251778957-DEPRECIATION-only-lecture-ppt.ppt

251778957-DEPRECIATION-only-lecture-ppt.ppt

• 1.
  DEPRECIATION DEPRECIATION
• 2.
  DEPRECIATION DEPRECIATION • Decrease invalue of physical properties Decrease in value of physical properties due to the passage of time and use due to the passage of time and use • Accounting concept: Accounting concept: establishing annual establishing annual deduction against before-tax income deduction against before-tax income - - to reflect effect of time and use on asset’s to reflect effect of time and use on asset’s value in firm’s financial statements value in firm’s financial statements - - to match yearly fraction of value used by asset to match yearly fraction of value used by asset in production of income over asset’s in production of income over asset’s economic life economic life
• 3.
  PURPOSES OF DEPRECIATION PURPOSESOF DEPRECIATION Because property decreases in value, it is desirable Because property decreases in value, it is desirable to consider the effect that this depreciation has to consider the effect that this depreciation has on engineering projects. Primarily, it is necessary on engineering projects. Primarily, it is necessary to consider depreciation for two reasons to consider depreciation for two reasons 1. 1. To provide for the recovery of capital that has To provide for the recovery of capital that has been invested in physical property. been invested in physical property. 2. 2. To enable the cost of depreciation to be charged To enable the cost of depreciation to be charged to the cost of producing products or services that to the cost of producing products or services that result from the use of the property. Depreciation result from the use of the property. Depreciation cost is deducible in computing profits on which cost is deducible in computing profits on which income taxes are paid. income taxes are paid.
• 4.
  PROPERTY IS DEPRECIABLEIF PROPERTY IS DEPRECIABLE IF IT MUST : IT MUST : • be used in business or held to produce be used in business or held to produce income income • have a determinable useful life which is have a determinable useful life which is longer than one year longer than one year • wear out, decay, get used up, become wear out, decay, get used up, become obsolete, or lose value from natural causes obsolete, or lose value from natural causes • not be inventory, stock in trade, or not be inventory, stock in trade, or investment property investment property
• 5.
  WHEN DEPRECIATION STARTS WHENDEPRECIATION STARTS AND STOPS AND STOPS • Depreciation Depreciation starts starts when property is placed in when property is placed in service for use in business or for production service for use in business or for production of income of income • Property is considered in service when ready Property is considered in service when ready and available for specific use, even if not and available for specific use, even if not actually used yet actually used yet • Depreciation Depreciation stops stops when cost of placing it in when cost of placing it in service is removed or it is retired from service service is removed or it is retired from service
• 6.
  Types of Depreciation Typesof Depreciation • Physical property depreciation Physical property depreciation – – deterioration due to the effects of deterioration due to the effects of various chemical and mechanical factors on various chemical and mechanical factors on the material composing the property. the material composing the property. • Functional depreciation Functional depreciation – due to the – due to the decrease in the demand for the function of decrease in the demand for the function of the equipment for which it was designed. the equipment for which it was designed. • Changes in the price level of a similar Changes in the price level of a similar property property – it is the capital that depreciated – it is the capital that depreciated not the property. not the property.
• 7.
  DEPRECIATION CONCEPTS DEPRECIATION CONCEPTS •Depreciation Cost Depreciation Cost – – depends upon the physical or depends upon the physical or economic life of the equipment and its first cost. economic life of the equipment and its first cost. • Physical Life Physical Life – – length of time which it is capable of length of time which it is capable of performing the function for which it was designed performing the function for which it was designed and manufactured. and manufactured. • Economic life Economic life – – length of time of an equipment length of time of an equipment which it will operate at a satisfactory profit. which it will operate at a satisfactory profit. • First Cost First Cost – includes the original purchase price, – includes the original purchase price, freight and transportation charges, installation freight and transportation charges, installation expenses, initial taxes, permits to operate and other expenses, initial taxes, permits to operate and other expenses needed to operate the equipment. expenses needed to operate the equipment.
• 8.
  DEPRECIATION CONCEPTS DEPRECIATION CONCEPTS •Salvage Value Salvage Value – – the amount for which the the amount for which the equipment or machine can be sold as a second equipment or machine can be sold as a second hand. hand. • Scrap or Junk Value Scrap or Junk Value – – the amount that equipment the amount that equipment can be sold for, when disposed off as a junk. can be sold for, when disposed off as a junk. – The equipment/property cannot be used anymore. The equipment/property cannot be used anymore. • Book Value (BV) Book Value (BV) - Worth of depreciable property - Worth of depreciable property as shown on accounting records. as shown on accounting records. – Original cost basis of property, including adjustments, Original cost basis of property, including adjustments, less allowable depletion or depreciation deductions less allowable depletion or depreciation deductions
• 9.
