Question

 Case Study #2

 The Raincloud Inc. is in the paper products industry. Industry being very capital intensive has been using

 straight-line depreciation as the industry standard. The Raincloud Company is contemplating the purchase

 of a large milling machine that will cost $3 million. The machine will probably have a useful life of ten

 years, at which time the machine's salvage value will be negligible. However, the machine is the most

 productive in its first five years. After that, increasing repairs and maintenance requirements will increase

 the machine's downtime and decrease its efficiency. Prior experience indicates that repairs and

 maintenance expense will be $40,000 in the first year and will increase at a rate of 10% per year.

 Required:

 The CEO is contemplating the use of different depreciation methods and requests from you, his financial

 adviser, to provide a report answering the following questions in detail (in layman terms, at least

 paragraph long discussion)

 a) I (CEO speaking) have read in a business magazine that for this type of asset an accelerated

 depreciation method such as double-declining balance is conceptually the most appropriate

 method. Why is it so? If you disagree, please let me know why?

Answer 1

We generally select the method of depreciation by seeing factors .

• The depreciation method used should reflect the pattern in which the Future economic benefits of the asset are expected to be consumed by the entity
• If there has been a significant change in the expected pattern of consumption of the Future economic benefits emboided in the asset ,the method should be changed to reflect the changed pattern. Such a change in method of depreciation should be accounted for as change in an accounting estimate ie prospective accounting . It means the remaining carrying amount of the asset should be depreciated over the remaining useful life usingbyhe New depreciation method
• If the effectiveness of the asset is gradually reducing and reduction in efficiency cannot be measured reliably

Yes ,I agree , when the realisable value at the end of 10th year is immaterial to the entity then we can use double declining method. By following Double declining method also our Asset value remains more than comparitive to straight line method

Example 10000$ at rate of 10% dep for 5yrs

In slm 10000$×10% = 1000$ for 10yrs the depreciation is 10000

Ie Asset at the end of 5th year without giving any economic benefit it's value will be zero

In double decline method

10000$-1000=9000

9000$-900=8100

8100$-810=7290

7290$-729= 6561

At the end of 10th year still the asset value remains $3486,But not zero.

# SLM is a constant burden of expenses till the Asset end

# In double declining the Depreciation expenses will gradually decrease in descending order. So the decrease in expense in P&L Statement the Net profit will also increase .