Question

Kim is planning on driving her business vehicle a roughly equal amount for ten years. However, she admits that there can be significant drops in kilometers driven during economic downturns (they are unpredictable). Discuss an appropriate depreciation method. Explain, in detail, why it would work better than other depreciation options.

Answer 1

The appropriate depreciation method should be based on the usage of asset. In the given case the usage of assets was same every year and straight line method of depreciation was used to charge depreciation based on total life of asset. But since there is significant drop in the kilometres driven during economic downturn the depreciation expense is not reduced under the straight line method. The appropriate depreciation method is units of activity method and it is better than other depreciation options due to following reasons:

· Depreciation is calculated at per unit level like miles, kilometres etc

· The charge of depreciation expense to income statement is based on actual usage of distance rather than constant amount based on life of asset

· Charing depreciation on asset usage basis gives a true and fair view of financial statements.

· It is in line with matching concept because the depreciation expense reflects the actual usage of assets for generation of revenue.

· Depreciation expense represents the actual wear and tear of the asset in business.