Eng Econ Im 8

Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY

Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENG ECON – 1STSEM-2020-2021
COLLEGE OF ENGINEEERING
DEGREE PROGRAM BSCE COURSE NO. ENG ECON

SPECIALIZATION SE/CEM/TE/WRE COURSE TITLE ENGINEERING ECONOMICS
YEAR LEVEL 2nd Year TIME FRAME WK NO. IM NO. 8
I. UNIT TITLE/CHAPTER TITLE

8. DECISION UNDER CERTAINTY
II. LESSON TITLE

Depreciation
III. LESSON OVERVIEW

This chapter concentrates on the use of depreciation or depletion methods
to reduce the book value of a capital investment in an asset and natural
resource.
IV. DESIRED LEARNING OUTCOMES

At the end of the topic, the students should be able to:
• define and use the basic terms of asset depreciation.
• apply the straight line (SL) method of depreciation
• apply the declining balance (DB) and double declining balance (DDB)
methods of depreciation.
• apply the sum-of-years-digits (SYD) and methods of depreciation.
• apply the sinking fund method of depreciation
•
V. LESSON CONTENT
A. TERMINOLOGIES
Depreciation – is defined as the decrease in the value of a property, such

as machinery, equipment, building or other structure, due to the passage
of time. This is due to many reasons, from deterioration and obsolescence
to impending retirement. Depreciation cost depends upon the physical
and economic life of the equipment and its first cost.
Amortization - is used to reflect the decreasing value of intangibles, such
as loans, mortgages, patents, trademarks, and goodwill.
Annual Depreciation - is the amount of the asset's cost that is charged off
in a given year.
Accumulated Depreciation – the total of the annual depreciations to date.
Value – is the present worth (PW) of all the future profits that are to be
received though ownership of a particular property.
“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be
reproduced for educational purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 1 of 12
Market value is usually taken as the actual value an asset can be sold for in
an open market. Of course, the only way to determine the actual market
value for an asset is to sell it. Consequently, the term market value usually
means an estimate of the market value. One way to make such an
estimation is by using a depreciation model that reasonably captures the
true loss in value of an asset.
Salvage Value or Scrap Value of an asset is the estimated proceeds that
will be realized from its sale or disposition when it is retired.
Net Salvage Value is either zero or the salvage value minus the cost of
removing the asset from the premises, whichever is greater.
Adjusted Cost of an asset is its original cost less its net salvage value.
Book Value (BV) is the worth of a property as shown on the accounting
records of a company. Ordinarily, it means the original cost of the
property less all amounts that have been charged as depreciation expense.
Useful life sometimes referred to as depreciable life, is the expected
period of time that a property will be used in a trade or business or to
produce income. It is not how long the property will last but how long the
owner expects to productively use it.
Depreciable property – property for which depreciation is allowed under
federal, state or municipal income tax laws and regulations.
A property is depreciable if it meets all of the following basic
requirements:
1. It must be used in business or held to produce income.
2. It must have a determinable useful life, and the life must be
longer than one year.
3. It must be something that wears out, decays, gets used up,
becomes obsolete or loses value from natural causes.
4. It is not inventory, stock in trade, or investment property.
Examples of depreciable assets are cars, computers, office furniture,
machines, buildings, and significant additions or improvements (as opposed to
repairs) to these kinds of property.
B. REASONS FOR DEPRECIATION
An asset starts to lose value as soon as it is purchased. For example, a

car bought for Php 20 000 today may be worth Php 18 000 next week, Php 15
000 next year, and Php 1000 in 10 years. This loss in value, occurs for several
reasons.
• Use-related physical loss: As something is used, parts wear out. An

automobile engine has a limited life span because the metal parts
within it wear out. This is one reason why a car diminishes in value
over time.
• Time-related physical loss: This can be due to environmental
factors affecting the asset or to endogenous physical factors. Time
related physical loss is expressed in units of time.
• Functional loss: Losses can occur without any physical changes. For
example, a car can lose value over time because styles change so
that it is no longer fashionable.
C. DEPRECIATION METHODS
Requirements of a Depreciation Method:
• It should be simple
• It should recover capital
• Ensure that the book value will be reasonably close to the market
value at any time
• The method must be acceptable by the BIR.
1. Straight-Line (SL) Method

