ENGINEERING

ECONOMICS
(CET 0216)
PA M A N TASA N N G LU N G S O D N G M AY N I LA
(UNIVERSITY OF THE CITY OF MANILA)
CO L L E G E O F E N G I N E ER IN G A N D T E C H N O L O G Y
CI V I L E N G I N E E RING D E PA RT ME N T

Engr. Co and Engr. Polinga

 DEPRECIATION
Module 05

Straight Line Method

Sinking Fund Method
Declining Balance Method
Double Declining Balance Method
Sum of the Year’s Digit Method
Hour Output Method
Service Output Method
 DEPRECIATION
Depreciation
A book method (noncash) to represent the reduction in value of a tangible
asset.
The method used to depreciate an asset is a way to account for the decreasing
value of the asset to the owner and to represent the diminishing value (amount)
of the capital funds invested in it.
The annual depreciation amount is not an actual cash flow, nor does it
necessarily reflect the actual usage pattern of the asset during ownership.
Applied to tangible assets.
The term capital recovery is sometimes used to identify depreciation.
 DEPRECIATION
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.).
Even though depreciation itself is not a cash flow, it can result in actual cash
flow changes because the amount of tax depreciation is a deductible item when
calculating annual income taxes for the corporation or business.
In most industrialized countries, the annual tax depreciation is tax deductible.
It is subtracted from income when calculating the amount of taxes due each
year.
Must be calculated using a government-approved method.
Must be calculated using MACRS.
 DEPRECIATION
Book Depreciation
Used by a corporation or business for internal financial accounting to track the
value of an asset or property over its life.
May be calculated using any classical method or MACRS.
Common Terms
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
adjusted basis used after some depreciation has been charged.
When the first cost has no added, depreciable costs, the basis is the first cost,
that is, P = B.
 DEPRECIATION
Common Terms
Book value BVt 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), which is consistent with the end-of-year convention.
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
Common Terms
Market value MV, 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.
Salvage value S 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.
 DEPRECIATION
Common Terms
Depreciation rate or recovery rate dt 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.
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. Included is most manufacturing and service industry
property—vehicles, manufacturing equipment, materials handling devices,
computers and networking equipment, communications equipment, office
furniture, refining process equipment, construction assets, and much more.
 DEPRECIATION
Common Terms
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 not depreciable.
Half-year convention assumes that assets are placed in service or disposed of
in midyear, regardless of when these events actually occur during the year. This
convention is utilized in this text and in most U.S.-approved tax depreciation
methods. There are also midquarter and midmonth conventions.
 DEPRECIATION
There are several models for
depreciating assets. The
straight line (SL) method is
used historically and
internationally. Accelerated
models, such as the
declining balance (DB)
method, decrease the book
value to zero (or to the
salvage value) more rapidly
than the straight line
method, as shown by the
general book value curves in
Figure 16–1.
 STRAIGHT LINE METHOD
Straight Line Method (SL)
Straight line depreciation derives its name from the fact that the book value
decreases linearly with time. The depreciation rate dt is the same (1∕n) each
year t of the recovery period n.
Straight line depreciation is considered the standard against which any
depreciation model is compared. For book depreciation purposes, it offers an
excellent representation of book value for any asset that is used regularly over
an estimated number of years. For tax depreciation, as mentioned earlier, it is
not used directly in the United States, but it is commonly used in most other
nations for tax purposes.
 STRAIGHT LINE METHOD
Straight Line Method (SL)
The annual SL depreciation is determined by multiplying the first cost minus
the salvage value by dt.

t = year (t = 1, 2, . . . , n)
Dt = annual depreciation charge
B = first cost or unadjusted basis
S = estimated salvage value
n = recovery period
dt = depreciation rate = 1∕n
 STRAIGHT LINE METHOD
Straight Line Method (SL)
Since the asset is depreciated by the same amount each year, the book value
after t years of service, denoted by BVt, will be equal to the first cost B minus
the annual depreciation times t.

The SL model has the same rate for all years, that is,
 STRAIGHT LINE METHOD
Sample Problem
Question:
If an asset has a first cost of $50,000 with a $10,000 estimated salvage value
after 5 years, (a) calculate the annual depreciation, and (b) calculate and plot
the book value of the asset after each year, using straight line depreciation.
 STRAIGHT LINE METHOD
Sample Problem
Solution:
(a) calculate the annual depreciation
 STRAIGHT LINE METHOD
Sample Problem
Solution:
(b) calculate and plot the book value of the asset after each year, using straight
line depreciation.
The book value after each year t is computed using

The BVt values are plotted in the figure.

