Assume you are one of three members of the accounting staff working for a small,

Question

Assume you are one of three members of the accounting staff working for a small, private company. At the beginning of this year, the company expanded into a new industry by acquiring equiptment that will be used to make several new lines of products. The owner and general manager of the company has indicated that, as one of the conditions for providing financing for the new equipment, the company’s bank will receive a copy of the companys annual financial statements. Another condition of the loan is that the companys total assets canot fall below 250,000. Violation of this condition gives the bank the option to demand immediate repayment of the loan. Before making the adjustment for this years depreciation, the companys total assets are reported at $255,000. The owner has asked you to take a look at the facts regarding the new equipment and “work with the numbers to make sure everything stays onside with the bank.” A depreciation method has not yet been adopted for the new equipment. Equipment used in other parts of the company is depreciated using the double-declining-balance method. The cost of the new equipment was $35,000 and the manager estimates it will be worth “at least 7,000” at the end of its four-year useful life. Because the products made with the new equipment are only beginning to catch on with consumers, the company used the equipment to produce just 4,000 units this year. It is expected that, over all four years of its useful life, the new equipment will make a total of 28,000 units. 1. Calculate the depreciation that would be reported this year under each of the three methods (straight-line, units of production, and double depreciation.) Which of the methods would meet the owners objective. 2. Evaluate whether it is ethical to recommend that the company use the method identified in question 1. What two parties are most directly affected by this recommendation? How would each party benefit from or be harmed by the recommendation? Does the recommendation violate any laws or applicable rules? Are there any other factors that you would consider before making a recommendation?

Explanation / Answer

Answer:

1. Straight line depreciation = (35000-7000)/4 = $7,000
Units of production= (35000-7000)*(4000/28000) = $4000
double declining method (35000)(2/4) = $17,500
2. The units of production method would achieve the owner's objective. The company wants the assets to be at least $250,000. Using the units of production method would give them current assets of $251,000.
3. It is snot ethical because company is not using the double declining method which they normally use. and it is against the matching principle.
4. The two parties directly affected are the bank and the company. Using this method the company will not have to pay all the loan off. The bank also thinks that the company is doing good which is not true.
5.The bank would be harmed because they think company is doing good but they only produced 4000 units where they should have produced 7000. the company will be benefited because they wasn't have to pay the loan off.
6. I don't think this violates any laws. it does violates the matching principle rule.
7. I would recommend that we should disclose what we have and tell the bank that business will get better.

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