Depreciation Essay

1456 words - 6 pages

IntroductionFinancial statements are usually prepared by an entity to communicate information about its financial performance, position, cash flows, and movement of equity to users and help them make decision. A statement of accounting policies is specified with these statements to help users understand how the information is collected and make it understandable and useful. In this essay, the author will attempt to explain the importance of understanding which accounting policies have been used in preparing a set of financial statements, mainly to which applied to property plant and equipment.The Statement of Accounting PoliciesThere are various assumptions that are made to specific business ...view middle of the document...

DepreciationConceptDepreciation is the accounting policy which applied to property plant and equipment. It is a significant item of expenditure and only represents the expired portion of cost. Depreciation is the mechanism by which the original cost of the asset is allocated over the estimated number of accounting periods that match the useful economic life of the non-current asset. In doing this, the allocations are based on the assumptions that:The useful life of the asset can be measured in that the firm will use the asset for the forecast period. There should be a continuing demand for using of equipment and its products. In the case of Hallenstein's annual report 2003, under accounting policy of depreciation, it individually specified economic lives of different items, such as office equipment, building and other fixed assets.On the expiry of the useful life of the equipment, the expected residual value will be received.The usage of the equipment will be as expected. Any changes of use will affect on its useful life.MethodTwo methods of calculating a depreciation charge are commonly used. They are straight line method and diminishing value method.Straight line methodBy this method, the benefits which accrue to the entity are assumed to accrue evenly over the useful life of the asset. Under this method, an equal amount of the depreciable value is expensed in each accounting period over the useful life of the asset, such as the method adopted in the case of Hallestein's annual report 2003. That is to say the same cost is allocated to each accounting period in which the asset is used. The advantage of this method is its simple calculation, but will frequently not produce an appropriate matching of cost ad revenue.Diminishing value methodThis method assumes that greater benefits accrue to the entity earlier in the asset's life and that those benefits decline with the passage of time. A constant rate is used to calculate the depreciation charge. The depreciable amount is reduced by each period's depreciation charge before calculating the following period's amount of depreciation. In other words, the asset's productivity declines with age. On this basis, the annual amount of depreciation reduces to offset anticipated increases in maintenance costs as the asset ages.A Prorate MethodAs usual, a firm will choose a method that is simple to calculate, rather than a method that requires more complex calculations. The use of the matching process suggests that the fairest allocation over the useful life of the asset should determine the method used. We would like to know which of those two methods is most fairly reflected the way of benefit received is different because case is different. We should consider complexity of the calculation and fairness of the allocation. The author supposes the choice of method have a significant influence on the level of profit of the firm. More rapid depreciation will reduce both operating profit (higher depreciation...

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