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Learning Outcome

Use depreciation or depletion methods to reduce


the book value of a capital investment in an asset
and natural resource.

DEPRECIATION
Engr. Charity Hope Gayatin

Purposes of Depreciation Depreciation Terminologies


1. To provide for the recovery of capital which has
DEPRECIATION is a book method to represent the
been invested in physical property.
reduction in value of a tangible asset. (Amortization used
to reflect the decreasing value of intangible assets)
2. To enable the cost o f depreciation to be charged
to the cost producing products or services that
FIRST COST P OR UNADJUSTED BASIS B is the
results from the use of the property.
delivered and installed cost of the asset including
purchase price, delivery and installation fees, and other
3. Depreciation is a tax-allowed deduction included
depreciable direct costs incurred to prepare the asset for
in tax calculations.
use. The term unadjusted basis , or simply basis , is used
Taxes = (income – deductions)(tax rate)
when the asset is new, with the term adjusted basis
used after some depreciation has been charged.

Depreciation Terminologies Depreciation Terminologies


BOOK VALUE BV represents the remaining,
undepreciated capital investment on the books after the
total amount of depreciation charges to date has been
subtracted from the basis. SALVAGE VALUE SV is the estimated trade-in or market
value at the end of the asset’s useful life.
RECOVERY PERIOD n is the depreciable life of the asset
in years. Often there are different n values for book and DEPRECIATION RATE OR RECOVERY RATE d is the
tax depreciation. Both of these values may be different fraction of the first cost removed by depreciation each
from the asset’s estimated productive life. year. This rate may be the same or different each year.

MARKET VALUE MV a term also used in replacement


analysis, is the estimated amount realizable if the asset
were sold on the open market.

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Depreciation Terminologies Depreciation Terminologies

PERSONAL PROPERTY, one of the two types of property


for which depreciation is allowed is the income-
producing, tangible possessions of a corporation used to PHYSICAL LIFE length of time during which the property
conduct business. is capable of performing the function for which it was
designed and manufactured.
REAL PROPERTY includes real estate and all
improvements—office buildings, manufacturing ECONOMIC LIFE length of time during which the
structures, test facilities, warehouses, apartments, and property may be operated at a profit.
other structures. Land itself is considered real property,
but it is not depreciable.

Depreciation Depreciation
TYPES OF DEPRECIATION

1. Normal Depreciation TYPES OF DEPRECIATION

a. PHYSICAL DEPRECIATION- is due to the 2. Depreciation due to changes in price levels


lessening of the physical ability of a property to
produce results 3. DEPLETION- this refers to the decrease in the
value of a property due to the gradual extraction
b. FUNCTIONAL DEPRECIATION- is due to the of its contents.
lessening in the demand for the function which
the property was designed to render.

Depreciation Methods Problem


1. STRAIGHT LINE METHOD
assumes that the loss in value is directly
proportional to the age of the property
1. An electronic balance costs P90,000 and has an
d = ( CO – CL ) / L
estimated salvage value of P8000 at the end of
Dn = n ( C O – CL ) / L
its 10years lifetime. What would be the book
Cn = CO – Dn
value after 3years using the straight line method
where
in solving for the depreciation?
d - annual cost of depreciation
L - useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

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Depreciation Methods Problem
2. SINKING FUND
assumes that the funds will accumulate for
replacement
d = ( CO – CL ) / (F/A, i%, L) 2. A firm bought equipment for P560,000. Other
Dn = d ( F/A, i%, n) expenses including installation amounted to
Cn = CO – Dn P4000. The equipment is expected to have a life
where of 16years with a salvage value of 10% of the
d - annual cost of depreciation original cost of the equipment. Determine the
L - useful life of the property in years book value at the end of 12years by sinking fund
CO - original cost method at 12% interest.
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Depreciation Methods Depreciation Methods


3. DECLINING BALANCE METHOD 3. DECLINING BALANCE METHOD
percentage method or Matheson Formula Cn = CO ( 1 – K ) n
assumes that the annual cost of depreciation is a CL = CO ( 1 – K ) L
fixed percentage of the salvage value at the dn = KCO ( 1 – K ) n – 1
beginning of the year. where
The ratio of the depreciation in any year to the dn - depreciation charge during the nth year
book value at the beginning of that year is L - useful life of the property in years
constant through out the life of the property and CO - original cost
is designated by K, the rate of depreciation. CL - value at the end of life, scrap value
K = 1 – n √ ( Cn / C O ) Cn - book value at the end of n years
= 1 – L√ ( C L / C O ) Dn - depreciation up to age n years
*not applicable if salvage value is zero because K = 1

Problem Depreciation Methods


4. DOUBLE DECLINING BALANCE METHOD
similar to the declining balance method except
that the rate of depreciation K is equal to 2/L.
3. A certain type of machine loses 10% of its value
Cn = CO ( 1 – K ) n
each year. The machine costs P20,000 originally.
CL = CO ( 1 – K ) L
Make out a schedule showing the yearly
dn = KCO ( 1 – K ) n – 1
depreciation, the total depreciation and the
where
book value at the end of each year for 5years.
dn - depreciation charge during the nth year
L - useful life of the property in years
CO - original cost
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

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Problem Depreciation Methods
5. SUM OF THE YEARS DIGIT METHOD
assumes that the funds will accumulate for
replacement
4. Determine the rate of depreciation, the total
dn = (Reverse Digit/Sum of Digit) * (CO – CL)
depreciation up to the end of the 8th year and
dn = (depreciation factor) * (total depreciation)
the book value at the end of 8 years for an asset
where
that costs P15,000 new and has an estimated
dn - depreciation charge during the nth year
scrap value of P2,000 at the end of 10 years by
L - useful life of the property in years
(a) the declining balance method and (b) the
CO - original cost
double declining balance method.
CL - value at the end of life, scrap value
Cn - book value at the end of n years
Dn - depreciation up to age n years

Problem

5. A structure costs P120,000. It is estimated to


have a life of 5years, with a salvage value at the
end of its life of P1000. Determine the book
value at the end of each year of life. Use sum-of-
the-years’-digit method.