BATAAN HEROES COLLEGE

DEPRECIATION
Module Description:
This module contains the basic knowledge and other terminologies in Annuity that can be used in
economic analysis problem solving.

Depreciation is the decrease in value of physical property with the passage of time.

Purpose of Depreciation

1. To provide for the recovery of capital which has been invested in physical property.

2. To enable the cost of depreciation to be charged to the cost of producing products or services
that results from the use of the property.

Definition of Value

 Value is the present worth of all future profits that are to be received through ownership of
particular property.
 Market value of a property 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 and sell.
 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.
 Book value, sometimes called 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 of property would sell for if disposed off as junk.

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 of a property is the length of time during which it is capable of performing the
function for which it was designed and manufactured.
 Economic Life is the length of time during which the property may be operated at a profit.

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Requirements of a Depreciation Method

1. It should be simple

2. It should recover capital

3. The book value will reasonably close to the market value at any time.

4. The method should be accepted by the Bureau of Internal Revenue.

DEPRECIATION METHODS

Symbols for the different depreciation methods:

𝐿 – useful life of the property in years

𝐶𝑜 – the original cost

𝐶𝐿 – the value at the end of the life, the scrap value (including the 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

STRAIGHT LINE METHOD

 This method assumes that the loss in value is directly proportional to the age of the property.

𝑪𝑶 − 𝑪𝑳
𝒅=
𝑳

𝒏(𝑪𝑶 − 𝑪𝑳)
𝑫𝒏 =
𝑳

𝑪𝒏 = 𝑪𝒐 − 𝑫𝒏

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Example:

An electronic balance costs Php 90,000 and has an estimated salvage value of Php 8,000 at the end of its
10 years life time. What would be the book value after three years, using the SLM in solving for the depreciation?

Given:

𝑪𝒐 = 𝑷 𝟗𝟎, 𝟎𝟎𝟎 𝑪𝑳 = 𝑷 𝟖, 𝟎𝟎𝟎 𝑳 = 𝟏𝟎 𝒚𝒆𝒂𝒓𝒔 n = 3 years

Formla:

𝑪𝑶 − 𝑪𝑳
𝒅=
𝑳

𝑪𝒏 = 𝑪𝒐 − 𝑫𝒏

Required:

Book value using straight line method

Solution

𝑪𝑶 − 𝑪𝑳
𝒅=
𝑳

First, we need to identify the annual cost of depreciation for the electronic balance which costs 90k and estimated
salvage value of 8k after 10 years.

𝟗𝟎 𝟎𝟎𝟎 − 𝟖 𝟎𝟎𝟎
𝒅=
𝟏𝟎

𝒅 = 𝑷 𝟖 𝟐𝟎𝟎

After solving for the annual cost of depreciation, we need to know by how much will it depreciate for three years.

𝑫𝟑 = (𝒏)(𝒅)

𝑫𝟑 = (𝟑)(𝟖 𝟐𝟎𝟎)

𝑫𝟑 = 𝑷𝟐𝟒 𝟔𝟎𝟎

After knowing how much the balance will depreciate after three years, we can commpute for the book value after
three years.

𝑪𝟑 = 𝑪𝒐 − 𝑫𝟑

𝑪𝟑 = 𝟗𝟎 𝟎𝟎𝟎 − 𝟐𝟒 𝟔𝟎𝟎

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𝑪𝟑 = 𝑷 𝟔𝟓 𝟒𝟎𝟎

SINKING FUND METHOD

 This method assumes that a sinking fund is established in which funds will accumulate for replacement.
The total depreciation that has taken place up to any given time is assumed to be equal to the accumulated
amount in the sinking fund at that time.

Dn Co – CL

0 1 2 3 n L

d d d d d

𝑪𝑶 − 𝑪𝑳
𝒅=
𝑭
𝑨 , 𝒊%, 𝑳

𝑭
𝑫𝒏 = 𝒅 ( , 𝒊%, 𝒏)
𝑨

𝑪𝒏 = 𝑪𝒐 − 𝑫𝒏

Example:

A broadcasting corporation purchased an equipment for Php 53,000 and paid Php 1,500 for freight and delivery
charges to the job site. The equipment has a normal life of 10 years with a trade-in value of Php 5,000 against the
purchase of a new equipment at the end of the life.

a. Determine the annual depreciation cost by the SLM.

b. Determine the annual depreciation cost by the SFM. Assume interest at 6.5% compounded annually.

Given:
𝑪𝒐 = 𝑷 𝟓𝟑 𝟎𝟎𝟎 + 𝑷 𝟏 𝟓𝟎𝟎 = 𝑷 𝟓𝟒 𝟎𝟎𝟎
𝑪𝑳 = 𝑷 𝟓, 𝟎𝟎𝟎

Formula

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𝑪 −𝑪 𝑪 −𝑪
𝒅 = 𝑶𝑳 𝑳 𝒅 = 𝑭𝑶 𝑳
,𝒊%,𝑳
𝑨

Required:

a. Annual depreciation SLM

b. Annual depreciation SFM. 6% compounded annually

Solution:

a.

