PROPERTY, PLANT AND EQUIPMENT-IMPAIRMENT

Depreciation

Cost Allocation_ an Overview

Property, Plant, and Equipment are purchased with expectation that they will provide future benefits,
usually for several years. Specifically, they are acquired to be used as part of the revenue-generating
operations. Logically, then, the costs of acquiring the assets should be allocated to expense during the
reporting periods benefited by their use.

Let’s suppose that a company purchases a used delivery truck for Php820,000 to be used to deliver
product to customers. The company estimates that five years from the acquisition date the truck will be
sold for Php220,000. It is estimated, then, that Php600,000 (Php820,000-Php220,000) of the truck’s
purchase price will be used up (consumed) during the five-year useful life.

Year 1 Year 2 Year 3 Year 4 Year 5

Cost-Php820,000 Residual Value-
Php220,000
Php820,000-Php220,000=Php600,000, to be expensed during the five year period
Yearly expense (depreciation) : Php600,000/5yrs = Php120,000
Php120,000 Php120,000 Php120,000 Php120,000 Php120,000

Journal Entry

Year 1
Delivery Truck 820,000
Cash/Accounts Payable 820,000

End of Year 1
Depreciation expense 120,000
Accumulated depreciation - Delivery Truck 120,000

End of Year 2
Depreciation expense 120,000
Accumulated depreciation - Delivery Truck 120,000

End of Year 3
Depreciation expense 120,000
Accumulated depreciation – Delivery Truck 120,000

End of Year 4
Depreciation expense 120,000
Accumulated depreciation – Delivery Truck 120,000
End of Year 5

Depreciation expense 120,000

Accumulated depreciation – Delivery Truck 120,000

Computation of Net Book Value

Year 1 Year 2 Year 3 Year 4 Year 5

Cost Php 820,000 Php 820,000 Php 820,000 Php 820,000 Php 820,000
Accumulated depreciation 120,000 240,000 360,000 480,000 600,000
Net book Value 700,000 580,000 460,000 340,000 220,00

Factors in Calculating Depreciation

Three factors affect the calculation of depreciation
1. Cost – Issues affecting the cost of a depreciable asset were explained earlier in this chapter. Recall
that PPE assets are initially recorded at cost, in accordance with the cost principle.
2. Useful Life. Useful life is an estimate of the asset’s expected productive life, also called service life.
Useful life may be expressed in terms of the time period over which the asset is expected to be
available for use. It may also be expressed in terms of the number of units of production or the output
expected to be obtained from the asset. In making the estimate; management considers such factors
as the intended use of the asset. In making the estimate, management considers such factors as the
intended use of the asset, its expected repair and maintenance and its vulnerability to obsolescence.
Past experience with similar assets is often helpful in deciding on the asset’s expected useful life. An
asset’s useful life may be shorter than its economic life. We might reasonably expect that the
estimated useful life used by Starbuck’s coffees to depreciate its stores will differ from that used by
starbucks.
3. Residual Value. Residual value is the current estimate of the asset’s disposal value, net of disposal
costs, if the asset is already of the age and in the condition expected at the end of its useful life. The
disposal value may be based on the asset’s worth as scrap or on its expected trade-in value. Like
useful life, residual value is an estimate. In making the estimate, management considers how it plans to
dispose of the asset, and its experience with similar assets.

What are the Main Types of Depreciation Methods?

There are several types of depreciation expense and different formulas for determining the book value of
an asset. The most common depreciation methods include:
1. Straight-line
2. Double declining balance
3. Units of production
4. Sum of years digits
Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life. In
other words, it is the reduction in the value of an asset that occurs over time due to usage, wear and tear,
or obsolescence. The four main depreciation methods mentioned above are explained in detail below
1. Straight-Line Depreciation Method
Straight-line depreciation is a very common, and the simplest, method of calculating depreciation expense.
In straight-line depreciation, the expense amount is the same every year over the useful life of the asset.
Depreciation Formula for the Straight Line Method:
Depreciation Expense = (Cost – Salvage value) / Useful life

Example
Consider a piece of equipment that costs Php25,000 with an estimated useful life of 8 years and a Php0
salvage value. The depreciation expense per year for this equipment would be as follows:

Depreciation Expense = (Php25,000 – Php0) / 8 = Php3,125 per year

2. Double Declining Balance Depreciation Method
Compared to other depreciation methods, double-declining-balance depreciation results in a larger amount
expensed in the earlier years as opposed to the later years of an asset’s useful life. The method reflects the
fact that assets are typically more productive in their early years than in their later years – also, the practical
fact that any asset (think of buying a car) loses more of its value in the first few years of its use. With the
double-declining-balance method, the depreciation factor is 2x that of the straight-line expense method.
Depreciation formula for the double-declining balance method:
Periodic Depreciation Expense = Beginning book value x Rate of depreciation

