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:
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.
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.
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