Question

View Policies Current Attempt in Progress Imporia Container Lid is suffering from declining sales of its main product, non biodegradable plastic carton The president, Benny Benson, instructs is controller. Yeoh Siew Hoon, to change estimates relating to a processing line of automated plastic extruding equipment, purchased for million in January 2016. The equipment was originally estimated to have a w ife of five years and a residual value of $200,000 and straight-line depreciation has been recorded for two years on that basis. Benny wants the estimated useful life changed to a total of seven years and the residual value raised to $500.000 in order to reduce the annual depreciation expense Yeoh Sewishesitant to make the change believing in propriate to manage profits in this way Benny says munder a lot of pressure from the shareholders to maximize net income. Don't you want your bonus, which is based on the income to be as high as possible Just go head and make the change the useful life and residual value are only an estimateway Who are the stakeholders in this situation? Wil Benny Benson's proposed change increderea or not the income in 2017 2018 eTextbook and Media What impact will the proposed change in and mover ratios? fe and residual value have on the company's profit margin BIVT TIE - Discuss whether the proposed change described above is nothical or simply a good business practice by an astute president eTextbook and Media Attempts of 10 used Sveforber Substwer

Answer 1

The stakeholders in this situation are the shareholders and other users of the company’s financial statements. Shareholders will be misguided by changing the profit numbers by managing depreciation figures and the financial statements will provide them with a wrong picture of the financial position of the company. Other stakeholders will be users of the company’s financial statements who base their decisions on the financial numbers. Such users will be creditors, banks, lending agencies etc.

The proposed changes will increase the company’s net income in both 2017 and 2018 as the company’s depreciation expenses will come down. This will push up the company’s EBIT figures (earnings before interest and taxes) and hence its net income (or PAT) figures will also go up.

If useful life is increased to seven years then the depreciation expense that will be charged each year will decline as the depreciation of the asset will now be spread out on a bigger denominator. It should be noted that annual depreciation = (cost of the asset – salvage value)/number of years. Thus the higher is the number of years the lower will be the amount of annual depreciation and higher will be the amount of net income. Also an increase in residual value or salvage value will reduce the numerator in the above formula and so annual depreciation will decline. This will cause the profit margins to go up.

The proposed change described above is completely unethical and is against the ethical provisions and guidelines of different accounting regulatory and professional bodies. The proposed change is nothing but cooking up the books of the company or as is called formally ‘earnings management’. This is unethical and will misguide the users of the company’s financial statements.