ENGINEERING

ECONOMY
DEPRECIATION &
VALUATION
WHICH METHOD SHOULD BE USED?
/ VALUATION
TOPIC OBJECTIVES:
 Which depreciation method should be
used?
 Valuation
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 With a number of methods of computing
depreciation available, we need to know which to
use in making economy studies, and the effects of
these methods when used for accounting purposes.
 Recalling that for general accounting purposes the
objective of a depreciation method is to assure that
the cost of depreciation is recognized and set aside
out of revenue so as to assure computation of the
proper amount of profits.
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 It is also worth mentioning what the Bureau of Internal
Revenue (BIR) says about depreciation specifically
Section 29 (f).
◦ GENERAL RULE: “There shall be allowed as a depreciation
deduction a reasonable allowance for the exhaustion, wear
and tear (including reasonable allowance for obsolescence)
of a property used in the trade or business.”
◦ Use of certain methods and rates. The term
“reasonable allowance” as used in the preceding
paragraph shall include (but not limited to) an
allowance computed in accordance with regulations
prescribed by the Secretary of Finance, under any of
the following methods:
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 The straight line method
 Declining balance method, using a rate not exceeding
twice the rate which would have been used had the
annual allowance been computed under the method
described in paragraph (f) (1).
 The sum-of-the-years’-digits method; and
 Any other method which may be prescribed by the
Secretary of Finance upon recommendation of the BIR
commissioner.
◦ NOTES: Taxpayer may enter into an “agreement in
writing specifically dealing with the useful life and rate
of depreciation of any property, the rate so agreed
upon shall be biding.”
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 1:
A machine costs PHP7,000, lasts 8 years and has a salvage value at
the end of life of PHP350. Determine the depreciation charge
during the 4th year and the book value at the end of 4 years by the
(a) straight line method, (b) declining balance method; (c) SYD
method; (d) sinking fund method with interest at 12%.
Solution:
C₀ = P7,000 CL = P350 L=8 n=4

(a) Straight line method

C₀ – CL P7,000 – P350
d = ------------ = -------------------- = P831
L 8

C₄ = C₀ – D₄ = P7,000 – P831(4) = PHP3,676

WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 1 cont’d:
(b) Declining balance method

L CL 8 P350
k =1– ----- = 1 – ----------- = 0.3123
C₀ P7,000

d₄ = C₀ (1 – k)4 – 1 k = P7,000(1 – 0.3123)³ (0.3123)

= P711

C₄ = C₀ (1 – k)⁴ = P7,000(1 – 0.3123)⁴ = PHP1,566

WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 1 cont’d:
(c) SYD method
8(8 + 1)
1 8 Sum of digits = -------------- = 36
2
2 7
3 6 d₄ = (5/36)(P7,000 – P350) = P924
4 5 D₄ = (26/36)(P7,000 – P350) = P4,803
5 26
6
7 C₄ = C₀ – D₄ = P7,000 – P4,803 = PHP2,197
8
36
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 1 cont’d:
(d) Sinking fund method

C₀ – CL P7,000 – P350
d = --------------- = --------------------- = P541
F/A, 12%, 8 12.2997

D₄ = d(F/A, 12%, 4) = P541(4.7793) = P2,586

C₄ = C₀ – D₄ = P7,000 – P2,585 = PHP4,414

WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 2:
A machine costs PHP20,000 and has a salvage value of
PHP2,000 after a useful life of 8 years. Money is worth 12%. If
average inflation is 8% per year during this period, what is the
annual cost of depreciation to replace the machine after 8
years? What is the annual cost of depreciation if inflation is
not considered?
Solution:
With inflation:
Future cost = PC (1 + f )n = P20,000 ( 1 + 0.08 )⁸
= P37,018
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 2 cont’d:
P35,018

0 1 2 3 8

A A A A

FC P35,018
A = ---------------- = -------------- = PHP2,847.06
F/A, 12%, 8 12.2997
WHAT DEPRECIATION
METHOD SHOULD BE USED?
 Problem 2 cont’d:
Without inflation: P18,000

0 1 2 3 8

A A A A

P18,000 P18,000
A = ---------------- = ------------- = PHP1,463
F/A, 12%, 8 12.2997
VALUATION
 Frequently the engineer is called upon to decide the value of
engineering properties. The reasons for determining the
value of property vary.
 Similarly, a valuation that is correct for one need may not be
correct for another.
 The need for determining the value of property often occurs
when a private buyer is purchasing a property from a private
owner.
 When a municipality wishes to purchase a privately owned
utility plant, the value must be decided upon. In establishing
utility rates, the regulating bodies must arrive at a fair value
of the property that is used to render the service.
VALUATION
 If the company examines the book value of a property at
periodic intervals in order to determine whether the
established depreciation rates are adequate, it must have
some method of establishing the correct value of the
property.
 Obviously, both physical and functional depreciation affect
the value of a property. Addition to and deletions from a
property also will affect its value. But another, and very
troublesome, factor is the matter of price changes due to
inflation and deflation.
 Valuation or appraisal is the process of determining the value
of a certain property for specific reasons. The person
engaged in the task of valuation is called the appraiser.
INTANGIBLE VALUES
 In the determination of the value of an industrial
property or equipment, four intangible items are often
encountered. These are as follows:
◦ Goodwill – It is that element of value which a business has
earned through the favourable consideration and
patronage of its customers arising from its well-known and
well conducted policies and operations.
◦ Franchise – It is an intangible item of value arising from the
exclusive right of a company to provide a specific product
or service in a stated region of the country.
INTANGIBLE VALUES
◦ Going value – It is an intangible value which an actually
operating concern has due to its operation. As a rule, 8 to
15% of the value of the assets is allowed for going value.
◦ Organization cost – It is the of money spent in organizing a
business and arranging for its financing and building.