Problem in measuring depreciation, Microeconomics

Assignment Help:

Economists view depreciation as capital consumption for them, there are two distinct ways of charging for depreciation (1) the depreciation of equipment must equal its opportunity cost, or alternatively (2) the replacement cost that will produce comparable earning. Opportunity cost of an equipment is the most profitable alternative use of it that is foregone by putting it to its present use. The problem is then of measuring the opportunity cost. One method of estimating opportunity cost suggested by Joel Dean, is to measure the fall in value during a year. Going by this method one assumes selling of the equipment as an alternative use. This method however cannot be applied when a applied capital equipment as an alternative use. Like a hydro power project. In such cases, replacement cost is the appropriate measure of depreciation. To accounts, depreciation is an allocation of capital expenditure over time. Such allocation of historical cost of capital over time, charging depreciation is made under unrealistic assumptions of (a) stable prices, (b) a given rate of objects. What is more important in this regard is that the methods of charging depreciation over the life time of an equipment are various. The use of the different methods of charging depreciation results in different levels of profit reported by the accountants. For example, suppose a firm purchases a machine for Rs. 10000 having an estimated life of the 10 years. The firm can apply any of the following four methods of charging depreciation.

1.    Straight method

2.    Reducing balance method

3.    Annuity method, and

4.    Sum of the year's digit approach.

Under the straight line method, an amount of Rs. 10000 +10 = Rs. 1000 would be charged as depreciation each year. Under the reducing balance method, depreciation is charged at a constant (percent) rate of annually written down values of the machine. Assuming a depreciation rate of 20 percent Rs. 2000 in the first year, Rs. 1600 in the second year, Rs 1280 in the third year, and so on, shall be charged as depreciation. Under annuity method, rate of the depreciation is fixed as d = (C + Cr)/n, where n is the number of active years of capital, C = total and r is the interest a rate. Finally under the sum of the year the digit approaches (a variant of the reducing balance method) the years of equipment life are agreement to give an unvarying denominator. Depreciation is than charged as the rate of the ratio of the unvarying denominator. Depreciation is then charged at the rate of the ratio of the last year digits to the total of the years. In our example, the aggregated years of capital life equals 1 + 2 +3 + ......... + 10 = 55. Depreciation is than charged at the rate of in the 1 year will be 10000 * 10/55 = Rs. 1818.18, in the 2nd year it will be 1000 * 9/55 = Rs. 1636.36 and in the 3 year it will be 10000 * 8/55 = Rs. 1454.54, and so on. Note that the four methods yields four different measures of depreciation in subsequent years and, hence, the different levels of the profit.


Related Discussions:- Problem in measuring depreciation

Firms in a competitive markets, illustrate a long-run equilbrium using diag...

illustrate a long-run equilbrium using diagrams for the gold market and for a representative gold mine

Explain opportunity costs using a ppf, Explain opportunity costs using a PP...

Explain opportunity costs using a PPF where investment goods are on one axis and consumption goods on the other. Again, a good definition of opportunity costs linked to the not

Market systems, what is a perfect competition and how does it differ from m...

what is a perfect competition and how does it differ from monopoly?

Elasticity of demand for laptops, The price of a laptop increases by 20% an...

The price of a laptop increases by 20% and there is a 40% drop in the quantity demanded. What would answer be

Theory of customs union, THEORY OF CUSTOMS UNION: A customs union is a...

THEORY OF CUSTOMS UNION: A customs union is an association of two or more countries to encourage trade. The countries making such an arrangement agree to eliminate tariffs and

Find the equilibrium price and quantity, 1. Assume that the market for whea...

1. Assume that the market for wheat is perfectly competitive. Suppose the demand curve for wheat is given by: QD = 200 – 2P where QD is the quantity demanded, in bushels, and P i

Explain the economic principle, Various studies have concluded that the dem...

Various studies have concluded that the demand for movie cinema attendance is responsive to advertising.  A study of one company, with movie cinemas in three neighbouring towns, sh

Fundamental economy problem., how a capitalist system solves the three fund...

how a capitalist system solves the three fundamental economic problems

Composite goods, what is the effect on the market for dvd players if the pr...

what is the effect on the market for dvd players if the price of dvd rises

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd