CE 215: ENGINEERING

ECONOMICS
E n g r. C h e z a n i e M i y a S . A s u n c i o n ,
ME-CE, RMP, SO2
 Interest Cost of Money

Capital Cash Flow

DEPRECIATION
Time Value

2
 DEPRECIATION
It is defined as decrease in the value of a physical
property or asset with the passage of time.

Represents decrease in the value due to lessening

in the ability to produce these future cash flows,
as a result of several causes such as wear and tear
and obsolescence
depreciation is an accounting concept that
establishes an

annual deduction against before tax income such

that the effect of time and use on the
asset’s value can be reflected in a firm financial
statement
Interest and Money Time Relationship _T4_ Week5 3
 DEFINITION OF TERM

Value is the present worth of all future profits that are to be

received through ownership of a particular property
s the amount which a willing buyer will pay to a willing
Market value of a
seller for the property where each has equal advantage
property and is under no compulsion to buy or sell

use value of a property is what the property is worth to

Utility
the owner as an operating unit.

the value which is usually determined by a disinterested

Fair value third party in order to establish a price that is fair to
both seller and buyer

Interest and Money Time Relationship _T4_ Week5 4

 DEFINITION OF TERM

sometimes called depreciated book value, is the worth of

Book value/ a property as shown on the accounting records of an
depreciated value enterprise

Salvage/Resale Value is the price that can be obtained from the sale of the
property after it has been used

is the amount the property would sell for, if disposed off

Scrap value
as junk

Interest and Money Time Relationship _T4_ Week5 5

 Purpose of Depreciation

1 2
To enable the cost of depreciation to be
To provide for the recovery of capital
changed to the cost of producing
which has been invested in physical
products or services that results from the
property.
use of the property.

Interest and Money Time Relationship _T4_ Week5 6

 Purpose of Depreciation

1 2
To enable the cost of depreciation to be
To provide for the recovery of capital
changed to the cost of producing
which has been invested in physical
products or services that results from the
property.
use of the property.

Interest and Money Time Relationship _T4_ Week5 7

 Types of Depreciation
1 2 3
Normal depreciation Depreciation due to Depletion
changes in price levels
a) Physical
b) Functional Depletion refers to the
depreciation is due to
depreciation is due to Depreciation due to decrease in the value
the lessening of the
the lessening of the changes in price levels is of a property due to
physical ability of a
demand for the function most impossible to predict the gradual
property
which the and extraction of its
to produce results.
property was designed therefore is not considered contents
Its common causes are
to render in economy studies.
wear and deterioration.
Interest and Money Time Relationship _T4_ Week5 8
 Properties of Depreciation

1 It must have a determinable life and the life must be greater than 1 year

2 .It must be something used in business or held to produce income.

It must be something that gets used up, wears out decays, become obsolete,
3
or loses its value due to natural causes

4 It must not be an inventory or stock in trade or investment

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 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.
4
Interest and Money Time Relationship _T4_ Week5
1 It should be simple.
2 It should be recover capital.
The book value will be reasonably
3
close to the market value at any time.
The method should be accepted by the
Bureau of Internal Revenue.
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 Depreciation Methods
1 The 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’-Digits Method (SYDM)
5 The Service-Output Method
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 1 T h e S t r ai ght L i n e Me t hod ( SLM )
The method assumes that the loss in value is directly proportional
to the age of the property. It also assumes that a constant amount
is depreciated each year over the depreciable (useful) life of the
asset.
𝑪𝒐 −𝑪𝑳
• 𝒅= ; the annual cost of depreciation
𝑳
• 𝑫𝒏 = 𝒏𝒅 ;depreciation up to age n years
• 𝑪𝒏 = 𝑪𝒐 − 𝑫𝒏 ; the book value at the end of
n years
𝑪𝒐 −𝑪𝑳
• 𝑫𝒏 = 𝒏
𝑳
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 Example :

1. An electronic balance costs ₱90,000 and has an estimated salvage value of

₱8,000 at the end of 10 years life time. What would be the book value after
three years, using the straight line method in solving for the depreciation?
Given: Solution:
𝑪𝒐 = ₱90,000 𝐶𝑜 − 𝐶𝐿 ₱90,000 − ₱8,000
𝑑= =
𝑪𝑳 = ₱8,000 𝐿 10
𝐿 = 10 𝑑 = ₱8,200
𝑛=3 𝐷3 = 3 ₱8,200 = 24,600
𝐶3 = 𝐶𝑂 − 𝐷3 = ₱90,000 − ₱24,600
𝑪𝟑 = ₱𝟔𝟓, 𝟒𝟎𝟎

Interest and Money Time Relationship _T4_ Week5 13

 Example :

