Lyceum of the Philippines University- Cavite

Engineering Economy
April 18, 2020 Saturday

Lecture / Activity 2 CV19

EECN41E Engineering Economy

Time/Day/Section 10:00AM-11:30AM / S / ENG 107
1:00PM- 2:30PM / S / ENG 104
2:30PM- 4:00PM / S / ENG 105

Depreciation
Depreciation is the gradual decrease in the value of material property due to physical or economic reasons.

Types of Depreciation:
1. Physical Depreciation
2. Functional Depreciation
3. Accident

Physical Depreciation is the results in the decrease in the ability of a physical property to perform its intended service
which is caused by corrosion, abrasion, decay, impact, heat, stress, and vibration.

Functional Depreciation is the results from obsolescence or inadequacy of the property to meet the demand required,
this occurs when new and better equipment that is more efficient and less expensive to operate becomes available.
This also occurs when the property can no longer satisfy the current or anticipated demand or when demand no
longer exists.

Accident is the results when the property becomes a casualty of fire, flood, accident or any form of disaster.
Terminologies
Value is the measure of the worth that an individual ascribes to a property or service.
Market Value is the amount that a willing seller for the purchase of his property, where neither buyer nor seller is
compelled to buy or sell.
Fair Value is the worth of a property to a disinterested third party, in order to establish a price that is fair to both
buyer and seller.
Book Value, BV, is the worth of a property at a given time as reflected in the accounting records of a business. It is the
acquisition cost of the property, plus any adjustments, less the accumulated depreciation charges for a given period.
Assessed Value is the reported value used for property tax purposes. It is usually obtained by appraisal
Salvage Value, S, is the price of a property when it can no longer operate at a profit. It is the estimated worth of the
property at the end of its productive life.
Scrap Value, S, is the value of the property after it can no longer perform its intended function. It is the price that the
property can command if it is sold as junk.
Physical Life is the period in which a given property is able to perform the function for which it was designed for.

Economic or Useful Life, L, is also referred to as the property’s depreciable life. It is the period during which a
property may be operated at a profit.

Acquisition Cost, P, is also referred to as first cost, it includes the purchase price of the property plus any expenses
incurred (shipping, installation, improvement and repair) prior to initial service or operation of the property.
dn,is the depreciation charge for a given year of the property
Yearly Depreciation charge,
Accumulated Depreciation, Dn, is the total depreciation expense charged to a property after n years of service.
Depreciation Table is a tabulated depreciation schedule showing the yearly and accumulated depreciation charges,
together with the book value at the end of each year of the property’s useful life.

Wearing cost, (P-S), is the accumulated depreciation of a property at the end of its useful life.
Depreciation Funds are funds that are set aside out of profit so that capital is available for replacing essential
equipment at the time of retirement.

Depreciation Rate, k, is the decrease in property value for a given year expressed as a percentage.
Recovery Period is the time period required for capital cost recovery. This period is usually shorter than the economic
life of the property in order to encourage capital investment and improve productivity.

Depreciation Method
1. Straight Line Method (SLM)
2. Sinking Fund Method (SFM)
3. Declining Balance Method (DBM)
4. Double Declining Balance Method (DDBM)
5. Sum of the Years Digit Method (SYDM)
6. Units of Production Method (UPM)
The Straight Line Method, SLM, is the simplest and most commonly used depreciation method.
The Sinking Fund Method, SFM, assumes that a sinking fund earning interest is created for replacement purposes.
The fund is established by depositing equal amounts at the end of each year for L years at an interest rate of i% per
year.

Declining Balance Method (DBM) or Matheson Method

This method is also referred to as the constant percentage method. The DBM assumes that the depreciation charge
for a given year is a fixed percentage of the book value at the start of the year, such that, the depreciation charge
decreases as the property nears the end of its useful life.

Depreciation Table

Equations
Double Declining Balance Method (DDBM)
In this method, the depreciation rate, k, is computed as 200%/L, such that k is replaced by the value in equations
from DBM. For this method, the estimated useful life of the property must exceed 2 years so that k< 1.

Equations

Sum of the Years-Digits Method, SYD

This method requires that the digits corresponding to the number of each year of the property life first be listed in
reverse order. The depreciation rate for a given year is found by taking the corresponding number from the reversed
listing and dividing it by the sum of the years digits, y.

Equations

Units – of – Production Method

The Units-of-Production method is used to determine the depreciation of property not as a function of time, in years,
but as a function of use. In this method, depreciation is charged in proportion to units of production, or time of use,
or the amount of work performed. Thus, welding equipment in a car assembly plant may be depreciated on the basis
of the number of units welded, or motor vehicles may be depreciated in proportion to kilometers traveled.

Since this method provides that the wearing cost, (P-S), be allocated equally over the estimated production output,
PO, of the property, the depreciation rate per unit, d, is constant, and the accumulated depreciation charge, D n, is
proportional to the rate of production.

Equations

Example Problem
Straight Line Method

1. A machine costs P80 000.00 and has an estimated life of 10 years with a salvage value of P5 000.00. What is
its book value after 8 years using straight-line method.

2. Based on its purchase price, a machine is expected to depreciate at uniform rate of 18% annually until it has
zero salvage value. What is the useful life of the machine using SLD method?

Activity 2 CV19 (From the book of Tolentino)

Page 94 – 98
Nos. 2, 4, 6, 8, 10, 12