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DEPRECIATION
COLLEGE OF ENGINEERING, ARCHITECTURE, AND TECHNOLOGY
Subject: Quantitative Management Depreciation Concepts Topic: Introduction to Operations Research/LP (Graphical Method) Lecturer: Engr. Ma. Estrella Natalie B. Pineda
• Depreciation is the decrease in the value of physical
property due to physical or economic reasons. Physical property shall include both tangible and intangible business property with the exception of real estate.
*Tangible – may be seen or touched (furniture,
machinery, office equipment, etc.) *Intangible – includes copyright , franchise, or patent. Types of Depreciation 1. Physical Depreciation Results in the decrease in the ability of a physical property to perform its intended service which is caused by corrosion, abrasion, decay, impact, heat, stress, and vibration. 2. Functional Depreciation Results from obsolescence or inadequacy of the property to meet the demand required, which occurs when new and better equipment is available that is more efficient and less expensive to operate. 3. Accident Results when the property becomes a casualty of fire, flood or any accident. Purpose of Depreciation Studies
1. To provide for the replacement of
tangible property. 2. To provide for the recovery of invested capital. 3. To enable the cost of depreciation to be charged to the cost of manufacturing products or services rendered. Terminologies • Value - Is the measure of the worth that an individual ascribes to a property or service. • Market Value - Is the amount that a willing buyer pays a willing seller for the purchase of his property, where neither buyer nor seller is compelled to buy or sell. • Fair value - Is the worth of a property to a disinterested third party, in order to establish a price that is fair to both buyer and seller. • Book Value - Is the worth of a property at a given time as reflected in the accounting records of a business. It is the acquisition cost of the any adjustments, property, plus any adjustments, less the accumulated depreciation charges for a given period. Terminologies • Assessed Value - Is the reported value used for property tax purposes. It is usually obtained by appraisal. • Salvage value - Is the price of a property when it can no longer operate at a profit. It is the estimated worth of the property at the end of its productive life. • Scrap Value - Is the value of the property after it can no longer perform its intended function. It is the price that the property can command if it is sold as junk. • Physical Life - Is the period in which a given property is able to perform the function for which it was designed for. Terminologies • Economic or Useful Life - The period during Is also referred to as the property's depreciable life. It is which a property may be operated at a profit. • Acquisition Cost - Is also referred to as first cost, it includes the purchase the property price of plus any expenses incurred (shipping, installation, improvement and repair) prior to initial service operation of the property. • Yearly Depreciation Charge - Is the depreciation charge for a given year of the property. • Accumulated Depreciation - Is the total depreciation expense charged to a property after n years of service. Terminologies • Depreciation Table - Is a tabulated depreciation schedule showing the yearly and accumulated depreciation charges, together with the book value at the end of each year of the property's useful life. • Wearing Cost - Is the accumulated depreciation of a property at the end of its useful life. • Depreciation Funds - Are funds that are set aside out of profit so that capital is available for replacing essential equipment at the time of retirement. • Depreciation Rate - Is the decrease in property value for a given year expressed as a percentage. • Recovery Period - Is the time period required for capital cost recovery. This period is usually shorter than the economic life of the property in order to encourage capital investment and improve productivity. Depreciation Methods • Straight-Line Method (SLM) The SLM is the simplest and most commonly used depreciation method. It assumes that the loss of value is directly proportional to the age of the property so that the annual depreciation charge, d, and the depreciation rate, k, is constant. Hence, the book value, BV, of the property decreases each year at a uniform rate. Depreciation Methods • Sinking Fund Method or Formula The SFF assumes that a sinking fund earning interest is created for replacement purposes. The fund is established by depositing equal amounts at the end of each year for L years at an interest rate of i% per year. Depreciation Methods • Declining Balance Method or Matheson Method (DBM) This method is also referred to as the constant percentage method. The DBM assumes that