DEPRECIATION AND DEPLETION Straight Line Method – assume that the loss in value is

directly proportional to the age of the property.

Depreciation is the decrease in the value of physical
property with the passage of time. 𝐶𝑂 − 𝐶𝐿 𝑛(𝐶𝑂 − 𝐶𝐿 )
𝑑= 𝐷𝑛 =
𝐿 𝐿
Definitions of Value:
𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛
 Value – the present worth of all future profits that
are to be received through ownership of a particular
property. Sinking Fund Formula – assumes that a sinking fund is
 Market Value – the amount which a willing buyer will established in which funds will accumulate for
pay to a willing seller for the property where each replacement. The total depreciation that has taken place
has equal advantage and is under no compulsion to up to any given time is assumed to be equal to the
buy or sell. accumulated amount in the sinking fund at that time.
 Utility/Use Value – the worth of a property to the
𝐶𝑂 − 𝐶𝐿 (1 + 𝑖)𝑛 − 1
owner as an operating unit. 𝑑= 𝐷𝑛 = 𝑑 [ ]
(1 + 𝑖)𝐿 − 1 𝑖
 Fair Value – the value which is usually determined by [
𝑖
]
a disinterested third party in order to establish a
price that is fair to both seller and buyer. 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛
 Book Value – worth of the property as shown on the
accounting records of an enterprise. Declining Balance Method – (constant percentage
 Salvage/Resale Value –price that can be obtained for method / Matheson Formula) assumed that the annual
the sale of the property after it has been used. cost of depreciation is a fixed percentage of the salvage
 Scrap Value – the amount the property would sell for value at the beginning of the year. The ratio of the
if disposed off as a junk. depreciation in any year to the book value of the at the
beginning of that year is constant throughout the life of
Types of Depreciation: the property and is designated by 𝑘, the rate of
1. Normal Depreciation depreciation. (not applicable if salvage value is zero)
a. Physical – due to the lessening of the physical
ability of a property to produce results. 𝑑𝑛 = 𝐶𝑂 (1 − 𝑘)𝑛−1 𝑘 𝐶𝐿 = 𝐶𝑂 (1 − 𝑘)𝐿
b. Functional – due to the lessening in the demand 𝑛
for the function which the property was design 𝑛
𝐶𝐿 𝐿
𝐶𝑛 = 𝐶𝑂 (1 − 𝑘) = 𝐶𝑂 [ ]
to render. 𝐶𝑂
2. Depletion –the decrease in the value of property due
to the gradual extraction of its contents. 𝑛 𝐶𝑛 𝐿 𝐶𝐿
𝑘 = 1− √ =1− √
𝐶𝑂 𝐶𝑂
Physical Life – the length of time during which it is
capable of performing the function for which it was Double Declining Balance Method – similar to DBM
designed and manufactured. except that the rate of depreciation 𝑘 is replaced by 2/𝐿.
Economic Life – the length of time during which the
property may be operated at a profit. 2 𝑛−1 2 2 𝑛
𝑑𝑛 = 𝐶𝑂 (1 − ) ( ) 𝐶𝑛 = 𝐶𝑂 (1 − )
𝐿 𝐿 𝐿
Requirements of a Depreciation Method
1. It should be simple. 2 𝐿
𝐶𝐿 = 𝐶𝑂 (1 − )
2. It should recover capital. 𝐿
3. The book value will be reasonably close to the
market value at any time. Sum-of-the-Year’s-Digits
4. The method should be accepted by the BIR.
𝐿(𝐿 + 1)
𝑆𝑢𝑚 𝑜𝑓 𝐷𝑖𝑔𝑖𝑡𝑠 =
2
Depreciation Methods:
1. Straight Line 𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
2. Sinking Fund 𝑑𝑛 = (𝐶 − 𝐶𝐿 )
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 𝑂
3. Declining Balance
4. Double Declining Balance Service-Output Method – assumes that the total
5. Sum-of-the-Year’s-Digits depreciation that has taken place is directly proportional
6. Service Output Method to the quantity of output of the property up to that time.

𝐿 = useful life of the property in years 𝐶𝑂 − 𝐶𝐿

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡 =
𝐶𝑂 = original cost 𝑇
𝐶𝐿 = value at the end of the life, the scrap value 𝐶𝑂 − 𝐶𝐿
(including gain or loss due to removal 𝑑−𝑁 =( ) (𝑄𝑛 )
𝑇
𝑑 = annual cost of depreciation
𝐶𝑛 = book value at the end of n years 𝑇 = 𝑡𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡 𝑡𝑜 𝑡ℎ𝑒 𝑒𝑛𝑑 𝑜𝑓 𝑙𝑖𝑓𝑒
𝐷𝑛 = depreciation up to age n years 𝑄𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑛𝑡ℎ 𝑦𝑒𝑎𝑟