Lecture 12

Topics to be Covered:
- Depreciation and Depreciation Accounting

- Reasons for Depreciation
Lecture 12 - Value of an Asset
- Straight-Line Depreciation
- Declining-Balance Depreciation
- Elements of Financial Accounting
- Measuring the Performance of a Firm
Depreciation and Financial - The Balance Sheet
- The Income Statement
Accounting - The Statement of Changes in Financial Position
- Estimated Values in Financial Statements
- Financial Ratio Analysis
- Financial Ratios
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Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)
Reasons for Depreciation

Depreciation
Assets begin to lose value as soon as they are purchased.
Something bought for $10,000 today may be worth $8,000 next - Use-related physical loss: As things are used, they wear out.
week, $3,000 five years later and $100 in ten years. For example, the surface of a die will wear out a certain
amount each time it produces a part.
This loss in value is called depreciation. Use-related physical loss is often measured in units of
production. This measurement could be kilometers traveled,
thousands of cycles, or hours of use.
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- Time-related physical loss: Some things deteriorate over time - Functional loss: Losses may occur without physical changes.
whether or not they are being used. Things may go out of style (fashion), become technologically
This could be due to environmental factors affecting them or obsolete, or may be affected by legislative changes (pollution
other physical factors. control devices).
For example, an unused tool may rust, and thus lose value over This type of loss is usually expressed simply in terms of the
time. particular unsatisfied function.
This type of loss is expressed in units of time
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Value of an Asset
- Book Value: The depreciated value of an asset for accounting
Depreciation models can be used to estimate the loss in value of an
purposes.
asset, as well as the remaining value of that asset at any point in
time. This remaining value can have several names. Book value can be more or less than market value.
The depreciation model used to arrive at a book value may be
- Market Value: The actual value an asset can be sold for in an open controlled by regulations, such as tax rules, or may be governed
market. by a choice based on the ease of calculation of one method over
Unless the asset is actually sold, market value can only be estimated. another.
Depreciation models may be used to estimate market value.
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Why Bother with Depreciation?
- Scrap Value: can either be the actual value of an asset at the

end of its physical life (when it is scrapped for material recovery) To assist in decision-making: it may be necessary to know the
or a calculated estimate of scrap value using a depreciation model. value of owned assets.
- Salvage value: can either be the actual value of an asset when it To assist in planning: e.g. deciding which equipment to
is sold at the end of its useful life (when it is sold), or an estimate refurbish or replace.
of the salvage value calculated using a depreciation model.
Tax calculation: since the treatment of the depreciation of
assets directly affects expenses and it also affects profit,
hence taxes. The government provides depreciation rules.
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Depreciation Methods
- Double-declining balance
- Straight Line
Depreciation rate is calculated as 2/N with a service life
Book value diminishes by an equal amount each year of N years
- Declining Balance - 150% declining balance:

Book value diminishes by an equal proportion each Depreciation rate is calculated as 1.5/N with a service life
year of N years
- Sum-of-the-year’s-digits - Units-of-production:
The depreciation rate is calculated as the ratio of Depreciation rate is determined per unit of production by
remaining years of life to the sum of the digits of the distributing initial cost over the estimated lifetime of the
remaining life production capacity
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Straight-Line Depreciation
Straight-Line Depreciation
Assumes the rate of loss in value of an asset is constant over
the useful life
P
Dsl(n)= (P - S)/N
Book Value
Dsl(n) = depreciation amount for period n
P = purchase price
S = salvage value S
N = useful life, in periods
BVsl(n) = P - n[(P - S) / N ] Time
0 N
BVsl(n) = book value at the end of period n
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Example 6.1 ( p. 176): Declining-balance depreciation

A laser cutting machine was purchased four years ago. Its Assumes the rate of loss in value of an asset as a constant
purchase price was $380,000. In two years, its salvage value proportion (constant percentage) over the useful life
will be $30,000. Using straight line depreciation, calculate its
current book value Ddb(n) = BVdb(n-1) x d
Ddb(n) = the depreciation amount in period n

Solution:
BVdb(n) = the book value at the end of period n
P = $380,000, S = $30,000, N = 6, n = 4
P = purchase price or current market value
BVsl(4) = 380,000 - 4[ (380,000-30,000) / 6 ]
d = the depreciation rate
BVsl(4) = $146,667
BVdb(0) = P
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Declining-balance depreciation
BVdb(n) = P (1-d)n
P
- Given P and S, the declining balance rate can be estimated as follows:
Value
BVdb(n) = S = P (1-d)n
S S
(1 − d ) = n
P
Time
S N
d = 1− n
P
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Example 6.2 (p. 177):

Paquita wants to estimate the scrap value of a smokehouse twenty
years after purchase. She feels the depreciation is best
represented using the declining-balance method, but she doesn’t
know what depreciation rate to use. She observes that the
purchase price of the smokehouse was $245,000 three years ago,
and an estimate of its current salvage value is 180,000. What is a
good estimate of the of the smokehouse after 20 years?
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Engineering Economy 85-313-(01 & 02)

Lecture 12

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Lecture 12

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Topics to be Covered:

- Depreciation and Depreciation Accounting

Reasons for Depreciation

Depreciation models may be used to estimate market value.

- Scrap Value: can either be the actual value of an asset at the

- Declining Balance - 150% declining balance:

Example 6.1 ( p. 176): Declining-balance depreciation

Ddb(n) = the depreciation amount in period n

- Given P and S, the declining balance rate can be estimated as follows:

Example 6.2 (p. 177):

Engineering Economy 85-313-(01 & 02)

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