The cost of an entity's assets three years ago was £24,000. Depreciation was charged at the rate of 10% per annum using the straight line method. The firm decided to change its method to reducing balance at 10% per annum with retrospective effect. The total difference in the profits over the three years would be:

Question

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Under the straight-line method, the annual depreciation would be £2,400 (£24,000 * 10%). Over three years, this totals £7,200. With the reducing balance method, the depreciation for the first year is also £2,400, but for the second year, it's £2,160 (£24,000 - £2,400 = £21,600; £21,600 * 10%), and for the third year, it's £1,944 (£21,600 - £2,160 = £19,440; £19,440 * 10%). The total depreciation over three years with the reducing balance method is £6,504 (£2,400 + £2,160 + £1,944). The difference in depreciation, and thus the difference in profits, is £696 (£7,200 - £6,504).

The Cost of an Entity's Assets Three Years Ago Was