Question

Describe the different approaches used to calculate depreciation and its effect on corporate taxable income.

Answer 1

Depreciation is charge of expanses in book of account to recover the cost made towards an asset to write off all expense during the useful life of the asset, generally these assets are involved in production . Depreciation is being calculated by use the concept of the matching principle, to match revenues to expenses. Depreciation expense affects the net values of business entities by reducing the book value of asset and net taxable income.

There are some different approaches and methods are used for depreciation calculation in GAAP or generally accepted accounting principles.

• straight line,
• units of production,
• sum-of-years-digits, and
• Double-declining balance.

• straight line:

Simplest and most popular method

Charges an equal amount of depreciation to each accounting period

Asset is remain equal in productive for whole use full life period

Equal amount of deduction from Net Income for Tax purpose

• units of production:

Equal depreciation charged to each unit produced

Easy in calculation of per unit cost

Charge of depreciation in line with production level.

• sum-of-years-digits, and

Depreciation is calculated by multiplying depreciable cost of an asset by a fractions depend on the sum of useful life of asset.

Charge depreciation varies every year

• Double-declining balance (accelerated depreciation ) :

Higher depreciation charge in the early years of operation

Decreases depreciation expense in gradually in subsequent years

Asset is remain high in productive in initial stage

High amount of deduction from Net Income for Tax purpose, recover cost of asset