MSci261-2007-Ch_6 - Chapter 6 Depreciation and financial...

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Chapter 6 1 Chapter 6 Chapter 6 MSci 261: Managerial and Engineering Economics Spring 2007 Instructor: Bon Koo Depreciation and financial accounting Depreciation and financial accounting
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Chapter 6 2 Overview Overview Depreciation Assets (e.g., equipment, building) lose value over time. Financial statements need the asset value at a specific time. Financial accounting Records and organizes the financial data of a business Shows the financial health of a firm Engineers should at least know how to read and use the financial statements. We will learns a few methods of estimating depreciations and two basic financial statements.
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Chapter 6 3 1. Depreciation and accounting 1. Depreciation and accounting Reasons for depreciation Use-related physical loss: tire, engine, light bulbs Time-related physical loss: unused car or machine Functional loss: change in style, standard, or technology Values of an asset Market value: the actual value of an asset in an open market Book value: value for accounting purpose; ca lculated with a depreciation model Scrap value (part) or salvage value (whole): actual value at the end of life
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Chapter 6 4 1. Depreciation model 1. Depreciation model Why depreciation model? Managerial decision: Money can be borrowed using the firm’s assets as collateral. Planning purpose: Firms need to decide whether to keep an asset or replace it. Taxation purpose: Tax is levied on profits, and depreciation of assets affects the profits. Types of depreciation model Straight-line depreciation model: Easy to calculate Declining-balance depreciation model: basis of the Canadian tax system
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Chapter 6 5 1.1. Straight-line (SL) depreciation (1) 1.1. Straight-line (SL) depreciation (1) Straight-line depreciation model The amount of loss in value of an asset is constant over time Easy to understand and commonly used But, the value is often too different from the market value. Tim e Book value N S P
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Chapter 6 6 1.1. Straight-line depreciation (2) 1.1. Straight-line depreciation (2) Depreciation charge per period where P is the purchase price, S is the salvage value and N is the service life The amount of depreciation is the same for every year. Note that interest rate is not considered. Book value at the end of period n sl P S D N - = ( ) sl P S BV n P n N - = -
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Chapter 6 7 Example 1-1: SL depreciation Example 1-1: SL depreciation Joan purchased a $760 mower last year. She expects the value will decline by a constant amount for the next 6 years, with a salvage value of $100. What is the book value at the end of each year?
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