the depreciation charge for a given year is a fixed percentage of the book value at the start of the year, such that, the depreciation charge decreases as the property nears the end of its useful life. Depreciation Methods • Double Declining Balance Method, DDBM In this method, the depreciation rate, k, is computed as 200%/L, such that k is replaced by the value 2/L. For this method, the estimated useful life of the property must exceed 2 years so that k<1. Depreciation Methods • Sum of the Years-Digit Method, SYD This method requires that the digits corresponding to the number of each year of the property life first be listed in reverse order. The depreciation rate for a given year is found by taking the corresponding number from the reversed listing and dividing it by the sum of the years digits, y. Depreciation Methods • Units-of-Production Method The units-of-production method is used to determine the depreciation of property not as a function of time, in years, but as a function of use. In this method, depreciation is charged in proportion to units of production, or time of use, or the amount of work performed. The depreciation rate per unit(d) in this method is constant and the accumulated depreciation charge, Dn, is proportional to the rate of production. Depreciation Methods • Problems: 1. An electronic balance costs P 90,000 and has an estimated salvage value of P 8,000 at the end of its 10 yrs lifetime. What would be the book value after three years, using the SLM in solving for the depreciation? 2. A broadcasting corporation purchased an equipment for P 53,000 and paid P 1,500 for freight and delivery charges to the job site. Depreciation Methods • Problems: The equipment has a normal life of 10yrs with a trade-in value of P 5,000 against the purchase of a new equipment at the end of the life. a. Determine the annual depreciation cost by SLM. b. Determine the annual depreciation cost by SFM. Assume interest at 6-1/2% annually. Depreciation Methods • Problems: 3. A firm bought an equipment for P 56,000. Other expenses including installation amounted to P 4,000. The equipment is expected to have a life of 16 yrs with a salvage value of 10% of the original cost. Determine the book value at the end of 12 yrs., by (a) SLM and (b) SFM at 12% interest. Depreciation Methods • Problems: 4. Determine the rate of depreciation, the total depreciation up to the end of the 8th year and the book value at the end of 8yrs for an asset that costs P 15,000 new and has an estimated scrap value of P 2,000 at the end of 10 yrs by (a) DBM and (b) DDBM 5. A plant bought a calciner for P 220,000 and used it for 10 yrs, the life span of the equipment. What is the book value of the Depreciation Methods • Problems: calciner after 5 yrs of use? Assume a scrap value of P 20,000 for SLM; P 22,000 for DBM and P 20,000 for the DDBM. 6. A structure costs P 12,000 new. It is estimated to have a life of 5 yrs with a salvage value at the end of life of P 1,000. Determine the book value at the end of each year of life. Depreciation Methods • Problems: 7. A television company purchased machinery for P 100,000 on July 1, 1979. It is estimated that it will have a useful life of 10 years; scrap value of P 4,000, a production of P 400,000 units and working hours of P 120,000. The company uses the machinery for P 14,000 hours in 1979 and 18,000 hours in 1980. The machinery produces 36,000 Depreciation Methods • Problems: units in 1979 and 44,000 units in 1980. Compute the depreciation for 1980 using the methods, SLM; SFM at 10% interest; SOM; WHM. 8. A machine costs P 7,000 last 8 years and has a salvage value at the end of life of P 350. Determine the depreciation charge during the 4th year and the book value at the end of Depreciation Methods • Problems: of 4 years by the SLM; SYD; DBM and DDBM. 9. The original cost of a certain machine is P 150,000, has an economic life of 8 years; with a salvage value of P 9,000 at that time. If the depreciation of the first year is equal to P 44,475, what method is used in the calculation of the depreciation? Depreciation Methods • Problems: 10. A telephone company is contracted for the purchase and installation of a fiber optic cable at a total cost of P 960M. 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. What is the annual depreciation charge given the Depreciation Methods • Problems: sinking fund deposit factor of 0.0430 at 6% interest where n=15. b. what is the depreciation charge during the 8th year using the sum of the years digits method? 11. In the purchase of a rice cooker, a buyer pays P 200 as an advance fee. He will discharge the balance, principal and interest included at 18% payable monthlyon the Depreciation Methods • Problems: unpaid balance by payments of P 75 at the end of each month for a year. Find the cash value of the rice cooker.