𝑪𝑶 − 𝑪𝑳
𝒅=
𝑳
𝟓𝟒 𝟓𝟎𝟎 − 𝟓 𝟎𝟎𝟎
𝒅=
𝟏𝟎
𝒅 = 𝑷 𝟒 𝟗𝟓𝟎

b.

54 500 – 5 000

0 1 2 3 n 10

d d d d d

𝑪𝑶 − 𝑪𝑳
𝒅=
(𝟏 + 𝒊)𝒏 − 𝟏
𝒊

𝟓𝟒 𝟓𝟎𝟎 − 𝟓 𝟎𝟎𝟎
𝒅=
(𝟏 + 𝟎. 𝟎𝟔𝟓)𝟏𝟎 − 𝟏
𝟎. 𝟎𝟔𝟓

𝒅 = 𝑷 𝟑𝟔𝟔𝟖. 𝟏𝟖𝟐𝟏

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DECLINING BALANCE METHOD

 Sometime called the constant percentage method or the Matheson Formula.

 It is assumed that the annual cost of depreciation is a fixed percentage of the salvage value at the beginning
of the year.
 The ratio of the depreciation in any year to the book value at the beginning of that year is constant
throughout the life of the property and is designated by k, the rate of depreciation.

𝒅𝒏 = 𝑪𝒐 (𝟏 − 𝒌)𝒏−𝟏𝒌

𝑪𝒏 = 𝑪𝒐 (𝟏 − 𝒌)𝒏

𝑪𝑳 = 𝑪𝒐 (𝟏 − 𝒌)𝑳

𝒏 𝑪𝒏
𝒌 =𝟏− √
𝑪𝒐

Where:

𝐋 = 𝐮𝐬𝐞𝐟𝐮𝐥 𝐥𝐢𝐟𝐞 𝐨𝐟 𝐭𝐡𝐞 𝐩𝐫𝐨𝐩𝐞𝐫𝐭𝐲 𝐢𝐧 𝐲𝐞𝐚𝐫𝐬

𝑪𝟎 = 𝑶𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝑪𝒐𝒔𝒕
𝑪𝑳 = 𝑽𝒂𝒍𝒖𝒆 𝒂𝒕 𝒕𝒉𝒆 𝒆𝒏𝒅 𝒐𝒇 𝒍𝒊𝒇𝒆, (𝒔𝒄𝒓𝒂𝒑 𝒗𝒂𝒍𝒖𝒆)
𝒅 = 𝒂𝒏𝒏𝒖𝒂𝒍 𝒄𝒐𝒔𝒕 𝒐𝒇 𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏
𝑪𝒏 = 𝒃𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆 𝒂𝒕 𝒕𝒉𝒆 𝒆𝒏𝒅 𝒐𝒇 𝒏 𝒚𝒆𝒂𝒓𝒔
𝑫𝒏 = 𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 𝒖𝒑 𝒕𝒐 𝒂𝒈𝒆 𝒏 𝒚𝒆𝒂𝒓𝒔

Note: This method does not apply, if the salvage value is zero, because k will be equal to one and d 1 will be
equal to Co
Example:
A certain type of machine loses 10% of its value each year. The machine costs Php 2,000.00 originally. Make
out a schedule showing the yearly depreciation, the total depreciation and the book value at the end of each year
for 5 years.

Given:

𝑪𝒐 = 𝑷 𝟐 𝟎𝟎𝟎 𝑳=𝟓 k = 10% or 0.10

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Formula:

YEAR Book value at Depreciation Total depreciation at Book value at

beginning of year during the year, end of year end of year
(10%)
1 𝑪𝟎 𝒅𝟏 = 𝒌𝑪𝟎 𝑫𝒏 = 𝑫𝒏−𝟏 + 𝒅𝒏 𝑪𝒏
= 𝑪𝟎 (𝟏 − 𝒌)𝒏
2 𝑪𝟎 (𝟏 − 𝒌)𝒏−𝟏 𝒅𝟐 = 𝒌𝑪𝟐−𝟏 𝑫𝒏 = 𝑫𝒏−𝟏 + 𝒅𝒏 𝑪𝒏
= 𝑪𝟎 (𝟏 − 𝒌)𝒏
3 𝑪𝟎 (𝟏 − 𝒌)𝒏−𝟏 𝒅𝟑 = 𝒌𝑪𝟑−𝟏 𝑫𝒏 = 𝑫𝒏−𝟏 + 𝒅𝒏 𝑪𝒏
= 𝑪𝟎 (𝟏 − 𝒌)𝒏
4 𝑪𝟎 (𝟏 − 𝒌)𝒏−𝟏 𝒅𝟒 = 𝒌𝑪𝟒−𝟏 𝑫𝒏 = 𝑫𝒏−𝟏 + 𝒅𝒏 𝑪𝒏
= 𝑪𝟎 (𝟏 − 𝒌)𝒏
5 𝑪𝟎 (𝟏 − 𝒌)𝒏−𝟏 𝒅𝟓 = 𝒌𝑪𝟓−𝟏 𝑫𝒏 = 𝑫𝒏−𝟏 + 𝒅𝒏 𝑪𝒏
= 𝑪𝟎 (𝟏 − 𝒌)𝒏
Solution:

Yr Book value at beginning of Depreciation Total Book value at end

year during the year, depreciation at of year
(10%) end of year
1 𝐶0 =2000 𝑑 = 0.10(2000) 𝐷1 = 𝐶1
= 200 2000(0.10) = 2000(1 −
= 200 0.10)1
=1800
2 2000(1 − 0.10)1 =1800 𝑑2 = 0.10(1800) 𝐷2 = 𝐷𝑛−1 + 𝑑𝑛 𝐶2= 𝐶0 (1 − 𝑘)2
= 180 = 180 + 200 =1620
= 380
3 2000(1 − 0.10)2 =1620 𝑑3 = 0.10(1620) 𝐷3 = 𝐷𝑛−1 + 𝑑𝑛 𝐶3= 𝐶0 (1 − 𝑘)3
= 162 = 380 + 162 =1458
= 542
4 2000(1 − 0.10)3 =1458 𝑑3 = 0.10(1458) 𝐷4 = 𝐷𝑛−1 + 𝑑𝑛 𝐶4= 𝐶0 (1 − 𝑘)4
= 145.8 = 542 + 145.8 =1312.2
=687.8
5 2000(1 − 0.10)4 =1312.2 𝑑4 = 𝐷5 = 𝐷𝑛−1 + 𝑑𝑛 𝐶5= 𝐶0 (1 − 𝑘)5
0.10(1312.2) = 687.8 + 131.22 =1180.98
= 131.22 =819.12

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Note: All values are in Peso

DOUBLE DECLINING BALANCE METHOD

 This method is very similar to the DBM except that the rate of depreciation k is replaced
by 2/L.

𝟐 𝟐
𝒅𝒏 = 𝑪𝒐 (𝟏 − )𝒏−𝟏
𝑳 𝑳

𝟐
𝑪𝒏 = 𝑪𝒐 (𝟏 − )𝒏
𝑳

𝟐
𝑪𝑳 = 𝑪𝒐 (𝟏 − )𝑳
𝑳

Note: When the DDBM is used, the salvage value should not be subtracted from the first cost when calculating
the depreciation charge.
Example:

Determine the rate of depreciation, the total depreciation up to the end of the 8 th year and book value at the
end of 8 years for an asset that costs Php 15,000 new and has an estimated scrap value of Php 2,000 at the end of
10 years by:

b. double declining balance method (DDBM)

Given:

𝑪𝒐 = 𝑷 𝟏𝟓 𝟎𝟎𝟎 𝑳 = 𝟏𝟎 n=8 𝑪𝑳 = 𝑷 𝟐 𝟎𝟎𝟎

Formula:

𝟐
𝑪𝒏 = 𝑪𝒐 (𝟏 − )𝒏
𝑳
𝑫𝟖 = 𝑪 𝒐 − 𝑪 𝟖

Solution:

𝟐 𝟖
𝑪𝟖 = 𝟏𝟓 𝟎𝟎𝟎(𝟏 − )
𝟏𝟎
𝑪𝟖 = 𝑷 𝟐, 𝟓𝟏𝟕
𝑫𝟖 = 𝟏𝟓, 𝟎𝟎𝟎 − 𝟐 𝟓𝟏𝟕
𝑫𝟖 = 𝑷 𝟏𝟐, 𝟒𝟖𝟑

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SUM-OF-THE-YEARS-DIGITS (SYD) METHOD

Let 𝑑𝑛 – depreciation charge during the nth year

𝑑𝑛 = (depreciation factor) (total depreciation)

𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕
𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

Example:

A structure costs Php 12,000 new. It is estimated to have a life of 5 years with salvage value at the end of
life Php 1,000. Determine the book value at the end of each year of life.

