Engineering Economy

Depreciation
Engineering Economy
Depreciation

Definition of Terms

1. Depreciation 9. Straight Line Method

2. Value 10. Sinking Fund Method
3. Market Value 11. Declining Balance method (Matheson Formula)
4. Utility/Use Value 12. Rate of Depreciation, k
5. Fair Value 13. Double Declining Balance (DDB) Method
6. Book Value
7. Salvage or Resale Value
8. Scrap Value
Engineering Economy
Depreciation

Types of Depreciation

1. Normal depreciation
a) Physical depreciation
b) Functional depreciation

2. Depreciation due to changes in price levels

3. Depletion
Engineering Economy
Depreciation

Physical 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.

Economic life – is the length of time during which the property may be operated at a profit.
Engineering Economy
Depreciation

Depreciation Methods:

Where:
𝐿= useful life of the property in years
𝐶𝑜 = the original cost
𝐶𝐿 = the value at the end of the life, the scrap value/ salvage value
𝑑 = the annual cost of depreciation
𝐶𝑛 = the book value at the end of n years
𝐷𝑛 = total deprecation up to n years
Engineering Economy
Depreciation

1. Straight Line Method (SLM)

𝐶𝑜 − 𝐶𝐿
𝑑=
𝐿
𝑛(𝐶𝑜 − 𝐶𝐿 )
𝐷𝑛 =
𝐿
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Engineering Economy
Depreciation

2. Sinking Fund Method (SFM)

𝐶𝑜 − 𝐶𝐿
𝑑=
𝐹
𝐴 , 𝑖%, 𝐿
𝐶𝑜 − 𝐶𝐿
𝑑=
(1 + 𝑖)𝐿 −1
𝑖
𝐹
𝐷𝑛 = 𝑑( , 𝑖%, 𝑛)
𝐴
(1 + 𝑖)𝑛 −1
𝐷𝑛 = 𝑑( )
𝑖
𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
Engineering Economy
Depreciation

3. Declining Balance Method/ Matheson Formula (DBM)

𝑑𝑛 = 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑛𝑡ℎ 𝑦𝑒𝑎𝑟

𝑑𝑛 = 𝐶𝑜 (1 − 𝑘)𝑛−1 𝑘
𝐶𝑛 = 𝐶𝑜 (1 − 𝑘)𝑛
𝐶𝐿 = 𝐶𝑜 (1 − 𝑘)𝐿

𝐿 𝐶𝐿
𝑘 =1−
𝐶𝑜
Engineering Economy
Depreciation

4. Double Declining Balance Method (DDBM)

𝑛−1
2 2
𝑑𝑛 = 𝐶𝑜 1−
𝐿 𝐿
2 𝑛
𝐶𝑛 = 𝐶𝑜 (1 − )
𝐿
2
𝐶𝐿 = 𝐶𝑜 (1 − )𝐿
𝐿
Engineering Economy
Depreciation

5. Sum of the Year’s Digit Method (SYD)

Let 𝑑𝑛 = depreciation charge during the nth year

𝑑𝑛 = (depreciation factor)(total depreciation)

𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
𝑑𝑛 = (𝐶 −𝐶 )
𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 𝑂 𝐿
𝐿(𝐿 + 1)
෍ 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 =
2
 Engineering Economy
Depreciation

Illustrative Examples

1. A firm bought an equipment for P56,000. Other expenses including installation mounted 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) the straight line method and b) sinking fund
method at 12% interest.

Solution
𝐶𝑜 = P56,000 + P4,000 = P60,000
𝐶𝐿 = P60,000(0.10) = P6,000
𝐿 = 16 𝑛 = 12 𝑖 = 12%
Engineering Economy
Depreciation

a) Straight Line Method

𝐶𝑜 − C𝐿
𝑃60,000 − 𝑃6,000
𝑑 = = = 𝑃3,375
𝐿 16
𝐷12 = 𝑛 𝑑 = 12 𝑃3,375 = 𝑃40,500
𝐶12 = 𝐶𝑜 − 𝐷12 = 𝑃60,000 − 𝑃40,500 = 𝑃19,500

a) Sinking Fund method

C𝐿
P60,000−P6,000
𝑑 = 𝐹Τ𝐴,12%,16
𝐶 −
𝑜 = = 𝑃1,263
42.7533

𝐷12 = 𝑑 𝐹 Τ𝐴 , 12%, 12 = 𝑃1,263 24.1331 = 𝑃30,480

𝐶12 = 𝐶𝑜 − 𝐷12 = 𝑃60,000 − 𝑃30,480 = 𝑃29,520
Engineering Economy
Depreciation

2. 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 book value at the end
of each year for 5 years.
Solution:

Year Book value at beginning of the Depreciation during the year Book value at the end of year
year
1 P2,000.00 P200.00 P1,800.00
2 P1,800.00 P180.00 P1,620.00
3 P1,620.00 P162.00 P1,458.00
4 P1,458.00 P145.80 P1,312.20
5 P1,312.20 P131.22 P1,180.98
Engineering Economy
Depreciation

3. 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) the declining balance method and b) the double declining balance
method.

Solution: 𝐶𝑜 = 𝑃15,000 𝐶𝐿 = 𝑃2,000 𝐿 = 10 𝑛=8

Declining balance method

𝐿 𝐶𝐿 10 𝑃2,000
𝑘 = 1− = 1− = 0.1825 𝑜𝑟 18.25%
𝐶𝑜 𝑃15,000
𝐶8 = 𝐶𝑜 (1 − 𝑘)𝑛 = 𝑃15,000(1 − 0.1825)8 = 𝑃2,992
𝐷8 = 𝐶𝑜 − 𝐶8 = 𝑃15,000 − 𝑃2,992 = 𝑃12,008
Engineering Economy
Depreciation

a) Double declining balance method

2 2
Rate of depreciation = 𝐿 = 20 = 0.20 𝑜𝑟 20%
2 2 8
𝐶8 = 𝐶𝑜 (1 − )8 = 𝑃15,000(1 − ) = 𝑃2,517
𝐿 10
𝐷8 = 𝐶𝑜 − 𝐶8 = 𝑃15,000 − 𝑃2,517 = 𝑃12,483
Engineering Economy
Depreciation

4. A plant bought a calciner for P220,000 and used it for 10 years, the life span of the equipment. What
is the book value of the calciner at the end of 5 years if the salvage value isP20,000 for straight line
method; P22,000 for declining balance method and P20,000 for the double declining balance method.

Solution:
𝐶𝑜 = 𝑃220,000 𝐿 = 10 𝑛=5
a) Straight line method 𝐶𝐿 = 𝑃20,000

C𝐿 ) 5(𝑃220,000 − 𝑃20,000)
𝐷5 = 𝑛(𝐶𝑜 − = = 𝑃100,000
𝐿 10
𝐶5 = 𝐶𝑜 − 𝐷5 = 𝑃220,000 − 𝑃100,000 = 𝑃120,000
Engineering Economy
Depreciation

a) Declining balance method

𝐶𝐿 = 𝑃22,000
𝐶𝐿 𝑛 𝑃22,000 5
𝐶5 = 𝐶𝑜 (𝐶 ) 𝐿 = 𝑃220,000(𝑃220,000)10 = 𝑃69,570
𝑜

a) Double declining balance method

𝐶𝐿 = 𝑃20,000
2 2
𝐶5 = 𝐶𝑜 (1 − )5 = 𝑃220,000(1 − )5 = 𝑃72,090
𝐿 10