DEPRECIATION

 Is the decrease in the value of physical property with the passage of time.

Definitions of Value
 Value – in a commercial sense is the present worth of all future profits that are to be received through
ownership of a particular property
 Market Value – is the amount which a willing buyer will pay to a willing seller for the property where each
has equal advantage and is under no compulsion to buy or sell.
 Fair Value – is the value which is usually determined by a disinterested party in order to establish a price
that is fair to both seller and buyer.
 Book Value – sometimes called the depreciated book value, is the worth of a property as shown on the
accounting records of an enterprise
 Salvage value or Resale Value – is the price that can be obtained from the sale of the property after it has
been used.
 Scrap Value – is the amount the property would sell for if disposed off as a junk
Purposes of Depreciation
 To provide for the recovery of capital which has been invested in physical
property
 To enable the cost of depreciation to be charge to the cost of producing
products or services that results from the use of the property.

Types of Depreciation
 Normal Depreciation
1. Physical- its due to the lessening of the physical ability of the property to results. Its common causes
are wear and deterioration.
2. Functional- is due to the lessening in the demand for the function which the property was designed to
render. Its common causes are inadequacy, changes in styles, population center shift, saturation of
markets or more efficient machines are produce.
 Depreciation due to changes in price levels- is almost impossible to predict and therefore in not
considered in economy studies.
 Depletion- refers to the decrease in the value of a property due to the gradual extraction of its contents
Physical and Economic Life
 Physical life- is the length of time during which it is capable of performing the
function for which it was design and manufactured.
 Economic life- is the length of time during which the property may be
operated at a profit.

Requirements of a Depreciation Method

 It should be simple
 It should recover capital
 The book value will be reasonably close to the market value at any time
 The method should be accepted by the BIR
Symbols use for Depreciation

 𝐿 = useful life of the property in years

 𝐶𝑜 = the original cost
 𝐶𝐿 = the value at the end of life, the scrap value (
including gain or loss due to removal)
 𝑑 = the annual cost of depreciation
 𝐶𝑛 = the book value at the end of n years
 𝐷𝑛 = depreciation up to age n years
The Straight Line Method
𝐶𝑜 − 𝐶𝐿
𝑑=
𝐿

𝑛(𝐶𝑜 − 𝐶𝐿 )
𝐷𝑛 =
𝐿

𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
The Sinking Fund Formula
𝐶𝑜 − 𝐶𝐿
𝑑=
𝐹 Τ𝐴 , 𝑖%, 𝐿

𝐷𝑛 = 𝑑(𝐹 Τ𝐴 , 𝑖%, 𝑛)

𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Declining Balance Method
Year Book Value at Depreciation Book Value at the end of year
beginning of year during the year
1 𝐶𝑜 𝑑1 = 𝑘𝐶𝑜 𝐶1 = 𝐶0 − 𝑑1 = 𝐶0 (1 − 𝑘)
2 𝐶𝑜 (1 − 𝑘) 𝑑2 = 𝑘𝐶1 𝐶2 = 𝐶1 − 𝑑2 = 𝐶0 (1 − 𝑘) 2

3 𝐶𝑜 (1 − 𝑘)2 𝑑3 = 𝑘𝐶2 𝐶3 = 𝐶2 − 𝑑3 = 𝐶0 (1 − 𝑘) 3

… …
n 𝐶𝑜 (1 − 𝑘)𝑛−1 𝑑𝑛 = 𝑘𝐶𝑛−1 𝐶𝑛 = 𝐶𝑛−1 − 𝑑𝑛 = 𝐶0 (1 − 𝑘) 𝑛
… …
L 𝐶𝑜 (1 − 𝑘)𝐿−1 𝑑𝐿 = 𝑘𝐶𝐿−1 𝐶2 = 𝐶𝐿−1 − 𝑑𝐿 = 𝐶0 (1 − 𝑘) 𝐿

𝑑𝑛 = 𝑘𝐶0 (1 − 𝑘)𝑛−1 𝐶𝐿 = 𝐶0 (1 − 𝑘) 𝐿

𝑛
𝑛
𝐶𝐿 𝐿 𝑛 𝐶𝑛 𝐿 𝐶𝐿
𝐶𝑛 = 𝐶0 (1 − 𝑘) = 𝐶0 𝑘 =1− =1−
𝐶0 𝐶0 𝐶0
Double Declining Balance (DDB) Method

2 𝑛−1
𝑑𝑛 = 𝐶0 (1 − 𝑘)
𝐿
2 𝑛
𝐶𝑛 = 𝐶0 (1 − )
𝐿
2 𝐿
𝐶𝐿 = 𝐶0 (1 − )
𝐿
The Sum of the Years’ Digits (SYD)
Method
Let 𝑑𝑛 = depreciation charge during nth year

𝑑𝑛 = (depreciation factor)(total depreciation)

𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
𝑑𝑛 = (𝐶0 − 𝐶𝐿 )
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠
Example
 A machine costs P7,000 last 8 years and has a salvage value at the end of life of
P350. Determine the depreciation charge during the 4th year and the book value at
the end of 4 years by a) Straight Line Method, b) Declining Balance Method, c) SYD
Method, and d) Sinking Fund Method with interest at 12%
 A consortium of international telecommunication companies contracted for the
purchase and installation of a fiber optic cable linking two major cities at a total
cost of $560 million. This amount includes freight and installation charges estimated
at 10% of the above contract prize. If the cable shall be depreciated over a period of
15 years with zero salvage value:
a) Given the sinking fund deposit factor of 0.0430 at 6% interest where n=15, what
is the annual depreciation charge?
b) What is the depreciation charge during the 8th year using the sum of the years
digit method
 Determine the rate of depreciation, the total depreciation up to the end of the 8th
year and the book value at the end of 8 years for an asset that cost P15000 new and
has an estimated scrap value of P2000 at the end of 10 years by a) declining balance
method and b) double declining balance method