Question

James Wright is the chief financial officer (CFO) for The Butcher Block, a major steakhouse restaurant chain. As CFO, James has the final responsibility for all aspects of financial reporting. James tells investors that The Butcher Block should post earnings of at least $1 million.

      In examining the preliminary year-end numbers, James notices that earnings are coming in at $950,000. He also is aware that The Butcher Block has been depreciating most of its restaurant equipment over a five-year useful life. He proposes to change the estimated useful life for a subset of the equipment to a useful life of seven, rather than five, years. By depreciating over a longer useful life, depreciation expense will be lower in the current year, increasing earnings to just over $1 million. It looks like The Butcher Block is going to exceed earnings of $1 million after all.

     Do you think James Wright’s change in the depreciable life of assets is ethical? What concerns might you have?

Answer 1

Depreciation is an expense for usage of assets in the business. It reflects the wear and tear of the asset and a gradual fall in value of asset over a period of time. Depreciation is charged income statement based on useful life of the asset. The charge of depreciation expense to income statement is in line with matching concept because the asset depreciated helps in generating revenue for the business.

The change in depreciable life of asset is not ethical to show the net profit target for the year. The following are the concerns

· Depreciation expense for the year will be understated and net profit will be overstated. Assets will be overvalued and Equity will be overstated

· The financial statements – Income statement and balance sheet will not reflect the true and fair view of the business

· It leads to window dressing of the accounts and is against the integrity and ethical policy of the organisation