Chapter 3.

DEPRECIATION

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1
 Definitions

Depreciation - the decrease in the value of a physical

property with the passage of time.

Types of Depreciation
1. Physical depreciation – this is due to the reduction of
the physical ability of an equipment or asset to produce
results.
2. Functional depreciation – this is due to the lessening
in the demand for the function which the property was
designed to render.

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 Purpose of Depreciation

1. To enable the cost of depreciation to be included as a

cost in the production of goods and services.

2. Annual costs of depreciation are being put up in a fund

called depreciation reserve for replacement of the
property.

3. To recover capital invested in the property.

4. Provide as an additional capital termed as depreciation

reserve.
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 Properties Depreciable Assets

1. It must have a determinable life and the life must be

greater than 1 year.

2. It must be something used in business or held to

produce income.

3. It must be something that gets used up, wears out

decays, become obsolete, or loses its value due to natural
causes.

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 Depreciation Terminology

Initial Investment/First Cost (FC) – the cost of

acquiring an asset, including transportation expenses and
other normal costs of making the asset serviceable for its
intended use.
Book Value (BV)– worth of property or an asset as
shown on the accounting records of the company. It is the
original cost of the property less all allowable
depreciation deductions.
Salvage Value (SV)- the amount that will be paid by a
willing buyer to a willing seller for a property after
depreciation is competed.
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 Depreciation Terminology

Useful life (L)– the expected period that a property will

be used in trade or business to produce income.
Physical life – the length of time during which the
property is capable of performing the function
Economic life – length of time during which the property
may be operated at a profit.
Recovery period (n)– the number of years over which
the basis of property is recovered through the accounting
process.
Recovery rate (i)- a percentage for each year of the
recovery period that utilized to compute an annual
depreciation deduction.
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 Methods of Depreciation Symbols
d = annual cost of depreciation
L = useful life
n = any year during the life of the property
dn = depreciation cost during year n
Dn = total cost of depreciation after n years
FC = initial investment, original cost, first cost
SV = salvage value/scrap value
BV = book value at the end of n years

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 Methods of Depreciation

1. Straight Line Method (SLM) –The simplest

depreciation method. This method assumes that the
loss in the value is directly proportional to the age of
the equipment or asset.
a. Annual cost of depreciation
𝐹𝐶 − 𝑆𝑉
𝑑=
𝐿
b. Total depreciation after n years
Dn = nd
c. Book value at the end of n years
BVn = FC – Dn
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 Methods of Depreciation

Example 1. An electric balance costs P90,000 and has an

estimated salvage value of P8,000 at the end of its 10 years’
life time. What would be the book value after three years,
using SLM.
Given:
Fc = P90,000
SV = P8,000
L =10 years
n=3 years

Required: BV3
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 Methods of Depreciation

Solution: Find the annual deprecation (d)

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 Methods of Depreciation

Solution: Find the annual deprecation (d)

𝐹𝐶 − 𝑆𝑉 𝑃90,000 − 𝑃8,000
𝑑= = = 𝑃8,200
𝐿 10
Get the total depreciation after 3 years

D3 = nd = 3(P8,200) = P24,600

Find the book value after 3 years by subtracting the total

depreciation after 3 years to original cost.

BV3 = FC – D3 = P90,000 – P24,600 = P65,400

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 Methods of Depreciation
Example 2. A new electric saw for cutting small piece of
lumber in a furniture manufacturing plant has a cost basis of
$4,000 and a 10 –year depreciable life. Determine the annual
depreciation amounts and tabulate the annual depreciation
amounts and the book value of the saw at the end of each year.
Given: Fc = $4,000 SV = 0 L =10 years
Required: d

