Question

1. Explain which of the Generally Accepted Accounting Principles (GAAP) require the use of depreciation for assets that have useful lives beyond one year, and explain why.

2. For-profits can use different methods for reporting depreciation to owners and to the government (for tax purposes). What is the practical effect of this allowance?

Answer 1

(1).

As per GAAP there are some given methods of calculating depreciation for assets that have useful lives beyond one year. These methods can be as follows;

·        The straight-line (SL) method

·        The units of production (UOP) or units of output method

·        Declining balance (DB) method

·        Sum-of-the-years’-digits (SYD) method

As we know that all methods are accepted by GAAP so any of above given method can be adopted by a firm for calculating amount of depreciation on assets because overall amount of depreciation will be same in whole time of the assets.

But we can choose Declining balance (DB) method because this method helps in charging higher amount of depreciation in starting years as the assets will generate higher returns in starting time. So it will be logical to adopt Declining balance (DB) method for charging depreciation.

This method also will be good for tax purpose also because in starting years due to higher profits higher amount of depreciation expenses can be charged from the profits apart from this tax authorities also approves this method.

(2).

Yes, it is possible to use different methods for reporting depreciation to owners and to the government (for tax purposes) because book income and taxable income both are difference concept. Tax is charged on taxable income hence as we adopt one particular method for charging depreciation then we have to adopt this method regularily.

But there will be a difference in book income and taxable income when we adopt different method for calculating depreciation because each method result into different amount of depreciation in a particular accounting period. And when depreciation expenses are higher or lower then net income will also be higher or lower depending opon amont od depreciation charged.

Thus it is quite clear that we can use different methods but it will result into difference in net income.