DEPRECIATION ACCOUNTING PRACTICES AND PROFITABILITY OF SELECTED SMES IN PORT HARCOURT
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Measuring the SME’s profitability is a central task both in accounting practice and theory (Benjamine, 2002). The management of SMEs need the profitability information for their decision making both in the short and in the long run and therefore must take steps to ensure the profitability of the organization (Goldberg, 2009). However, using one or another depreciation accounting method, an additional deduction of the income tax is possible, thus increasing the net profit available for the SME for the organization development. In depreciation accounting practices, the methods used includes linear depreciation, regressive depreciation and accelerated depreciation. The bigger the expense input with the depreciation, the bigger the net profit – situation found when a faster accounting depreciation policy is used (Wood, 2007). In other words, the effect of the depreciation accounting practices appears in choosing one of the depreciation methods used. In accountancy, depreciation practices refers to two aspects of the same concept: The decrease in value of assets (fair value depreciation) and the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle). A method of reallocating the cost of a tangible asset over its useful life span of it being in motion. Businesses depreciate long-term assets for both tax and accounting purposes. The former affects the balance sheet of a business or entity, and the latter affects the net income that they report. Generally the cost is allocated, as depreciation expense, among the periods in which the asset is expected to be used. This expense is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation, and the periods over which assets are depreciated, may vary between asset types within the same business and may vary for tax purposes (Akanni, 2008). These may be specified by law or accounting standards, which may vary by country. There are several standard methods of computing depreciation expense, including fixed percentage, straight line, and declining balance methods. Depreciation expense generally begins when the asset is placed in service. For example, a depreciation expense of 100 per year for five years may be recognized for an asset costing 500. In determining the profits (net income) from an activity of the SMEs, the receipts from the activity must be reduced by appropriate costs. One such cost is the cost of assets used but not immediately consumed in the activity. Such cost so allocated in a given period is equal to the reduction in the value placed on the asset, which is initially equal to the amount paid for the asset and subsequently may or may not be related to the amount expected to be received upon its disposal. Depreciation is any method of allocating such net cost to those periods in which the organization is expected to benefit from use of the asset. The asset is referred to as a depreciable asset. Depreciation is technically a method of allocation, not valuation, even though it determines the value placed on the asset in the balance sheet (Samuelson, 2001). Any business or income producing activity using tangible assets may incur costs related to those assets. If an asset is expected to produce a benefit in future periods, some of these costs must be deferred rather than treated as a current expense. The business then records depreciation expense in its financial reporting as the current period’s allocation of such costs. This is usually done in a rational and systematic manner. Generally this involves four criteria which includes cost of the asset, expected salvage value also known as residual value of the assets, estimated useful life of the asset, and a method of apportioning the cost over such life.
DEPRECIATION ACCOUNTING PRACTICES AND PROFITABILITY OF SELECTED SMES IN PORT HARCOURT