Business – 10.1 Financial statements – Depreciation | e-Consult

Straight‑line spreads the cost evenly, resulting in a constant depreciation charge each year. This produces a stable profit trend and a gradual reduction in the asset’s net book value, which can make the balance sheet appear less volatile.

Reducing balance applies a fixed percentage to the diminishing book value, leading to higher charges in early years and lower charges later. Early‑year profits are reduced more sharply, potentially lowering tax liabilities initially, while the asset’s net book value declines rapidly, giving a more conservative view of remaining asset value.

Units of production bases depreciation on actual usage or output. The expense fluctuates with production levels, aligning cost with revenue generation. In periods of high output, profit is lower, and the asset’s carrying amount falls faster; in low‑output periods, profit appears higher and the asset retains more of its book value.

Overall, the method chosen affects:

• Profitability ratios (e.g., gross profit margin, return on assets)
• Asset turnover and return on capital employed
• Perceived financial stability, as rapid depreciation can suggest aggressive asset write‑downs.

Stakeholders must understand the method used to interpret performance trends and the true economic condition of the business.