DEPRECIATION

 The monetary value of an asset decreases over

time due to use, wear and tear or obsolescence.
 This decrease is measured as
DEPRECIATION.
 Machinery, equipment, currency are some
examples of assets that are likely to depreciate
over a specific period of time.
 This is useful for estimation of property value
for taxation purposes.
2
 Service Life (or Useful Life) – length
of time that the asset will be used in the
operation of business

Salvage Value – the amount that is

expected to be recovered upon the sale or
disposal of the asset at the end of its
service life
 (1) STRAIGHT-LINE DEPRECIATION METHOD
Assumes that the asset’s value declines by the same
amount in every period of its service life.

𝑨𝑪 −𝑺𝑽
DEPP =
𝒏
Where:
DEPP – Depreciation expense per period
AC – Acquisition cost
SV – Salvage value (or Scrap value or Residual value)
n – Total number of periods in the Service life
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5
EXAMPLE 1: SSC-R College Department purchased a latest computer
at a cost of Php110,000. The estimated life of the computer is 6 years,
with a scrap value of Php20,000. Find the annual amount of
depreciation and the book value at the end of the first year.
SOLUTION:
A. Given: AC = Php110,000 SV= Php20,000 n = 6 years
𝐴𝐶 −𝑆𝑉 110,000 −20,000
DEPP = = = Php15,000/year
𝑛 6
The computer will be depreciated evenly over the 6-year life for an
annual depreciation of Php15,000

Since the annual depreciation of Php15,000, the book value at the end
of the first year will be
BV = AC – AD = 110,000 – 15,000 = Php95,000
6 Where: BV – Book Value AD – Accumulated Depreciation
 EXAMPLE 2: A manufacturing enterprise expects to use a new machine
costing Php200,000 for five years. It is expected to decline steadily in
value and be sold for about Php50,000 after five years. Using the
straight-line depreciation method:
A Determine the annual depreciation expense
B Prepare the depreciation schedule
SOLUTION:
A. Given: AC = Php200,000 SV= Php50,000 n = 5 years
𝐴𝐶 −𝑆𝑉 200,000 −50,000
DEPP = = = Php30,000/year
𝑛 5
The annual depreciation expense of the machine is Php30,000

7
 Year Depreciation Expense Accumulated Book Value (BV)
(DE) Depreciation (AD)
0 0.00 0.00 Php200,000.00

1 Php 30,000.00 Php30,000.00 170,000.00

2 30,000.00 (1) 60,000.00 (2) 140,000.00

3 30,000.00 90,000.00 110,000.00

4 30,000.00 120,000.00 80,000.00

5 30,000.00 150,000.00 50,000.00

(1) AD = ADEPP + CPDE = 30,000 + 30,0000 = 60,000

(2) BV = AC – AD = 200,000 – 60,000 = 140,000

BV = BVEPP – CPDE
Where:
ADEPP – Accumulated Depreciation at End of Previous Period
CPDE – Current Period’s Depreciation Expense
8 AC – Acquisition Cost
 #1 ENRICHMENT EXERCISE

RES Inc., bought a truck for Php1,500,000 with an estimated life of 8

years. The trade-in value of the truck is Php130,000. Assume a
straight-line method. Determine the annual depreciation expense of
the truck and value of the truck at the end of 4 years.

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 (2) UNITS-OF-PRODUCTION DEPRECIATION METHOD
The decline in the value of an asset is roughly proportional to some
measure of its use in the operation of the business. It is wise to
prorate the asset’s lifetime units of use.

