Question

You are the Controller of a publicly owned company. The company is in financial distress and is looking for ways to cut costs. The CEO approaches you and asks you to lengthen the life used for calculating depreciation of certain specialized equipment from 10 to 15 years. This will substantially reduce depreciation expense. This change would only affect financial depreciation and would have no impact on income taxes paid. Will the company achieve a cost savings if they implement this plan? Consider both net income and cash flow What ethical issues arise from this request by the CEO?

Answer 1

One of the ways to improve book profits or net income of the company is to reduce the depreciation expense. Depreciation is a non cash expense and hence does not improve the cash flow of the company and cash profit is what has to be ideally improved by the CEO. Also the length of the asset's age must be increased only if it can be proved and supported by sufficient evidence that the efficiency of the specialized equipment has increased to improve cash flows and has an extra useful life of 5 years. Other factors such as market conditions, replacement cost and technology improvements must be considered before revising the useful life. If the company does not disclose appropriate reasons for increasing the useful life of the asset and is only doing to window dress the accounts, the same is not in the best interests of the CEO and the company. It is certainly unethical to improve book profits without proper justification.