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DEPRECIATION
ACCOUNTING PRACTICES AND PROFITABILITY OF SELECTED SMES
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Measuring
the SME’s profitability is a central task both in accounting practice and
theory (Benjamine, 2002). The management of SMEs need the profitability
information for their decision making both in the short and in the long run and
therefore must take steps to ensure the profitability of the organization
(Goldberg, 2009).
However,
using one or another depreciation accounting method, an additional deduction of
the income tax is possible, thus increasing the net profit available for the
SME for the organization development. In depreciation accounting practices, the
methods used includes linear depreciation, degressive depreciation and
accelerated depreciation.The bigger the expense input with the depreciation,
the bigger the net profit - situation found when a faster accounting
depreciation policy is used (Wood, 2007). In other words, the effect of the
depreciation accounting practices appears in choosing one of the depreciation
methods used. In accountancy, depreciation practices refers to two aspects of
the same concept: The decrease in value of assets (fair value depreciation) and
the allocation of the cost of assets to periods in which the assets are used
(depreciation with the matching principle).
A method of
reallocating the cost of a tangible asset over its useful life span of it being
in motion. Businesses depreciate long-term assets for both tax and accounting
purposes. The former affects the balance sheet of a business or entity, and the
latter affects the net income that they report. Generally the cost is
allocated, as depreciation expense, among the periods in which the asset is
expected to be used. This expense is recognized by businesses for financial
reporting and tax purposes. Methods of computing depreciation, and the periods
over which assets are depreciated, may vary between asset types within the same
business and may vary for tax purposes (Akanni, 2008). These may be specified
by law or accounting standards, which may vary by country. There are several
standard methods of computing depreciation expense, including fixed percentage,
straight line, and declining balance methods. Depreciation expense generally
begins when the asset is placed in service. For example, a depreciation expense
of 100 per year for five years may be recognized for an asset costing 500.
In
determining the profits (net income) from an activity of the SMEs, the receipts
from the activity must be reduced by appropriate costs. One such cost is the
cost of assets used but not immediately consumed in the activity. Such cost so
allocated in a given period is equal to the reduction in the value placed on
the asset, which is initially equal to the amount paid for the asset and
subsequently may or may not be related to the amount expected to be received
upon its disposal. Depreciation is any method of allocating such net cost to
those periods in which the organization is expected to benefit from use of the
asset. The asset is referred to as a depreciable asset. Depreciation is
technically a method of allocation, not valuation, even though it determines
the value placed on the asset in the balance sheet (Samuelson, 2001).
Any business
or income producing activity using tangible assets may incur costs related to
those assets. If an asset is expected to produce a benefit in future periods,
some of these costs must be deferred rather than treated as a current expense.
The business then records depreciation expense in its financial reporting as
the current period's allocation of such costs. This is usually done in a
rational and systematic manner. Generally this involves four criteria which
includes cost of the asset, expected salvage value also known as residual value
of the assets,estimated useful life of the asset, anda method of apportioning the
cost over such life
According to
Dobrota (2003), accounting depreciation acts on the organization profitability
within the meaning of the operating profit/loss and implicitly of the net
earnings value and the fiscal depreciation causes the reduction of the income
tax to be paid. The only one which influences the self-funding capacity is the
fiscal depreciation, as it leads to the reduction of the income tax to be paid.
The accounting depreciation does not influence the self-funding capacity, which
may be seen in the formulas that underlie the self-funding capacity of an
organization. Therefore in the deductive method the depreciation is not taken
into account (the income tax that is influenced by the fiscal depreciation is
taken into account) and in the additional method, even if the accounting
depreciation is added to the net earnings, it was initially deducted from the
gross operating surplus and therefore, the net earnings were reduced with its
value.
