An analysis of the Depreciation Methods in GAAP in the UK

An analysis of the Depreciation Methods in GAAP in the UK Depreciation is the allocation of the cost of a plant asset to expense over its useful (service) life in a rational and systematic manner† (Weygandt, Kieso and Kimmel, 2003:416). There are three factors affect the calculation of depreciation, which are asset cost, useful life and salvage value (Weygandt, Kieso and Kimmel, 2003). Accountant in different companies will use various methods to compute the depreciation. There are straight-line method, reducing balance method (double declining balance, sum of digits, reducing percentage), annuity method, and unit of production method (Mike, Ron and Allister, 1994). And in most companies, especially in the large corporations, they will use the straight-line method, because it is the easiest one to compute the depreciation. This essay will illustrate some method that usually used in the companies and contract with each method to find out which one is the most useful. At the beginning, the essay will illustrate the straight-line method , the second one is reducing balance method, the third method is sum of digits, and the last one is the unit of production method. Below each method, the essay will give an example, which is calculated by me. Under the straight-line method, the annual depreciation expense is the same over the asset’s estimated useful life every year. The annual depreciation expense is determined by depreciation cost divided by the useful life of the asset or multiplied by the annual rate of depreciation (Weygandt, Kieso and Kimmel, 2003). Example 1 An asset costs  ¿Ã‚ ¡11,000, its expected salvage value is  ¿Ã‚ ¡1,000, its estimated useful life is 5 years. Depreciable cost = ¿Ã‚ ¡11,000- ¿Ã‚ ¡1,000 = ¿Ã‚ ¡10,000 Annual depreciation expense = ¿Ã‚ ¡10,000/5years= ¿Ã‚ ¡2,000 OR Annual rate of depreciation =100%à ·5years=20% Annual depreciation expense = ¿Ã‚ ¡10,000*20%= ¿Ã‚ ¡2,000 Year 1 Cost  ¿Ã‚ ¡11,000 Depreciation 2,000 Year 2 Net book value 9,000 Depreciation 2,000 Year 3 Net book value 7,000 Depreciation 2,000 Year 4 Net book value 5,000 Depreciation 2,000 Year 5 Net book value 3,000 Depreciation 2,000 Net book value 1,000 The straight-line method is the simplest way among all the methods; it suitable for the use of asset is unvarying during the useful life; it is popular used by large corporation, such as Campbell Soup, Marriott Corporation and General Mills. However, the reducing balance method has a falling depreciation amount every year during the useful life of the asset. The changing depreciation is depended on the book value (cost less accumulated depreciation). It is calculated to multiply the book value at the beginning of the year and the reducing balance depreciation rate (Weygandt, Kieso and Kimmel, 2003). Example 2 An asset costs (book value at the beginning of year)  ¿Ã‚ ¡11,000, its expected salvage value is  ¿Ã‚ ¡1,000, its estimated useful life is 5 years. Reducing balance depreciation rate = 100%à ·5years=20%* Calculation o f  ¿Ã‚ ¡901.12( ¿Ã‚ ¡4505.6ÃÆ'-20%) is adjusted to  ¿Ã‚ ¡3505.6 in order to make the book value equal salvage value (Weygandt, Kieso and Kimmel, 2003). Sum of digits is another kind of reducing balance method, which has the closest connection with useful life and salvage value of the asset. The depreciation cost is multiply depreciation cost (asset cost less salvage value) by digits of each year (Mike, Ron and Allister, 1994). Example 3 An asset costs  ¿Ã‚ ¡11,000, its expected salvage value is  ¿Ã‚ ¡1,000, its estimated useful life is 5 years The digits add up is 1+2+3+4+5=15