EXAMPLE 1: A piece of equipment was purchased at a cost of

Php2,800,000. The estimated salvage value is Php250,000 with the
useful life of 7 years. Assume a production of 75,000 units. Compute
the depreciation for the first two years using units-of-production
method with 11,5000 and 13,000 units produced, respectively.
SOLUTION:
AC =Php2,800,000 SV = Php250,000 TLU = 75,000 units
AC – Acquisition Cost SV – Salvage Value
10 TLU – Total Lifetime Units
 UNITS-OF-PRODUCTION DEPRECIATION METHOD

SOLUTION:
AC =Php2,800,000 SV = Php250,000 TLU = 75,000 units
AC – Acquisition Cost SV – Salvage Value
TLU – Total Lifetime Units DE – Depreciation Expense
DEPU – Depreciation Expense Per Unit of Use or Produce

𝑨𝑪 −𝑺𝑽 𝟐,𝟖𝟎𝟎,𝟎𝟎𝟎 −𝟐𝟓𝟎,𝟎𝟎𝟎

DEPU = = = Php34 per unit produced
𝑻𝑳𝑼 𝟕𝟓,𝟎𝟎𝟎

11
 UNITS-OF-PRODUCTION DEPRECIATION METHOD

SOLUTION: (cont.)
Then we need to multiply the units of production and depreciation
per unit to determine the depreciation amount for the first two years.
DE = Number of units produced x DEPU
= 11,500 (34)
= Php391,000

DE = Number of units produced x DEPU

= 13,000 (34)
= Php442,000
Therefore the amount of depreciation for the first two years is
12 Php391,000 and Php442,000, respectively.
 UNITS-OF-PRODUCTION DEPRECIATION METHOD

EXAMPLE 2: SJS Liner produced a new passenger bus for

Php3,000,000. SJS Liner usually replaces buses after they have
accumulated 250,000 km. The estimated resale value of this bus is
Php600,000.
A Determine the depreciation per 1,000 km travelled
B Construct a depreciation schedule for the first four years if the
distance driven in successive years is 45,000 km, 57,000 km, 60,000
km, and 33,000 km

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 UNITS-OF-PRODUCTION DEPRECIATION METHOD

SOLUTION:
AC =Php3,000,000 SV = Php600,000 TLU = 250,000 km
A unit of use is 1,000 km travelled. The useful service life is 250,000
km which represents

𝟐𝟓𝟎,𝟎𝟎𝟎 𝒌𝒎
= 250 lifetime units
𝟏,𝟎𝟎𝟎 𝒌𝒎 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝑨𝑪 −𝑺𝑽 𝟑,𝟎𝟎𝟎,𝟎𝟎𝟎 −𝟔𝟎𝟎,𝟎𝟎𝟎

DEPU = = = Php 9,600 per 1,000 km travelled
𝑻𝑳𝑼 𝟐𝟓𝟎

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 Year Depreciation Expense Accumulated Book Value
(DE) Depreciation (AD) (BV)
0 0.00 0.00 Php3,000,000

1 (1) Php 432,000 432,000 2,568,000

2 (2) 547,200 (3) 979,200 (4) 2,020,800

3 576,000 1,555,200 1,444,8000

4 316,000 1,872,000 1,128,000

(1) DE = Number of units used x DEPU = (45,000km) (Php9,600/1,000km) = P432,000

(2) DE = Number of units used x DEPU = (57,000km) (Php9,600/1,000km) = P547,200
(3) AD = ADEPP + CPDE = 432,000 + 547,200 = Php979,200
(4) BV = AC – AD = 3,000,000 – 979,200 = Php2,020,800

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 ▪ #2 ENRICHMENT EXERCISE

Motor Trucking purchased a new dump truck

garbage disposal of the municipality for
Php4,250,000. The truck has a scrap value of
Php800,000 and an estimated life of 600,000
kilometres. Find the depreciation for a year in
which the truck is driven 57,500 km.

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 ▪ (3) SERVICE-HOURS DEPRECIATION METHOD

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 ▪ (3) SERVICE-HOURS DEPRECIATION METHOD
- In proportion to the expected total hours of use

EXAMPLE 1: The Red Laundry purchased new washing machine and

dryers for Php2,600,000. The machines are expected to last 40,000
hours and have a residual value of Php120,000. If Red Laundry
elects to use the service-hours depreciation method, determine the
depreciation if the machine is used for 8,200 hours.

