Question

1.)Discuss the meaning of depreciation and describe how it is treated on the balance sheet and income statement. Discuss how it impacts the repayment capacity for a firm.

2.)Why do accountants usually value assets at cost and not market value?

3)Why is it important for the gross margin to exceed the operating expenses and interest expense?

Answer 1

As per policy, only one question of its four parts are allowed to answer at a time, so answering question 1 here:

1) Depreciation means the process of absorbing the costs of the assets over its useful life by charging the same as Depreciation expense on the Income statement.

The depreciation has to be reported as “Depreciation Expense” on the Income statement which is calculated as per use of assets in a particular period or on straight line method over the useful life of the asset.

The same depreciation entry which is posted on the Income statement is accumulated from acquisition date of asset to the Balance Sheet date is posted as “Accumulated Depreciation” on Balance Sheet to report the present book value of the asset ie. Acquisition Cost of Asset – Accumulated Depreciation.

It will increase the repayment capacity for a firm by increasing the cash flow through taking the depreciation (a non-cash item) as expense and paying less tax on the lower “income before tax”. To calculate the cash inflow we will add the Non-cash items like depreciation expense to the Net Income.

Higher the depreciation expense, lower would be the “Income before tax” and less tax is paid resulting in higher cash inflow. Thus, higher depreciation expense, more would be the capacity of the firm to repay.