W4_HPO_Choosing The Best Depreciation Method


1. Problem Statement

My friend ask my help to choose the best depreciation method he should apply in his accounting book. He has bought some Kijang Innova cars cost around US$ 25,000 each intended for rentals. Because the rentals is intended for offices, he is ready for 3-years fixed rate with a risk of increasing operation and maintenance cost around 10% inflation each year. He also said that the cars will be rejuvenated for every 5 years and sold at least next year after the commissioning. Because the cars are Toyota’s, the salvage value is predicted to stay around 60% after 5 years conservatively. Tax will be assumed at 30%  averagely.

2. Feasible Alternatives

The best approach to solve this problem is to model the free cash flow in order to find the IRR. The model of the depreciation methods follow Indonesian Tax Law (UU 7/83 jo. UU 36/2008) which are the straight line method and declining balance method. According to Indonesian Tax Law, car is categorized to movable fixed assets with four years useful age, different with common business practice of 5 years economic useful life.

3. Develop The Outcome of Each Alternative

The depreciation method of straight line and declining balance method is as follow:

Figure 1

W4_Model Depreciation Method Only

4. Selection of The Acceptable Criteria

The best depreciation method  is the method which gives the highest IRR result.

5. Analysis of Comparison Between Alternative and Criteria

The result of the models between two, declining balance method is slightly more superior than straight line method in generating IRR.

Figure 2.

W4_Model Depreciation Method to FCF

6. Selection of The Best Alternative

The best depreciation method is declining balance method because it gives higher IRR. The declining balance method also can give the inflation protection.

7. Follow Up Assessment

My friend must choose the declining balance method to get the highest utility of IRR.

References:

Anonym (2013). Harga Toyota New Kijang Innova Bulan September 2013. [ONLINE] Available at: http://www.astra-toyota.com/2013/01/harga-toyota-kijang-innova-2013-di.html. [Last Accessed 26 September 2013].

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Time Value of Money. In Engineering Economy (15th ed., pp. 289-333). Upper Saddle River, N.J: Prentice Hall.

Wiston Manihuruk (2011). PENYUSUTAN DAN AMORTISASI. [ONLINE] Available at: http://wistonmanihuruk.blogspot.com/2011/03/penyusutan-dan-amortisasi_23.html. [Last Accessed 28 September 2013].

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1 Comment

Filed under Hadianto P, Week 04

One response to “W4_HPO_Choosing The Best Depreciation Method

  1. Excellent case study, Pak Hadianto and you did a nice job of your assessment using our 7 step process, but what I am curious about is why you didn’t include the other two major methods as shown in Chapter 7 of Engineering Economy? Sum of the Years Digits and the Modified Accelerated Cost Recovery System (MACRS)

    While I will accept this posting, I would STRONGLY recommend that you do a follow on posting which includes BOTH the SOYD and MACRS methods. Why do I recommend you do this? Because I can almost GUARANTY that you will see a problem using these four methods on the CCC/E, the CEP and the DRMP exams…….. (See also your supplemental materials provided to you during the F-2-F Kick Off session in the back of your hard binder?)

    So if you want to increase your chances of passing one or more of these exams, I would urge you to expand on your knowledge using the same case study and creating a more complete blog posting based not just on Chapter 4, the Time Value of Money, but also on Chapter 7, Depreciation and Taxes…. 😉

    BR,
    Dr. PDG, Jakarta

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