INTERMEDIATE ACCOUNTING 2
CHAPTER 28
THE PORTION THAT IS ALLOCATED TO EXPENSE IN A PARTICLAR PERIOD IS REFERRED TO AS:
DEPRECIATION
For PLANT, PROPERTY &
EQUIPMENT
CONCEPT OF
DEPRECIATION
DEPRECIATION IS AN
EXPENSE
PHYSICAL DEPRECIATION
*Wear and tear
*Passage of time
*Action of the elements
*Casualty or accident
*Disease or decay (for
animals & wooden buildings.
DEPRECIATION
DEPLETION AMORTIZATION
For For
WASTING ASSETS INTANGIBLE ASSETS
*systematic allocation of the depreciable amount of an
asset over the useful life.
*a cost allocation in recognition of the exhaustion of the
useful life of an item of PPE
*objective is to have each period benefiting from the use
of the asset bear an equitable share of the asset cost.
Expense as part of
COST OF GOODS MANUFACTURED
or
Expense as part of OPERATING EXPENSE
KINDS OF
DEPRECIATION
FUNCTIONAL OR ECONOMIC DEPRECIATION
*Inadequacy- asset is no longer useful because of increase in
production.
*Supersession-new asset becomes available & can perform more
efficiently and economically or for substantially less cost.
*Obsolescence-a catchall for economic or functional
depreciation, hence an asset is obsolete if it is inadequate or
superseded .
1
 DEPRECIABLE AMOUNT OR DEPRECIABLE COST -Cost less residual
(scrap/salvage) value

FACTORS OF RESIDUAL VALUE -the estimated net amount of the asset at the end of its useful
DEPRECIATION life.

USEFUL LIFE –is expressed in terms of time periods, and service hours over
which an asset is available for use or the number of production (units) expected
from an asset .

DETERMINANTS OF USEFUL LIFE

*Expected usage of the asset – based on asset’s expected capacity or physical
output
*Expected physical wear and tear- depends on the number of shifts the asset
is used, the repair and maintenance program, and the care and maintenance
of the asset while idle.
*Technical or commercial obsolescence- based on changes or improvements
in production or change in the market demand for the product output
*Legal limits-dependent on the expiry date of the related lease

SERVICE LIFE- period of PHYSICAL LIFE- period of

time the asset is usable VS time the asset shall last.

METHODS OF
DEPRECIATION 1. The depreciation
method shall reflect the
pattern in which the
EQUAL OR UNIFORM 1. Straight line method
future economic
CHARGE METHODS 2. Composite method
benefits from the asset
3. Group method
are expected to be
consumed by the entity.

VARIABLE CHARGE OR 1. Working hours or service 2. The depreciation

USE FACTOR OR ACTIVITY hours method method shall be
METHODS 2. Output or production reviewed at least at
method every year-end. The
method shall be
changed if there is a
significant change in the
DECREASING CHARGE OR 1. Sum of Years’ digit method expected pattern of
ACCELERATED OR 2. Declining balance method future economic
DIMINISHING METHODS 3. Double declining balance benefits.
method
3. Such change in
depreciation method
shall be accounted for
1. Inventory or appraisal method as change in accounting
OTHER METHODS 2. Retirement method estimate.
3. Replacement method
2
1. STRAIGHT LINE METHOD
a. Rationale : Principal cause of depreciation is passage of time. (function of time
rather than function of usage.

b. Formula : Cost minus residual value / Useful life in years

c. Straight line rate : 100% / useful life

d. Illustration: Depreciation Straight line rate

Cost of equipment P105,000 105,000-5,000 100%
Residual value 5,000 5 yrs. 5 yrs
Useful life 5 years = P20,000 = 20%

e. Depreciation Table

Year Particular Depreciation Accum. dep’n Carrying Amt.

