Accounting
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Genre: Accounting

3. Different accounting methods for deprecation will lead to different profits. Explain by way of an example how this will effect qualitative characteristics and name one specific characteristic that will be effected.

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Introduction

There are various methods for accounting depreciation like straight line method,declining balance method, activity based depreciation, etc. Different methods will have different depreciation amounts for each year and thus will impact the amount of profit. Let us take an example of a vehicle with a value of $1000 with economic life of 4 years, scrap value of $200 and usage of 800 miles. Let us further assume that the usage of vehicle in the first year is 300 miles. As per straight line method, the depreciation for the first year comes out to be $200, while as per activity based depreciation method, the depreciation comes out to be $300. Using activity based depreciation method will reduce the profit by $100 as compared to using straight line method. The different accounting methods will effect qualitative characteristics of financial reporting because the choice of method will determine the quality of financial reports of the company. The companies many times use this tool for their benefit and compromises on the quality rather than using the correct method. One such characteristic that is affected directly is comparability. If two business entities of similar nature use different methods of depreciation as stated in above example, keeping all otherthings similar, one entity will have higher profits and the other will have lower profits. It will be difficult for the user to compare the financial statements of both the companies.

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