ME005 ENGINEERING

ECONOMICS
5 APRIL 2022
 DEPRECIATION
Depreciation is the loss of value for a fixed
asset between two periods.

Value – in the commercial sense, is the

present worth of all future profits that are to
be received through the ownership of a
particular property
 VALUE
MARKET VALUE – The amount which a
willing buyer will pay to willing seller for the
property where each has equal advantage
and is under no compulsion to buy or sell

UTILITY/USE VALUE – What the property is

worth to the owner as an operating unit
 VALUE
FAIR VALUE – Usually determined by a
disinterested party in order to establish a
price that is fair to both seller and buyer

BOOK VALUE – Also called depreciated

book value, is the worth of the property as
shown on the accounting records of an
enterprise
 VALUE
SALVAGE OR RESALE VALUE – The price
that can be obtained from the sale of the
property

SCRAP VALUE – The amount the property

would sell if disposed off as junk
 PURPOSES OF
DEPRECIATION
1. To provide the recovery of capital which
has been invested in physical property

2. To enable the cost of depreciation to be

charged to the cost of producing products
or services that results from the use of
the property
 TYPES OF DEPRECIATION
1. Natural
(a) physical
(b) functional
2. Depreciation due to change in price levels
3. Depletion
 PHYSICAL AND ECONOMIC
LIFE
PHYSICAL LIFE – The length of time during
which a property is capable of performing a
function for which it is designed and
manufactured

ECONOMIC LIFE – The length of time

during which a property may be operated at
a profit
 REQUIREMENTS OF A
DEPRECIATION
1. It should be simple
2. It should recover a capital
3. The book value is reasonable close to the
market value at anytime
4. The method should be accepted by the
Bureau of Internal Revenue
 DEPRECIATION METHODS
1. Straight Line Method
2. Sinking Fund Method
3. Declining Balance Method
4. Double Declining Balance Method
5. Sum-of-the-years’ Digits Method
6. Service Output Method
 IMPORTANT VARIABLES
L = useful life of the property in years
Co = original cost
CL = value at the end of life, scrap or
salvage value (gain or loss due to
removal)
d = annual cost of depreciation
Cn = book value at the end of n years
Dn = depreciation up to age n years
 STRAIGHT LINE METHOD
This method assumes that the loss in value
is directly proportional to the age of property
 An electronic balance costs P90,000 and
EXAMPLE 1 has an estimated salvage value of P8000
at the end of its 10 years life time. What
would be the book value after three
years, using the straight-line method in
solving for the depreciation?
 SINKING FUND METHOD
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
time is assumed to be equal to the accumulated amount in
the sinking fund at the time.
Dn (Co – CL)

0 1 2 3 n L

d d d d d
EXAMPLE 2
A broadcasting corporation purchased an equipment for P53,000 and paid
P1,500 for freight and delivery charges 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 the life.

(a) Determine the annual depreciation cost by the SLM.

(b) Determine the annual depreciation cost by SFM. Assume 6.5%
compounded annually interest.
EXAMPLE 2
A broadcasting corporation purchased an equipment for P53,000 and paid
P1,500 for freight and delivery charges 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 the life.

(a) Determine the annual depreciation cost by the SLM.

(b) Determine the annual depreciation cost by SFM. Assume 6.5%
compounded annually interest.
 DECLINING BALANCE
METHOD
This method is also called the constant percentage method
or the 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 the year is constant throughout the life
of the property, and is designated by k, the rate of
depreciation.
DECLINING BALANCE
METHOD
 DECLINING BALANCE
METHOD

This method does not apply when CL is zero.

EXAMPLE 3
A certain type of machine loses 10 percent 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.
EXAMPLE 3
A certain type of machine loses 10 percent 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.
 DOUBLE DECLINING
BALANCE (DDB) METHOD
This method is very similar to the declining
balance method, except that the rate of
depreciation k is replaced by 2/L.
In this method, the
salvage value should not
be subtracted from the
first cost when calculating
the depreciation charge.
EXAMPLE 4
Determine the rate of depreciation, the total depreciation up to the end of
eighth year and the book value at the end of eight years for an asset that costs
P15,000 new and has a scrap value of P2,000 at the end of 10 years by

(a)Declining Balance Method; (b) Double Declining Balance Method

EXAMPLE 4
Determine the rate of depreciation, the total depreciation up to the end of
eighth year and the book value at the end of eight years for an asset that costs
P15,000 new and has a scrap value of P2,000 at the end of 10 years by

(a)Declining Balance Method; (b) Double Declining Balance Method

EXAMPLE 4
Determine the rate of depreciation, the total depreciation up to the end of
eighth year and the book value at the end of eight years for an asset that costs
P15,000 new and has a scrap value of P2,000 at the end of 10 years by

(a)Declining Balance Method; (b) Double Declining Balance Method

 SUM-OF-THE-YEARS DIGITS
(SYD) METHOD
The depreciation rate percentage for each
year is calculated as the number of years in
remaining asset life for the same year
divided by the sum of remaining asset life
every year through the asset's life.
As the depreciation rate decreases over
time, so does the depreciation charge.
SUM-OF-THE-YEARS DIGITS
(SYD) METHOD
EXAMPLE 5
A structure costs P12,000 new. It is estimated to have a life of five years with a
salvage value at the end of life of 1,000. Determine the book value at the end
of each year of life.
EXAMPLE 5
A structure costs P12,000 new. It is estimated to have a life of five years with a
salvage value at the end of life of 1,000. Determine the book value at the end
of each year of life.
EXAMPLE 5
A structure costs P12,000 new. It is estimated to have a life of five years with a
salvage value at the end of life of 1,000. Determine the book value at the end
of each year of life.
EXAMPLE 5
A structure costs P12,000 new. It is estimated to have a life of five years with a
salvage value at the end of life of 1,000. Determine the book value at the end
of each year of life.
EXAMPLE 5
A structure costs P12,000 new. It is estimated to have a life of five years with a
salvage value at the end of life of 1,000. Determine the book value at the end
of each year of life.
 SERVICE-OUTPUT METHOD
Assumes that the total depreciation has
taken place is directly proportional to the
output of the property up to that time.
This method has an advantage of making
the unit cost of depreciation constant and
giving low depreciation expense during
periods of low production.
SERVICE-OUTPUT METHOD
EXAMPLE 6
A Television Company purchased machinery for P100,000.00 on July 1, 1979.
It is estimated that it will have a useful life of 10 years; scrap value of
P4,000.00, production of 400,000.00 units and working hours of 120,000. The
company uses the machinery for 14,000 hours in 1979 and 18,000 hours in
1980. The machinery produces 36,000 units in 1979 and 44,000 units in1980.
Compute the depreciation for 1980 using (a) service-output method, (b)
working hours method
EXAMPLE 6
A Television Company purchased machinery for P100,000.00 on July 1, 1979.
It is estimated that it will have a useful life of 10 years; scrap value of
P4,000.00, production of 400,000.00 units and working hours of 120,000.the
company uses the machinery for 14,000 hours in 1979 and 18,000 hours in
1980. The machinery produces 36,000 units in 1979 and 44,000 units in1980.
Compute the depreciation for 1980 using (a) service-output method, (b)
working hours method