Decreasing Charge Method Essay

Companies have a choice among the many methods available with which to allocate the cost of fixed assets they have acquired. One of type of these methods is the decreasing charge methods consisting of sum-of-the-years’-digits and declining-balance method (author 525). Under these methods, the company allocates a higher portion of the cost of the asset in its earlier years than in later ones. Because of the higher cost allocation in the earlier year these methods are also called the accelerated method (526). Sum-of-the-years’-digits The name of this method is very descriptive of the formula used to compute depreciation cost. As one of the accelerated methods to allocate cost, sum-of-the-years’-digits allocates a higher depreciation cost in the early life of the asset, with the depreciation cost decreasing every year (527). The first part of computing the depreciation cost under this method is to determine the depreciable cost of the asset, which is computed by deducting the salvage value from the acquisition cost. The depreciable cost is multiplied by the rate of the depreciation for the year to arrive at the depreciation cost for the year. To compute for the rate of depreciation for the year, the years of the estimated life of the asset are added. This serves as the denominator. To illustrate: an asset with a useful life of three year will use a denominator of six computed as (3+2+1). The numerator is the estimated life of the asset at the beginning of the year. To illustrate: the rate of depreciation to be used on the asset above on its second year of use is 2/6 or 1/3. This method of computing depreciation is characterized by a rate of depreciation that changes every year. At the end of the useful life of the asset, the remaining balance of the asset will be its salvage value. (527) Computing for the sum of the years for an asset with a very high estimated life can be time-consuming. Mathematicians came out with a formula to speed up the process. The formula is expressed as: n(n+1) all over 2, with n as the estimated life of the asset. (527) Declining-balance Method The declining-balance method, on the other hand, uses a constant rate in computing the depreciation cost for the year. The rate is usually a multiple of the straight-line method. (527) To illustrate: an asset with an estimated useful life of five years is depreciated at the rate of 20% under the straight-line method and at the rate of 40% under the declining-balance method. The rates used by the companies vary from industry to industry and from asset to asset (527). Unlike the sum-of-the-years’-digits, the declining balance method do not deduct the salvage value of the asset when computing for the depreciation cost. Instead, the book value of the asset is multiplied by the rate of depreciation to arrive at the allocated cost for the year, and the process is repeated every year until such time that the book value of the asset is equal to the salvage value. The depreciation cost of the asset declines every year under this method because the book value is decreased every year by the depreciation cost. (527)