ENS 191- Engineering Economy

Chapter 3

Depreciation
Engr. Myra V. Cabatingan
Depreciation

§ Reduction in the value of an asset over time.

§ Depreciation is the decrease in value of physical properties with the passage of
time and use.
§ Cost of usefulness or cost of diminution of service yield a used of fixed asset.

Some examples of assets that are

Allocating costs of long-lived assets:
depreciated include:
•Buildings (excluding land)
• Fixed assets = Depreciation expense
•Machinery and equipment • Intangibles = Amortization expense
•Trucks and automobiles • Natural resources = Depletion expense
•Computer systems
•Furniture and fixtures
•Land improvements (parking lots, outdoor lighting, etc.)

Engineering Economy 1
Definition
Value (in commercial sense)
• The present worth of all future profits that are to be received through
ownership of a particular property

The Market Value of a Property

• The amount which a willing buyer will pay to a willing seller for the property
where each has equal advantage and is under no compulsion to buy or sell

The Fair Value of a Property

• The value which is usually determined by a disinterested party in order to
establish a price that is fair to both seller and buyer

The Utility or Use Value of a Property

• What the property is worth to the owner as an operating unit

Engineering Economy 2
Definition

Book Value, BV
• Sometimes called Depreciated Book Value
• The worth of a property as shown on the accounting records of an enterprise

Salvage or Resale Value, S

• The price that can be obtained from the sale of the property after it has been
used

Scrap Value
• The amount the property would sell for if disposed off as junk

Engineering Economy 2
Definition
Physical life of a Property
• The length of time during which it is capable for performing the function for which
it was designed and manufactured

Economic Life
• The length of time during which the property may be operated at a profit

Physical Depreciation
• Due to the lessening of physical ability of a property to produce results
• Wear and tear of the property

Functional Depreciation
• Due to the lessening in the demand for the function which the property was
designed to render
• relates to deficiencies in the property's functionality or utility

Engineering Economy 2
Definition
Depletion
• The decrease in the value of a property due to the gradual extraction of its contents

Valuation or Appraisal
• The process of determining the value of certain property for specific reasons

Appraiser
• The person engaged in the task of valuation

Trade-In Allowance
• The amount by which the seller reduces the sale price of a property in return for the
property of the buyer (i.e. a new item is offered at a lower price if the customer brings the
old item for return or exchange)

Engineering Economy 2
Depreciation

• Definition: Loss of value for a fixed asset

• Example: You purchased a car worth $15,000 at the beginning of year 2021

End of Year Market Value Loss Value

0 $ 15,000
1 $ 10,000 $ 5,000

Depreciation
2 $ 8,000 $ 2,000
3 $ 6,000 $ 2,000
4 $ 5,000 $ 1,000
5 $ 4,000 $ 1,000

Engineering Economy 2
Purpose of Depreciation

Ø To provide for the recovery of capital which has been invested in physical
property.
Ø To enable the cost depreciation to be charge to the cost of producing
products or services that results form the used of the property.

Types of Depreciation:
Ø Normal Depreciation
a. physical Economic depreciation
b. functional
Ø Depreciation due to changes in price level
Ø Depletion

Engineering Economy 2
Asset Depreciation Concept

1. Economic Depreciation
• The decline in the economic value of an asset over time.
• Economic loss due to both physical deterioration and
technological obsolescence
Causes:
- wear and tear
- New technology replacing the old technology
- Perishability
- Expiration of rights

2. Accounting Depreciation
• A systematic allocation of cost basis over a period of time
• Often used in engineering economic analysis

Engineering Economy 2
Requirements of a Depreciation Method

Ø It should be simple.
Ø It should recover the capital.
Ø The book value will be reasonably close to the market value at any time.
Ø The method should be accepted by Bureau of Internal Revenue.

Factors Affecting Depreciation:

Engineering Economy 2
What Can Be Depreciated?

• Assets used in business or held for production of income

• Assets having a definite useful life and a life longer than one year

• Assets that must wear out, become obsolete or lose value

A qualifying asset for depreciation must satisfy all of the three conditions above.

Engineering Economy 2
Depreciation Methods

1. Straight-Line Method
2. Sinking Fund Method
3. Declining Balance Method
4. Double Declining Method
5. Sum of the Years’ Digits (SYD) Method
6. Unit Production Method

Engineering Economy 2
Depreciation Methods
Symbols for different depreciation method:

L = useful life of property in years

CO = the original cost
CL = the value at the end of the life, the scrap value(including gain or
loss due to removal)
d = the annual cost of depreciation
Cn = the book value at the end of n years
Dn = depreciation charge during the nth years
T = total units of output up to end of life
k = rate of depreciation

Engineering Economy 2
1. The Straight-Line Method
Principle

• A fixed asset is providing its service in a

uniform fashion over its life
• Assumes that the loss in value is directly
proportional to the age of the
property

Formula

Engineering Economy 2
Example
2. 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) straight-line method.

Given:
Initial Cost, Co = ₱90,000 + ₱10,000 = ₱100,000 a.
Scrap Value, CL = ₱5,000
Useful Life of Property, L = 17 years
�100,000−�5,000
= = P5,584.24
17

Required: = (13) (P5,584.24) = P 72,595.12

Depreciation charge during the 13th , d13
Book value at the end of 13 years, C13
= P1000,000 – P72,595.12

= P 27,404.88

Engineering Economy 2
Example
1. An electronic balance costs P90,000 and has estimated salvage value of P8,000 at the end of 10
years
life time. What would be the book value after three years, using the straight-line method in solving for
the depreciation?.

