Depreciation Methods Questions and Answers

Answer: A

Correct answer: systematic allocation of an asset's cost over its life

Depreciation is an accounting allocation, not a valuation and not a fund. It spreads the cost of an asset across the years that benefit from it, according to a chosen method. The fall in market price is a separate matter and generally follows a quite different path, and nothing is set aside unless a sinking fund is deliberately created.

Answer: B

Correct answer: the tax it saves

No money moves when depreciation is charged, but the charge reduces taxable income, and the tax not paid is a genuine cash saving. That is why depreciation appears in a project’s cash flow analysis at all: it enters only through the tax computation, and its value to the firm is the charge multiplied by the tax rate.

Answer: C

Correct answer: estimated salvage value

The depreciable base is what will actually be consumed over the life, so the amount expected to be recovered at the end is deducted from the first cost. Only that difference is written off in total, whatever method is used to spread it - with the exception of declining balance, which ignores salvage in its annual calculation.

Answer: D

It is an accounting figure that follows from the method chosen and has no reason to equal what the asset would fetch. Economic analysis needs the market value; book value enters only through the tax on any gain or loss.

Answer: A

Correct answer: obsolescence or a change in requirements

Physical depreciation is the asset wearing out; functional depreciation is its ceasing to be worth using although it still works. A machine superseded by a faster one, or a plant sized for a demand that has changed, has lost value functionally. It is often the larger of the two and the harder to forecast.

Answer: B

Correct answer: equal in every year

Straight line divides the depreciable base by the number of years, so the charge is the same each year and the book value falls in a straight line to the salvage value. It is the simplest method and the usual choice for reporting, where a smooth charge is preferred to an accelerated one.

Answer: C

Correct answer: in the early years of the life

Accelerated methods front-load the charge, taking more in the early years and less later, while the total over the life is unchanged. The attraction is the timing of the tax saving: the same total deduction taken sooner is worth more in present value, which is why tax codes permit and firms choose accelerated methods.

Answer: D

Correct answer: book value at the start of the year

Declining balance applies a fixed percentage to the book value remaining, so the charge falls each year as the base shrinks. This is why it never reaches zero by arithmetic alone, and why salvage plays no part in the annual calculation - it enters only as a floor below which the asset may not be written.

Answer: A

Correct answer: twice the straight line rate

The straight line rate is one over the life, so for a five-year asset it is 20 per cent and the double declining rate is 40. Other multiples are used - 150 per cent declining balance is common - and the multiplier is what fixes how aggressively the charge is front-loaded.

Answer: B

Correct answer: below its salvage value

Because the rate is applied to a shrinking book value and takes no account of salvage, the calculation will carry the book value past the salvage value and towards zero if it is left to run. The charge must therefore be stopped at the salvage value, and many schemes switch to straight line for the remaining years.