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Case 9-3 Computer System Depreciation Method
Conventional Depreciation Method
Depreciation is an important facet of determining the income of the company. As
accountants, determining income has been viewed at the transaction level, when we determine
the revenue recognition, we also couple it with the appropriate matching of expenses (Schroeder
et al., p311, 2019). Depreciation is the process of allocation and not valuation, it distributes the
value of capital assets, less salvage value, over the useful life of the asset (FASB, 2001). There
are many ways to depreciate an asset, you can use the straight-line units of production, declining
balance, and the sum of the years’ digits.
Value of the Asset
Depreciation does not change the value of the asset; it changes the amount of fixed or
capital assets on the balance sheet. Take a building, when you build a building, you will take the
cost of the building and depreciate it over 30 years, the standard depreciation time of a building.
But the building you have built has a much greater lifespan than 30 years, thus the depreciation
has nothing to do with the value of the asset, just the amount on the balance sheet. When all the
costs are calculated and the building costs end up being $300,000, the expense each year would
be $10,000, this means after the first year the asset value would be $290,000, the second year
would be $280,000, and so on.
Charges to the Expense
After the costs are incurred and the final value of the asset is determined you can start
calculating the depreciation expense. The depreciation expense is calculated differently
depending on the asset you are depreciating. If you have a manufacturing company and need new
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computers, a new drill press, a new company car, and new office furniture, they all have different
useful lives and will all be expensed differently due to their depreciation. Your new computers
and car will be depreciated over five years, your new drill press will be depreciated over three
years, and your new office equipment will be depreciated over seven years.
Discretion of the Management
Management must select a method to depreciate the asset once the acquisition of the asset
is complete. As discussed above, the methods of depreciation are straight-line, units of
production, declining balance, and the sum of the years’ digits. The management must choose
one of these methods for the asset that is being depreciated.
Factors of Assigning Depreciation
The factors that must be considered are the cost of the asset, the useful life, and the
estimated salvage value. You must determine if the costs of the computer system are that of a
lump purchase, was the system self-constructed, and did the old computer system need to be
removed. Once you have determined the cost of the computer system you then need to determine
its useful life, computers are usually depreciated over five years. After you decide on the cost and
the useful life of the computer system you must then determine the salvage value of the asset, for
computers that will be a low salvage value due to it being obsolete. For this example, the
computer system will cost $10,000 with a useful life of five years, and a salvage value of $500.
You will charge fixed assets the $10,000 value, and each year you will then debit depreciation
expense – computer system and credit accumulated depreciation for $1,900 ((10,000-500)/5
years).
Choosing a Depreciation Method
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The methods that can be used to depreciate the asset are the straight-line, units of
production, declining balance, and the sum of the years’ digits. The benefit of the straight-line
method it is easy to calculate and is the most widely used method, the drawback is the same
amount is expensed over the life of the asset even though computer systems lose more value in
the early years of their life. A declining balance places greater reductions on the computer system
in the earlier life of the asset. The drawback to this method is that it is harder to calculate than
straight-line and needs to be recalculated annually. Units of production is useful when a product
is used in production, like a drill press, and the depreciation can help offset the revenue it is
making. The disadvantage is it is not practical to use for a computer system. The sum of the
year’s digits is an accelerated depreciation method that takes more of the depreciation in the first
years of useful life, this would be useful in areas where the asset loses value quickly, like a car.
The disadvantage of this method is its complexity to compute. I would recommend using the
declining balance depreciation method due to it reducing the asset more quickly in the early
years than straight-line, due to the fact the computer system will lose value quicker than a normal
asset.
Christian Worldview
Depreciation is important in financial accounting; it is a tool to separate out the expense
of a fixed asset over a longer period. It is a tool to help a company not take a huge loss in the
year the asset was purchased and then overstated profits in the following years, Provers 21:20
reminds us “There is precious treasure and oil in the dwelling of the wise, But a foolish man
swallows it up.” This tells us not to expense the large asset all at once or that may be foolish.
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References
ESV. (2016). Proverbs 22:7, Proverbs 21:20, (ESV). Bible Gateway. Retrieved November 27,
2022, from https://www.biblegateway.com/
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and
Analysis: Text and Cases (13th ed.). Retrieved November 25, 2022, from Wiley Global
Education US. https://mbsdirect.vitalsource.com/books/9781119577713
FASB. (2001, August). FASB Accounting Standards Codification 360-10-35-4.
https://asc.fasb.org/1943274/2147482190
