Essay Writing


Critical Thinking

Depreciation refers to the allocation of cost to an asset for its whole lifetime. Allocating such costs is undertaken in a means whereby the asset cost is deducted from the accounting periods in the course of the asset’s economic lifetime then reduces fixed assets’ net value (Horngren, 2017). Application of differing depreciation accounting, as well as valuation methods in countries or companies, renders financial statements different and unrelated to each other (Galabov M, 2017). This paper seeks to describe various methods of depreciation, analyze the reason why depreciation is regarded as an allocation process and explain why there could exist a difference between the company’s tax return depreciation and the company’s book.

Essentially depreciations is indeed a process involving allocation and not valuation. This is because depreciation is a constant and continuous process that is balanced pertaining to an asset’s lifecycle until its termination (Yates, 2017). However, the statement that depreciation is indeed a process involving allocation and not valuation is intending to define the method of depreciation while detailing on the way to undertake a depreciation of an asset based on the underlying physical assets available.

In the actual world, depreciation tends to be more complicated. Therefore, there are various methods of depreciation calculation. Straight-Line Depreciation is the simplest method for calculating depreciation (Yates, 2017). As the name suggests, the asset is depreciating by equal amount every year up to the point where the whole cost is already allocated. Another method of depreciation calculation is the Declining balance. This method facilitates organizations to alleviate the depreciation through compelling extra depreciation expense during the early life of an asset (Galabov M, 2017). For this method, the organization utilizes an aspect and multiply the straight-line depreciation using that aspect.

Units of Production Depreciation is another method of calculating depreciation by utilizing the number of times the asset is operating while attaching the value for every instance. This method is commonly utilized by companies for industrial machinery (Galabov M, 2017). This method is advantageous in that it has a direct connection with the depreciation expenses to the tools utilized in production. This method is so effective and efficiently allocates depreciation expense to the time duration it happened. The only disadvantage of this method is that it needs careful and accurate records of use and production (Galabov M, 2017). Nonetheless, Sum of the Years Digits Depreciation is a method that accelerates depreciation. This a commonly used method and varies from the other methods.

Modified Accelerated Cost Recovery System is the latest depreciation calculation method that is utilized by most countries in calculating tax deductions using depreciation in assets that can depreciate instead of intangible assets (Galabov M, 2017). When claiming depreciation deductions, IRS Form 4562 is utilized. This method facilitates a larger deduction in earlier years then reduced deductions in some years at a later time when in comparison with the straight-line method (Yates, 2017). Moreover, MACRS is needed by the IRS when it comes to tax reporting though not granted approval by GAAP to be used in external reports.

Another depreciation calculating method is Accelerated Cost Recovery System (ACRS) which allocates assets time duration of cost recovery on the basis of precise IRS criteria (Galabov M, 2017). From 1986, MACRS has been so prevalent. Instead, assets that generate income which is depreciating use a straight-line method on the basis of the asset’s life, ACRS enables taxpayers to depreciate their taxes more short time period on the basis of cost recovery (Galabov M, 2017). Accelerated depreciation increases the deductions that property owners are capable of claiming of which law practitioners perceive that this would increase economic growth. In general, ACRS is applied to property in service since 1981. The areas addressed entail effective dates, eligible property, property classification, deduction calculations, anti-churning rules, and limitations together with special rules impacting the deduction available.

In terms of cost recovery, cost recovery for natural resources is quite different. Companies investing in natural resources are capable of recovering their costs with respect to the natural resource depletion (Galabov M, 2017). IRS only recognizes two cost recovery methods applying to natural resources which are percentage depletion and cost depletion. With regards to cost depletion, it utilizes the cost basis pertaining to natural resources then dividing the cost over the anticipated resourceful asset’s life. Percentage depletion, however, facilitates cost recovery with respect to the resource’s actual percentage that depleted due to its use.

A difference can exist between a company’s book depreciation and tax depreciation due to the time factor. The timing of the company’s depreciation expense brings about the difference between a company’s book depreciation and tax depreciation (Horngren, 2017). Another factor that can contribute to the difference that can arise between a company’s book depreciation and tax depreciation is since each of the depreciation is based on a different rule (Yates, 2017). Book depreciation is subjected under the principle of accounting while for tax depreciation, the company is subjected to IRS rules.

To sum up, depreciation is an important aspect of accounting. Depreciation is indeed a process involving allocation and not valuation as it is a continuous process. The various methods of calculating depreciation are different and unique thus have to be applied only to relevant aspects and companies. Therefore, companies need to take into consideration aspects that might lead that the difference between tax depreciation and book depreciation.