LEARNING OUTCOME

Use depreciation or depletion methods to reduce the book value of a capital investment in an asset and
natural resource.

PURPOSES OF DEPRECIATION

1. To provide for the recovery of capital which has been invested in

physical property.

2. To enable the cost o f depreciation to be charged to the cost

producing products or services that results from the use of the

property.

3. Depreciation is a tax-allowed deduction included in tax

calculations.

Taxes = (income – deductions)(tax rate)

DEPRECIATION TERMINOLOGIES

DEPRECIATION

is a book method to represent the reduction in value of a tangible

asset. (Amortization used to reflect the decreasing value of

intangible assets)

FIRST COST, P OR UNADJUSTED BASIS, B

is the delivered and installed cost of the asset including purchase

price, delivery and installation fees, and other depreciable direct

costs incurred to prepare the asset for use. The term unadjusted

basis , or simply basis , is used when the asset is new, with the term

DEPRECIATION TERMINOLOGIES

BOOK VALUE, BV

represents the remaining, undepreciated capital investment on the

books after the total amount of depreciation charges to date has

RECOVERY PERIOD, n

is the depreciable life of the asset in years. Often there are different

n values for book and tax depreciation. Both of these values may

be different from the asset’s estimated productive life.

DEPRECIATION TERMINOLOGIES

MARKET VALUE, MV

a term also used in replacement analysis, is the estimated amount

realizable if the asset were sold on the open market.

SALVAGE VALUE, SV

is the estimated trade-in or market value at the end of the asset’s

useful life.

DEPRECIATION RATE OR RECOVERY RATE, d

is the fraction of the first cost removed by depreciation each year.

This rate may be the same or different each year.

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 conduct business.

REAL PROPERTY

includes real estate and all improvements—office buildings,

manufacturing structures, test facilities, warehouses, apartments,

and other structures. Land itself is considered real property, but it is

DEPRECIATION TERMINOLOGIES

PHYSICAL LIFE

length of time during which the property is capable of performing

the function for which it was designed and manufactured.

ECONOMIC LIFE

length of time during which the property may be operated at a

profit.

TYPES OF DEPRECIATION

1. NORMAL DEPRECIATION

a. PHYSICAL DEPRECIATION- is due to the lessening of the physical

ability of a property to produce results

b. FUNCTIONAL DEPRECIATION- is due to the lessening in the

demand for the function which the property was designed to

render.

2. Depreciation due to changes in price levels

3. DEPLETION- this refers to the decrease in the value of a property

due to the gradual extraction of its contents.

DEPRECIATION METHODS

1. STRAIGHT LINE METHOD

assumes that the loss in value is directly proportional to the age of

the property d = ( CO – CL

)/L
Dn = n (CO – CL

)/L

Cn = CO – Dn

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

DEPRECIATION METHODS

STRAIGHT LINE METHOD PROBLEM An electronic balance costs P90,000 and has an estimated salvage
value of P8000 at the end of its 10years lifetime. What would be the book value after 3years using the
straight line method in solving for the depreciation?

DEPRECIATION METHODS

STRAIGHT LINE METHOD PROBLEM

An electronic balance costs P90,000 and has an estimated salvage

value of P8000 at the end of its 10years lifetime. What would be the

book value after 3years using the straight line method in solving for

the depreciation?

CHAGAYATIN

DEPRECIATION METHODS

CO3-DEPRECIATION
d = ( CO – CL

)/L

Dn = n ( CO – CL

)/L=nd

Cn = CO – Dn

d = ( 90,000 – 8,000 ) / 10 = P8,200

D3 = 3 (8,200) = P24,600

C3 = 90,000 – 24,600 = P65,400

2. SINKING FUND METHOD

assumes that the funds will accumulate for replacement

d = ( CO – CL) / ( F/A, i%, L )

Dn = d ( F/A, i%, n )

Cn = CO – Dn

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

SINKING FUND METHOD PROBLEM

A firm bought equipment for P560,000. Other expenses including

installation amounted to P4000. The equipment is expected to

have a life of 16years with a salvage value of 10% of the original

cost of the equipment. Determine the book value at the end of

12years by sinking fund method at 12% interest.

A firm bought equipment for P560,000. Other expenses including

installation amounted to P4000. The equipment is expected to

have a life of 16years with a salvage value of 10% of the original

cost of the equipment. Determine the book value at the end of

12years by sinking fund method at 12% interest.

d = ( CO – CL) / (F/A, i%, L)

Dn = d ( F/A, i%, n)

Cn = CO – Dn

CO- unadjusted basis

= 560,000+4000

=P564,000

CL=10%Co Equipment

= 0.10(560,000)

=P56,000
DECLINING BALANCE METHOD

percentage method or Matheson Formula assumes that the annual

cost of depreciation is a fixed percentage of the salvage value at

the beginning of the year.

The ratio of the depreciation in any year to the book value at the

beginning of that year is constant through out the life of the

property and is designated by K, the rate of depreciation.

K = 1 − n CnΤCo K = 1 − n CLΤCo *not applicable if salvage value is zero because K = 1

DECLINING BALANCE METHOD

assumes that the funds will accumulate for replacement

Cn = CO 1 − K

CL = CO 1 − K

L
dn = KCO 1 − K

n−1

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

DECLINING BALANCE METHOD PROBLEM

A certain type of machine loses 10% of its value each year. The

machine costs P20,000 originally. Make out a schedule showing the

yearly depreciation, the total depreciation and the book value at

the end of each year for 5years.

DECLINING BALANCE METHOD PROBLEM

A certain type of machine loses 10% of its value each year. The

machine costs P20,000 originally. Make out a schedule showing the

yearly depreciation, the total depreciation and the book value at

the end of each year for 5years.

CHAGAYATIN

DEPRECIATION METHODS

CO3-DEPRECIATION

BVB- beginning book value

d- yearly depreciation charge

BVE- end book value

10% =K

DOUBLE DECLINING BALANCE METHOD

similar to the declining balance method except that the rate of

depreciation K = 2/L

Cn = CO 1 − K

CL = CO 1 − K

dn = KCO 1 − K

n−1

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

DOUBLE DECLINING BALANCE METHOD PROBLEM

Determine the rate of depreciation, the total depreciation up to

the end of the 8th year and the book value at the end of 8 years

for an asset that costs P15,000 new and has an estimated scrap

value of P2,000 at the end of 10 years by (a) the declining balance

method and (b) the double declining balance method.

Determine the rate of depreciation, the total depreciation up to

the end of the 8th year and the book value at the end of 8 years

for an asset that costs P15,000 new and has an estimated scrap

value of P2,000 at the end of 10 years by (a) the declining balance

method and (b) the double declining balance method.

CHAGAYATIN

SUM OF THE YEARS DIGIT METHOD

assumes that the funds will accumulate for replacement

dn = Reverse DigitΤSum of Digit CO − CL

dn = Depreciation Factor CO − CL

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

SUM OF THE YEARS DIGIT METHOD PROBLEM

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

SUM OF THE YEARS DIGIT METHOD PROBLEM

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.