Depreciation Method to Adopt
Depreciation is calculated with the aim of associating ware and tear of an asset to the profit made in a given period. Though depreciation is a non cash expenditure it is appropriate to charge it on the asset so as to get the correct market value of the asset. This will make sure that the fixed assets are reported at a true and fair value. All assets except land undergo wear and tear that’s why in the land has not been subjected to any form of depreciation (Gary & Curtis, 2010).
There are different methods of depreciation which are used by the company i.e straight line, sum of digits units of out put and double declining method. The suitability of any method depends on how the characteristic of an asset fit well with the features of the depreciation method. In this respect, if an asset undergoes uniform wear and tear over its life time irrespective of intensity of its use then straight line method is the most appropriate method of depreciation.
On the other hand, if the asset undergoes intensive wear and tear in its early year’s of its useful life then it is appropriate to use double declining method. This is because this method allocates higher amount of depreciation in early years of an asset. This method is however not very suitable to for the equipment because in the latter years of the equipment there is no depreciation charged (refer to the excel calculations).
It is therefore suitable for the company to adopt straight line method of depreciating building. This is because the value of wear and tear for the building is the same. However, if the building is expected to remain idle in any of the year’s straight line method will not be appropriate. Hence, assuming continuous production it is appropriate for straight line method to be used for the building.
On the other hand, the equipment should not be depreciated on straight line basis because its productivity differs from year to year. This means that in some years the amount of wear and tear is higher than in years with low level of production. It is therefore reasonable for the company to use units produced per year as the basis of depreciation. Failure to depreciate the equipment according to number of units produced means that profits of year after year will not be associated with the correct amount of profit (Gary & Curtis, 2010).
It is also unreasonable to depreciate the company equipment in accordance with double digit method. This is because the productivity of the equipment does not rapidly fall over time. Referring to the company’s machine productivity it is clearly seen that in the seven and sixth year the amount of units are not very low. In addition, the productivity in seventh year is even above the productivity in the sixth year (year seven is 91000 while year sixth is 82,000).
In a nut shell, the company should not depreciate the land. However, it should use straight line method for the building and number of units as basis of depreciating the equipment.
Gary, A. & Curtis, N. (2010). Using financial accounting information: the alternatives to debits and credits. USA: Cangage learning.