Let us start with a simple question. When is it best to use the straight-line method or the Accelerated method when reporting depreciation? But, to answer this question the quadrant would need to understand the differences between the two. Recognize the benefits and faults of each method when put into practice. Is the straight-line depreciation method better suited for tax purposes or should it be used for financial reporting? The quadrant could look to industry; seeing that the straight-line method is used for reporting to stockholders by most firms. To see why we would need to study how the straight-line method works and why it is better used for financial accounting.
               The key to understanding anything is to always start with the basics. The simple mechanics of how the straight-line depreciation method works and even what depreciation is. Simply defined depreciation is a term used to spread the cost of an asset over a span of several years. In other words, it is the reduction in the value while that asset is being used by the company or organization. The straight-line depreciation method is one way of recording this reduction in value. This method calculates the annual depreciation expense by taking the cost of the fixed asset minus the scrap value of that asset then dividing by the life span (the number of years the fixed asset will be in use). For example, a fixed asset that depreciates over six years is purchased by a firm. The cost of that asset is $35,000 and it has a scrap value of $5000. The calculated annual depreciation expense will be $5000. This method is used in financial accounting because it allows for the firm or organization to report a higher net income in the earlier years to the stockholders. Financially it makes the company or organization look better to current investors and future investors. But for tax purposes it might not be the company or organization’s first choice for recording depreciation.  Often the company or organization will use a method such as the double declining depreciation method because of its benefit to maximize the early tax deduction.
               How can the double declining depreciation method help with maximizing the early tax deductions for a company or organization’s fixed asset? When the method is broken down to mechanics it becomes easy to see. The double declining depreciation method, like the straight-line method, is another way to record the reduction in value of an asset while it is in use.  In this method the annual depreciation expense is calculated by doubling the straight-line depreciation rate then multiplying it by the asset’s net book value at the beginning of the year. So, hypothetically, if a company or organization’s fixed asset has a twenty percent straight-line depreciation rate the double declining balance depreciation rate would be forty. But, unlike the straight-line depreciation method, when using the double declining depreciation the depreciation expense is recalculated each year using the previous year’s net book value at end of year. The early calculations are noticeably higher forcing higher taxes early on. But, the benefit to using the double declining balance depreciation method is that as the fixed asset is used throughout its life span the depreciation expense decreases significantly.  So, companies and organizations choose this method so they can pay a larger sum of the taxes upfront instead of having to pay them further down the road.
               If you think about it, it does make sense why each the straight-line depreciation method and the double declining depreciation method are used for different types of reporting. While the straight-line depreciation method allows the company or organization to reflect higher earnings for their investors the double declining depreciation method lets them take care of the higher expenses up front for tax purposes. Companies and organizations would prefer to have the tax deduction earlier in the life span then later. When explained simply the benefits of these two methods are easy to spot. But remember this is just an outline of the simple mechanics of these depreciation methods. In practice there are a number of other technical challenges that should be considered when calculating the depreciation. Such considerations could be a re-estimated salvage value, investment asset improvement or a change in the life span of the fixed asset. But with the understanding of the basic calculations and benefits of the two different methods it becomes easier to expand into more challenging examples of depreciation reporting. As well as to understand how it effects both the income and balance sheet statement.
Article Source:http://www.articlesbase.com/accounting-articles/straightline-or-double-down-depreciation-method-1320996.html
Orignal From: Straight-Line or Double Down Depreciation Method?
No comments:
Post a Comment