Question

Discuss in detail the straight line method and written down value method
of depreciation. Distinguish between the two and also give situations where
they are useful.

Answer 1

Straight line method and written down value method of depreciation

Explanation:

The straight-line method (SLM) of depreciation involves the charge of a constant and generally fixed amount of depreciation across the useful life of the fixed asset.  

The written down value (WDV) method of depreciation involves charging depreciation at a specified rate on the opening book value of the fixed asset for each accounting period.

The differences between SLM and WDV methods are as detailed below:

• Under SLM, the depreciation is based on the original costs of the fixed asset for each accounting period.
• Under WDV, depreciation is charged each accounting period on the opening book value i.e.: on the book value as reduced by the accumulated depreciation.
• Under SLM, the depreciation amount is set each year and remains constant for all periods of the accounting.
• The amount of depreciation under WDV is variable, which continues to decrease in each subsequent accounting cycle.
• Under SLM, the book value reduces to its scrap value or to zero at the end of its useful life. Hence it is completely written off over its useful life.
• Within WDV, the depreciation is based on the reduced book value which ensures that each year the depreciation expense continues to be reduced. Thus the meaning of the book is not fully written off.
• When a company practices SLM, then the depreciation to benefit ratio will be lower in the initial years as opposed to WDV.
• If the company follows WDV, then the depreciation cost will be higher in the initial years in comparison with SLM. As the depreciation on reducing balance keeps lowering from year to year, the SLM depreciation will then ultimately become higher than the WDV depreciation.
• Depreciation under SLM is expressed as the number of years across which the asset is to be depreciated or as a % of the original cost.
• Depreciation under WDV is generally expressed as a % per annum, which is then applied to the opening book value of the fixed asset each year.
• Under the SLM method, the impact on profits is consistent across accounting periods as the same amount is charged to profit and loss account in each accounting period.
• Under the WDV method the amount of depreciation in initial years is increased, hence the charge to profit and loss account is also higher in initial years. Thus in the initial years, the income under WDV will be comparatively lower.

Preference

• SLM is preferred to be applied to fixed assets whose utility is equally spread across the years of its useful life. For e.g.: Intangible assets such as patents and copyrights have a specified legal life – businesses usually receive the benefits of patents consistently across the years, hence SLM may be preferred.
• WDV is preferred to be applied for fixed assets that have a higher degree of wear and tear or obsolescence i.e.: whose benefits are higher in the initial years than in subsequent years. For example, the WDV approach may be more suitable in the case of plant and machinery or technology-related assets.

The correct depreciation method depends on the nature of the fixed asset and how that asset will be used in the business.