Question

Everyone knew that Bob Mcallister was a great businessman. He had taken a small garbage collection company in Kentucky and built it up to be one of the largest and most profitable waste management companies in the Midwest. But when he was convicted of massive financial fraud, what surprised everyone was how crude and simple the scheme was. To keep earnings up and stock prices soaring, he and his coworkers came up with an almost foolishly simple scheme: first, they doubled the useful lives of the dumpsters. That allowed them to cut depreciation in half. The following year, the following year, they simply increased the estimated salvage value of the dumpsters, allowing them to further reduce depreciation expense. With thousands of dumpsters spread over 14 states, these simple adjustments gave the company an enormous boost to the bottom line. When it all came down, McAllister had to sell everything he owned to pay for his legal costs and was left with nothing.

1) If an asset has either too long a useful life or too high an estimated salvage value, what happens from an accounting perspective, when that asset is worn out and has to be disposed of?

2) Do the rules of GAAP (Generally Accepted Accounting Principles) mandate specific lives for different types of assets?

3) How might either too long a useful life or too high an estimated salvage value affect key performance indicators such as return on investment and residual income?

Answer 1

1. If an asset has too long useful life or too high an estimated salvage value then the depreciation charged to the profit and loss account would be less so they can show an increased profit figure. From the accounting prespective the matching principle does't fulfil, that is  revenue of the curent year not match with the expenses. Also when the asset really worn out and disposed off, the net proceeds would be too less than the value actually exist in the books. Therefore a loss from sale of fixed asset will be occur.

2.No, GAAP did not mandate any specific lives for different types of asset. GAAP spcify ony that assets sould be recorded at cot (cost principle).

3. If the resudial value is too high or too high the useful life of an asset, then the depreciation expenses charged to profit and loss account would be too less that will result increased priofit figure.Therefore the Return on investment will be high. It does't show the actual figures. if the profit increases then the ROI( return on investment) will also increase. Also if the profit is high because of resudial value and useful life of fixed asset then the resudial income would be high. resudial income is the excess of income generated in excess of minimum rate of return. If the profit is meassured correctly  then the resudial income and ROI can't be meassured accurately.