ACC205 Week 3 – Discussion 2
| Depreciation |
| A variety of depreciation methods are used to allocate the cost of an asset to all of the accounting periods benefited by the use of the asset. Your client has just purchased a piece of equipment for $100,000. Explain the concept of depreciation. Which of the following depreciation methods would you recommend: straight-line depreciation, double declining balance method, or an alternative method? |
ACC205 Week 3 – Discussion 2 Answer
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. The objective is to match the cost of the asset with the revenue it generates throughout its operational years. This process recognizes the wear and tear, obsolescence, or loss of value that occurs over time.
Now, let’s briefly discuss the three depreciation methods mentioned:
- Straight-Line Depreciation:
- Calculation: (Cost – Salvage Value) / Useful Life
- Advantages: Simple and easy to understand. Provides a consistent annual expense.
- Consideration: Suitable when the asset’s utility and productivity are expected to decline evenly over its useful life.
- Double Declining Balance Method:
- Calculation: (2 / Useful Life) * Book Value at the Beginning of the Year
- Advantages: Accelerates depreciation in the early years, reflecting a more rapid decrease in the asset’s value.
- Consideration: Suitable for assets that rapidly lose value early in their useful life.
- Alternative Methods (e.g., Units of Production or Sum-of-the-Years-Digits):
- Units of Production: Depreciation is based on actual usage or production output.
- Sum-of-the-Years-Digits: Accelerates depreciation similar to double declining balance but in a more gradual manner.
- Consideration: Useful for assets whose productivity varies each year.
Recommendation: The choice of depreciation method depends on the nature of the asset, its pattern of utility, and the financial goals of the company. For a newly purchased piece of equipment, the straight-line depreciation method might be a prudent choice. It is simple, easy to apply, and provides a consistent annual expense, which can be advantageous for budgeting and financial planning. Additionally, if the equipment is expected to have a fairly uniform decrease in value over its useful life, straight-line depreciation would evenly distribute the cost across accounting periods. However, it’s crucial to consider the specific characteristics of the asset and consult with the client to align the chosen method with their financial objectives and reporting preferences.
