Question

Discuss the three most common depreciation methods used in business practice. Why would a company choose one method over another

Answer 1

The four most common depreciation methods are:

1. straight line: the simplest to calculate, you just divide the net depreciable value (purchase cost - salvage value) by the number of useful years. This method provides a stable depreciation expense, and is mandatory when you depreciate certain fixed assets like buildings.
2. units of production: used by mines, oil companies and other extracting companies. First you must calculate total reserves or total useful life in units and then you divide the total cost by the total units in order to determine depreciation rate per unit.
3. sum-of-years-digits: type of accelerated depreciation where the depreciable value is multiplied by a fraction of the asset's useful life. It depreciates assets faster than straight line, but not as fast as double declining method.
4. double-declining balance: is a type of accelerated depreciation that increases depreciation expense during the first periods. It is calculated by doubling the calculation made for the straight line method. It lowers taxes during the first years since it increases depreciation expense.