Question

At Q Company, the annual depreciation expenses for the production equipment are computed under an accelerated depreciation method, resulting in annually changing depreciation amounts. With respect to the production volume, the depreciation amount total level is a: _______ cost [Select one: Fixed or Variable]. Then, explain your ground concisely below.

Answer 1

Answer : Fixed.

Under accelerated depreciation method the depreciation expense during early years will be high compared to later years. This method is used for those assets which becomes obsolete quickly. However, this method of depreciation don't depreciate asset based on the production levels.

For example, an asset has 5 years of useful life and it is depreciated based on sum of digits method (an accelerated depreciation method). If the business don't produce any goods using this asset in the fourth year, depreciation won't be zero as 2/15th of the asset value taken as depreciation expense in the fourth year.

That means, depreciation expense under accelerated depreciation method is not variable cost as it doesn't depends on number of units produced. If the units of production method is used then the depreciation is calculated based on number of units produced and not based on number of years completed. So, under units of production method depreciation expense becomes variable as total value of asset is allocated to each unit produced equally. In the above example, if the units of production method is used then depreciation expense in the fourth year would be zero as no units produced.

So it means that depreciation expense under accelerated depreciation method is fixed cost and not variable cost as depreciation is not based on activity level.