Depreciation Term

7/31/2019 Depreciation Term

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Depreciation Practices by Service-Oriented

Firms in Bangladesh


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Table of Contents

1.0 Introduction...1

1.1: Origin of the Study..1

1.2: Objectives........1

1.3: Scope of the Report1

1.4: Methodology.......2

1.5: Limitations.......2

2.0 Conceptual Overview of Depreciation.....3

2.1: Definition..3

2.2: Importance of Depreciation...3

2.3: Depreciation Methods.......4

3.0 Literature Survey.....6

4.0 Interview Findings and Analysis.......9

4.1 Brief Company Profile.9

4.2 Interview Summary.......10

4.3 Analysis......13

4.3.1 Objective Analysis.......13

4.3.2 Theory Analysis.......14

4.3.3 General Analysis......14

5.0 Concluding Remarks........16

Appendix

List of Tables

Table 1. Interviewee Details..12


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1.4 Methodology

As we were advised to prepare an extensively interview based report, we have

conducted interviews in each of our target companies for data collection and

information gathering.

Secondary data has been collected from internet, books and reports related to the

topic.

We have thoroughly studied the theory and linked the concept with information

gathered from different firms to have a better understating of the practical implication

of depreciation.

1.5 Limitation

Few potential interviewees were not available either due to their time constraints or

due to difficulty in reaching them during the Eid-ul-Azha vacation.

Employees of the Marketing departments were reluctant to talk about the topic since

they are not directly involved in the matters related to accounting principles such as

depreciation practices of their organization.


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2.0 Conceptual Overview of Depreciation

2.1 Definition

The word Depreciationis derived from a Latin word Depretium where De means decline and

pretium means price. In accounting, the term Depreciation means the systematic allocation of

the cost of a depreciable asset to expense over the assets useful life. Simply defined it is the

reduction in the value while that asset is being used by the company or organization. To be

precise, depreciation refers to gradual loss in the utility value of an asset with time due to

physical deterioration, inadequacy or obsolescence.

There are different methods for depreciation from which an entity can choose depending on the

nature of the assets inn questions and the needs of the entity. However firms must abide by the

rule of consistency in depreciating assets and cannot change depreciation methods followed for a

specific asset over its useful life without justifiable cause.

2.2 Importance of Depreciation

Annual charge of depreciation is an important practice in every organization. Deprecation is

often a significant factor in determining net income. It is determined and provided in the

accounts to find out the current cost of production. Depreciation means loss of an assets value as

it is consumed gradually over a period of time, without proper depreciation of the asset it will

appear overvalued in the balance sheet. It is also necessary to show the assets in their net book

value since all outside parties and potential investors requires this information for their

assessment of the company's performance and making educated investment decision.


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2.3 Depreciation methods

In Bangladesh, Straight-Line and Reducing Balance method are the most commonly used

depreciation methods.

Straight-line methodresults in a constant charge over the useful life if the assets salvage values

do not change.

Asset cost- Salvage value

Depreciation per period=

Estimated useful life

Or, Depreciation per period= Asset Cost X Deprecation-percentage rate

Reducing balance methodresults in a decreasing charge over the useful life of the asset, where

asset looses greater share of the value during its earlier years.

Under these broader categories there are other depreciation methods which are less used which

are-

The units-of-production method: The unit-of-production method results in a charge based

on the expected output of production.

Accelerated methods: Accelerated depreciation methods include sum-of-years digits and

double-declining balance methods. Similar to reducing-balance methods, Accelerated

method assume that an asset is used more heavily during the earlier years and loses

majority of its value during the first several years of use.


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The calculation of depreciation requires determination and evaluation of certain issues such as:

Depreciation cost: The basis of an asset is usually its cost. It can be its historical cost or fair

market value of the cost based on individual firms depreciation treatments.

Useful life: Useful life is the number of years an asset is expected to remain in use.

Salvage value: Salvage value is the estimated value of an asset at the end of its estimated useful

life.

Choice of method: Depreciation methods vary in financial reports and tax reporting.

Depreciation method is chosen in align with the firms business activities and consumption of

future benefits embodied in the asset.


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3.0 Literature Survey

Most researches conducted in the field of depreciation are in the context of western countries.

