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Engineering Economics By: Samiullah Khan, P.E.

Engineering Economics By: Samiullah Khan, P.E.


BALOCHISTAN UNIVERSITY OF INFORMATION TECHNOLGY
ENGINEERING & MANAGEMENT SCIENCES

BY:
 SAMIULLAH KHAN, P.E.
LECTURER
DEPARTMENT OF CIVIL ENGINEERING
Tangible and Non Tangible Assets
Tangible Assets
• Assets with a physical existence that can be touched, felt and
measured.
• They are used primarily in the operation of the business to produce
products or services. (Income)
• Tangible assets can be accounted for as either long-term (Fixed) or
current assets depending on their estimated life.
• These types of assets include Land and buildings, automobiles,
physical inventory, furniture, machines and equipment, raw
materials etc.

Engineering Economics By: Samiullah Khan, P.E.


Intangible Assets
are nonphysical assets that add value to a company or business
can have either a definite or indefinite life depending on the type of asset.

Intangible assets have the ability to appreciate in value

Examples of intangible assets include goodwill, intellectual property (patents,


copyrights and trademarks), brand names, customer relationships, contracts and
non-compete agreements
Software, internet Domain, License agreements
Educational contents

Engineering Economics By: Samiullah Khan, P.E.


• Land & Building
• Automobiles
Fixed • Machinery
• Furniture
• equipment

• Inventory
Current • Raw material
• Finished goods

Engineering Economics By: Samiullah Khan, P.E.


Fixed Assets vs Current Assets
Fixed Asset/ Capital Asset / Long Term assets
• Fixed assets are long-term assets that a company has purchased and is using
for the production of its goods and services (producing Income directly or
indirectly)
• Cannot be converted into cash readily.
• Fixed assets are purchased for a period of more than one year.
• Some Examples are

Land
• the most important and expensive item in the business world.
• The land is included in the fixed assets because it cannot be for a short
period item.

Engineering Economics By: Samiullah Khan, P.E.


Building
• the most essential and expensive item in the business world.
• Buildings are either constructed of Rented but in both cases, it is for a long
period of time, more than one year.

Cars and Trucks


• mostly used in almost every business.
• purchased for a long period of time for more than a year.

Furniture
• There is no business in the world where furniture is not used.
• People buy the best furniture for their business and it is not for a short
period of time. That is why it is included in the fixed assets.

Engineering Economics By: Samiullah Khan, P.E.


Machinery
• Machinery or machines are important for every type of business either
small or large.
• It can be large machine or a small computer as well.
• Machines are used for more than one year and considered as the
essential part of the fixed assets.

Current Assets/ Short Term assets


• Current assets are those items of the business which can easily convert into
cash.
• Current assets can convert into cash within a year.
• These assets are used in day to day operations of the business.
• Examples are Cash or Cash Equivalents, Inventories, Short Term
Investments, Account Receivable (Customer Credit) etc.

Engineering Economics By: Samiullah Khan, P.E.


Cash or Cash Equivalents :
• Most essential in current assets because cash work in day to day business operations.
• Cash in Hand
• Bank Deposits/ Fixed Deposits
• Mutual Funds, Insurance Policies.

Account Receivable:
• Account receivable is for goods of the business received in a short period of time.
• The short period of time is less than a year.
• Also called as Customer Credit Since customer cannot pay you readily.

Finished goods
Work in Progress
Short Term Loans or Advances

Engineering Economics By: Samiullah Khan, P.E.


Inventory
• It is the most important part of the business.
• Inventory is the goods in stocks.
• It has two types;
short and long inventories.
• Short inventories use less
than a year and included in
the current assets.
Example: cars?

Engineering Economics By: Samiullah Khan, P.E.


Engineering Economics By: Samiullah Khan, P.E.
Tangible Assets Intangible Asset
1. They don’t have a physical
1. They have a physical existence.
existence.
2. Tangible assets are depreciated. 2. Intangible assets are amortized.
3. Are generally much easier to
3. Are not that easy to liquidate and
liquidate due to their physical
sell in the market.
presence.
4. The cost can be easily determined 4. The cost is much harder to
or evaluated. determine for Intangible assets.