Solution: Find the annual deprecation d

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 Methods of Depreciation
Using Tabulated form;
End of Year (n) Depreciation ($) Book Value ($)
0 - 4,000
1 400 3,600
2 400 3,200
3 400 2,800
4 400 2,400
5 400 2,000
6 400 1,600
7 400 1,200
8 400 800
9 400 400
10 400 0
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 Methods of Depreciation
2. Sinking Fund Method (SFM) - This method assumes that
a sinking fund is established in which funds will accumulate
for replacement. The total depreciation that has taken place up
to any given times is assumed to be equal to the accumulated
amount in the sinking fund at that time.
a. Annual cost of depreciation
𝑖
𝑑 = (𝐹𝐶 − 𝑆𝑉)
(1 + 𝑖)𝐿 −1
b. Total depreciation after n years
(1+𝑖)𝑛 −1
𝐷𝑛 = 𝑑
𝑖
c. Book value at the end of n years
17
BVn = FC – Dn
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 Methods of Depreciation
Example 3: A broadcasting corporation purchased an equipment for
P53,000 and paid P1,500 for freight and delivery to the job site. The
equipment has a normal life of 10 years with a trade-in-value of P5,000
against the purchase of a new equipment at the end of life. Determine the
annual depreciation and the book value at the end of 5 years if interest is
6.5% compounded annually.
Given: FC = P54,500 (Original cost + freight and delivery)
SV = P5,000
L = 10
n=5
i=6.5%
Required: d and BV5
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 Methods of Depreciation
Solution: Find the annual deprecation d
𝑖
𝑑 = (𝐹𝐶 − 𝑆𝑉)
(1 + 𝑖)𝐿 −1

Get the total depreciation after 5 years

(1 + 𝑖)𝑛 − 1
𝐷𝑛 = 𝑑
𝑖

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 Methods of Depreciation
Example 4. A firm bought an equipment for P56,000. Other expenses
including installation amounted to P4,000. The equipment is expected to
have a life of 16 years with a salvage value of 10% of the original cost.
Determine the book value at the end of 12 years by SFM at 12% interest.
Given:
FC = 60,000 from (P56,000+P4,000)
SV = P6,000 from (P60,000x0.10)
L = 16 years
n = 12
i=12%

Required: BV12
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 Methods of Depreciation
Solution: Find the annual deprecation d
𝑖
𝑑 = (𝐹𝐶 − 𝑆𝑉)
(1 + 𝑖)𝐿 −1

Get the total depreciation after 12 years

(1 + 𝑖)𝑛 − 1
𝐷𝑛 = 𝑑
𝑖

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 Methods of Depreciation
3. Declining Balance Method. In this method, sometimes
called the constant percentage method or the Matheson
Formula, it is assumed 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
throughout the life of the property and is designated by k,
the rate of depreciation.
𝑛 𝐵𝑉 𝐿 𝑆𝑉
𝑘 =1− 𝑜𝑟 1 −
𝐹𝐶 𝐹𝐶

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 Methods of Depreciation
a. Annual depreciation d
𝑑𝑛 = 𝐹𝑐 𝑘 (1 − 𝑘)𝑛−1

b. Salvage value
𝑆𝑉 = 𝐹𝑐(1 − 𝑘)𝐿

c. Total depreciation Dn
𝑛
𝐷𝑛 = 𝐹𝑐(1 − 1 − 𝑘 )

d. Book value at the end of n years

BVn = FC – Dn

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 Methods of Depreciation
Example 5. Determine the rate of depreciation, the total
depreciation up to the end of the 8th year and the book
value at the end of 8th 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 DBM.
Given: FC = P15,000
SV= P2,000
L = 10 years
n = 8 years

Required: k, D8 and BV8

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 Methods of Depreciation
Solution: Find the value of rate of depreciation k
𝐿 𝑆𝑉
𝑘 =1−
𝐹𝐶
Total depreciation D8
𝐷𝑛 = 𝐹𝑐(1 − 1 − 𝑘 𝑛 )

Book value at the end of 8 years

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 Methods of Depreciation
Example 6. A certain type of machine loses 10% of its
value each year. The machine costs P2,000 originally.
Make out a schedule showing the yearly depreciation, the
total depreciation and the book value at the end of each
year for 5 years.

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 Methods of Depreciation
4. Double Declining Balance Method (DDBM) - This method is
very similar to the DBM except that the rate of depreciation k is
replaced by 2/L
a. Annual depreciation d
2 2 𝑛−1
𝑑𝑛 = 𝐹𝑐 (1 − )
𝐿 𝑙
b. Salvage value
2 𝐿
𝑆𝑉 = 𝐹𝑐(1 − )
𝐿
c. Total depreciation Dn
𝑛
2
𝐷𝑛 = 𝐹𝑐(1 − 1 − )
𝐿
d. Book value at the end of n years
BVn = FC – Dn
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 Methods of Depreciation
Example 7. Determine the rate of depreciation, the total
depreciation up to the end of the 8th year and the book
value at the end of 8th 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 DDBM.
Given: FC = P15,000
SV = P2,000
L = 10 years
n = 8 years

