MODULE 3

Depreciation

UNIT LEARNING OUTCOMES

 TLO 3: To understand the purposes of depreciation and be able to know how to

solve for different depreciation values.

Diagnostic Test.

Please read the questions and answer on the space provided.

Submit your answers in the Google classroom under classwork
Diagnostic Test M3.1

What is depreciation for you?

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Cite example or situation in which depreciation is applicable.

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 Depreciation

 is the decrease in value of physical properties with the passage of time and
use.

 depreciation is an accounting concept that establishes an annual deduction

against before-tax income such that the effect of time and use on an asset’s
value can be reflected in a firm’s financial statements.

 Is a noncash cost that is intended to “match” the yearly fraction of value used
by an asset in the production of income over the asset’s life. The actual
amount of depreciation can never be established until the asset is retired from
service.

1. Definition of Value

Value, in a commercial sense, is the present worth of all future profits that are to be
received through ownership of a particular property.

 The market value of a property is the amount which a willing buyer will pay to
a willing seller of a property where each has equal advantage and is under no
compulsion to buy or sell.
 The utility or use value of a property is what the property is worth to the owner
as an operating unit.
 Fair value is the value which is usually determined by a disinterested third party
in order to establish a price that is fair to both seller and buyer.
 Book value, sometimes called depreciated book value, is the worth of a
property as shown on the accounting records of an enterprise.
 Salvage, or resale, value is the price that can be obtained from the sale of the
property after it has been used.
 Scrap value is the amount the property would sell for if disposed off as junk.

2. Purpose of Depreciation

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

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 3. Depreciation Methods

We shall use the following symbols for the different depreciation methods:

L = economic or useful life of the property in years

Co= the original cost (including shipping + installation cost)

CL= the value at the end of the life, the scrap/salvage value (including gain or loss
due to removal)

d = the annual cost of depreciation per year

Cn= the book value at the end of n years (C0 –Dn)

Dn= depreciation up to age n year/ total Depreciation or accumulated Depreciation

(a) The Straight Line Method

This method assumes that the loss in value is directly proportional to the age of
the property.

d = (Co – CL) / L

Dn = n {(Co – CL) / L} = n(d)

C n = Co – D n

Example 1:

Power to a remote transmitting station is provided by a Diesel-Electric-Generator unit.

The original cost of the unit is P65,000. It cost P2000 to ship the unit to the job site. An
additional cost of P3000 was incurred for installation. Determine the annual
depreciation expense by the straight line method, if the unit has an expected life of
10 years. The salvage value of the unit at the end of its life was estimated at P5,000.
Given: Co = P65,000+2,000+3,000= P70,000

L = 10 years

CL = P5,000

Required:

d = annual cost of depreciation =?

Solution:

d = 70,000 – 5,000 d = P6,500 answer D2= 6,500 +6,500 = 13,000

10

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 (b) The Sinking Fund Formula

This method assumes that a sinking fund is established in which funds

accumulate for replacement. The total depreciation that has taken place up to any
given time is assumed to be equal to the accumulated amount in the sinking fund at
that time.

d = (Co – CL) / (A/F , i%, L)

Dn = d(F/A , i%, L)

C n = Co – D n

Example 2:

Using the data found in Example 1, determine the annual depreciation expense by
the sinking fund formula. Assume that the annual depreciation charge was
deposited in a fund drawing compound interest at the rate of 5%.

i = 0.05/yr

d = (70,000-5,000) 0.05

(1.05) 10-1

d = 5, 167.80 answer

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 (c) Declining Balance Method

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. The ratio of the
depreciation in any year to the book value at the beginning of that year is constant
throughout the life of the property and is designated by k, the rate of depreciation.

Year Book value at Depreciation during Book value at the end

beginning of year the year of year
1 Co d1 = k Co C1 = Co – d1 = Co(1 – k)
2 Co(1 – k) d2 = k C1 C2 = C1 – d2 = Co(1 – k)2
3 Co(1 – k)2 d3 = k C2 C3 = C2 – d3 = Co(1 – k)3
… … … …
n Co(1 – k)n-1 dn = k Cn-1 Cn = Cn-1 – dn = Co(1 –
k)n
… … … …
L Co(1 – k)L-1 dL = k CL-1 CL = CL-1 – dL = Co(1 –
k)L

d = Co(1 – k)n-1 k

Cn = Co(1 – k)L = Co(CL – Co)n/L

CL = Co(1 – k)L

𝒏 𝑪𝒏 𝑳 𝑪𝑳
k=1- √ =1- √
𝑪𝒐 𝑪𝒐

Note:

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.