Acquisition cost 105,000
1 Depreciation for 1st year 20,000 20,000 85,000
2 Depreciation for 2nd year 20,000 40,000 65,000
3 Depreciation for 3rd year 20,000 60,000 45,000
4 Depreciation for 4th year 20,000 80,000 25,000
5 Depreciation for 5th year 20,000 100,000 5,000
100,000

f. Journal entry:
Depreciation 20,000
Accumulated depreciation 20,000

g. Statement presentation:
Property, plant and equipment:
Equipment P105,000
Accumulated depreciation ( 20,000)
Carrying amount P 85,000

2. COMPOSITE AND GROUP METHOD

a. Nature
1. Composite method: Assets that are dissimilar in nature or having different
physical characteristics and vary widely in useful life, are grouped and treated as
a single unit.

2. Group method: All assets that are similar in nature and estimated useful life are
grouped and treated as a single unit.

3. The average useful life and the composite or group rate are computed, and the
assets in the group are depreciated on that basis.

3
b. Accounting procedure:
1. Depreciation is reported in a single accumulated depreciation account.

2. The composite or group rate is multiplied by the total cost of the assets in the
group to get the periodic depreciation.

3. When the asset in the group is retired, no gain or loss is reported.

Accumulated depreciation xxx
Asset xxx

4. When the asset retired is replaced by a similar asset, the replacement is

recorded by debiting the asset account and crediting cash or other appropriate
account.

Subsequently, the composite or group rate is multiplied by the balance of the

asset account to get the periodic depreciation.

c. Illustration:

(a) (b) (a÷b)

Residual Depreciable Useful life Annual
Asset Cost value amount Depreciation
Building 650,000 50,000 600,000 15 40,000
Machinery 220,000 20,000 200,000 8 25,000
Equipment 130,000 30,000 100,000 4 25,000
1,000,000 100,000 900,000 90,000

1. Composite life : Total depreciable cost ÷ Total annual depreciation

900,000 ÷ 90,000 = 10 years

2. Composite rate: Total annual depreciation ÷ Total cost

90,000 ÷ 1,000,000 = 9%

3. Entry: Depreciation 90,000

Accumulated depreciation 90,000

4. Statement Presentation:
Property, Plant and Equipment
Building 650,000
Machinery 220,000
Equipment 130,000
Total 1,000,000
Accumulated depreciation ( 90,000)
Carrying amount 910,000

4
 d. Retirement of asset in the group
1. If the equipment is retired after four (4) years and sold for P20,000, the entry is:
Cash 20,000
Accumulated depreciation 110,000
Equipment 130,000

2. If there are no proceeds from the retirement of the equipment, the entry is:
Accumulated depreciation 130,000
Equipment 130,000

3. After the retirement of the equipment, the remaining cost of the assets in the
group is (1,000,000 minus 130,000) 870,000

4. The subsequent annual depreciation would be (9% x 870,000) 78,300

e. Retirement and replacement of asset:

If after the retirement of the equipment, the same is replaced by a new equipment
costing P160,000:

1. The total cost of the assets in the group becomes

(870,000 + 160,000) 1,030,000

2. The annual depreciation starting the 5th year would be

(1,030,000 x 9%) 92,700

3. Depreciation shall be discontinued when the same would result to a carrying

amount of the assets in the group which is below the residual value of the assets
in the group.

3. VARIABLE CHARGE OR ACTIVITY METHODS

a. Assumptions:
1. That depreciation is more a function of use rather than passage of time.
2. Useful life for the asset is considered in terms of output it produces or the
number of hours it works.
3. It is expressed in terms of rate per unit of output or per hour of use.

b. Rationale:
1. Variable charge method is adopted if the principal cause of depreciation is usage.
2. Assets depreciate more rapidly if they are used full time or overtime.
3. There is a direct relationship between utilization of assets and realization of
income.
4. Method used is appropriate for machinery.
5. Major objection of this method: units of output or service hours as a basis may
be difficult to estimate.

