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Choice of Depreciation Methods

(Depreciation Decisions)

A comparison of various depreciation methods would disclose that the difference does exit between depreciation expenses under each method. Although the choice of method is often a matter of personal preference yet method selected should be most practical and meaningful. The decision should be based on the characteristics of a particular asset. There is substantial evidence based on actual studies that most production assets tend to become less and less valuable over time. This would mean increase in the maintenance costs with the corresponding decline in the quality of the assets as time goes on. Moreover, the introduction of new equipment on account of innovation has relatively affected the quality of the existing equipment on account of innovation has relatively affected the quality of the existing equipment. These factors suggest that accelerated depreciation methods such as sum of years digits and double declining balance methods would be profitably employed under such conditions. The increasing maintenance costs in the later years tend to increase the cost of the used asset. It means that the cost of each unit of output also increases in later year. “The increasing maintenance cost in the later years is offset by the lessening depreciation expenses thus equalizing, to some extent, the total asset cost per unit. Such significant aspects are overlooked by the Straight Line Method and Units of Production Method which are based on the assumptions that the depreciation charge is uniform either per period (S.L.M) or per unit (unit of production method.)

However, the straight line method has been found suitable or assets like buildings, furniture, short leases, patents and those assets which benefit all accounting periods equally which do not require many repairs and renewals. More often the management uses depreciation accounting as an instrument of financial policy. It is well known that the choice of a method has significant impact on the amount of reported net income. Managements might, therefore, select the depreciation method of combination which would show the desired results over a period of time.

It would be found that the total depreciation expense over the useful life of the asset is the same. The difference is the allocation of the cost on year to year basis. Ideally the method used should be one as to give as good a matching of cost and revenue as possible, that is, to properly allocate the acquisition cost over the expected useful life of the asset.

A choice of depreciation method affects the balance sheet too since the amount of depreciation expense increases the accumulated depreciation. This would directly affect the net book value of the asset.

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