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Depreciation: - Physical Assets Decrease in Value With Age - May Be Due To

Physical assets like machinery decrease in value over time due to factors like deterioration, technological advances, and economic changes. This reduction in value is called depreciation. Depreciation can be measured using methods like straight-line, declining balance, and sum-of-years digits. These methods allocate the cost of the asset over its useful life.

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VISHNU P KATKOORI
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89 views20 pages

Depreciation: - Physical Assets Decrease in Value With Age - May Be Due To

Physical assets like machinery decrease in value over time due to factors like deterioration, technological advances, and economic changes. This reduction in value is called depreciation. Depreciation can be measured using methods like straight-line, declining balance, and sum-of-years digits. These methods allocate the cost of the asset over its useful life.

Uploaded by

VISHNU P KATKOORI
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Depreciation

•Physical assets decrease in value with age


•May be due to
Physical deterioration
Technological advances
Economic changes (government policies)
Or other factors which ultimately cause retirement of property
•The reduction in value due to any of these causes is a
measure of DEPRECIATION

1 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Meaning of Value

• From the view point of design engineer:


The total cost due The original or new  Value of the same Property at 
   
 to depreciation   value of a property   the end of depreciation period 

• The original value is


– the total cost of property at the time it is ready for initial
use
• Total depreciation period is
– assumed to be the length of property useful life
• The value at the end of useful life is
– assumed to be the probable scrap or salvage value

2 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Terminology in Depreciation

• Service Life
• Salvage Value
• Scrap or Junk Value
• Present Value
– Book Value
– Market Value
– Replacement Value

3 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Service Life

• The period during which the use of a


property is economically feasible is known as
service life of the property

• Synonymous with economic or useful life

• Both physical and functional depreciation are


taken into consideration in determining
service life
4 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Salvage Value

• The net amount of money obtainable from the sale


of used property over and above any charges
involved in removal and sale

• Asset can give some type of further service and is


worth more than merely its scrap or junk value

5 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Scrap or Junk Value

• If the property cannot be disposed-off as an useful


unit
– It can often be dismantled and sold as junk
– To be used again as a manufacturing raw material
– The profit obtainable from this type of disposal is known
as the Scrap, or Junk value
– “Write-off” & “dispose-off” as scrap

6 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Methods of Depreciation
Arbitrary Methods (no consideration to interest costs)
1. Straight line method (SLM)
2. Declining balance method (DBM)
3. Sum of the years digits method (SDM)

Methods taking into account of interest on investment


1. Sinking fund method (SFM)
2. Others

7 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Straight Line Method (SLM)

• Assumption: The value of the property decreases


linearly with time
• Equal amounts are charged for depreciation each
year throughout the service life of property
– if, d = annual depreciation, Rs/yr
V = original value of the property at start of the service life
period, completely installed and ready for use, Rs
VS = Salvage value of property at the end of service life, Rs
n = service life, yrs

V  Vs
d
n
8 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Straight Line Method (SLM)

• The asset value (or book value) of the equipment at


any time during the service life is:
– if, Va = asset or book value, Rs
a = number of years in actual use, yrs
d = annual depreciation, Rs/yr

Va  V  ad

9 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Declining Balance (or Fixed %)
Method
• The annual depreciation cost is a fixed % of the
property value at the beginning of a particular year
• The fixed % (or declining balance) factor f is
constant for entire service life
• Annual depreciation cost is different each year

10 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Declining Balance (or Fixed %)
Method
The depreciation cost for
1st year of the property’s life, d1 = Vf
where,
f = fixed percentage factor
V = original value of property at start

Asset value  Va  V (1  f )

At the end of 2nd year of the property’s life,


d 2  V (1  f ) f Asset value  Va  V (1  f )2
11 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Textbook Declining Balance
method

At the end of ' a' years

Asset value  Va  V (1  f ) a

At the end of ' n' years (i.e. at the end of the service life)
Va  V (1  f )n  Vs

1
Fixed % factor, f  1   Vs 
n

V 

12 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Sum-of-the-years Digits
Method (SDM)
depreciation for year ' a'  d a

2(n  a  1)
da  (V  Vs )
n(n  1)

13 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Annuity

• A series of equal payments occurring at equal


intervals
• Examples
– Making deposits in a savings account rather than just
single deposit (salaries)
– Pay-off a debt (installments) (borrowed money)
– Accumulate a desired amount of capital (installments)
– Receiving a lump sum of capital that is due in periodic
installments, as in some life insurance policies (money-
back)

14 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Annuity

• The common type of Annuity involves


– Payments which occur at the end of interest period
This is known as ‘ORDINARY ANNUITY’
• Interest is paid on all accumulated amounts; and
the interest is compounded each payment period
• Annuity term
– The time from the beginning of the first payment period
to the end of the last payment period

15 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Sinking Fund Method (SFM)

• Use of compound interest is involved in this method


• It is assumed that the basic purpose of depreciation
allowances is
– to accumulate a sufficient fund to provide for the recovery
of original capital invested in the property
• An ordinary annuity plan is set up
– wherein a constant amount of money should theoretically
be set aside each year
• At the end of service life
– the sum of all deposits plus accrued interest must equal to
the total amount of depreciation
16 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Sinking Fund Method (SFM)

• Notation:
i = annual interest rate expressed as a fraction
R = uniform annual payment made at end of each
year (Annual depreciation cost, Rs)
S = V – VS, Total amount of annuity accumulated
in an estimated service life of ‘n’
years, Rs
• According to the equation developed for ordinary
annuity (discrete case) Discrete
uniform-series
(1  i )  1
n
i
SR RS compound
i (1  i ) n  1 amount factor
17 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Sinking Fund Method (SFM)

i
R  (V  Vs )
(1  i ) n  1 Eq.1

• The amount accumulated in the fund after ‘a’


years of useful life must be equal to total amount
of depreciation up to that time, i.e. (V – Va)

(1  i ) a  1 i
V  Va  R  R  (V  Va )
i (1  i )  1
a

Eq.2
18 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus
Sinking Fund Method (SFM)

• Combining equations 1 and 2:


(1  i )  1
a
V  Va  (V  Vs )
(1  i )  1
n

• Asset (or book) value after ‘a’ years = Va

(1  i )  1
a
V  Va  (V  Vs )
(1  i )  1
n

19 Dr. Pradipta Chattopadhyay | BITS Pilani, Pilani Campus


Important References

• M.S. Peters & K.D. Timmerhaus, Plant Design and Economics for
Chemical Engineers, McGraw- Hill, 4th Edition, 1991.

30 January 2020 20

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