Module 6 – DEPRECIATION.

Gospel Reading………
Prayer………..

DEPRECIATION – is the decrease in the value of value of the physical property due to passage
of time.

Terminologies:
A. Value – in a commercial sense, is the present worth of a particular property.
B. Market value – of a property, is the amount which a willing buyer will pay to a willing
seller for the property where each has an equal advantage and is under no compulsion to buy
or sell.
C. Utility or Use value – of a property, is what the property is worth to the owner as an
operating unit.
D. Fair value – is the value which is normally determined by a disinterested third party in
order to establish a price that is fair to both seller and buyer.
E. Book value – sometimes called depreciated book value, is the worth of the property as
shown in the accounting records of an enterprise.
F. Salvage or Resale value – is the price that can be obtained from the sale of the property as
second hand.
G. Scrap value – is the amount of the property would sell for if disposed as junk.
H. 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.
I. Economic life – of a property, is the length of time during which the property maybe
operated at a profit.

Purpose of depreciation:
1. To provide for recovery of capital this can be invested in physical property.
2. To enable the cost of depreciation to be charged to the cost of producing products or services
that result from the use of property.
3. To provide for the replacement of the property.

Types of depreciation:
A. Normal depreciation.
a. Physical depreciation – is due to the lessening of the physical ability of the 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. It’s common causes are inadequacy, changes in style,
population center shift, saturation of markets or more efficient machines are produce or
available.
B. Depreciation due to changes in price levels.
C. Depletion – refers to decrease in the value of a property due to gradual ‘extraction of its
contents. 3

Requirements of depreciation method.

a. It should be simple.
b. It should recover capital.
c. The book value will not be greater than the actual value at any time.
d. The method should be accepted by the Bureau of Internal revenue.
Depreciation Methods:

1. Straight Line Method (SLM) – assumes that the loss in value is directly proportional to
the age of the property.

d = 𝐶O – 𝐶L
𝐿
where: d = depreciation per year
𝐶O = original cost
𝐶L = value at the end of the life of the property
𝐿 = useful life of the property in years

𝐷n = 𝑛 ( 𝐶O− 𝐶L )
𝐿
Dn = d (n)

where: 𝐷n = depreciation up to age n years.

𝐶n = 𝐶O – 𝐷n

where: 𝐶n = book value at the end of n years.

Example 1. A broadcasting corporation purchased equipment for P530,000 and paid P11,500
for freight and delivery charges to the job site. The equipment has a normal life of 10 years
with a trade-in value of P50,000 against the purchase of new equipment at the end of the life.
A. Determine the annual depreciation cost by straight line method.
B. How much does the equipment depreciated at the end of 6th year?
C. What is the book value of the equipment at the end of 8th year?

Solution: 𝐶O = P530,000 + P11,500 ; 𝐶L = P50,000 ; L = 10 yrs

A. Solving the depreciation Cost, d

d = 𝐶O – 𝐶L ; d = ( P530,000 + P11,500 ) − P50,000
L 10
d = Php 𝟒𝟗, / 𝒚𝒓 Ans.

B. Solving the total depreciation, Dn at n = 6 yrs

𝐷n = 𝑛 (𝐶O – 𝐶L) / ; or Dn = D6 = d (n) = P49,150 𝑦𝑟 x 6 yr
𝐷6 = Php 294,900 Ans.

C. Solving the Book value, Cn at n = 8 yrs.

𝐶n = 𝐶O – 𝐷n
𝐶8 = 𝐶O – 𝐷8
Where: D8 = d (n) ; 𝐷8 = P49,150 𝑦𝑟 x 8 yr = P393,200
𝐶8 = ( P530,000 + P11,500 ) – P393,200
C8 = Php 148,300 Ans.
 Example 2. A machine costs P90,000 and has estimated salvage value of P8,000 at the end of
10 years life time. Determine the book value after 3 years, using SLM.

Solution: CO = P90,000 ; CL = P8,000 ; L = 10 yrs. ; n = 3

Solving for the depreciation, d

d = 𝐶O – 𝐶L ; d = (P90,000 – P8,000) = P8,200
L 10
Solving for the total depreciation, Dn = D3:
D3 = n(d) = 3 (P8,000) = P24,600

Solving for the book value, Cn = C3

C3 = CO – D3 = P90,000 – P24,600 = Php 65,400

2. Sinking Fund Method (SFM) – 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.
CFD.

From: F = A ( F/A, i%, L )

F = A¿¿

C O−C L = d ¿¿

d = C O−C L ( i ) or d = ( CO – CL ) i .
¿¿
¿

Dn = d ¿ ¿ Total Depreciation

C n = C O - Dn Book Value

Example 1. A firm bought equipment for P56,000. Other expenses including installation amounted
to P4,000. The equipment is expected to have a life of 16 years with a salvage value of 10
percent of the original cost. Determine the book value at the end of 12 years by a) straight line
method b) sinking fund method at 12% interest.

