It has two major interpretations. The first one is from an economics perspective and is related to a drop in the value of assets or currency under unfavorable market conditions and in relation to foreign assets held by local entities or foreign currency correspondingly. For instance, depreciation will be present when the local currency has less purchasing power in other countries. This was observed during the Russian ruble crisis of 1998 although the Russian Central Bank tried to control the exchange rate. The second interpretation is from an accounting perspective and takes into account the fact that an asset may need to be replaced at the end of its useful life therefore the asset will suffer a reduction in its value over time because of wear and tear, or obsolescence. Therefore, it is a non-cash accounting expense and not a real expense that will require cash disbursements from the asset holder. This accounting expense will be allocated over the useful life of the asset under one of the depreciation methods allowed by local tax regulations. Given the fact that this is an accounting expense, and then it will reduce earning at the end of the accounting period. For instance: a company acquired a machine for $20,000 and it will depreciate the machine using the straight line method. The machine is expected to be obsolete after ten years and the estimated salvage value is $1,000. Therefore, the annual depreciation expense will be calculated as follows: (20000-1000)/10=$1,900. $1,900 is an annual non-cash charge. There is also a possibility that the actual salvage value after ten years may be $100 instead of the original estimated value of $1,000. If this is the case, then the company will need to report a loss of $900. The Internal Revenue Service (IRS) is the U.S. federal government agency in charge of the revenue code and in charge of collecting taxes. The IRS defines depreciation as an income tax deduction in the form of an annual allowance. Under IRS regulations, most tangible and intangible assets are depreciable, such as buildings, machines, equipment, software, and patents among others. IRS regulations do not allow land to be depreciated. There are different methods of depreciation, but among the main ones we find the Straight-line method, Declining balance method, Units-of-production depreciation method, Sum-of-years-digits method, and the Accelerated Cost Recovery System. The IRS uses The Modified Accelerated Cost Recovery System (MACRS) to encourage companies to engage in capital investment more often. Under MACRS, depreciation is calculated using one of the following methods: declining balance method or straight line method. Depreciation is reported under Form 4562 of the IRS. For instance, if a company buys a machine for $100,000 and expects a useful life of 10 years, then the machine will be depreciated over a period of 10 years. If the straight line method is used to depreciate the machine, then every year, the company will report an expense equivalent to $100,000/10 = $10,000 per year.
Published in Chapter:
Accounting Standards in the U.S. Banking Industry during the Financial Crisis
Copyright: © 2016
|Pages: 14
DOI: 10.4018/978-1-4666-9484-2.ch007
Abstract
The global financial crisis became evident when U.S. house prices fell related to the subprime mortgage-backed securities crisis. In the years preceding the financial crisis of 2008, there was a real estate bubble that pushed U.S. real estate prices to high levels, and at the same time financial institutions were holding large amounts of subprime mortgage-backed securities. Fair value accounting (FVA) and its link to the recent global financial crisis has been a focus of discussion and interest for accounting researchers, financial analyst and policy makers. During the financial crisis, a large percentage of assets in the balance sheets of banks were calculated using fair value. The main concern was that those assets were calculated using mark-to-model accounting (Goh, Ng, & Yong 2009). There are still contradictory conclusions on the implications of fair value accounting and the global financial crisis (Laux & Leuz, 2009). The main objective of this chapter is to provide a better understanding of the global financial crisis and of the mechanisms of fair value accounting.