Module
Module
Engineering Economy
Depreciation
Depreciation
Definition of Terms
1. Depreciation – is the decrease in the value of physical property with the
passage of time.
2. Value – present worth of all future profits that are to be received
through ownership of a particular property.
3. Market Value- the amount which a willing buyer will pay to willing
seller for the property each has equal advantage and is under no
compulsion to buy or sell.
4. Utility/Use Value – is what the property is worth to the owner as an
operating unit.
5. Fair Value- is the value which is usually determined by a disinterested
third party in order to establish a price that is fair to both seller and
buyer.
6. Book Value – sometimes called depreciated book value, it is worth of a
property as shown on the accounting records of an enterprise.
7. Salvage or Resale Value- is the price that can be obtained from the sale
of the property after it has been used.
8. Scrap Value- is the amount of property would sell for if disposed off as
junk.
9. Straight Line Method – this method assumes that the loss in value is
directly proportional to the age of property.
10. Sinking Fund Method – this method assumes that a sinking fund is
established in which funds will accumulate for replacement.
11. Declining Balance method (Matheson Formula) – also called the
constant percentage method – it is assumed that the annual cost of
depreciation is a fixed percentage of the salvage value of the beginning
of the year.
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Engineering Economy
Depreciation
Types of Depreciation
1. Normal depreciation
a) Physical depreciation – is due to the lessening of the physical ability
of a property to produce results. Its common causes are wear and
deterioration.
b) Functional depreciation – 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 centers shift,
saturation of markets or more efficient machines are produced.
Depreciation Methods:
Where:
𝐿= useful life of the property in years
𝐶𝑜 = the original cost
𝐶𝐿 = the value at the end of the life, the scrap value/ salvage value
𝑑 = the annual cost of depreciation
𝐶𝑛 = the book value at the end of n years
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Engineering Economy
Depreciation
𝐿 𝐶𝐿
𝑘 =1− √
𝐶𝑜
This method does not apply if the salvage value is zero, because k will be
equal to one and 𝑑1 will be equal to 𝐶𝑜 .
4. Double Declining Balance Method (DDBM)
2 𝑛−1 2
𝑑𝑛 = 𝐶𝑜 (1 − )
𝐿 𝐿
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Engineering Economy
Depreciation
2
𝐶𝑛 = 𝐶𝑜 (1 − )𝑛
𝐿
2
𝐶𝐿 = 𝐶𝑜 (1 − )𝐿
𝐿
When the DDB method is used, the salvage value should not be subtracted from
the first cost when calculating the depreciation charge.
𝑛(𝑛 + 1)
∑ 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 =
2
Illustrative Example 1:
Solution
𝐶𝑜 = P56,000 + P4,000 = P60,000
𝐶𝐿 = P60,000(0.10) = P6,000
𝐿 = 16 𝑛 = 12 𝑖 = 12%
a) Straight Line Method
𝐶𝑜 − C𝐿 𝑃60,000 − 𝑃6,000
𝑑 = = = 𝑃3,375
𝐿 16
𝐷12 = 𝑛(𝑑) = 12(𝑃3,375) = 𝑃40,500
𝐶12 = 𝐶𝑜 − 𝐷12 = 𝑃60,000 − 𝑃40,500 = 𝑃19,500
b) Sinking Fund method
𝐶 −C P60,000−P6,000
𝑑 = 𝐹⁄𝐴𝑜,12%,16
𝐿
= 42.7533
= 𝑃1,263
Illustrative Example 2:
A certain type of machine loses 10% of its value each year. The machine
costs P2,000 originally. Make out a schedule showing the yearly depreciation,
the total depreciation and book value at the end of each year for 5 years.
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Engineering Economy
Depreciation
Solution:
Illustrative Example 3:
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 costs P15,000 new and has an estimated scrap value of P2,000
at the end of 10 years by a) the declining balance method and b) the
double declining balance method.
Solution
𝐶𝑜 = 𝑃15,000 𝐶𝐿 = 𝑃2,000 𝐿 = 10 𝑛=8
𝐿 𝐶𝐿 10 𝑃2,000
𝑘 = 1− √ = 1− √ = 0.1825 𝑜𝑟 18.25%
𝐶𝑜 𝑃15,000
2 2 8
𝐶8 = 𝐶𝑜 (1 − )8 = 𝑃15,000(1 − ) = 𝑃2,517
𝐿 10
𝐷8 = 𝐶𝑜 − 𝐶8 = 𝑃15,000 − 𝑃2,517 = 𝑃12,483
Illustrative Example 4:
A plant bought a calciner for P220,000 and used it for 10 years, the life
span of the equipment. What is the book value of the calciner at the end of 5
years if the salvage value isP20,000 for straight line method; P22,000 for
declining balance method and P20,000 for the double declining balance method.
