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ECONOMY
DEPRECIATION &
VALUATION
DEFINITION OF TERMS AND
METHODS Cont’d...
TOPIC OBJECTIVES:
Continuation of DEPRECIATION &
VALUATION
◦ Learn the other Depreciation Methods as
follows:
Declining Balance Method
Double Declining Balance (DDB) Method
Sum-of-the-years’-Digits (SYD) Method
Service Output Method
◦ Solve sample problems on these Depreciation
Methods
DEPRECIATION METHODS – The
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
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.
DEPRECIATION METHODS – The
Declining Balance Method
The declining balance procedure, like the straight
line method, is simple to apply. However, it has two
weaknesses as follows:
◦ The annual cost of depreciation is different each year
and, from an engineering economy viewpoint, this is
inconvenient.
◦ Also with this formula, an asset can never depreciate
to zero value.
DEPRECIATION METHODS – The
Declining Balance Method
C₀ C₁ C₂ C₃ Cn- 1 Cn CL – 1 CL
0 1 2 3 n–1 n–1 L–1 L
d₁ d₂ d₃ dn dL
n CL L CL
k =1– ---- = 1 – ---- (3-10)
C₀ C₀
2 n–1 2
dn = C₀ (1 – ---) --- (3-11)
L L
2 n
Cn = C₀ (1 – ---) (3-12)
L
2 L
CL = C₀ (1 – ---) (3-13)
L
When the DDB method is used, the salvage value should not be
subtracted from the first cost when calculating the depreciation
charge.
DEPRECIATION METHODS –
Double Declining Balance Method
Problem 2:
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 PHP15,000 new and has an estimated scrap
value of PHP2,000 at the end of 10 years by (a) the declining
balance method and (b) the double-declining balance method.
Solution:
C₀ = P15,000 CL = P2,000 L = 10 n = 8
L CL 10 P2,000
k =1– --- = 1 – ----------- = 0.1825 or 18.25%
C₀ P15,000
DEPRECIATION METHODS –
Double Declining Balance Method
Problem 2 cont’d:
C₈ = C₀ (1 – k)⁸ = P15,000 (1 – 0.1825)⁸ = P2,992
reverse digit
dn = ----------------- (C₀ – CL ) (3-14)
sum of digits
DEPRECIATION METHODS –
Sum-of-the-Years’-Digits Method
For example, for a property whose life is 5 years,
Year in
Depreciation Depreciation during
Year reverse
factor the year
order
1 5 5/15 (5/15) (C₀ – CL )
2 4 4/15 (4/15) (C₀ – CL )
3 3 3/15 (3/15) (C₀ – CL )
4 2 2/15 (2/15) (C₀ – CL )
5 1 1/15 (1/15) (C₀ – CL )
Σ of digits = 15
DEPRECIATION METHODS –
Sum-of-the-Years’-Digits Method
Problem 4:
A structure costs PHP12,000 new. It is estimated to have a life of 5
years with a salvage value at the end of life of PHP1,000. Determine
the book value at the end of each year of life.
Solution:
C₀ – CL = P12,000 – P1,000 = P11,000
C₀ – CL
(A) d = --------------- = (C₀ – CL )(A/F, 6%, 15)= $960,000,000(0.0430)
F/A, 6%, 15
d = $41,280,000
L (L + 1) 15(15 + 1)
(B) Sum of digits = ------------- = -------------- = 120
2 2
8
d₈ = ------ ($960,000,000) = $64,000,000
120
DEPRECIATION METHODS –
Service-Output Method
Some companies attempt to compute the depreciation
of equipment on the basis of its output. When
equipment is purchased, an estimate is made of the
amount of service it will render during its economic life.
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.
DEPRECIATION METHODS –
Service-Output Method
Let T = total units of output up to the end of life.
Q n = total number of units of output during the nth
year
C₀ – CL
Depreciation per unit of output = -------------
T
C₀ – CL
dn = (-------------) (Qn ) (3-15)
T
DEPRECIATION METHODS –
Service-Output Method
Problem 6:
A television company purchased machinery for PHP100,000
on July 1, 1979. It is estimated that it will have a useful life of
10 years; scrap value of PHP4,000, 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 machinery
produces 36,000 units in 1979 and 44,000 units in 1980.
Compute the depreciation for 1980 using the following
methods:
(1) Straight line
(2) Working hours
(3) Output method
DEPRECIATION METHODS –
Service-Output Method
Solution:
C₀ = P100,000 CL = P4,000 L = 10 years
T = 400,000 units H = 120,000 hours
C₀ – CL P100,000 – P4,000
(1) d 80 = ----------- = ------------------------- = PHP9,600
L 10
C₀ – CL P100,000 – P4,000
(2) d 80 = ----------- H80 = -------------------------- (18,000)
H 120,000
d 80 = PHP14,400
C₀ – CL P100,000 – P4,000
(3) d80 = ----------- Q = (--------------------------)(44,000)
T 400,000
d80 = PHP10,560