Question

Identify a specific asset that could be significant to a business and perform the following:

Describe the asset and identify a potential change in the estimated life of this asset.

Analyze the impact this change would have on the financial reporting, specifically identifying the accounts and the financial statements where these impacts would be reported.

Evaluate whether you believe this change it ethical or not and why.

Answer 1

Suppose a machinery used in the production of identical small nuts used to bind the rods and angles of steel racks-- used as storage shelves at factories, offices & homes.

Let us further suppose,that the company initially estimated the useful life of the machinery to be 7 years & was depreciating the machinery on straight-line basis for 7 years.

Subsequently, at the end of 2 years,when a quality-control inspection team found the machine to be highly efficient & suggested a slower rate of cost-recovery, the management decided to extend the recovery to 3 more years,ie. For a total of 10 years.

It decided to depreciate the current book value of the machinery, at the end of 2 yrs. --be depreciated for the next 8 years.

As the book value has reduced over the past 2 years , the subsequent depreciation amounts to be charged to the income statement ,will naturally be less--which will push-up income & consequently more income-tax.

Also depreciation tax shields available to the company, will be less due to decrease in depreciation amounts --- which alters the operating cash flow .

So, the accounts affected /impacted by the change in useful life of the asset will be :

Depreciation account (Income statement account)

Accumulated depreciation (Balance sheet account)

Income tax expense /Payable account (Income statement/Balance sheet)

Carrying value of the asset (Balance sheet)

Cash generated from operating activities (Cash flow statement)

Ethics about the change

If the change is decided after some scientific studies as mentioned above, there sholud not be any ethical issues attached.

It it is done arbitrarily to post a different net income figure than what is normal,then there is the possibility of wrong assessment of before-tax income , subsequent tax-liabilities & because of all these, wrong Earnings Per Share to the shareholders--- which may also affect the market price of the stock.

In the latter case, it is not ethical to indiscretely extend/shorten the useful life of the currently-being-depreciated asset.