ENSC31 - Engineering Economy Depreciation PDF

ENSC31 - Engineering Economy DEPRECIATION DEPRECIATION the decrease in value of physical properties with the passage of time. For equipment and machines, it is the decrease in value and service  capacity as a result of natural wear, obsolescence,...

ENSC31 - Engineering Economy DEPRECIATION DEPRECIATION the decrease in value of physical properties with the passage of time. For equipment and machines, it is the decrease in value and service  capacity as a result of natural wear, obsolescence, damage, corrosion, and weathering. VALUE this is the present worth of all the future profits that are to be received through ownership of a particular property. SALVAGE VALUE (Market Value) the estimated value of property at the end of its useful life.  USEFUL LIFE (depreciable life) the expected (estimated) period of time that a property will be used on a trade or business or to produce income. BOOK VALUE the worth of a depreciable property as shown on the accounting records. It is the original cost (first cost) less all allowable depreciation. PURPOSE OF DEPRECIATION Because property decreases in value, it is desirable to consider the effect that this depreciation has on projects. Primarily, it is necessary to consider depreciation for two reasons: 1. To provide for the recovery of capital that has been invested in physical property. 2. To enable the cost of depreciation to be charged to the cost of producing products or services that result from the use of the property. (Depreciation cost is deductible in computing profits on which income taxes are paid). Methods of Computing  Double Declining Balance Method, DBM Depreciation Sum-of-Year Digit Method (SYDM) Straight line Method (SLM) Straight line Method (SLM) Straight Line Method is the simplest depreciation method.  Goals& Tasks It assumes that a constant amount is depreciated each year over the useful life of the property It assumes that a constant Straight line amount is depreciated each year over the useful life of Method (SLM) the property Annual Depreciation Straight Line Method is the = − simplest depreciation Where: method. Goals& Tasks D Depreciation per year FC First cost  of the property SV Salvage value of the property (value at the end of its useful life) Straight Line Method is the N Useful/ depreciable/ economic life simplest depreciation method. Useful life (N) is the expected/estimated Goals& Tasks period of time that an equipment or It assumes that a constant property will be used on a trade or to amount is depreciated each produce income. year over the useful life of Straight line the property Total Depreciation Method (SLM) = ( ) Book Value  cost of the property = − Total depreciation at nth year Book value at nth year n Where: Number of years D Depreciation per year FC First Example The initial cost of a processing equipment including its installation is Php 500,000. The BIR approved life of this equipment is 10 years for depreciation. The estimated salvage value is Php 40,000, and the cost of dismantling is estimated to be Php 15,000. a) Using straight-line method, what is the annual depreciation charge? b) What is the book value of the equipment at the end of 6 years? Example Depreciation = − = ℎ 500,000 − ℎ 40,000 10 = ℎ 46,000 Total depreciation = ( )( ) 6 = ( ℎ 46,000)(6)  6 = ℎ 276,000 Example Book Value = − = ℎ 500,000 − ℎ 276,000 = , Example Determine the book value of the machine on the 3rd year given its useful life of 10 years. The first cost of the machine is P20,000 and the trade-in value (Salvage value) is 10% of its first cost. Given: FC = Php 20, 000 N = 10 years SV = 10% of FC rd Required: Value of the machine on the 3 year