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 ▪ (3) SERVICE-HOURS DEPRECIATION METHOD

A Ltd. purchased a machine at a cost of Rs.99, 600. It was

expected to last for 6 years with a scrap value of Rs.3,
000. Find out the depreciation for each of the six years
under (a) Production Units Method and (b) Machine Hour
Rate Method.

Total estimated life in units of production is 77,280 units

and total estimated life in machine hours is 19,320 hours.

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 ▪ (3) SERVICE-HOURS DEPRECIATION METHOD
Additional data are:

20
21
22
 #3 PRACTICE PROBLEM
A Machinery was purchased for Rs.5,000,000 with an
estimated working hours or machine hours of about 25,000
hours. The expected scrap value is Rs.200,000 and the
estimated machine hours for 10 years is as follows. You are
required to calculate the depreciation under the machine
hours method.

Year Machine Hours

1-3 3000 Hours
4-6 2600 Hours
23
7-10 800 Hours
 Depreciation by Declining Balance Method

Declining Balance Method is sometimes called the

Constant-Percentage Method or the Matheson formula. The
assumption in this depreciation method is that the annual
cost of depreciation is the fixed percentage (1 - K) of the
Book Value (BV) at the beginning of the year. The formulas
for Declining Balance Method of Depreciation are:
Annual Rate of Depreciation(K): SV = FC (1 - K)n
Book Value = FC (1 - K)m
Depreciation at mth year = FC (1 - K)m-1 (K)
Total Depreciation = FC - SV
25
26
 Problem 1: Declining Balance Method

The equipment bought at a price of Php 450,000 has an economic life of 5 years
and a salvage value of Php 50, 000. The cost of money is 12% per year. Compute
the first year depreciation using Declining Balance Method.

Solution
a. Solve for the annual rate of depreciation.
Annual Rate of Depreciation(K): SV = FC (1 - K)n
SV = FC (1 - K)^n Book Value = FC (1 - K)m
50,000 = 450,000 (1 - K)^5 Depreciation at mth year = FC (1 - K)m-1 (K)
K = 0.356 Total Depreciation = FC - SV

b. Solve for the depreciation at the end of the first year.

Depreciation = (K) (FC) (1 - K)^(m-1)

Depreciation = (0.356) (450,000) (1 - 0.356)^0
28
Depreciation = Php 160,200
 Problem 2: Declining Balance Method
The first cost of a machine is Php 1,800,000 with a salvage
value of Php 400,000 at the end of its life of five years.
Determine the depreciation after three years using
Constant-Percentage Method.
Solution Annual Rate of Depreciation(K): SV = FC (1 - K)n
Book Value = FC (1 - K)m
Depreciation at mth year = FC (1 - K)m-1 (K)
a. Solve for (1 - k). Total Depreciation = FC - SV

SV = FC (1 - K)^n
400,000 = 1,800,000 (1 - K)^5
29 (1 - K) = 0.74
 b. Solve for the book value at the end of the third year.

BV = FC (1 - K)^m Annual Rate of Depreciation(K): SV = FC (1 - K)n

Book Value = FC (1 - K)m
BV = 1,800,000 (0.74)^3 Depreciation at mth year = FC (1 - K)m-1 (K)
Total Depreciation = FC - SV
BV = Php 730,037.21

c. Solve for the total depreciation after three years.

Total depreciation = FC - BV
Total depreciation = 1,800,000 - 730,037.21
Total depreciation = Php 1,069,962.79

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 #4 PRACTICE PROBLEM
BnW frames bought a printing machine for $250,000. It is
expected that machine has a residual value of $30,000.
Entity uses declining balance method of depreciation and
depreciates at 20% every year.

Give a schedule showing depreciation of asset for 5 years

with workings.

