Ph.D, Associate Professor Markus O V

lecturer in accounting and auditing,

Eastern National University named after Lesya Ukrainian, Ukraine

 

Hrab O B

5 course Student in accounting and auditing

Eastern National University named after Lesya Ukrainian, Ukraine

 

Problematic issues of use slow depreciation methods (annuity method, sinking fund method) of fixed assets in the current conditions of european integration process in Ukraine

The abstract.  European integration processes in Ukraine lead to convergence of national standards with international. In modern terms, although IAS is advisory in nature, more business users are guided by international accounting standards for transparency and clarity of information to foreign counterparts.

The bulk of the companies' assets are fixed assets. State and fixed assets are essential to ensure the competitiveness of enterprises, and their composition and structure determine the possibility of the company in respect of the production process. The question of accounting depreciation is very important and requires detailed study.

Keywords: depreciation; annuity method; sinking fund method.

I. Analysis of recent research and publications.  Basic principles of the subject studied such foreign scientists as: Alexis Hardin, Henry Ergas, John Small, Anil Kumar Gupta , Poonam Ca Patni. Among local scientists, researchers investigated this issue: Zhmaylova A. G., Nadvornyak J. M., Ozarko L. M. funnel R. M. and other scientists. However, in Ukraine the question of the use and application of slow depreciation is not fully disclosed.

II. Formulation of the problem. The aim is to research issues of slow methods depreciation (annuity method and the method of depreciation fund) and the benefits and the applicability of these methods to Ukrainian enterprises.

III. Presenting the main material. Many researchers point out, that domestic sources of investment company formed just by depreciation on operating capital, and deductions from profits on investment needs [5]. IAS 16 defines Depreciation as a systematic allocation of the cost of fixed assets subject to amortization over their useful life. The term Useful Life is the period during which the company provides to use the feature or number of units (services), which the company expects to receive from its use [3].

Amortization method is chosen independently by enterprise with
the expectation to obtain benefits from its use. GAAP 7 differs from IAS 16. According to GAAP 7 [2] distinguish such basic methods of depreciation as straightforward, reducing the residual value, the accelerated reduction of the residual value, production, cumulative. While IAS 16 suggested for use straightforward method of reducing balance method amount units.

Private sector activity (ex. utilities, enterprises engaged in real estate) is used in the calculation of depreciation methods as progressive (slow) depreciation, which involves a gradual increase in the amounts of depreciation during the period of use fixed assets.  Methods include the method of depreciation fund and annuity method, which provide discounted future cash flows from investments in fixed assets using compound interest [1].

Annuity method and the method of depreciation fund belonging to interest method of amortization. Annuity method of depreciation is also commonly called compound interest method of amortization. If the cash flow the asset is depreciated continuously throughout the life of the asset, this method is called annuity. However, the annuity method of depreciation is not approved principles GAAP [4].

The principle of the annuity method of depreciation is that in the calculating of depreciation attention should be paid not only the cost of the asset and the percentage, which the capital blocked in that asset would have earned had it been invested outside the business. So under this method, a fixed fee of amortization is charged on income for each year of the useful life of the asset so that at a given interest rate the present value of the sum of all these contributions equal to the value of assets Stated otherwise, depreciation for each year is made to include an interest on unrecovered capital outlay but the interest which is credited annually to Profit and Loss Account, gradually diminishes. On the other hand, depreciation excluding interest, depreciation is the net continues to grow.  In addition, we note that annuity depreciation method can satisfy the cash to recover more than the usual methods of depreciation.

This method is best suited for those assets that require significant investments and do not require permanent changes in value and useful life of the period, such as long-term lease. [6]

To determine the annuity depreciation using the following formula:

Let, A = Annuity depreciation; C = Cost of the asset; S =Salvage value; i = Rate of interest in decimal term; n = Estimated life of the asset.

It also assume that salvage value is equal to zero.

Then, the present value of A due in 1 year =

the present value of A due in 2 years =

So, the present value of A in n year=

The sum of the present value of fiture annuity depreciation is to be equal to the cost of the asset.

= + + + ..+ (1)

Multiplying both side of the equation by (1+i)

(1+) = + + + + ..+ (2)

Subtracting equation (1) from equation (2), we get,

. = -

Or, . = [ 1 - ]

or, . = [ ]

or, A = (3)

This method has several advantages:

1)    In this method of depreciation included not only the recovery of invested capital, but also the interest on investment. That is why this method of depreciation is more logical and realistic than other methods.

2)      During inflation, it is possible for the company to replace the asset a total value of its accumulated depreciation.

3)    This method is most suitable for intangible assets, such as the acquisition of lease rights, patents etc. In these cases, the depreciation changes with time, but not with the intensity of its use.

