Finals Week 5

Lesson 5: Depreciation

Topic: Straight Line Method

Sinking Fund Formula

Declining Balance Method

Double Declining Method

Sum of Years’ Digit Method

Service-Output Method

Learning Outcomes: At the end of this module, you are expected to:

1. Use a specific method to reduce the value of capital invested in an asset or natural resource.
2. Understand and use the basic terminologies of depreciation.
3. Determine the different depreciation methods.
4. Apply the different depreciation methods.

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LEARNING CONTENT

DEPRECIATION

- is the decrease in the value of physical property with the passage of time.

DEFINITION OF TERMS:

Value - is the present worth of all future profits that are to be received through ownership of a particular
property.

Market Value – is the amount which a willing buyer will pay to a willing seller for the property where each has
an equal advantage and is under no compulsion to buy or sell.

Utility or use value – 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 a price
that is fair to both seller and buyer.

Book Value – sometimes called depreciated book value, is the worth of a property as shown on the accounting
records of an enterprise.

Salvage value – or resale, value is the price that can be obtained from the sale of the property after it has
been used.

Scrap value – is the amount the property would sell for if disposed-off as junk.

Depreciation rate - or recovery rate dt is the fraction of the first cost removed by depreciation each year.

Physical Life – is the length of time of a property during which it is capable of performing the function for which
it was designed and manufactures.

Economic Life – is the length of time during which the property may be operated at a profit.

The Straight Line Method - This method assumes that the loss in value is directly proportional to the age of
the property.

The Sinking Fund Formula - This method assumes that a sinking 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.

Declining Balance Method - This is sometimes called constant percentage method or the Matheson Formula,
it is assumed that the annual cost of depreciation is 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.

Double Declining Method - This method is very similar to the declining balance method except that the rate of
depreciation "k" is replaced by 2/L.

The sum of years' digits method - It is a form of accelerated depreciation that is based on the assumption
that the productivity of the asset decreases with the passage of time. Under this method, a fraction is
computed by dividing the remaining useful life of the asset on a particular date by the sum of the year's digits.

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The Service-Output Method -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.

REQUIREMENT 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.

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 *** END of LESSON 5***
QUIZ

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PROBLEM-SOLVING. Solve each of the problems below and show your complete, systematic, and neat
solution on a clean sheet of paper.

1. The original cost of a certain piece of equipment is P150,000.00 and it is depreciated by 10% sinking
fund method. Determine the annual depreciation charge if the book value of the equipment after 10
years is the same as if it had been depreciated at P14,000 each year by straight-line formula.
2. A certain company makes it the policy that for any new piece of equipment the annual depreciation cost
should not exceed 10% of the original cost at any time with no salvage or scrap value. Determine the
length of service life necessary if the depreciation method used is: a. The straight-line formula
b. The sinking formula at 8%
3. Engineer Paat bought a 5-ton fixed tower crane for erecting tall buildings. It was invoiced from Japan
CIF (cost, insurance, freight) Manila at P25,550,000. Brokerage, bank, arrastre fees, customs’ duties,
permits, etc. total P720,000. At the end of 12 years, he expects to sell it for P10,000,000. Prepare a
depreciation schedule for each of the following methods: a. Straight Line formula
b. SYD Method
4. Accenture purchased a machine for P9,700,000, used it for 10 years and then sold it for P4,200,000. If
capital is worth 8%, determine the annual cost of depreciation and interest using the following: a.
Sinking fund depreciation and interest on first cost
b. Straight-line depreciation plus average interest
5. An asphalt and aggregate mixing plant having a capacity of 50cu.m. every hour costs P2,500,000. It is
estimated to process 800,000 cu.m. during its life. During a certain year it processed 60,000 cu.m. If its
scrap value is P100,000, determine the total depreciation during the year and the depreciation cost
chargeable to each batch of 50 cu.m. using the production-units method.
6. The original cost of 80m3/h diesel construction concrete pumping machine is P2,550,000.00 and it is
depreciated by 15% sinking fund method. Determine the annual depreciation charge if the book value
of the equipment after 15 years is the same as if it had been depreciated at P110,000 each year by
straightline formula.
7. Megawide purchased a machine for precast casting for P7,500,000 used it for 15 years and then sold it
for P2,810,000. If capital is worth 17%, determine the annual cost of depreciation and interest using the
following:
a. Sinking fund depreciation and interest on first cost
b. Straight-line depreciation plus average interest
8. Engineer Castro bought a gantry crane for erecting tall buildings. It was invoiced from Japan CIF (cost,
insurance, freight) Manila at P950,000. Brokerage, bank, arrastre fees, customs’ duties, permits, etc.
total P320,000. At the end of 10 years, he expects to sell it for P460,000. Prepare a depreciation
schedule for each of the following methods:
a. Sinking Fund Formula at 17%
b. Matheson Formula
9. Engineer Cureg bought a mobile crane for erecting structural steel for warehouses. It was invoiced from
Japan CIF (cost, insurance, freight) Manila at P2,250,000. Brokerage, bank, arrastre fees, customs’
duties, permits, etc. total P520,000. At the end of 10 years, she expects to sell it for P950,000. Prepare
a depreciation schedule for each of the following methods: a. Sinking Fund Formula at 15%
b. SYD Method
10. Engr. Borja’s company makes it the policy that for any new piece of equipment the annual depreciation
cost should not exceed 10% of the original cost at any time with no salvage or scrap value. Determine
the length of service life necessary if the depreciation method used is: a. The straight-line formula
b. The SYD method

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REFERENCES

Textbooks

Chan Park. (2018). Fundamentals of Engineering Economy. Pearson Prentice Hall.

Niall M. Fraser and and Elizabeth Jewkes. (2016). Engineering Economics Financial Decision Making for
Engineers. Pearson Canada.

R. Paneerselvam. (2014). Engineering Economics. PHI Learning Private Limited, New Delhi.

Leland Blank and Anthony Tarquin. (2013). Basics of Engineering Economy. McGraw-Hill Higher Education.

Hipolito Sta. Maria. (). Engineering Economy. National Bookstore.

Online Reference

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