i understand that straigh line method reduces the volatility of earning compared to accelerated methods. now since units of production makes depreciation expense a variablwe rather than a fixed cost, this decreases the volatility of reported earnings as compared to straight line or accelerated method? how is this so?
It would act as a natural hedge. E.g. if revenue spikes up, more units are produced, depreciation expense spikes up, so the net effect is less than if the expense were constant.
I think this is an easy point to misinterpret. Not sure if you have gotten into corporate finance or not, but this will be addressed when looking at degree of operating leverage. Operations with higher fixed costs have more volatile earnings. By making depreciation a variable cost, you are decreasing volatility. Accelerated depreciation is a fixed cost while units of production is a variable cost (expense is contingent upon level of output.) Straight line and accelerated method both result in a fixed cost. Your depreication expense is predetermined. Anyone care to improve?
now i am getting a better picture of this… thanks