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.
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 will result in the same total effect on income.