Explain the conventional accounting concept of depreciation accounting, and disc

Question

Explain the conventional accounting concept of depreciation accounting, and discuss its conceptual merit with respect to (a) the value of the asset, (b) the amount(s) expensed, and (c) the discretion of management in selecting the method. Once you have presented a response, choose a depreciation method and describe how it is used. Explain how depreciation is calculated using the method and whether or not you feel the depreciation method gives a good estimate of the cost allocation of the asset. Use your readings from the text and at least one additional academic resource to provide support for your response.

Explanation / Answer

Conventional accounting concept of depreciation accounting:

Conventional accounting concept of depreciation accounting is nothing but straight-line method of depreciation accounting or static depreciation method where by cost of the asset is depreciated equally over expected life of the asset concerned. Conventional method takes into account the salvage / resale / residual value that the asset is expected to fetch at the end of its life for calculating annual depreciation. That is, cost of the asset is reduced by residual value expected to be fetched by the asset to calculate DEPRECIABLE VALUE which will be depreciated equally over life of the asset provided the asset is purchased at the first day of the accounting period. If the asset is purchased in between accounting period, first year of and final year of depreciation shall be calculated proportionately based on number of months of put of use of such asset. However, equal amount of annual depreciation shall be provided for other years of asset's useful life. Final year represents the year in which asset disposed too.

a) Value of the Asset:    

If conventional accounting concept of depreciation accounting is used, value of the asset shall be calculated first so as to calculate depreciable value as explained. In general, value of the asset is equal to purchase price of the asset dealt with. However, all necessary expenses incurred to bring the asset to current location and incurred till the time asset is ready for use such as carrying cost, freight paid, installation charges, etc. shall be added to the purchase price of the asset to derive value of the asset to be used to calculate depreciation.

b) Amount(s) expensed:

Amount that must be expensed by using conventional accounting concept of depreciation accounting must be equal period-by-period (annual or semiannual or monthly, depending on reporting period followed) over life of the asset. If the asset is sold in between a reporting period but before expiry of life of the asset, value of the asset shall be expensed till the date of disposal and then net book value as on the date of disposal shall be calculated which will in turn be used to calculate gain or loss on such disposal. Value of the asset is expensed off over life of the asset in terms of periodical depreciation expense.

c) Discretion of management in selecting the method:   

One of the basic accounting principles named MATCHING PRINCIPLE says that all expenses related to generating revenue for a particular period shall be expensed off during that reporting period itself. It also says that only those expenses which are related to generating reporting period's revenue alone shall be expensed in that period. So, based on management's judgement on effective utilization of the asset in generating firm's revenue, it is at the discretion to choose suitable depreciation method to be followed to charge depreciation expense and management must make sure that the method selected is followed consistently for a handful number of years without changing the same very often in order to have proper financial reports.             

Method of depreciation chosen:

I am choosing MACRS depreciation method for discussion on how depreciation is calculated using the method and whether or not I feel the depreciation method gives a good estimate of the cost allocation of the asset.

Using accelerated depreciation method (MACRS instead of straight line) for income tax reporting increases an investment’s value as equipment used in the project will have higher usage and effectiveness during earlier years and will have minimum usage during later years due to equipment's wear and tear condition and obsolescence. I don't this depreciation method gives a good estimate of the cost allocation of the asset.

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