Baum (1991) defines depreciation as a loss in the existing value of property and attributes the

causes to physical deterioration, functional obsolescence or aesthetic obsolescence. Mansfield

(2000) also notes that property-based depreciation is the result of two negatives processes;

physical deterioration and obsolescence. Barreca (1999) classifies depreciation into three

classifications namely physical depreciation, functional depreciation and other economic losses.

These three views of depreciation obviously have something in common and that is the fact that

depreciation is the result of physical deterioration, functional and economic obsolescence.

Only a few studies have been found from Bangladesh perspectives on conceptual issues of

depreciation and the methods of depreciation.

STUDY 1: DEPRICIATION METHODS OF THE LISTED COMPANIES IN

BANGLADESH

A study conducted by Prof. Dr. Syed Mohammad Ather (2008) discussed the current

depreciation practices in of the listed companies in Bangladesh.

Focus:

The study mainly focused on listed companies in the Chittagong stock exchange.


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Methodology:

From random sampling method 100 companies were selected and survey was conducted by

questioning officials of those organizations. The questions were asked concerning depreciation

methods, calculation of depreciation, accounting standards etc. As few studies have been done on

depreciation methods in Bangladesh this particular study contributed to gain better understanding

regarding depreciation practices.

Conclusions:

The major finding of the study suggests that the two most common practices in Bangladesh are

Straight-line and Reducing Balance method and they differ significantly. The study also revealed

the trend of switching from reducing balance method to straight line method in organizations.

This particular finding preference to straight line method is also reflected more prominently in

our report. A relationship between accounting recording system and depreciation method is also

depicted.

STUDY 2: THE IMPACT OF DEPRECIATION- A HEDONIC ANALYSIS OF OFFICES

IN THE CITY OF KUALA LUMPUR

Dr. Aminah Md Yusof from University Technology of Malaysia made substantial contributions

in the understanding of depreciation regarding investment property. For the Pacific Rim Real

Estate Society (PRRES) Conference 2000 which was held in Sydney, 23 - 27 January 2000, he


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wrote a paper which focused on the impact of depreciation on offices in the city of Kuala

Lumpur.

Focus

The writer analyzed Kuala Lumpur's office market from 1996 to 1998. He highlighted the

various causes of fluctuations in the office rents, vacancy rates and economic growth in Malaysia

during this time frame.

Methodology

A survey on offices was undertaken to obtain comprehensive details of property characteristics.

Rental depreciation method was one of the key performance indicators. The variables found from

this survey were further examined. The main analytical tool which was used in this study was

Multiple Regression Analysis and its extension of Hedonic Price Technique. Some related

statistical tools such as Principal Component Analysis were also included.

Conclusions

The study concluded that depreciation may arise from factors, which are specific and systematic

to the property. In 1998, the city of Kuala Lumpur suffered high level of depreciation as shown

by an increase of 100% from 1996. This was due to the low demand created during the recession.

Moreover the creation of a large number of high-quality office spaces worsened the situation.

When all offices are affected by slow demand, some offices depreciate faster than others do. The

trend is explained by specific dimension of depreciation. The massive scale of depreciation in the

city of Kuala Lumpur was attributed to the Variation in offices c haracteristics, denoted by site

obsolescence, building obsolescence and physical deterioration. Among these three, physical

deterioration and obsolescence were found to be major sources of depreciation in the City of

Kuala Lumpur.


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4.0 Interview Findings and analysis

4.1 Brief Company Profile

To link the theories learnt from books and their practical implications, interviews were

conducted in four major companied currently operating in the service sector. They are:

Grameenphone

Banglalink

Sheraton Hotel and BSL

Basic Bank Limited

A brief introduction of the companies is given below:

Grameenphone: Grameenphone, widely known as GP, is the leading telecommunications

service provider in Bangladesh. With more than 20 million subscribers (as of June 2008),

Grameenphone is the largest cellular operator in the country. It is a joint venture enterprise

between Telanor and Grameen Telecom Corporation, a non-profit sister concern of the

internationally acclaimed microfinance organization and community development bank Grameen

Bank.

Banglalink: Banglalink, is the second largest cellular service provider in Bangladesh after

Grameenphone. As of June, 2009, Banglalink has a subscriber base of more than 11 million. It is

a wholly owned subsidiary of Orascom Telecom.


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Sheraton and BSL: Sheraton is one of the brands of nine-branded hotel management services of

USA company Starwood Hotels and Resorts. It manages the Sheraton Hotel which is owned by

Bangladesh Service Limited (BSL).