Engineering Economics By: Samiullah Khan, P.E.


The monetary value of an asset decreases over
time. This decrease is measured as
depreciation.

Depreciation is defined as the reduction of recorded


cost of a fixed asset in a systematic manner until the
value of the asset becomes zero or negligible

Engineering Economics By: Samiullah Khan, P.E.


1. Internal causes
a) Natural wear and tear,
b) Disuse,
c) Maintenance,
d) Change in production,
e) restriction in production
f) Reduced Demand.
2. External Causes
a) Obsolescence of Technology
b) Lapse of time
Engineering Economics By: Samiullah Khan, P.E.
1. It must be used in business or held for the production of
income.
2. It must have a definite service life, which must be longer
than one year.
3. It must be something that wears out. decays, gets used
up, becomes obsolete. Or loses value from natural causes.

DOES LAND DEPRECIATE?


Engineering Economics By: Samiullah Khan, P.E.
Value of portion of tangible assets utilized for
generating revenue must be charged during a
particular accounting year to ascertain the true
cost.
The allocation of this cost of tangible asset is
termed as Depreciation.

Engineering Economics By: Samiullah Khan, P.E.


1. To calculate proper profit.
2. To show the assets at its true and reasonable (fair) value.
3. To provide the funds for the replacement of an asset.

Engineering Economics By: Samiullah Khan, P.E.


Purposes for using the depreciation
methods
1. Book depreciation
Used by a corporation or business for internal financial
accounting to track the value of an asset or property
over its life.
2. Tax depreciation
Used by a corporation or business to determine taxes due based
on current tax laws of the government entity (country, state,
province, etc.).
Engineering Economics By: Samiullah Khan, P.E.
Basis/ Cost Basis/ or unadjusted basis B
• The delivered and installed cost of the
asset including purchase price,
transportation and installation fees, and
any other direct costs incurred to prepare
the asset for use.
• may include commissions, fees, survey
costs, transfer taxes, or title insurance etc.
Engineering Economics By: Samiullah Khan, P.E.
Rockford Corporation purchased an automatic hole-punching
machine priced at $62,500. The vendor's invoice included a
sales tax of $3,263. Lanier also paid the inbound
transportation charges of $725 on the new machine, as well as
a labor cost of $2,150 to install the machine in the factory. In
addition, Lanier had to prepare the site before installation, at a
cost of $3,500. Determine the cost basis for the new machine
for depreciation purposes.

Engineering Economics By: Samiullah Khan, P.E.


Book value BVt
• It represents the remaining, undepreciated
capital investment on the books after the
total amount of depreciation charges to date
has been subtracted from the basis.
• The book value is determined at the end of
each year t ( t = 1, 2, . . . , n ).

Engineering Economics By: Samiullah Khan, P.E.


Market value MV
• It a term also used in replacement analysis,
• is the estimated amount realizable if the asset were sold
on the open market.
• Because of the structure of depreciation laws, the book
value and market value may be substantially different.
For example, a commercial building tends to increase in
market value, but the book value will decrease as
depreciation charges are taken. However, a computer
workstation may have a market value much lower than
its book value due to rapidly changing technology.

Engineering Economics By: Samiullah Khan, P.E.


Useful life / Depreciable life
• The expected period of time that a property will be
used in a trade or business or to produce income.
• Actual useful life of an asset however, may be
different than its depreciable life.

Engineering Economics By: Samiullah Khan, P.E.


Salvage value S
• It is the estimated trade-in or market value at the
end of the asset’s useful life.
• The salvage value, expressed as an estimated dollar
amount or as a percentage of the first cost, may be
positive, zero, or negative due to dismantling and
carry-away costs

Engineering Economics By: Samiullah Khan, P.E.


