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ENGINEERING

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

d n = depreciation during the nth year


Year Book value at the Depreciation Book value at the end of the
beginning of year during the year year
1 C₀ d₁ = kC₀ C₁=C₀ – d₁= C₀(1 – k)
2 C₀ (1 – k) d₂ = kC₁ C₂=C₁ – d₂= C₀(1 – k)²
3 C₀ (1 – k)² d₃ = kC₂ C₃= C₂ – d₃= C₀(1 – k)³
--- --- --- ---
n–1 n
n C₀ (1 – k) dn = kC n – 1 C n =C n – 1 – dn = C₀(1 – k)
--- --- --- ---
L–1
L C₀ (1 – k) dL = kC L – 1 CL =C L – 1 – d = C₀(1 – k)L
DEPRECIATION METHODS – The
Declining Balance Method
d n = C₀ (1 – k)n – 1 k (3-7)
n
---
C L
C n = C₀ (1 – k)n = C₀ ----L (3-8)
C₀
L
CL = C₀ (1 – k) (3-9)

n CL L CL
k =1– ---- = 1 – ---- (3-10)
C₀ C₀

 This method does not apply if the salvage value is zero


because k will be equal to one and d₁ will be equal to C₀.
DEPRECIATION METHODS – The
Declining Balance Method
 Problem 1:
A certain type of machine loses 10% of its value each year.
The machine costs PHP2,000.00 originally. Make out a
schedule showing the yearly depreciation, the total
depreciation and the book values at the end of each year for
5 years.

Year Book value at Depreciation Total Book value at


beginning of during the year, depreciation at end of year
year 10% end of year
1 PHP2,000.00 PHP200.00 PHP200.00 PHP1,800.00
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
DEPRECIATION METHODS –
Double Declining Balance Method
 In this procedure the depreciation rate k is computed as 2/L
with any prospective final salvage value being disregarded.

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

(a) Declining balance method

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

D₈ = C₀ – C₈ = P15,000 – P2,992 = PHP12,008

(b) Double declining balance method


Rate of depreciation = 2/L = 2/10 = 0.20 or 20%

C₈ = C₀ (1 – 2/L)⁸ = P15,000 (1 – 2/10)⁸ = P2,517

D₈ = C₀ – C₈ = P15,000 – P2,517 = PHP12,483


DEPRECIATION METHODS –
Double Declining Balance Method
 Problem 3:
A plant bought a calciner for PHP220,000 and used it for 10 years,
the life span of the equipment. What is the book value of the
claciner after 5 years of use? Assume a scrap value of PHP20,000
for straight line method; PHP22,000 for textbook declining balance
method and PHP20,000 for the double declining balance method.
Solution:
C₀ = P220,000 L = 10 n = 5 CL = P20,000

(a) Straight line method

n(C₀ – CL ) 5(P220,000 – P20,000)


D₅ = -------------- = ----------------------------- = P100,000
L 10
DEPRECIATION METHODS –
Double Declining Balance Method
 Problem 3 cont’d:
C₅ = C₀ – D₅ = P220,000 – P100,000 = PHP120,000

(b) Declining balance method CL = P22,000


n 5
CL --- P22,000 ) = PHP69,570
---
C₅ = C₀ (-----)L= P220,000 (-------------10
C₀ P220,000

(c) Double declining balance method

C₅ = C₀ (1 – 2/L)⁵ = P220,000 (1 – 2/10)⁵ = PHP72,090


DEPRECIATION METHODS –
Sum-of-the-Years’-Digits Method
 In order to obtain the depreciation charge in any year of life
by the sum-of-the-years’-digits method (commonly designated
as SYD), the digits corresponding to the number of each year
of life are listed in reverse order. The sum of these digits then
is determined, or in other words, the sum of the digits for a
life L can be calculated by the relationship L (L + 1)/2.

Let d n = depreciation charge during the nth year

dn = (depreciation factor) (total depreciation)

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

Year in Depreciation during the Book value at


Year
reverse order year the end of year
1 5 (5/15)(P11,000) = P3,667 P8,333
2 4 (4/15)(P11,000) = P2,933 5,400
3 3 (3/15)(P11,000) = P2,200 3,200
4 2 (2/15)(P11,000) = P1,467 1,733
5 1 (1/15)(P11,000) = P733 1000
Σ of digits = 15
DEPRECIATION METHODS –
Sum-of-the-Years’-Digits Method
 Problem 5:
A consortium of international telecommunications
companies contracted for the purchase and installation of a
fiber optic cable linking two major cities at a total cost of
$960 million. This amount includes freight and installation
charges estimated at 10% of the above contract price. If the
cable shall be depreciated over a period of 15 years with
zero salvage value;
(a) Given the sinking fund deposit factor of 0.0430 at 6%
interest where n = 15, what is the annual depreciation
charge?
(b) What is the depreciation charge during the 8th year using
the sum-of-the-years’-digits method?
DEPRECIATION METHODS –
Sum-of-the-Years’-Digits Method
Solution:
C₀ = $960,000,000 CL = 0 L = 15

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

Reverse digit corresponding to the 8th year of life = 8

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