Summary of the article - Essay Example

Summary of the article The article begins by mentioning depreciation as a very important component of accounting. Doubts are expressed over the efficiency of net income and Funds from Operations (FFO) in determining the depreciation in real estate sector. This statement is then supported by citing the results and findings of other authors. The article then proceeds towards highlighting the lack of competence of straight line method in computation of depreciation. Recent changes in the accounting standards focus on two vital issues.

They are –1- The method of amortization should reflect the pattern of consumption of intangible assets. In case of unreliability of data, straight line method shall be used. 2- Depreciation method should reflect pattern of consumption of assets by an enterprise. Here also straight line method is to be used as a default method. These standards pose a problem for existing depreciation methods as impairment would occur if they violate the requirement of depreciation charges while reflecting the use of the asset in revenue-generating process.

The article then proposes an axiomatic system that is compatible with the recent accounting standards. This system shall also test the compatibility of the any depreciation method with the changed requirements for accounting. The axiomatic system proposed has three requirements. Firstly, the periodic depreciation charge has to be non-negative. Secondly, the depreciation charge is not greater than the cash flow for that period. And lastly, the periodic depreciation charge maintains the essential aspect of matching principle between depreciation and cash flow.

The article then highlights how current depreciation methods violate the above axiomatic system. The focus of the article then shifts to proportional depreciation method which directly depends on the cash flow of the asset. Two requirements of consistency are then proposed, namely, Partition Consistency and Dynamic Consistency. The first requirement assures that there is consistency between depreciation charges throughout any sub-period division throughout an asset’s life. The second requirement demands that if there is no change in the economic fundamentals during the asset’s useful life, then the original computation of the depreciation charges will sustain.

A detailed description of the axiomatic system is given along with its implications. The three axioms are formulated, their definitions are provided while their respective proofs are provided in the appendix. The proportional depreciation system is described and proof is provided about it sustaining the three axioms. The article then enters into the phase of defining partition consistency and dynamic consistency. They are linked to the axioms and a very solid relationship is established between these two consistencies and proportional depreciation method.

The article then ends by summarizing its own contents and repeating the need for a new depreciation method in accounting. The axioms and the consistency requirements suggested by the article are declared to be the most efficient as they require less data and can help in evaluating depreciation over a large course of time. In the last few lines many questions are asked about current depreciation system insinuating towards lack of clarity.