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 at least one academic resource to provide support for your response.

Explanation / Answer

CONVENTIONAL ACCOUNTING CONCEPT OF DEPRECIATION ACCOUNTING:

IN ACCRUAL ACCOUNTING, DDA OR DEPRECIATION, DEPLETION AND AMORTIZATION ARE NOT EXPENSES THAT WE PAY FOR. THIS IS A WAY IN WHICH AN ASSET’S COST IS SPREAD OVER ITS USEFUL LIFE ON SOME RATIONAL BASIS DEPENDING ON THE FALL IN VALUE OF THE ASSET ITSELF AND ITS USAGE.

FOR EXAMPLE WE MIGHT USE STRAIGHT LINE DEPRECIATION FOR A BUILDING AS WE CANNOT QUANTIFY THE ‘WASTING’ PART OF THE BUILDING. THUS WE SPREAD THE COST OF THE BUILDING ON A TRADITIONAL BASIS OF 50 YEARS OR 2% PER ANNUM. IN THE CASE OF AN OIL FIELD WE CANNOT USE THE SAME CONCEPT AS WE ARE EXTRACTING THE ‘GOODNESS’ OF THE ASSET OVER TIME SO WE CALL IT DEPLETING THE ASSET. CONTRARILY IN THE CASE OF AN INTANGIBLE ASSET LIKE A COPYRIGHT OR TRADE MARK WE CANNOT USE THE WORD DEPRECIATION OR DEPLETION AS BOTH ARE NOT RELEVANT BUT WE USE AMORTIZATION TO EXPLAIN THE PROCESS OF ‘KILLING’ THE VALUE. FOR EXAMPLE CHEVRON CORP REPORTED $21 BILLION AS DDA IN 2015 10-K WHEREAS IT WAS $16.8 IN THE PREVIOUS YEAR. THE RISK WAS CONNECTED WITH HIGH IMPAIRMENT IN OIL AND GAS FIELDS.

FOR EXAMPLE, IN A TEAK TREE FOREST WHERE THE TEAK WOOD IS USED FOR MAKING WOODEN FURNITURE. THE WOOD IS PARTICULARLY VALUED FOR ITS DURABILITY AND WATER RESISTANCE, AND IS NATIVE TO SOUTH AND SOUTHEAST ASIA. DEPLETION OCCURS WHEN THE TREES ARE FELLED FOR CONSUMPTION AND DEPLETION IS CALCULATED AS THE PERCENTAGE WHICH IS FELLED AND ADJUSTED AS AN EXPENSE IN THE INCOME STATEMENT BY DEBITING IT AND CREDITING IN BALANCE SHEET AND DEDUCTING FROM THE ASSET COST.

A COMPANY CALCULATES THE ANNUAL STRAIGHT-LINE DEPRECIATION FOR THE MACHINE AS: PURCHASE COST OF $60,000 – ESTIMATED SALVAGE VALUE OF $10,000 = DEPRECIABLE ASSET COST OF $50,000. 1 / 5-YEAR USEFUL LIFE = 20% DEPRECIATION RATE PER YEAR. 20% DEPRECIATION RATE X $50,000 DEPRECIABLE ASSET COST = $10,000 ANNUAL DEPRECIATION

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