2. A machine has an initial cost of ₱50,000 and a salvage value of ₱10,000

after 10 years. What is the straight line depreciation rate as a percentage of
initial cost?
Given: Solution:
𝑪𝒐 = ₱50,000 𝐶𝑜 − 𝐶𝐿 ₱50,000 − ₱10,000
𝑑= =
𝑪𝑳 = ₱10,000 𝐿 10
𝐿 = 10 𝑑 = ₱4,000
𝑑 ₱4,000
= = 𝟎. 𝟎𝟖 𝒐𝒓 𝟖%
𝐶𝑜 ₱50,000

Interest and Money Time Relationship _T4_ Week5 14

 2 S i n k i ng F u n d Me t hod ( S F M)
This method assumes that a sinking fund is established in which
funds will accumulate for replacement.

𝐶𝑜 −𝐶𝐿 𝑖 𝐶𝑜 −𝐶𝑛 𝑖
• 𝑑= or 𝑑 = ; the
1+𝑖 𝑛 −1 1+𝑖 𝑛 −1
annual cost of depreciation
• 𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛 ; the book value at
the end of n years
1+𝑖 𝑛 −1
• 𝐷𝑛 = 𝑑
𝑖

Interest and Money Time Relationship _T4_ Week5 15

 Example :

3. A broadcasting corporation purchased an equipment for ₱53,000 and paid

₱1,500 for freight and delivery charges to the job site. The equipment has a
normal life of 10 years with a trade-in value of ₱5,000 against the purchase of a
new equipment at the end of the life.

a. Determine the annual depreciation cost by the straight line method.

b. Determine the annual depreciation cost by the sinking fund method. Assume
interest at 6.5% compounded annually.

Solution:
𝑪𝒐 = ₱𝟓𝟑, 𝟎𝟎𝟎 + ₱𝟏, 𝟓𝟎𝟎 = ₱𝟓𝟒, 𝟓𝟎𝟎
𝑪𝑳 = ₱𝟓, 𝟎𝟎𝟎
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 a. by the straight line method.

Solution:
𝐶𝑜 − 𝐶𝐿 ₱𝟓𝟒, 𝟓𝟎𝟎 − ₱5,000
𝑑= =
𝐿 10
𝑑 = ₱4,950

b. by sinking fund method

Solution:
𝐶𝑜 − 𝐶𝐿 𝑖 ₱𝟓𝟒, 𝟓𝟎𝟎 − ₱5,000 0.065
𝑑= 𝑛
=
1+𝑖 −1 1 + 0.065 10 − 1
𝑑 = ₱3,668.18
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 3 De cl i ni n g Ba l a nce Me t hod ( DBM)

In this method, sometimes called the

constant percentage method or the
Matheson Formula, it is assumed
that the annual cost of depreciation
is a fixed percentage of the salvage
value at the beginning of the year

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 3 De cl i ni n g Ba l a nce Me t hod ( DBM)

• 𝑑𝑛 = 𝐶𝑜 1 − 𝑘 𝑛−1 𝑘; the annual cost of depreciation "

𝑛
𝑛 𝐶𝐿 𝐿
• 𝐶𝑛 = 𝐶𝑜 1 − 𝑘 = 𝐶𝑜 ; the book value at the end of n
𝐶𝑜
years
𝐿
• 𝐶𝐿 = 1 − 𝑘
𝑛 𝐶𝑛 𝐿 𝐶𝑛
• 𝑘 =1− == 1 −
𝐶𝑜 𝐶𝑜

This method does not apply, if the salvage value is zero, because k will
be equal to one and d1 will be equal to 𝐶𝑜 19
Interest and Money Time Relationship _T4_ Week5
 Example :

4. A certain type of machine loses 10% of its value each year. The machine
costs ₱2,000 originally. Make out a schedule showing the yearly depreciation,
the total depreciation and the book value at the end of each year for 5years.

Interest and Money Time Relationship _T4_ Week5 20

 4 Do ubl e De cl i ni n g Ba l a nce Me t hod ( DDBM)
This method is very similar to the declining balance method
except that the rate of depreciation k is replaced by 2/L.

