Consider two hypothetical companies: A and B. At the beginning of year 1, each company buys an identical piece of equipment for £2,100. The two companies have the same assumptions about the equipment useful life, estimated residual value, and productive capacity. The annual production of each company is the same. However, each company uses a different method of depreciation. As disclosed in each company’s notes to the financial statements, each company’s depreciation method, assumptions, and production are as follows: Estimated residual value: £100 Estimated useful life: 5 years Depreciation methods: Company A: straight-line method Company B: accelerated method (assume that 50% of the depreciable amount is depreciated in year 1, and the remaining balance is depreciated equally during the subsequent years) Critically discuss the differences in the timing of the recognition of the depreciation expense for each method. Under what circumstances do you think a manager could choose to use the accelerated depreciation method?
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Consider two hypothetical companies: A and B. At the beginning of year 1, each company buys an
identical piece of equipment for £2,100. The two companies have the same assumptions about the
equipment useful life, estimated residual value, and productive capacity. The annual production of
each company is the same. However, each company uses a different method of
disclosed in each company’s notes to the financial statements, each company’s depreciation method,
assumptions, and production are as follows:
Estimated residual value: £100
Estimated useful life: 5 years
Depreciation methods:
Company A: straight-line method
Company B: accelerated method (assume that 50% of the depreciable amount is depreciated in year
1, and the remaining balance is depreciated equally during the subsequent years)
Critically discuss the differences in the timing of the recognition of the depreciation expense for
each method. Under what circumstances do you think a manager could choose to use the accelerated
depreciation method?
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