Differentiating and Depreciation Methods

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Discuss and differentiate straight line method of depreciation and accelerated method.

Depreciable assets lose value as time due to aging, obsolescence, wear and tear. The loss in value of tangible assets with time is called depreciation.

The most commonly method used is straight line depreciation and in this method charges are spread evenly over the life of an asset. Every year in this method depreciation charged is constant which allows more income smoothing where income has a gradual change over the life of an asset without highs and dips.

The accelerated method of depreciation assumes an asset is used heavily during the early years of its useful life then loses most of its value during first few years of use. In early years there will be heavy depreciation. It then decreases with time and by the end of life of an asset, the depreciation becomes zero meaning that this method lacks constant expense over time. Since depreciation is deducted from income for tax reporting, accelerated method allows larger tax deduction in early years that improves profit. Straight line method will also provide the same amount of tax deduction in later years but because of time value of money, tax saving in early years would be better for a company.

Why do companies use different depreciation methods for tax reporting and financial reporting?

Straight line method is used for financial reporting only since it resembles the benefit derived from an asset and actual loss in value of an asset with time. It will also charge less depreciation as compared to accelerated method in early years but the book value of an asset remains higher as compared to accelerated method. This means that a company would have more value.

Accelerated method is used for tax reporting purpose because it provides a larger tax deduction sooner. A tax deduction is…...

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