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Dear Tutor!
I am going through the Kaplan study text. It says that one of the disadvantages of ROCE is that it varies depending on accounting policies. I do understand it broadly that if company A uses SLM to value its assets and company B uses RBM to value its assets, then company B will show lower depreciation in the last years of use of asset and hence higher profit, so ROCE will be a bit higher for company B. (assuming that companies A and B have comparable figures for revenue, income, expenses e.t.c).
Have I got this right and can you please clarify this with some other examples?
Yes the relative age of assets (and therefore the amount of accumulated depreciation reducing net book value)
Straight line method
The rate of depreciation and the amount remain constant.
The value of an asset at the end of its life is zero.
As the asset ages, the cost of its repair goes up. The depreciation amount remains unchanged. This diminishes annual profit.Reducing balance method
The rate of depreciation remains unchanged, but the amount gradually decreases.
The value of an asset at the end of its life is never zero.
As the asset ages, the cost of its repair goes up, but so does the depreciation amount. They balance each other out, so there is little or no effect on annual profit/loss.
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