Question

At a recent luncheon, you were seated next to Mr. Hopkins, the president of a local company that manufactures bicycle parts. He heard that you were a CPA and made the following comments to you: "Why is it that I am forced to recognize depreciation expense in my company's income statement when I know that I could sell many of my assets for more than I paid for them? I thought that the purpose of the balance sheet was to reflect the value of my business and that the purpose of the income statement was to report the net change in value or wealth of a company. It just doesn't make sense to penalize my profits when there hasn't been any loss in value from using the assets."

At the conclusion of the luncheon, you promised to send him a short explanation of the rationale for current depreciation practices.

Required:

Prepare a letter to Mr. Hopkins. Explain the accounting concept of depreciation and include a brief example in your explanation showing that over the life of the asset the change in value approach to depreciation and the allocation of cost approach that will result in the same total effect on income.

Answer 1

Answer :-

To

Mr. Hopkins

president

Bike Company

Subject : Sending clarification about deterioration with respect to.

Dear Hopkins,

Sir, you examined the uncertainty about deterioration which you have in the Luncheon.To clear you doubt,I might want to clarify the bookkeeping idea of devaluation.

As per American Institute of guaranteed open Accounting "Deterioration bookkeeping is an arrangement of bookkeeping which intends to disperse the expense or other fundamental estimation of unmistakable capital resources, less rescue an incentive over the evaluated helpful existence of the unit in a precise and sane manner.It is a procedure of allotment, not of valuation, devaluation for the year is segment of the aggregate change under such a framework, to the point that is dispensed to the year.

Designation of devaluation is must in light of the fact that the sum put on settled resources utilized in business is an expense to be utilized recuperated from the business over the valuable existence of the assets.Depreciation implies the expense of the repaired resources utilized in the period.This must be treated as expense or costs side of pay explanation .

Second reason is that , devaluation of settled resources utilized in a costs of doing business like different operational expense, for example, salaries,rent etc.As different costs of doing business are charged to pay explanation, deterioration on settled resources ought to be charged to salary proclamation.

Third reason, if devaluation isn't charged on settled resources, the estimations of settled resources will be over expressed and the monetary record won't mirror the genuine budgetary condition.

Fourth reason , deterioration is non money cost. The sum recorded in pay explanation is held in business. No installment is made like different costs .This will aggregate year after year.At the season of replacement,funds will be available.Funds created by offer of products are held in the business by charging deterioration .

Fifth reason ,Depreciation is a chargeable cost from wage assess purpose of view.By figuring deterioration according to impose law and charging it to wage proclamation, will result in expense obligation.

Model :-

Assume a benefit is acquired for $110,000.It has an expected existence of 10 years and its evaluated scarp esteem following 10 years is $10,000 ,at that point yearly devaluation will be :

Depreciation = [ Amortized cost - residual value ] / Estimated life

= [ 110,000 - 10,000 ] /10

= 100,000 / 10

= 10,000

Depreciation = $10,000

Subsequently deterioration is $10,000 is accounted for money explanation.

Foundations for deterioration: 1.Wear and tear because of steady utilize. 2. Efflux of time.Some resources have a settled time of legitimate life, for example, rent. patent right etc.on the expiry of the existence the benefits will stop to exist 3.Obsolesce.An old hardware , however in great condition may end up out of date because of presentation of new apparatus which delivers more than the old hardware.

In view of above reasons one organization should tail anybody of the devaluation techniques Giving deterioration technique is must.I figure you ought to comprehend why one organization ought to give devaluation resources; even it is invaluable to your organization as well. So please pursue the devaluation strategy and all the bookkeeping standards.

Thanking you.   

Your's faithfully ,

******** .