Turner Container Company is suffering declining sales of its principal product,

Question

Turner Container Company is suffering declining sales of its principal product, nonbio-degradeablc plastic cartons. The president, Robert Griffin, instructs his controller, Alexis Landrum, to lengthen asset lives to reduce depreciation expense. A processing line of automated plastic extruding equipment, purchased for $3.5 million in January 2017, was originally estimated to have a useful life of 8 years and a salvage value of $300,000. Depreciation has been recorded for 2 years on that basis. Robert wants the estimated life changed to 12 years total, and the straight-line method continued. Alexis is hesitant to make the change, believing it is unethical to increase net income in this manner. Robert says, "Hey, the life is only an estimate, and I've heard that our competition uses a 12-year life on their production equipment." Instructions (a) Who are the stakeholders in this situation? (b) Is the change in asset life unethical, or is it simply a good business practice by an astute president? (c) What is the effect of Robert Griffin's proposed change on income before taxes in the year of change?

Explanation / Answer

a) The stakeholders would be the shareholders, lenders and others who have interest in the company financials.

b) Depreciation is charged as on expense to income statement so that the sufficient cash / reserve is made for the purchase of another machinery by the time the current one becomes obselete. We can see that the dividends distributed is from the net profit, which is after depreciation expense - which means before distributing the cash to shareholders, sufficient reserve to buy the machinery in future is made. Hence the changing the useful life thereby changing the depreciation expense only to show higher profits is unethical. Useful life of the asset can be changed only if there is significant repairs or improvemnts to the asset which increases its useful life.

c) As explained above increase in useful life decreases the expenses per year thereby increasing the profits.

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