Statement of
problem
Depreciation
and profitability has a complex, intricate and confusing relationship in the
field of accounting. As a result, depreciation accounting practices has been
over used, over stressed, and over worked by the accountants and professional
valuers. International Accounting Standard (IAS), qualifies assets for
depreciation when assets are used for more than one accounting period, i.e.
assets held by an enterprise for production or service, and has economic useful
life. Whereas, under Standard Statement of Accounting Practice (SSAP),
depreciation is viewed as wearing out, consumption or other loss of value of
fixed asset, whether arising from use, affluxion of time or obsolescence
through technology and market changes. Complexity may arise when it is viewed
as a fall in price, physical deterioration, allocation of cost, fall in value,
valuation technique and asset replacement. Intricate
and
confusion are inevitable when accountants employ various methods of providing
for depreciation accounting practices on the same or similar assets of
different life span. The consequential effect is either to undermine or
overstate the reported profit or distributable profit in the hands of the
stakeholders, hence the absurdity of the financial reports. Based on these
imminent issues, this study is examining the relationship between depreciation
accounting practices and profitability of some selected SMEs in Port Harcourt.
Purpose of
the Study
The Purpose
of this study is to assess the relationship betweenDepreciation accounting
practices and profitability of selected SMEsin Port Harcourt: The following are
the purpose/objectives of this study:
To identify
the fixed installment methodand their influence on the profitability of small
and medium scale enterprise.
To
analyzedigit method of depreciation and its impact on the profitability of a
small and medium scale enterprise.
To examine
whether diminishing balance method of depreciation a good depreciation method
for small and medium scale enterprise.
4. To examine whether annuity method of
depreciation increase or decrease the profitability of small and medium scale
enterprise.
Research
Question
What are the
different methods of depreciation and what influence do they have in the
profitability of small and medium scale enterprise.
How does sum
of the digit method of depreciation impact on the profitability of a small and
medium scale enterprise?
Is
diminishing balance method of depreciation a good depreciation method for small
and medium scale enterprise?
Can annuity
method of depreciation increase or decrease the profitability of small and
medium scale enterprise?
1.5 Research hypotheses
HO: There is
no significant relationship between the digit method of depreciation impact on
the profitability of a small and medium scale enterprise.
HA: There is
significant relationship between digit method of depreciation impact on the
profitability of a small and medium scale enterprise.
Significance
of the study
Depreciation
Accounting Practices and Profitability of selected Small and medium Enterprises
development has been an area of intense research both in practice and academia.
This empirical investigation of SMEs is therefore a significant contribution to
existing literature. Furthermore, the study would provides evidence on the extent to which
Rivers state Small and Medium Enterprise are accounting accommodating in
readiness for gaining strategic competitive advantages in their businesses.
The study
would also provide uniqueness of small and medium scale businesses call for
careful consideration in the design of accounting systems. Small and medium
scale enterprises are a vast majority of businesses found in variety of primary
and intermediate production of the economy.
The outcome
of this study will be useful for business managers and stakeholders in
accounting sector on ways by which various depreciation accounting practices
can influence the profitability of a small and medium scale business.This
research will be a contribution to the body of literature in the area of the
effect of personality trait on student’s academic performance, thereby
constituting the empirical literature for future research in the subject area.
1.7 Scope of the study
This study
will cover some selected Small and medium scale enterprises in Port Harcourt.
This study will also cover the depreciation accounting practices in the various
selected business organizations with a view to determining their effects on the
profitability of the firm.
1.8 Limitation of study
Financial
constraint- Insufficient fund tends to impede the efficiency of the researcher
in sourcing for the relevant materials, literature or information and in the
process of data collection (internet, questionnaire and interview).
Time
constraint- The researcher will simultaneously engage in this study with other
academic work. This consequently will cut down on the time devoted for the
research work.
1.9 Definition of terms
Depreciation:
a reduction in the value of an asset with the passage of time, due in
particular to wear and tear.
Profitability:
is the ability of a business to earn a profit. A profit is what is left of the
revenue a business generates after it pays all expenses directly related to the
generation of the revenue, such as producing a product, and other expenses
related to the conduct of the business activities.
Tax: a
compulsory contribution to state revenue, levied by the government on workers'
income and business profits or added to the cost of some goods, services, and
transactions.
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