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.
Ñ =
Multiplying
both side of the equation by (1+i)
Ñ (1+³) = À
+
Subtracting
equation (1) from equation (2), we get,
Ñ.³ = À -
Or, Ñ.³ = À [ 1 -
or, Ñ.³ = À [
or, A =
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:
Ñ = d
or,
C(1+i)
= d
Subtracting
equation 4 from equation 5, get,
Ñ.³
= d
or, Ñ.³ = d [
or, d
=
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.