Question

The following is an example in which the proposed method is applied to a fixed asset with an original cost of $248,000, an estimated useful life of 5 years, and a salvage value of approximately $8,000. Year Years of Life Used Fraction Rate Depreciation Expense Accumulated Depreciation at End of Year Book at End of Year 1 1 1/15 $16,000 $16,000 $232,000 2 2 2/15 $32,000 $48,000 $200,000 3 3 3/15 $48,000 $96,000 $152,000 4 4 4/15 $64,000 $160,000 $88,000 5 5 5/15 $80,000 $240,000 $8,000 The president favors the new method because he has heard the following. It will increase the funds recovered during the years near the end of the assets’ useful lives when maintenance and replacement disbursements are high. It will result in increased write-offs in later years and thereby will reduce taxes. Instructions What is the purpose of accounting for depreciation? Is the president’s proposal within the scope of generally accepted accounting principles? In making your decision, discuss the circumstances, if any, under which use of the method would be reasonable and those, if any, under which it would not be reasonable. The president wants your advice on the following issues. (1) Do depreciation charges recover or create funds? Explain. (2) Assume that the Internal Revenue Service accepts the proposed depreciation method in this case. If the proposed method were used for stockholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?

Answer 1

The purpose of accounting for depreciation is to allocate the cost of a tangible or physical asset over its useful life.

What is depreciation?

It should be noted that depreciation simply means the wear and tear of a product based in usage. Depreciation shows how much of an asset has been used.

The scope of generally accepted accounting principles aims to improve the clarity and consistency if the communication of financial information. The five principles include:

Revenue recognition.

Cost principle.

Matching principle.

Objectivity principle.

Full disclosure.

The president’s proposal is within the scope of generally accepted accounting principles. It should be noted that depreciation doesn't guarantee funds.

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