Answer to Question #41859 in Microeconomics for jayashree

Question

Why is depreciation charged? Explain the two methods of charging depreciation. In which method the value of the asset is reduced to zero earlier. Which one is more rational? Explain why?

Answer 1

In accountancy, depreciation refers to two aspects of the same concept:
-the decrease in value of assets (fair value depreciation), and
-the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).

The former affects the balance sheet of a business or entity, and the latteraffects the net income that they report. Generally the cost is allocated, as depreciation expense, among the periods in which the asset is expected to be used. This expense is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation, and the periods over which assets are depreciated, may vary between asset types within the same business and may vary for tax purposes. These may be specified by law or accounting standards, which may vary by country. There are several standard methods of computing depreciation expense, including fixed percentage, straight line, and declining balance methods. Depreciation expense generally begins when the asset is placed in service. For example, a depreciation expense of 100 per year for 5 years may
be recognized for an asset costing 500.

There are various methods that can calculate depreciation expense for theperiod; the method used should reflect the asset's business use.
-Straight-line depreciation is the simplest and most popular method; itcharges an equal amount of depreciation to each accounting period.
-The units-of-production depreciation method assigns an equal amount of expense to each unit produced or service rendered by the asset.
-The sum-of-the-years digits method determines annual depreciation by multiplying the asset's depreciable cost by a series of fractions based on the sum of the asset's useful life digits.
-The double-declining balance is a type of accelerated depreciation method that calculates a higher depreciation charge in the first year of an asset's life and gradually decreases depreciation expense in subsequent years.