DEPRECIATION AND

ITS METHODS
ES301 Engineering Economy
OUTLINE OF PRESENTATION
✓ INTRODUCTION AND DEFINITION OF TERMS
✓ PURPOSE AND TYPES OF DEPRECIATION
✓ DEPRECIATION METHODS
- STRAIGHT LINE METHOD
- SINKING FUND METHOD
- DECLINING BALANCE METHOD
- DOUBLE DECLINING BALANCE METHOD
- SUM OF THE YEAR DIGITS METHOD
- SERVICE OUTPUT METHOD
✓ WHAT DEPRECIATION METHOD SHOULD BE USED?

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 3

Depreciation is the
decrease in the values of
physical property with
the passage of time.

“
 DEFINITIONS OF VALUE
❖ VALUE, is the present worth of all future profits that are to be received
through ownership of a particular property.
❖ MARKET VALUE, is the amount which a willing buyer will pay to a willing
seller for the property where each has equal advantage and is under no
compulsion to buy or sell.
❖ BOOK VALUE, sometimes called the DEPRECIATED BOOK VALUE, is the
worth of a property as shown on the accounting records of an
enterprise.
❖ SALVAGE VALUE or RESALE VALUE, is the price that can be obtained
from the sale of the property after it has been used.
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 DEFINITIONS OF VALUE
❖ SCRAP VALUE, is the amount the property would sell for if disposed off
as junk.

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PURPOSE OF DEPRECIATION

◉ To provide for the recovery if capital which

has been invested in physical property.
◉ To enable the cost of depreciation to be
charged to the cost of producing products or
services that results from the use of the
property.

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TYPES OF DEPRECIATION

◉ Normal Depreciation
◉ Physical
◉ Functional
◉ Depreciation due to changes in price levels
◉ Depletion

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PHYSICAL AND ECONOMIC
LIFE

Physical Life of a property Economic Life of a property

is the length of time during
which it is capable of
performing the function for
which it was designed and
manufactured.
is the length of time during
which the property may be
operated at a profit.

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DEPRECIATION METHODS

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SYMBOLS TO BE USED FOR DEPRECIATION METHODS

◉ L = useful life of the property in years

◉ CO = the original cost
◉ CL = the value at the end of the life (e.g. scrap value, salvage value)
◉ d = the annual cost of depreciation
◉ Cn = the book value at the end of n years
◉ Dn = depreciation up to age n years/ total depreciation in n years

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1
Formulas to be used:
STRAIGHT LINE
METHOD ◉ 𝑑 = 𝐶𝑂 −𝐶𝐿
𝐿
This method assumes
𝑛(𝐶𝑂 −𝐶𝐿 )
that the loss in value is ◉ 𝐷𝑛 = 𝐿
directly proportional to
the age of the property. ◉ 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛

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 SAMPLE PROBLEM#1
An electronic balance costs P90,000 and has an estimated salvage value of
P8,000 at the end of its 10 years lifetime. What would be the book value
after three years, using straight line method in solving for the depreciation?

Given: Solution:
CO = P90,000 𝐶𝑂 −𝐶𝐿 90000 − 8000
❖
❖𝑑 = 𝐿
=
10
= P8,200.00
❖ CL = P8,000
❖ L = 10 ❖ 𝐷𝑛 = 𝑛(𝐶𝑂 −𝐶𝐿 )
= 3 8200 = P24,600.00
𝐿
❖ n =3
❖ 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛 = 90000 − 24600 = P65,400.00
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2 SINKING FUND Formulas to be used:
FORMULA Dn CO - CL

