[00:03.06]Text 4.1 Methods of depreciati
[00:07.34]By definition, fixed assets are those which will provide services over a number of years and the matching convention tells us that we should recognise the expense in the same periode as we recognise the associated revenu
[00:20.27]Thus we must not write off ,or expense ,the whole cost of the asset in the period in which the asset is acquire
[00:27.35]but should instead convert the asset into an expense over its lif
[00:30.98]This gradual conversion is known as depreciatio
[00:34.74]How should we compute the depreciation charge for each yea
[00:38.01]An obvious way would be to compare the current value of an asset at the end of the year with its value at the start of the year and say that the difference is depreciatio
[00:46.60]But as we have already emphasized, traditional accounting practice is based on historic cost and not current value
[00:53.39]consequently that method is generally not acceptabl
[00:56.61]The traditional approach is to estimate the total expenditure to be written off.i.e.the cost of the asset less its estimated scrap value
[01:05.31]and then to write off that expenditure over the estimated lifef of the asset by using one of the methods that we shall describ
[01:12.39]It would be helpful to look at a simple exampl
[01:14.84]If a firm purchased a machine on 1 January 199X for $22,000,which is expected to last for four years and then be sold for $ 2,00
[01:26.00]The life of the asset is usually measured in time, but in some instances may be measuerd on the basis of actual usag
[01:33.02]Depreciation on the basis of 'actual usage'is rar
[01:37.04]In order to consider the difficulties inherent in estimating the life of an asset we should think about the reasons why most fixed assets,other than land,have a limited lif
[01:47.02]These reasons may be classified as physical wear and tear,and obsolescence.
[01:52.07]Obsolescence may be of the asset itself, e.g.a new machine may make the use of the original asset,an older machine
[01:58.91]uneconomic because the new machine is faster or requires less labour
[02:03.17]Obsolescence may also be caused by the object produced by the asset,if,for example,it goes out of fashion.
[02:10.19]In the latter case,the degree of obsolescence will depend on the specific nature of the asset;
[02:15.47]some assets may be easily adapted to alternative uses while others may have only one use,the original.
[02:22.37]None of the above variables can be determined with any accuracy, obsolescence, in particular, is rapidly increasing in importance because of rapid changes in technolog
[02:31.75]Deciding how much should be written off and over what period is not the only problem, for there are a number of depreciation methods from which to choos
[02:40.73]A firm's management must decide which one to emply , and a user of financial statements who wishes to compare the financial performance of a number of companies must appreciate the effects of the various method
[02:52.83]In practice we find two main methods of depreciation-the straight-line basis and accelerated depreciatio
[03:00.82]There is another method ,tha annuity method which takes account of the interest costs involved in investing in a long-lived asse
[03:07.79]this method has many theoretical attractions but is rarely use
[03:12.29]Heading
[03:13.57]The total expected cost is simply spread over the number of years of expected service giving the amount of depreciation expense per annu
[03:21.98]Heading 2 With these methods the depreciation charge in the earlier years of use is greater than in the last year
[03:29.76]Accelerated methods include(a) the Sum of the Year's Digits Method and (b) the Reducing Balance Metho
[03:38.41]Heading
[03:39.72]Let n be the asset's life ,the years are each represented by a digit:1.2.3.4...
[03:49.43]Having fixed on n, the digits are summed and the fractions of the asset cost are charged to the years in reverse order so that the earlier years are charged more than the later year
[04:01.24]Heading
[04:02.99]Here the depreciation charge for each year is a fixed percentage of the net.amount'of the asset(cost less accmulated depreciation to date) at the start of the yee
[04:14.01]Text 4.2
[04:16.31]An important tax bill pending in the US Congress would permit depreciation of intangibles,including goodwill ,for tax purpose
[04:25.90]This would appear to eliminate a major US tax barrier against takeover
[04:31.15]Just a short time ago, Congress had been carefully scrutinising possible tax incentives for acquisitions, such as deductions for interest expense ,with an eye towards removing the
[04:42.38]Now it is considering a proposal that appears to increase the tax attractiveness of acquisitions,especially those in which large premiums are pai
[04:51.94]In July last year, Congressman Dan Rosteknowski, introduced a bill,HR 3035 entitled 'Amortisation of Goodwill and Certain other Intangibles
[05:05.03]The bill would provide a uniform 14 year amortisation period for goodwill and other intangible
[05:12.56]The inability to deduct or amortise amounts paid for goodwill has long been one of the main constraints in tax planning of acquistions in the U
[05:23.00]While businessmen recognise that goodwill may be an important business asset, they also recognise that its value may be fleetin
[05:31.89]During the 1980s ,the large premiums paid in acquisitions often resulted in prices that greatly exceeded the value of tangible asset
[05:41.66]further increasing the significance of the non-deductibility of goodwil
[05:46.64]By allowing amortisation of goodwill ,HR 3035 would appear to increase the attractiveness of acquistion
[05:55.53]A closer examinaion of the proposal, however, reveals that the motive behind it is not to provide a tax incentive for acquisition
[06:03.73]During the 1980s, as the premiums paid in acquisitions increased so did the incentives for creativity by tax adviser
[06:13.13]Acquirers did not accept fatalistically that the large premiums they paid had to be additional goodwil
[06:20.53]Instead ,the assets of targets were closely scrutinised to ensure that no possible depreciable or amortisable asset was overlooked
[06:30.27]Along with patents ,licences, favourable contracts, the deductible assets uncovered included such items a
[06:38.81]workforce in place (experience and composition of existing workforc
[06:44.74]information base (business records, operating systems, et
[06:49.68]customer-based intangibles (market share and compositio
[06:54.75]and supplier-based intangibles (any expected special value in the future from the acquisition of goods and service
[07:03.31]In many instances, the result was that the amount of the purchase price remaining to be allocated to goodwill was quite smal
[07:11.67]However, the Internal Revenue Service challenged many of these claimed deduction
[07:17.84]Disputes between the Internal Revenue Service and taxpayers involving very large sums of money ensued over whether these intangibles existed,
[07:28.00]the appropriated period for their amortisation, and the portion of the total purchase price that could be allocated to the
[07:36.44]These problems are the driving force behind the proposed legislatio
[07:40.59]The uniform amortisation period for intangibles is intended to eliminate disputes over the existence, value and life of intangible asset
[07:50.02]The bill is designed to be neutral with regard to tax revenue although savings are anticipated from the reduction in complex dispute
[07:59.14]Hence, the amortisation of goodwill is expected to be financed by increasing the amortisation period for some intangible asset
[08:07.60]For example, acquired computer software would be amortised over 14 years rather than the current five years and covenants not to compete would be amortised over 14 years rather than their likely much shorter live
[08:23.46]Generally, the benefits(or detriments) of this new legislation would depend on whether an acquirer bought assets rather than stoc
[08:32.63]Business considerations may limit an acquirer's ability to choos
[08:36.94]For example ,an acquirer may strongly prefer to buy assets because of concerns about large, difficult-to-measure liabilities of the business being acquire
[08:47.60]On the other hand, an acquirer who must make a hostile tender offer can only buy stoc
[08:53.73]A purchase of stock would not automatically permit an amortisation of the acquired corporation's goodwill since the goodwill itself would not have been purchase
[09:03.71]An acquirer could elect to treat a purchase of stock as a constructive purchase of assets for tax purpose and thereby come within the scope of this new provisio
[09:15.18]However, generally,this would not ahcieve the best tax result for an acquirer because of the immediate taxable gain on the difference between the purchase price and the tax basis of the asset
[09:26.86]In any contemplated acquistion, the effects of the proposed legislation should be reviewed in detail |