DEPRECIATION Is the decrease in the value of physical property with the passage of time o VALUE In a commercial sense, is the present worth of all future profits that are to be received through ownership of a particular property a. MARKET VALUE Is the amount which a willing buyer will pay to a willing seller for the property where each has equal advantage and is under no compulsion to buy or sell b. USE VALUE What the property is worth to the owner as an operating unit c. FAIR VALUE 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 d. BOOK VALUE Sometimes called depreciated book value The worth of a property as shown on the accounting records of an enterprise e. SALVAGE VALUE Also called resale value The price that can be obtained from the sale of the property after it has been used Salvage year is the time when the scrap value is equal to the book value f. SCRAP VALUE The amount of the property would sell for if disposed off as a junk o PURPOSES OF DEPRECIATION 1. To provide for the recovery of capital which has been invested in physical property 2. To enable the cost of depreciate to be charged to the cost of producing products or services that results from the use of the property. o TYPES OF DEPRECIATION 1. Normal depreciation a. Physical Is due to the lessening of the physical ability of a property to produce results Common causes are wear and deterioration b. Functional Due to the lessening in the demand for the function which the property was designed to render Common causes are inadequacy, changes in styles, saturation of markets or more efficient machines are produced 2. Depreciation due to changes in price levels Almost impossible to predict and therefore is not considered in economy studies 3. Depletion Refers to the decrease in the value of a property due to the gradual extraction of its contents. o PHYSICAL LIFE The length of time during which it is capable of performing the function for which it was designed and manufactured o ECONOMIC LIFE The length of time during which the property may be operated at a profit o REQUIREMENTS OF A DEPRECIATION METHOD 1. 2. 3. 4. It should be simple It should recover capital The book value will be reasonably close to the market value at any time The method should be accepted by the Bureau of Internal Revenue o DEPRECIATION METHODS We shall use of the following symbols for the different depreciation methods L Co CL = = = d Cn Dn = = = useful life of the property in years the original cost the value at the end of life, the scrap value (including gain or loss due to removal) the annual cost of depreciation the book value at the end of n years depreciation up to age n years a. STRAIGHT LINE METHOD This method assume that the loss in value is directly proportional to the age of the property d= V O −V s n D a= a( V O−V s) L V n=V O −Da Example: a. An electronic balance costs P90,000 and has an estimated salvage value of P8,000 at the end of its 10 years lifetime. What would be the book value after three years, using straight line method in solving for the depreciation? Ans. P65,400 b. Prepare a depreciation table for an asset which was brought at 15,000 and estimated to be useful for a period of 4 years. Estimated salvage value is 10% of its original cost. Ans: d=3375 year Beginning book value 15,000 11,625 8,250 4,875 1 2 3 4 Depreciation Book value 3375 3375 3375 3375 11,625 8,250 4,875 1,500 b. SINKING FUND FORMULA This method assumes that a sinking fund 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 d= CO −C L F Da=d , i ,n Cn =CO −D a F A ,i , L A ( ) Example: A firm bought an equipment fee for P56,000. Other expenses including installation amounted to P4,000. The equipment is expected to have a life of 16 years with a salvage value of 10% of the original cost. Determine the book value at the end of 12 years by straight line methods and sinking fund methods at 12% interest. Ans: P19,500;P29,520 a. Prepare a depreciation table for an asset which was brought at 15,000 and estimated to be useful for a period of 3 years. Estimated salvage value is 10% of its original cost. Money is worth 10% compounded annually initial book value yr 1 2 3 15000 10468. 74 5484.5 64 ending depreciati book on total dep value 10468. 4531.26 4531.26 74 5484.5 4531.26 9515.436 64 14998.13 4531.26 96 1.8604 c. DECLINING BALANCE METHOD Sometimes called the constant percentage method of 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 This method does not apply if the salvage value is zero, because k will be equal to one and d will be equal to Co. 1−k ¿ ¿ 1−k ¿ ¿ d a=C o ¿ 1−k ¿ ¿ C a=C o ¿ Example: A certain type of machine loses 10% of its value each year. The machine costs P2,000 originally. Make out a schedule showing the yearly depreciation, the total depreciation and the book value at the end of each year for 3 years. Ans: endin initial g book depreciati total book value on dep value 1 2,000 200 200 1,800 2 1800 180 380 1620 3 1620 162 542 1458 yr c. A machine worth 800,000 is brought from china, freight charges amount to 200,000. If the scrap value of the machine is 50,000 that occurs at the end of 17 years. (a) compute the depreciation at the end of the year11 (b) Compute the book value at the end of 11 years . d. DOUBLE DECLINING BALANCE METHOD This method is very similar to declining balance method except that the rate of depreciation k is replaced by 2/L. The salvage value should not be subtracted from the first cost when calculating the depreciation charge. 1− ¿ ¿ 1− ¿ ¿ 1− 2 L 2 L 2 L ¿ ¿ d n=C o ¿ Example: Determine the rate of depreciation, the total depreciation up to end of the 8 year and the book value at the end of 8 years for an asset that costs P15,000 new and has an estimated scrap value of P2,000 at the end of 10 years by double declining balance method. Ans: 20%, P12, 483 th e. SUM – OF-THE-YEARS (SYD) METHOD Let dn = depreciation charge during the nth year reverse digit (C −C ) = ∑ of digits o L Sum of the years= n(n+1)/2 Example: A structure costs P12,000 new. It is estimated to have a new life of 5 years with a salvage value at the end of life of P1,000. Determine the book value at the end of each year of life. Ans: P8,333 ; P5,400; P 3,200; P 1,733; P 1,000 f. 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. Has the advantage of making the unit cost depreciation constant and giving low depreciation expense during periods of low production. Let T Qn = total units of output up to the end of life = total number of units of output during the nth year C o−C L Depreciation per unit of output = T Co −C L dn = Qn T ( ) Example: A Television Company purchased machinery for P100,000 on July 1, 1979. It is estimated that it will have a useful life of 10 years; scrap value of P4,000, production of P400,000 units and working hours of P120,000. The company uses the machinery for 14,000 hours in 1979 and 18,000 hours in 1980. The machinery produces 36,000 in 1979 and 44,000 units in 1980. Compute the depreciation in 1980 using service-output method. Ans: P10,560 Hour/ output method D= h/H (C-Cl) ; Cn = Co- Dn H=total hours of economic life h=hours the asset has been used an electric bulb bought for 100 is guaranteed to be useful for 50 hours, the certain company uses the said bulb 10 hrs a day. If there is no scrap value, compute for the daily depreciation . determine the book value on the 4 th day. d=20/a day