Depreciation

Some terminologies are useful

• P – purchase price of a depreciable asset. It is also termed
as book value (BV) at time zero
• N – number of life of the asset
• F or S, - estimated salvage value of asset at time N
• m – age of asset at time of calculation
• Dm – annual depreciation amount taken for year m
• Rm – depreciation rate for year m
• BVm – book value of asset at a particular age, m, (BV0 = P)
• SL – straight line method of depreciation
• DB – decline method of depreciation
• SOY – sum of year digit method of depreciation etc.
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• Definition:
It represents the loss of value of a property such as
machine, building, vehicle or other investments
over a period of time, caused by numerous
factors, including:
(i) Unrepaired wear – accumulates as a function of
hours of use, severity of use, and level of
preventive maintenance
(ii) Deterioration – the gradual decay, corrosion, or
erosion of property, occurs as a result of
function of time and severity of exposure
conditions
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iii. Obsolescence – arise due to competition of
the marketability of a product caused by newer
or more modernized models – e.g. modernized
equipment for example, has more outputs than
the outdated one, causing the later depreciates
more.
iv. Changes in demands – decreased value of
asset in accordance with the marketplace –
low of supply and demand – number of factors
may contribute this: general business
recession, change in development pattern,
consumer habits, change in weather, etc..
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• The amount of depreciation being known, the
present value of a property can be calculated
after deducting the total amount of
depreciation from the original cost.

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 Cash, new

Repairs, renovations, overhauls

Value

Market value at
EOY n

n
Time

Figure 1: Schematic graph of depreciation

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 An example of the depreciation of a car investment

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 Method of calculating depreciation:

There are various methods of calculating

depreciation, four of them are as follows
• Straight line Method
• Declining balance depreciation
• Sinking fund method and
• Sum of the year digit method.
[only two types, bullets one & two would be
dealt with here].
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 Straight line method:

• Here, knowing the initial cost, P, the full service

life of the assert is estimated.
• The prospective net salvage [SV]/resale value
at the end of life is also estimated
Two methods to compute straight line
depreciation
(i) Depreciation charge (dr)= estimated cost (P) –
salvage value (SV)/ estimated duration (m).
dr = (P – SV)/n – it is the constant value

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Depreciation calculation using a straight line rate
has three steps:
(i) when SV is expressed as a percentage of P, it is
known as the salvage percent
(ii) Then, when full P in % subtracts SV in % , and
the whole is divided by the service life, the value
is denoted as the straight line rate.
Thus, straight line rate = 100% minus estimated
salvage percent divide by estimated service life
..(iii) depreciation (dr) = straight line rate times the
first cost (P)
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 Example one

Consider a machine tool with a first cost of 35,000/= an estimated life of

20 years, and an estimated net salvage value of 3,500. Find the salvage
percentage and depreciation

Method one
straight line depreciation charge (dr) =?
dr = first cost (P) minus estimated salvage value (SV) divided by estimated
service life (n).

• P = 35,000, SV = 3,500, n = 20, dr = ?

• Depreciation charge (dr)= [35,000 – 3,500]/20 = 1575

This assert depreciates at constant amount of 1575 annually, for twenty

years
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 Method two
• Salvage percentage % = 3,500/35,000 = 1/10 =
0.1 = 10%

• Straight line rate = full first cost (P%) – salvage

percent (SV%)/duration
• [100% - 10%]/20 = 4.5%

• Depreciation charge now every year is 4.5/100

* 35,000 = 1575
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 Example 2
• Truck was purchased at Tshs, 80,000/- and placed
on a sale at Tshs, 24,000/- for seven years. Find
depreciation charge using the two methods:
(i) Direct method – dr = (P –SV)/m
= (80,000 – 24,000)/7 = 8,000/-