Basic Bank Limited: BASIC Bank Limited 1988, started its operations from the 21st

of January,

1989. It is governed by the Banking Companies Act 1991. The Bank is state-owned. However,

the Bank is not nationalized; it operates like a private bank as before.

4.2 Interview Summary

All the organizations currently use Straight Line depreciation method to record reduction in their

assets value per period. They use it mainly because of ease in calculation and simplicity in

understanding it. The firms charge depreciation on historical costs of assets but they revalue

these assets during special occasions.

Although the interviewed firms operate in different industries of the service sector, all of them

think Straight Line depreciation best reflects the cost associated in benefit received from all of

their depreciable assets. Every organizations is reluctant to switch to other depreciation methods

either due to (a)cumbersome problems involved in switching to other methods or (b) due to

possible negative impacts on financial health of the organization resulting from such change.

Much of the company policies and regulations regarding depreciation of the interviewed firms

were predetermined since the commencement of their operations or they remained unchanged

during the tenure of the interviewee. Government rules and regulations regarding depreciation


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methods in times of tax calculations result in different depreciation expense, taxable profit and

deferred tax assets or liabilities. This leads the firms to maintain two sets of books one for the

company where depreciation is calculated under the guidance of company policies and another

for tax authority purpose which uses depreciation rules and methods under the guidance of

Bangladesh Accounting Standards (BAS).

Even though the preferences for and use of depreciation methods, and the affects of external

parties like government on companies were more or less the same, there are few points on which

the interviewees and the firms as a whole differed in opinions/views. They are:

Separate Reserve Fund for Depreciation:

None of the companies interviewed has any reserve fund allocated for depreciation. Of

the interviewed people, 28% treats accumulated depreciation as a reserve fund, another

28% said they dont have any such fund due to company policies, 14% feel the need for a

sinking fund and the rest 30% are unaware of it.

Shareholders suggestions regarding current depreciation methods:

Of the 4 firms interviewed, 25%of the companys shareholders suggest to change the life

span of some technical assets, another 25% have their depreciation policies consistent

with the desire of the stakeholders, another 25% havent had any annual shareholder

meetings as this was the first year they issued shares to the public, and the rest 25% said

that the shareholders are not bothered about it.


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The interview was conducted through a generel questionnaire consiting of 15 questions. Detail

Information regarding the interviewees and interview timetable is give below:

Table 1. Interviewee detail

ompany

ame

Interviewee

Name

Designation Contact No. Education

Background

Time of

Interview

Grameen

phone

Muhammad

Khatibur

Rahman

Manager, Fixed

Asset, Finance

Division

Telephone:9882990

Mobile:01717505529Email:khatibur@

grameenphone.com

Chartered Accountant

Firm

11am- 12pm

25.11.2009

Imrul Karim

Marketing

Communications

Mobile: 01711081004BBA, MBA

1-1:30pm

25.11.2009

Bangla

link

S.M. ShawkatUllah

Manager, Fixed

Asset, Accounting

& Finance

Mobile:01911310516

Email:[email protected]

------------

2-3pm

24.11.2009

Md.

Tariquzzama

n Khan

Budgeting, Planning& Reporting Sr.

Executive

Accounting &

Finance

Mobile:01924400102

Email:tarkhan@

banglalinkgsm.com------------

12:30-1:30pm

24.11.2009

Sheraton

Shahidus

Sadeque

Marketing

CommunicationManager

Telephone:8330001,8358060

Mobile:01713046050Email:

sadeque@sheraton-

dhaka.com

-----------

5:30-5:50pm

24.11.2009

BSL

Md. Nazrul

Islam

Manager, Accounts

and Finance And

Head of Internal

Audit

Telephone:8358060

Email:

[email protected]

-----------

9.40-

10.00am

25.11.2009

Basic

Bank

Limited

Mohammad

Sayadur

Rahaman

Assistant Manager,

Central Accounts

Division

Telephone:7176017Mobile:01713444211

Email:rahamansa@

basicbanklimited.com

BBA(Hons),

MBA(Accounting &I.S.) University of

Dhaka

3-4pm

24.11.2009


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4.3 Analysis:

4.3.1 Objective Analysis:

The interviewees were either from finance or marketing department. Those from finance

department had a thorough understanding and clear conceptions regarding depreciation practices.

