Engineering Economics

V-Depreciation
Date:
14/10/2016

Depreciation
Contents
Introduction
Depreciation

Calculation

Fundamentals
Depreciation

Methods:

Straight Line
Sum of Years Digits
Declining Balance

Outcome of Todays Lecture

After
The

completing this lecture

students should be able to:.

Describe depreciation
Distinguish
various types of depreciable
property
and
differentiate
between
depreciation expenses and other business
expenses.
Use depreciation methods to calculate the
annual depreciation charge and book value
over the asset's life.

Depreciation
Depreciation

is a decrease in value of an asset

each year:

a decrease in market value

a decrease in the value to the owner

Important

reasons for depreciation include

deterioration
obsolescence

Accountants

define depreciation as follows:

the systematic allocation of the cost of an asset over

its useful, or depreciable life

The

latter definition is used for determining

income taxes, which is most important because it
affects the taxes that firms pay:

TAXES proportional to TAXABLE INCOME (PROFIT

COSTS)

COSTS = Maintenance Cost + Depreciated Initial

Cost

Depreciation

Depreciable life is the number of years over

which a machine is depreciated. It is also
called Recovery Period.

This period may differ from the useful life.The

depreciation method determines the depreciable life.
At least six different depreciation methods are
available.
Depreciation is a noncash cost. No money changes
hands.
Usually you pay for the asset up front, but
depreciate it over time (e.g. a new truck).
Depreciation is a business expense the government
allows to offset the loss in value of business assets.

Depreciation deductions reduce the taxable income

Depreciation
The type of property to be depreciated may be tangible
(berwujud) or intangible (tidak berwujud).
A tangible property is one that one can touch or see, whereas an
intangible property is one that has value but cannot be touched or seen,
e.g., copyrights, patents, trademarks, franchises, trade names, and
software.

Depreciation expense is the amount of cost allocation within

an accounting period.
Only items that lose useful value over time can be
depreciated. Land can't be depreciated because it can always
be used for a purpose.

Depreciation Calculation Fundamentals

Example: A PC costs $1,800. Its annual depreciation
charges are
$800, $600, and $350 for three years.
$1,800 is called the cost, initial cost, or cost basis.
dt denotes the depreciation deduction in year t
d1= $800, d2= $600, d3= $350

BVt denotes the book value at the end of year t.

Depreciation Calculation Fundamentals

Book value = Cost Depreciation charges made to
date
BVt= Cost Basis (d1+ d2+ + dt) = BVt-1- dt

i.e. BV2= BV2-1- d2= BV1- d2

This equation is used to compute the book value of
an asset at the end of any time t.
Book value can be viewed as the remaining
unallocated cost of an asset.
If the item has a salvage value then the final book
value will be the salvage value.

Example:The book value of the PC declines

during the useful life from a value of B = $1,800
at time 0, to a value of S = $50 at time 3.
Numerous depreciation methods are possible.

Depreciation Methods
Depreciation

Methods:
Straight Line

Sum of Years
Digits

Declining
Balance

Depreciation Methods
There are three main methods of depreciating capital assets:
Straight-line
Declining balance
Sum-of-years-digits

Declining balance method, as well as the sum-of-the-yearsdigits, is called an accelerated depreciation method because,
by nature of its calculation, it allows more depreciation in
earlier years and less in later years.
Rapid depreciation is most useful when the asset is expected to
generate larger incomes in the early life of the asset. This
allows for greater tax deductions early in the assets life to
offset the larger income that the asset produces.

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(1). Straight Line (SL) Depreciation

Straight line depreciation is the simplest and best known:

Annual depreciation charge, dt= (B-S)/N
Example: An asset has a cost of B = $900, a useful life
of N = 5 years, and an EOL salvage value of S = $70.
Using straight line, depreciation:
Annual depreciation charge: dt= (B-S)/N = (900-70)/5 = 830/5 =
$166 each year

(1). Straight Line (SL) Depreciation

(2). Sum-of-Years Digits (SOYD) Depreciation

Sum-of-Years Digits (SOYD) Depreciation

Example: An asset has a cost of B = $900, a

useful life of N = 5 years, and an EOL salvage
value of S = $70.With SOYD depreciation, we
would compute the following

(2). Sum-of-Years Digits (SOYD) Depreciation

(3). Declining Balance Depreciation

For straight line depreciation with N

years, the rate of decrease each year is
1/N.

