MODULE 3

Depreciation, Capital
Recovery and Break
Even Analysis
 LESSON 6

Depreciation

Depreciation refers to decrease the value of an asset, due to usage of passage of time.
An asset may depreciate physically or functionally.

Book Value of the property at any time m is

BVm = FC – Dm
where: BVm – book value after m years
FC – first cost
Dm – total depreciation for m years

Methods of Computing Depreciation

A. Straight Line Depreciation (SLD) – the most common method in computing

depreciation. The cost of the property is assumed to vary linearly with time.
FC−SV
d=
n
Dm = d x m
where: d – depreciation charge
SV – salvage value or trade-in value
m – any time before n
n – economic life of the property in years
In some cases, the life n may be the number of outputs. An example is the copying
machine where the life span is dependent o the number of copies made.
B. Sinking fund Method – an imaginary fund d is called a sinking fund is invested
yearly at a rate of i to amount to (FC – SV) at the end of the life of the property.

(FC −SV ) i
d=
(1+i)n−1
d [(1+i)¿¿ m−1]
Dm = ¿
i
C. Sum of the Years Digit Method (SOYD) – the depreciation charge in this method is
assumed to vary directly to the number of years and inversely to the sum of the year’s
digit.

n
Sum of the year’s digit, SUM =
2 (1 + n)

n−m+1
dm = (FC – SV)
∑ ¿¿
m(2n−m+1)
Dm = (FC – SV)
2 x ∑ ¿¿
D. Declining Balance Method ( Constant Percentage Method) – this method is based
on the compound interest formula F = P(1 + i) n where P is the first cost, F is the book
value at any time and i is the depreciation rate and is equal to –K.
BVm = FC (1 – K)m
SV = FC(1 – K)n
SV
Constant Percentage, K = 1 -

dm = FC(1 – K) m-1
K
√
n

FC

where: BV – book value after m years

E. Double Declining Balance Method
2
Depreciation charge to date = x BV at the beginning of the year
n
2
BVm = FC(1 - )m ≥ SV
n

2
dm = BVm
n

SAMPLE PROBLEM
1. What is the value of an asset after 8 years of use if it depreciates from the original
value of P120,000.00 to its salvage value of 3% in 12 years?
Solution
By straight-line depreciation, BV8 = FC – D8

FC −SV 120000−0.03(120000)
d= = = P 9,700/year
n 12
D8 = d x 8 = 9700(8) = P 77,600
BV8 = 120000 – 77600 = P 42, 400.00
2. An equipment costing P 185,000.00 has a salvage value of P20,000 at the end of its
economic life of 5 years. Cost of money is 20% per annum. The first year depreciation is
calculated to be P 66,439.00. Find the method of depreciation used.
Solution
SV = FC(1 – K)n
20000 = 185000(1 – k)n
K = 0.03913
1 – K = 0.064087
dm = FC(1 – K)m-1K = 185000(0.064087)0(0.03913) = P66439.00

Use declining balance method

3. A machine costing P100,000 has an estimated scrap value of P10,000 at the end of
its economic life of 10 years. Determine the book value at the end of 5 years, using
double declining balance method.
Solution
K = 2/n = 2/10 = 0.20
2 m
BVm = FC(1 - ) = 100000(1 -0.20)5 = P 32, 768.00
n

4. A machine costing P500,000 has a life of 10 years using the sum of the years digit
method. The total depreciation at the end of 4 years is P 276, 945.45. Determine the
salvage value.
Solution:
n 10
Sum of the years digit =(1 + n) = (1 + 10) = 55
2 2
m(2n−m+1) 4 (2(10)−4+1)
Dm = (FC – SV) = (500000 – SV) = 276945.45
2 x ∑ ¿¿ 2 x 55
SV = 52000
 LESSON 7

Capital Recovery (Depletion)

If you invest FC now and desires a rate of return of r at n period and if you can deposit to
an account earning an interest of i for n period to recover an amount of RC and will also
receive a salvage value of SV from your invested property at the end of n period, then
the periodic dividend or income D required is
( RC−SV ) i
D = (FC)r +
(1+i)n−1
Note: If RC is not specified, RC = FC

SAMPLE PROBLEM
A mine costs P21M and will last for 20 years. Its plant has a salvage value of 1M at the
end of the time. The mine will yield an equal dividend at the end of each year. What is
the annual dividend, if it is sufficient to pay interest annually at the rate of 6% on the
original investment and to accumulate a replacement fund, invested at 4%?

Solution
( RC −SV ) i ( 21000000−1000000 ) (0.04)
D = (FC)r + = D = (21000000)(0.06) +
n
(1+i) −1 (1.04)20−1
D = P1,931,635.00

Bond – is a written contract to pay a certain redemption value C on a specified

redemption date and to pay equal dividends D periodically.
D=Fxr
where:
D - periodic dividend
F - Face value or par value of the bond
r – bond rate or dividend rate
Price of a bond at a given i
C
P= n + D ¿¿¿
(1+i)
where:
C – redemption value on a specified redemption date
i – investor’s interest rate of return
P – price of the bond at a given interest i

SAMPLE PROBLEM
A P100,000.00, 6% bond, pays dividends semi annually and will be redeemed at 110%
on July 1, 1999. Find its price if bought on July 1,1996, to yield an investor 4%,
compounded semi annually.
Solution
C
P= + D ¿¿¿
(1+i)n
110000
P= 6 + 3000 ¿ ¿ ¿
(1.02)
 P = P 114,481.14
LESSON 8

Break-Even Analysis

It is a method of determining when costs exactly equal revenue. If the manufactured

quantity is less than the break-even quantity, a loss is incurred. If the manufactured
quantity is greater than the break-even quantity, a profit is incurred.

R = pN
where:
R – total revenue
p – incremental revenue or selling price per unit
N – break-even point or quantity produced and sold for break-even

C = f + aN
where:
C – total cost
f – fixed cost which does not vary with production
a – incremental cost which is the cost to produce one additional item. It
may also be called the marginal cost or differential cost.

Assuming there is no change in inventory, the break-even point can be found from

Cost = Revenue

f + aN = pN

SAMPLE PROBLEM

The cost of producing a computer diskette is as follows: Material cost if P7.00 each,
labor cost is P2.00 each, ang other expenses is P1.50 each. If the fixed expenses is
P69,000.00 per month, how many diskettes must be produced each month for break-
even if each diskette is worth P45.00?

Solution

f 69000
N= = = 2000 diskettes per month
p−a 45−10.5