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Plant Management:

Depreciation

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2

Construction asset loses value with age

Depreciation: The loss of value of a piece of

plant or facility over time.

Why a manager needs to know depreciation?

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Caused by wear & tear, deterioration,

obsolescence, or reduced need.

Determines decline in market valueduring the time period

Determines the depreciation amount to

use in replacement decision analysis Used to evaluate tax liability

Realistically reflects asset/liability of a

company

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There are many depreciation accountingmethods. We will only discuss two.

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Depreciates the Equipment Value equally in each of the yearsthe Equipment is Owned.

R Annual Depreciation Rate

N Number of years the equipment is owned.

R = 1/N

D Annual Depreciation Amount

P Purchase PriceF Salvage Value at the end of N years

D = R(P - F )

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BV Equipment value at the end of each year after the annualdepreciation has been subtracted.

BVm= BVm-1- Dm

Where BVmis the book value in the year m, BVm-1is the book value in

the year m-1, and Dmis the annual depreciation amount

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A contractor purchased a plant for

$250,000 and will use it for 6 years. The

estimated salvage value is $60,000.Using the straight-line method of

depreciation accounting, what is the

annual depreciation amount and the bookvalue of the plant at the end of the third

year?

Example 1

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Annual depreciation rate

R =

Annual depreciation amount

D =

Book value BVm= BVm-1- Dm

BV1= BV0D1=

BV2= BV

1D

2=

BV3= BV2D3=

Example 1

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Annual depreciation rate

R = 1/N=1/6=0.167

Annual depreciation amount

D = R(P - F )=

Book value BVm= BVm-1- Dm

BV1= BV0D1=

BV2= BV1D2=

BV3= BV2D3=

Example 1

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Example 1

After Year Depreciation Rate Dep. Amount Book Value

1 1/6

2 1/6

3 1/6

4 1/6

5 1/6

6 1/6

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The Annual depreciation rate differs for each year.

Annual Depreciation Rate

Rm = (N - m + 1) / SOY

N : the number of years the equipment is owned

m : the specific year in which depreciation is being

determined

SOY : the sum of the years that equals N+(N-1)+(N-2)+!

SOY = N(N+1) / 2

Annual Depreciation Amount

Dm

= Rm

(P-F)

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A contractor purchased a plant for

$250,000 and plans to use if for 6 years.

The estimated salvage value is $60,000.Using the sum-of-the-years method, what

is the depreciation amount for the year

three and the book value of the plant at

the end of the third year?

Example 1 Revisited

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The sum of the year SOY = N(N+1) / 2=

Depreciation amount for the third year

Rm = (N - m + 1) / SOY=

Dm= Rm(P-F)=

Book value

Example 1 Revisited

After Year Depreciation Rate Dep. Amount Book Value

1

2

3

4

5

6