Definition of Systematic and Rational Allocation
Systematic and rational allocation is typically included in the definition of depreciation. In this context, it means that a company’s annual depreciation expense reported on its financial statements should be based on a formula that is:
- Logical
- Consistently applied
- Objective and acceptable to another unbiased accountant
The depreciation expense reported on a company’s financial statements is usually different from the depreciation expense reported on the company’s income tax return.
Example of Systematic and Rational Allocation
Assume that a retailer purchases new fixtures which are expected to have a useful life of 10 years with no salvage value. Therefore, if the retailer pays $120,000 for new fixtures, its income statements will report depreciation expense of $12,000 each year ($1,000 each month) for 10 years.
Assume that another company purchases equipment for $20,000 that will be useful for producing a total of 20,000 items. If in the first year of operations the company produces 1,800 items, the depreciation expense will be $1,800. If in the second year the company produces 3,700 units, the depreciation expense will be $3,700.
Both of these depreciation calculations are logical, consistently applied, and objective.