Example
Consider a piece of property, plant, and equipment (PP&E) that costs Php25,000, with an estimated useful
life of 8 years and a Php2,500 salvage value. To calculate the double-declining balance depreciation, set
up a schedule:
The information on the schedule is explained below:
1. The beginning book value of the asset is filled in at the beginning of year 1 and the salvage value is
filled in at the end of year 8.
2. The rate of depreciation (Rate) is calculated as follows:
Expense = (100% / Useful life of asset) x 2
Expense = (100% / 8) x 2 = 25%
Note: Since this is a double-declining method, we multiply the rate of depreciation by 2.
3. Multiply the rate of depreciation by the beginning book value to determine the expense for that
year.
For example, Php25,000 x 25% = Php6,250 depreciation expense.
4. Subtract the expense from the beginning book value to arrive at the ending book value. For
example,
Php25,000 – Php6,250 = Php18,750 ending book value at the end of the first year.
5. The ending book value for that year is the beginning book value for the following year. For
example, the year 1 ending book value of Php18,750 would be the year 2 beginning book value.
Repeat this until the last year of useful life.

Learn more in CFI’s Accounting Courses.

3. Units of Production Depreciation Method

The units-of-production depreciation method depreciates assets based on the total number of hours used
or the total number of units to be produced by using the asset, over its useful life.
The formula for the units-of-production method:
Depreciation Expense = (Number of units produced / Life in number of units) x (Cost – Salvage value)

Example
Consider a machine that costs Php25,000, with an estimated total unit production of 100 million and a Php0
salvage value. During the first quarter of activity, the machine produced 4 million units.

To calculate the depreciation expense using the formula above:

Depreciation Expense = (4 million / 100 million) x (Php25,000 – Php0) = Php1,000

4. Sum-of-the-Years-Digits Depreciation Method

The sum-of-the-years-digits method is one of the accelerated depreciation methods. A higher expense is
incurred in the early years and a lower expense in the latter years of the asset’s useful life.
In the sum-of-the-years digits depreciation method, the remaining life of an asset is divided by the sum of
the years and then multiplied by the depreciating base to determine the depreciation expense.
The depreciation formula for the sum-of-the-years-digits method:
Depreciation Expense = (Remaining life / Sum of the years digits) x (Cost – Salvage value)
Consider the following example to more easily understand the concept of the sum-of-the-years-digits
depreciation method.

Example
Consider a piece of equipment that costs Php25,000 and has an estimated useful life of 8 years and a
Php0 salvage value. To calculate the sum-of-the-years-digits depreciation, set up a schedule:

The information in the schedule is explained below:

1. The depreciation base is constant throughout the years and is calculated as follows:
Depreciation Base = Cost – Salvage value
Depreciation Base = Php25,000 – Php0 = Php25,000
2. The remaining life is simply the remaining life of the asset. For example, at the beginning of the
year, the asset has a remaining life of 8 years. The following year, the asset has a remaining life of
7 years, etc.
3. RL / SYD is “remaining life divided by sum of the years.” In this example, the asset has a useful life
of 8 years. Therefore, the sum of the years would be 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 = 36 years. The
remaining life in the beginning of year 1 is 8. Therefore, the RM / SYD = 8 / 36 = 0.2222.
or SYD = life(life+1)/2 ; 8 (8+1)2 = 36 years
4. The RL / SYD number is multiplied by the depreciating base to determine the expense for that year.
5. The same is done for the following years. In the beginning of year 2, RL / SYD would be 7 / 36 =
0.1944. 0.1944 x Php25,000 = php4,861 expense for year 2.

Each method is acceptable under generally accepted accounting principles. Management selects the
method (s) it believes to be appropriate. The objective is to select the method that the best measures an
asset’s contribution to revenue over its useful life. Consistency enhances the comparability of financial
statements. Entities are required to disclose the depreciation method they are applying in their financial
statements, as well as the depreciation expense for the reporting period.
To Illustrate. Compare the four depreciation methods using the data for a delivery truck purchased by
Pau’s Florists on January 1 ,2020
Cost Php 130,000
Expected residual value 10,000
Estimated useful life in years 5
Estimated useful life in kilometers
Year 1 15,000
Year 2 30,000
Year 3 20,000
Year 4 25,000
Year 5 10,000
----------- 100,000 kilometers
Double Declining Balance method

Note: Depreciation affects the statement of financial position through accumulated depreciation and the
Income statement through depreciation expense. It has no impact on the statement of cash flows as it does
not involve a cash outflow.

