251778957-DEPRECIATION-only-lecture-ppt.ppt

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1. DEPRECIATIONDEPRECIATION

2. DEPRECIATIONDEPRECIATION
•Decrease in value of physical properties Decrease in value of physical properties
due to the passage of time and usedue to the passage of time and use
•Accounting concept:Accounting concept: establishing annual establishing annual
deduction against before-tax incomededuction against before-tax income
- - to reflect effect of time and use on asset’s to reflect effect of time and use on asset’s
value in firm’s financial statementsvalue in firm’s financial statements
- - to match yearly fraction of value used by asset to match yearly fraction of value used by asset
in production of income over asset’s in production of income over asset’s
economic lifeeconomic life

3. PURPOSES OF DEPRECIATIONPURPOSES OF DEPRECIATION
Because property decreases in value, it is desirable Because property decreases in value, it is desirable
to consider the effect that this depreciation has to consider the effect that this depreciation has
on engineering projects. Primarily, it is necessary on engineering projects. Primarily, it is necessary
to consider depreciation for two reasonsto consider depreciation for two reasons
1.1.To provide for the recovery of capital that has To provide for the recovery of capital that has
been invested in physical property.been invested in physical property.
2.2.To enable the cost of depreciation to be charged To enable the cost of depreciation to be charged
to the cost of producing products or services that to the cost of producing products or services that
result from the use of the property. Depreciation result from the use of the property. Depreciation
cost is deducible in computing profits on which cost is deducible in computing profits on which
income taxes are paid.income taxes are paid.

4. PROPERTY IS DEPRECIABLE IF PROPERTY IS DEPRECIABLE IF
IT MUST :IT MUST :
•be used in business or held to produce be used in business or held to produce
incomeincome
•have a determinable useful life which is have a determinable useful life which is
longer than one yearlonger than one year
•wear out, decay, get used up, become wear out, decay, get used up, become
obsolete, or lose value from natural causesobsolete, or lose value from natural causes
•not be inventory, stock in trade, or not be inventory, stock in trade, or
investment propertyinvestment property

5. WHEN DEPRECIATION STARTS WHEN DEPRECIATION STARTS
AND STOPSAND STOPS
•Depreciation Depreciation startsstarts when property is placed in when property is placed in
service for use in business or for production service for use in business or for production
of incomeof income
•Property is considered in service when ready Property is considered in service when ready
and available for specific use, even if not and available for specific use, even if not
actually used yetactually used yet
•Depreciation Depreciation stopsstops when cost of placing it in when cost of placing it in
service is removed or it is retired from serviceservice is removed or it is retired from service

6. Types of DepreciationTypes of Depreciation
•Physical property depreciationPhysical property depreciation
– – deterioration due to the effects of deterioration due to the effects of
various chemical and mechanical factors on various chemical and mechanical factors on
the material composing the property.the material composing the property.
•Functional depreciationFunctional depreciation – due to the – due to the
decrease in the demand for the function of decrease in the demand for the function of
the equipment for which it was designed.the equipment for which it was designed.
•Changes in the price level of a similar Changes in the price level of a similar
property property – it is the capital that depreciated – it is the capital that depreciated
not the property. not the property.

7. DEPRECIATION CONCEPTSDEPRECIATION CONCEPTS
•Depreciation CostDepreciation Cost – – depends upon the physical or depends upon the physical or
economic life of the equipment and its first cost.economic life of the equipment and its first cost.
•Physical Life Physical Life – – length of time which it is capable of length of time which it is capable of
performing the function for which it was designed performing the function for which it was designed
and manufactured.and manufactured.
•Economic life Economic life – – length of time of an equipment length of time of an equipment
which it will operate at a satisfactory profit.which it will operate at a satisfactory profit.
•First CostFirst Cost – includes the original purchase price, – includes the original purchase price,
freight and transportation charges, installation freight and transportation charges, installation
expenses, initial taxes, permits to operate and other expenses, initial taxes, permits to operate and other
expenses needed to operate the equipment. expenses needed to operate the equipment.

8. DEPRECIATION CONCEPTSDEPRECIATION CONCEPTS
•Salvage ValueSalvage Value – – the amount for which the the amount for which the
equipment or machine can be sold as a second equipment or machine can be sold as a second
hand.hand.
•Scrap or Junk ValueScrap or Junk Value – – the amount that equipment the amount that equipment
can be sold for, when disposed off as a junk. can be sold for, when disposed off as a junk.
–The equipment/property cannot be used anymore.The equipment/property cannot be used anymore.
•Book Value (BV) Book Value (BV) - Worth of depreciable property - Worth of depreciable property
as shown on accounting records.as shown on accounting records.
–Original cost basis of property, including adjustments, Original cost basis of property, including adjustments,
less allowable depletion or depreciation deductionsless allowable depletion or depreciation deductions

