Inventory turnover

In accounting, the Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. The equation for inventory turnover equals the Cost of goods sold divided by the average inventory. Inventory turnover is also known as inventory turns, stockturn, stock turns, turns, and stock turnover.]

The formula for inventory turnover:

or

45. Describe the following methods of depreciation: straight line, declining balance

Straight-line depreciation

Straight-line depreciation is the simplest and most often used method. In this method, the company estimates the salvage value (scrap value) of the asset at the end of the period during which it will be used to generate revenues (useful life). (The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage value is also known as scrap value or residual value.) The company will then charge the same amount to depreciation each year over that period, until the value shown for the asset has reduced from the original cost to the salvage value.

Straight-line method:

For example, a vehicle that depreciates over 5 years is purchased at a cost of $17,000, and will have a salvage value of $2000. Then this vehicle will depreciate at $3,000 per year, i.e. (17-2)/5 = 3. This table illustrates the straight-line method of depreciation. Book value at the beginning of the first year of depreciation is the original cost of the asset. At any time book value equals original cost minus accumulated depreciation.

book value = original cost − accumulated depreciation Book value at the end of year becomes book value at the beginning of next year. The asset is depreciated until the book value equals scrap value.

Depreciation expense	Accumulated depreciation at year-end	Book value at year-end
		(original cost) $17,000
$3,000	$3,000	$14,000
3,000	6,000	11,000
3,000	9,000	8,000
3,000	12,000	5,000
3,000	15,000	(scrap value) 2,000

If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess would be considered a gain and subject to depreciation recapture. In addition, this gain above the depreciated value would be recognized as ordinary income by the tax office. If the sales price is ever less than the book value, the resulting capital loss is tax deductible. If the sale price were ever more than the original book value, then the gain above the original book value is recognized as a capital gain.

If a company chooses to depreciate an asset at a different rate from that used by the tax office then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit.

Declining Balance Method

Suppose a business has an asset with $1,000 original cost, $100 salvage value, and 5 years of useful life. First, the straight-line depreciation rate would be 1/5, i.e. 20% per year. Under the double-declining-balance method, double that rate, i.e. 40% depreciation rate would be used. The table below illustrates this:

Depreciation rate	Depreciation expense	Accumulated depreciation	Book value at end of year
			original cost $1,000.00
40%	400.00	400.00	600.00
40%	240.00	640.00	360.00
40%	144.00	784.00	216.00
40%	86.40	870.40	129.60
129.60 - 100.00	29.60	900.00	scrap value 100.00

When using the double-declining-balance method, the salvage value is not considered in determining the annual depreciation, but the book value of the asset being depreciated is never brought below its salvage value, regardless of the method used. Depreciation ceases when either the salvage value or the end of the asset's useful life is reached.

Since double-declining-balance depreciation does not always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life.

With the declining balance method, one can find the depreciation rate that would allow exactly for full depreciation by the end of the period, using the formula:

,

where N is the estimated life of the asset (for example, in years).