Given:
Initial Cost, Co = ₱90,000 a.
Salvage Value, CL = ₱8,000
Useful Life of Property, L = 10 years
�90,00−�8,000
= = P8,200
10
Required:
= (3) (P8,200) = P 24,600
Book value after 3 years, C3

= P90,000 – P24,600

= P 65,400

Engineering Economy 2
 2. The Sinking Fund Method Principle
• A technique for depreciating an asset while generating
enough money to replace it at the end of its useful life
• Assumes that a sinking fund is established in which
funds will accumulate for replacement
• These funds sit in a sinking fund account and generate
interest
• 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.

Formula

Engineering Economy 2
Example
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
(b) sinking fund method at 12%

Given:
Initial Cost, Co = ₱90,000 + ₱10,000 = ₱100,000 b.
Scrap Value, CL = ₱5,000
Useful Life of Property, L = 17 years
Rate of Interest, I = 12%

Required:
Depreciation charge during the 13th , d13
Book value at the end of 13 years, C13

Engineering Economy 2
3. The Declining Balance Method Principle
• Where assets experience a more rapid decline in value in the earlier years of their useful life.
• It is assumed that the annual cost of depreciation is a fixed percentage of the salvage value
at the beginning of the year
• This method does not apply if the salvage value (CL ) is zero. because k will be equal to 1
and d1 will be equal to C0 .
- allocates higher depreciation expenses in the earlier years of an asset's life and lower expenses
in the later years.

Formula

2
Engineering Economy
Example
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
(c) declining balance method

�� = �0 ((1 − �)�−1 )�
Given:
Initial Cost, Co = ₱90,000 + ₱10,000 = ₱100,000 �� = ₱100,000((1 − 0.1616)13−1 )0.1616
Scrap Value, CL = ₱5,000
Useful Life of Property, L = 17 years �� = ₱�, ���

�13 = �0 ((1 − �)�

�13 = ₱100,000((1 − 0.1616)13

��� = ₱��, ���. ��

��� = �� − ��
�13 = ₱100,000 − ₱10,112.69 = ₱89,887.31

2
Engineering Economy
 4. The Double Declining Balance Method Principle
• Very similar to the Declining Balance Method except that the rate of depreciation,
k , is replaced by 2/L
• assets experience higher levels of depreciation in their earlier years, and the
asset's productivity or value decreases more rapidly at the beginning of its useful
life.
Formula

Engineering Economy 2
Example
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
(d) double declining balance method.

�−1
2 2
Given: d. �� = �0 1 −
Initial Cost, Co = ₱90,000 + ₱10,000 = ₱100,000 � �
Scrap Value, CL = ₱5,000 13−1
2 2
Useful Life of Property, L = 17 years �� = ₱100,000 1 −
17 17
Required:
Depreciation charge during the 13th , d13 �� = ₱�, ���. ��
Book value at the end of 13 years, C13
�
2 �� = �0 − ��
�� = �0 1 −
�
13
�� = ₱100,000 − ₱19,649.45
2
�� = ₱100,000 1 − = ₱��, ���. �� �� = ₱��, ���. ��
17

Engineering Economy
2
5. The Sum-of-the-Years-Digits (SYD) Method Principle
• Depreciation concept similar to DB but with decreasing depreciation rate.
• Charges a larger fraction of the cost as an expense of the early years than of the
later years
1 2 3 4 5 = 15
5 4 3 2 1 = 15
Formula

RD= (L-n+1) SYD= L/2 (1+L)

Engineering Economy 2
6. The Service-Output Method Principle
• Assumes that the total depreciation that has taken place is directly proportional to
the quantity of output of the property up to that time
• Has the advantage of making the unit cost of depreciation constant and giving low
depreciation expense during periods of low production

Formula
Let
T = total units of output up to end of life
Qn = total number of units of output during the nth
year

H = total working hours up to end of life

Hn = total number of working hours during the nth year

Engineering Economy 2
Example
A television company purchased machinery for ₱100,000 on July 1, 1979. It is estimated that it will
have a useful life of 10 years; scrap value of ₱4,000, production of 400,000 units and working hours
of 120,000. The company uses the machinery for 14,000 hours in 1979 and 18,000 hours in
1980.The company produces 36,000 in 1979 and 44,000 units in 1980. Compute the depreciation for
1980 using each method given below: 1) Straight Line Method 2) Working Hours 3) Output Method

Given:
Co = ₱100,000 = ₱9,600
CL = ₱4,000
L = 10 years
T = 400,000 = ₱14,400
H = 120,000 hours

= ₱10,560

Engineering Economy 2
Example
A plant bought a calciner for P220,000 and used it for 10 years, the life span of equipment. What is the
book value of the calciner after 5 years of use? Assume a scrap value of P20,000 for straight line method;
P22,000 for textbook declining balance method and P20,000 for the double declining balance method.

Co = ₱220,000 n=5 L = 10 years

b. Declining balance method
�
a. Straight line method (�22,000) ��
=
CL = ₱22,000 �220,000
5(�220,000 − �20,000) = ₱69,570
=
� c. Double declining balance method
= ₱100,000 CL = ₱20,000

= (P220,000 – P100,000)

= ₱120,000 5
�
= ₱220,000 1 -
��
C5= ₱72,090
Engineering Economy 2