Plant Management: Depreciation

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?

Caused by wear & tear, deterioration, obsolescence, or reduced need. Determines decline in market value during 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

There are many depreciation accounting methods. We will only discuss two.

Depreciates the Equipment Value equally in each of the years the Equipment is Owned. R Annual Depreciation Rate N Number of years the equipment is owned. R = 1/N D Annual Depreciation Amount P Purchase Price F Salvage Value at the end of N years D = R(P - F )

 BV Equipment value at the end of each year after the annual depreciation has been subtracted. BVm= BVm-1 - Dm Where BVm is the book value in the year m, BVm-1 is the book value in the year m-1, and Dm is the annual depreciation amount

Example 1

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 book value of the plant at the end of the third year?

Example 1

Annual depreciation rate

R=

Annual depreciation amount

D=

Book value

BVm= BVm-1 - Dm BV1= BV0 D1= BV2= BV1 D2=

BV3= BV2 D3=

Example 1

Annual depreciation rate

R = 1/N=1/6=0.167

Annual depreciation amount

D = R(P - F )=
BVm= BVm-1 - Dm BV1= BV0 D1= BV2= BV1 D2= BV3= BV2 D3=

Book value

Example 1

After Year

Depreciation Rate

Dep. Amount

Book Value

1
2 3

1/6
1/6 1/6

4
5 6

1/6
1/6 1/6

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)

Example 1 Revisited

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

The sum of the year

SOY = N(N+1) / 2=
Rm = (N - m + 1) / SOY=
Dm = Rm(P-F)=
Depreciation Rate Dep. Amount Book Value

Depreciation amount for the third year

1 2 3 4 5 6

Book value
After Year