When the DDB 2𝐶𝑜 2 𝑛−1

method is used, • 𝑑𝑛 = 1− ; the annual cost of
the salvage value 𝐿 𝐿
should not be depreciation "
subtracted from 2 𝑛
the first cost when • 𝐶𝑛 = 𝐶𝑜 1 − ; the book value at the end of n years
calculating the 𝐿
depreciation 2 𝐿
charge. • 𝐶𝐿 = 𝐶𝑜 1 −
𝐿

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 Example :

5. Determine the rate of depreciation, the total rate of depreciation up to the

end of the 8th year and the book value at the end of 8 years for an asset that
costs ₱15,000 new and has an estimated scrap value of ₱2,000 at the end of
10 years by (a) the declining balance method and (b) the double declining
balance method.
Given: Solution:
𝑪𝒐 = ₱15,000 a. Declining Balance Method
𝑪𝑳 = ₱2,000
𝐿 = 10 𝐿 𝐶𝑛 10 2000
𝑘 =1− =1− = 0.1825 𝑜𝑟 18.25%
𝑛=8 𝐶𝑜 15000
𝐶𝑛 = 𝐶𝑜 1 − 𝑘 𝑛 = 15000 1 − 0.1825 8 = ₱2,992.22
𝐷8 = 𝐶𝑂 − 𝐶8 = ₱15,000 − ₱2,992.22 = ₱12,007.44
Interest and Money Time Relationship _T4_ Week5 22
 Solution:
b. Double Declining Balance Method
2 2
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = = = 0.20 𝑜𝑟 20%
𝐿 20
𝑛 8
2 2
𝐶8 = 𝐶𝑜 1 − = 15,000 1 − = ₱2,516.58
𝐿 10
𝐷8 = 𝐶𝑂 − 𝐶8 = ₱15,000 − ₱2,516.58 = ₱12,483.43

Interest and Money Time Relationship _T4_ Week5 23

 5 S u m- of - t he- Year s’ -Di gi t s Me t hod ( S Y DM)
The depreciation charge is computed based on the reverse digit and sum of
the digits
𝑅𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡
𝑑𝑛 = 𝐶𝑜 − 𝐶𝐿
𝑆𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠
𝐿−𝑚+1
=2 𝐶𝑜 − 𝐶𝐿
𝐿(𝐿 + 1)
• 𝐶𝑛 = 𝐶𝑜 − 𝐷𝑛
• 𝐷𝑛 = 𝑑1 + 𝑑2 + 𝑑3 + ⋯ + 𝑑𝑛
𝑚(2𝐿−𝑚+1)
• 𝐷𝑛 = 𝐶𝑜 − 𝐶𝐿
𝐿(𝐿+1)
Interest and Money Time Relationship _T4_ Week5 24
 Example :

6. A structure costs ₱12,000 new. It is estimated to have a life of 5 years with a

salvage value at the end of life of ₱1,000. Determine the book value at the end
of each year of life.
Given:
𝑪𝒐 − 𝑪𝑳
= ₱12,000-₱1,000=₱11,000

Interest and Money Time Relationship _T4_ Week5 25

 6 T h e S e r vi ce -Out put Me t hod
This method assumes that the total depreciation that has taken place is
directly proportional to the quantity of output of the property up to that
time.

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 Example :

1. A television Company purchased machinery for ₱100,000 on July 1, 1979. I

is estimated that it will have a useful life of 10years; scrap value of ₱4,000,
production of 400,000 hours and working hours of 120,000. The company
uses the machinery for 14,000 hours in 1979 and 18,000 hours in1980.
The machinery produces 36,000 units in 1979 and 44,000 units in 1980.
Compute the depreciation for 1980 using each method given below:

a. Straight line

b. Working hours

c. Output method

Interest and Money Time Relationship _T4_ Week5 27

 Solution:
𝑪𝒐 = ₱100,000
𝑪𝑳 = ₱4,000
𝐿 = 10
𝑇 = 400,000 𝑢𝑛𝑖𝑡𝑠
𝐻 = 120,000 ℎ𝑜𝑢𝑟𝑠

Interest and Money Time Relationship _T4_ Week5 28

 VALUATION AND INTANGIBLE VALUE
Valuation
Valuation or appraisal is
the process of determining
the value of certain
property
for specific reasons. The
person engaged in the task
of valuation is called an
appraiser.
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Intangible Value
• Goodwill is that element of value which a business has earned
through the favorable consideration and patronage of its
customers arising its well-known and well conducted policies
and operation.
• Franchise is an intangible item of value arising from the exclusive
right of a company to provide a specific product or service in a
stated region of the company.
• Going value is an intangible value which an actually operating
concern has due to its operation.
• Organization cost is the amount of money spent in organizing a
business and arranging for its financing and building. 29
 DE P LETION

Depletion is the decrease in

the value of a property due
to gradual extraction of its
contents. The term is
commonly used in
connection with mining
properties, oils and gas
wells, timberlands and so
on.

Interest and Money Time Relationship _T4_ Week5 30

End of “Depreciation“
Thank you
E n g r. C h e z a n i e M i y a S . A s u n c i o n , M E - C E , R M P , S O 2
Engr.chezaniemiyaasuncion@gmail.com