DEPRECIATION

Notes compiled by:

JONEIL B. MEDINA, MSciEd
For EDM101 (MathEd 105) – Arithmetic Number Theory and Business Mathematics
Disclaimer
The following notes are not of my own. The copyrights (if there are any) and the credits belongs
to the respective owners as cited. These notes is compiled as a guided reading for the course.
Depreciation Defined
Depreciation, in accounting, the allocation of the cost of an asset over its economic life.
Depreciation covers deterioration from use, age, and exposure to the elements. It also includes
obsolescence—i.e., loss of usefulness arising from the availability of newer and more efficient
types of goods serving the same purpose. It does not cover losses from sudden and unexpected
destruction resulting from fire, accident, or disaster.1
Similarly, Depreciation is also an accounting method of allocating the cost of a tangible or
physical asset over its useful life or life expectancy. Depreciation represents how much of an
asset's value has been used up. Depreciating assets helps companies earn revenue from an asset
while expensing a portion of its cost each year the asset is in use. If not taken into account, it can
greatly affect profits.2
Example of Depreciation3
If a company buys a piece of equipment for $50,000, it could expense the entire cost of the asset
in year one or write the value of the asset off over the asset's 10-year useful life. This is why
business owners like depreciation. Most business owners prefer to expense only a portion of the
cost, which boosts net income.
In addition, the company can scrap the equipment for $10,000 at the end of its useful life, which
means it has a salvage value of $10,000. Using these variables, the accountant calculates
depreciation expense as the difference between the cost of the asset and its salvage value, divided
by the useful life of the asset. The calculation in this example is ($50,000 - $10,000) / 10, which
is $4,000 of depreciation expense per year.
This means the company's accountant does not have to expense the entire $50,000 in year one,
even though the company paid out that amount in cash. Instead, the company only has to expense
$4,000 against net income. The company expenses another $4,000 next year and another $4,000
the year after that, and so on until the asset reaches its $10,000 salvage value in ten years.
Types of Depreciation4
Straight-Line
Depreciating assets using the straight-line method is typically the most basic way to record
depreciation. It reports equal depreciation expense each year throughout the entire useful life
until the entire asset is depreciated to its salvage value. The example above used straight-line
depreciation.

1 Editors of of Encyclopedia Britannica (2017). Depreciation. Encyclopædia Britannica. Date Accessed: January 24,
2020. Accessed from: https://www.britannica.com/topic/depreciation
2 Tuovila, A. (2019). Depreciation. Investopedia. Date Accessed: January 25, 2020. Accessed from:

https://www.investopedia.com/terms/d/depreciation.asp
3 Ibid.

4 Ibid.
Assume, for another example, that a company buys a machine at a cost of $5,000. The company
decides on a salvage value of $1,000 and a useful life of five years. Based on these assumptions,
the depreciable amount is $4,000 ($5,000 cost - $1,000 salvage value) and the annual
depreciation using the straight-line method is: $4,000 depreciable amount / 5 years, or $800 per
year. As a result, the depreciation rate is 20% ($800/$4,000). The depreciation rate is used in
both the declining balance and double-declining balance calculations.
Another Example5:
A commercial building has a salvage value of Php 1 million after 50 years. Annual
depreciation is Php 2 M. Using the Straight Line Method, how many years after should
you sell the building for Php 30 M?
Solution
a. Solve for the first cost.
Annual depreciation = (FC - SV) / n
2 = (FC - 1) / 50
FC = Php 101 million
b. Solve for the total depreciation after n years.
Total depreciation = FC - BV
Total depreciation = 101 - 30
Total depreciation = 71 million
c. Solve for the number of years.
Total depreciation = Annual depreciation (n)
71 = 2 (n)
n = 35.5 years
Declining Balance
The declining balance method is an accelerated depreciation method. This method depreciates
the machine at its straight-line depreciation percentage times its remaining depreciable amount
each year. Because an asset's carrying value is higher in earlier years, the same percentage causes
a larger depreciation expense amount in earlier years, declining each year.

5Ray* (2018). Methods of Depreciation: Formulas, Problems, and Solutions. Owlcation.com. Date accessed:
January 25, 2020. Available at: https://owlcation.com/stem/Depreciation-Methods-in-Engineering-Economics-
Formulas-Problems-and-Solutions#
Using the straight-line example above, the machine costs $5,000, has a salvage value of $1,000,
a 5-year life, and is depreciated at 20% each year, so the expense is $800 in the first year ($4,000
depreciable amount * 20%), $640 in the second year (($4,000 - $800) * 20%), and so on.
Another Example6:
The equipment bought at a price of Php 450,000 has an economic life of 5 years and a
salvage value of Php 50, 000. The cost of money is 12% per year. Compute the first year
depreciation using Declining Balance Method.
Solution
a. Solve for the annual rate of depreciation.
SV = FC (1 - K)^n
50,000 = 450,000 (1 - K)^5
K = 0.356
b. Solve for the depreciation at the end of the first year.
Depreciation = (K) (FC) (1 - K)^(m-1)
Depreciation = (0.356) (450,000) (1 - 0.356)^0
Depreciation = Php 160,200
Double Declining Balance (DDB)
The double-declining balance (DDB) method is another accelerated depreciation method. After
taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the
depreciable base, book value, for the remainder of the asset’s expected life. For example, an
asset with a useful life of five years would have a reciprocal value of 1/5 or 20%. Double the
rate, or 40%, is applied to the asset's current book value for depreciation. Although the rate
remains constant, the dollar value will decrease over time because the rate is multiplied by a
smaller depreciable base each period.
Sum-of-the-Year's-Digits (SYD)
The sum-of-the-year’s-digits (SYD) method also allows for accelerated depreciation. To start,
combine all the digits of the expected life of the asset. For example, an asset with a five-year life
would have a base of the sum of the digits one through five, or 1+ 2 + 3 + 4 + 5 = 15. In the first
depreciation year, 5/15 of the depreciable base would be depreciated. In the second year, only
4/15 of the depreciable base would be depreciated. This continues until year five depreciates the
remaining 1/15 of the base.

