Question

From a business owner perspective, When it comes to your assets (buildings, equipment, furniture & fixtures, etc.) please answer the following questions:

What depreciation method would you use to depreciate your assets? Explain Why.

How does depreciation affect the income statement and balance sheet?

Explain how depreciation might affect your decisions to purchase expensive equipment or real estate.

Answer 1

1. I would like to use straight line method of depreciation, the main reason will be it will provide for depreciation equally for all the periods and also it is very simple to calculate. Unlike other depreciation methods which uses other basis such as units produced during the year etc, it will be very easy to ascertain depreciation under straight line method. Further it is also accepted by the Generally accepted accounting principles to use this depreciation method. But sometimes based on the wear and tear of the asset, I may be forced to use other depreciation methods also.
2. Depreciation is an expense which is reduced from the revenue to arrive at the net income. So depreciation will reduce the net income and also it reduced the balance of the assets amount. Therefore depreciation reduced the amount of net income in income statement and amount of assets balances in balance sheet. The depreciation will go on occur as long as the asset has a value in the balance sheet.
3. When we purchase an expensive equipment or real estate, we must take into consideration the depreciation. When we purchase the asset there will be a huge outflow of funds, but the expenditure can be claimed as depreciation for several years and not the year of purchase. With depreciation, there might also be an effect on the return on equity every year. As the value of asset decreases, the value of equity also decreases in the same way.