(c) 2001 Contemporary Engineering Economics 1

PRESENTED BY:

Javeria

11-arid-3303

MIT-3

University Institute of Information Technology, Rawalpindi(UIIT,UAAR)

Pakistan

DEPRECIATION

METHODS

DEPRECIATION

Depreciation is the reduction in value of an asset over time due to:

wear and tear effluxion of time obsolescence

What Can Be Depreciated?

A qualifying asset for depreciation must satisfy all these conditions:

should be used in business

should have a definite useful life and a life longer than 1 year

must wear out, become obsolete or lose value

Types of Depreciation

Book Depreciation

Tax Depreciation

Methods to Calculate Depreciation

Straight-Line Method

Declining Balance Method

MACRS Method

Required Factors in Calculating Asset Depreciation

Useful life of asset

Residual value

Cost basis

Method of depreciation

Principle A fixed asset provides its service in a uniform fashion over its life

FormulaAnnual Depreciation = cost – residual value useful life

1. Straight-Line (SL) Method

EXAMPLE (Straight-Line Method)

Year Computation DepreciationExpense

AccumulatedDepreciation

Book Value

$45,000

First (45,000-5,000)/5 $8,000 $8,000 37,000

Second (45,000-5,000)/5 8,000 16,000 29,000

Third (45,000-5,000)/5 8,000 24,000 21,000

Fourth (45,000-5,000)/5 8,000 32,000 13,000

Fifth

Total

(45,000-5,000)/5 8,000

40,000

40,000 5,000

Cost of machinery = $45,000Residual value = $5,000Useful life = 5 years.Calculate annual cost of depreciation?

Example - (Straight-Line Method)

Years

1 2 3 4 5

Annual Depreciation expense

PrincipleA fixed asset provides its service in a decreasing fashion. The book value is reduced by a fixed percentage each year.

FormulaAnnual Depreciation = Depreciation rate * Book value at start of

year

Depreciation rate200% Declining Method: Depreciation rate = 2/useful life150% Declining Method : Depreciation rate = 1.5/useful life130% Declining Method: Depreciation rate = 1.3/useful life

2. Declining Balance Method

EXAMPLE(200% Declining Balance Method)

Year Computation DepreciationExpense

AccumulatedDepreciation

Book Value

$70,000

First $70,000 x 40% $28,000 $28,000 42,000

Second 42,000 x 40% 16,800 44,800 25,200

Third 25,200 x 40% 10,080 54,880 15,120

Fourth 15,120 x 40% 6,048 60,928 9,072

Fifth

Total

9,072-$5,000 4,072

65,000

65,000 5,000

Cost of machinery = $70,000Residual value = $5000 Useful life = 5 yearsCost of annual Depreciation?

Example – 200% Declining Balance Method

Years

1 2 3 4 5

Annual Depreciation expense

PrincipleAn asset has a fixed life according to the category in which it falls. The residual value is always zero.

FormulaAnnual Depreciation = cost x appropriate MACRS % rate

3. MACRS Method

(c) 2001 Contemporary Engineering Economics 15

TABLE OF PROPERTY CLASS AND NUMBER OF YEARS

Years

(c) 2001 Contemporary Engineering Economics 16

EXAMPLE(MACRS Method)

Year Computation DepreciationExpense

AccumulatedDepreciation

Book Value

$30,000

First 33.33% x 30,000 9,999 9,999 20,001

Second 44.45% x 30,000 13,335 23,334 6,666

Third 14.81% x 30,000 4,443 27,777 2,223

Fourth 7.41% x 30,000 2,223 30,000 0

Cost of tractor = Rs. 30,000Cost of annual Depreciation?

THANK YOU!