• It is the simplest and most widely used depreciation method.
• This depreciation derives its name from the fact that the book
value decreases linearly with time. The depreciation rate is
the same (1/n) each year of the recovery period n.
• It assumes that the loss in value is directly proportional to the
age of the property.
• In the straight-line method, the depreciation base is evenly
allocated over the lifetime of the asset, resulting in equal
annual depreciation.
We determine the depreciation per period from the asset’s current value and its
estimated salvage value at the end of its useful life, N periods from now, by equation
1. Similarly, in equation 2, the book value at the end of any particular period is easy
to calculate:
Equation 1
Equation 2
Where:
P = first cost of the asset,
F = salvage value of the asset,
n = life of the asset,
Bt = book value of the asset at the end of the period t,
Dt = depreciation amount for the period t.
In addition, earlier we defined dt as a depreciation rate for a specific year t.
However, the SL model has the same rate for all years, that is,
1
d = dt = 𝑛 Equation 3
Example 1. If an asset has a first cost of ₱50,000 with a ₱10,000
estimated salvage value after 5 years, calculate the annual depreciation using
straight line depreciation.
Solution
The depreciation each year for 5 years can be found by Equation 1
𝐵 − 𝑆 50,000 − 10,000
𝐷𝑡 = = = ₱8,000
𝑛 5
Example 2. A laser cutting machine was purchased four years ago for
₱380 000. It will have a salvage value of ₱30 000 two years from now. If we
believe a constant rate of depreciation is a reasonable means of determining
book value, what is its current book value?
Solution
From Equation 2, with P = ₱380 000, F = ₱30 000, n = 6, and t = 4,
𝑃−𝐹 380 000 − 30,000
𝐵𝑡 = 𝑃 − 𝑡 ( ) = 380 000 − 4 ( ) = ₱146,667
𝑛 6
The current book value for the cutting machine is ₱146 667
The straight-line depreciation method has the great advantage of being

easy to calculate. It is also easy to understand and is in common use. The
main problem with the method is that its assumption of a constant rate of loss
in asset value is often not valid. Thus, book values calculated using straight-
line depreciation will frequently be different from market values. The declining-
balance method of depreciation covered in the next section allows for “faster”
depreciation in earlier years of an asset’s life.
• Declining-Balance 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 BV at the beginning of the year.
• The ratio of the depreciation is a fixed percentage of the BV at
the beginning of the year is constant throughout the life of the
asset and is designated by R (0 ≤ R ≤ 1). In this method, R =
2/N when a 200% declining balance is being used.
• The annual depreciation charges, different each year, decrease
from year to year, greatest during the 1st year and least in the
last year of life of the property.
• With this method, a property can never depreciate to zero value.
• The book value at the end of the life of the asset may not be
exactly equal to the salvage value of the asset.
The formulae for depreciation and book value are as follows:
Equation 4
Equation 5
The formulae for depreciation and book value in terms of P are

as follows:
Equation 6
Equation 7
Where
Bt = book value of the asset at the end of the period t,
K = a fixed percentage, and
Dt = depreciation amount at the end of the period t.
While availing income-tax exception for the depreciation amount

paid in each year, the rate K is limited to at the most 2/n. If this rate is
used, then the corresponding approach is called the double declining
balance method of depreciation.
*** Impact salvage value

It is important to understand that the book value for the DB
method never goes to zero, because the book value is always
decreased by a fixed percentage. The implied salvage value after n
years is the Bt amount, that is,
Implied F = Bn = P (1 - K )n Equation 8
If a salvage value is estimated for the asset, this estimated F

value is not used in the DB or DDB method to calculate annual
depreciation.
If the fixed percentage d is not stated, it is possible to determine
an implied fixed rate using the estimated F value, if F > 0. The range for
K is 0 < K < 2/n.
Example 3. A company has purchased an equipment whose first
cost is ₱ 100,000 with an estimated life of eight years. The estimated
salvage values of the equipment at the end of its lifetime are ₱ 20,000.
Demonstrate the calculations of the declining balance method of
depreciation by assuming 0.2 for K.
Solution
P = ₱ 100,000
F = ₱ 20,000
n = 8 years
K = 0.2
(𝑃 − 𝐹 )
𝐷𝑡 =
𝑛
(100,000 − 20,000)
𝐷𝑡 =
8
𝐷𝑡 = ₱ 10,000
The calculations pertaining to Dt and Bt for different values of t