Annuity method has some flaws and these flaws are as follows:

1)    This method is not used for all assets in the calculation of depreciation. Preference for time-out value, not the physical deterioration of the asset.

2)      This method assumes that the interest rate for uncovered capital cost equal to the cost of capital, but in the real world is unlikely to happen.

3)    The annual repairs and maintenance costs, as expected, will remain unchanged throughout the life of the asset, but it does not happen.

4)    This method makes it difficult to measure the depreciation if the replacement of the old asset by a new asset is the term for using the old asset.

Another interest depreciation method is "Method of depreciation fund."  According to him, depreciation is secured through deductions from income for asset replacement. This method is based on the assumption that the fund should be formed and that the amount of the fund should equal to the total amount of depreciation at the end of its useful life of the depreciable asset. An equal amount by way of depreciation is set aside by charging to the profit and Loss Account at the end of every accounting period, so that, all such equal installments if allowed to accumulate at a compound interest would equal to the depreciable cost of the asset at the expiry of its useful life [6].

In line with all other depreciation methods available cash may not be available to the company at the time of the replacement asset because in those cases the amount of depreciation is retained in the business. In this method armual equal installment set off as depreciation is regularly invested outside the business in interest bearing easily marketable securities. Interest yielded on such securities is compounded or reinvested in each year. When the life of the asset expires, investments are disposed off and the proceeds are utilised for replacing the old asset. This method is also known as Depreciation Fund Method or Redemption Fund Method.

Let, d = Sinking Fund Depreciation; C = Cost of the asset; S = Salvage value; i = Rate of interest in decimal term; n = Years.

Let it be assumed that the salvage value equal to zero. The accumulated amounts should then be equal to the cost of the existing asset. The accumulated amount can be obtained from the following:

= d +d + d +.+ d +

or, +d + d +.+ d (1+i) +d (4) Multiplying both sides to the equation by (1 + i)

C(1+i) = d +d + d +.+ d + d (1+i) (5)

Subtracting equation 4 from equation 5, get,

. = d d

or, . = d [ 1]

or, d = (6)

The main advantages of this method are as follows:

1) According to this method, at the end of the specified time, a certain amount of cash available to replace old assets.

2) Since the amount invested out of business there is no need to take money from business to replace the asset at the end of the useful life of the asset. This helps avoid pressure on working capital.

There are some drawbacks to this method, and they are as follows:

1)                In terms of this method is ineffective. Typically, the internal rate of return the company is higher than the return on investment.

2)                The company may encounter difficulties in finding appropriate investments that provide the required rate of return per year.

3)                It is difficult to accurately estimate the lifetime of the asset to be replaced.

4)                The effect of price level change is not considered at all. Since the amount of available fund at the end of the asset does not exceed the historical cost of the asset, the claim that fund invested outside the business will effectively replace the asset, remains doubtful.

5)                According to this method, the amount of depreciation does not bear any relation to the usage of the asset.

6)                This method does not take into account the residual value of the asset at the end of life. It is truly unjustified.

IV. Conclusions. There is a very close link between the annuity method and the sinking fund method, namely taken into account compound interest; appropriations provided for the replacement of assets and the level of annual meetings of income. The use of these methods is appropriate for large enterprises with constant efficiency and profitability of the company. Despite the Euro integration processes and the convergence of national regulations to the international economic situation in Ukraine is not stable and frequent changes in legislation cannot guarantee economic stability of domestic enterprises because the use of slow depreciation for them is inappropriate.

References:

1.                   Voronko R.M. (2012) Oblik u zarubizhnykh krainakh: [Navch.posib.], Mahnoliia 2006, L'viv, Ukraine.

2.                  The Ministry of Finance of Ukraine (2000), Regulation (Standard) Accounting 7 "Fixed Assets" available at: http://zakon5.rada.gov.ua/laws/show/z0288-00

3.                    International Financial Reporting Standard 16 "Fixed Assets" (2012),  available at: http://zakon2.rada.gov.ua/laws/show/929_014

4.                  Farid S. (2016), Annuity Method of Depreciation available at: http://www.accountingdetails.com/annuity_method_of_depreciation.htm

5.                  Onys'ko S.M., Shmatkovska T.O. (2010), Do problematyky formuvannia ta vidtvorennia osnovnykh zasobiv na sil's'kohospodars'kykh pidpryiemstvakh, aggressive Economics and Business, Vol.2., pp. 139-145.

6.                  Methods of depreciation (2016), available at: http://shodhganga.inflibnet.ac.in/bitstream/10603/64018/8/08_chapter%203.pdf.