Mindanao State University – General Santos City

Agricultural Engineering Review Class

DEPRECIATION

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

Purposes of Determining Depreciation:

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

Types of Depreciation:
1. Normal Depreciation
a. Physical Depreciation
i. Deterioration due to the effects of various chemical and mechanical factors on the
materials composing the property.
ii. Wear and tear due to abrasion, friction between moving parts of equipment, impact,
vibration, or fatigue of the materials in the property.
b. Functional Depreciation – due to the lessening in the demand for the function which the
property was designed to render.
i. inadequacy of the equipment
ii. obsolence
iii. changes in methods of production
iv. changes in styles and designs of the goods produced on the equipment
v. transfer of population due to various causes.
2. Depreciation due to Changes in Price Levels of Similar Property
3. Depletion – due to the gradual extraction of the contents of natural assets/ properties

Depreciation Cost – depends upon the physical or economic life of the equipment and its first cost.

Physical Life – the length of time during which it is capable of performing the function for which
it was designed and manufactured.
Economic Life – the length of time during which it will operate at a satisfactory profit.
Useful Life – the period of time as asset is kept in productive use in a trade or business.

*A property is depreciable if it meets all three requirements as follows:

1. It must be used in business or held for the production of income.
2. It must have determinable life, and the life must be longer than one year.
3. It must be something that wears out, decays, gets used up, become obsolete, or losses value
from natural cause.

Definitions of Value:
Value – present worth of all future profits that are to be received through the ownership of a property
First Cost – includes the original purchase price, freight and transportation charges to the site,
installation expenses, initial taxes and permits to operate, and all other expenses needed to put
the equipment into operation.
Salvage Value – second-hand value or resale value; the amount for which the equipment or machine
can be sold as second-hand.
Scrap or Junk Value – amount the equipment can be sold for, when disposed off as a junk.
Market Value – the amount which a willing buyer will pay to a willing seller for a property, where each
has equal advantage and is under no compulsion to buy or sell.
Utility or Use Value – is what the property is worth to the owner as an operating unit.
Fair Value – is usually determined by a disinterested third party in order to establish a price that is fair
to both seller and buyer.
Book Value/ Depreciated Book Value – is the worth of a property as shown on the accounting records of
an enterprise.
Going Value or Going-Concern Value – considered to be an intangible value, which an actually operating
concern has due to its operation.
Goodwill Value – that element of value, which a business has earned through the favorable
consideration and patronage of its customers arising from its well-known and well-conducted
policies and operations.
Rate-Base Value – the value assigned to the property for the purpose of establishing rates.
Franchise Value – is an intangible item of value arising from the exclusive right of the company to
provide a specific product or service in a stated region of the country.

*Requirements of a depreciation method:

1. It should be simple.
2. It should recover capital.
3. The book value will be reasonably close to the market value at any time.
4. The method should be accepted by the Bureau of Internal Revenue.

Symbols: L = useful life of the property in years CO = original cost

CL = the value at the end of the life d = annual cost of depreciation
DN = depreciation up to age n years

Depreciation Methods:

A. Straight Line Method – The loss on value is directly proportional to the age of the equipment or asset.
- simplest method; gives uniform annual charge
C O − CL
d =
L
n ( CO − CL )
DN = = nd
L
CN = CO - DN

Problem: A tax and duty free importation of a 30-Hp sandmill (for paint manufacturing) cost
P360,000. Bank charges and brokerage cost P5,000. Foundation and installation costs were
P25,000. Other incidental expenses amounted to P20,000. Salvage value of the mill is
estimated to be P60,000 after 20 years. Find the appraisal value of the mill at the end of (a) 10
years and (b) 15 years. Ans: a. P235,000 b. P147,500

B. Sinking Fund Formula – The sinking fund is established in which funds will accumulate for
replacement purposes.
CO − CL
d =
F / A ,i%,L
DN = d (F/A, i%, n)
CN = CO - DN

Problem: A broadcasting corporation purchased equipment worth P53,000 and paid P1,500 for
freight and delivery charges to the job site. The equipment has a normal life of 10 years with a
trade-in value of P5,000 against the purchase of new equipment at the end of the life.
(a) Determine the annual depreciation cost by the straight line method. Ans: P4950
(b) Determine the annual depreciation cost by the sinking fund method. Assume interest at
6- ½ % compounded annually. Ans: P3668

C. Declining Balance Method – The annual cost of depreciation is a fixed percentage of the book value
at the beginning of the year; also called the Matheson Formula and Constant Percentage
Method.

d = CO ( 1 – k ) n – 1 k
n

n ⎡ C ⎤L
CN = CO (1 − k ) = CO ⎢ L ⎥
⎣ CO ⎦
CL = CO ( 1 – k ) L
CN C
k = 1−n = 1−L L
CO CO
CN = CO - DN
 Problem: The cost of a certain asset is P3,000; its life is 6 years and scrap value is P500. Find the
annual rate of percentage and construct a depreciation table. Ans: k = 0.2582

D. Double Declining Balance (DDB) Method – Salvage value does not enter into the computation.

n
2 2
d = C O ⎛⎜ 1 − ⎞⎟ n − 1 ⎛⎜ ⎞⎟
⎛ 2⎞
CN = CO ⎜ 1 − ⎟
⎝ L ⎠ ⎝L⎠ ⎝ L⎠
CL = CO ( 1 – k ) L k = 2/L
CN = CO - DN

Problem: 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 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. Ans: a. 18.25%, P2992, P12008; b. 20%, P2517, P12483

E. Sum-Of-The-Year’s-Digit (SYD) Method

⎛n⎞ 2(L − n + 1 )
∑ YEARS = ⎜ ⎟ (n + 1 )
⎝2⎠
DN = ( C O − CL )
L (L + 1 )

Problem: A structure costs P12,000 new. It is estimated to have a life of 5 years with a salvage
value at the end of life of P1,000. Determine the book value at the end of each year of life.

F. Service-Output Method

C O − CL CO − CL
d
unit
= DN = (QN )
T T

Problem: A television company purchased machinery for P100,000 on July 1, 1979. It is estimated
that it will have a useful life of 10 years; 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
Ans: P9600, P14400, P10560

More Problems:

1. A civil engineer bought a gantry crane for erecting tall buildings. It was invoiced from Japan CIF
Manila at P250,000. Brokerage, bank, arrester fees, custom’s duties, permits, etc. total
P120,000. At the end of 10 years, he expects to sell it for P50,000. Prepare a depreciation
schedule for each of the following methods: (a) straight line method, (b) sinking formula at 12%,
(c) Matheson formula, and (d) double declining balance method.
2. A telephone company purchased a microwave radio equipment for P6,000,000. Freight and
installation charges amounted to 3% of the purchase price. If the equipment is depreciated over
an eight-year period with salvage value of 5%, prepare a depreciation schedule for each of the
following methods: (a) straight line method, (b) sinking formula at 12%, (c) Matheson formula,
(d) double declining balance method and (e) SYD method.
3. An industrial plant bought a generator set for P90,000. Other expenses including installation
amounted to P10,000. The generator set is to have a life of 17 years with a salvage value at the
end of life of P5,000. Determine the depreciation charge during the 13th year and the book
value at the end of 13 years by the (a) declining balance method, (b) DDB method, (c) sinking
fund method at 12%, and (d) SYD method.
4. A firm bought an 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% of the
original cost. Determine the book value at the end of 12 years by (a) the straight line method,
and (b) sinking fund method at 12% interest.