Those from marketing depratment know well about depreciation and different methods.

However, since they are not directly involved in the financial matters of their respective

organizations, they lack expertise knowledge in accounting and are unaware of company policies

regarding depreciation.

All the organizations prefer straight-line method and believe it to be suitable for their respective

businesses. Straight-line method is preferred by the organizations for various reasons such as-

Simplicity (Easy to understand)

Easy to calculate

Used for a very long period of time

Relevance to the consumption of benefits


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4.3.2 Theory Analysis

By depreciating assets per period, the firms are complying with the matching principle by

writing off costs for benefit received for a particular period. They are also practicing

conservatism by expensing this estimated cost. However, it can also be argued that organizations

with cream investment on assets, particularly with technological equipments, are appearing to be

not too conservative. Technological equipments have a greater probability of being obsolete

quickly and it would seem more prudent to recognize this increased potential loss of such assets

in their initial years of estimated useful life.

4.3.3 General Analysis

In different organizations of the same sector, historical costs of similar assets (with

similar benefits) of two companies may differ because of their difference in

acquisition time. As a result, depreciation expense might be less in one company and

more in the other. So true value of asset and proper depreciation expense is not

reflected in the financial statement. For example, Sheraton, Westin and Radisson are

the three major companies operating in the hospitality industry. However, they started

their operations at different times. Sheraton was established in 1963 whereas

Radisson and Westin entered the industry in recent years, the fixed assets acquired by

these firms are similar in nature but due to difference in acquisition time, historical

costs recorded of these assets differ greatly. This results in significant difference in

the value of assets and depreciation expense in the financial statements. Ultimately

comparison of such organizations in same sector becomes less valid and reliable.


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The provision of sinking fund or reserve fund is also an important issue in the study.

Although all the firms interviewed do not keep such provision, many of them felt the

need of having a sinking fund. For example, the need for sinking fund becomes

necessary when BSL (Owner company of Dhaka Sheraton Hotel) faced the upcoming

renovation problem. Agreement between BSL and Sheraton will soon expire and BSL

premises need massive renovation before it can actually give contract to or invite

other hotel managerial teams. This involves huge cost and lump-sum fund to finance

it.


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5.0 CONCLUDING REMARKS

USE OF REDUCING BALANCE METHOD

Instead of using Straight Line depreciation method for depreciating all assets, companies

should write off technological assets values using Reducing Balance method. One benefit

relates to offsetting future expenses in the upkeep of such assets. Often this approach is more

beneficial when the annual benefit from the assets use decreases with age and assets cost of

repair and maintenance increases. By offsetting the increased repair and maintenance costs, the

accelerated method equalizes the combined charges of both repairs and depreciation.

PROVISON OF SINKING FUND

Unpredictably undesirable circumstances always work as potential threats to organizations.

Hence it is wise to take proactive measures to overcome them. Provision of sinking fund could

be such a step in situations when (a) unexpected drastic physical/functional deterioration of

equipments occur or (b) assets get stolen, before these are being fully depreciated. In such cases,

the funds available in sinking fund will at least help organizations to expedite their attempt to

replace the old equipments/assets without causing much disruption in the organizations

operational function. Moreover, this reserve can always be maintained to replace fully

depreciated and disposed off assets.


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CONSISTENCY AND COMPARABILITY PRINCIPLES

All the firms with similar businesses and operations (e.g. mobile operating firms like

Banglalink and GrameenPhone) have fair knowledge about depreciation methods used by them

and they also apply similar depreciation method. This practice complies with consistency and

comparability principles, and allows reliable comparison of financial statements of these similar

firms.


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Bibliography

Books:

Hermanson, Roger H., Edwards, James Don and Salmanson, 1987. R.F.Accounting Principles,

Business Publications Inc.