0 1 2 3 n L
This method assumes that a
sinking fund is established in d d d d d
which funds will accumulate
𝐶𝑂 −𝐶𝐿
for replacement. The total ◉ 𝑑= 𝐹 (1 + 𝑖)𝐿 −1
depreciation that has taken , 𝑖%, 𝐿
𝐴 𝑖
place up to any given time is
assumed to be equal to the 𝐹 (1 + 𝑖)𝑛 −1
accumulated amount of the ◉ 𝐷𝑛 = 𝑑( , 𝑖%, 𝑛)
𝐴 𝑖
sinking fund at that time.
◉ 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛
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 SAMPLE PROBLEM#2
A broadcasting corporation purchased an equipment for P53,000 and paid P1,500 for
freight and delivery charges to the job site. The equipment has a normal life of 10 years
with a trade-in value of P5,000 against the purchase of a new equipment at the end of
the life.
(a) Determine the annual depreciation cost by straight line method.
(b) Determine the annual depreciation cost by sinking fund method. Assume interest
6.5% compounded annually.
Given: Solution:
CO = P53,000 + P1,500 𝐶𝑂 −𝐶𝐿 54500 −5000
❖
❖𝑑 = 𝐿
=
10
= P4,950.00
= P54,500
❖ CL = P5,000 𝐶𝑂 −𝐶𝐿 54500 −5000
❖ L = 10 ❖𝑑 = 𝐹 = (1+0.065)10 −1
= P3,668.18
𝐴
, 𝑖%, 𝐿
0.065
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 SAMPLE PROBLEM#3
A firm bought an equipment for P56,000. Other expenses including installation amounted
to P4,000. The equipment is expected to have a life of 16 years with a salvage value of
10% of the original cost. Determine the book value at the end of 12 years by (a) straight
line method (b) sinking fund method at 12% interest.

Given: Solution for a:

CO = P56,000 + P4,000 𝐶𝑂 −𝐶𝐿 60000 −6000
❖
❖𝑑 = 𝐿
=
16
= P3,375.00
= P60,000
𝑛(𝐶𝑂 −𝐶𝐿 )
❖ CL = P60,000(0.10) ❖ 𝐷𝑛 = 𝐿
= 12 3375 = P40,500.00
= P6,000
L = 16
❖
❖ 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛 = 60000 − 40500 = P19,500.00
❖ n = 12
❖ i = 12%
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 SAMPLE PROBLEM#3
A firm bought an equipment for P56,000. Other expenses including installation amounted
to P4,000. The equipment is expected to have a life of 16 years with a salvage value of
10% of the original cost. Determine the book value at the end of 12 years by (a) straight
line method (b) sinking fund method at 12% interest.

Given: Solution for b:

❖ CO = P56,000 + P4,00 𝐶𝑂 −𝐶𝐿 60000 −6000
= P60,000
❖𝑑 = 𝐹 = (1+0.12)16 −1
= P1,263.00
, 𝑖%, 𝐿
𝐴 0.12
❖ CL = P60,000(0.10)
𝐹 1+0.12 12 −1
= P6,000 ❖ 𝐷𝑛 = 𝑑 𝐴
, 𝑖%, 𝑛 = 1263[
0.12
]= P30,480
❖ L = 16
n = 12
❖
❖ 𝐶𝑛 = 𝐶𝑂 − 𝐷𝑛 = 60000 − 30480 = P29,520.00
❖ i = 12%
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 3 DECLINING dn = depreciation during nth year

BALANCE METHOD Year

Book value at the
beginning of the year
Depreciation
during the year
Book value at the end of
year

1 C0 d1 = kC0 C1=C0–d1= C0(1-k)

In this method, sometimes called
the constant percentage method or 2 C0(1 - k) d2 = kC1 C2=C1–d2= C0(1-k)2
the Matherson Formula, it is 3 C0(1 - k)2 d3 = kC2 C3=C2–d3= C0(1-k)3
assumed that the annual cost of
depreciation, is a fixed percentage - - - -
of the salvage value at the beginning
n C0(1 - k)n-1 dn = kCn-1 Cn=Cn-1–dn= C0(1-k)n
of the year. The ratio of depreciation
in any year to the book value at the - - - -
beginning of that year is constant
throughout the life of the property L C0(1 - k)L-1 dL = kCL-1 CL=CL-1–dL= C0(1-k)L
and is designated by k, the rate of
depreciation.
◉ 𝑑𝑛 = 𝐶𝑂 (1 − 𝑘)𝑛−1 𝑘 ◉ 𝐶𝐿 = 𝐶𝑂 (1 − 𝑘)𝐿
𝑛

Note: This method does not apply if the salvage value is zero. ◉ 𝐶𝑛 = 𝐶𝑂 (1 − 𝑘) = 𝑛 𝐶 𝐿
𝐶𝑂 𝐿
𝐶0
◉ 𝑘 =1−
𝑛 𝐶𝑛
𝐶0
=1−
𝐿 𝐶𝐿
𝐶0 17
 SAMPLE PROBLEM#4
A certain type of machine loses 10% of its value each year. The machine costs
P2,000 originally. Make out a schedule showing the yearly depreciation, the total
depreciation and the book value at the end of each year for 5 years.

