Week 17_LanreGiwa_Asset Depreciation Method

Problem Recognition / Identification

The condition of service of my company stipulates that all depreciable tangible assets such as vehicles, furniture, machinery and computers should be auctioned after the cost of placing the asset in service has been recovered. The estimated period that the property will be used productively and can be recovered through the accounting process (Useful life) is 5 years .The challenge facing the company is what depreciation method to be adopted for this exercise.

Development of Feasible Alternatives/Solutions

For this task, I have thought of two alternatives or plans for the company and then consider which will be best suited for the company and will be easy to use.

Plan 1 – Straight Line Depreciation Method

Plan 2 – Declining-Balance Depreciation Method

Possible Outcomes and Cash Flow of Alternatives / Solutions

Plan 1: With the first plan or alternative, it is simple, easy and cheap to implement. It assumes that a constant amount is depreciated each year over the depreciable life of the asset. With this method, an estimate of the final salvage value will be determined. For my company, the estimated salvage value or final book value is 5% of the Initial Book Cost

Plan 2: With the second plan, it is assumed that the annual cost of depreciation is a fixed percentage of the Book Value at the beginning of the year.

Selection Criteria / Attributes of best solution

• Simple to deploy
• Ease of Calculation
• Time value of Money

Analysis and comparison of the Alternatives/Solutions

The analysis was carried out by quantitative analysis using excel spreadsheet and the values are shown below:

Case 1 – Assuming that the company wants to calculate the depreciation of a 1.8 Litre Vehicle at an initial Cost of NGN5, 000, 000 over a five year period at a salvage value of 5% of the initial cost. Case 1 will be using the single Line depreciation method.

Cost	5,000,000.00
Useful Life	5
Salvage Value (5% of Initial Cost )	250,000.00

EOY,k	dk	dk*	BVk
0	0		5,000,000.00
1	950000	950000	4,050,000.00
2	950000	1900000	3,100,000.00
3	950000	2850000	2,150,000.00
4	950000	3800000	1,200,000.00
5	950000	4750000	250,000.00
Legend
EOY	End of Year
dk	Annual depreciation deduction in year k
BVk	Book Value at the end of the year k
dk*	cumulative depreciation through year k

Case 2 – Assuming that the company wants to calculate the depreciation of a 1.8 Litre Vehicle at an initial Cost of NGN5, 000, 000 over a five year period. Case 2 will be using the Declining Balance Method.

Cost	5,000,000.00
Useful Life (N)	5
Salvage Value	-
Declining - Balance	200%
R	0.40

EOY,k	dk	dk*	BVk
0	0	0	5,000,000.00
1	2,000,000.00	3,000,000.00	3,000,000.00
2	1,200,000.00	1,800,000.00	1,800,000.00
3	720,000.00	1,080,000.00	1,080,000.00
4	432,000.00	648,000.00	648,000.00
5	259,200.00	388,800.00	388,800.00
Legend
EOY	End of Year
dk	Annual depreciation deduction in year k
BVk	Book Value at the end of the year k
dk*	cumulative depreciation through year k
R	Ratio of Depreciation

Best Alternative to be Selected

Based on the options analyzed, Plan 1 is a simpler tool and easy to implement. This I believe is a good option for the company.

Performance Monitoring / Post evaluation

For performance monitoring and post evaluation, the company will consider how comfortable the spread is in terms of Time Value of Money and may also experiment with the declining method to compare notes.

References:

1. AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-13, pp.13.1-13.7 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

2. Sulliven, W. G., Wicks, E.M., Koelling, C. P., et al. (2009). Engineering Economy (14^th ed.), Chp 7 pp288 -310. New Jersey: Pearson Education.
3. Brassard M, Ritter D. The memory Jogger 2. Tools for Continuous Improvement and Effective Planning.2010.