  Methods used forthe Determination Methods used for the Determination of Depreciation Cost of Depreciation Cost • Straight Line Formula Straight Line Formula • Sinking Fund Formula Sinking Fund Formula • Matheson formula Matheson formula (Constant/Fixed % method, (Constant/Fixed % method, Declining Balance method or Diminishing balance Declining Balance method or Diminishing balance method). method). • Sum-of-the-Years Digit method Sum-of-the-Years Digit method • Service-Output or Production-Units method Service-Output or Production-Units method
• 10.
  Notations on Depreciation Notationson Depreciation The following terms are used in the classical The following terms are used in the classical (historical) depreciation method equations: (historical) depreciation method equations: n n = useful life/depreciable life of the asset (in years) = useful life/depreciable life of the asset (in years) m = age of property at any time m = age of property at any time < < n n d d m m = annual depreciation cost in year m (1 = annual depreciation cost in year m (1< < m m < < n) n) D D m m = accrued or total depreciation through year m = accrued or total depreciation through year m C CO O = original or first cost of the property = original or first cost of the property C Cm m = book value of the property at the end of m years = book value of the property at the end of m years C Cn n = book value at the end of useful life. = book value at the end of useful life. K = the ratio of depreciation in any one year to the BV at the K = the ratio of depreciation in any one year to the BV at the beginning of the year beginning of the year
• 11.
  STRAIGHT-LINE (SL) METHOD STRAIGHT-LINE(SL) METHOD • Simplest depreciation method Simplest depreciation method • Assumes constant amount is depreciated each year Assumes constant amount is depreciated each year over depreciable (useful) life; gives uniform annual over depreciable (useful) life; gives uniform annual charge. charge. • Does not take into account the interest rate on the Does not take into account the interest rate on the accumulated depreciation fund. accumulated depreciation fund. • This method requires an estimate of the final SV ( also This method requires an estimate of the final SV ( also the final book value at the end of year N ) the final book value at the end of year N ) d dm m = ( = (C CO O - C - Cn n ) / n ) / n D Dm m = m x d (for 1 = m x d (for 1 < < m m < < n) n) C Cm m = = C CO O - D - Dm m
• 12.
  • Example (7-6/p.334) Example (7- 6/p.334) EOY EOY (m) (m) d dm m D Dm m C Cm m 1 11,000 11,000(1) = 11,000 120,000 – 11,000 = 109,000 2 11,000 11,000(2) = 22,000 120,000 – 22,000 = 98,000 3 11,000 11,000(3) = 33,000 87,000 4 11,000 11,000(4) = 44,000 76,000 5 11,000 11,000(5) = 55,000 65,000 6 11,000 11,000(6) = 66,000 54,000 7 11,000 11,000(7) = 77,000 43,000 8 11,000 11,000(8) = 88,000 32,000 9 11,000 11,000(9) = 99,000 21,000 10 11,000 11,000(10) = 110,000 10,000
• 13.
  • Example 2. Example2. A company purchased a machine for P30,000, A company purchased a machine for P30,000, used it for 5 years and then sold it for P10,000. used it for 5 years and then sold it for P10,000. If the capital worth is at 8% determine the If the capital worth is at 8% determine the annual cost of depreciation using straight-line annual cost of depreciation using straight-line method. method. d d = (30,000-10,000) / 5 = (30,000-10,000) / 5 = (20,000 / 5) = (20,000 / 5) = = $ 4,000/year $ 4,000/year
• 14.
  The Sinking FundFormula The Sinking Fund Formula In this method it is assumed that a sinking fund is In this method it is assumed that a sinking fund is established in which funds will accumulate for established in which funds will accumulate for replacement purposes and will beat interest. The replacement purposes and will beat interest. The total depreciation which has occurred up to any total depreciation which has occurred up to any given time is assumed to equal the amount in the given time is assumed to equal the amount in the sinking fund at that time. sinking fund at that time. Also gives a uniform annual charge Also gives a uniform annual charge d dm m = ( = (C CO O – C – Cn n) ( A/F, i %, N) ) ( A/F, i %, N) D Dm m = ( = (C CO O – C – Cn n) [(F/A, i%, m)/(F/A, i%, n) ) [(F/A, i%, m)/(F/A, i%, n) = ( = (C CO O – C – Cn n) [((1+i)m-1)/((1+i)n-1)] ) [((1+i)m-1)/((1+i)n-1)] C Cm m = = C CO O – D – Dm m
• 15.