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 SOLUTION

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 DECLINING BALANCE (DB)AND DOUBLE
DECLINING BALANCE (DDB) DEPRECIATION
DECLINING BALANCE(DB) - fixed percentage or uniform
percentage method
- Annual depreciation is determined by multiplying the book value at
the beginning of the year by a fixed percentage, d

- The maximum annual depreciation rate for the DB method is twice

the straight line: 𝒅𝒎𝒂𝒙 = 𝟐/𝒏

DOUBLE DECLINING BALANCE(DDB) : 𝒅 = 𝟐/𝒏

Example: If n=10 years, the DDB rate is 2/10 = 20%, so 20% of the book
value is removed annually.

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 DECLINING BALANCE (DB) AND DOUBLE
DECLINING BALANCE (DDB) DEPRECIATION
 The depreciation for year t is the fixed rate d times the book value
at the end of the previous year: 𝑫𝒕 = 𝒅 𝑩𝑽𝒕−𝟏
 The actual depreciation rate for each year t , relative to the first cost
B is: 𝒅𝒕 = 𝒅(𝟏 − 𝒅)𝒕−𝟏
 If 𝑩𝑽𝒕−𝟏 is not known, the depreciation in year t can be calculated
using B and d: 𝑫𝒕 = 𝒅𝑩(𝟏 − 𝒅)𝒕−𝟏
 Book value in year t is determined in two ways:
(1) 𝑩𝑽𝒕 = 𝑩(𝟏 − 𝒅)𝒕
(2) 𝑩𝑽𝒕 = 𝑩𝑽𝒕−𝟏 − 𝑫𝒕
 The book value for the DB method never goes to zero
 The implied salvage value after n years is the BV amount:
𝑰𝒎𝒑𝒍𝒊𝒆𝒅 𝑺 = 𝑩𝑽𝒏 = B(𝟏 − 𝒅)𝒏
34
 DECLINING BALANCE (DB) AND DOUBLE
DECLINING BALANCE (DDB) DEPRECIATION
 If the salvage value is estimated for the asset, the estimated value
is not used in the DB and DDB method to calculate the annual
depreciation.
 If the implied S is less than the estimated S, it is necessary to stop
charging further depreciation when the book value is at or below
the estimated salvage value
 In most cases the estimated S is in the range of zero to the implied
S value
 If the fixed percentage d is not stated, determine the implied fixed
rate using the estimated S value, if S>0. The range for d is 0<d<n/2:
𝑺 𝟏/𝒏
𝑰𝒎𝒑𝒍𝒊𝒆𝒅 𝒅 = 𝟏 −
𝑩
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 EXAMPLE
Underwater electroacoustic transducers were purchased
for use in SONAR applications. The equipment will be
DDB depreciated over an expected life of 12 years. There
is a first cost of $25,000 and an estimated salvage value
of $2,500.
(a)Calculate the depreciation and book value for years 1
and 4
(b)Calculate the implied salvage value after 12 years

36
 SOLUTION
𝟐 𝟐
(a)The DDB fixed depreciation rate is 𝒅 = = = 𝟎. 𝟏𝟔𝟔𝟕
𝒏 𝟏𝟐
Year 1: 𝑫𝟏 = (0.1667)(25,000)(𝟏 − 𝟎. 𝟏𝟔𝟔𝟕)𝟏−𝟏 = $4,167
𝑩𝑽𝟏 = 𝟐𝟓, 𝟎𝟎𝟎(𝟏 − 𝟎. 𝟏𝟔𝟔𝟕)𝟏 = $20,833

Year 4: 𝑫𝟒 = (0.1667)(25,000)(𝟏 − 𝟎. 𝟏𝟔𝟔𝟕)𝟒−𝟏 = $2,411

𝑩𝑽𝟒 = 𝟐𝟓, 𝟎𝟎𝟎(𝟏 − 𝟎. 𝟏𝟔𝟔𝟕)𝟒 = $12,054

(b) Implied salvage value = 25,000(𝟏 − 𝟎. 𝟏𝟔𝟔𝟕)𝟏𝟐 =$2,803

Since the estimated S=$2,500 is less than $2,803, the asset is
not fully depreciated when its 12-year expected life is
reached.
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 EXAMPLE
Freeport-McMoRan Copper and Gold has purchased a
new ore grading unit for $80,000. The unit has an
anticipated life of 10 years and a salvage value of
$10,000. Use the DB and DDB methods to compare the
schedule of depreciation and book values for each year.

