What is the meaning of systematic and rational allocation?

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.

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