Question

Describe how the depreciation schedule decision might influence the rate-of-return on farm assets.

Answer 1

for any business, depreciation is a direct expense. if you buy a truck worth $10000 in exchange for cash $10000 it may seem like a huge expense if recorded at once but it is just exchanging one type of asset(cash) for another(plant, property, equipment).

This equipment would be used for several years before it loses its value. the amount by which it loses its value is called depreciation expense.

Types of depreciation:

1. Straight-line
2. Double declining balance
3. Units of production

Rate of return on total assets= Net profit / Total assets

Net Profit= Revenues- Expenses(including Depreciation expense)

Total Assets- value of assets decrease as they depreciate

As both numerator and denominator of ROR are impacted by Depreciation expense, its clear that the ROR will be effected by the choice of depreciation method.

1. Straight line depreciation

Depreciation Expense = (Cost – Salvage value) / Useful life

Depreciation happens in equal amounts each year

2. Double Declining Balance Depreciation Method

Periodic Depreciation Expense = Beginning book value x Rate of depreciation

Depreciation expense depends on the value of the remaining asset after previous depreciation, depreciation expense decreases with time

3. Units of Production Depreciation Method

Depreciation Expense = (Number of units produced / Life in number of units) x (Cost – Salvage value)

Depends on the expected units of goods the equipment is expected to generate.