No discussion of fixed assets is complete without considering depreciation, its method of calculation and final impact on financial statements. Although somewhat removed from tactical supply chain activities, depreciation does have an effect on the income statement, balance sheet and cash flow statement, a reality that requires analysis of all depreciable items.Because depreciation is shown as an expense on the income statement, its relationship to net income is palpable. It is for this reason that some companies will slow down the depreciation of assets to boost bottom line figures. This practice always comes back to haunt an organization, however, as a lethargic depreciation policy inevitably creates overvalued assets on the balance sheet. As was the case with obsolete inventories and bad debt, the day of reckoning comes when these values must be written off to the income statement in their entirety. Apart from postponing the inevitable write-offs, inflated values of fixed assets also obscure the interpretation of total asset measurements, including total asset turnover and return on assets.The above points should be a cause for concern to NikoTech's management. In the incredibly volatile electronics manufacturing services industry, where product life cycles are measured in months or even weeks, retooling, upgrading and/or replacing production lines is a fairly common occurrence. With a view toward fiscal responsibility, in this environment it would be wise to depreciate assets (at least production equipment) at a fairly aggressive pace, so as to avoid financial pain farther down the road. In addition to avoiding income statement hits in future periods, this policy actually improves asset-related measures due to their lower net values on the balance sheet, a desirable scenario for companies with NikoTech's business model.Historically, NikoTech has employed the straight-line method of depreciation and shows a consistent figure from period to period. Because the net increase in fixed assets was only $24 million in Y2, the figure $36 million was used to depreciate that year's assets. Taken as a percentage of total fixed assets, $36 million represents a Y2 depreciation rate of 6.5%. Considering that NikoTech's depreciable assets are a combination of P&E (land is not depreciated), it seems the company has taken a fairly neutral stance on depreciation. It is neither aggressively depreciating nor being overly generous to its income statement. Based on the fact that NikoTech is in an ever-changing industry, management may consider a more aggressive policy on depreciation of fixed assets.
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