Question

American Movieplex, a large movie theater chain, leases most of its theater facilities. In conjunction with recent operating leases, the company spent $28 million for seat and carpeting. The question being discussed over breakfast on Wednesday morning was the length of the depreciation period for these leasehold improvements. The company controller, Sarah Keene, was surprised by the suggestion of Larry Person, her new assistant.

Keene: Why 25 years? We've never depreciated leasehold improvements for such a long period.

Person: I noticed that in my review of back records. But during our expansion to the Midwest, we don't need expenses to be any higher than necessary.

Keene: But isn't that a pretty rosy estimate of these assets' actual life? Trade publications show an average depreciation period of 12 years.

Read through the dilemma. For the Original Post*, you will be arguing in favor of Larry Person's proposal to increase the depreciation period for leasehold improvements. Remember to use logic and the accounting principles you have learned thus far to develop your argument. You must include at least three points as to why this route is the best route to go (with one of those points being related to the learned accounting principles).

Answer 1

Answer

When a facility, or the improvements to the facility is leased by a company, then the lease amount can be capitalized and can be depreciated as would any other fixed asset of a company. Any improvements made in a leased facility normally revert to the asset (property) owned at the expiration of the lease. In addition to this, the improvements in lease such as the carpeting and seats and needs to be replaced periodically to remain competitive in the market. Person’s Question is a valid observance. The depreciation of a leasehold improvement should be limited to an extent of the time that the company should get benefit from the asset. The asset, given the use of the leasehold improvements will likely not benefit the firm for the 25 years currently depreciated. The increased depreciation level will decrease the profitability of the firm if followed however the change in accounting estimate can be disclosed to the users of the financial information. The revising of the estimate does not pose an ethical dilemma because the responsibility of the firm is to report the most accurate information possible. If 12 years are the most conservative and realistic view of the asset's life, the asset depreciation method should change.