The Straight-Line Depreciation is Wanted, Dead or Alive
26 Pages Posted: 28 Feb 2006 Last revised: 15 Jan 2008
Date Written: June 2007
We propose a simple axiomatic system that any depreciation and amortization method - complying with the recent developments in the guidelines set by GAAP and IASB - must obey. The system is consistent with both the matching and the impairment principles. We show that none of the prevalent depreciation methods (e.g., straight-line) altogether ex ante conforms to these principles. We then examine the accredited proportional depreciation method and show that it both maintains the axiomatic system and constitutes an extension to the economic depreciation method for positive net present value investments. Moreover, following Moulin (1988), we show that, for a plausible family of depreciation methods, the proportional method is the unique method that complies with the axiomatic system. Finally, we propose two consistency requirements of a depreciation method - dynamic consistency and partition consistency - and show that, in contrast to the commonly used methods, the proportional depreciation method is the only one to always sustain both. Depreciation and amortization in this study apply to all types of assets (tangible and intangible); however, they are particularly significant for costly investments such as real estate, machinery, and costumer relationship.
JEL Classification: M41, M44, M46
Suggested Citation: Suggested Citation