38
 SOLUTION
An implied DB depreciation rate is
𝑺 𝟏/𝒏 𝟏𝟎,𝟎𝟎𝟎 𝟏/𝟏𝟎
𝑰𝒎𝒑𝒍𝒊𝒆𝒅 𝒅 = 𝟏 − = 𝟏 − = 0.1877 (<2/10)
𝑩 𝟖𝟎,𝟎𝟎𝟎

39
 SOLUTION
Year Declining Balance, $ (d = 0.1877) Double Declining Balance, $ (d=0.2)
t 𝑫𝒕 𝑩𝑽𝒕 𝑫𝒕 𝑩𝑽𝒕
0 - 80,000 - 80,000
1 15,016 64,948 16,000 64,000
2 12,197 52,787 12,800 51,200
3 9,908 42,879 10,240 40,960
4 8,048 34,831 8,192 32,768
5 6,538 28,293 6,554 26,214
6 5,311 22,982 5,243 20,972
7 4,314 18,668 4,194 16,777
8 3,504 15,164 3,355 13,422
9 2,846 12,318 2,684 10,737
10 2,318 10,000 737 10,000
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41
 #1 PRACTICE PROBLEM
Software and hardware for optimizing cell design of
robotic picking lines have an installed cost of $78,000
with no residual value after 5 years. For years 2 and 4,
use DDB book depreciation to determine
(a) The depreciation charge
(b) The book value

42
 #2 PRACTICE PROBLEM
Determine the first cost of a machine that is used for
making spill-containment pallets if its book value in year
3 is $25,000. The machine has a 5-year life and the
double declining balance method is applied.

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 MODIFIED ACCELERATED COST
RECOVERY SYSTEM (MACRS)
- Tax depreciation method
- Annual depreciation amount: 𝑫𝒕 = 𝒅𝒕 𝐁 𝐰𝐡𝐞𝐫𝐞 𝒅𝒕 is provided in
tabulated form and B is the first cost or unadjusted basis
- Book value in year t: 𝑩𝑽𝒕 = 𝑩𝑽𝒕−𝟏 − 𝑫𝒕
- 𝑩𝑽𝒕 = unadjusted basis – sum of accumulated depreciation
𝒋=𝒕
= B - 𝒋=𝟏 𝑫𝒋
- The basis B (or first cost P) is completely depreciated; salvage
value is always assumed to be zero, or S=$0
- Recovery periods are standardized to specific values:
n = 3,5,7,10,15,or 20 years For personal property (e.g. equipment or vehicles)
n = 27.5 or 39 years For real property (e. g. rental property or structures)
44
 Generally, the difference between book depreciation and
tax depreciation involves the "timing" of when the cost of
an asset will appear as depreciation expense on a
company's financial statements versus the depreciation
expense on the company's income tax return.

By charting the decrease in the value of an asset or assets,

depreciation reduces the amount of taxes a company or
business pays via tax deductions. The larger the
depreciation expense, the lower the taxable income and
the lower a company's tax bill.
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 Depreciation Rate (%) for Each MACRS Recovery Periods in Years
Year for Personal Property
n=3 n=5 n=7 n=10 n=15 n=20
1 33.33 20.00 14.29 10.00 5.00 3.75
2 44.45 32.00 24.49 18.00 9.50 7.22
3 14.81 19.20 17.49 14.40 8.55 6.68
4 7.41 11.52 12.49 11.52 7.70 6.18
5 11.52 8.93 9.22 6.93 5.71
6 5.76 8.92 7.37 6.23 5.29
7 8.93 6.55 5.90 4.89
8 4.46 6.55 5.90 4.52
9 6.56 5.91 4.46
10 6.56 5.90 4.46
11 3.28 5.91 4.46
12 5.90 4.46
13 5.91 4.46
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 Depreciation Rate (%) for Each MACRS Recovery Periods in Years
Year for Personal Property - continuation
n=3 n=5 n=7 n=10 n=15 n=20
14 5.90 4.46
15 5.91 4.46
16 2.95 4.46
17-20 4.46
21 2.23

