Literature Review
Question:
Discuss about the Accounting for Depreciation in Fixed assets.
The paper presents a detail literature review on the topic accounting for depreciation in fixed assets. The purpose of the project is to derive an understanding about accounting variables and their use in the real-world scenario. The accounting for depreciation needs a current series of entries to alter a fixed asset to expense. Thus, such sets of entries could reflect the ongoing assets with time. Thus, these sets of entries to reflect the ongoing usage of fixed assets over time. A more clear definition and concepts of depreciation has been analyzed in the following. In order to conduct the analysis of existing papers, almost 15 journals have been selected and presented in the discussion.
The major objective of the project is to critically develop an understanding about accounting and the variables related to it such as depreciation and fixed asset, methods of measuring fixed assets and other related variables. A detailed literature review helps to find out and discuss the issues associated with the depreciation.
The literature review covers the discussion and analysis on depreciation and how depreciation can be applied to fixed assets. An intensive analysis has been presented in the paper about effectiveness of depreciation in fixed cost, which means whether depreciation should be done on monthly or yearly basis. The analysis is comprehensive enough because the methods of applying depreciation have been discussed with the opinions of authors of the previous studies. In order to the support the discussion about 15 peer-reviewed journals have been cited inside the analysis. Moreover, the review has been done of all relevant journals articles on accounting. No particular or unique method has been applied to build the discussion; however, a qualitative research method has been applied to conduct the analysis. Nonetheless, the search has been widened to seek literature in the related discipline.
Accounting policies
As mentioned by Christensen and Nikolaev (2013), under the framework of the regulation and the standards of accounting, the organizations might be able to adopt accounting policies with different degree of conservatism. However, the organizations that implement conversation policies could make it with the purpose of ignoring any particular statement of carrying the assets. Thus, the organizations following the conservative policies could over impairment losses on a frequent basis compared to the firms with less conservative policies. Furthermore, in the case of the tangible and intangible assets, the major difference between the conservative as well as the less conservative accounting policies remains in the depreciation schedule. In this context, Istrate (2012 mentioned that an organization with the conservative policies might implement a less estimated economic state particularly for the linear depreciation of fixed assets in comparison with limited conservative policies. Thereby, the length of anticipated economic lives of fixed assets might be the measure of the extent of accounting conservatism. On the other side, the characteristics could be calculated with the help of some ordinary depreciation charges in the proportion of expense of the asset (Istrate 2012).
Depreciation and Fixed Asset Accounting
Furthermore, it is observed that if the capital market is efficient, the participants in the market might not be misguided by organizations’ use of multiple accounting policies and they are effectively revealed. Furthermore, it was also studied that in an efficient market, the organizations with discrepancies in the selection of accounting policies might observe a similar value and hence, the participants of the market are updated about the content of the policies. Thus, if this particular situation sustains for a while, an individual might estimate the demand of market value to hire value of the equity to be greater for the firm with conservative policies compared to the organizations with limited conservative policies. Radu and Marius (2011) added that if the losses of impairment are due to the accounting policies, the price-book ratio of impairers might be estimated compared to the range of non-impairers prior to the identification of the loss of impairment.
Figure 1: Measures of accounting conservatism
(Source: Christensen and Nikolaev 2013)
The above-mentioned table compares the rate of depreciation as well as price-book ratio for the impairers as well as non-impairers. In order to make it comprehensive, the rate of average depreciation is calculated only for the impairers that include the impairments of the significant class and non-impairers.
Concept of Depreciation
Depreciation is known as the steady changing to expense of an asset’s price over its anticipated conventional life. Carpenter, Durtschi and Gaynor (2011) claims that the major factor using depreciation to dramatically increase the anticipated cost of fixed asset is identify a particular area of the asset’s cost and simultaneously the organization report the profits that was generated in the fixed asset. Rambaud and Richard (2015) mentioned that the if an individual takes the price of an entire fixed cost asset to expenditure in a single period, however, it kept the base of the revenue for several years into future and this might remain as an inappropriate accounting transaction under some similar principles. This happens, as the revenue might not be similar with some associated expense. However, Kitchen and Knittel (2011) mentioned that in reality, the revenue might not be linked to a fixed asset. Instead, they can be easily related to an entire system of a set of grouped assets. As put forward by Ahangar (2011), the entry of journals for depreciation could be an easy entry for each kind of fixed asset.
