Question

Discuss the factors that a company would typically consider in choosing a depreciation method. Also, is depreciation an attempt to reflect the fair market value of the asset?

Answer 1

FACTORS TO BE CONSIDERED WHILE CHOOSING A METHOD OF DEPRECIATION :

NATURE OF THE ASSETS : This is the primary factor required to be considered. It will be considered as how much repairs do such asset requires with passage of time or in how much time it is to be replaced. All these are concerned with the nature of assets hence it is an important factor.

PRICE FLUCTUATIONS : When due to any reason the prices of any asset fluctuate with time, tgen company should opt for replacement method of depreciation rather than historical method, thus price fluctuation do effect the choice of method of depreciation.

TAX CONSIDERATION : The company by charging depreciation saves tax hence it is a tax shield for any business. It tends to provide tax free amount to business (or less taxable profit) thus method of depreciation should be choosed very wisely.

ACCOUNTING CONVENTIONS : Accounting conventions for preparing business accounts are based on certain conventions like consistency, a method once opted should not changed frequently and should be kept consistent if possible.

OBSOLESCENCE : If the asset is seem to get obsolete in small period off te tgen it should be written off quickly. This is to prevent excessive burden in profit and loss account in year of obsolescence of such asset. If it will obselete in longer term then it should be written off slowly.

The reason for charging depreciation is not an attempt to reflect assets at fair value but it is charged in order to Calculate the recovery of cost incurred on the assets. and spread it over the estimated useful life of such asset. To ensure that the capital of business is intact and does not get a burden in year of purchase of such asset and in year of replacement.