How the Companies Manipulate the Depreciation
One of the things that analysts and investors frequently look for while analyzing a company is the capital expenditure. With many Indian companies on a growth track, capex activities like building a new factory, buying new machinery etc are constantly going on. But with purchase of new assets comes the frequently heard term i.e. depreciation! All of us must have heard about depreciation and know that it is deducted before arriving at Net Profit. However, not many of us are aware of its nitty-gritty’s and the part that it plays in determining the profits of a company. In fact many of us completely ignore analyzing this important parameter. However, with considerably flexibility over how depreciation is calculated, it is one of the easiest figures to manipulate for the companies.
But before we start with all the techniques used to manipulate depreciation let’s understand what it actually means. To start with, have a look at the table that gives you an idea about where depreciation actually features in the Profit & Loss statement. WHAT IS DEPRECIATION?
Mr. A. has a small bakery which produces the finest bread in town. Recently, he purchased a new oven for baking his delicious bread. The machine costs Rs. 10,000, which is an expense. However, the oven that Mr. A has purchased will be used not only in this year but also in the years to come. Let’s assume that it can be used for a period of 5 years. So, the cost or expense incurred by Mr. A in purchasing the machine should be distributed over a period of 5 years and then subsequently deducted from the respective sales figures for these 5 years. This cost of the machine to be deducted annually is nothing but depreciation.
There are two methods by which Mr. A can calculate the annual amount that should be deducted as depreciation: Straight-line method (SLM) and Written-down value (WDV) method.
Straight Line Method:
This method involves distributing the total cost of the machine equally during the useful life
But before we start with all the techniques used to manipulate depreciation let’s understand what it actually means. To start with, have a look at the table that gives you an idea about where depreciation actually features in the Profit & Loss statement. WHAT IS DEPRECIATION?
Mr. A. has a small bakery which produces the finest bread in town. Recently, he purchased a new oven for baking his delicious bread. The machine costs Rs. 10,000, which is an expense. However, the oven that Mr. A has purchased will be used not only in this year but also in the years to come. Let’s assume that it can be used for a period of 5 years. So, the cost or expense incurred by Mr. A in purchasing the machine should be distributed over a period of 5 years and then subsequently deducted from the respective sales figures for these 5 years. This cost of the machine to be deducted annually is nothing but depreciation.
There are two methods by which Mr. A can calculate the annual amount that should be deducted as depreciation: Straight-line method (SLM) and Written-down value (WDV) method.
Straight Line Method:
This method involves distributing the total cost of the machine equally during the useful life