Question

Flo Choi owns a small business and manages its accounting. Her company just finished a year in which a large amount of borrowed funds was invested in a new building addition as well as in equipment and fixture additions. Choi’s banker requires her to submit semiannual financial statements so he can monitor the financial health of her business. He has warned her that if profit margins erode, he might raise the interest rate on the borrowed funds to reflect the increased loan risk from the bank’s point of view. Choi knows profit margin is likely to decline this year. As she prepares year-end adjusting entries, she decides to apply the following depreciation rule: All asset additions are considered to be in use on the first day of the following month. (The previous rule assumed assets are in use on the first day of the month nearest to the purchase date.)

Required

1.Identify decisions that managers like Choi must make in applying depreciation methods.

2.Is Choi’s rule an ethical violation, or is it a legitimate decision in computing depreciation?

3.How will Choi’s new depreciation rule affect the profit margin of her business?

Please write 3 paragraphs for each question!

Answer 1

1. Depreciation refers to the wear and tear of the assets. Computation of depreciation should be done from the date the assets is put to use. The managers like Choi should ensure the accuracy and the legimate of the decision for selecting the method of depreciation as the data is to be presented to bank. In case of loans the bank have the right to conduct the audit of the books and if the books represent the incorrect picture then it may amount to non-compliance of loan terms & conditions

Choi should provide the depreciation from the date of put to use. All the additional assets should be depreciated from the date when they are put to use, irrespective of purchase date.

In the given case, both methods selected by CHOI are incorrect as in 1st case CHOI is charging depreciation with delay. For example, if the assets is purchased on 02.04, CHOI will charge depreciation from the month of May i.e. with delay of 1 month and in 2nd case if the assets is purchased on 14th April, then CHOI will charge full depreciation for the month of April i.e. excess depreciation for 14 days and in case the same is purchased on 16th April, CHOI will charge depreciation in the month of May i.e. depreciation for month of April remain uncharged