Cash-Flow Patterns and the Choices of a Depreciation Method
Volume: Volume 3, No. 1
Issue: Spring 1972
Pages: pp. 316-334
Authors: Alan Kraus, Ronald J. Huefner
Title: Cash-Flow Patterns and the Choices of a Depreciation Method
Abstract: The determination of annual depreciation charges is important in several management contexts. A major context is the determination of book value and net income (and the associated rate of return on investment). This is important for all firms, but especially for those in regulated industries due to the role of income in rate setting.
This paper builds upon the notion of change in present value as the ideal definition of annual depreciation. The usual approach is to develop depreciation methods from cash-flow patterns. This paper, however, proceeds in the opposite direction, beginning with depreciation methods and determining the cash-flow patterns for which each method is appropriate. To achieve this, two generalized depreciation patterns are defined (which include the commonly used methods as special cases). The results are developed mathematically and are illustrated numerically. Consideration is also given to problems of application, particularly in analysis of the choice of depreciation pattern when projected cash flows differ from the patterns consistent with the general depreciation method to be used.