Question

Expand Your Critical Thinking 9-7

Monty Corporation is suffering declining sales of its principal product, nonbiodegradeable plastic cartons. The president, Robert Griffin, instructs his controller, Alexis Landrum, to lengthen asset lives to reduce depreciation expense. A processing line of automated plastic extruding equipment, purchased for $2.20 million in January 2019, was originally estimated to have a useful life of 8 years and a salvage value of $280,000. Depreciation has been recorded for 2 years on that basis. Robert wants the estimated life changed to 12 years total, and the straight-line method continued. Alexis is hesitant to make the change, believing it is unethical to increase net income in this manner. Robert says, “Hey, the life is only an estimate, and I’ve heard that our competition uses a 12-year life on their production equipment.”

What is the effect of Robert Griffin’s proposed change on income before taxes in the year of change?

Income before income taxes in the year of change has increased by $? .

Answer 1

Cost of the asset = $220000

Residual value = $280000

Initial estimated useful life = 8 years

Depreciation for 2 years = (Historical cost - salvage value)/useful life of the asset = (2200000-280000)/8 =$240000 per year

Accumulated depreciation for 2 years =$480000

Therefore book value of fixed asset at the end of year 2 = $1720000

Monty Corp. changes the estimated useful life of the asset to 12 years in total and SLM depreciation is continued.

Therefore change in depreciation from revision of useful life = ((Historical cost - Accumulated Depreciation) - salvage value)/remaining useful life = ((2200000-480000) - 280000)/10 =$144000

For the remaining 10 years the company would make the following journal entry

Depreciation Expense A\c Dr 144000

To Accumulated Depreciation Cr 144000

Before revision of useful life of asset the depreciation expense on the asset was $240000.After revision the depreciation expense on account reduced to $ 144000.So here Monty Corp income before tax increases due to the proposed change in the useful life of asset.The income before taxes are increased by $96000 due to the revision of useful life of asset for the remaining years.

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