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Chapter 11: Q11-5CA (page 597)

(Depreciation Choice鈥擡thics) Jerry Prior, Beeler Corporation鈥檚 controller, is concerned that net income may be lower this year. He is afraid upper-level management might recommend cost reductions by laying off accounting staff, including him.

Prior knows that depreciation is a major expense for Beeler. The company currently uses the double-declining-balance method for both financial reporting and tax purposes, and he鈥檚 thinking of selling equipment that, given its age, is primarily used when there are periodic spikes in demand. The equipment has a carrying value of \(2,000,000 and a fair value of \)2,180,000. The gain on the sale would be reported in the income statement. He doesn鈥檛 want to highlight this method of increasing income. He thinks, 鈥淲hy don鈥檛 I increase the estimated useful lives and the salvage values? That will decrease depreciation expense and require less extensive disclosure, since the changes are accounted for prospectively. I may be able to save my job and those of my staff.鈥�

Instructions

Answer the following questions.

  1. Who are the stakeholders in this situation?
  2. What are the ethical issues involved?
  3. What should Prior do?

Short Answer

Expert verified

Answer

  1. The taxation agency and the accounting team member are some of the stakeholders in this situation.
  2. Ethical values are being used to improve the current year's profits.
  3. Prior can predict depreciation costs and the possibility of prolonging an asset's useable life based on available data.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Depreciation

Depreciation is an accounting term used to indicate the expense in the books of accounts for the assets whose value declines over time. It is computed at the end of the year or whenever an asset is sold.

02

(a) Explaining the stakeholders in the given situation

The parties involved in this lawsuit are Jerry Prior, other accounting team personnel, Beeler Corporation, and the taxation agency.

Jerry Prior is responsible for reducing depreciation expenses and generating net profitability. Any changes in the two criteria mentioned above would have a big influence on him.

Beeler Corporation has a negative impact on depreciation costs and accumulated non-cash revenue.

Beeler Corporation's increased tax revenue would have an impact on the taxing agency.

03

(b) Explaining the ethical issues

In order to enhance the current year's revenues, the case incorporates ethical concerns such as enhancing the equipment's useable life and residual value. Manipulation of depreciation expenses will provide non-real income in the short term, but it will have a negative impact on the firm in the long run.

04

(c) Explaining the situation of Prior

Prior can predict depreciation costs and the possibility of prolonging an asset's useable life based on real-world data. If there is no option to extend the machinery's usable life, Prior can sell it for fair market value. Although it is not recommended, selling machinery to improve current-year profitability is still acceptable.

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Most popular questions from this chapter

In its 2014 annual report, Campbell Soup Company reports beginning-of-the-year total assets of \(8,113 million, end-of-the-year total assets of \)8,323 million, total sales of \(8,268 million, and net income of \)807 million.

(a) Compute Campbell鈥檚 asset turnover.

(b) Compute Campbell鈥檚 profit margin on sales.

(c) Compute Campbell鈥檚 return on assets using

(1) asset turnover and profit margin and

(2) net income. (Round to two decimal places.)

Silverman Company purchased machinery for \(162,000 on January 1, 2017. It is estimated that the machinery will have a useful life of 20 years, salvage value of \)15,000, production of 84,000 units, and working hours of 42,000. During 2017, the company uses the machinery for 14,300 hours, and the machinery produces 20,000 units. Compute depreciation under the straight-line, units-of-output, working hours, sum-of-the-years鈥�-digits, and double-declining-balance methods.

What basic questions must be answered before the amount of the depreciation charge can be computed?

Companies following international accounting standards can revalue fixed assets above the assets鈥� historical costs. Such revaluations are allowed under various countries鈥� standards and the standards issued by the IASB. Liberty International, a real estate company headquartered in the United Kingdom (U.K.), follows U.K. standards. In a recent year, Liberty disclosed the following information on revaluations of its tangible fixed assets. The revaluation reserve measures the amount by which tangible fixed assets are recorded above historical cost and is reported in Liberty鈥檚 stockholders鈥� equity.

Liberty International

Completed Investment Properties

Completed investment properties are professionally valued on a market value basis by external valuers at the balance sheet date. Surpluses and deficits arising during the year are reflected in the revalution reserve.

Liberty reported the following additional data. Amounts for Kimco Realty (which follows GAAP) in the same year are provided for comparison.

Liberty

(pounds sterling, in thousands)

Kimco

(dollars, in millions)

Total revenues

拢 741

$ 517

Average total assets

5,577

4,696

Net income

125

297

Instructions

  1. Compute the following ratios for Liberty and Kimco.
    1. Return on assets.
    2. Profit margin on sales.
    3. Asset turnover.

How do these companies compare on these performance measures?

  1. Liberty reports a revaluation surplus of 拢1,952. Assume that 拢1,550 of this amount arose from an increase in the net replacement value of investment properties during the year. Prepare the journal entry to record this increase.
  2. Under U.K. (and IASB) standards, are Liberty鈥檚 assets and equity overstated? If so, why? When comparing Liberty to U.S. companies, like Kimco, what adjustments would you need to make in order to have valid comparisons of ratios such as those computed in (a) above?

(Depreciation Basic Concepts) Burnitz Manufacturing Company was organized on January 1, 2017. In 2017, it has used in its reports to management the straight-line method of depreciating its plant assets.

On November 8, you are having a conference with Burnitz鈥檚 officers to discuss the depreciation method to be used for income tax and stockholder reporting. James Bryant, president of Burnitz, has suggested the use of a new method, which he feels is more suitable than the straight-line method for the needs of the company during the period of rapid expansion of production and capacity that he foresees. 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

Year of life used

Fraction rate

Depreciation expense

Accumulated depreciation at the end of year

Book value at the 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 that:

  1. It will increase the funds recovered during the years near the end of the assets鈥� useful lives when maintenance and replacement disbursements are high.
  2. It will result in increased write-offs in later years and thereby will reduce taxes.

Instructions

  1. What is the purpose of accounting for depreciation?
  2. Is the president鈥檚 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.
  3. 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?
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