Uncertainty resolution and the theory of depreciation measurement

This paper examines how a firm's depreciation policy influences the relation between the resulting accounting numbers and the market value of the firm's equity.' Traditional financial accounting theory conceptualizes depreciation measurement as a cost allocation procedure that matches an investment's cost with the flow of benefits it produces. As has long been recognized, in a setting with certain future cash flows and zero net present value (NPV) investments, investment costs can be allocated using standard present value techniques to yield, at each date, book values equal to market values, and accounting earnings equal to economic earnings.2 The resulting book value and accounting earnings numbers are such that, for all periods, the book rate of return equals the cost of