Question

Flo Choi owns a small business and manages its accounting. Her company just finished a year in which a large amount of borrowed funds was invested in a new building addition as well as in equipment and fixture additions. Choi’s banker requires her to submit semiannual financial statements so he can monitor the financial health of her business. He has warned her that if profit margins erode, he might raise the interest rate on the borrowed funds to reflect the increased loan risk from the bank’s point of view. Choi knows profit margin is likely to decline this year. As she prepares year-end adjusting entries, she decides to apply the following depreciation rule: All asset additions are considered to be in use on the first day of the following quarter. (The previous rule assumed assets are in use on the first day of the month nearest to the purchase date.)

Discuss the following: Identify decisions that managers like Choi must make in applying depreciation methods. Is Choi’s rule an ethical violation, or is it a legitimate decision in computing depreciation? How will Choi’s new depreciation rule affect the profit margin of her business?

Answer 1

As per accounting standard deprectiation is to be calculated from the date of purchase of an asset or date of put to use to the last day of the financial year . This will have an imapct on the profit & loss a/c of the respective person.

In accordance with the above choi's method of calculating depreciation in both ways was wrong -

ie: 1.all asset additions are considered to be in use on the first day of the following ( which he wants to incorporate)

2. assumed assets are in use on the first day of the month nearest to purchase date

choi's option affect on profit & loss ac -This will affect the profit & loss ac of the company .There will be a raise in net profit due to less depreciation booked .

Therfore choi have to calculate depreciation from the date of purchase to last day of financial year and requried to be booked accordingly.