The K value can also be assumed by the owner. If in the problem the K value is not
given then the fomula will be used.

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 Example:

If the physical property considered has an original cost of P800,000 and a life of 5
years and is assumed to be depreciated at the rate of 10% per year. Construct the
depreciation schedule.

Given
C0 = P800,000
L = 5 years
K = 10 %

Solution
Depreciation Schedule:

Year Bookvalue at Depreciaton Total Bookvalue at

beginning of per year (d) depreciation end of year Cn
yr. (D)
1 800,000 80,000 80,000 720,000
2 720,000 72,000 152,000 648,000
3 648,000 64,800 216.800 583200
4 583,200 58,320 275.120 524,880
5 524,880 52488 327,608 472,392
Sample computation using table and using formula
d1 = 10% (800,000) = P80,000 or d1 = 800,000(1-.10)0(.10)= 80,000

d3 = 10% (648,000) = P64,800 or d3 = 800,000(1-.10)2 (.10) =64,800

D2 = d1 + d2 = 80,000 + 72,000 = 152,000

C2 = C0 – Dn = 800,000 – 152,000= 648,000 or

C2 = 800,000 (1-.10)2 = 648,000

(d) Double Declining Balance (DDB) Method

This method is very similar to the declining balance method except that the

rate of depreciation k is replaced by 2/L.

𝟐 n-1 𝟐
d = Co (1 - )
𝑳 𝑳

𝟐 n
Cn = Co (1 - )
𝑳
𝟐 L
CL = Co (1 - )
𝑳

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 (e) The Sum-of-the-Years’-Digits (SYD) Method

Let dn = depreciation charge during the nth year

dn = (depreciation factor) ( total depreciation)

𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕
dn = (Co – CL)
𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔

Example :

Construct the depreciation schedule of an equipment that costs P 800,000 with a 5

year life and a salvage value of P100,000.

Solution:

Depreciation Schedule

Year Year in Depreciation Depreciation Total Bookvalue

Reverse factor per year Depreciation at end of
year
1 5 5/15 233,333 233,333 566,667
2 4 4/15 186,667 420,000 380.000
3 3 3/15 140,000 560,000 240,000
4 2 2/15 93,333 653,333 146,667
5 1 1/15 46,667 46,667 100,000
Sum= 15

(f) The Service – Output Method

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. This method has
the advantage of making the unit cost of depreciation constant and giving low
depreciation expense during periods of low production.

Let T = total units of output up to the end of life

Qn = total number of units of output during the nth
year
(𝐂𝐨 – 𝐂𝐋)
Depreciation per unit of output =
𝑻
(𝐂𝐨 – 𝐂𝐋)
dn = (Qn)
𝑻

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 Example:

Construct the depreciation schedule of an equipment with original cost of P500,000

and a salvage value of P200,000 and a life of 4 years, using service output method
if the maximum units it can produce is 1,000,000 units of product. The quantity
produced per year are as follows: Year 1 200,000 units, Year 2 150,000 units, Year 3,
300,000, Year 4 350,000.

Given:

T = 1,000,000

Co = P500,000

CL = 200,000

L = 4 years

Solution:

Depreciation per unit = 500,000 -200,000 = 0.30 per unit

1,000,000

Year Qn Depreciation Total Book value

per year Depreciation at end of
year
1 200,000 60,000 60,000 440,000
2 150,000 45,000 105,000 395,000
3 300,000 90,000 195,000 305,000
4 350,000 105,000 300,000 200,000
Total 1,000,000 300,000

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 The above discussions are further clarified by the following examples. Examining the
solution to each example can give you deeper insights into the subject matter.

Example 1: An electronic balance costs ₱90,000 and has estimated salvage value of ₱8,000
at the end of its 10 years’ life time. What would be the book value after three years, using
the straight line method in solving for the depreciation?
Solution:
Co = ₱90,000 CL = ₱8,000 L = 10 n=3
d = (Co – CL) / L = (₱90,000 - ₱8,000) / 10 = ₱8,200

Dn = (n) (d) = (3) (₱8,200) = ₱24,600

Cn = Co – Dn = (₱90,000 - ₱24,600) = ₱65,400

Example 2: 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 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
6-1/2% compounded annually.
Solution:
Co = ₱53,000 + ₱1,500 = ₱54,500
CL = ₱5,000