Example SV = 10% of the first cost = ℎ 20,000 0.10 = ℎ 2,000  ℎ 20,000 − ℎ 2,000 = 10 = ℎ 1,800/ Example rd The book value of the machine on the 3 year is 14,600 as shown in the computation below: Year First Cost Depreciatio Book Value (BV) (FC) n (D) (End of the Year) 0 20,000  1 1,800 (20,000 – 1,800) = 18,200 2 1,800 (18,200 – 1,800) = 16,400 3 1,800 (16,400 – 1,800) = 14,600 Decline Balance Method, DBM Sometimes called Constant Percentage Method, CPM or the Matheson Formula Goals& Tasks  The DBM depreciates the value of the machine at the same percentage of the value remaining each year. Decline Balance The DBM depreciates the value of the machine at the Method, DBM same percentage of the value remaining each year. Rate or percentage of reducrtion is determined by: Sometimes called Constant = − Τ Percentage Method, CPM or the Matheson Formula Depreciation for the nth year can be Goals& Tasks estimated by:  Depreciation on the nth year = − ( ) −1 Book value of the property Where: the year before the nth year (Book value at the beginning R Percentage annual of of the nth year) depreciation N Total service life, years Example Determine the book value of the machine on the 3rd year given its useful life of 10 years. The first cost of the machine is P20,000 and the trade-in value (Salvage value) is 10% of its first cost. Given: FC = Php 20, 000  N = 10 years SV = 10% of FC rd Required: Value of the machine on the 3 year Example = − Τ Percentage annual depreciation, R: = 1 − Τ = 1 − 2,000Τ20,000 10 = 1 − 2,000Τ20,000 10 = 0.2056717653 Depreciation in the first year, 1:  = −1( ) 1 = ( ℎ 20,000)(0.2056717653) 1 = ℎ 4113.435306 Example = − Τ Book Value at the end of first year, 1: 1 = ℎ 20,000 − ℎ 4113.435306 1 = ℎ 15,886.56469 Depreciation in the second year, 2: = −1( )  2 = ( ℎ 15,886.56469)(0.2056717653) 2 = ℎ 3267.417805 Example = − Τ Book Value at the end of second year, 2: 2 = ℎ 15,886.56469 − ℎ 3267.417805 2 = ℎ 12,619.14688 Depreciation in the third year, 3: = −1( ) 3 = ( ℎ 12,619.14688)(0.2056717653)  3 = ℎ 2595.402216 Example = − Τ Book Value at the end of third year, 3: 3 = ℎ 12,619.14688 − ℎ 2595.402216 = ,. Year First Depreciatio Book Value (BV) Cost n (D) (End of the Year) (FC) 0 20,000 1 4,113.435306 (20,000.00000 – 4,113.435306) = 15,886.56469  2 3267.417805 (15,886.56469 – 3267.417805) = 12,619.14688 3 2595.402216 (12,619.14688 – 2595.402216) = 10,023.74466 year and the depreciable Sum-of-the-Year value of the machine Digit Method Sum of year (Y) is computed by: (SYDM) The depreciation for any year is the product of the depreciation factor for that Goals& Tasks  = ( + Where: Y sum of year ) Depreciation on the nth year N Economic/ useful life, years Depreciation is estimated by: = − Example Determine the book value of the machine on the 3rd year given its useful life of 10 years. The first cost of the machine is P20,000 and the trade-in value (Salvage value) is 10% of its first cost. Given: FC = Php 20, 000 N = 10 years SV = 10% of FC rd Required: Value of the machine on the 3 year Example = − Τ Sum of year, Y: = 2( + 1)  10 10 + 1 = 2 = 55 Example = − Τ st Depreciation for 1 Year 1 = − Τ 1 = ( ℎ 20,000 − ℎ 2,000) 10Τ55 =. nd Depreciation for 2 Year  2 = − Τ 2 = ( ℎ 20,000 − ℎ 2,000) 9Τ55 = ,. Example = − Τ rd Depreciation for 3 Year 3 = − Τ 3 = ( ℎ 20,000 − ℎ 2,000) 8Τ55 =. Example = − Τ The computations of depreciation and book value for the succeeding years are shown below: Year Factor Depreciatio Book Value (BV) n (DV x (End of the Year) Factor) 1 10/55 3272.727273 (20,000.00000 – 3,272.727273) = 16,727.27273 2 9/55 2945.45454 (16,727.27273 – 2,945.45454) = 13,781.81819 3 8/55 2618.181818 (13,781.81819 – 2,618.181818) = 11,163.63637