CE-725

Construction
Economics and Finance

Depreciation
One story
• Sandy inherited $100,000 to start a landscaping service
• She took a $80,000 loan and bought a tractor for
$180,000
• Gross income was $125,000
• Annual operating and loan repayment $62,000
• Rest was spent personally
• After 5 years, loan was repaid but the equipment worn
out.
• No money left to replace the machine. Where did
Sandy go wrong?
What is depreciation?
• Decrease in worth of an asset
• Production equipment gradually lose value with
age
• Lessening in value is recognized in accounting
practices as an expense of operating.
• One time charge or outlay over the useful life?
Causes of declining reserves
• Physical depreciation
• Functional depreciation
• Technological depreciation
• Sudden failure
• Depletion
• Monetary Deprciation
Depreciation
• It is an accounting concept really
Depreciation
• Depreciation charges are not true cash-flows

• Depreciation are provisions for recovering capital

invested in income-producing assets.
• Made by charging depreciation to the current
income.

• Depreciation does not capture the true market

value of the assets’
• Only certain assets are allowed to be depreciated
What are depreciable assets?
• Expected to be used for more than one accounting
period
• Have limited useful life
• Held to be used on projects but not as sale goods
Some terms
• Cost of the asset
• Useful life of the asset
• Scrap value or Residual Value
• Depreciable amount
One example throughout
• Assets are purchased at Rs 7000
• Useful life is 5 years
• After 5 years they are not worth anymore
• The cost of capital is 7%
Straight line method
Reducing Balance Method
• A fixed percentage of the first cost is written off
each year.

• Rate of depreciation is
Double declining balance
method
• R = 200/N or 150/N %
Sum of digits method
Annuity Method
Machine hour method
Production units method
Depletion method