Select one of the following independent cases. Each student should select a diff

Question

Select one of the following independent cases. Each student should select a different case. For the case you select, discuss whether you agree or disagree with the position taken by the company or individual. Use generally accepted accounting principles in defending your position.

Mr. Fogle, the president of a company that manufactures food processors asks:

Why is it that I’m forced to record depreciation expense on my property when I could sell it for more than I originally paid? I thought that the purpose of the balance sheet is to reflect the value of my business and that the purpose of the income statement is to report the net change in value of a company. It doesn’t make any sense to penalize my profits when the building hasn’t lost any value.

Ms. Carter, president of a company that manufactures specialty food items, states:

We shall have no difficulty in paying for our new plant assets needed during the coming year because our estimated outlays for new equipment amount to only $80,000 and we have more than twice that amount in our accumulated depreciation account at present.

The policy of the Liebnitz Co. is to recondition its building and equipment each    year so that they are maintained in perfect repair. Because of the extensive maintenance and repair costs incurred in 2012, the company president believes that depreciation expense should not be recorded for 2012.

Maxie Smith, a student who has had no accounting courses, is looking at the balance sheets of two companies in which he is thinking of investing. He remarks that both companies have the same amount of equipment.

Explanation / Answer

1.Depreciation expense needs to be provided to match the expense with revenue.

At the time of acquiring the poperty, the expense is not reduced from the income in the year the property was purchased.

Since the property will be used for number of years, depreciation will be charged as cost over the useful life .This is as per matching principle of accounting which means all the expenses of the period should be charged to revenue of the period to arrive at the correct amount of profit to be reported

If the depreciation is not charged, the Income Statement will be distorted

At the time of sale, if the property is sold at higher price it will be capital gain in the year of sale. This income cannot be recognized till the actual sales takes place.

.2.Amount in accumulated depreciation account is not a cash balance. For purchasing equipment we need cash. The accumulated depreciation charged may be used up already in property and equipments. In order to find out whether $80,000 will be available, we need to analyse the projected cash flow and determine whether cash will be available when required for investment

.3.Maintenance and repair costs are not same as depreciation expense.

Depreciation is deferred expenses to match with the use of equipment. If depreciation expenses are not charged, the Income Statement will be distorted.

Repair &maintenance cost Is annual revenue expense, in addition to depreciation.

.4.For the purpose of analysing companies for investment, we need to look at shareholders wealth and generation of wealth. Two companies may have same amount of equipment, but efficiency and effectiveness of equipment utilization may vary, resulting in different amount of wealth generation for the shareholders. one should look at return on assets instead of amount of assets in dollars.

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