Depreciation rate or recovery rate d t

• It is the fraction of the first cost removed by


depreciation each year t.
• This rate may be the same each year, which is
called the straight line rate d , or different for
each year of the recovery period.

Engineering Economics By: Samiullah Khan, P.E.


Straight Line (SL) Depreciation / Fixed
Installment Method
• interprets a fixed asset as an asset that provides its
services in a uniform fashion
• the asset provides an equal amount of service in
each year of its useful life.

• derives its name from the


fact that the book value
decreases linearly with
time.

Engineering Economics By: Samiullah Khan, P.E.


where t year ( t 1, 2, . . . , n )
D annual depreciation charge
t

B Unadjusted basis
S estimated salvage value
n recovery period
d depreciation rate 1/n
t

Engineering Economics By: Samiullah Khan, P.E.


Since the asset is depreciated by the same amount each
year, the book value after t years of service, denoted by
BV t , will be equal to the Unadjusted cost basis B minus
the annual depreciation times t .

Engineering Economics By: Samiullah Khan, P.E.


Engineering Economics By: Samiullah Khan, P.E.
Example: A company has purchased an
equipment whose first cost is Rs. 1,00,000 with
an estimated life of eight years. The estimated
salvage value of the equipment at the end of its
lifetime is Rs. 20,000. Determine the
depreciation charge and book value at the end
of various years using the straight line method
of depreciation.

Engineering Economics By: Samiullah Khan, P.E.


Declining Balance (DB) and Double
Declining Balance (DDB) Depreciation
• A method in which the depreciation expense declines
with age of the fixed asset
• It is also known as the fixed percentage or uniform
percentage method

• A constant percentage of the book value of the


previous period of the asset will be charged as the
depreciation amount for the current period.
Engineering Economics By: Samiullah Khan, P.E.
Declining Balance (DB) and Double
Declining Balance (DDB) Depreciation
• It is a more realistic approach, since the
depreciation charge decreases with the life of the
asset which matches with the earning potential
of the asset

• Limitation of this approach: The book value at


the end of the life of the asset may not be exactly
equal to the salvage value of the asset.

Engineering Economics By: Samiullah Khan, P.E.


• The annual depreciation is determined by multiplying the
book value at the beginning of a year by a fixed (uniform)
percentage d , expressed in decimal form.
• If d = 0.1 then 10% of the book value is removed each
year.
• The maximum annual depreciation rate for the DB
method is twice the straight line rate

d = 2/n
max

Therefore, it is called double declining balance (DDB).

Engineering Economics By: Samiullah Khan, P.E.


If n = 10 years, the DDB rate is 2/10 = 0.2; so 20% of the
book value is removed annually

The depreciation for year t is the fixed rate d times the


book value at the end of the previous year.
Dt = (d)BVt-1
The actual depreciation rate for each year t , relative to
the basis B , is
dt = d (1 - d) t-1
Engineering Economics By: Samiullah Khan, P.E.
If BV t-1 is not known, the depreciation in year t can be calculated
using B and d .
Dt = B d (1- d ) t-1
Book value in year t is determined in one of two ways:
1. by using the rate d and basis B or
2. by subtracting the current depreciation charge from
the previous book value
BVt = B (1 - d )t
BVt = BV (t-1)- Dt
Engineering Economics By: Samiullah Khan, P.E.
Example:
Underwater electroacoustic transducers were purchased for
use in SONAR applications. The equipment will be DDB
depreciated over an expected life of 12 years. There is a
first cost of $25,000 and an estimated salvage of $2500.
Calculate the depreciation and book value for years 1 and 4.

Engineering Economics By: Samiullah Khan, P.E.


Engineering Economics By: Samiullah Khan, P.E.
Engineering Economics By: Samiullah Khan, P.E.
Sum-of-Years-Digits (SYD) Method
• It is a historical accelerated depreciation technique that removes
much of the basis in the first one-third of the recovery period
• It removes much of the basis in the first one-third of the recovery
period
• It involves the sum of the year’s digits from 1 through the
recovery period n

Engineering Economics By: Samiullah Khan, P.E.


where SUM is the sum of the digits 1 through n .

