THE IMPACT OF DIFFERENT METHODS OF DEPRECIATION ON THE PROFITABILITY OF A COMPANY

By

CHINAWA NORAH U.

Presented To

Department of Accountancy

TABLE OF CONTENTS

Title page ii

Certification iii

Dedication iv

Acknowledgement v

Table of contents vii

CHAPTER ONE

1.0 introduction 1

1.1 background of the study 1

1.2 objective of the study 2

1.3 scope and limitation of the study 3

1.4 significance of the study 4

1.5 statement of the problem 5

1.6 identification of some terms 7

CHAPTER TWO

2.0 review of related literature 9

2.1 the nature of depreciation accounting 9

2.2 causes of depreciation 10

2.3 methods of calculating depreciation 11

2.4 evaluation of depreciation method 14

2.5 the concept of profit 15

2.6 definition of profit 16

2.7 cost of a plant asset 18

2.8 estimated life of an asset 19

2.9 terminal value of an asset 20

CHAPTER THREE

3.1 Summary of findings 21

3.2 Recommendation 22

3.3 Conclusion 23

Bibliography 25

CHAPTER ONE

1.0 INTRODUCTION

1.1 BACKGROUND OF THE STUDY

This research work is aimed at critically studying the different methods of depreciation and the impact on the profit ability of business enterprises.

The different methods of providing for depreciation have been posing problems to many people because the understanding and the use of these methods provide varying depreciation expenses on the same fixed assets. In view of this, when profit is reported using different methods for a period, the reported income will vary under the different methods.

Although most of the different methods of providing for depreciation expenses will be discussed in this work, the analysis is restricted to the straight-line, double decline balance, reducing balance and the sum of the years methods of depreciation provision.

Depreciation is a part of the cost of a fixed asset that is not receivable on disposed and is thus part of the cost of fixed asset consumed. During its periods of use by the firm. It is an expenses which is charged to the profit and loss account of a period before ascertaining the real net profit or loss of an enterprise.

According to Kermit Harson, depreciation is the expiration of plant assets quality of usefulness. In accounting, this term describes the process of allocating and charging the cost of the usefulness to the accounting periods that benefit from the asset's use.

The International Accounting Standard (IAS) defined depreciation as the allocation of depreciable amount of an asset over its estimated useful life. Depreciation for the accounting period is charged to the income either directly or indirectly. Depreciable assets comprises a significant portion of the assets of an enterprise.

1.2 OBJECTIVE OF THE STUDY

The general objective of this work is to assess the impact of different methods of depreciation on the profitability of a company.

The specific objectives include the following:

i. To find out what impact depreciation has on the company's studies and what influenced their choice.

ii. To find out what impact depreciation has on the company's tax and profitability.

iii. To discover what other significance depreciation now on the company's financial statement.

iv. To ascertain whether proper treatment is given to depreciation accounting by the company studied.

v. To look into the records kept in respect of plants, machinery, and equipment in order to secure effective control over them through proper accounting.

vi. Make recommendation based on findings thereof.

1.3 SCOPE AND LIMITATION OF THE STUDY

This dissertation covers the impact of different methods of depreciation on the profitability of a company. It includes the impact of depreciation accounting on income statement reporting in all perspective. An overall evaluation of the depreciation policy and concepts of profit are studied.

1.4 SIGNIFICANCE OF THE STUDY

1. This dissertation will be useful to many companies in Nigeria in that it will provide an insight into the effect of depreciation on income statement. It will help them determine the extent towhich depreciation help them to;

a. Build funds for the replacement of their asset at the existing asset useful life.

b. Reducing tax payable to the government by reducing the company's profit.

2. The study will also prove useful to the shareholders that depreciation reduces the declared profit and amount payable as divided to shareholders. It has the advantage of not affecting the company's working capital as other expenses do.

3. Both the federal and the state government will benefit from this study since depreciation determines the volume of the company's profit and the amount of tax payable to the government.

4. The study will hopefully be useful to other researchers in that it will add to the existing literature on the subject.

5. Finally the dissertation will be useful to the researcher in that it is presented in partial fulfillment for the award of Ordinary National Diploma (OND) in accountancy.

1.5 STATEMENT OF THE PROBLEMS

Depreciation is a periodic expenses which is charged against revenue in order to determine the profit of an organizations and to evaluate an organization's performance. It is that portion of fixed asset cost which is employed by a firm to earn its revenue. Against this background, there are different methods of providing depreciation expenses in companies account. Each method has a different impact on the reported profit of an organization or firm at a given period.

To this effect, different depreciation methods give rise to different book value or that assets reported in a company's balance sheet. Two different accountants might reveal different profit from the same set of books. The cause in a nutshell is ascribed to the impact different depreciation method has on companies profitability which this work set to address.

The mere presence of profits in the income statement of an organization does not necessarily signify that a company's performance is better than others that are in the same line of business.

Variation in the profit which a company reported in its annual financial statement might be caused by;

a. Different depreciation methods

b. Different stock valuation methods

c. Deferred of certain expenses.

Accounting standards provides that a company may adopt in dependant on a number of factors

i. Management policy

ii. Legal standard

iii. Professional standard and others

Many factors are being taken into consideration in determining the amount of depreciation namely;

a. Cost of the asset

b. Useful life of the asset

c. The terminal value of the asset.

1.6 DEFINITION OF SOME TERMS

For the purpose of understanding, it is important to define some terms used in this work as follows;

a. Depreciation

Himmelblan (third international congress on accounting) defined depreciation as the price spreading the value of fixed asset over the accounting periods comprising its useful life. Depreciation is a sense is into productive activities and such cost is usually spread over the span of the asset in question.

b. Profit

As its name implies, it is the expense of revenue over expenses that results from an exchange of goods and services between a firm and its customers.

c. Balance sheet

This is the summary of profit nd loss account of a company which shows a true andfair view.

d. Goodwill

This is the difference between the value of a business as a going concern and the fair value of its separate net assets.

e. Inflation

This is the continuous or intermiltent rise in prices. It is a condition of rising prices of goods and services in the economy particularly at full employment.

f. Asset

Means the total property, money etc of a person or company that are of great useful or valuable.