Question

Depreciation Choice - Ethics

Jerry Prior, Beeler Corporation's 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's 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't want to highlight this method of increasing income. He thinks, “Why don't 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.”

My Response

Here, the financial books are manipulated which will show income at a higher side and therefore, the stakeholders are the external and internal users of this financial information like creditors, shareholders, employees, investors etc. Who will be benefited by this manipulation? - Jerry Prior and the staff.

This action is not at all ethical as Jerry Prior wants to change the estimates of the depreciation to benefit himself. Changing an accounting estimate without genuine reason and without proper notes and disclosures is not permitted.

Prior should discuss his concern with the management and try to find out the areas and ideas of increasing revenue and cost reduction. Study and analyze the avoidable costs, unavoidable costs, alternative ways to reduce costs. Organize employee motivation programs so they work harder, employee training programs so they are well equipped with new advancements, create a healthy working environment so that employees perform better, and more revenue is generated.

Please help with the follow up question

Since useful life and salvage value are estimates, could Jerry convince management that these numbers for useful life and salvage value could be changed in accordance with US GAAP? Why or why not? Be specific and back up your response.

Answer 1

Yes, Jerry can convince management that the numbers of useful life and salvage value can be changed.

Justification: Since assets are not depriciated below their salvage value - The amount management beleives it can sell asset for at the end of its useful life.

An increase in the asset's salvage value will reduce the amount that can be depriciated on the asset.

The salvage value and useful life can be increased if the recent historical estimates and data indicates that certain assets may sell at a higher amount in the future than previously setimated.

Since there are several method's to compute depriciation a change to a less aggressive depriciation method may result into the reduction of company's depriciation expense.