Question

Explain the purpose of purchasing plant assets.

Compare at least two depreciation methods that can be used.

Answer 1

Purpose of purchasing plant assets is that plant assets have -

• relatively long life
• held for use rather than for resale
• does not become incorporated as part of the product
• tangible in nature
• used repeatedly to furnish service

Depreciation is the amount of plant asset cost allocated to each accounting period benefiting from the plant asset’s use. Depreciation is a process of allocation, not valuation.

1)Straight-line method Straight-line depreciation has been the most widely used depreciation method in the United States for many years because, as you saw in Chapter 3, it is easily applied. To apply the straight-line method, a firm charges an equal amount of plant asset cost to each accounting period. The formula for calculating depreciation under the straight-line method is:

Depreciation Expense =(Cost- Salvage )/ Useful Life

2)Double Declining Balance Depreciation Method

Compared to other depreciation methods, double-declining-balance results in larger expense in the earlier years as opposed to the later years of an asset’s useful life. The method reflects the fact that assets are more productive in its early years than in its later years. With the double-declining-balance method, the depreciation factor is 2x that of a straight line expense method.

Depreciation formula for double declining balance method:

Periodic Depreciation Expense = Beginning book value x Rate of depreciation

3)Unit of Production Method of Depreciation

Unit of production method calculates depreciation charge on the basis of actual usage of asset. The expected total output, usually express in units produced or hours worked, is estimated at the time of acquisition and based on the activity in the period proportionate depreciation is calculated. Although the right name of method is unit of production but units of production is widely used.

Unit of production method uses the following formula to calculate depreciation:

Depreciation for the period =

(Output of current period/Total expected output over useful life) x Cost – Residual value