For years 1 and 5, for example,
 SINKING FUND METHOD
Sinking Fund Method (SF)
Sinking Fund Method is a depreciation method wherein funds will accumulate
for replacement purposes.
[ (FC − SV) (i) ]
Annual depreciation (A) = 𝑛
[(1 + i) −1 ]
𝑛
[(1 + i) −1]
Total depreciation after x years = A
𝑖
Book Value = FC - Total depreciation
 SINKING FUND METHOD
Sample Problem
Question:
A machine costs Php 300,000 with a salvage value of Php 50,000 at the end of
its life of 10 years. If money is worth 6% annually, use Sinking Fund Method
and determine the depreciation at the 6th year.
Solution:
[ (300,000 − 50,000) (0.06) ]
Annual Depreciation (A) = 10
[(1 + 0.06) −1 ]
A = Php 18,966.99
6
[(1 + 0.06) −1]
Total depreciation after x years = (18,966.99)
0.06
Total depreciation = Php 132,300.79
DECLINING BALANCE METHOD
Declining Balance (DB) and Double Declining Balance (DDB)
Commonly applied as the book depreciation method.
Also known as the fixed percentage or uniform percentage method.
DB depreciation accelerates the write-off of asset value because 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. Therefore, the
depreciation amount decreases each year.
DECLINING BALANCE METHOD
Declining Balance (DB) and Double Declining Balance (DDB)
The maximum annual depreciation rate for the DB method is twice the straight
line rate, that is,

If n = 10 years, the DDB rate is 2∕10 = 0.2; so 20% of the book value is
removed annually. Another commonly used percentage for the DB method is
150% of the SL rate, where d = 1.5∕n.
DECLINING BALANCE METHOD
Declining Balance (DB) and Double Declining Balance (DDB)
The depreciation for year t is the fixed rate d times the book value at the end of
the previous year.

The actual depreciation rate for each year t, relative to the basis B,
If BVt−1 is not known, the depreciation in year t can be calculated using B and
d.

Book value in year t is determined in one of two ways: by using the rate d and
basis B or by subtracting the current depreciation charge from the previous
book value.
DECLINING BALANCE METHOD
Declining Balance (DB) and Double Declining Balance (DDB)
The book value for the DB method never goes to zero because the book value
is always decreased by a fixed percentage. The implied salvage value after n
years is the BVn amount, that is,

If a salvage value is estimated for the asset, this estimated S value is not used in
the DB or DDB method to calculate annual depreciation. However, if the
implied S < estimated S, it is necessary to stop charging further depreciation
when the book value is at or below the estimated salvage value. In most cases,
the estimated S is in the range of zero to the implied S value.
DECLINING BALANCE METHOD
Declining Balance (DB) and Double Declining Balance (DDB)
If the fixed percentage d is not stated, it is possible to determine an implied
fixed rate using the estimated S value, if S > 0. The range for d is 0 < d < 2∕n.
DECLINING BALANCE METHOD
Sample Problem 1
Question (DB):
The equipment bought at a price of Php 450,000 has an economic life of 5
years and a salvage value of Php 50, 000. The cost of money is 12% per year.
Compute the first year depreciation using Declining Balance Method.
Solution (DB):
SV = FC (1 - d)t or
50,000 = 450,000 (1 - d)5
d = 0.356
Depreciation = (d) (FC) (1 - d)(t-1) or
Depreciation = (0.356) (450,000) (1 - 0.356)0
Depreciation = Php 160,200
DECLINING BALANCE METHOD
Sample Problem 2
Question (DDB):
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. (a)
Calculate the depreciation and book value for years 1 and 4. (b) Calculate the
implied salvage value after 12 years.
DECLINING BALANCE METHOD
Sample Problem 2
Solution (DDB):
(a) Calculate the depreciation and book value for years 1 and 4. (b) Calculate
the implied salvage value after 12 years.
(a) The DDB fixed depreciation rate is d = 2∕n = 2∕12 = 0.1667 per year.

