount by a series
Thus, the rate per unit is P4, computed by dividing
difficult to estimate. of fractions whose numerator is the digit in the
P600,000 by 150,000 units.
useful life of the asset and whose denominator
4. Working hours / Service hours The depreciation rate per unit is then multiplied by the is the sum of the digits in the useful life of the
yearly output to get the annual depreciation. asset.

For example, if the useful life is 4 years, the sum

of the years’ digit is 1+2+3+4=10

Thus, the depreciation would be 4/10 in the 1st

year, 3/10 in the 2nd year, 2/10 in 3rd yea, and
1/10 in the 4th year.

Decreasing charge or accelerated method

• Results in higher depreciation figures in the earlier years
of ownership and lower depreciation in the later years of
the useful life of the asset.
• Don’t deduct salvage value when figuring the depreciable
base for the declining balance method.

Rationale for Accelerated Depreciation:

• 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.’’
 The formula cannot be used unless there is a residual value. In the
absence of any residual value, a nominal amount of P 1 should
Fractional Depreciation – Sum of years’ digits be assumed.

8. Double declining method

• Common application of the declining balance
method is the double declining balance.
• The procedure for the double declining balance
method is as the same as declining balance
method. Fixed rate x declining carrying amount
of the asset = annual depreciation.
• Under this method, the straight line method is
doubled to get the fixed rate.
• Also known as ‘’200% declining balance
method.”

36.8% times P79,770 equals P29,355. But the depreciation

7. Declining Balance method provided for the fifth year is P29,770. The difference of P415 is due
to rounding of figures and the computation of the fixed rate uses As in the declining balance method, the residual value is ignored
• Under this method, a fixed or uniform rate is multiplied
limited decimal places. in the first year in the computation of depreciation.
by the declining carrying amount of the asset in order to
arrive at the annual depreciation.
Note that the fixed rate of 36.8% is multiplied by the total cost of Thus, for 2022, the rate of 40% is multiplied by the total cost of
• This method is also known as ‘’fixed rate on diminishing P500,000 in the first year and not by the depreciable amount of P500,000. However, in the last year 2026, the fixed rate of 40% is
carrying amount method.’’ P450,000. Meanwhile, the residual value is ignored. no longer multiplied by the carrying amount.

The declining balance method is not used extensively in practice The depreciation for 2026 is simply the difference between the
because the calculations are complex. carrying amount of P64,800 and the residual value of P50,000.
 Inventory tools – Dec. 31 (125,000)
Depreciation 63,000
10. Retirement method
• No depreciation is recorded until the asset is
retired.
• Depreciation = Original cost of the asset Journal entries:
retired less salvage value. 1. To record acquisition of tools in excess of the
retirement (2,500 – 1,200 = 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
Other methods
9. Inventory method Journal entries:
• Merely estimating the value of the asset at the end of Replacement cost of tools retired (1,200 x 70) 84,000
the period. 1. To record acquisition. Proceeds from retirement (5,000)
• Depreciation = Difference of balance of the asset Tools 175,000 Depreciation 79,000
account and the value at the end of the year. Cash 175,000
• Generally, applied to assets which are small and 2. To record the retirement.
Cash 5,000 12. Change in useful life
relatively inexpensive.
Depreciation 58,000 • Useful life of an item of PPE shall be reviewed at
least at each financial year-end.
Tools 64,000
• If expectations are significantly different from
previous estimate → change is accounted as change
Cost of tools (FIFO) in accounting estimate
1,000 units x 50 = 50,000
200 units x 70 = 14,000
1,200 units = 64,000
Journal entries:
1. To record the acquisition. 11. Replacement method 13. Change in depreciation method
Tools 90,000 • No depreciation is recorded until the asset is • Shall reflect the patter in which the asset's
Cash 90,000 economic benefits are expected to be consumed
retired and replaced.
2. To record the sale of used tools at residual value. by the entity
• Depreciation = Replacement cost of the asset
Cash 2,000 • Depreciation method shall be reviewed at least
Tools 2,000 retired less the salvage proceeds.
• If the asset is retired but not replaced. at each financial year-end
3. To record the depreciation of tools:
• If there is significant change in the expected
Depreciation 63,000 Depreciation = Original cost of the asset.
pattern of economic benefits embodied in the
Tools 63,000
asset → change is accounted as change in
accounting estimate
Balance of tools account (100k + 90k – 2k) 188,000