y attracting investors.
2. Straight-line calculation of depreciation is based on assessing equal depreciation to equipment over its lifetime. Double-declining-balance depreciation deducts higher amounts for depreciation in the first few years of the life of a piece of equipment, reasoning that this is when most of the depreciation occurs, and it tails off in later years. Double-declining balance depreciation can also add a considerable amount to the company's net income in the early years. This is important to company managers who get bonuses tied to the net income of the company.
The item in question here is a piece of high-tech equipment which will be obsolete in the near future due to rapidly changing technology. This means the equipment will suffer the most depreciation in the early years, and it would therefore be beneficial to the company to take the depreciation in the early years because the equipment will no doubt have to be replaced in a few years, before the full value of the depreciation can be realized by using straight-line depreciation.
As the auditor, I would ask the management to continue to use the double-declining-balance depreciation method so that the value of the depreciation recovered can be realized before the equipment becomes obsolete. If they switch to the straight-line depreciation method, the machine will be obsolete before they have recovered the full value by depreciation. High-tech equipment should always be subject to double-declining-balance depreciation because of its high risk of obsolescence in a short period of time. Using the straight-line depreciation also increases pretax income.
In the given example, in 2002 the piece of equipment cost $320,000 and has a predicted 8-year lifespan. Using straight-line depreciation in 2005 would reduce the depreciation by $80,000 and increase pretax income by $56,000 (CompUSA is subject to a 30% income tax). Using the double-declining...