Allocating Costs of Tangible Assets - Essay Example

? Depreciation Depreciation has been defined by scholars as the process of allocating costs of tangible assets over periods which the asset has benefitted the company (Peterson, 2002, P. 95). With time, the long-term assets of a company become obsolete while some lose value due wear and tear effects. These factors will reduce the production capacity of the asset as compared to when it was still new. Therefore, for the company to take care of these decreases, it has to calculate the depreciation value of the asset. Depreciation is therefore calculated using the estimated remaining useful life of the asset and the initial cost of the asset. Recommendations To overcome the problem of unsystematic allocation of depreciable amount over the asset’s useful life, SASB has to find a method to allocate the total amount which is to be depreciated over each accounting period in the assets useful life. This can be done by use of either of two methods which include: straight-line method or residual method. Straight-line method is applied by allocating the depreciable amount equally to the whole useful life of the asset. The company should therefore, choose a constant annual depreciation charge, usually a percentage. This will be a systematic method since at no one point will the company fail to allocate the depreciation amount. The problem of revision of residual value on the other hand can be overcome by ensuring that the amount is revised on an annual basis with the written down value of the asset being used as the base of the percentage. Application of this method also requires that qualified professionals are employed to ensure that there are no inconsistencies involved in calculation (Alexander & Archer, 2008, P. 27). To the problem of revision of the depreciation method, I would recommend that SASB does not change the method that it decides to use between the two options. Instead, the company should ensure that the method that it decides to use is applied consistently. This is because regular changes in the method applied would lead to ambiguity in the results obtained (Warren, Reeve & Duchac, 2011, P. 452). One more recommendation to SASB is the application of the provision for depreciation. Estimating a value for provision for depreciation would help to reduce the likely uncertainties of the company. Though the company still subtracts the accumulated provisions, it will benefit by reducing any possible losses (Bebbington, Gray & Laughlin, 2001, P. 187). Advantages and Disadvantages of the Recommendations Every accounting principle applied in any business unit has its own advantages and disadvantages, and depreciation is no exception. However, most companies have realized that the advantages indeed outdo the disadvantages. Advantages Increased accuracy in accounting for business assets; though depreciation is mostly termed as just a capital allowance which might not have any effect on the company’s accounts, it indeed will affect the company’s profits as well as the overall incomes if not taken care of systematically. Thus, a systematic allocation of depreciation will help the company avoid cases of overstatement of the value of the assets. The level of accuracy in the accounting procedures is also increased since; the company will not overstate its profits. An additional advantage of the recommendations is that; a regular review of the residue value will help the company avoid uncertainties and also ensure that it keeps all its information updated in case of an abrupt audit of the accounts. Consistent application of a single depreciation method is indeed advantageous to the company since it avoids confusion of the system and any possible malfunctions. In addition, a company should apply the same depreciation method for all assets. Estimation of a provision for depreciation is advantageous since it will help the company minimize it losses. Disadvantages The main disadvantage of the recommendations is time consumption. Calculation of depreciation can be time consuming and tedious especially when using the residual method. The methods can also be costly in terms of technology required, qualified personnel and documentation of the procedures. Thus, the systematic calculation of depreciation will require patience to acquire correct and adequate results. The company must also ensure that it employs qualified personnel to carry out the calculation. This can be costly to the company but it is worthwhile since mistakes will be avoided. Profit understatement; depreciation is an indirect expense which cannot be traced back to its income. Therefore, it will tend to lead to understatement of profits and overstatement of the expenses. This might appear as inaccuracy since amounts subtracted as depreciation represent amounts which the business has not actually spent (Warren, Reeve & Duchac, 2011, P. 451). In addition, the amount is not added back after obtaining the final profit figures. Thus, this will be a disadvantage especially for companies whose main objective is profit maximization. However, with a more keen observation, one realizes that deduction of depreciation from profits will not be a total disadvantage since at the same time it lowers the tax expense for the business. This is due to the fact that, being a capital expenditure, depreciation is tax allowable and thus an advantage since the amounts paid to the tax authorities will be lower. One other disadvantage of the recommendations given is that creation of a provision for depreciation might be just but a mere estimation which depends on human judgment. Though the estimation is mostly done by experienced people, still the amount estimated is prone to error. The estimations might at times be even completely different from the actual amounts and therefore leading to inaccuracies. SASB also needs to be aware of the fact that in case of a revaluation of the business assets or a disposal, the revaluation methods and the method used to calculate the disposal value should be consistent. In case of a revaluation also, a business is allowed to change the depreciation method used as long as it applies it on all the revalued assets (Bragg, 2002, P.187). These procedures of changing the method and calculating the disposal value might also be over involving and cumbersome to the business. References Alexander, D, & Archer, S 2008, International Accounting/Financial Reporting Standards Guide 2009. Chicago: CCH. Bebbington, J, Gray, R, & Laughlin, R 2011, Financial Accounting: Practice and Principles. (3rd ed.). London: Cengage Learning EMEA. Bragg, SM 2002, Accounting Reference Desktop. New York: John Wiley & Sons. Peterson, RH 2002, Accounting for Fixed Assets. (2nd ed.). New York: John Wiley & Sons. Warren, CS, Reeve, JM, & Duchac, J 2011, Accounting. (24th ed.). U.S.A: Cengage Learning. Read More