Given: Solution:
❖ CO = P2,000 Year
Book value at the
beginning of the year
Depreciation during
the year
Total depreciation
at the end of the yr
Book value at the end of year

❖ k = 10% 1 C0 = 2,000 d1 = kC0 = 200 σ𝑑 = 200 C1=C0–d1= C0(1-k) = 1,800

2 C0(1 - k) = 1,800 d2 = kC1 = 180 σ𝑑 = 380 C2=C1–d2= C0(1-k)2 = 1,620
3 C0(1 - k)2 = 1,620 d3 = kC2 = 162 σ𝑑 = 542 C3=C2–d3= C0(1-k)3 = 1,458
4 C0(1 - k)3 = 1,458 d4 = kC3 = 145.80 σ𝑑 = 687.8 C4=C3–d4= C0(1-k)4 = 1,312
5 C0(1 - k)4 = 1,312.2 d5 = kC4 = 131.22 σ𝑑 = 819.12 C5=C4–d5= C0(1-k)5 = 1,181

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4
DOUBLE DECLINING
BALANCE METHOD
This method is very similar
to the declining balance
method except that the rate
of depreciation k is replaced
by 2/L.
Formulas to be used:
◉ 𝑑𝑛 = 𝐶0 (1 − 2𝐿)𝑛−1 2𝐿
◉ 𝐶𝑛 = 𝐶0 (1 − 2𝐿)𝑛
◉ 𝐶𝐿 = 𝐶0 (1 − 2𝐿)𝐿
When the DDB method is used, the salvage value
should not be subtracted from the first cost when
calculating the depreciation charge.
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 SAMPLE PROBLEM#5
Determine the rate of depreciation, the total depreciation up to the end of the 8th
year and the book value at the end of 8 years for an asset that costs P15,000 new
and has an estimated scrap value of P2,000 at the end of 10 years by (a) declining
balance method, and (b) double declining balance method.
Given: Solution for a:
CO = P15,000
❖
❖ 𝑘 =1−
𝐿 𝐶𝐿
𝐶0
=1−
10 2000
15000
= 0.1825 or 18.25%
❖ CL = P2,000
L = 10
❖
❖ 𝐶𝑛 = 𝐶𝑂 (1 − 𝑘)𝑛 = 15000(1 − 0.1825)8 = P2,992
❖ n=8
❖ 𝐷𝑛 = 𝐶0 −𝐶𝑛 = 15000 − 2992 = P12, 008.00
 SAMPLE PROBLEM#5
Determine the rate of depreciation, the total depreciation up to the end of the 8th
year and the book value at the end of 8 years for an asset that costs P15,000 new
and has an estimated scrap value of P2,000 at the end of 10 years by (a) declining
balance method, and (b) double declining balance method.
Given: Solution for b:
❖ CO = P15,000 ❖ 𝑘= =
2
𝐿
2
10
= 0.20 or 20%
❖ CL = P2,000
❖ L = 10
❖ n=8
❖ 2 2
𝐶𝑛 = 𝐶𝑂 (1 − 𝐿)𝑛 = 15000(1 − 10)8 = P2,517.00

❖ 𝐷𝑛 = 𝐶0 −𝐶𝑛 = 15000 − 2157 = P12, 843.00

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Let

SUM-OF-THE- ◉ dn = depreciation charge during the nth year

YEAR’S DIGIT
◉ dn =
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
(𝐶0 − 𝐶𝐿 )
METHOD 𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠

◉ Sum of Digits (SYD) =

𝐿(𝐿+1)
2

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For example, a property whose life is 5 years

Year in reverse Depreciation Depreciation

Year
order Factor during the year
1 5 5/15 (5/15)(C0 – CL)

2 4 4/15 (4/15)(C0 – CL)

3 3 3/15 (3/15)(C0 – CL)

4 2 2/15 (2/15)(C0 – CL)

5 1 1/15 (1/15)(C0 – CL)

Sum of digits
(SYD) = 15

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 SAMPLE PROBLEM#6
A structure costs P12,000 new. It is estimated to have a life of 5 years with a salvage
value at the end of life of P1,000. Determine the book value at the end of each year of life.

