Comparative Analysis –
The two methods generally used to calculate depreciation are Straight Line method and Written Down Value method. An organisation can use either of the two depending on its policies and the prevalent law. The following points are noteworthy for a comparative analysis between the two methods.
1. Basis of Charging Depreciation: Depreciation is charged based on original cost or historical cost in the straight line method.
While in written down value method, the basis of charging depreciation is net book value i.e., original cost less depreciation till date of the asset, in the beginning of the year.
2. Annual Charge of Depreciation: Under the straight line method the yearly amount of depreciation charged each year stays fixed or constant. Wherein the written down value method the yearly amount of depreciation is most elevated in the first year and subsequently decreases in later years.
The explanation behind this difference, is the distinction in the basis of charging depreciation under both methods. Under straight line method depreciation is determined on original cost while under written down value method it is calculated on written down value.
3. Total Charge Against Profit and Loss Account on Account of Depreciation and Repair Expenses: Under straight line method it is a well-accepted phenomenon that repair and maintenance expenses increase in the later years of the valuable existence of the asset.
Therefore, total charge against profit and loss account in respect of depreciation and repair expenses increases in the later years. This happens in light of the fact that yearly depreciation charge stays fixed while repair costs increase. On the other hand, depreciation charge decreases in later years, under the written down value method, accordingly total of depreciation and repair charge stays similar or equivalent year after year.
4. Recognition by Income Tax Law: The Income Tax Act, 1961 does not recognise Straight line method for calculating depreciation. Whereas, the Written Down Value method is acceptable under the Income Tax Law.
5. Suitability: Written down value method is very suitable for assets which are influenced by technological changes and require more repair costs with passage of time, for example, plant and machinery, vehicles, and so on.
Straight line method is appropriate for assets in which repair charges are low and the possibility of obsolescence is also low and scrap value relies on the timespan included, for example, buildings and freehold lands, licenses, patents, trademarks marks, and so forth.
Thus, a comparative analysis between the straight line method and written down value method reveals that the major difference is caused by the value on which depreciation is charged in each of the two methods. The former charges it on the original cost less the salvage value and the latter on the diminishing value each year, thus creating the differences in the amount of depreciation.