The book value for any year t is calculated as

Engineering Economics By: Samiullah Khan, P.E.


Calculate the SYD depreciation charges for
year 2 for Front Shovel with B = Rs.
15,250,000 , S = Rs. 400,000, and an 8-year
recovery period.

Engineering Economics By: Samiullah Khan, P.E.


Unit-of-production (UOP) method.

It is used when the decreasing value of equipment is based


on usage, not time

It is also known as Service Output Method of Depreciation

Engineering Economics By: Samiullah Khan, P.E.


Sami Khan Contractors purchased an $80,000 mixer for use
during the next 10 years for contract work on N-25 in Kalat
Section. The mixer will have a negligible salvage value after 10
years, and the total amount of material to process is estimated at
2 million m3. Use the actual usage per year shown in Table below
and the unit-of-production method to determine annual
depreciation.

Year t Actual Usage m3


1 400
2-8 200
9-10 100
Total 2000

Engineering Economics By: Samiullah Khan, P.E.


Sinking Fund Method of Depreciation
This method not only takes depreciation into account but also makes
provision for the replacement of asset when it becomes useless.

A sinking fund account (savings)is created by taking out some cash from
the profit account.

The credit balance of sinking fund is equal to the depreciated amount


compounded annually at a fixed interest rate.

Initially, the Net Reduction in Basis in discounted annually at a fixed rate


for each term.
A = (B – S) [A/F, i%, n]

Engineering Economics By: Samiullah Khan, P.E.


The annual fixed payments are then invested and compounded
annually with a fixed interest rate, eventually generating actual
Deprecation amount

Dt = A (F/P, i%, t – 1)

Dt = (B – S) (A/F, i%, n) (F/P, i%, t – 1)


The book value at the end of period t

Bt = B – (B – S) (A/F, i%, n) (F/A, i%, t)

Engineering Economics By: Samiullah Khan, P.E.


A company has purchased an equipment whose
first cost is Rs. 100,000 with an estimated life of
eight years. The estimated salvage value of the
equipment at the end of its lifetime is Rs. 20,000.
Determine the depreciation charge using sinking
fund method of depreciation with an interest rate
of 12%, compounded annually.

Engineering Economics By: Samiullah Khan, P.E.


Engineering Economics By: Samiullah Khan, P.E.
Engineering Economics By: Samiullah Khan, P.E.
Engineering Economics By: Samiullah Khan, P.E.
Engineering Economics By: Samiullah Khan, P.E.
Engineering Economics By: Samiullah Khan, P.E.
Depreciation Tax Shield
• A depreciation tax shield is a tax reduction technique under which
the overall amount of taxes owed by an individual taxpayer or a
business is lowered.

• The amount by which depreciation shields the taxpayer from


income taxes is the applicable tax rate, multiplied by the amount
of depreciation.
• For example, if the applicable tax rate is 21% and the amount of
depreciation that can be deducted is $100,000, then the
depreciation tax shield is $21,000.

Engineering Economics By: Samiullah Khan, P.E.


Example:
A company has just purchased an asset costing
Rs. 780,000. The Straight line method is used for
depreciation and the entire cost of the asset will
be depreciated over 6 years. The Tax rate of the
company is 30%.
Find the annual saving in tax.

Engineering Economics By: Samiullah Khan, P.E.


Gain / Loss on the disposal of an asset
• A depreciable asset can be disposed or sold
either at the end of its useful life or during its
useful life.
• Disposal of asset may be during its useful life
due to obsolescence or other factors.

When does Gains or Loss occur?

Engineering Economics By: Samiullah Khan, P.E.


Gain or loss occurs when the market value differs
from the Book Value.

Gain or loss = Salvage Value – Book Value

Engineering Economics By: Samiullah Khan, P.E.