Given: Solution:
❖ CO = P12,000 ❖ CO – CL = 12,000 – 1,000 = P11,000
❖ CL = P1,000 Year
Year in Depreciatio
Depreciation during the year
Book Value at the
reverse order n Factor end of year
❖ L =5
1 5 5/15 (5/15)(11,000) = 3,667 8,333
2 4 4/15 (4/15)(11,000) = 2,933 5,400
3 3 3/15 (3/15)(11,000) = 2,200 3,200
4 2 2/15 (2/15)(11,000) = 1,467 1,733
5 1 1/15 (1/15)(11,000) = 733 1,000
Sum of
digits (SYD)
= 15 24
 SAMPLE PROBLEM#7
A consortium of international telecommunication companies contracted for the purchase
and installation of a fiber optic cable linking two major cities at a total cost of US$960M.
This amount includes freight and installation charges estimated at 10% of the above
contract price. If the cable shall be depreciated over a period of 15 years with zero
salvage value:
(a) What is the depreciation charge during the 8th year using the sum-of-the-year-digits
method?

Given: Solution:
❖ CO = $960,000,000 ◉ Sum of Digits (SYD) =
𝐿(𝐿+1)
2
=
15(15+1)
2
= 120
❖ CL = 0
◉ Reverse digit corresponding to the 8th year of life = 8
❖ L = 15
◉ dn =
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠
𝐶0 − 𝐶𝐿 =
8
120
960𝑀 = $64,000,000
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6
SERVICE OUTPUT Let
METHOD
T = total units of output up to the end of life
This method assumes that the Qn = total number of units of output during the
total depreciation that has taken
place is directly proportional to nth year
the quantity of output of the
property up to that time. This
method has the advantage of
◉ Depreciation per unit of output =
𝐶𝑂 −𝐶𝐿
𝑇
making the unit cost of
depreciation constant and giving
low depreciation expense during ◉ 𝑑𝑛 =
𝐶𝑂 −𝐶𝐿
𝑇
(𝑄𝑛 )
periods of low production.

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 SAMPLE PROBLEM#8
A Television Company purchased machinery for P100,000 on July 1, 1979. It is estimated
that it will have a useful life of 10 years, scrap value of P4,000, production of 400,000
units and working hours of 120,000.
The company uses machinery for 14,000 hours in 1979 and 18,000 hours in 1980. The
machinery produces 36,000 units in 1979 and 44,000 units in 1980. Compute the
depreciation for 1980 using service output method.

Given: Solution:
❖ CO = P100,000
❖ CL = P4,000
◉ 𝑑𝑛 =
𝐶𝑂 −𝐶𝐿
𝑇
𝑄𝑛 =
100000−4000
400000
44000 = P10,560

❖ L = 10 years
❖ T = 400,000 units

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WHAT DEPRECIATION METHOD SHOULD BE USED?

✓ NATIONAL INTERNAL REVENUE CODE (SECTION 29 f)

(1) General Rule. “There shall be allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including reasonable allowance for
obsolescence) of property used in trade and business.”
(2) Use of certain methods and rates. The term “reasonable allowance” as used in
the preceding paragraph shall include (but not limited to) an allowance
computed in accordance with regulations prescribed by the Secretary of
Finance, under any of the following methods:
(a) The Straight Line Method;
(b) Declining Balance Method, using a rate not exceeding twice the rate which
would have been used had the annual allowance been computed under the method
described in paragraph (f).
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WHAT DEPRECIATION METHOD SHOULD BE USED?

✓ continuation
(c) The sum-of-the-years-digit method, and
(d) any other method which may be prescribed by the Secretary of Finance
upon recommendation of the Commissioner of Internal Revenue.

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