are summarized in Table using the equation 4 and 5:
If we are interested in computing Dt and Bt for a specific period t, the

respective formulae can be used.
Example 4. Underwater electroacoustic transducers were purchased for use

in SONAR applications. The equipment will be DDB depreciated over an expected
life of 12 years. There is a first cost of ₱ 25,000 and an estimated salvage of ₱ 2500.
(a) Calculate the depreciation and book value for years 1 and 4. Write the
spreadsheet functions to display depreciation for years 1 and 4.
(b) Calculate the implied salvage value after 12 years.
Solution
• The DDB fixed depreciation rate is K= 2/n= 2/12 = 0.1667 per year. Use
Equations 5 and 6.
Year 1:𝐷1 = (0.1667)(25,000)(1 − 0.1667)1−1 = ₱ 4,167

𝐵𝑉1 = 25,000(1 − 0.1667)1 = ₱ 20,833
Year 4: 𝐷1 = (0.1667)(25,000)(1 − 0.1667)4−1 = ₱ 2,411
𝐵𝑉4 = 25,000(1 − 0.1667)4 = ₱ 12,054
• The implied salvage value after 12 years

𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐹 = 25,000(1 − 0.1667)12 = ₱ 2, 803
Since the estimated F = ₱ 2,500 is less than ₱ 2,803, the asset is not
fully depreciated when its 12-year expected life is reached.
• Sum-of-the-Years-Digits Method
• It provides very rapid depreciation during the early years of life of
the property, and therefore enables faster recovery of capital.
• The basic assumption for this method is that the value of the
property decreases at a decreasing rate.
• To compute:
a) List the digits corresponding to the number for each
permissible year of life in reverse order
b) Determine the sum of these digits
c) For any year, the depreciation factor is the number from the
reversed-order listing for that year divided by sum of the
digits.
d) The depreciation deduction for any year is the product of the
SYD depreciation factor that year and the difference between the
cost basis (P) and the salvage value (F)
In this method of depreciation also, it is assumed that the book value of

the asset decreases at a decreasing rate. If the asset has a life of eight years,
first the sum of the years is computed as
Sum of the years = 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8

= 36 = n(n + 1)/2
Equation 9
Equation 10
The formulae for Dt and Bt for a specific year t are as follows:
Equation 11
Equation 12
Example 5. A company has purchased an equipment whose first cost is

₱ 1,000,000 with an estimated life of eight years. The estimated salvage
values of the equipment at the end of its lifetime are ₱ 20,000. Demonstrate
the calculations of the sum-of-the-years-digits method of depreciation.
Solution:
P = ₱ 100,000
F = ₱ 20,000
n= 8 years
Sum = n(n + 1)/2 = 8 _ 9/2 = 36
The rates for years 1–8, are respectively 8/36, 7/36, 6/36, 5/36, 4/36, 3/36,
2/36 and 1/36.
The calculations of Dt and Bt for different values of t are summarized in Table
below using the equation 9-10:
If we are interested in calculating Dt and Bt for a specific t, then the

usage of the formulae would be better.
• Sinking Fund Method of Depreciation

• This method depreciates an asset as if the firm were to
make a series of equal annual deposits (a sinking fund) whose
value at the end of the asset's useful life just equaled the cost of
replacing the asset.
• In this method of depreciation, the book value decreases
at increasing rates with respect to the life of the asset.
Let,
i = rate of return compounded annually,
A = the annual equivalent amount,
Bt = the book value of the asset at the end of the period t,
and
Dt = the depreciation amount at the end of the period t.
The loss in value of the asset (P – F) is made available an the form of
cumulative depreciation amount at the end of the life of the asset by
setting up an equal depreciation amount (A) at the end of each period
during the lifetime of the asset.
A = (P – F) [A/F, i, n] Equation 13
The fixed sum depreciated at the end of every time period earns an interest
at the rate of i% compounded annually, and hence the actual depreciation amount
will be in the increasing manner with respect to the time period. A generalized
formula for
Dt is Dt = (P – F) (A/F, i, n) (F/P, i, t – 1). Equation 14
The formula to calculate the book value at the end of period t is
Bt = P – (P – F) (A/F, i, n) (F/A, i, t) Equation 15
The above two formulae are very useful if we have to calculate Dt and Bt for
any specific period. If we calculate Dt and Bt for all the periods, then the tabular
approach would be better.
Example 6.
A company has purchased an equipment whose first cost is ₱ 100,000 with an
estimated life of eight years. The estimated salvage values of the equipment at the
end of its lifetime are ₱ 20,000. Give the calculations regarding the sinking fund
method of depreciation with an interest rate of 12%, compounded annually.
Solution:
P = ₱ 100,000
F = ₱ 20,000
n = 8 years
i = 12%
𝐴 = (𝑃 – 𝐹) [𝐴/𝐹, 12%, 8]
= (100,000 – 20,000) (0.0813)
= ₱ 6,504
In this method of depreciation, a fixed amount of ₱ 6,504 will be depreciated at