Solution: CO = P56,000 + P4,000 ; CL = CO x10%

a. By Straight Line Method: Solving for the Book Value at n = 12 yrs.

C 12 = C O - D12

n(C O−C L )
and D12 = = d (n) = d (12)
L

( P 56,000+ P 4,000 )−( P56,000+ P 4,000 ) (0.10) P 3,375

where: d = =
16 yr

P 3,375
D12 = (12 yr)( ) = P40,500
yr

C 12 = ( P 56,000+ P 4,000 ) - P40,500 = Php 19,500 Ans.

b. By Sinking Fund Method: Solving for the Book Value at n = 12 yrs., i = 12%
and L = 16 yrs.

C 12 = C O - D12

D12 = d ¿ ¿

C O−C L i
d =
¿¿

d = ( P 56,000+ P 4,000 )−( P 56,000+ P 4,000 ) (0.10) 0.12

¿¿

P 1,263.06
d=
yr

D12 = P 1,263.06 ¿¿

D12 = P30,481.59

C 12 = ( P 56,000+ P 4,000 )- P30,481.59 = Php 29,518.41 Ans.

Example 2. An engineer imported an engine for his job, paying P250,000 to the dealer. Freight
and insurance charges amounted to P18,000; customs’, broker’s fees, and other services,
P8,500; taxes, permits, and other expenses, P25,000. If the engineer estimates the life of the
 engine to be 10 years with a salvage value of P20,000, determine the book value at the end of
6 years, using (a) SLM and (b) SFM at 8%.

Solution: CL = P20,000 ; L = 10 yrs. ; n = 6 yrs.

CO = P250,000 + P18,000 + P8,500 + P25,000 = P301,500

(a) By SLM: Solving for Cn @ n = 6,

d = 𝐶O – 𝐶L ; d = P301,500 − P20,000 , = P28,150
L 10

Dn = D6 = n (d) = 6 (P28,150) = P168,900

Cn = C6 = CO – D6 = P301,500 – P168,900

C6 = Php 132,600 Ans.

(b) By SFM: Solving for Cn @ 8%, n = 6,

i
d = C O−C L = (P301,500 – P20,00) 0.08 .
¿¿
(1 + 0.08)10 – 1
d = P281,500 (0.06902949)

d = P19,431.80

D n = D6 = d ¿ ¿ = ( P19,431.80 ) 0.08 .
(1 + 0.08)6 – 1
D6 = P19,431.80 (7.33592904)

D6 = P142,550.31

Cn = C6 = CO – D6 = P301,500 – P142,550.31

C6 = Php 158,949.69 Ans.

3. Declining Balance Method (DBM) – or Matheson Formula – is called the constant

percentage method, and it is assumed that annual cost of depreciation is a fixed percentage of
the salvage value at the beginning of the year.
Let k – the rate of depreciation
dn – the depreciation during the nth year
 Book Value at the Depreciation Book Value
Year Beginning of the During the at the End of the
Year (Cn-1) Year (d) Year (Cn)
1 CO d1 = kCO C1 = C0 – d1 = CO (1 – k)
2 C1 = CO (k-1) d2 = kC1 C2 = C1 – d2 = CO (1 – k) 2
3 C2 = CO (k-1) 2 d3 = kC2 C3 = C2 – d3 = CO (1 – k) 3
- - - -
n CO (k-1) n-1 dn = kCn-1 Cn = Cn-1 – dn = C0 (1 – k) n
- - - -
L CO (k-1) L-1 dL = kCL-1 CL = CL-1 – dL = C0 (1 – k) L

For dn: dn = CO (1 – k) n-1 . k

For Cn: Cn = CO (1 – k) n or C n = C O CL n /L

CO
For CL: CL = CO (1 – k) L

For Dn: D n = C O – Cn

n L
For k: k = 1– Cn . or k = 1– CL .
CO CO

Note: This method does not apply, if the salvage value is zero (0), because k will be
equal to one (1) and d1 will be equal to CO.

Example 1. A certain type of machine loses 10% of its value each year. The machine costs
P2,000 originally. Make out schedule showing the yearly depreciation and the book value
at the end of each year for 5 years.

