Depreciation

What is DEPRECIATION?

• Depreciation is the decrease in value of

physical properties with the passage of
time and use
• It is an accounting concept that
establishes an annual deduction
against before-tax income in order for
the effect of time and use on an asset’s
value can be reflected in a firm’s
financial statements
• In general, property is depreciable if it
meets the following criteria:
1. It must be used in business or held to
produce income
2. It must have a determinable useful life and
the life must be longer than one year
3. It must be something that wears out,
decays, get used up, becomes obsolete, or
loses value from natural causes
4. It is not inventory, stock in trade, or
investment property
• Depreciable property can be classified as
tangible or intangible
• Tangible property can be further classified
as:
• Personal property
• Machinery, vehicles, equipment, furniture, and similar
items
• Real property
• Land, and generally anything that is erected on, growing
on, or attached to land
• Land though is not depreciable because it does not have
a determinable life
The Classical (Historical) Depreciation
Methods

1. Straight-Line Method
2. Declining Balance Method (Matheson
Formula)
3. Sum-of-the-Years Digits Method
Straight-Line Depreciation Method

• The simplest depreciation method available

• It assumes that a constant amount is
depreciated each year over the depreciable
(useful) life
EXAMPLE: A new electric saw for cutting small
pieces of lumber in a furniture
manufacturing plant has a cost basis of
US$4,000 and a 10-year depreciable life.
The estimated salvage value of the saw is
zero at the end of 10 years. Determine the
annual depreciation amounts using the SL
method.
Declining Balance Method (1/2)

• Sometimes called the Constant

Percentage Method
• It is assumed that the annual cost of
depreciation is a fixed percentage of
the BV at the beginning of the year
Declining Balance Method (2/2)

d k  B1  R  R  -  annual depreciati on

k 1

d k  B1  1  R  -  accumulate d depreciati on

* k

BVk  B1  R  -  book value at year k

k
Sum-of-the-Years Digits Method (1/2)

• To compute the depreciation deduction

by the SYD method, the digits
corresponding to the number for each
permissible year of life are first listed
in reverse order, and the sum of these
digits is then determined
• The depreciation factor for any year is
the number from the reverse-ordered
listing for that year divided by the sum
of the digits
 Sum-of-the-Years Digits Method (2/2)

 2 N  k  1
d k  B  SVN     -  annual depreciati on
 N N  1 
d k*  B  BVk -  accumulate d depreciati on
 2B  SVN   B  SVN 
BVk  B    k  k k  1-  book value
 N   N N  1 