Conversely, the major journal entries for depreciation help to debit the depreciation expense account and accumulated depreciation account. This usually comes up in the balance sheet, which remains as the contract account that decreases the sum of fixed assets.
Furthermore, it is also studied in the research paper conducted by Van Leuvensteijn et al. (2011), with time, the balance of accumulated depreciation might continue to increase because more depreciation is added to it. In order to oppose the above-mentioned concept, depreciation remains as an expense but there is a related to cash flow, which is unlike the most of the expense. This happens because an organization has a net cash outflow in the whole amount of the asset when the asset was originally purchased.
Measuring Fixed Asset Value
Concept of Fixed Asset
As put forward by Berlemann and Wesselhöft (2014), a fixed asset remains as the long-term tangible element of property that an organization acquires and utilizes in its operation to create income. Brown, Beekes and Verhoeven (2011) mentioned that fixed assets are usually not expected to be considered or converted into cash within a year. On the contrary, Ihantola and Kihn (2011) mentioned that fixed assets are usually known as property, plant and equipment and they can be referred to as the capital assets. Furthermore, it is also observed that an organization’s balance sheet statement might contain the assets, liabilities and shareholders’ equity. The assets are categorized into current and non-current assets and hence the difference usually lies in their useful lives. As commented by Benson et al. (2015), the current assets usually known as the liquid assets that can be transferred into cash in less than a year. On the other side, the non-current assets are referred to assets as well as property owned by a particular business, which cannot be easily converted to cash. Moreover, multiple divisions of non-current assets might include fixed assets, intangible assets, deferred charges and long-term investment. A study conducted by Bampton and Cowton (2013), commented that a fixed asset is bought for production or supply of goods services, particularly for rental to third parties and for the use in the organization. Hence, Adibah et al. (2013) mentioned that the term “fixe” is referred to the fact that these assets would not be used or sold within the accounting year. On the other side, Rambaud and Richard (2015) mentioned that a fixed asset conventionally has a physical form and it is usually reported on the balance sheet as the property, equipment and plant.
Conventional unresolved issues of depreciation
The long-standing confusion with respect to depreciation in accounting practices could be the lack of agreement among the accountants on what the word depreciation stands for. In conventional accounting practices with respect to depreciable assets, depreciation stands for the actions of minimizing the purchasing cost to the ultimate selling price at the point of disposal. As put forward by Van Leuvensteijn et al. (2011), the reference is usually made to the market value only at the initial stage and at the end of the lifetime of an asset. Nonetheless,Bampton and Cowton (2013) considered depreciation as the physical deterioration of assets. On the other side, Ihantola and Kihn (2011) consider it as the deferred maintenance. In this context, Berlemann and Wesselhöft (2014) also commented that accountants are concerned with the financial aspects but not with the physical factors.
Conversely, some people with the profession such as Engineering probably develop their individual depreciation concept. According to Istrate (2012), physical factors in the field of engineering is related to wear and tear of productive plants and equipment. Furthermore, Radu and Marius (2011) supported this concept, as he mentioned that depreciation remains as decrease of value any factor of “wears and tears”, deterioration of asset might be caused by taking them in the production. As put forward by Rambaud and Richard (2015), Economist concept of value, which includes the cost value, exchange value or used or utility value of relative significance is faced with the considerable difficulty in deriving the concept. Unless the value of asset is specified, the economic value does not remain relevant to the measurement of depreciation. It is usually considered as the condition for the replacement of durable asset at the end of its useful life.
