Monday, October 29, 2007

Depreciation

Here’s a funny accounting story.

 

We’re sitting in class and the prof is going over depreciation techniques.  The first is the most basic, straight line depreciation.  For those of you who don’t know how it works, depreciation is the dollar amount of an asset purchase that gets expensed over time.  In practical terms, it’s the difference in what you bought your car for and how much you can sell it.

 

Straight line depreciation works just how it sounds.  You take depreciable value of the thing and divide it by the number of years in its planned life and that’s your depreciation—on a graph it makes a straight line of an equal amount each year.

 

Here’s the example:  Machine purchased at $11,000; residual value $1,000; estimated life 5 years.

 

The prof put on the board $2,000 depreciation in years 1 through 4, then $3,000 in year 5.

 

Five hands immediately went up and an argument with the prof ensued.

 

“Shouldn’t it be $2000 in the final year?”  “no, no…  this is right.”

 

“Shouldn’t there be $1000 in residual value remaining in the asset account?”  “No, no, this is right.”

 

“Are you sure about?  Really sure?  Because that’s not right.”  “I’m sure.”

 

“Is this going to be on the test?  Because that’s not right.”  “I’m sure it’s right and I can prove it.”

 

Out comes the book… a couple of seconds of silence… then “Ok, so it’s $2000 each year.”

 

Exactly.

 

Of course, there would be some that would say “My reality is that it should be $3000 in the final year and my understanding of accounting is just as right as your understanding of accounting”.

 

There is just no reasoning with those people.

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