DEPRECIATION

What is Depreciation
• Depreciation is the reduction in value of an asset.
• Book depreciation and tax depreciation are the terms used to
describe the purpose for reducing asset value.
Common Depreciation Terms
• First cost P or unadjusted basis
• B: Total installed cost of asset Book value
• BVt: Remaining undepreciated capital investment in year t
• Recovery period n: Depreciable life of asset in years
• Market value MV: Amount realizable if asset were sold on open market
• Salvage value S: Estimated trade-in or MV at end of asset’s useful life
• Depreciation rate dt: Fraction of first cost or basis removed each year t
Classification Of Depreciation
• Physical Depreciation
• Functional Depreciation
• Physical Depreciation: Depreciation resulting in physical impairment
of an asset.
• E.g. The causes may be due to deterioration, wear & tear
• Functional Depreciation: It results not only from deterioration
(decline) in the assets ability but from a change in the demand for the
services it can render.
• E.g. Obsolescence resulting from the discovery of another asset that is
sufficiently superior than existing one.
Methods of Depreciation
• Straight line
• Declining Balance
• Double Declining Balance
• Modified Accelerated Cost Recovery
• Depletion Methods
• Sinking fund method
Straight Line (SL)Method
• In straight line method, the book value of the asset decreases linearly with time
• In annual SL method, Depreciation charge is determined by multiplying the
depreciation rate to the difference between first cost and the salvage value by
the.
• If Dt is depreciation charge for the year t, B is first cost, S is estimated salvage
value, n is recovery period and d is depreciate rate then
• Dt= (B-S)*d or (B-S)/n
• d=1/n
• BV, the Book Value is computed as follows
• BVt = B- (t *Dt)
• A blast furnace for a metallurgical operation was purchased for Rs.
300,000. An amount of Rs. 50,000 more was spent on its installation
and commissioning. The estimated residual value after 10 year was
Rs. 70,000
• (a) Calculate the depreciation charge
• (b) Determine the amount of depreciation at the end of 6 years after
the purchase of the furnace.
• Solution,
• we have basis
• (B) = Rs. 300,000,
• Installation and Commision = 50,000
• salvage value (SV10) = Rs. 70,000 and
• depreciable life (N) = 10 years,
• Then
• (a)Depreciation charge per yer is given by (B-S)/N
• Dt= [(300000+50,000) – 70000]/ 10 = 28000 per year
• Amount of Depreciation at the end of year 6
• Dt*6= 28000*6= Rs 168,000
• Electrostatic precipitators costing Rs. 100,000 are used to separate
ash particles from hot flue gases being discharged into the air. These
precipitators must be replaced after every 5,000 hours. If the plant
operates 24 hours a day and 30 days a month, what is the
depreciation charged per month for the precipitators?
• We have B = Rs. 100,000, N = 5,000/24 = 208.333 days = 6.94 month
= 7 months (approx). Then depreciation charged per month is
• Dt= (B-S)/N= (100000-0)/7= Rs. 14,285.71/month
 Declining Balance Method

1. This method assumes that an asset decreases in value at

a faster rate in the early portion of the service life than in
the later portion of its life.
2. By this method fixed percentage is multiplied times the
book value of the asset.
3. Hence book value of the asset decreases through time, so
does the size of the depreciation charge.
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Declining Balance Depreciation
• This is also known as fixed percentage or uniform percentage method.
• The annual depreciation is determined by multiplying the book value
at the beginning of a year by a fixed percentage
• Dt = d* BVt-1
• Book Value in a year t is determined by
• BVt= B(1-d)t
• If book value is not known then the depreciation in the year t is
calculated by using B and d
• Dt= d*B(1-d)t-1
End of Depreciation charge Book value at the end of year, t
Year during year t
0 ------ P = B0

1 R x B0= D1 B0 - D1= B1

2 R x B1= D2 B1 – D2= B2

3 R x B2 = D3 B2 –D3= (1-R)3 P = B3
.
.
.

t R x Bt-1 = Dt Bt-1 -Dt = Bt

.
.
.

n R x Bn -1 = Dn Bn-1 -Dn = Bn

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 Depreciation for previous year, Dt = d x BVt-1
Where Dt = depreciation charge for year t

BVt-1= Book value for year (t-1)

d = depreciation rate

Expression to determine book value for the year t, Bt = BVt-1 - Dt

Therefore, BVt = Bt-1 – d BVt-1

BVt to
Using this expression it is possible = determine
BVt-1 (1-d)
the general expression,
Depreciation at any time t,
Dt = d (1-d)t-1 P

Book value at any time t,

t
BVt = (1-d) B t Therefore,1- d=t√ BVt /B
 Numerical
1. An asset costs Rs.5000 now and its salvage value is Rs.1000
estimated and an estimated service life of 5 years and a
depreciation rate of 30% per year. Determine the depreciation
charges for 5 years and its book value on the end of year.
• An asset was purchased for 2,50,000 Rs. It has an
expected life of 10 years and a salvage value of Rs.50000
at the end of 10th year. What will be the undepreciated
amount of capital remaining in the asset at the end of 6th
year. If the asset is being depreciated according to the
declining balance method. Also calculate the
depreciation charge for the 8th year.

R = 1- (Bt /P)1/t
Depreciate charge during year 8
1- (50000/2,50,000) ^ (1/10)
=R (1-R)^t-1 * P
= 0.1487 = 14.87%
=0.1487(1-0.1487)^(8-1) * 250000
Undreciated amount at the end of 6th year,
Bt = (1-R)t P = (1-0.1487)^6 x 250000
= 95156
Numerical 1

• An asset was purchased 10 years ago for Rs. 5,00,000. it is

depreciated according to DDB method for an estimated life of 20
years and a salvage value of Rs. 50,000. calculate its current book
value.

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Double Declining Balance Method

• In this method the depreciation rate is given as the

double the straight line rate that would be allowed for a
particular asset being depreciated.

• Depreciation rate= 2 x 1/n = 2/n

• Remaining terms are same as Declining Balance method.

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Double declining balance method
• d= 2/n
Numerical 2

• An asset has a first cost of Rs. 48,000 with an estimated life of 20

years. What is the total accumulated depreciation charge during the
first 5 years of the asset life if it is depreciated according to DDM
Method?

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Problem
• Albert Natural Stone Quarry purchased a computer controlled face
cutter saw for $80,000. The unit has an anticipated life of 5 years and
a salvage value of $10,000
• Compare the schedules for annual depreciation and book value using
two methods.: DB at 150% of straight line method and at DDB rate.
• DB rate is d= 150%/n = 1.50/5 = 0.30
• DDB rate = 2/n = 2/5 = 0.40

Year Dt when d=0.30 BVt

0 80000
1 =0.30*80000
2
3
4
5