Declining balance depreciation uses a

rate of either 150% or 200% of the
straight-line rate.

Since 200% is twice the straight-line

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

The DDB equation for any year is:

Since Book value = Initial cost total

charges to date

(3). Declining Balance Depreciation

Example: An asset has a cost of B = $900, a useful life

of N = 5 years, and an EOL salvage value of S =
$70.With DDB depreciation, we would compute the
following:

Year

Multiplier Depreciation

Book Value

dt=(2/N)BVt-1

Sum of
Depreciati
on
dt

t
0

2/N

2/5

(2/5)900= 360

360

2/5

(2/5)540 =216

576

2/5

(2/5)324 = 130

706

2/5

(2/5)194= 78

784

2/5

(2/5)116= 46

830

900360=540
900576=324
900706=194
900784=116
900-830=70

BVt=B-dt
900

1
8

(3). Declining Balance Depreciation

(3). Declining Balance Depreciation

Example: An asset has a cost of B = $900, a useful

life of N = 5 years, and an EOL salvage value of S
= $70.With 150% Declining depreciation method,
we would compute the following:

Year

Multiplier Depreciation

Sum of
Depreciati
on

Book Value

1.5/N

dt

BVt=B-dt

0
1
2
3
4
5

dt=(1.5/N)BVt-1

900

Double Declining Balance Depreciation

Summary
DDB

is an accelerated depreciation compared

to straight line method

Book

value (not first cost) is reduced by

same fraction (or %) each year (not same
constant amount, as in straight line)

Converges

to an implied salvage value

usually different than estimated salvage
value

Conclusions
Depreciation is a charge against income.
There is always a loss in value of the assets,
such as plant and machinery, in operation or
even if they are lying idle.
Since the useful life of the asset is longer
than the accounting period, a periodic
charge is made for depreciation to
systematically apportion the asset cost
over its useful life.
Straight line and declining balance are
the most common methods.

Examples of
Problems

1
Some

special handling devices can be

obtained for
$12,000. At the end of 4 years, they can be
sold for $3,500. Compute the depreciation
schedule for the devices using the following
methods:
(a)

Straight-line depreciation.
(b) Sum-of-years' -digits depreciation.
(c) Double declining balance depreciation.

1
P=B=$12,000
S=$3,500
(a) Straight Line
Depreciation

Year

Initial Book
Value
B

N=
4

Depreciation
Charge
dt=(B-S)/N

EOY Book
Value
B-dt
12000

0
1

12000

2125

9875

9875

2125

7750

7750

2125

5625

5625

2125

3500

1
P=B=$12,000
S=$3,500
(b) Sum-of-Years Digits
Depreciation

Year

Life Multiplier

t
0
1
2
3
4
10

B-S

(Nt+1)/SOY
D
4
3
2
1
SOYD

0.4
0.3
0.2
0.1

8500
8500
8500
8500

N=
4

Depreciation EOY book

Charge
Value
(Nt+1)/SOYD*(BS)
12000
3400
8600
2550
6050
1700
4350
850
3500

1
P=B=$12,000
S=$3,500
N=4
(c) Double Declining Balance
Depreciation

DDB in any year

= 2/N(Book Value)
Depreciation
Sum of
EOY Book
Year Multiplie
Charge
Depreciation
Value
r
dt
BVt=B-dt
t
2/N
dt=(2/N)BVt-1
0
12000
1
0.50
6000
6000
6000
2
0.50
3000
9000
3000
3
0.50
1500
10500
1500
4
0.50
750
11250
750

2
The

company treasurer is uncertain which of

three depreciation methods the firm should
use for office furniture that costs $50,000,
and has a zero salvage value at the end of a
1O-year depreciable life. Compute the
depreciation schedule for the office furniture
using the methods listed:
(a) Straight line.
(b) Double declining balance.
(c) Sum-of-years' -digits.
The computations for the first three
methods (SL, DB, SOYD) are similar to
Problem 1

3
The

Acme Chemical Company purchased

$45,000 of research equipment, which it
believes will have zero salvage value at the
end of its 5-year life. Compute the
depreciation schedule for the equipment by
each of the following methods:

(a)

Straight line.
(b) Sum-of-years'-digits.
(c) Double declining balance.

Thank You