Required: k, D8 and BV8

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 Methods of Depreciation
Solution: Find the value of rate of depreciation k
2
𝑘= =
𝐿

Total depreciation D8
𝑛
2
𝐷𝑛 = 𝐹𝑐(1 − 1 − )
𝐿

Book value at the end of 8 years

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 Methods of Depreciation
Example 8. A plant bought a calciner for P220,000 and
used it for 10 years, the life span of the equipment. What
is the book value of the calciner after 5 years of use?
Assume a scrap value P22,000 for DBM and P20,000 for
DDBM.
Given: FC = P220,000
SV (DBM)= P22,000
SV (DDBM)= P20,000
L = 10
n=5

Required: BV after 5 years using DBM and DDBM

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 Methods of Depreciation

Solution: For DBM

𝑺𝑽 𝒏
𝑩𝑽 = 𝑭𝑪( )𝑳 =
𝑭𝑪

For DDBM
𝟐 𝒏
𝑩𝑽 = 𝑭𝑪(𝟏 − ) =
𝑳

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 Methods of Depreciation

5. Sum of the year digit method (SOYDM) - It is a method

of evaluating depreciation where the depreciation changes
from year to year.
a. annual depreciation
2 𝐿−𝑛+1
𝑑𝑛 = (𝐹𝐶 − 𝑆𝑉)
𝐿 𝐿+1
b. Total depreciation
𝑛 2𝐿 − 𝑛 + 1
𝐷𝑛 = (𝐹𝐶 − 𝑆𝑉 )
𝐿 𝐿+1
c. Book value
BVn = FC – Dn
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 Methods of Depreciation

Example 9. A machine costs P70,000 and an estimated life

of 10 years with a salvage value of P5,000. What is the
depreciation at 7th year and the book value after 5 years
using the SOYD method?
Given:
FC = P70,000
SV= P5,000
L = 10
n = 7,5

Required: d7, BV5

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 Methods of Depreciation
Solution:
2 𝐿−𝑛+1
𝑑𝑛 = (𝐹𝐶 − 𝑆𝑉)
𝐿 𝐿+1
𝑑7 =

In getting the book value after 5 years, we need to determine the total
depreciation after 5 years.
𝑛 2𝐿 − 𝑛 + 1
𝐷𝑛 = (𝐹𝐶 − 𝑆𝑉 )
𝐿 𝐿+1
𝐷5 =

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 Methods of Depreciation

6. Service-Output Method (SOM) - This method assumes

that the total depreciation that has taken place is directly
proportional to the quantity of output of the property up to
that time. This method has the advantage of making the unit
cost of depreciation constant and giving low depreciation
expense during periods of low production.

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 Methods of Depreciation
6.1 Service Method (Number of hours used)
Let H= total units of hours used and within the useful life
Hn = total number of hours used at nth year.
𝑑 𝐹𝐶 − 𝑆𝑉 𝑑
= and 𝑑𝑛 = (𝐻𝑛)
ℎ𝑟 𝐻 ℎ𝑟

6.2 Output Method (Number of units produced)

Let T= total number of units produced w/in the useful life.
Tn = number of units produced at the nth year
𝑑 𝐹𝐶 − 𝑆𝑉 𝑑
= and 𝑑𝑛 = (𝑇𝑛)
𝑢𝑛𝑖𝑡 𝑇 𝑢𝑛𝑖𝑡

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 Methods of Depreciation
Example 10. A television Company purchased machinery for
P100,000 and it has an estimated useful life of 10 years, scrap value
of P4,000, production of 400,000 units and working hours of
120,000.
The company uses the machinery for 18,000 hr during its 1st year and
produces 44,000 units. Compute the annual depreciation using:
A. SLM
B. Working hours
C. Output method
Given: Fc = P100,000 Sv = P4,000 L= 10 years
H = 120,000 hrs Hn = 18,000 hrs T = 400,000 units Tn =
44,000 units
Required: dn
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 Methods of Depreciation
Solution:
A. Straight Line Method
𝐹𝐶−𝑆𝑉
𝑑= =
𝐿

B. Working hours or service method

𝑑
=
ℎ𝑟

𝑑𝑛 =
C. Output Method
𝑑 𝐹𝐶−𝑆𝑉
= =
𝑢𝑛𝑖𝑡 𝑇
𝑑𝑛 =
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