DECISIONS UNDER CERTAINTY
expenses in general accounting
Principle 1 – Emphasized that a
choice or decision is among
alternatives.
Principle 2 – focus on the differences.
METHODS OF COMPARING
ALTERNATIVES
Present Worth Method - When 2 or
more alternatives are capable of
performing the same functions, the
economically superior alternative
would be the largest present worth.
Future Worth Method – for economy
studies is exactly comparable to the
present worth method except that all
cash inflows and outflows are
compounded forward to a reference
point in time called the future.
Annual Cost Analysis – Alternatives
that accomplish the same purpose
but that have unequal lives must be
compared by the annual cost
method.
Rate of Return – An intuitive
definition of the rate of return (RoR)
is the effective annual interest rate at
which an investment accrues income.
LESSON 3: Depreciation
Depreciation – is an allowable
purposes and income tax accounting
purposes.
Methods of Depreciation
1. The cost of the asset
2. The life if the asset
3. The expected residual value of
the asset
4. And, by the method of
depreciation selected for
amortization of the asset which
must be systematic and
rational.
Depreciation – the decrease in the
value of a physical property with the
passage of time.
Types of depreciation
1. Physical Depreciation – this is
due to the reduction of the
physical ability of an
equipment or asset to produce
results.
2. Functional depreciation – this
is due to the lessening in the
demand for the function that
the property was designed to
render.
Depreciation Terminology
Initial Investment/First Cost(FC) –
The cost of acquiring an asset,
including transportation expenses
and other normal costs of making the
asset serviceable for its intended use.
Book Value (BV) – worth of property
or an asset as shown on the
accounting records of the company. It
is the original cost of the property
less all allowable depreciation
deductions.
Salvage Value (SV) – the amount that
will be paid by a willing buyer to a
willing seller for a property after
depreciation is completed.
Useful Life (L) – the expected period
that a property will be used in trade
or business to produce income.
Physical life – the length of time
during which the property is capable
of performing the function.
Economic life – length of time during
which the property may be operated
at a profit.
Recovery period (n) – the number of
years which the basis of property is
recovered through the accounting
deduction.
Methods of Depreciation
Straight Line Method (SLM) – the
simplest depreciation method.
Sinking Fund Method (SFM) – this
method assumes that a sinking fund
is established in which funds
accumulate for replacements.
Declining Balance Method –
sometime 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.
Double Declining Balance Method
(DDBM) – this method is very similar
to the DBM except that the rate
depreciation k is replaced by 2/L
Sum of the year digit method
(SOYDM) – it is a method of
evaluating depreciation where the
depreciation changes from year to
year.
Service-output Method (SOM) – this
method assumes that the total
depreciation that has taken place is
directly proportional to the quantity
of the property up to that time.
Depletion – this method is generally
applied in case of wasting assets e,g,
mines, quarries and natural
resources.
Lesson 4: Replacement Analysis
Replacement Analysis – plays an
important role in the economic
running of any concern for years or
decades.
4 Major Reasons for Replacement
Physical Impairment
The existing asset is completely
or partially worn out and will no
longer function satisfactorily without
extensive repairs.
Inadequacy
The existing asset does not
have sufficient capacity to meet the
present demands that are placed on
it.
Obsolescence
This may be caused either by a
lessening in the demand for the
service rendered by the asset or the
availability of more efficient assets
which will operate with lower out-of-
pocket costs.
Rental or lease possibilities It is
possible to rent identical or
comparable asset or property, thus
freeing capital for other and more
profitable use.
when replaced. Unamortizedva
should be considered a sunk cost or a
loss.
Basic Patterns for Replacement
Studies Replacement economy
studies may be made by any of the
basic procedures or patterns which
have been discussed previously.
However, in most cases either the
rate of return method or the annual
cost method is used.
Lesson 5: Break-even analysis
Break-even analysis – is a method of
determining when value of one
alternatice becomes equal to the
value of another.
Break-even chart can be determined
by calculating the points at which the
income is equal to total cost.

Sunk Cost Due to Unamortized Value

Unamortized value of an equipment
or property is the difference between
its book value and its resale value