5
c. Illustration:
Machinery, at cost P600,000
Residual value None
Estimated useful life:
Years 5 years
Service hours 60,000 hrs.
Output 150,000 units
Actual operations Service hours Output
1st year 14,000 34,000
2nd year 13,000 32,000
3rd year 10,000 25,000
4th year 11,000 29,000
5th year 12,000 30,000
60,000 150,000
1. Working hours method
a. Depreciation rate per hour = depreciable cost ÷ est. useful life (hrs.)
P600,000 ÷ 60,000 hrs. = P10 per hour

b. Depreciation = Actual hours worked x depreciation rate

c. Depreciation Table
Year Particular Depreciation Accum. Dep’n Carrying amt.
Acquisition cost 600,000
1 14,000 x 10 140,000 140,000 460,000
2 13,000 x 10 130,000 270,000 330,000
3 10,000 x 10 100,000 370,000 230,000
4 11,000 x 10 110,000 480,000 120,000
5 12,000 x 10 120,000 600,000 -

2. Output or production method

a. Depreciation rate per unit = depreciable cost ÷ est. useful life (output)
P600,000 ÷ 150,000 units = P4 per unit

b. Depreciation = yearly output x depreciation rate

c. Depreciation Table
Year Particular Depreciation Accum. Dep’n Carrying amt.
Acquisition cost 600,000
1 34,000 x 4 136,000 136,000 464,000
2 32,000 x 4 128,000 264,000 336,000
3 25,000 x 4 100,000 364,000 236,000
4 29,000 x 4 116,000 480,000 120,000
5 30,000 x 4 120,000 600,000 -
600,000

6
4. DECREASING CHARGE OR ACCELERATED METHODS
a. Nature: Provides higher depreciation in the earlier years and lower depreciation in
the later years of the useful life of the asset.

b. Rationale:
1. New assets are generally capable of producing more revenue in the earlier years
than in the later years.
2. The cost of using an asset includes not only depreciation but also repairs on such
assets.
3. Such repair cost should be allocated over the useful life of the asset on a
systematic and uniform basis.
4. Repairs tend to increase with the age of the asset, hence repairs are small in the
earlier years and large during the later years.
5. The overall effect would be a uniform charge because the decreasing amount of
depreciation and the increasing repairs will tend to equalize each other.

c. Methods:
1. Sum of Years’ Digits (SYD) – depreciable amount is multiplied by a series of
fractions whose numerator is the digit in the useful life of the asset and whose
denominator is the sum of the digits in the useful life of the asset.

a. Formula: If the useful life of the asset is 4 years, the SYD is 1 + 2 + 3+ 4 = 10.
Thus the depreciation would be:
1st year 4/10 or Using the formula:
2nd year 3/10 SYD = Life ( Life + 1 )
3rd year 2/10 2
th
4 year 1/10 = 4 ( 4 + 1)
2
= 4(5)/2
= 20/2
= 10 yrs
b. Illustration:
Machinery , cost 430,000
Residual value 30,000
Estimated useful life 4 yrs.

Depreciation Table:
Accum. Carrying
Year Particular Depreciation Depn Amount
Acquisition cost 430,000
1 4/10 x 400,000 160,000 160,000 270,000
2 3/10 x 400,000 120,000 280,000 150,000
3 2/10 x 400,000 80,000 360,000 70,000
4 1/10 x 400,000 40,000 400,000 30,000
400,000

7
c. Sum of half years’ digits:
Cost of machinery 330,000
Salvage amount 30,000
If the useful life is 2 ½ years, the procedure is to multiply the useful life by 2
to get the useful life of the asset in half years.
Hence, the useful life of the asset is ( 2 ½ x 2) 5 yrs.
The Sum of Half Years therefore is (1 + 2 + 3 + 4 + 5) 15

Thus, the depreciation table would be:

Accum. Carrying
Year Particular Depreciation Depn Amount
Acquisition cost 330,000
1st year 6 mos. 300,000 x 5/15 100,000 100,000 230,000
6 mos. 300,000 x 4/15 80,000 180,000 150,000
2nd year 6 mos. 300,000 x 3/15 60,000 240,000 90,000
6 mos. 300,000 x 2/15 40,000 280,000 50,000
3rd year 6 mos. 300,000 x 1/15 20,000 300,000 30,000
300,000

d. Fractional depreciation -sum of years’ digits:

Cost of asset 300,000 SYD = ((1 + 2 + 3) = 6
or
Residual value None 3 ( 3 + 1) = 12 = 6
Date of acquisition 4/1/2021 2 2
Estimated useful life 3 years

Accum Carrying
Year Particular Depreciation dep’n. Amt
Acquisition cost 300,000
4/1/21-3/31/22 3/6 x 300,000 150,000 150,000 150,000
4/1/22-3/31/23 2/6 x 300,000 100,000 250,000 50,000
4/1/23-3/31/24 1/6 x 300,000 50,000 300,000 0

e. Depreciation- Calendar period:

Depreciation for Particular Depreciation

2021 4/21/21 to 12/31/21 150,000 x 9/12 112,500
2022 1-1-22 to 3/31/22 150,000 x 3/12 37,500
4/1/22 to 12/31/22 100,000 x 9/12 75,000
Total 112,500
2023 1/1/23 to 3/31/23 100,000 x 3/12 25,000
4/1/23 to 12/31/23 50,000 x 9/12 37,500
Total 62,500
2024 1/1/24 to 3/31/24 50,000 x 3/12 12,500
TOTAL 300,000

8
2. DECLINING BALANCE- (also known as fixed rate on diminishing carrying amount)
- a fixed or uniform rate is multiplied b y the declining carrying amount of the
asset in order to arrive at the annual depreciation.
a. Formula for fixed rate:
n
Rate = 1 - √ Residual value ÷ Cost

Where: n = useful life

Note: The formula cannot be used unless there is a residual value.

b. Illustration:
Cost of asset 500,000
Residual value 50,000
Estimated useful life 5 yrs.

Using the formula: n

Rate = 1 - √ Residual value ÷ Cost

5
=1- √ 50,000 ÷ 500,000
5
= 1- √ .10 (read as 5th root of .10 or .632)

= 1 - .632 or .368 or 36.8% (use table of logarithm)

c. Depreciation Table- declining balance

Accum. Carrying
Year Particular Depreciation Dep’n amount
Acquisition cost 500,000
1 36.8% x 500,000 184,000 184,000 316,000
2 36.8% x 316,000 116,288 300,288 199,912
3 36.8% x 199,712 73,494 373,782 126,218
4 36.8% x 126,218 46,448 420,230 79,770
5 36.8% x 79,770 29,770* 29,770* 50,000
Total 450,000

Note: 1. *Difference is due to rounding off.

2. 36.8% is multiplied by the total cost in the first year and
not the depreciable cost, hence residual value is ignored.
3. Declining balance is not used extensively because of complex
calculations

9
3. DOUBLE DECLINING BALANCE (200% declining balance method) – an
approximation of the declining balance method. The straight line rate is doubled
to get the fixed rate.
a. Illustration
Cost of asset 500,000
Date of acquisition Jan. 1, 2021
Residual value 50,000
Estimated useful life 5 years
Straight line rate (100%/5 yrs) 20%
Double declining rate (20% x 2) 40%

b. Depreciation table- Double declining balance

Accum. Carrying
Year Particular Depreciation Dep’n amount
Acquisition cost 500,000
2021 40% x 500,000 200,000 200,000 300,000
2022 40% x 300,000 120,000 320,000 180,000
2023 40% x 180,000 72,000 392,000 108,000
2024 40% x 108,000 43,200 435,200 64,800
2025 40% x 50,000 14,800 450,000 50,000
Total 450,000

4. 150% DECLINING BALANCE – the fixed rate is 150% of the straight line rate
a. Illustration
Cost of asset 500,000
Date of acquisition Jan. 1, 2021
Residual value 50,000
Estimated useful life 5 years
Straight line rate (100%/5 yrs) 20%
150% declining rate (150% x 20%) 30%

Hence, the depreciation for 2021 is (30% x P500,000) 150,000

5. INVENTORY METHOD – applies generally to assets which are small and

relatively inexpensive such as hand tools or utensils.
a. Formula = Balance of the asset account less value at the end of the year
b. Illustration:
Tools account, January 1 100,000
Acquisition, at cost 90,000
Sale of used tools, at residual value 2,000
Inventory of tools, Dec. 31, at cost 125,000

10
 Entries:
Tools 90,000
Cash 90,000
Acquisition of tools

Cash 2,000
Tools 2,000
Sale of used tools at residual value.