Solution:
𝐶𝑜 = 𝑃220,000 𝐿 = 10 𝑛=5
a) Straight line method 𝐶𝐿 = 𝑃20,000
Illustrative Example 5:
(3-9) 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 4 th year and
the book value at the end of 4 years by the a) straight line method. b) Declining
balance method, c) SYD method, and d) sinking fund method with interest at
12%.
Solution
𝐶𝑜 = 𝑃7,000 𝐶𝐿 = 𝑃350 𝐿=8 𝑛=4
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Engineering Economy
Depreciation
𝐿 𝐶𝐿 8 𝑃350
𝑘 = 1− √ = 1− √ = 0.3123
𝐶𝑜 𝑃7,000
3 6
5
4 5 𝑑4 = (𝑃7,000 − 𝑃350) = 𝑃924
36
5 26
6 26
𝐷4 = (𝑃7,000 − 𝑃350) = 𝑃4,803
7 36
8
36 𝐶4 = 𝐶𝑂 − 𝐷4 = 𝑃7,000 − 𝑃4,803 = 𝑃2,197
𝐶𝑜 − C𝐿 P7,000 − P350
𝑑 = = = 𝑃541
𝐹 ⁄𝐴 , 12%, 8 12.2997
𝐷4 = 𝑑(𝐹 ⁄𝐴 , 12%, 4) = 𝑃541(4.7793) = 𝑃2,586
𝐶4 = 𝐶𝑜 − 𝐷4 = 𝑃7,000 − 𝑃2,586 = 𝑃4,414
Illustrative Example6:
A contractor imported a bulldozer for his job, paying P250,000 to the
manufacturer. Freight and insurance charges amounted to P18000; custom’s,
and broker’s fees, P8500; taxes, permits, and other expenses, P25000. If the
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Engineering Economy
Depreciation
Solution:
a) Straight-line formula:
𝐶𝑜 = 250000 + 18000 + 8500 + 25000 = 𝑃301500
𝐶𝐿 = 20000; 𝐿 = 10 𝑦𝑒𝑎𝑟𝑠; 𝑛 = 6𝑦𝑒𝑎𝑟𝑠
𝐶𝑜 − C𝐿 301500 − 20000
𝑑 = = = 𝑃28150
𝐿 10
6(301500 − 20000)
𝐷6 = 𝑛(𝑑) = = 𝑃168900
10
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛 ; 𝐶6 = 301500 − 168900
𝑪𝟔 = 𝑷𝟏𝟑𝟐𝟔𝟎𝟎 𝑨𝒏𝒔.
𝐶𝑜 − 𝐶𝐿
𝑑=
𝐹
𝐴 , 𝑖%, 𝐿
301500 − 20000
𝑑= = 𝑃19431.80
(1 + 0.08)10 − 1
0.08
𝐹
𝐷𝑛 = 𝑑( , 𝑖%, 𝑛)
𝐴
(1 + 0.08)6 − 1
𝐷6 = 19431.80 [ ] = 𝑃142550.31
0.08
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
𝐶6 = 301500 − 142550.31
𝑪𝟔 = 𝑷𝟏𝟓𝟖𝟗𝟗. 𝟔𝟗 𝑨𝒏𝒔.
10 20000
𝑘 = 1− √ =0.2376
301500
𝐶6 = 301500(1 − 0.2376)6
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Engineering Economy 0
Depreciation
𝑪𝟔 = 𝑷𝟓𝟗𝟐𝟎𝟏. 𝟓𝟑 𝑨𝒏𝒔.
2 6
𝐶6 = 301500 (1 − )
10
𝑪𝟔 = 𝑷𝟕𝟗𝟎𝟑𝟔. 𝟒𝟐 𝑨𝒏𝒔.
e) SYD:
𝐿(𝐿+1) 1(10+1)
∑ 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 = = = 55
2 2
10 + 9 + 8 + 7 + 6 + 5
𝐷6 = (301500 − 20000) = 𝑃230381.18
55
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
𝐶6 = 301500 − 230381.18
𝑪𝟔 = 𝑷𝟕𝟏𝟏𝟖𝟏. 𝟖𝟐 𝑨𝒏𝒔.