6Ray* (2018). Methods of Depreciation: Formulas, Problems, and Solutions. Owlcation.com. Date accessed:
January 25, 2020. Available at: https://owlcation.com/stem/Depreciation-Methods-in-Engineering-Economics-
Formulas-Problems-and-Solutions#
Another Example7:
An equipment costs Php 1,500,000. At the end of its economic life of five years, its
salvage value is Php 500,000. Using Sum of the Years Digit Method of Depreciation,
what will be its book value for the third year?
Solution
a. Solve for the sum of years.
Sum of years = (n / 2) (n + 1)
Sum of years = (5 / 2) (5 + 1)
Sum of years = 15 years
b. Solve for the total depreciation up to the third year.
Total depreciation = (FC - SV) (5 + 4 + 3) /15
Total depreciation = (1,500,000 - 500,000) (12) / 15
Total depreciation = Php 800,000
c. Solve for the book value in the third year.
Book Value = FC - Total depreciation
Book Value = 1,500,000 - 800,000
Book Value = Php 700,000
Depreciation Using Constant Unit (similarly, Working Hours) Method8
Working Hours Method also called as Service Output Method is a depreciation method that
results in the cost basis allocated equally over the expected number of units produced during the
period of tangible properties. The formula for Working Hours Method of Depreciation is:
 Depreciation per hour = (FC - SV) / Total number of hours
Constant Unit Method is the same with Working Hours Method in the structure of the formula.
The formula for Constant Unit Method of Depreciation is:
 Depreciation per unit = (FC - SV) / Total number of units
Example9 1:

7 R ay* (2018). Methods of Depreciation: Formulas, Problems, and Solutions. Owlcation.com. Date accessed:
January 25, 2020. Available at: https://owlcation.com/stem/Depreciation-Methods-in-Engineering-Economics-
Formulas-Problems-and-Solutions#
8 Ibid.

9 Ibid.
 A machine costs Php 400,000 with a salvage value of Php 200,000. Life of it is six years.
In the first year, 4000 hours. In the second year, 6000 hours and 8000 hours on the third
year. The expected flow of the machine is 38000 hours in six years. What is the
depreciation at the end of the second year?
Solution
a. Solve for the depreciation per hour.
Depreciation per hour = (FC - SV) / Total number of
hours
Depreciation per hour = (400,000 - 20,000) / 38000
Depreciation per hour = Php 10
b. Solve for the depreciation at the end of 2nd year.
Depreciation = 10 (6000)
Depreciation = Php 60,000
Example10 2:
A coin machine costing Php 200,000 has a salvage value of Php 20,000 at the end of its
economic life of five years. Determine the annual reserve for depreciation for the third
year only. The schedule of production per year is as follows:
Year Number of Coins
1 100,000
2 80,000
3 60,000
4 40,000
5 20,000
Constant Unit Method
Solution
a. Solve for the total number of coins.
Total number of coins = 100,000 + 80,000 + 60,000 +
40,000 +20,000
Total number of coins = 300,000
b. Solve for the depreciation per unit.
Depreciation per unit = (FC - SV) / Total number of

10R ay* (2018). Methods of Depreciation: Formulas, Problems, and Solutions. Owlcation.com. Date accessed:
January 25, 2020. Available at: https://owlcation.com/stem/Depreciation-Methods-in-Engineering-Economics-
Formulas-Problems-and-Solutions#
 coins
Depreciation per unit = (200,000 - 20,000) / 300,000
Depreciation per unit = 0.60
c. Solve for the depreciation reserve for the third year.
Depreciation = 0.66 (60,000)
Depreciation = Php 36,000

Some Terminologies used in the Examples

Terminologies in Depreciation
There are some terminologies that you need to remember in understanding the different types of
depreciation methods.
a. Adjusted Cost Basis is the asset's original cost basis used to compute depreciation deductions
adjusted by allowable increases or decreases.
b. First Cost (FC) or Cost Basis is the unadjusted cost basis of an asset. It is the initial cost of
acquiring an asset.
c. Book Value (BV) is the original cost basis of the property including any adjustments, less all
allowable depreciation deductions.
d. Market Value (MV) is the amount paid to a willing seller by a willing buyer of an asset.
e. Salvage Value (SV) is the estimated value of a property at the end of a property's life.
f. Recovery Period is the number of years of an asset's recovery.
g. Usual Life (n) is the anticipated period of a property's life.
Exercises11
<I am not done with the exercises. I will still have to consult some references. Like hard bound
references. Please pardon me for the dealy>
Your Turn
Research for good problems with depreciation.
You can reach out to these helpful sites for this exercise:
https://owlcation.com/stem/Depreciation-Methods-in-Engineering-Economics-Formulas-
Problems-and-Solutions

11 Bacani, …
https://investinganswers.com/dictionary/d/depreciation
https://accounting-simplified.com/financial/fixed-assets/depreciation-methods/straight-
line.html
https://www.toppr.com/guides/principles-and-practice-of-accounting/concept-and-
accounting-of-depreciation/
https://www.profitbooks.net/what-is-depreciation/
A higher kind of depreciation exercise:
http://www.yourarticlelibrary.com/accounting/problems-accounting/top-8-problems-on-
depreciation-of-an-asset/79628