Well it’s audit time at my company and the internal auditors would like a calculation that supports the fact that we are depreciating properly.
The method they have devised is this:
Average Original Depreciable Basis divided by the weighted average original asset life = expected depreciation for the year. They want expected to be within 3% of actual.
Well it turn out that I can only get the numbers to reflect that actuals are 4 to 5% over expected.
Just to make this simple, we basically only have 5 year assets and 3 year assets (I’m leaving out Building/Leashold Assets), but 5 year assets greatly outnumber the 3 leaving a 4.7 average depreciable life. We are constantly buying new equipment at a higher rate.
My argument is that this calculation is totally flawed and the fact that we are greater than 3% over expected doesn’t really tell us anything.
Does anyone concur with my opinion. If so, can you recommend a different calculation that would help out?
Your building’s useful life can most likely be set at a minimum of 10 years. If it’s not already, knock a year off the useful life left that you are using for the building and see if that changes your overage percentage by the 1 percent you need. Otherwise, convince them that you have statistical outliers so the average method won’t work. Thus, they should throw out the high and low life items and then take the average.
Your math looks right. Basically, the firm picks a depreciation method (you chose straight-line, Shade) and develops a depreciation schedule that shows how much the asset depreciates for each year.
From what I can tell from the OP, your internal auditors are expecting you to depreciate the assets at about the same rate each year. Imagine two points on a graph, with the first being purchase price and the second being salvage value. Your auditors want to see them connect in the form of an approximate straight line. If the OP’s company declared that they use the straight-line method and their numbers are off 5%, then something’s wrong. However, if the OP’s company is using the sum-of-the-year’s-digits or double-declining method then you certainly would have a steeper decline at first (toward the salvage value point), then leveling off a bit.
OP: Check what kind of depreciation method you declared that you use. If it’s not straightline depreciation, tell them their calculation is meaningless. You’re using a curve.
Here was part of my message to internal audit. Please let me know if my thinking is flawed. Keep in mind that this is the first year that they have asked for this ever.
I’m to divide the average depreciable asset balance by the average asset life to get my expected depreciation for the year, but I don’t understand how that is possible.
For instance, Let’s say that I have $1 Million in 5 year assets and $300,000 in 3 year assets. This is how I would calculate weighted average:
$1,000,000 x 5 (asset life in years) = 5,000,000 weighted
300,000 x 3 (’’) = $900,000 weighted
$5,900,000/$1,300,000 = 4.53 average asset life
Actual Depreciation for year 1 would be $300,000
Expected Depreciation for year 1 would be $286,975.71
A difference of roughly -4.5%
Now granted that ***** isn’t exactly in year 1, but the amount of our new purchases are growing steady. Can you provide me any further guidance with this? I’m to get the percentage within 3%, but I’m not sure that it is a reasonable goal.
I think you should show your internal auditors two sheets. Separate your 3yr and 5yr assets into separate “classes.” Do the calculations for the 3yr page and you should get the same actual as expected. Then do the same for the 5yr page. Then tell them that using an average for a set of data with basically two points is not smart.