Question

Can you explain the effects three depreciation methods on annual depreciation expense.

Answer 1

Effects of three depreciation method on annual depreciation expense

1. straight line depreciation : constant amount

Straight line depreciation is a common method of depreciation where the value of a fixed asset is reduced gradually over its useful life.

The default method used to gradually reduce the carrying amount of a fixed asset over its useful life is called Straight Line Depreciation. Each full accounting year will be allocated the same amount of the percentage of asset’s cost when you are using the straight-line method of depreciation.

This method was created to reflect the consumption pattern of the underlying asset. It is used when there no particular pattern to the manner in which the asset is being used over time. Since it is the easiest depreciation method to calculate and results in the fewest calculation errors, using straight line depreciation to calculate an asset’s depreciation is highly recommended

2. Units of activity : varying amount

The units of activity depreciation is one of several methods of depreciation. Units of activity depreciation is also known as units of production depreciation. The units of activity method of depreciation is unique in that a plant asset's useful life is expressed in the total units that are expected to be produced or the asset's total activity during its life. The asset's cost is then allocated to the accounting periods based on the plant asset's usage, units produced, activity, etc. Years and partial years are not relevant when using this depreciation method. (The other methods of depreciation express the plant asset's useful life in years and will allocate the plant asset's cost based on the mere passage of those years. Under these methods partial years are relevant).

3.Declining balance method : decreasing amount

Declining balance method of depreciation is an accelerated depreciation method in which the depreciation expense declines with age of the fixed asset. Depreciation expense under the declining balance is calculated by applying the depreciation rate to the book value of the asset at the start of the period.

While the straight-line depreciation method is straight-forward and most popular, there are instances in which it is not the most appropriate method. Assets are usually more productive when they are new, and their productivity declines gradually due to wear and tear and technological obsolescence. Thus, in the early years of their useful life, assets generate more revenues. For true and fair presentation of financial statements, matching principle requires us to match expenses with revenues. Declining-balance method achieves this by enabling us to charge more depreciation expense in earlier years and less in later years.

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