1.

GRADIENT
- Gradients are special cases where a series of cash flows consists of regular, unequal amounts
that increase or decrease following a specific pattern.
Arithmetic Gradient
An arithmetic gradient series is a cash flow series that either increases or decreases
by a constant amount each period. Starts at base amount and increases by constant gradient
G in years 2 through n.
The cash flow, whether income or disbursement, changes by the same constant
amount each period. The amount of the increase or decrease is the gradient G.

CFn=base amount + ( n1 ) G
Where G -constant arithmetic change in cash flows from one time period to the next; G may be positive
or negative.
CF n for cash flow in year n

The present worth point is always one time period to the left of the first cash flow in the series or,

Two periods to the left of the first gradient cash (G) flow.

Geometric Gradient
A geometric gradient series is a cash flow series that either increases or decreases by a
constant percentage each period. The uniform change is called the rate of change.

2. DEPRECIATION
Depreciation is the decrease in the value of physical property with the passage of time. It is a book
method (noncash) to represent the reduction in value of a tangible asset. The annual depreciation amount is
not an actual cash flow, nor does it necessarily reflect the actual usage pattern of the asset during
ownership.
The method used to depreciate an asset is a way to account for the decreasing value of the asset to the
owner and to represent the diminishing value (amount) of the capital funds invested in it.
3. DEPLETION
Depletion refers to the decrease in the value of a property due to the gradual extraction of its
contents. It is a book method (noncash) to represent the decreasing value of a natural resource as it is recovered,
removed, or felled.
2 Methods of Depletion
Cost depletion sometimes referred to as factor depletion, is based on the level of activity or usage, not
time, as in depreciation. Cost depletion may be applied to most types of natural resources and must be applied to
timber production.

CDt=

first cost
resource capacity

Percentage depletion is a special consideration given for natural resources. A constant, stated
percentage of the resources gross income may be depleted each year provided it does not exceed 50% of the
companys taxable income.

depletion= percentage depletion rate ( PD ) gross income (GI )

4. FIRST COST
First cost P or unadjusted basis B is the delivered and installed cost of the asset including
purchase price, delivery and installation fees, and other depreciable direct costs incurred to prepare the
asset for use.
The term unadjusted basis, or simply basis, is used when the asset is new, with the term
adjusted basis used after some depreciation has been charged. When the first cost has no added,
depreciable costs, the basis is the first cost, that is, P = B.
5. LIFE
Physical life of a property is the length of time during which it is capable of performing the
function for which it was designed and manufactured.
Economic life is the length of time during which the property may be operated at a profit.

6. SCRAP VALUE
Scrap value is the worth of a physical asset's individual components when the asset itself is
deemed no longer usable.
Scrap value is associated with the depreciation of assets used in a business. In this situation,
scrap value is defined as the expected or estimated value of the asset at the end of its useful life. Scrap
value is also referred to as an asset's salvage value or residual value.

Scrap Value=Cost of asset( RV lifespan)

Where, RV = depreciation

7. SALVAGE VALUE
Salvage value S is the estimated trade-in or market value at the end of the assets useful life.
Salvage value is a tool used in accounting to estimate the value that a tangible asset can be sold for
when it has reached the end of its useful life in short, what the asset can be salvaged for when a
company can no longer make viable use of it.

1i

S=P
Where P = original price
i = depreciation rate
y = age in years
S = salvage value
8. Depreciation Method
Requirements of a Depreciation Method
1. It should be simple.
2. It should recover capital
3. The book value will be reasonably close to the market value at any time.
4. The method should be accepted by the Bureau of Internal Revenue.
The following are symbols used for different depreciation methods:
L = useful life of the property in years
Co= the original cost
CL= the value at the end of the life, the scrap/salvage value
d = annual cost of depreciation
Cn = book value at the end of n years
Dn = depreciation up to age n years

Straight line method

Straight line method assumes that the loss in value is directly proportional to the age
of property. This is the classical, non-accelerated depreciation model which estimated
salvaged value is always considered. Straight line depreciation derives its name from the fact
that the book value decreases linearly with time. The depreciation rate is the same (1/n )
each year of the recovery period n .

Sinking Fund Method

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.

Sum of the year digit method

The SYD method is a historical accelerated depreciation technique that removes much of the
basis in the first one-third of the recovery period.

Declining Balance Method (DB)

In this method, sometimes called the constant percentage method or 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 if the property and designated by k,
the rate of depreciation. The method accelerates depreciation compared to the straight line
method.

Double Declining Balance Method (DDB)

This method is very similar to the declining balance method except that the rate of
depreciation k is replaced by 2/L.
When DDB method is used, the salvage value should not be subtracted from the first
cost when calculating the depreciation charge.

2
2
1 n1 ;
L
L
d n=C 0
2 n
1
L
Cn =C0
2
1 n1
L
C L =C 0

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. This method has the
advantage of making the unit cost of depreciation constant and giving low depreciation
expense during periods of low production.

Service Hour Method

This method is mostly useful for depreciating Transport vehicles. It takes into consideration the
running time of the asset for calculating the depreciation. This method has the same concept as unit of
production depreciation except that the depreciation expense is a function of total hours of service used
during an accounting period. . Under this method the depreciation is calculated by dividing the net total
cost of the asset by its estimated service life. This method can he used only in case of those assets
whose life can be measured in terms of working time.
For example, the cost of a car is Rs. 150,000 and its estimated life is 50,000 running hours. The car runs for
1,200 miles in the first year. Compute depreciation for the first year.