Question

You are advising management, who has just gone into business, in selecting accounting depreciation policies. The client’s capital assets comprise of the following assets:
i) Office furniture with a useful life of 5 years.
ii) Computer Hardware which is expected to be obsolete in 5 years.
iii) A Van which will be used for short-distance deliveries that can drive up to 200,000KM.

By referring to the matching principle, explain the best choice of depreciation policy (straight-line, declining balance or units of production) for each of the capital assets, and also comment on the duration (e.g. years) of depreciation in each case.

Answer 1

i) Office furniture with useful life of 5 years

The life of office furniture is 5 years. The asset should be depreciated over the useful life of the asset. Hence Straight line depreciation method is recommended. The depreciation expense is calculated based on depreciable cost (cost of asset –salvage value) divided by life of asset (5 years)

ii) Computer hardware with is expected to be obsolete in 5 years

The asset should be depreciated based on the double declining balance method. DDB method is applied to assets which are expected to have heavy usage in early years and asset becomes obsolete with passage of time. The depreciation rate is 40% (1/ 5 years *2) charged on closing book value each year

iii) A Van used in deliveries

The asset should be depreciated based on units of production or activity method. The asset usage is based on kms it runs during its life. Hence higher the asset usage higher the depreciation expense to be charged. So depreciation is calculated on per kms basis for the depreciable cost of the asset. The depreciation per kms is applied to the kilometres used in delivery for each period. The depreciation charged depends on kilometres used in delivery.