  • Example #3 Example # 3 A civil engineer bought a crane used to erect tall buildings. It A civil engineer bought a crane used to erect tall buildings. It will be invoiced from Vietnam, CIF (cost, freight, & insurance) will be invoiced from Vietnam, CIF (cost, freight, & insurance) Manila at P250,000. Brokerage fees, arrastre fees, customs, Manila at P250,000. Brokerage fees, arrastre fees, customs, duties, permits, etc. amounts to P120,000. At the end of 10 duties, permits, etc. amounts to P120,000. At the end of 10 years, he expects to sell it for P50,000. Prepare a depreciation years, he expects to sell it for P50,000. Prepare a depreciation schedule for the crane. Use i = 12%. schedule for the crane. Use i = 12%. Sol’n: Sol’n: Co = 370,000 Co = 370,000 n = 10 years n = 10 years Cn = 50,000 Cn = 50,000 d d = (370,000-50,000) [ 0.12 / ((1.12)^10 – 1)) = (370,000-50,000) [ 0.12 / ((1.12)^10 – 1)) = P 18,234.93 = P 18,234.93
• 16.
  • Example Example * * D2= 320,000*[((1.12) D2 = 320,000*[((1.12)2 2 -1)/((1.12) -1)/((1.12)10 10 -1)] = 38,658.05 -1)] = 38,658.05 ** **D3 = 320,000*[((1.12) D3 = 320,000*[((1.12)3 3 -1)/((1.12) -1)/((1.12)10 10 -1)] = 61,531.9653 -1)] = 61,531.9653 EOY (m) EOY (m) d dm m D Dm m C Cm m 1 18,234.93 18,234.93 351,765.07 2 18,234.93 38,658.05* 331,341.95 3 18,234.93 61,531.97** 308,468.03 4 18,234.93 87,150.72 282,849.28 5 18,234.93 6 18,234.93 7 18,234.93 8 18,234.93 9 18,234.93 10 18,234.93
• 17.
  SUM-OF-THE-YEARS-DIGITS (SYD) METHOD SUM-OF-THE-YEARS-DIGITS(SYD) METHOD 1. Number for each permissible year of life are listed in 1. Number for each permissible year of life are listed in reverse order reverse order 2. The 2. The depreciation factor depreciation factor for any year is the corresponding for any year is the corresponding number from the reverse order listing divided by the sum number from the reverse order listing divided by the sum of those digits, or the following of those digits, or the following 2 (n - m + 1 ) 2 (n - m + 1 ) df df = ----------------- = ----------------- n ( n + 1 ) n ( n + 1 ) 3. Depreciation for any year is the product of that year’s SYD 3. Depreciation for any year is the product of that year’s SYD depreciation factor and the difference between First Cost depreciation factor and the difference between First Cost and the final estimated BV at end of useful life. and the final estimated BV at end of useful life. d d m m = ( = (C CO O – C – Cn n) ) • df df 4. Enables a very rapid depreciation during the early years of 4. Enables a very rapid depreciation during the early years of life. life.
• 18.
  SUM-OF-THE-YEARS-DIGITS (SYD) METHOD SUM-OF-THE-YEARS-DIGITS(SYD) METHOD a. Determine the sum of years. a. Determine the sum of years. ∑ ∑ years = (n / 2)( n + 1) years = (n / 2)( n + 1) b. Determine the loss in value due to depreciation b. Determine the loss in value due to depreciation C CO O – C – Cn n c. Compute annual depreciation charges c. Compute annual depreciation charges d d1 1 = ( = (C CO O – C – Cn n) (n / ∑ years ) ) (n / ∑ years ) d d2 2 = ( = (C CO O – C – Cn n) (n-1 / ∑ years) ) (n-1 / ∑ years) d d3 3 = ( = (C CO O – C – Cn n) (n-2 / ∑ years) ) (n-2 / ∑ years) … … d dn n = ( = (C CO O – C – Cn n) (1/ ∑ years ) ) (1/ ∑ years ) Cumulative depreciation through year n is: Cumulative depreciation through year n is: D D1 1 = = d d1 1 D D2 2 = = d d1 1 + + d d2 2 D D3 3 = = d d1 1 + + d d2 2 + + d d3 3
• 19.
  • Reworking example# 3 Reworking example # 3 ∑ ∑ years = (n / 2)( n + 1) = (10/2)(10+1) = 55 years years = (n / 2)( n + 1) = (10/2)(10+1) = 55 years Year Year d d Dm Book Value @ EOY n 1 320,000(10/55) = 58,181.82 58,181.82 370,000 - 58,181.82 = 311.818.18 2 320,000(9/55) = 52,363.64 58,181.82+52,363.64 = 110,545.46 370,000 – 110,545.46 = 259,454,54 3 320,000(8/55) = 46,545.45 110,545.46+46,545.45 = 157,090.91 370,000 – 157,090.91 = 212,909.09 4 320,000(7/55) = 5 6 7 8 9 10