(b) The implied salvage value after 12 years is

Since the estimated S = $2500 is less than $2803, the asset is not fully depreciated when its 12-
year expected life is reached.
 SEATWORK #08: Depreciation 1
Instructions:
Use a clean sheet of A4 Sized Bond Paper.
Scan/Capture a photo of your activity and upload it in our MS Teams
Assignment tab “Seatwork#08: Depreciation 1”
Follow the uploaded guidelines.
 SEATWORK #08: Depreciation 1
Questions:
1. An energy production company has the following information regarding the
acquisition of new gas turbine equipment.
Purchase price = $780,000
Trans-oceanic shipping and delivery cost = $4300
Installation cost (1 technician at $1600 per day for 4 days) = $6400
Tax recovery period = 15 years
Book depreciation recovery period = 10 years
Salvage value = 10% of purchase price
Operating cost (with technician) = $185,000 per year
The manager of the department asked your friend in Accounting to enter the
appropriate data into the tax-accounting program. What are the values of B, n,
and S in depreciating the asset for tax purposes that he should enter?
 SEATWORK #08: Depreciation 1
Questions:
2. Goodson Healthcare purchased a new sonogram imaging unit for $300,000
and a truck body and chassis for an additional $100,000 to make the unit
mobile. The unit-truck system will be depreciated as one asset. The
functional life is 8 years, and the salvage is estimated to be 10% of the
purchase price of the imaging unit regardless of the number of years of
service. Use classical straight line depreciation to determine the salvage
value, annual depreciation, and book value after 4 years of service.
3. Software and hardware for optimizing cell design of robotic picking lines
have an installed cost of $78,000 with no residual value after 5 years. For
years 2 and 4, use DDB book depreciation to determine (a) the depreciation
charge, and (b) the book value.
 SUM OF THE YEARS DIGIT
METHOD
Sum of the Years Digit Method (SYD)
The SYD method is the first historical accelerated depreciation technique that
can remove over 40% of the first cost in the first 25% of a 20-year recovery
period.
This technique may be used in an engineering economy analysis in the book
depreciation of multiple-asset accounts (group and composite depreciation).
Sum of the Years Digit Method is an accelerated depreciation technique based
on the assumption that tangible properties are usually productive when they are
new, and their use decreases as they become old.
 SUM OF THE YEARS DIGIT
METHOD
Sum of the Years Digit Method (SYD)
The mechanics of the method involve the sum of the year’s digits from 1
through the recovery period n.
The depreciation charge for any given year is obtained by multiplying the basis
of the asset, less any salvage value, by the ratio of the number of years
remaining in the recovery period to the sum of the year’s digits, SUM.
 SUM OF THE YEARS DIGIT
METHOD
Sum of the Years Digit Method (SYD)
The book value for any year t is calculated as

The rate of depreciation decreases each year and equals the multiplier
SUM OF THE YEARS DIGIT METHOD
Sample Problem
Question:
Calculate the SYD depreciation charges for year 2 for electro-optics equipment
with B = $25,000, S = $4000, and an 8-year recovery period.
Solution:
The sum of the year’s digits is 36
The depreciation amount for the second year is
 SERVICE OUTPUT METHOD
Service Output Method
Service Output Method is a depreciation method that results in the cost basis
allocated equally over the expected number of units produced during the period
of tangible properties.

Depreciation per unit = (FC - SV) / Total number of units

 SERVICE OUTPUT METHOD
Sample Problem
Question:
A coin machine costing Php 200,000 has a salvage value of Php 20,000 at the
end of its economic life of five years. Determine the annual reserve for
depreciation for the third year only.
The schedule of production per year is as follows:
 SERVICE OUTPUT METHOD
Sample Problem
Solution:
Total number of coins = 100,000 + 80,000 + 60,000 + 40,000 +20,000
Total number of coins = 300,000

Depreciation per unit = (FC - SV) / Total number of coins

Depreciation per unit = (200,000 - 20,000) / 300,000
Depreciation per unit = 0.60

Depreciation3 = 0.60 (60,000)

Depreciation3 = Php 36,000
 HOUR OUTPUT METHOD
Hour Output Method
Hour Output Method is the same with Service Output Method.
The formula for Hour Output Method of Depreciation is:

Depreciation per hour = (FC - SV) / Total number of hours

 SERVICE OUTPUT METHOD
Sample Problem
Question:
A machine costs Php 400,000 with a salvage value of Php 20,000. Life of it is
six years. In the first year, 4000 hours. In the second year, 6000 hours and 8000
hours on the third year. The expected flow of the machine is 38000 hours in six
years. What is the depreciation at the end of the second year?
Solution:
Depreciation per hour = (400,000 - 20,000) / 38000
Depreciation per hour = Php 10

Depreciation2 = 10 (6000)
Depreciation2 = Php 60,000
 SEATWORK #09: Depreciation 2
Instructions:
Use a clean sheet of A4 Sized Bond Paper.
Scan/Capture a photo of your activity and upload it in our MS Teams
Assignment tab “Seatwork#09: Depreciation 2”
Follow the uploaded guidelines.
 SEATWORK #09: Depreciation 2
Questions:
1. An equipment costs Php 1,500,000. At the end of its economic life of five
years, its salvage value is Php 500,000. Using Sum of the Years Digit
Method of Depreciation, what will be its book value for the third year?
Ans. BV3 = Php 700,000.00
2. The first coat of a road laying machine is Php 8,000,000. Its salvage value
after five years is Php 50,000. The length of road that can be laid by the
machine during its lifetime is 75,000 km. In its third year of operation, the
length of road laid is 2,000 km. Find the depreciation of the equipment for
that year.
Ans. D3 = Php 212,000.00
 REFERENCES
Engineering Economy, Blank and Tarquin, 6th Edition, McGraw-
Hill, 2008
Engineering Economics, J. K. Yates, Taylor & Francis Group, 2017
https://owlcation.com/stem/Depreciation-Methods-in-Engineering-
Economics-Formulas-Problems-and-Solutions
https://www.brainkart.com/article/Methods-of-Depreciation_5338/