9. Methods used for the Determination Methods used for the Determination
of Depreciation Costof Depreciation Cost
•Straight Line FormulaStraight Line Formula
•Sinking Fund FormulaSinking Fund Formula
•Matheson formula Matheson formula (Constant/Fixed % method, (Constant/Fixed % method,
Declining Balance method or Diminishing balance Declining Balance method or Diminishing balance
method).method).
•Sum-of-the-Years Digit method Sum-of-the-Years Digit method
•Service-Output or Production-Units methodService-Output or Production-Units method

10. Notations on DepreciationNotations on Depreciation
The following terms are used in the classical The following terms are used in the classical
(historical) depreciation method equations:(historical) depreciation method equations:
n n = useful life/depreciable life of the asset (in years)= useful life/depreciable life of the asset (in years)
m = age of property at any time m = age of property at any time << n n
d d
mm = annual depreciation cost in year m (1 = annual depreciation cost in year m (1<< m m << n) n)
D D
mm = accrued or total depreciation through year m = accrued or total depreciation through year m
CC
OO = original or first cost of the property = original or first cost of the property
CC
mm = book value of the property at the end of m years = book value of the property at the end of m years
CC
nn = book value at the end of useful life. = book value at the end of useful life.
K = the ratio of depreciation in any one year to the BV at the K = the ratio of depreciation in any one year to the BV at the
beginning of the yearbeginning of the year

11. STRAIGHT-LINE (SL) METHODSTRAIGHT-LINE (SL) METHOD
•Simplest depreciation methodSimplest depreciation method
•Assumes constant amount is depreciated each year Assumes constant amount is depreciated each year
over depreciable (useful) life; gives uniform annual over depreciable (useful) life; gives uniform annual
charge.charge.
•Does not take into account the interest rate on the Does not take into account the interest rate on the
accumulated depreciation fund.accumulated depreciation fund.
•This method requires an estimate of the final SV ( also This method requires an estimate of the final SV ( also
the final book value at the end of year N )the final book value at the end of year N )
dd
mm = ( = (CC
O O - C- C
nn ) / n ) / n
DD
m m = m x d (for 1 = m x d (for 1 << m m << n) n)
CC
mm = = CC
OO - D - D
mm

12. •Example (7- 6/p.334)Example (7- 6/p.334)
EOY EOY
(m)(m)
dd
mm DD
mm CC
mm
1 11,000 11,000(1) = 11,000 120,000 – 11,000 = 109,000
2 11,000 11,000(2) = 22,000 120,000 – 22,000 = 98,000
3 11,000 11,000(3) = 33,000 87,000
4 11,000 11,000(4) = 44,000 76,000
5 11,000 11,000(5) = 55,000 65,000
6 11,000 11,000(6) = 66,000 54,000
7 11,000 11,000(7) = 77,000 43,000
8 11,000 11,000(8) = 88,000 32,000
9 11,000 11,000(9) = 99,000 21,000
10 11,000 11,000(10) =
110,000
10,000

13. •Example 2. Example 2.
A company purchased a machine for P30,000, A company purchased a machine for P30,000,
used it for 5 years and then sold it for P10,000. used it for 5 years and then sold it for P10,000.
If the capital worth is at 8% determine the If the capital worth is at 8% determine the
annual cost of depreciation using straight-line annual cost of depreciation using straight-line
method.method.
d d = (30,000-10,000) / 5= (30,000-10,000) / 5
= (20,000 / 5)= (20,000 / 5)
= = $ 4,000/year$ 4,000/year

14. The Sinking Fund FormulaThe Sinking Fund Formula
In this method it is assumed that a sinking fund is In this method it is assumed that a sinking fund is
established in which funds will accumulate for established in which funds will accumulate for
replacement purposes and will beat interest. The replacement purposes and will beat interest. The
total depreciation which has occurred up to any total depreciation which has occurred up to any
given time is assumed to equal the amount in the given time is assumed to equal the amount in the
sinking fund at that time.sinking fund at that time.
Also gives a uniform annual chargeAlso gives a uniform annual charge
dd
mm = ( = (CC
O O – C– C
nn) ( A/F, i %, N) ) ( A/F, i %, N)
DD
mm = ( = (CC
O O – C– C
nn) [(F/A, i%, m)/(F/A, i%, n)) [(F/A, i%, m)/(F/A, i%, n)
= (= (CC
O O – C– C
nn) [((1+i)m-1)/((1+i)n-1)]) [((1+i)m-1)/((1+i)n-1)]
CC
mm = = CC
O O – D– D
mm

