Question

Mackey Biotechnical, Inc., develops, manufactures, and sells pharmaceuticals. Significant research and development (R&D) expenditures are made for the development of new drugs and the improvement of existing drugs. During 2017, $180 million was spent on R&D. Of this amount, on January 1, 2017, $20 million was spent on the purchase of equipment to be used in a research project involving the development of a new drug. The controller, Margret Davidson, is considering capitalizing the equipment and depreciating it over the five-year useful life of the equipment at $4 million per year, even though the equipment will be used on only one project. Separately, the company president has asked Margret to make every effort to increase 2017 earnings because in 2018 the company will be seeking significant new financing from both debt and equity sources. “I guess we might use the equipment in other projects later,” Margret wondered to herself.

1) identification of the facts, 2) identification of the ethical dilemma, 3) identification of the stakeholders and ethical obligations to the stakeholders, 4) identification of the accounting issue and proper treatment of it, 5) identification of alternative options to address the ethical dilemma, 6) identification of the consequences of the options, and 87) choice of a course of action and description of why the choice was made.

Answer 1

First four full parts have been answered:

Part 1:

The facts here is the accounting treatment to be given to the $20 million which has been used to acquire a equipment for research and development. The company president wants to show less amount of depreciation on the equipment to maximize the amount of profit whereas according to the accounting principles the whole expenditures should be capitalized and appropriate amount of depreciation should be recognized in the books of accounts.

Part 2:

The ethical dilemma is with the accounting treatment. Whether to give in to the demand of the company president and to provide less amount of depreciation or to provide annual depreciation of $4 million per year.

Part 3:

The stakeholders of the financial statements will be the stakeholders in this case also. Thus, the investors, i.e. shareholders, financial institutions, creditors, debtors, government agencies and other authorities are the stakeholders here.

The ethical obligations to the stakeholders are as following:

1. To prepare and present the financial statements in accordance with the appropriate accounting principles and policies.
2. To make sure that the financial statements reflect the true and fair picture of the company as to its state of affairs and financial performance.
3. To provide the users of financial statements correct and proper information about the company and its financial performance to help them take correct decisions affecting their interests in the company.        

Part 4:

The cost of equipment of $20 million should be expensed in the year of acquisition if the inflow of economic benefits from the use of the drugs which is being developed with the help of the research and development activities is very slim. However, if the chances of earning economic benefits from the use of the drug which is to be developed with the help of the R&D activities and the equipment which is used in the R&D activities then the equipment should be capitalized for the five years’ period and accordingly, $4 million shall be charged per year as depreciation in the books of accounts of the company. However, at no cost the financial statements should be manipulated to satisfy the requirements of the president of the company.