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

Ans :-

Prepare a letter to Mr. Hopkins :-

To

Mr. Hopkins ,

president ,

Bicycle Company .

Subject : Sending elucidation about disintegration as for.

Dear Hopkins,

Sir, you inspected the vulnerability about disintegration which you have in the Luncheon.To clear you doubt,I should need to illuminate the accounting thought of depreciation.

According to American Institute of ensured open Accounting "Disintegration accounting is a course of action of accounting which expects to scatter the cost or other major estimation of obvious capital assets, less safeguard an impetus over the assessed accommodating presence of the unit in an exact and rational manner.It is a strategy of assignment, not of valuation, debasement for the year is section of the total change under such a system, to the point that is administered to the year.

Assignment of downgrading is should in light of the way that the aggregate put on settled assets used in business is a cost to be used recovered from the business over the important presence of the assets.Depreciation suggests the cost of the fixed assets used in the period.This must be treated as cost or costs side of pay clarification .

Second reason is that , cheapening of settled assets used in an expenses of working together like diverse operational cost, for instance, salaries,rent etc.As distinctive expenses of working together are charged to pay clarification, crumbling on settled assets should be charged to compensation decree.

Third reason, if cheapening isn't charged on settled assets, the estimations of settled assets will be over communicated and the money related record won't reflect the honest to goodness budgetary condition.

Fourth reason , decay is non cash cost. The entirety recorded in pay clarification is held in business. No portion is made like diverse costs .This will total year after year.At the period of replacement,funds will be available.Funds made by offer of items are held in the business by charging disintegration .

Fifth reason ,Depreciation is a chargeable expense from wage evaluate motivation behind view.By figuring disintegration as per force law and charging it to wage decree, will result in cost commitment.

Show :-

Accept an advantage is procured for $110,000.It has a normal presence of 10 years and its assessed scarp regard following 10 years is $10,000 ,by then yearly cheapening will be :

Devaluation = [ Amortized cost - leftover esteem ]/Estimated life

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

= 100,000/10

Devaluation = $10,000

In this manner crumbling is $10,000 is represented cash clarification.

Establishments for decay:

1.Wear and tear due to enduring use.

2. Efflux of time.

Some assets have a settled time of genuine life, for instance, lease. patent right etc.on the expiry of the presence the advantages will stop to exist 3.Obsolesce.An old equipment , anyway in incredible condition may wind up outdated due to introduction of new contraption which conveys more than the old equipment.

In perspective of above reasons one association should tail anyone of the downgrading strategies Giving weakening method is must.I figure you should appreciate why one association should give cheapening assets; even it is important to your association too. So please seek after the degrading system and all the accounting norms.

Expressing gratitude toward you.

Your's reliably ,

******** .