Reports:

The impact of depreciation- A Hedonice analysis of offices in the city of Kuala lampur

Aminah Md Yusof

Assessing Depreciation for Valuation PurposesA Decompositional Approach

Frank Gyamfi-Yeboah and Jonathan Ayitey, Ghana

Depreciation Methods of the Listed Companies in Bangladesh

Prof. Dr. Syed Mohammad Ather, FCMA

Farid Ahammad Sobhani, Abdul Hamid Chowdhury

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http://office.microsoft.com/en-us/excel/HA012264421033.aspx

http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page49.htm

http://www.thefreelibrary.com/Depreciation+method+changes+allowed+without+IRS+consent.-

a078405517

http://www.gwf.org.bd/JIDS/JIDSV2I3Nov2008/48-54.pdf

http://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&res

num=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+dep

reciation+method&spell=1&fp=befd3a870de5664a

http://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq

=f&aqi=&oq=&cad=h

http://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdf

http://www.oecd.org/dataoecd/56/53/2662373.pdf

http://www.aasb.com.au/admin/file/content102/c3/AASB1021_8-97.pdf

http://www.aasb.gov.au/admin/file/content105/c9/INT1030_09-04.pdf

http://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdf
http://office.microsoft.com/en-us/excel/HA012264421033.aspxhttp://office.microsoft.com/en-us/excel/HA012264421033.aspxhttp://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page49.htmhttp://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page49.htmhttp://www.gwf.org.bd/JIDS/JIDSV2I3Nov2008/48-54.pdfhttp://www.gwf.org.bd/JIDS/JIDSV2I3Nov2008/48-54.pdfhttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq=f&aqi=&oq=&cad=hhttp://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq=f&aqi=&oq=&cad=hhttp://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq=f&aqi=&oq=&cad=hhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.oecd.org/dataoecd/56/53/2662373.pdfhttp://www.oecd.org/dataoecd/56/53/2662373.pdfhttp://www.aasb.com.au/admin/file/content102/c3/AASB1021_8-97.pdfhttp://www.aasb.com.au/admin/file/content102/c3/AASB1021_8-97.pdfhttp://www.aasb.gov.au/admin/file/content105/c9/INT1030_09-04.pdfhttp://www.aasb.gov.au/admin/file/content105/c9/INT1030_09-04.pdfhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.aasb.gov.au/admin/file/content105/c9/INT1030_09-04.pdfhttp://www.aasb.com.au/admin/file/content102/c3/AASB1021_8-97.pdfhttp://www.oecd.org/dataoecd/56/53/2662373.pdfhttp://www.pwc.com/en_CO/co/ifrs/assets/impact-ifrs-telecommunications-sector.pdfhttp://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq=f&aqi=&oq=&cad=hhttp://www.google.com.bd/search?hl=en&safe=off&q=+depreciation+methods+in+service+sector&aq=f&aqi=&oq=&cad=hhttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.google.com.bd/#hl=en&safe=off&ei=9JgWS4rwF5zInAP539iHBw&sa=X&oi=spell&resnum=0&ct=result&cd=1&ved=0CAYQBSgA&q=what+a+company+needs+to+do+to+switch+to+depreciation+method&spell=1&fp=befd3a870de5664ahttp://www.gwf.org.bd/JIDS/JIDSV2I3Nov2008/48-54.pdfhttp://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page49.htmhttp://office.microsoft.com/en-us/excel/HA012264421033.aspx


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Appendix

Questionnaire

[Dear respondent, we are conducting interviews for our report on Depreciation practices by

service-oriented firms in Bangladesh It is assuredthat the objective of the report is purely

academic and will be used for classroom purposes only]

Name:

Name of organization: ..

Position in the Company: .

Contact Information:

1. What depreciation methods are currently used in your organization?

2. In your opinion what are the advantages of using the current depreciation methods?

3. Does your company charges depreciation on fair market value or on historical cost of

assets?

4. Does your company revalue assets after the end of each accounting period and recognize

both gain/loss on revaluation or does it revalue assets only when a permanent

impairment/fall of market value of assets occurs?

5. Do you believe an alternative depreciation method would be more beneficial for your

organization? If so, why?


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6. What types of fixed assets does the organization have?

7. What types of fixed asset are being depreciated in your organization?

8. How much are you involved in deciding depreciation to be used in the organization and

the calculation of depreciation?

9. Were there other methods practiced before the current depreciation policy for any of the

fixed asset?

10.If there were, what are they and why they have been replaced by the current method or

methods?

11.Is there any reserve fund allocated for depreciation. If there isnt, why not?

12.What are the opinions of the stakeholders regarding the current depreciation methods?

13.What are the governments regulations regarding depreciation methods?

14.What are the effects of taxation policies on depreciation?

15.Do you have any suggestion regarding the practiced depreciation methods?

Documents

Depreciation Term