Solution: CO = P,000 ; k = 10% = 0.10

For year 1: CO = P2,000

d1 = kCO = 0.10 (P2,000) = P200
D1 = d1 = P200
C1 = CO – d1 = P2,000 – P200 = P1,800 or
C1 = CO (1 – k) = P2,000 (1.0 – 0.10) = P2,000 (0.90) = P1,800

For year 2: C1 = P1,800

d2 = kC1 = 0.10 (P1,800) = P180
D2 = D1 + d2 = P200 + P180 = P380
C2 = C1 – d2 = P1,800 – P180 = P1,620 or
C2 = CO (1 – k) 2 = P2,000 (0.90) 2 = P1,620

For year 3: C2 = P1,620

d3 = kC2 = 0.10 (P1,620) = P162
D3 = D2 + d3 = P380 + P162 = P542
C3 = C2 – d3 = P1,620 – P162 = P1,458 or
C3 = CO (1 – k) 3 = P2,000 (0.90) 3 = P1,458
 For year 4: C3 = P1,458
d4 = kC3 = 0.10 (P1,458) = P145.80
D4 = D3 + d4 = P542 + P145.80 = P687.80
C4 = C3 – d4 = P1,458 – P145.80 = P1,312.20 or
C4 = CO (1 – k) 4 = P2,000 (0.90) 4 = P1,312.20

For year 5: C4 = P1,312.20

d5 = kC4 = 0.10 (P1,312.20) = P131.22
D5 = D4 + d5 = P687.80 + P131.22 = P819.12
C5 = C4 – d5 = P1,312.22 – P131.22 = P1,180.98 or
C4 = CO (1 – k) 5 = P2,000 (0.90) 5 = P1,180.98

Book Value and Depreciation Schedule Table:

Book Value at the Depreciation Total Book Value

Year Beginning of the During the Depreciation at at the End of the
Year (Cn-1) Year (dn) the End of Year Year (Cn)
@10% (Dn)
1 P2,000.00 P200.00 P200.00 P1,800.00
2 P1,800.00 P180.00 P380.00 P1,620.00
3 P1,620.00 P162.00 P542.00 P1,458.00
4 P1,458.00 P145.80 P687.80 P1,312.20
5 P1,312.20 P131.22 P819.12 P1,180.98

Example 2. Equipment initially costs P56,000. Its resale value at the end of fifth year is
estimated at P15,000. Using declining balance method, determine the yearly depreciation
and book value for the first and second years.

Solution: CO = P56,000 ; CL = P15,000 ; L = 5 yrs.

L 5
Solving for k: k = 1– CL . = 1– P15,000 = 0.2316
CO P56,000

Solving for the yearly depreciation and Book Value for the first and second year:

For Year 1: d1 = kCO = 0.2316 (P56,000) = P12,969.60

C1 = C0 – d1 = P56,000 – P12,969.60 = P43,030.40

For Year 2: d2 = kC1 = 0.2316 (P43,030.40) = P9,965.84

C2 = C1 – d2 = P43,030.40 – P9,965.84 = P33,064.56

4. Double Declining Balance Method (DDBM) – this method is very similar to the declining
balance method except that the rate of depreciation k is replaced by 2/L.
n-1
dn = CO 1 – 2 . 2.
L L
 n
Cn = C O 1 – 2 .
L
L
CL = C O 1 – 2 .
L

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

Example 1. Determine the rate of depreciation, the total depreciation up to the end of 8th
year and the book value at the end of 8 years for an asset that costs P15,000 new and has
estimated scrap value of P2,000 at the end of 10 years by (a) DBM and (b) DDBM.

Solution: CO = P15,000 ; CL = P2,000 ; L = 10 ; n = 8

(a) By DBM:
Solving for the rate of depreciation, k:
L
k = 1– CL . = 1 – 10 P2,000 = 0.1825 or 18.25%
CO P15,000

Solving for the Book Value at n = 8 yrs.

Cn = C8 = C0 (1 – k) n = P15,000 (1 – 0.1825) 8
C8 = P2,992

Solving for the total depreciation at n = 8 yrs.

Cn = CO – Dn ; C8 = CO – D8
D8 = CO – C8 = P15,000 - P2,992
D8 = P12.008

(b) By DDBM:
Solving for the rate of depreciation, L / 2:
2 . = 2 . = 0.20 or 20%
L 10

Solving for the Book Value at n = 8 yrs.

C8 = CO 1 – 2 . n = P15,000 1 – 2 . 8 = P2.517
L 10

Solving for the total depreciation at n = 8 yrs.

D8 = CO – C8 = P15,000 – P2,517 = P12,483

Example 2. A certain plant bought a machine for P220,000 and used it for 10 years life
span. What is the book value of the machine using DBM and DDBM after 5 years of use?
Assume the a scrap value of P22,000 for DBM, and P20,000 for DDBM.

Solution: CO = P220,000 ; L = 10 ; n = 5
(a) For DBM: Solving for the book value, C5: CL = P22,000
n /L 5 /10
C5 = C O CL = P220,000 P22,000 .
CO P220,000

C5 = P69,570

(b) For DDBM: Solving for the book value, C5: CL = P20,000
n 5
C5 = C O 1 – 2 . = P220,000 1– 2.
L 10

C5 = P72,090