Differentiating Depreciation Methods

The straight line depreciation method takes the expense and spreads evenly by periods. One example of how this method would work is say for instance a company purchases a computer for $5,000 and expects it to last for four years and resell it at $1,000. The remaining $4,000 would be spread out between those four years at $1,000 each year, which would make the depreciation of $1,000 per year.

The accelerated depreciation method has higher yield expenses in the early years of the assets lifetime and lowers the depreciation expense in the years to come. The total amount of the depreciation stays the same as the straight line, but the amount is higher in the beginning. One example this could involve is a piece of equipment, the depreciation maybe 75%, but then gradually goes to 50% and so on.

Tax reporting uses the accelerated because it helps to lessen the net income and it is better to approach the tax savings early one for an asset. Financial reporting uses the straight line since it makes it easier to calculate and the look is better for the financial statements. If financial reporting used accelerated then the asset would show less profit for the early years.

The advantages of straight line are that you will know the future value of that asset and a disadvantage is that the tax savings in the beginning is missed. The advantages of accelerated is the early tax savings, but an disadvantage is that as the time goes on the depreciation percentage continues to fall.

Understanding financial statements by Lyn M Fraser and Aileen Ormiston

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