Question

Write a 1–1.5 page letter to Joe Davison explaining how each of the above changes should be presented in the December 31, 2017, financial statements. CA22-6 ETHICS (Change in Estimate) Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation's annual audit engagement. Frost has been a client of Crane's firm for many years. Frost is a fast-growing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost's accounting manager, “I don't really see your problem. After all, it's perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”

Instructions Answer the following questions.

(a) What are the ethical issues concerning Frost's practice of changing the useful lives of fixed assets?

(b) Who could be harmed by Frost's unusual accounting changes?

(c) What should Crane do in this situation?

Answer 1

a) Through the changing the useful lives of fixed assets, the company unethically impose the depreciation expense in the concerned year according to their wish. Without any base, if the Company want to reduce the profit, it reduces the useful life of the fixed assets (results in higher depreciation in remaining life of the asset) and if wants to increase earnings, they just extend the useful life of the fixed assets (results in lower depreciation in remaining life of the asset). There should be some base like technical report of the asset or break-down frequency of the asset or other, to make changes in the depreciation and useful life of the asset.

b) The unusual changes in the accounting policies will not only disturb the accounting manual, now and then, but the investors or shareholders would not able to access their return on their investment in the company. Regular changes in the accounting policies disturb the Accounting department, where additional work and time wastage take place. The capital expenditure budget also keeps on jumping as per the changes in the accounting policies regarding useful life and replacement decisions of the asset. In totally, the final accounts reporting and the related parties are the most affected ones in such Frost’s unusual accounting changes.

c) In such situation, the Audit Senior, Mike Crane should check the bases, like technical report of the asset or break-down frequency of the asset or other, of the changes in the useful life of the asset. If the change is without any appropriate base then he should disqualify the change and get the correction done in the accounts.

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