1. Straight Line Method

Cost – Expected Residual Value
Yearly depreciation = ----------------------------------------------------------------
Estimated useful life
Php 130,000 – Php10,000
= ------------------------------------------------
5 years
 Php 120,000
= -------------------------------
5 years

= Php24,000

Entry to record depreciation

Year 1 Depreciation expense 24,000

Accumulated depreciation - Delivery truck 24,000

Year 2 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 3 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 4 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 5 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 1 Year 2 Year 3 Year 4 Year 5

Cost Php 130,000 Php 130,000 Php 130,000 Php 130,000 Php 130,000
Accumulated depreciation 24,000 48,000 72,000 96,000 120,000
Net Book Value 106,000 82,000 58,000 34,000 10,000

Note: net book value at the end of useful life (end of year 5) = Net book value at Year 5

2. Units of Production Method/Output Method

Cost – Estimated Residual value
Depreciation rate/ unit = ------------------------------------------------------------
Estimated Useful Life in Kilometers
Php130,000 – Php10,000
= ---------------------------------------------
100,000 kilometers
Php120,000
= -----------------------------------
100,000 kilometers

= Php1.20 per kilometer

 Computation
Calculation Annual End of Year Balance
End of Kilometer Depreciation cost per Depreciation Accumulated Depreciation
Year consumed unit Expense Carrying Value
Php 130,000
Year 1 15,000 Php 1.20 Php 18,000 Php 18,000 112,000
Year 2 30,000 1.20 36,000 54,000 76,000
Year 3 20,000 1.20 24,000 78,000 52,000
Year 4 25,000 1.20 30,000 108,000 22,000
Year 5 10,000 1.20 12,000 120,000 10,000
Residual Value = Value of Asset at the End of its Useful Life which is on the 5th year

Journal Entry

Year 1 Depreciation expense 18,000

Accumulated depreciation – Delivery truck 18,000

Year 2 Depreciation expense 36,000

Accumulated depreciation – Delivery truck 36,000

Year 3 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 4 Depreciation expense 30,000

Accumulated depreciation – Delivery truck 30,000

Year 5 Depreciation expense 12,000

Accumulated depreciation – Delivery truck 12,000

3. Sum-Of-Years Digit Method

SYD = Life (Life +1)/2

= 5 (5+1)/2
= 5 (6)/2
= 15

OR SYD = 5 +4+3+2+1
= 15

Depreciable Amount= Cost – Estimated Residual value

= Php130,000 – Php10,000
= Php120,000

Depreciation Rate = Remaining Life/ SYD

Year 1 : 5/15; Year 2: 4/15; Year 3: 3/15; Year 4: 2/15; Year 5: 1/15
 Computation
Depreciable Annual Accumulated
End of Year Amount Depreciation rate Depreciation Depreciation Carrying Value
Php 130,000
Year 1 Php 120,000 5/15 Php 40,000 Php 40,000 90,000
Year 2 120,000 4/15 32,000 72,000 58,000
Year 3 120,000 3/15 24,000 96,000 34,000
Year 4 120,000 2/15 16,000 112,000 18,000
Year 5 120,000 1/15 8,000 120,000 10,000

RESIDUAL VALE = VALUE OF ASSET AT THE END OF ITS USEFUL LIFE

Journal Entry

Year 1 Depreciation expense 40,000

Accumulated depreciation – Delivery truck 40,000

Year 2 Depreciation expense 32,000

Accumulated depreciation – Delivery truck 32,000

Year 3 Depreciation expense 24,000

Accumulated depreciation – Delivery truck 24,000

Year 4 Depreciation expense 16,000

Accumulated depreciation – Delivery truck 16,000

Year 5 Depreciation expense 8,000

Accumulated depreciation – Delivery truck 8,000

4. Declining Balance Method

Depreciation rate = Straight line method rate x % of Declining rate

= (1/5) x 2
= 20% x 2
= 40%

Carrying Value beg or Annual Accumulated Carrying

End of Year Net Book Value, beg Depreciation rate Depreciation Depreciation Value
Php 130,000
Year 1 Php 130,000 40% Php 52,000 Php 52,000 78,000
Year 2 78,000 40% 31,200 83,200 46,800
Year 3 46,800 40% 18,720 101,920 28,080
Year 4 28,080 40% 11,232 113,152 16,848
Year 5 16,848 40% 6,739 119,891
16,848-10,000 =
6,848 120,000 10,000
Journal Entry

Year 1 Depreciation expense 52,000

Accumulated depreciation-Delivery truck 52,000

Year 2 Depreciation expense 31,200

Accumulated depreciation – Delivery truck 31,200

Year 3 Depreciation expense 18,720

Accumulated depreciation – Delivery truck 18,720

Year 4 Depreciation expense 11,232

Accumulated depreciation – Delivery truck 11,232

Year 5 Depreciation expense 6,739

Accumulated depreciation – Delivery truck 6,739