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    Chapter 16 - Depreciation Methods

    Uploaded by

    Cedrick S Tan
    Engineering Economy

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd

    Chapter 16 - Depreciation Methods

    Uploaded by

    Cedrick S Tan
    306 views13 pages
    Engineering Economy

    Copyright

    © © All Rights Reserved

    Available Formats

    PPT, PDF, TXT or read online from Scribd

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    Engineering Economy

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    306 views13 pages

    Chapter 16 - Depreciation Methods

    Uploaded by

    Cedrick S Tan
    Engineering Economy

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 13

    16-1

    DEPRECIATION

    2012 by McGraw-Hill
    All Rights Reserved
    PREPARED BY: TAN CEDRICK
    Depreciation Terminology
    16-2

    Definition: Is the decrease in the value of property due to the use and

    2012 by McGraw-Hill
    passage of time
    Two types: book depreciation and tax depreciation

    All Rights Reserved


    Book depreciation: used for internal accounting to
    track value of assets
    Tax depreciation: used to determine taxes due
    based on tax laws
    Common Depreciation Terms 16-3

    First cost P or unadjusted basis B: Total installed cost of asset

    2012 by McGraw-Hill
    Book value BVt: Remaining undepreciated capital investment in year t
    Recovery period n: Depreciable life of asset in years
    Market value MV: Amount realizable if asset were sold on open market

    All Rights Reserved


    Salvage value S: Estimated trade-in or MV at end of assets useful life
    Depreciation rate dt: Fraction of first cost or basis removed each year t

    Personal property: Possessions of company used to conduct business


    Real property: Real estate and all improvements
    (land is not depreciable)
    Half-year convention: Assumes assets are placed in service in midyear
    Straight Line Depreciation 16-4

    Book value decreases linearly with time

    2012 by McGraw-Hill
    B
    Dt = n- S Where: Dt = annual depreciation charge

    All Rights Reserved


    t = year
    B = first cost or unadjusted basis
    S = salvage value
    n = recovery period

    BVt = B - tDt Where: BVt = book value after t years

    SL depreciation rate is constant for each year: d = dt = 1/n


    Example: SL Depreciation 16-5

    An argon gas processor has a first cost of $20,000 with a


    $5,000 salvage value after 5 years. Find (a) D3 and (b) BV3
    for year three. (c) Plot book value vs. time.

    Solution: (a ) D3 = (B S)/n
    = (20,000 5,000)/5 (c) Plot BV vs. time
    = $3,000 BVt
    20,000

    (b) BV3 = B tDt 11,000


    = 20,000 3(3,000) 5,000
    = $11,000
    0 3 5 Year, t
    2012 by McGraw-Hill All Rights Reserved
    Declining Balance (DB) and
    Double Declining Balance (DDB) 16-6

    Depreciation
    Determined by multiplying BV at beginning of year by fixed percentage d

    2012 by McGraw-Hill
    Max rate for d is twice straight line rate, i.e., d 2/n
    Cannot depreciate below salvage value

    All Rights Reserved


    Depreciation for year t is obtained by either relation:
    Dt = dB(1 d)t-1 = dBVt-1
    Where: Dt = depreciation for year t
    d = uniform depreciation rate (2/n for DDB)
    B = first cost or unadjusted basis
    BVt -1 = book value at end of previous year
    Book value for year t is given by:
    BVt = B(1 d)t
    Example: Double Declining
    16-7
    Balance

    2012 by McGraw-Hill
    A depreciable construction truck has a first cost of $20,000
    with a
    $4,000 salvage value after 5 years. Find the (a)

    All Rights Reserved


    depreciation, and
    (b) Solution:
    book value after 3 years using DDB depreciation.
    (a) d = 2/n = 2/5 = 0.4
    D3 = dB(1 d)t-1
    = 0.4(20,000)(1 0.40)3-1
    = $2880

    (b) BV3 = B(1 d)t


    = 20,000(1 0.4)3
    = $4320
    Spreadsheet Functions for
    Depreciation 16-8

    2012 by McGraw-Hill
    Straight line function: SLN(B,S,n)

    Declining balance function: DB(B,S,n,t)

    All Rights Reserved


    Double declining balance function: DDB(B,S,n

    Note: It is better to use the DDB function for DB and DDB


    depreciation. DDB function checks for BV < S and is more
    accurate than the DB function.
    Switching Between Depreciation
    Methods
    Switch between methods to maximize PW of depreciation

    t=n
    PWD = Dt (P/F,i%,t)

    t=1
    A switch from DDB to SL in latter part of life is usually better

    Can switch only one time during recovery period

    Procedure to switch from DDB to SL:


    1) Each year t compute DDB and SL depreciation using the
    relations
    DDDB = d(BVt-1) and DSL = BVt-1 / (n-t+1)
    2) Select larger depreciation amount, i.e., Dt = max[DDDB,
    DSL]
    3)Alternatively, use spreadsheet
    If required, calculatefunction
    PWD VDB(B,S,n,start_t,end_t) to determine Dt
    16-9 2012 by McGraw-Hill All Rights Reserved
    Example: MACRS
    Depreciation
    16-
    10

    A finishing machine has a first cost of $20,000 with a $5,000

    2012 by McGraw-Hill
    salvage value after 5 years. Using MACRS, find (a) D and (b) BV
    for year 3.

    All Rights Reserved


    Solution: (a) From table, d3 = 19.20
    D3 = 20,000(0.1920)
    = $3,840

    (b) BV3 = 20,000 - 20,000(0.20 + 0.32 + 0.1920)


    = $5,760

    Note: Salvage value S = $5,000 is not used by MACRS and BV6 = 0


    Unit-of-Production (UOP) 16-

    Depreciation
    Depreciation based on usage of equipment, not time
    11

    Depreciation for year t obtained by relation

    actual usage for year t


    Dt = (B S)
    expected total lifetime usage
    Example: A new mixer is expected to process 4 million yd3
    of concrete over
    10-year life time. Determine depreciation for year 1 when
    400,000 yd3 is processed. Cost of mixer was $175,000 with
    no salvage expected.

    Solution: D1 = (175,000 0) = $17,500


    400,000
    4,000,000

    2012 by McGraw-Hill All Rights Reserved


    Depletion Methods 16-
    12

    Depletion: book (noncash) method to represent decreasing

    2012 by McGraw-Hill
    value of natural resources
    Two methods: cost depletion (CD) and percentage depletion (PD)

    All Rights Reserved


    Cost depletion: Based on level of activity to remove a natural resource
    Calculation: Multiply factor CDt by amount of resource removed
    Where: CDt = first cost / resource capacity
    Total depletion can not exceed first cost of the resource

    Percentage depletion: Based on gross income (GI) from resource


    Calculation: Multiply GI by standardized rate (%) from table
    Annual depletion can not exceed 50% of companys taxable income (TI)
    Example: Cost and Percentage
    16-
    Depletion 13

    A mine purchased for $3.5 million has a total expected yield of one
    million ounces of silver. Determine the depletion charge in year 4 when

    2012 by McGraw-Hill
    300,000 ounces are mined and sold for $30 per ounce using (a) cost
    depletion, and (b) percentage depletion. (c) Which is larger for year 4?

    All Rights Reserved


    Solution: Let depletion amounts equal CDA4 and PDA4

    (a) Factor, CD4 = 3,500,000/ 1,000,000 = $3.50 per ounce


    CDA4 = 3.50(300,000) = $1,050,000

    (b) Percentage depletion rate for silver mines is 0.15


    PDA4 = (0.15)(300,000)(30) = $1,350,000

    (c) Claim percentage depletion amount, provided it is 50% of TI

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