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Dear tutor,
Can you please give an example of when we would need to do Annuity Depreciation?
I understand the concept but as we arrive at a Fixed RI, why are we doing this?
For the purpose of Management performance we look at the RI bottom line. Why do we need to split the interest and depreciation?
Thank you in Advance
Using ordinary depreciation ROI and RI increase as the asset gets older (eg NBV decreases and if using reducing balance depreciation, net income increases). This can distort the apparent performance of the asset and its manager as performance seems to be improving even though everything is really the same.
Annuity depreciation is a way of evening out this distortion so that a constant RI and ROI is obtained.
I have never been a big fan and think it’s a bit of a mathematical trick. My advice is not to worry about it too much. It is not specifically mentioned in the syllabus so you shouldn’t be required to do it, but you could mention it when if talking about the care needed with ordinary RI and ROI calculations.
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