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On 1 January 2007, Ryan Ltd purchased new property for €900,000 consisting of land €150,000 and buildings €750,000 - Leaving Cert Accounting - Question 4 - 2022
Question 4
On 1 January 2007, Ryan Ltd purchased new property for €900,000 consisting of land €150,000 and buildings €750,000. The company depreciates buildings at the rate of ... show full transcript
Worked Solution & Example Answer:On 1 January 2007, Ryan Ltd purchased new property for €900,000 consisting of land €150,000 and buildings €750,000 - Leaving Cert Accounting - Question 4 - 2022
Step 1
Distinguish between the straight line method and reducing balance method of depreciation.
Answer
The straight-line method and the reducing balance method are two different techniques used for calculating depreciation. Here are the distinctions:
Straight-Line Method
- Calculation: The same amount is charged as depreciation expense for each period over the asset’s useful life.
- Formula:
ext{Depreciation Expense} = rac{ ext{Cost of Asset} - ext{Salvage Value}}{ ext{Useful Life}} - Impact: Results in a consistent expense amount year over year, allowing for easier forecasting.
Reducing Balance Method
- Calculation: Applies a fixed percentage to the asset's remaining book value each year, resulting in a higher depreciation expense in the earlier years and lower expenses in later years.
- Formula:
- Impact: Reflects the actual usage pattern of the asset better, as it assumes greater utility and risk in early years.
Summary
The choice of method depends on the business’s accounting policy and how they wish to reflect asset usage. The straight-line method is simple and predictable, while the reducing balance method is better for assets that lose value quickly.
Step 2
What would cause a company to choose one method of depreciation over another?
Answer
Companies may choose one depreciation method over another based on several factors:
- Nature of the Asset: Some assets may lose value quickly (e.g., vehicles), making the reducing balance method preferable.
- Financial Reporting Goals: The method can affect profit reporting; companies may prefer straight-line for more stable profit reporting.
- Tax Considerations: Different methods may provide tax advantages in certain jurisdictions, leading companies to choose the more favorable option.
- Usage Patterns: If an asset is used more in its early years, companies may opt for the reducing balance method to better match expense with revenue.
- Regulatory Compliance: Some industries may have specific regulations necessitating the use of a particular method.
By analyzing these factors, a company can determine the most suitable depreciation method for its financial situation and reporting requirements.