(ii) Method 2, in straight line rate

Salvage percent = (24,000/80,000) = 0.3, = 30%
Straight line rate = (100% - 30%)/7 = 10%
Therefore, dr = 10% X 80,000 = 8,000/-
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 Book value
This is a value of an assert after it has actually written off
at any period of time

Following are symbols for computation of depreciation

charges:
• P = first cost of the assert
• Sv = the estimated salvage value at the end of the
estimated service life
• n or m = estimated service life in years
• r = any predetermined duration
• Dr/dr = depreciation charge for rth year
• BVr = book value at the end of the rth year after the
depreciation charge for the
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rth year has been made
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Hence,
• dr = (P –Sv)/n
• BVr = P –rDr
Example:
• From the previous example, determine the book value
in the forth year.
• r = 4, dr = 1575, therefore, rdr = 4 * 1575 = 6,300
• (BVr)4 = P – rDr, = 35,000 - 6,300 = 28,700
Find Bv on the sixth year: = 6 * 1575 = 9450
Thus, Bv6 = 35,000 - 9450 = 25,550/=
etc.
Use previous example 2 to determine BVs, when r = 3 and
5 respectively
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 Example 3
If salvage value is $ 24,000 for ten years time, and a
stock purchase is $ 120,000, use straight line
method to find the following (i) depreciation
percentage, (ii) straight line rate (iii) annual
depreciation and (iv)plot a specified graph.
Soln:
(i) Depr. % = 24,000/120,000 = 0.2 = 20%
(ii) Str. Line rate = (100% - 20%)/10 = 8%
(iii) dr = 8% * 120,000 = 9,600
[alternatively: dr = (120,000 – 24,000)/10 = 9,600
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 Declining balance depreciation

• It is also termed as double rate declining balance

method
• In this method, the contribution of assets to income is
often greater in the early years of life than in the final
years computed on the depreciable factor
For example, a 10% rate is applied to an asset that cost
35,000; the depreciation charge in the first year is 0.10
* 35,000 = 3,500
• In the second year, the charge is 0.10 * (35,000 –
3,500) = 0.10 * 31,500 = 3,150
• In the third year, the charge is 0.10 * (35,000 – 3,150)
= 0.10 * 28,350 = 2,835 and so on
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 The formula for computation

f = declining balance rate expressed as a

decimal;
• f = 2.0/n [remember n is considered equal to
N i.e. full life of investment]

• BVr = P(1 – f)r

• dr = f(BVr -1) = (BVr – BVr-1)

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 Example:
• An asset costing 26,000= is estimated to have an
economic life of 15 years with a net salvage
value of 2000/= for i = 10%, find the
depreciation charge for the forth year and the
book value at the end of the forth year using
double rate declining method
Consider the formula:
• f = 2.0/n = 2/15 = 0.1333
• BVr = P(1 –f)r
• BV4 = 26,000(1 – 0.13333)4
BV4 = 26,000 (0.564168) = 14,668.4
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• Book value at the end of year four = 14,668.4

• Dr = D4 =
• Dr = f(BVr -1) = (BVr – BVr -1)

• BV4 = BV4 -1 = f(BV3)

• BV3 = P(1 – f)r = 26,000(1 – 0.01333)3 = 26,000 *
0.660963) = 16,925

d4 = f(BV3) = 0.1333 * 16,925 = 2256.7

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• Depreciation charge for the fourth year
therefore is 2256.7.

• Alternatively, BVr – BVr -1 from the above

formula = 14,668.4 – 16,925 =2256.6

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 Exercises
• Q1. a truck’s purchase price was $ 40,000 with
resale value of $ 8,000 for 10 years. Find the
following:
(i) Bv3, Bv7, and BV9 using both the straight line
and double decline depreciation methods
(ii) Find also the depreciation charge by using
straight line rate method
(iii) Find the depreciation charge in the third,
seventh, fourth and the ninety year, using the
both SLD and the DD methods
(iv) From the calculations in (i) and (iii)above, sketch
the graphs showing the trends
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