Engineering Economy Presentation 6 Depreciation Part 1

ENGINEERING
ECONOMY
COURSE CODE: BES211

LEC: 3 Units
DEPRECIATION
Depreciation
Depreciation is the decrease

in the value of physical property with
the passage of time.
VALUE
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 for the property where each has 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 price that is fair to both seller and
buyer.
Definition of Value
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 in a sense if you resell it at
the end of it’s useful life.)
SCRAP VALUE is the amount the property

would sell for if disposed off as junk.
Purposes of Depreciation
1. To provide for the RECOVERY OF CAPITAL

which has been invested in physical property.
2. 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.
Types of Depreciation
1. NORMAL DEPRECIATION
(a) physical
(b) functional
2. Depreciation due to
CHANGES IN PRICE LEVELS.
3. DEPLETION
1. NORMAL DEPRECIATION
(a) physical
(b) functional
PHYSICAL DEPRECIATION is due to the lessening of the physical ability

of a property to produce results. Its common causes are wear and deterioration.
FUNCTIONAL DEPRECIATION is due to the lessening in the demand for

the function which the property was designed to render. Its common causes are
inadequacy, changes in styles, population centers shift, saturation of markets or
more efficient machines are produced.
2. Depreciation due to CHANGES IN

PRICE LEVELS.
DEPRECIATION DUE TO CHANGES IN PRICE LEVELS is almost

impossible to predict and therefore is not considered in economy studies.
3. DEPLETION
DEPLETION refers to the decrease in the

value of a property due to the gradual extraction of
its contents.
Physical and Economic Life
PHYSICAL LIFE of a property is the length of
time during which it is capable of performing the
function for which it was designed and
manufactured.
ECONOMIC LIFE is the length of time during

which the property may be operated at a profit.
Requirements of a
DEPRECIATION METHOD
1. It should be SIMPLE.
2. It should RECOVER CAPITAL.
3. The BOOK VALUE will be REASONABLY

CLOSE to the MARKET VALUE at any time.
4. The method should be ACCEPTED BY THE

BUREAU OF INTERNAL REVENUE.
DEPRECIATION METHODS
We shall use the following symbols for the different depreciation
methods
𝐨
𝐋
(including gain or loss due to removal)
𝐧
𝐧
THE STRAIGHT-LINE METHOD
The Straight-Line Method
This method assumes that the loss in value is directly proportional to the
age of the property.
Example Problem:
An Electronic balance costs P90,000 and has an estimated salvage value of P8,000 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 = 𝐏𝟗𝟎, 𝟎𝟎𝟎 𝐎 𝐋
𝐂𝐋 = 𝐏𝟖, 𝟎𝟎𝟎
𝐋 = 𝟏𝟎
𝐧=𝟑
𝐎 𝐋
𝐧
𝐧 𝐎 𝐧
THE SINKING FUND FORMULA
The Sinking-Fund Formula
This method assumes that a sinking

fund is established in which funds will
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.
The Sinking-Fund Formula
𝐃𝐧 𝐂𝐎 − 𝐂𝐋
0 1 2 3 n L
𝐝 𝐝 𝐝 𝐝 𝐝
𝐎 𝐋 𝐎 𝐋
𝐋
𝐧
𝐧
𝐧 𝐎 𝐧
Example Problem:
A broadcasting corporation purchased an equipment for P53,000 and paid P1,500 for freight and delivery
charges to the job site. The equipment has a normal life of 10 years with a trade-in value of P5,000
against the purchase of a new equipment at the end of the 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 = 𝐏𝟓𝟑, 𝟎𝟎𝟎 + 𝐏𝟏, 𝟓𝟎𝟎 = 𝐏𝟓𝟒, 𝟓𝟎𝟎

𝐂𝐋 = 𝐏𝟓, 𝟎𝟎𝟎
𝐎 𝐋
(a)
𝐎 𝐋
(b) 𝟏𝟎
Example Problem:
A firm bought an equipment for P56,000. Other expenses including installation amounted to P4,000. The
equipment is expected to have a life of 16 years with a salvage value of 10% of the original cost.
Determine the book value at the end of 12 years by (a) the straight-line method and (b) sinking fund
method at 12% interest.
Solution: 𝐂𝐎 = 𝐏𝟓𝟔, 𝟎𝟎𝟎 + 𝐏𝟒, 𝟎𝟎𝟎 = 𝐏𝟔𝟎, 𝟎𝟎𝟎

𝐂𝐋 = 𝐏𝟔𝟎, 𝟎𝟎𝟎 𝟎. 𝟏𝟎 = 𝐏𝟔, 𝟎𝟎𝟎
𝐋 = 𝟏𝟔 𝐧 = 𝟏𝟐 𝐢 = 𝟏𝟐%
(a) Straight-Line Method
𝐎 𝐋
𝐎 𝐋
𝐧
𝐧 𝐎 𝐧
Continuation 𝐂𝐎 = 𝐏𝟓𝟔, 𝟎𝟎𝟎 + 𝐏𝟒, 𝟎𝟎𝟎 = 𝐏𝟔𝟎, 𝟎𝟎𝟎 𝐋 = 𝟏𝟔
(a) Sinking Fund Method 𝐂𝐋 = 𝐏𝟔𝟎, 𝟎𝟎𝟎 𝟎. 𝟏𝟎 = 𝐏𝟔, 𝟎𝟎𝟎 𝐧 = 𝟏𝟐
𝐢 = 𝟏𝟐%
𝐎 𝐋 𝐎 𝐋
𝐋 𝟏𝟔
𝐧 𝟏𝟐
𝐧
𝐧 𝐎 𝐧
DECLINING BALANCE METHOD
THE SUM OF THE YEARS DIGITS
METHOD (SYD)
THE SERVICE OUTPUT METHOD

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ENGINEERING

COURSE CODE: BES211

Depreciation is the decrease

The MARKET VALUE of a property is the

The UTILITY OR USE VALUE of a property

FAIR VALUE is the value which is usually

BOOK VALUE, sometimes called

SALVAGE, or resale, value is the price that

SCRAP VALUE is the amount the property

1. To provide for the RECOVERY OF CAPITAL

2. To ENABLE THE COST OF DEPRECIATION to

PHYSICAL DEPRECIATION is due to the lessening of the physical ability

FUNCTIONAL DEPRECIATION is due to the lessening in the demand for

2. Depreciation due to CHANGES IN

DEPRECIATION DUE TO CHANGES IN PRICE LEVELS is almost

DEPLETION refers to the decrease in the

ECONOMIC LIFE is the length of time during

2. It should RECOVER CAPITAL.

3. The BOOK VALUE will be REASONABLY

4. The method should be ACCEPTED BY THE

This method assumes that a sinking

The TOTAL DEPRECIATION that

Solution: 𝐂𝐎 = 𝐏𝟓𝟑, 𝟎𝟎𝟎 + 𝐏𝟏, 𝟓𝟎𝟎 = 𝐏𝟓𝟒, 𝟓𝟎𝟎

Solution: 𝐂𝐎 = 𝐏𝟓𝟔, 𝟎𝟎𝟎 + 𝐏𝟒, 𝟎𝟎𝟎 = 𝐏𝟔𝟎, 𝟎𝟎𝟎

THE SERVICE OUTPUT METHOD

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