I need 2 substantive responses to the 2 included posts that my classmates shared in discussion this week. Substantive responses should have a minimum of 50 words.
Flo Choi owns a small business and manages its accounting. Her company just finished a year in which a large number of borrowed funds were 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 as profit margins erode, this might raise the interest rate on borrowed funds to reflect the increased loan risk from the bank’s point of view. Choi knows that profit margins are 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 month following the purchase date. (The previous rules assume that assets are in use on the first day of the month nearest to the purchase dates.)
In your response, address the following:
- Identify decisions that managers like Choi must make in applying depreciation methods.
- Is Choi’s rule an ethical violation, or is it a legitimate choice for computing depreciation?
- How will Choi’s new depreciation rule affect the profit margin of her business?
When talking about the depreciation, we are talking about how the cost of tangible and indelible assists are going to be allocated over the time and usage. In order to expense the assets, both private and public companies must use depreciation methods in accordance with the GAAP (Generally Accepted Account Principle). According to the GAAP, those depreciable assets which are bought the 1st half of the month must be deprecated starting the first day of the month purchased. The rule continue to add that any assets which is purchased after the 15th of a month must be calculated as depreciated 1st day of the up coming month.
After reading Choi’s scenario and comparing it with the GAAP regarding depreciation, I think it is unethical business conduct that she is doing. Bank asked her to submit semiannual financial statement to monitor Choi’s financial health of the business, and Choi knows that profit margin is going to decline for this year, in order to prevent interest increase by the bank on the amount barrowed, she decided to apply a totally new rule that all asset additions are in use on the very first day of the month following the purchase. However, the previous rule within her company was that assets are in use on the first day of the month nearest to the purchase dates. This was done by Choi just only for the purpose of deceiving the bank not to increase interest rate and I think it is totally unethical.
In my opinion the outcome on the profit margin is not going to be a lot. That is because, on her previous method, she depreciated asset from the 1st day of the month closest to the date of purchase. Any assets Choi buys after the second half of the month is going to be depreciated the upcoming months. With her new rule of asset depreciation, only purchases in the 1st of the month is going to be depreciated.
Managers like Choi must consider the factors involved in applying depreciation methods such as cost, salvage value, depreciable cost, and estimated useful life.
More information is needed for me to be able to declare Choi’s application of the depreciation rule to consider the first day of use of the assets as the first day of the following month ethical or not. With the information at hand, the most I’d be comfortable saying is that depending on variables such as the purchase date and the methods of determing when an asset is placed into service. If the assets were purchased in the latter half of a given month, I would say that it makes sense for the asset to be considered in use on the first day of the following month. If, however, the assets were purchased in the first half of a given month, it may be difficult to find a method that reasonably determines the asset to be in use on the first day of the following month, as Choi is indicating. If however, the method to determine when active use of the asset begins reasonably agrees with Choi’s accounting determination, it may not be considered unethical.
What Choi is trying to do is increase her profit margin for the the year in which she expects it to decline by removing one month of depreciation expense from that year by holding off on when the purchased assets are considered in use. Thus, if she is successful, the bank is less likely to increase the interest rate on the borrowed funds because the loan risk isn’t as great with the profit margin not eroding as much as it would with a month of depreciation expense being removed.
If Choi knows that the application of this depreciation rule is misleading and does not reflect the reality of the asset’s usage, then it is certainly unethical. If the change in the accounting is allowed and rational, then I don’t think it should be considered unethical.
Wild, J.J., Shaw, K.E., & Chiappetta, B. (2013). Fundamental Accounting Principles (21st ed.). New York, NY: McGraw-Hill.