Given:

𝑪𝒐 = 𝑷 𝟏𝟐 𝟎𝟎𝟎 n=5 𝑪𝑳 = 𝑷 𝟏𝟎𝟎𝟎

Yr Yr in Depreciation factor Depreciation during the yr

reverse
order
1 5 𝒏 (𝒓. 𝒐) 𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕
𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

2 4 𝒏 (𝒓. 𝒐) 𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕

𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

3 3 𝒏 (𝒓. 𝒐) 𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕

𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

4 2 𝒏 (𝒓. 𝒐) 𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕

𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

5 1 𝒏 (𝒓. 𝒐) 𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕

𝒅𝒏 = (𝑪 − 𝑪 𝑳 )
∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 𝒐

∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 15

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Solution

Yr Yr in Depreciation factor Depreciation during the yr

reverse
order
1 5 𝟓/𝟏𝟓 𝒅𝟏 = (𝟓/𝟏𝟓) (𝟏𝟏 𝟎𝟎𝟎)
= P 8 333
2 4 𝟒/𝟏𝟓 𝒅𝟐 = (𝟒/𝟏𝟓) (𝟏𝟏 𝟎𝟎𝟎)
= P 5 400
3 3 𝟑/𝟏𝟓 𝒅𝟑 = (𝟑/𝟏𝟓) (𝟏𝟏 𝟎𝟎𝟎)
= P 3 200
4 2 𝟐/𝟏𝟓 𝒅𝟒 = (𝟐/𝟏𝟓) (𝟏𝟏 𝟎𝟎𝟎)
= P 1 733
5 1 𝟏/𝟏𝟓 𝒅𝟓 = (𝟏/𝟏𝟓) (𝟏𝟏 𝟎𝟎𝟎)
= P 1 000

∑ 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 15

SERVICE-OUTPUT METHOD

 This method assumes that the total depreciation that has taken place is directly proportional to the quantity
of output of the property up to that time. This method has the advantage of making the unit cost of the
depreciation constant and giving low depreciation expense during the periods of the low production.

Let 𝑇 – total units of output up to the end of life

𝑄𝑛 – total number of units of output during the nth year

𝑪𝒐 −𝑪𝑳
Depreciation per unit of output = 𝑻

𝑪𝒐 −𝑪𝑳
𝒅𝒏 = (𝑸𝒏 )
𝑻

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Example:

A Television Company purchased machinery for P100,000 on July 1, 1979. It is estimated that it will have a
useful life of P10years; scrap value of P4,000, production of 400,000 units and working hours of 120,000.

The company uses the machinery for 14,000 hours in 1979 and 18,000 hours in 1980. The machinery produces
36,000 units in 1979 and 44,000 units in 1980. Compute the depreciation for 1980 using each method given
below:

1. Straight line
2. Working hours
3. Output method

Given:

𝑪𝒐 = 𝑷 𝟏𝟎𝟎 𝟎𝟎𝟎 𝑳 = 𝟏𝟎 𝑪𝑳 = 𝑷 𝟒 𝟎𝟎𝟎

Formula:
Straight line:
𝑪𝒐 − 𝑪𝑳
𝒅𝒏 =
𝑻

Working Hours:

𝑪𝒐 − 𝑪𝑳
𝒅𝒏 = (𝑯𝒏 )
𝑻

Output Method:

𝑪𝒐 − 𝑪𝑳
𝒅𝒏 = (𝑸𝒏 )
𝑻

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Cash-flow Diagram
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Solution:
Straight line:
𝑪𝒐 − 𝑪𝑳
𝒅𝒏 =
𝑻

𝟏𝟎𝟎 𝟎𝟎𝟎 − 𝟒 𝟎𝟎𝟎

𝒅𝒏 = = 𝑷 𝟗 𝟔𝟎𝟎
𝟏𝟎

Working Hours:

𝑪𝒐 − 𝑪𝑳
𝒅𝒏 = (𝑯𝒏 )
𝑯

𝟏𝟎𝟎 𝟎𝟎𝟎 − 𝟒 𝟎𝟎𝟎

𝒅𝒏 = (𝟏𝟖 𝟎𝟎𝟎) = 𝑷 𝟏𝟒𝟒𝟎𝟎
𝟏𝟐𝟎 𝟎𝟎𝟎

Output Method:

𝑪𝒐 − 𝑪𝑳
𝒅𝒏 = (𝑸𝒏 )
𝑸

𝟏𝟎𝟎 𝟎𝟎𝟎 − 𝟒 𝟎𝟎𝟎

𝒅𝒏 = (𝟒𝟒 𝟎𝟎𝟎) = 𝑷𝟏𝟎 𝟓𝟔𝟎
𝟒𝟎𝟎 𝟎𝟎𝟎

12 | P a g e
Cash-flow Diagram
Prepared by: Engr. Lucas & Engr. Cortez
Bataan Heroes College

References

Arreola, Matias (1993). Engineering Economy – A Systematic Approach to Engineering Economy

(3rd ed.). Ken Incorporated.

Sta. Maria, Hipolito. (2007). Engineering Economy (3rd ed.). National Bookstore.

13 | P a g e
Depreciation
Prepared By: Engr. Lucas & Engr. Cortez