Easy for accounting degree, answer 3 questions based on lectures PPT attachment Essay Example

Depreciation

STRAIGHT LINE METHOD

Under this method, an equal amount is provided each year for depreciation of each asset until the asset has been written down to nil or its scrap value at the end of the estimated life of the asset. This method also keeps constant profits as can be shown in the calculation below;

I recommend the use of this method because it is easy to understand and also calculate. This means that consistency in accounting can easily be maintained. Under this method it is easy to write off the cost of the asset.

Some of the disadvantages of this method include:

a) This method does not take into account the interest on capital invested on the assets.

b) Under this method the amount of depreciation can never be equal to the value of services rendered from the asset.

DIMINISHING BALANCE METHOD

This depreciation is charges a fixed percentage of depreciation each year to the net asset balance. The depreciation charges are higher at the early stages than the later stages of the useful life of the asset.

Advantages.

a) Under this method, depreciation is calculated according to the service yielding capacity of the asset. As amount of depreciation decreases gradually with the decrease in service potential of asset.

b) This method can be proved very helpful in adopting the better matching of revenue and expenses as in the first few years’ depreciation being heavy and repairs light and in the last few years’ repairs being heavy and depreciation light.

Disadvantages

a) This method puts too much emphasis on the historical cost. Proper emphasis is not given on the capital invested on the asset.

b) Ignores capital invested

c) The use of this method mitigates against accurate costing. It has been observed in practice that sometimes the assets can earn more or less the same amount of revenue for a long period of time. In that case, different amount is charged for the use of same assets in different periods cannot be justified.

SUM-OF-THE-YEARS’-DIGITS METHOD

This method assumes that depreciation of the first year should be the highest as no portion of the capital has been recovered till then and the depreciation of the last year should be the least of all years because a major portion of the invested capital has been already recovered.

Advantages

1. In this method, the amount of depreciation is greater in the earlier years in comparison with the later years because the benefits received from the use of the asset are greater in the early years than in the later years.

b) In the earlier year repairs are light but depreciation is heavy but in the later year, as the asset gets older the repairs are heavy but depreciation is light. So depreciation plus repairs will more or less constant every year and the charge to Profit and Loss Account should be uniform.

c) If the asset is retired earlier than anticipated as result of unforeseen obsolescence, the loss upon retirement will be less than if straight line depreciation were used, because, asset is recovered at a higher rate in the earlier years where as only a small fraction remains left for recovering them in the later years.

Disadvantage

In the earlier year greater depreciation is charged at a result less profit is available for declaring dividend in the earlier year. This may create a serious problem for organization to attract new investor. As dividend is one of the motivating factors for investment. Again more depreciation in the earlier year may resultant the high cost of production in the competitive market.