Question

XM Radio was depreciating its satellites over 20 years (total cost of $20 million), for each of five satellites, useful life is only seven years due to the intensity of the sun rays. With reference to the scenario, answer the following questions:

What is the accounting implication in the situation and why?

Answer 1

Here, it is clearly provided that the life of the satellite is only seven-year but as per accounting it has been treated like that the useful life will be 20 Years.

Here we are violating the most principle of Prudent & Matching.

Present accounting will be effect our Income Statement and Financial Position as below stated:

1. Depreciation will be claimed as per seven-year life and due to this Profit will be shown excessively and profit to be shared with Shareholder or the owner. if we see this in-depth profit will be paid by the capital amount.

2. Assets will be shown in the Balance Sheet at higher value after adjusting the Depreciation as per Twenty Year's life. But in fact, if we see the actual value it is lower because of life is only seven years. Written Down Value of the Satellites will be window dressed and the wrong information will go the investors and stakeholders.

3. Income Statement and Financial position will not show the True and Fair status of the firm.

4. Prudent Concept says that you have to provide all the expenses, Losses, Provision properly but in the given case it is not done.

5. Matching Concept says if there is Income than there must be expenditure also. but if we see the 8 Year Position at that time, there will be depreciation but we will not gain any income from that satellite service because the life is only 7 Years. But we will show the Depreciation in the Profit & Loss Account as well as Written down value of Satellite in Balance Sheet which is not correct.

6. ultimately in the eighth year we have to write off the written Down Value of satellite and due to this firm has to bear a big loss and it will effect the Profitability and Financial Position.because which you don't have how you can show this in your Balance sheet.