by Michael Nnopu

Created on: October 29, 2009

Introduction

Fixed assets acquired by business organizations are expected to last for more than one accounting period, and as such, under the matching concept in Accounting, cannot be written off the books in the year of purchase, but rather its cost are apportioned over its expected life span (Nnopu, 2009). This apportionment or allocation is known as Depreciation.

The most commonly accepted definition of depreciation is a systematic and rational method of allocating costs to periods in which benefits are received (APB, 1970). In calculating depreciation, Thomas (1974) stated that no allocation method is fully defensible, and this posses a serious difficulty with depreciation. Before a value for depreciation can be arrived at, the following has to be ascertained: the historical cost of the assets; the expected life span; and residual or scrap value (if any).

Reasons for Depreciation

Several reasons have been advocated for introducing depreciation into the books of an organization. These include: decline in service potential through consumption, obsolescence, or deterioration. Under this assumption, any decline in service or productive potential should be written off as expenses (depreciation). Maintenance of capital this assumes that for the capital to be maintained or even replaced, that recovery of invested capital should be spread over the life of the asset to recover its cost. Replacement cost since assets by their nature will wear and tear, and needs to be replaced at a certain time in the future, depreciation is charged to provide for replacement.

Methods of Depreciation

The fact that plants and equipments are not meant to last forever necessitates the need to make provisions for the day when they will no longer be in active service either due to obsolescence, breakdown, or any other reason. According to Hendrickson (1977), during the 19th and the early part of 20th century, many firms treated the problem of depreciation by a periodic revaluation of assets or by charging either replacement or retirements to current expenses. However, accounting treatment of depreciation can be grouped into the following headings: Straight line or constant charge method; allocation according to usage (activity method); sum of the years' digit method; and double declining balance method.

Straight line method

The straight line method of depreciation charges a constant percentage of the cost of the assets as depreciation. It is a function of time rather than

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