Depreciation 63,000
Tools 63,000
Depreciation of tools

Computation:

Balance of tools account 188,000

Inventory of tools, Dec. 31 125,000
Depreciation 63,000

6. Retirement and replacement method – applicable when a large number of

similar items are employed by the entity and the items are constantly being
retired and replaced.

a. Retirement method
1. no depreciation is recorded until the asset is retired.
2. The amount of depreciation is equal to the original cost of the asset
retired minus salvage proceeds.

b. Replacement method
1. no depreciation is recorded until the asset is retired and replaced.
2. The amount of depreciation is equal to the replacement cost of the asset
retired, minus salvage value.
3. If the asset retired is not replaced, the original cost of the asset retired
but not replaced is recognized as depreciation.

c. Illustration
Balance, January 1, 1,000 units at P50 per unit 50,000
Acquisition – 2,500 units at P70 per unit 175,000
Retirement of tools – 1,200 units
Proceeds from retirement 5,000

11
1. Retirement method:
Entries
Tools 175,000
Cash 175,000
Record the acquisition.

Cash 5,000
Depreciation 59,000
Tools 64,000
Record the retirement.
Original cost of tools retired 64,000
Less: Proceeds of salvage 5,000
Depreciation 59,000

Cost of tools retired (FIFO)

1,000 units x 50 50,000
200 units x 70 14,000
1,200 64,000

2. Replacement method:
Entries:
Tools (1,300 x 70) 91,000
Cash 91,000
Acquisition of tools in excess of retirement.
(2,500-1,200 = 1,300)

Depreciation 79,000
Cash 79,000
Record replacement of tools retired.

Replacement cost of tools retired (1,200 x 70) 84,000

Proceeds from retirement (5,000)
Depreciation 79,000

12
 CHANGE IN USEFUL LIFE

Illustration: 1st year and 2nd year depreciation:

Cost of depreciable asset P500,000 1st year (500,000/5 yrs.) 100,000
Estimated useful life 5 yrs. 2nd year (500,000/5 yrs.) 100,000
After two years, the original useful is Accum. depreciation 200,000
revised to 8 years. Hence, the remaining
useful life becomes 6 yrs. 3rd year depreciation:
Cost 500,000
Procedure: Less: Accum. dep’n. 200,000
1. Past depreciation is not corrected. Carrying amount, beg. of 3rd yr. 300,000
2. Allocate the remaining carrying
amount of the asset over the Annual depreciation starting 3rd year:
remaining revised useful life to get (300,000 / 6 years) 50,000
the subsequent annual
depreciation.

CHANGE IN DEPRECIATION METHOD

Illustration: 1st year and 2nd year depreciation:

Jan. 1, 2019, an asset was SYD ( 1+2+3+4) 10 years
acquired costing P1,000,000 Cost, Jan. 1, 2019 1,000,000
Estimated useful life 4 yrs. Accum. dep’n.
After two years, January 1, 2021 2019 (4/10 x 1,000,000) 400,000
the entity decided to change from 2020 (3/10 x 1,000,000) 300,000 700,000
SYD to the straight line method Carrying amount-Jan. 1, 2021 300,000
of depreciation.

Procedure: Depreciation for the 3rd year:

3. The change will be accounted as
change in accounting estimate. Carrying amount, 1/1/2021 300,000
4. Depreciation charge for the current Divided by remaining life 2 yrs.
and future periods shall be Depreciation for 2021 150,000
adjusted.

13