Depreciation

ACA1 Task 5: Part C

Depreciation is a way for companies to expense purchases over a specific amount of time. There are four main methods of depreciation: straight line, units of activity, sum of the year’s digits, and double declining balance. Each method uses the same beginning data but distributes it over a given time differently. The following are the formulas for each method.

Straight Line Depreciation = Annual Depreciation Expense Units-of-Activity Depreciation

Sum of the Year’s Digits Depreciation

Double Declining Depreciation

Each method of depreciation affects the company’s financial statement. Accumulated depreciation (the aggregate of annual depreciation expense) is a contra-asset and located on the balance sheet, the annual depreciation expense is located on the income statement and depreciation is also found on the statement of cash flows. When a company purchases an item that will be depreciated, the original purchase will decrease the cash account and in future years, the depreciation appears only as an expense and is sometimes called a noncash expense. The amount of annual depreciation expense affects the net income of the company and can directly impact the perceived health of the company. Straight line depreciation is used most of the time. This method does not create an unexpected impact on the financial records for the company. It also allows the company to prepare a more accurate projected balance sheet since the same amount is depreciated over the life of the item.

Double declining depreciation is used when a company wants to increase the rate of depreciation. It can be useful when the item has a short useful life or if the company intends to dispose of the item early. This method allows the company to set a depreciation timeframe for any amount. In this case, the company wanted to depreciate the item twice as fast as normal. Using this method creates a higher expense account on the income statement and statement of cash...