(a) d = (Co – CL) / L = (₱54,500 - ₱5 ,000) / 10 = ₱4,950

(b) d = (Co – CL) / (F/A,i%,L) = (₱54,500 - ₱5 ,000) / (13.3846) = ₱3,668

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 Example 3: A certain type of machine loses 10% of its value each year. The machine costs
₱2,000.00 originally. Make out a schedule showing the yearly depreciation, the total
depreciation and the book value at the end of each year for 5 years.
Solution:

Year Book value at Depreciation Total depreciation Book value at the

beginning year during the year at the end of year end of year
10%
1 ₱2,000.00 ₱200.00 ₱200.00 ₱1,800.00
2 1,800.00 180.00 380.00 1,620.00
3 1,620.00 162.00 542.00 1,458.00
4 1,458.00 145.80 687.80 1,312.20
5 1,312.20 131.22 819.12 1,180.98

Example 4: Determine the rate of depreciation, the total 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 the double declining
balance method.
Solution:
Rate of depreciation = 2/ L = 2 / 20 = 0.20 or 20%
2 n 2 8
Cn = Co (1 - ) = ₱15,000 (1 - ) = ₱2,517
𝐿 10

Dn = Co – CL = ₱15,000 – ₱2,517 = ₱12,483

Example 5: 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.
Solution:
Co – CL = ₱12,000 – ₱1,000 = ₱11,000

Year Year in Depreciation during the year Book value at end of

Reverse year
order
1 5 (5/15) (₱11,000) = ₱3,667 ₱8,333
2 4 (4/15) (₱11,000) = 2,933 5,400
3 3 (3/15) (₱11,000) = 2,200 3,200
4 2 (2/15) (₱11,000) = 1,467 1,733
5 1 (1/15) (₱11,000) = 733 1,000
∑ 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 = 15

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 Work on the following exercise. This is an opportunity for you to practice your knowledge
and skills you acquired in this unit. Final answers are provided at the end of each problem to
serve as your guide. Submit your work to our Google classroom under classwork Exercises
M3.1
1. A machine shop purchased 10 years ago a milling machine for ₱60,000. A straight-
line depreciation reserve had been provided on a 20 year life of the machine. The
owner of the machine shop desires to replace the old milling machine with a modern
unit of many advantages costing ₱100,000. It can sell the old unit for ₱20,000. How
much new capital will be required for the purchase? Ans: ₱50,000

2. A tax and duty free importation of a 30 HP sandmill (for paint manufacturing) cost
₱360,000, CIF Manila. Bank charges, arrastre ₱25,000. Other incidental expenses
amounted to ₱20,000. Salvage value of the mill is estimated to be ₱60,000 after 20
years. Find the appraisal value of the mill, using straight-line depreciation, at the end
of (a) 10 years and (b) 15 years? Ans: (a) ₱235,000 (b) ₱147,500

3. An industrial plant bought a generator set for ₱90,000. Other expenses including
installation amounted to ₱10,000. The generator set is to have a life of 17 years with a
salvage value at the end of life of ₱5,000. Determine the depreciation charge during
the 13th year and the book value at the end of 13 years by the (a) declining balance
method, (b) double declining balance method, (c) sinking fund method at 12% and
(d) SYD Method. Ans: (a) ₱1,949; (b) ₱2,620; ₱19,649; (c) ₱1,943; ₱45,539; (d) ₱3,105;
₱11,209

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 Work on the following problems which will be submitted as written assignments. Requirement
for assignments are it should be hand written, neat and complete with problem, given,
solution and final answers properly enclosed in a box. Submit the written assignment in our
Google classroom under classwork Assignment M3.2

1. During the construction of a highway bypass, earth moving equipment costing

P400,000 was purchased for use in transporting fill from the borrow pit. At the end of
the 4-year project, the equipment will be sold for P200,000. The schedule for moving
fill calls for a total of 100,000 cubic feet during the project. In the first year, 40% of the
total fill is required; in the second year, 30%; in the third year 25%; and in the final year,
the remaining 5%. Determine a) the units-of-production depreciation schedule b) the
declining balance depreciation schedule.

2. A central air conditioning unit was installed on January 1, 2000 at an initial cost of
P650,000 and was expected to have a salvage value of P50,000 after a life of 7
years.
a. What amount of depreciation had accumulated in a sum-of-the-years’-digit
method at the end of 2003?
b. Using the declining balance method, determine the depreciation charged
for 2004 and the bookvalue at the end of 2004
c. If the equipment was sold on Jan 1, 2005 for P100,000, what amount of loss
would result from this sale if sinking fund method was being used with interest
of 12% per year?

End of Module 3

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