Question

The board of directors of Gold Structures Inc. is reviewing the 2016 annual report. A new board member – a wealthy woman with little business experience – questions the company’s accountant about the depreciation amounts. The new board member wonders why depreciation expense has decreased from R220 000 in 2014 to R204 000 in 2015 and R196 000 in 2016. She states that she could understand the decreasing annual amounts if the company had been disposing of properties each year, but that did not occur. Further, she notes that growth in the city is increasing the values of company properties.
Required:
Prepare a response to the new board member’s concerns. Also indicate why the company is recording depreciation when the property values are increasing?

Answer 1

These might be some of the probable reasons for the reducing depreciation:

1. The properties are recorded at purchase price in the books. And therefore there is no effect in the books with the increasing property value in the market.

2. The method of depreciation policy followed by the company is written down value method. As per this method, depreciation is charged on the written down value of the asset instead of the gross book values. Therefore even though there is no sale of properties, the depreciation amount is decreasing in the annual accounts.   

Even though the properties value is increasing in the market, the accounting norms is to charge depreciation as per specified rates. Additionally, it might be expected that properties value decrease and therefore the company might not be doing a fair valuation of the properties.