Depreciation a Comparison of Depreciation Methods: Income Essay

Depreciation

A Comparison of Depreciation Methods: Income and Tax Consequences of Various Accounting Practices

Depreciation is something that any business organization or entity must deal with on an ongoing basis for a variety of reasons. All consumers experience the effects of depreciation, in fact, though it is typically not necessary for average consumers to explicitly and consciously account for the depreciated values of their assets. For businesses, however, such depreciation is often mandated as a means of determining an accurate valuation for a company's assets and the degree of shareholder worth and profit potential that these assets might generate (Albrecht et al. 2008). Most assets that companies use in their day-to-day operations such as facilities, equipment furniture, vehicles, computers, etc., begin losing value the moment they are purchased and start being used, and all with a financial interest in a given business organization have a right to know the actual value of a company's assets at a given point in time (Albrecht et al. 2008; Bryant 2010).

In addition, tax right offs for business expenses are dependent on accurate calculations of the depreciation of a company's assets (Albrecht et al. 2008; Bryant 2010). It is this area that many organizations find significant differences in the methods for calculation of the depreciation of their assets; some methods can present significant tax savings over other (Bryant 2010). This paper will compare straight line deductions, the unit-of-production method, and the declining balance method, analyzing the practicalities of their calculation as well as their effects and benefits.

The Methods

The straight-line depreciation method is by far the simplest depreciation accounting method and makes the most intuitive sense at first glance (Albrecht et al. 2008; Bryant 2010). In this method the cost of an asset is simply divided by the number of years of useful life the asset will provide to the business organization, and the resulting amount is the amount deducted for the asset each year that it is utilized by the company (Albrecht et al. 2008; Bryant 2010).For example, a fifteen hundred dollar computer that would be useful for three years would receive a deduction of 1500/3 dollars per year, or five hundred dollars a year over three years in the straight-line depreciation accounting method (Bryant 2010).

The unit of production accounting method is not exactly suitable for all assets. As the name implies, this accounting method notes the depreciation of a given asset not over time, but over the amount that the asset is actually used (Albrecht et al. 2008; Bryant 2010). Computers, for example, do not really depreciate based on the amount of data that they store and transmit, and thus this accounting method would not be appropriate for this type of asset (Albrecht et al. 2008). Vehicles and many other pieces of equipment, however, do depreciate based on the amount they are used; a car with higher mileage is worth less than the same year's model will less mileage. In this accounting method, usable life would be determined by a certain measure of production (100,000 miles on a car, for example) and the yearly tax deduction would be taken based on the number of units produced divided by the total (Bryant 2010).

Assume that a given vehicle purchased by a company for business use has an estimated useful life to that company of one hundred thousand miles. If the vehicle costs twenty thousand dollars, then its depreciation value is simply $20,000 (the cost of the vehicle) divided by 100,000 (the number of useful units the vehicle can produce), or .2 dollars per unit of production, or twenty cents a mile. If the vehicle is driven twenty thousand miles in its first year of operation and thirty thousand miles in its second, the depreciation for each year would be four thousand dollars and six thousand dollars, respectively. This accounting method does not need to be utilized for assets that depreciate in this manner, but it can be useful to.....