Question

A publically traded company more than doubled its EPS by changing depreciation methods. In justifying the change, management supported the change as follows: In comparison to direct competitors, the previous depreciation method was more conservative and thus had a negative impact on earnings.

Although difficult to prove, there is considerable evidence that accounting changes are made for reasons other than improved financial reporting. GAAP are flexible in the initial selection of accounting methods and in making subsequent changes. However, the accounting standards specifically require that only changes to preferable accounting methods be made.

Comment on the appropriateness of making accounting changes to fulfill financial reporting objectives, Consisder relevant ethical issues in your response. Who are the stakeholders? Does this violate GAAP? What is the ethical issue? What is an alternative course of action?

Answer 1

Depreciation method helps accountants in aligning the recognition of cost with the benefits rendered by asset as per the requirement of accountig standard that requires rate of depreciation rate to match the rate at which benefits are extracted from the asset. Thus depreciation method in itself is an estimation of consumption of utility in the asset.

On the same footings, change in depreciation method is not a change in accounting policy rather it is a change in accounting estimate. Change in accounting policy only occurs if rules of either recognition, measurement or presentation of line item are changed. Change in depreciation method changes neither of these. Therefore, it is a change in accounting estimate.

"A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors."

Depreciation is an adjustment of carrying amount of asset over its useful life to correctly project the state of affairs of business. And on receipt of information if it is found that previous estimations were wrong regarding devaluation of asset then change in depreciation method is brought.

Additionally, change in scrap value of asset as a result of new developments will also trigger adjustment in accounting for depreciation and it is also a change in accounting estimate and not a change in accounting policy.

A change in accounting policy in relation to depreciation charge will occur if entity changes its policy whether to depreciate the asset or not. Change from historical cost basis to revaluation basis is a change in accounting policy. Changing the way depreciation expense is presented in the financial statement for example previously a depreciation of certain was recognized as part of admin expense but now it is included in cost of sales then such change is a change in accounting policy.

At the end of each financial year, management should review the method of depreciation. When there is a significant change in the pattern of the future economic benefits from the asset then the method of depreciation should also be changed.

So after analyzing the policies and the given situation , we can assure that the there is violation of GAAP has been made and  their is no inconsistency that has been made by the management.

Being the owner of the corporation and having financial interest in the buiness,  it is the management responsibilty to bring the requured changes made in accounting method and effect of such change in the financial position. to all the stakeholders.