the end of every year from the earning of the asset. The depreciated amount will earn
interest for the remaining period of life of the asset at an interest rate of 12%,
compounded annually. For example, the calculations of net depreciation for some
periods are as follows:
Depreciation at the end of year 1 (D1) = Rs. 6,504.

Depreciation at the end of year 2 (D2) = 6,504 + 6,504 x 0.12
= ₱ 7,284.48
Depreciation at the end of year 3 (D3) = 6,504 + (6,504 + 7,284.48) x 0.12
= Rs. 8,158.62
Depreciation at the end of year 4 (D4) = 6,504 + (6,504 + 7,284.48 + 8,158.62)
x 0.12
= ₱ 9,137.65
Table for Book Values
Example 7. A company has purchased an equipment whose first cost is ₱

100,000 with an estimated life of eight years. The estimated salvage values of the
equipment at the end of its lifetime are ₱ 20,000. Compute D5 and B7 using the
sinking fund method of depreciation with an interest rate of 12%, compounded
annually.
Solution:
P = ₱ 1,000,000
F = ₱ 20,000
n = 8 years
i = 12%
Dt = (P – F) (A/F, i, n) (F/P, i, t – 1)
D5 = (P – F) (A/F, 12%, 8) (F/P, 12%, 4)
= (100,000 – 20,000) (0.0813) (1.574)
= ₱ 10,237.30
This is almost the same as the corresponding value given in the table. The
minor difference is due to truncation error.
Bt = P – (P – F) (A/F, i, n) (F/A, i, t)
B7 = P – (P – F) (A/F, 12%, 8) (F/A, 12%, 7)
= 100,000 – (100,000 – 20,000) (0.0813) (10.089)
= 34,381.10
VI. LEARNING ACTIVITIES

Answer the following questions in a HANDWRITTEN FORM using the format
and attach it in the designated ASSIGNMENT tab in our Google Classroom.
1. Define the following:

(a) Depreciation
(b) Book value
2. Distinguish between declining balance method of depreciation and double
declining balance method of depreciation.
3. What is the difference between book value and market value?
4. What is the depreciation rate dt per year for an asset that has an 8-year
useful life and is straight line depreciated?
VII. ASSIGNMENT
(PS No. 8)Answer the following questions in a HANDWRITTEN FORM using
the format and attach it in the designated ASSIGNMENT tab in our Google
Classroom.
1. Paquito estimated the scrap value of a computer shop 20 years after

purchase. He senses that the best depreciation method to use is the
declining-balance method, but he doesn’t know what depreciation rate to
use. He observes that the purchase price of the computer shop was ₱ 245
000 three years ago, and an estimate of its current salvage value is ₱ 180
000. What is a good estimate of the value of the computer shop after 20
years?
2. The Alpha Drug Company has just purchased a capsulating machine for ₱
2,000,000. The plant engineer estimates that the machine has a useful life
of five years and a salvage value of ₱ 25,000 at the end of its useful life.
Compute the depreciation schedule for the machine by each of the
following depreciation methods:
a. Straight line method of depreciation
b. Sum-of-the-years digits method of depreciation
c. declining balance method of depreciation
d. double declining balance method of depreciation
3. A company has purchased a bus for its officers for ₱ 1,000,000. The
expected life of the bus is eight years. The salvage value of the bus at the
end of its life is ₱ 150,000. Find the following using the sinking fund method
of depreciation:
a. Depreciation at the end of the third and fifth year
b. Book value at the end of the second year and sixth year
4. An asset that is book-depreciated over a 5-year period by the straight-line
method has BV3 = ₱ 62,000 with a depreciation charge of ₱ 26,000 per
year. Determine (a) the first cost of the asset and (b) the assumed salvage
value.
VIII. REFERENCES
ARREOLA, M. Engineering Economy. Second Edition. Manila: KEN, Inc.
BESAVILLA, V. I. 1989. Engineering Economics. Cebu City Philippines:

VIB Publishers.
BLANK, L and TARQUIN, A. 2012. Engineering Economics. New York,

USA:McGraw-Hill Companies Inc.
CUARESMA, F.D. 1995-2000. Handouts in Engineering Economy.
CUARESMA, F.D. 2002. Economics of Precision Irrigation Systems. Paper

delivered during the Training on Precision Irrigation Systems for High
Productivity and Efficient Water Management, 4-6 Sept. 2002.
SULLIVAN, William G., Bontadelli James A, and Wicks, Elin M.. 2000.
Engineering Economy. 11th Edition. McMillan Pub. Co., New York:
(recommended text book)
KASNER, E. Essentials of Engineering Economy. New York: Mc. Graw-Hill

Book Co.
RIGGS, J.L., D.D. BEDWORTH., and S.U. RANDHAWA, S.U.1998. 4th

Ed. Engineering Economics . New York: Mc Graw-Hill.
STA. MARIA, H. Engineering Economy Reviewer. Third Edition.
SEPULVEDA, J., SOUDER, W., GOTTFRIED, S.. Theory and Problems of

Engineering Economics. McGraw-Hill Companies:USA. 1984
THUESEN, G.J. and W.J. FABRICKY, W. J. Engineering Economy. New

Jersey: Prentice Hall, Inc. 1989.

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Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

DEGREE PROGRAM BSCE COURSE NO. ENG ECON

I. UNIT TITLE/CHAPTER TITLE

II. LESSON TITLE

III. LESSON OVERVIEW

IV. DESIRED LEARNING OUTCOMES

Depreciation – is defined as the decrease in the value of a property, such

B. REASONS FOR DEPRECIATION

An asset starts to lose value as soon as it is purchased. For example, a

• Use-related physical loss: As something is used, parts wear out. An

1. Straight-Line (SL) Method

The straight-line depreciation method has the great advantage of being

The formulae for depreciation and book value are as follows:

The formulae for depreciation and book value in terms of P are

While availing income-tax exception for the depreciation amount

*** Impact salvage value

If a salvage value is estimated for the asset, this estimated F

The calculations pertaining to Dt and Bt for different values of t

If we are interested in computing Dt and Bt for a specific period t, the

Example 4. Underwater electroacoustic transducers were purchased for use

Year 1:𝐷1 = (0.1667)(25,000)(1 − 0.1667)1−1 = ₱ 4,167

• The implied salvage value after 12 years

In this method of depreciation also, it is assumed that the book value of

Sum of the years = 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8

Example 5. A company has purchased an equipment whose first cost is

Sum = n(n + 1)/2 = 8 _ 9/2 = 36

If we are interested in calculating Dt and Bt for a specific t, then the

• Sinking Fund Method of Depreciation

Dt is Dt = (P – F) (A/F, i, n) (F/P, i, t – 1). Equation 14

The formula to calculate the book value at the end of period t is

Bt = P – (P – F) (A/F, i, n) (F/A, i, t) Equation 15

In this method of depreciation, a fixed amount of ₱ 6,504 will be depreciated at

Depreciation at the end of year 1 (D1) = Rs. 6,504.

Table for Book Values

Example 7. A company has purchased an equipment whose first cost is ₱

VI. LEARNING ACTIVITIES

1. Define the following:

1. Paquito estimated the scrap value of a computer shop 20 years after

BESAVILLA, V. I. 1989. Engineering Economics. Cebu City Philippines:

BLANK, L and TARQUIN, A. 2012. Engineering Economics. New York,

CUARESMA, F.D. 1995-2000. Handouts in Engineering Economy.

CUARESMA, F.D. 2002. Economics of Precision Irrigation Systems. Paper

KASNER, E. Essentials of Engineering Economy. New York: Mc. Graw-Hill

RIGGS, J.L., D.D. BEDWORTH., and S.U. RANDHAWA, S.U.1998. 4th

STA. MARIA, H. Engineering Economy Reviewer. Third Edition.

SEPULVEDA, J., SOUDER, W., GOTTFRIED, S.. Theory and Problems of

THUESEN, G.J. and W.J. FABRICKY, W. J. Engineering Economy. New

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