Economics

Section (5)

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 Agenda

ü Depreciation

ü Sheet 5

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Depreciation
What’s depreciation?

What causes depreciation?

Does any asset depreciate?

Why is it important to calculate it?

How do we calculate it?

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Depreciation
An income tax deduction that allows a taxpayer
to recover the cost or other basis of certain
property; it is an annual allowance for the wear
and tear, deterioration, or obsolescence of the
property.

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Depreciation
• Most assets lose their value over time (in other
words, they depreciate), and must be replaced once
the end of their useful life is reached.

• Depreciation may be because of physical reasons or

functional reasons.

• Most types of tangible property (except, land), such

as buildings, machinery, vehicles, furniture, and
equipment are depreciable.

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Depreciation
Important Definitions:
Vo Original Value

n: Service Life

Vs Salvage Value (may be referred to scrap or junk)

Vo – Vs Total Depreciable Value

d Depreciation Charge

Present Value: Book Value vs. Market Value

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Depreciation
Sheet 5 – Problem 1
A company purchased a new delivery truck for $ 3,500. It was estimated
that it would render good service for 75,000 miles, have a salvage value
of $ 600 and have an estimated life of 4 years. The first year the truck was
driven 20,000 miles (19,000 miles, 18,000 miles and 18,000 miles for the
rest of the years, respectively). What would be the depreciation be on this
truck under each of the four major methods of depreciation?

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Depreciation
1. Straight line method:

V! − V"
d=
n

Where: d1 = d2 = d3 = ….. dn

3500 − 600
d= = $725
4

d1 = d2 = d3 = d4 = $725

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Depreciation
2. Use or production method:

Annual Production
d= ∗ V! − V" ≠ const
Total Production

20,000 19,000
d# = ∗ 3500 − 600 = $773.3 d$ = ∗ 3500 − 600 = $734.7
75,000 75,000

18,000 18,000
d% = ∗ 3500 − 600 = $696 d& = ∗ 3500 − 600 = $696
75,000 75,000

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Depreciation
3. Double declining balance method :
𝑑 = 2 ∗ straight line rate ∗ 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣alue

Straight line depreciation

=2∗ ∗ 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢e
tot𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝑣𝑎𝑙𝑢𝑒

𝑉# − 𝑉$ 1
=2∗ ∗ 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 = 2∗ ∗ 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒
𝑛 ∗ 𝑉# − 𝑉$ n

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Depreciation
3. Double declining balance method :
1
d=2∗ ∗ present value
n
1 1
d# = 2 ∗ ∗ V! = 2 ∗ ∗ 3500 = $1750
n 4
1 1
d$ = 2 ∗ ∗ (V! −d# ) = 2 ∗ ∗ (3500 − 1750) = $875
n 4
1 1
d% = 2 ∗ ∗ (V! −d# − d$ ) = 2 ∗ ∗ (3500 − 1750 − 875) = $437.5
n 4
1 1
d! = 2 ∗ ∗ (V" −d# − d$ − d% ) = 2 ∗ ∗ (3500 − 1750 − 875 − 437.5) = $218.8
n 4
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Depreciation
4. Sum of Years Digits Method (SYDM):

%&'()* !+ ,)-*" *)'-././0 -1 12) ()0././0 !+ 12) ,)-* 3!/".4)*)4

di = 5*12.'-1.3 "&' !+ 4.0.1" !+ ,)-*"
∗ (V! − V" )

/6.78
di = ∑) .
∗ (V! − V" )
&'(

/6.78
di = ) ∗ (V! − V" )
87/ ∗(* )

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Depreciation
4. Sum of Years Digits Method (SYDM):

!"#$%
𝑑i = ! ∗ (𝑉) − 𝑉* )
%$! ∗( " )

4−1+1 4−2+1
𝑑1 = ∗ 3500 − 600 = $1160 𝑑2 = ∗ 3500 − 600 = $870
4 4
1+4 ∗( ) 1+4 ∗( )
2 2

4−3+1 4−4+1
𝑑3 = ∗ 3500 − 600 = $580 𝑑4 = ∗ 3500 − 600 = $290
4 4
1+4 ∗( ) 1+4 ∗( )
2 2

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Depreciation
Laws’ Summary
Deprecation calculation methods

Double declining
Straight line Use / Production SYDM
balance

V# − V$ Annual Production 2 %&'()

∗ V! − V" ∗ 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 # ∗ (𝑉- − 𝑉. )
n Total Production n )(% ∗( $)

If the depreciation method is not mentioned, you can use the straight-line depreciation.

If the salvage value is not given, you can assume that it is equal to zero
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Depreciation

Sheet 5 – Problem 2
A reactor of special design is the major item of equipment in a small chemical plant.
The initial cost of the completely installed reactor is $60,000 and salvage value at
the end of the useful life is estimated to be $10,000. Excluding depreciation costs
for the reactor, the total annual expenses for the plant are $100,000. How many
years of useful life should be estimated for the reactor if 12% of the total annual
expenses for the plant are due to the cost of reactor depreciation? The straight-line
method for determining depreciation should be used. Ans: n=3.7 years

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Depreciation

Sheet 5 – Problem 3
A piece of equipment originally costing $40,000 was put into use 12 years ago. At the time
the equipment was put into use, the service life was estimated to be 20 years and the
salvage and the scrap value at the end of the service life were assumed to be zero. On this
basis, straight line depreciation fund was set up. The equipment can now be sold for
$10,000 and a more advanced model can be installed for $55,000. Assuming the
depreciation fund is available for use, how much new capital must be supplied to make the
purchase? Ans: $ 21,000

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Depreciation
Sheet 5 – Problem 4
A piece of equipment having a negligible salvage value is estimated to have a service life of
10 years. The original cost of equipment was $40,000. Determine the following:
a) The depreciation charge during the 5th year if straight line depreciation is used.
b) The depreciation charge during the 5th year if sum–of-years- digits depreciation is used.
c) The percent of original investment paid off in the first half of the service life using sum–
of-years- digits method.
d) The percent of original investment paid off in the first half of the service life using the
double declining balance method. Ans: $4,000, $4363.6, 72.7 %, 67.2%

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Depreciation
Sheet 5 – Problem 5
The original investment for an asset was $10,000 and the asset was assumed to have a
service life of 12 years with $2,000 salvage value at the end of the service life. After the asset
has been used for 5 years, the remaining service life and final salvage value are re-estimated
at 10 years and $1,000 respectively. Under these conditions, what is the depreciation cost
during the sixth year of the total life if the straight-line depreciation is used?

Ans: = $566.7

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Depreciation
Sheet 5 – Problem 6
A concern has a total income of $ 1 million / year, and all expenses except depreciation
amount to $ 600,000 / year. If the total depreciable items has an initial cost of $ 850,000,
service life of 20 years and salvage value of $ 50,000.

45% of all profits before taxes must be paid out as income taxes. What would be the
reduction in income taxes charge for the first year of operation if the sum-of-years digits
method were used for depreciation accounting instead of the straight-line method?

Ans: $16,286

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Depreciation
Sheet 5 – Problem 7
In order to make it worthwhile to purchase a new piece of equipment, the annual
depreciation costs for the equipment cannot exceed $3,000 at any time. The original cost of
the equipment is $30,000 and it has zero salvage and scrap value. Determine the length of
service life necessary if the equipment is depreciated by:
a) The straight-line method
b) The sum-of-years-digits method

Ans: 10 years, 19 years

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 Thank You

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