CHAPTER THREE

Depreciation
Depreciation is the decrease in value of physical properties with the
passage of time and use.
The decline the value of asset is called depreciation.
Depreciation:- is the systematic allocation of the initial cost of an
asset in parts over a time.
Asset:- something's such as building, furniture, machine, car hat has
value and that may be sold to pay a debit.
The depreciation should be recorded with suitable entries in account
book. The entire for depreciation are called depreciation charges.
The process of entire depreciation is called writing off asset.
1. Cost of basis(Bo)= first cost of an asset
It is the total expenditure required to place it in operating condition.
It represent total cost that is claimed as an expense over an assets life. i.e. the
sum of the annual depreciation expense.
Cost basis generally include actual cost of an asset and all incidental expense
such as freight ,site preparation and installation.
2. Useful life(n) and salvage value(L)
Depreciation accounting include choosing a depreciable life that was based
on the service life of an asset.
The salvage value of an asset is an asset’s estimated value(monetary) at the
ends of its life.
 salvage value of an asset is its monetary value to the firm at the date of
retirement. This value may be realized either by selling the asset or by
assigning to the asset some subordinate role within the firm, such as standby
equipment.
Salvage value = Selling price – incidental expense
Thus, an asset may have negative salvage value.
 The value of an asset as displayed on the books of the firm is
termed its book value. Usually, the book value of an asset at a
given date equals the difference between its first cost and the
cumulative amount of depreciation charged up to that date.
Depreciable property Characteristics
 It must be used in business or held for production of income.
 It must have a definite service life, which must be longer than one year.
 It must be something's that wear out, delays, gets used up, became obsolete
or lose valve from natural cause.
The notational system for depreciation is as follows:
Bo = first cost of asset
Br = book value of asset at end of rth year
L = estimated salvage value
Dr = depreciation charge for rth year
n = estimated life span of asset, years
Method of depreciation
1. Book depreciation method
2. Tax depreciation method
1. Book depreciation
• Used in reporting net income to investors and stockholders.
• Used in pricing decisions.
• The book depreciation enables firms to report depreciation to
stockholders and other significant outsiders based on the
matching concept. Therefore, the actual loss in value of the
assets is generally reflected.
2.Tax depreciation
• The tax depreciation method allows firms to benefit from the
tax advantages of depreciating assets more quickly than would
be possible using the matching concept.
• Used in calculating income taxes for the internal revenue
service.
• Used in engineering economics.
 Method of depreciation Calculation
1. Straight line method:-This is the simplest method of allocating depreciation. By this
method, the total depreciation is allocated uniformly over the life of the asset. Then,

Dr = Bo-L
n
It is simple
Essay to understand
Commonly used method
Example 1
A printing machine is costed birr 400,000 to make it
operational. It has an estimated life of 12 years and the
estimated selvage value is birr 70,000. calculate the annual
depreciation charge and book value of the machine at the ends
of fifth year understanding line depreciation method.
Given required
B0=400,000 Dr= ?
L=70,000 Solution
n= 12 years Dr= {B0-L}/n
Dr={400,000-70,000}/12
Dr=27,500 birr
• B1=B0- Dr
• B1=400,000-27,500=372,500
• B2= B1-Dr=372500-27500=345,000
• B3=B2-Dr=345,000-27,500=317500
• B4=B3-Dr=317,500-27,500=290000

•  B5=262,500 birr
2. Sum’s of years digit method
This method of allocating depreciation was devised to accelerate the write-off of
the asset.
It is appropriate if an asset depreciate more quickly or has greater production
capacity in the early years than it does as it age.
D1>D2>D3>……Dn
 This method, the depreciation charges form a descending arithmetic progression
in which the first term is n times the last term. It follows that:
Dr = (n - r + 1)Dn
The depreciation charge for the final year is the total depreciation divided by the
sum of the integers from 1 to n, inclusive.
Since this sum is n(n + 1)/2, we have
Br=Bo-(2nr-r(r-1))*(Bo-l)
n(n+1)
dn= 2(Bo-l)
n(n+1)

