Depreciation. Dr. M. S. Memon. Mehran UET, Jamshoro, Pakistan. Department of Industrial Engineering and Management
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1 Depreciation Dr. M. S. Memon Department of Industrial Engineering and Management Mehran UET, Jamshoro, Pakistan
2 Introduction Any equipment which is purchased today will not work for ever. This may be due to wear and tear of the equipment or obsolescence of technology. Hence, it is to be replaced at the proper time for continuance of any business. The replacement of the equipment at the end of its life involves money. This must be internally generated from the earnings of the equipment. The recovery of money from the earnings of an equipment for its replacement purpose is called depreciation fund since we make an assumption that the value of the equipment decreases with the passage of time. Thus, the word depreciation means decrease in value of any physical asset with the passage of time.
3 METHODS OF DEPRECIATION There are several methods of accounting depreciation fund. These are as follows: 1. Straight line method of depreciation 2. Declining balance method of depreciation 3. Sum of the years digits method of depreciation 4. Sinking-fund method of depreciation 5. Service output method of depreciation Some of these are discussed in detail in this course.
4 METHODS OF DEPRECIATION - Straight Line Method of Depreciation In this method of depreciation, a fixed sum is charged as the depreciation amount throughout the lifetime of an asset such that the accumulated sum at the end of the life of the asset is exactly equal to the purchase value of the asset. Here, we make an important assumption that inflation is absent.
5 METHODS OF DEPRECIATION - Straight Line Method of Depreciation
6 Straight Line Method of Depreciation - EXAMPLE 1 A company has purchased an equipment whose first cost is Rs. 1,00,000 with an estimated life of eight years. The estimated salvage value of the equipment at the end of its lifetime is Rs. 20,000. Determine the depreciation charge and book value at the end of various years using the straight line method of depreciation.
7 Straight Line Method of Depreciation - EXAMPLE 1
8 Straight Line Method of Depreciation - EXAMPLE 1
9 Straight Line Method of Depreciation Home Work Problem: Consider Example 1 and compute the depreciation and the book value for period 5.
10 Declining Balance Method of Depreciation In this method of depreciation, a constant percentage of the book value of the previous period of the asset will be charged as the depreciation amount for the current period. This approach is a more realistic approach, since the depreciation charge decreases with the life of the asset which matches with the earning potential of the asset. The book value at the end of the life of the asset may not be exactly equal to the salvage value of the asset. This is a major limitation of this approach.
11 Declining Balance Method of Depreciation
12 Declining Balance Method of Depreciation
13 Declining Balance Method of Depreciation Example 2 Problem: Consider Example 1 and demonstrate the calculations of the declining balance method of depreciation by assuming 0.2 for K.
14 Declining Balance Method of Depreciation Example 2
15 Declining Balance Method of Depreciation Example 2
16 Declining Balance Method of Depreciation Home Work Problem: Consider Example 1 and calculate the depreciation and the book value for period 5 using the declining balance method of depreciation by assuming 0.2 for K.
17 Service Output Method of Depreciation In some situations, it may not be realistic to compute depreciation based on time period. In such cases, the depreciation is computed based on service rendered by an asset. Let
18 Service Output Method of Depreciation Example 3 Problem: The first coat of a road laying machine is Rs. 80,00,000. Its salvage value after five years is Rs. 50,000. The length of road that can be laid by the machine during its lifetime is 75,000 km. In its third year of operation, the length of road laid is 2,000 km. Find the depreciation of the equipment for that year.
19 Service Output Method of Depreciation Example 3
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