would you provide a detailed solution for this problem ATC 3-5 \"Alaska Airlines
ID: 2328474 • Letter: W
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would you provide a detailed solution for this problem ATC 3-5 "Alaska Airlines and United Continental are both passenger airline companies. Although they use similar assets to conduct their businesses, the estimated lives they use to depreciate their assets vary, as shown in the following table."
here is the full problem:
Alaska Airlines and United Continental are both passenger airline companies. Although they use similar assets to conduct their businesses, the estimated lives they use to depreciate their assets vary, as shown in the following table.
Managers have significant flexibility in setting the estimated useful lives of depreciable assets, and as the table shows, United Continental uses longer estimated lives for its assets than does Alaska Airlines.
1) How does using a longer estimated life for a depreciable asset potentially affect its earnings?
2) Would using a longer estimated life for a depreciable asset be more likely to affect a company's fixed or variable costs?
3) In the past, some companies, not United Continental, have been accused of deliberately overestimating the useful lives of their companies' depreciable assets. Speculate as to what would cause them to do this.
4) Review the statement of ethical professional practice shown in Exhibit 1.15 of Chapter 1 and comment on which, if any, of the ethical standards are violated by deliberately overestimating the useful lives of depreciable assets.
5) Comment on the provisions of the Sarbanes–Oxley Act that are designed to prevent a company's executives from deliberately overestimating the useful lives of depreciable assets.
Estimated Useful Lives (years) Asset Category Aircraft Buildings Computer software Other equipment Alaska Airlines United Continental 15-20 25-30 3-5 5-10 27-30 25-45 4-15Explanation / Answer
1) How does using a longer estimated life for a depreciable asset potentially affect its earnings?
Using longer estimated useful life would mean that lower depreciation each year hence the earnings would accordingly be more by that much amount and even the book value of the asset would be overstated
Kindly refer the illustration
Say Value of Asset is $1000 and useful life in Case 1 be 5 years and Case 2 be 10 years
hence amount of deprecation
Case 1
Depreciation= Value / No of years
= 1000/5
= $ 200 each year
Case 2
Depreciation= Value / No of years
= 1000/10
= $ 100 each year
If the profit of company is say $ 5000 then
Case 1
Profit after depreciation= 5000 - 200
= $ 4800
Case 2
Profit after depreciation= 5000 - 100
= $ 4900
Hence if the useful life is more than profit would also be more and vice versa
2) Would using a longer estimated life for a depreciable asset be more likely to affect a company's fixed or variable costs?
The longer estimated useful life will mean lower depreciation hence lower fixed cost. The depreciation being a fixed cost variable cost will not be afected by increase/decrease in useful life.
3) In the past, some companies, not United Continental, have been accused of deliberately overestimating the useful lives of their companies' depreciable assets. Speculate as to what would cause them to do this.
The reason for increase in useful life of fixed assets would mean that the Company may want to show higher profits so as to attract the investors and shareholders. As shown in the illustration in question 1 answer the profits increase by increase in useful life.
4) Review the statement of ethical professional practice shown in Exhibit 1.15 of Chapter 1 and comment on which, if any, of the ethical standards are violated by deliberately overestimating the useful lives of depreciable assets.
Depreciation is a controlling cost and not a non-controllable cost hence overestimating the useful life of depreciable assets would definitely violate the ethical standards as it would mean delibarately showing higher profits by overestimating the useful life. The usefu life f assets should be reasonable and based on industry standards and not used as a means to show high or low profits.
5) Comment on the provisions of the Sarbanes–Oxley Act that are designed to prevent a company's executives from deliberately overestimating the useful lives of depreciable assets.
US GAAP does not mandate the useful life of assets however the useful life should be reasonable otherwise the higher useful lfe would mean overstating the net income and even the book value of asset which attracts criminal penalties
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