Dr= dn(n-r+1)
Example 2
A carding machine costing birr 240,000 is estimated to have a
service life of 10 years. At the ends of its service life it is
estimated to have a salvage value of birr 20,000.
A. Calculate the depreciation charge applying sum’s of years
digit method at the ends of fifth year?
B. Calculate the book value of the asset at the ends of 5 years ?
Given Required
Bo=240,000 Dn=?
N= 10 years Dr=?
L= 20,000 B5=?
Solution
A. Dn=2(Bo-L)=2(240,000-20,000) =440000=4000
n(n+1) 10(10+1) 110
D1=Dn(10-1+1)=4000(10)=40000
D2=Dn(10-2+1)=4000(8+1)=36000
D3=Dn(10-3+1)=4000(8)=32000
D4=Dn(10-4+1)=4000(7)=28000
D5=Dn(10-5+1)=4000(6)=24000
D6=? D7=? D8=? D9=?
B. Br=Bo-(2nr-r(r-1))*(Bo-L) B5=240,000-(2*10*5-5(5-1))*(240,000-20,000)
n(n+1) 10(10+1)
B5=240,000-(100-20)*(220,000)=240,000-(17600000)=240,000-160,000=80,000
110 110
3. Decline Balance Method
Value of an asset diminishes at a decreasing rate. The declining balance
depreciation assumes that an asset decreases in value-faster early rather
than in the latter portion of its service life.
By this method a fixed percentage is multiplied times the book value the
asset at the beginning of the year to determine the depreciation charge for
that year. Thus as the book value of the asset decreases through time, so
does the size of the depreciation charge.
The stream of service provided by fixed asset may be greatest in the first
year of an asset service life and least in its last year. Due to
An increase in maintainace cost ,the mechanical efficiency of an asset
tends to decline with age.
The availability of better equipment will make the original asset obsolete.
For this reason this method propose
the depreciation of an asset for a given year is directly proportional to its
book value at the beginning of the year. Let k” denote the constant of
proportionality.
For a depreciation rate a, the general relationship expressing
the depreciation charge in any year for declining balance
depreciation is:

Dr=k(Br-1)
n
Dr= deperication charge
Br= book value at the year r
Salvage value is ignored.
The most commonly used multiplier( k)are 1,1.25,1.5 (150%
DB ) and 2.0 ( 200% double decline balance )
Example 3
A single needle sewing machine has a cost of birr 200,000 and
estimated life of 8 years. Calculate the annual depreciation
allowance and the resulting book value for this asset if the
salvage value of the asset is
A. 40,000 let us consider K= 200% DB
B. B. zero
Given
• Bo=200,000 Required
• N= 8 years Dr=?
• L=40,000 Br=?
• L=zero
Solution
Dr=k/n(Br-1)
Br=Bo-Dr
D1=2/8(B1-1)=2/8(Bo)=1/4(200,000)=50000
D2=2/8(B2-1)=1/4(150,000)=37,500
D3=
Year Book value at Depreciation charge Book value at end
start
0 200,000 0 200,000
1 200,000 200,000*1/4=50,000 200,000-50000=150,000
2 150,000 150,000*1/4=37,500 150,000-37,500=112500
3 112,500 112,500*1/4=28125 112,500-28125=84375
4 84375 84375*1/4=21093.75 84375-21093.75=63281.25
5 63281.25 63281.25*1/4=15820 63281.25-15820=47460.93
6 47460.93 47460.93*1/4=11865.23 35595.69 this is imposible
<40,000
7
8
At this point( at the ends of year 5),the book value would be is
less than the salvage value( Tax law) doesn't permit us to
depreciate assets belong their salvage value.
Therefore the DBM stop to work properly after words, so we
will adjust the book value of year 6,7,and 8.when Br less than L
in this cause it is better to use from DBM to SLM to produce
book value of an asset to its salvage value in any way of n.
Dr=Book value at the begging-salvage value
remaining useful life
D6=D7=D8=B5-L=47,460.94-40,000=2,486.96
N 3
B6=B5-D6=47,460.94-2,486.96=44,973.96
B7=B6-D7=44,973.96-2,486.96=42,487.02
B8=B7-Dr=42,487.02-2,486.96=40,000
4. Unit production method
This method considers the asset as a bundle of service unit
rather than as a single unit for depreciation calculation.
Dn=Service units consumed during the year n*(Bo-L)
Total service unit
Advantage:-it gives more accurate picture of machine usage
because it include the fact that depreciation varies with
production volume.
Example 4
Knitting machine costing birr42,000 will have life of 5 years and salvage
value of birr 5,000.it is estimated that 100,000 t-shirts will be produced
employed this machine distribute in this manner.
Year Number of sweater
1 20,000
2 24,000
3 21,000
4 18,000
5 17,000
If the depreciation is allocated on the basis of production.
Calculate the depreciation charge ?
Given Required
Bo=42,000 D5=?
L=5,000
Total p=100,000
Solution:- Dn=20,000(42,000-5000)+24,000(42,000-5000)
100,000 100,000
+21,000(42,000-5000)+18,000(42,000-5000)+17,000(42,000-5000)
100,000 100,000 100,000
Dn total=39,000 birr
THANK YOU !