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 For real property, MACRS utilizes:

Year 1 100𝒅𝟏 = 1.391%

Year 2-39 100𝒅𝒕 = 2.564%
Year 40 100𝒅𝟒𝟎 = 1.177%

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 EXAMPLE
Chevron Philips Chemical Company in Baytown, Texas, acquired a new
equipment for its polyethylene processing line. This chemical is a resin
used in plastic pipe, retail bags, blow molding, and injection molding.
The equipment has an unadjusted basis of B = $400,000, a life of only 3
years, and a salvage value of 5% of B. The chief engineer asked the
finance director to provide an analysis of the difference between (1) the
DDB method, which is the internal book depreciation and book value
method used at the plant, and (2) the required MACRS tax depreciation
and its book value. He is especially curious about the differences after
2 years of service for this short-lived, but expensive asset. Determine
(a) Which method offers the larger total depreciation after 2 years
(b) The book value for each method after 2 years and at the end of the
recovery period

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 SOLUTION
The basis B= $400,000 and the estimated S=
0.05(400,000)=$20,000. The MACRS rates for n=3 are taken
from the Table. The depreciation rate for DDB is
𝒅𝒎𝒂𝒙 =2/3=0.667

50
 Comparing MACRS abd DDB Depreciation
MACRS DDB, d = 0.667

Year Rate Tax Book Book Book

Depreciation, Value, $ Depreciation, Value, $
$ $
0 400,000 400,000
1 0.3333 133,320 266,680 266,667 133,333
2 0.4445 177,800 88,880 88,889 44,444
3 0.1481 59,240 29,640 24,444 20,000
4 0.0174 29,640 0
NOTES:
Year 3 for DDB would be 44,444 (0.6667) = $29,629 except this would make
𝑩𝑽𝟑 < $20,000. Only the remaining amount of $24,444 is removed.
51
 SOLUTION
(a) The 2-year accumulated depreciation values are

MACRS: 𝑫𝟏 + 𝑫𝟐 = $𝟏𝟑𝟑, 𝟑𝟐𝟎 + $𝟏𝟕𝟕, 𝟖𝟎𝟎 =$311,120

DDB : 𝑫𝟏 + 𝑫𝟐 = $𝟐𝟔𝟔, 𝟔𝟔𝟕 + $𝟖𝟖, 𝟖𝟖𝟗 = $355,556

The DDB depreciation is larger. (Remember that for tax purposes, the
company does not have the choice in the United States of DDB as applied
here.)

(b) After 2 years the book value for DDB at $44,444 is 50% of the MACRS book
value of $88,880. At the end of recovery (4 years for MACRS due to the built-in
half year convention, and three years for DDB, the MACRS book value is 𝑩𝑽𝟒 =
0 and for DDB, 𝑩𝑽𝟑 = 20,000. This occurs because MACRS always removes the
entire first cost, regardless of the estimated salvage value. This is a tax
depreciation advantage of the MACRS method .
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53
 # 3 PRACTICE PROBLEM
Safe Windpower recently installed 50 wind turbines at a
cost of $100 million. (a) Calculate the depreciation under
MACRS method for the turbines assuming the half-year
convention is relevant. The wind power installations are a
5 year property, (b) find the book value in every recovery
period.

54
 SOLUTION

55
 PRACTICE PROBLEM
Del Norte Brick Co., is located near the intersection of
Texas, New Mexico, and Mexico. Improved access to the
company’s property is via a small bridge across the Rio
Grande. The cost of the bridge was $770,000. Determine
the depreciation and book value for year 3 according to
the MACRS method.

56