Accounting Conservatism
Measuring the value for fixed assets
As put forward by Radu and Marius (2011), the measurement and observation always assume the existence of underlying theory. The outcome of the observation as well as the measured value could be interrupted, based on such concept. According to this concept, Ihantola and Kihn (2011) mentioned that measurement of asset value could only be interrupted in the light of underlying theoretical basis. It is observed that theories behind the measurement of fixed asset value at the beginning and at the end are usually referred as the “economic value”. These have branched at the time of evolution into two distinct as well as opposed trends, the classical as well as non-classical school and the value theory of which is different from one another. This has further become a labor theory of value as well as marginalism. On the other side, Bampton and Cowton (2013) considers this as regards measurement, both the theories have the fundamental weakness of deriving their explanation back to the ultimate factors that are difficult to interpret in practice. A study conducted by Ahangar (2011), labor theory of value is based on an approach of value through the production technique and the roots of this could go back to the primitive societies where the natural resource were thought to be the “gifts” of nature which staff transformed into consumption goods through their work. As the result, the value of these gifts could be solely associated with the quantity of labor, which they implement. A representative of labor theory
Conclusion
After reviewing different articles from different reliable data sources like Google Scholar, it can be concluded that enigma of depreciation and depreciable assets and its application in financial reporting affect the existing thinking of accounting practice. In this review, investigating fixed assets depreciation from the perspective of business income have been developed which indicates that theoretical background of depreciation could go beyond the simple cost allocation approach. It is certain that calculation of depreciation could instead be considered as an issue of asset valuation.
Reference list
Adibah Wan Ismail, W., Anuar Kamarudin, K., van Zijl, T. and Dunstan, K., 2013. Earnings quality and the adoption of IFRS-based accounting standards: Evidence from an emerging market. Asian Review of Accounting, 21(1), pp.53-73.
Ahangar, R.G., 2011. The relationship between intellectual capital and financial performance: An empirical investigation in an Iranian company. African journal of business management, 5(1), p.88.
Bampton, R. and Cowton, C.J., 2013. Taking stock of accounting ethics scholarship: A review of the journal literature. Journal of Business Ethics, 114(3), pp.549-563.
Benson, K., Clarkson, P.M., Smith, T. and Tutticci, I., 2015. A review of accounting research in the Asia Pacific region. Australian Journal of Management, 40(1), pp.36-88.
Berlemann, M. and Wesselhöft, J.E., 2014. Estimating aggregate capital stocks using the perpetual inventory method. Review of economics, 65(1), pp.1-34.
Brown, P., Beekes, W. and Verhoeven, P., 2011. Corporate governance, accounting and finance: A review. Accounting & finance, 51(1), pp.96-172.
Carpenter, T.D., Durtschi, C. and Gaynor, L.M., 2011. The incremental benefits of a forensic accounting course on skepticism and fraud-related judgments. Issues in Accounting Education, 26(1), pp.1-21.
Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), pp.734-775.
Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), pp.734-775.
Ihantola, E.M. and Kihn, L.A., 2011. Threats to validity and reliability in mixed methods accounting research. Qualitative Research in Accounting & Management, 8(1), pp.39-58.
Istrate, C., 2012. Impact of IFRS on Romanian accounting and tax rules for fixed tangibles assets. Accounting and Management Information Systems, 11(2), p.243.
Kitchen, J. and Knittel, M., 2011. Business use of special provisions for accelerated depreciation: Section 179 expensing and bonus depreciation, 2002-2009.
Radu, D. and Marius, D., 2011. Issues related to the accounting treatment of the tangible and intangible assets depreciation. Annals of the University of Oradea: Economic Science, 1(2), pp.498-502.
Rambaud, A. and Richard, J., 2015. The “Triple Depreciation Line” instead of the “Triple Bottom Line”: towards a genuine integrated reporting. Critical Perspectives on Accounting, 33, pp.92-116.
Van Leuvensteijn, M., Bikker, J.A., Van Rixtel, A.A. and Sørensen, C.K., 2011. A new approach to measuring competition in the loan markets of the euro area. Applied Economics, 43(23), pp.3155-3167.
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