You have just landed an accounting position with a national telecommunications c

Question

You have just landed an accounting position with a national telecommunications company. Because this is your first job you are eager to please your co-workers and your supervisor, who works closely with the controller. Your supervisor has just paid you a visit, and she told you that the controller is concerned that profits for the last fiscal year are much less than profits for the preceding five years. The controller has asked that depreciation on a machine purchased at the beginning of last year be recalculated. The machine has a five-year useful life and is depreciated using the straight-line method. The controller has asked that the machine be depreciated over a ten-year useful life. Your supervisor contends that the “depreciation thing” really doesn’t matter because the machine has already been paid for. In addition, your supervisor gives you an adjusting journal entry to correct what she calls “expense transfers.” This entry transfers items originally recorded as repairs and maintenance to capital assets.

Address the following:

Do you agree with the supervisor regarding the change in the estimated useful life of the machine? Why or why not?

Are you going to recalculate the depreciation and change the entry? Why or why not?

What is the proper accounting treatment for: (a) repairs and maintenance and
(b) plant assets?

What is your supervisor trying to accomplish with the suggested “expense transfers” entry? What would be your course of action regarding the suggested entry?

Your response should include 2-3 pages of written text in addition to any calculations and solutions you offer to support your thinking. Document formatting and any citations should conform to

Explanation / Answer

Solution:

1) No, not if the change is purely for income manipulation. It is blatant earnings management with no justification for the change, which violates the accounting principles.

You have been put in a very tough position. To reclassify the machine from a 5-year asset to a 10-year asset for the sole purpose of income manipulation or “income management” is a violation of numerous laws and principles. You should make sure you understand the desire and intent of your supervisor. If your understanding is correct, you need to discuss this apparent violation of laws and principles with you supervisor. If this conversation is unsatisfactory in its end results, you should discuss it with your supervisor’s reporting senior or a member of the internal audit committee if the firm has one.

2) No, I will not recalculate the depreciation and change the entry because changing the useful lives from five years to ten years would not comply with the standards of the generally accepted accounting principles and would get me into further trouble if I chose to go through with the supervisor’s demand. Recalculating the depreciation and changing the entry would mean that I support the supervisor’s decision, and as stated before, depreciation cannot be extended beyond its estimated useful life because it has already been predetermined. Additionally, if I choose not to recalculate the depreciation, I may not be obeying my supervisor’s orders but I do have a better chance of keeping my new job than she does of keeping hers.

3) The proper accounting treatment for (1) repairs and maintenance are to record them as expenses that a business incurs to restore an asset to a previous operating condition or to keep an asset in its current operating condition. Under GAAP, they are recorded as expenses in the period in which they are incurred.

Plant assets should be treated as capital expenditures, costs that a company incurs to purchase an asset, extend its life, or increase its capacity or efficiency. Capital expenditures should be allocated, such as depreciated or amortized, over the useful or remaining lives of the assets.

4) The supervisor is trying to cheat the system to increase profits by transferring items that should be expensed in the income statement in the current year to the balance sheet as capital assets and be amortized over a number of years. The company’s operating expenses will be understated and the net income will be overstated. She may also be trying to manipulate taxable income so the company pays fewer taxes over the long run. This is illegal and violates the code of ethics or the generally accepted accounting principles, so the right course of action should be to report her to management, such as the chief financier, or the internal auditor committee.

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