15. •Example # 3Example # 3
A civil engineer bought a crane used to erect tall buildings. It A civil engineer bought a crane used to erect tall buildings. It
will be invoiced from Vietnam, CIF (cost, freight, & insurance) will be invoiced from Vietnam, CIF (cost, freight, & insurance)
Manila at P250,000. Brokerage fees, arrastre fees, customs, Manila at P250,000. Brokerage fees, arrastre fees, customs,
duties, permits, etc. amounts to P120,000. At the end of 10 duties, permits, etc. amounts to P120,000. At the end of 10
years, he expects to sell it for P50,000. Prepare a depreciation years, he expects to sell it for P50,000. Prepare a depreciation
schedule for the crane. Use i = 12%.schedule for the crane. Use i = 12%.
Sol’n:Sol’n:
Co = 370,000Co = 370,000n = 10 yearsn = 10 years
Cn = 50,000Cn = 50,000
d d = (370,000-50,000) [ 0.12 / ((1.12)^10 – 1))= (370,000-50,000) [ 0.12 / ((1.12)^10 – 1))
= P 18,234.93= P 18,234.93

16. •ExampleExample
* * D2 = 320,000*[((1.12)D2 = 320,000*[((1.12)
22
-1)/((1.12)-1)/((1.12)
1010
-1)] = 38,658.05-1)] = 38,658.05
****D3 = 320,000*[((1.12)D3 = 320,000*[((1.12)
33
-1)/((1.12)-1)/((1.12)
1010
-1)] = 61,531.9653-1)] = 61,531.9653
EOY (m)EOY (m)
dd
mm DD
mm CC
mm
1 18,234.93 18,234.93 351,765.07
2 18,234.93 38,658.05* 331,341.95
3 18,234.93 61,531.97** 308,468.03
4 18,234.93 87,150.72 282,849.28
5 18,234.93
6 18,234.93
7 18,234.93
8 18,234.93
9 18,234.93
10 18,234.93

17. SUM-OF-THE-YEARS-DIGITS (SYD) METHODSUM-OF-THE-YEARS-DIGITS (SYD) METHOD
1. Number for each permissible year of life are listed in 1. Number for each permissible year of life are listed in
reverse orderreverse order
2. The 2. The depreciation factor depreciation factor for any year is the corresponding for any year is the corresponding
number from the reverse order listing divided by the sum number from the reverse order listing divided by the sum
of those digits, or the followingof those digits, or the following
2 (n - m + 1 )2 (n - m + 1 )
dfdf = ----------------- = -----------------
n ( n + 1 ) n ( n + 1 )
3. Depreciation for any year is the product of that year’s SYD 3. Depreciation for any year is the product of that year’s SYD
depreciation factor and the difference between First Cost depreciation factor and the difference between First Cost
and the final estimated BV at end of useful life.and the final estimated BV at end of useful life.
d d
mm = ( = (CC
O O – C– C
nn) ) • dfdf
4. Enables a very rapid depreciation during the early years of 4. Enables a very rapid depreciation during the early years of
life.life.

18. SUM-OF-THE-YEARS-DIGITS (SYD) METHODSUM-OF-THE-YEARS-DIGITS (SYD) METHOD
a. Determine the sum of years.a. Determine the sum of years.
∑ ∑ years = (n / 2)( n + 1)years = (n / 2)( n + 1)
b. Determine the loss in value due to depreciationb. Determine the loss in value due to depreciation
CC
O O – C– C
nn
c. Compute annual depreciation chargesc. Compute annual depreciation charges
dd
11 = ( = (CC
O O – C– C
nn) (n / ∑ years )) (n / ∑ years )
dd
22 = ( = (CC
O O – C– C
nn) (n-1 / ∑ years)) (n-1 / ∑ years)
dd
33 = (= (CC
O O – C– C
nn) (n-2 / ∑ years)) (n-2 / ∑ years)
……
dd
nn = ( = (CC
O O – C– C
nn) (1/ ∑ years ) ) (1/ ∑ years )
Cumulative depreciation through year n is:Cumulative depreciation through year n is:
DD
11 = = dd
11
DD
22 = = dd
11 + + dd
22
DD
33 = = dd
11 + + dd
22 + + dd
33

19. •Reworking example # 3Reworking example # 3
∑ ∑ years = (n / 2)( n + 1) = (10/2)(10+1) = 55 yearsyears = (n / 2)( n + 1) = (10/2)(10+1) = 55 years
YearYear dd Dm Book Value @ EOY n
1 320,000(10/55) =
58,181.82
58,181.82 370,000 - 58,181.82
= 311.818.18
2 320,000(9/55) =
52,363.64
58,181.82+52,363.64 =
110,545.46
370,000 – 110,545.46 = 259,454,54
3 320,000(8/55) =
46,545.45
110,545.46+46,545.45
= 157,090.91
370,000 – 157,090.91 = 212,909.09
4 320,000(7/55) =
5
6
7
8
9
10