Jody Burden is a senior auditor with a public accounting firm and has been assig

Question

Jody Burden is a senior auditor with a public accounting firm and has been assigned to the Stanley Corporation's audit engagement. Stanley has been an audit client of the firm for many years and is in the fast-growing commercial construction industry. In reviewing fixed assets, Jody discovers a number of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate of their useful lives. For example, the useful life of a front-end loader was changed from 10 to six years in its fifth year of service. When Jody questioned the chief financial officer, she responded that it is perfectly legal to change accounting estimates and this helps the company shows bigger earnings. What is the impact to the financial statements of this change in estimate? Do you see any ethical problems with this scenario? If so, what are they? Who could be harmed by these problems? What should Jody do in this scenario?

Explanation / Answer

Answer: The ethical concern here is that Stanley is changing the useful life of fixed assets in order to inflate earnings. Once an asset has reached the end of the useful life the company will no longer have the depreciation expense on that equipment. The problem with that is if Stanley is changing the useful lives of these assets solely to inflate earnings than this practice is dishonest. It is dishonest because the company by all rights would have to pay the depreciation expense. Doing this only for that reason and no other reason is unethical and the earnings that are inflated would be artificial because the depreciation expense would technically still be an expense. Besides that once the useful lives of these assets are used up than new assets must be purchased which would begin the depreciation expense again which would make earnings go back down at a rapid pace.

Answer: The investors in the company would obviously be affected by these changes because the estimates used would inflate earnings making the investors think the company is doing better than it really is. Jody would be affected by this because he is the auditor and therefore his job is on the line here. Also CFO could be harmed for the same reason as Jody their jobs would be in balance with this issue. The CEOs of this company could be harmed because they are ultimately responsible for the financial reporting. Jody Burden should take this issue to a higher authority than stanley’s accounting manager. I would say he should report this at least to the CEOs or the board of directors. This way the issue can be taken care of properly according to the company’s policies. Jody could also issue a qualified or unqualified audit opinion with an explanatory paragraph that outlines the use of accounting estimates in this way. The bottom line is even though some things are legal they are still harmful to the investors so in my opinion Jody is professionally obligated to do something about this situation before it gets way out of hand. If he does nothing this will continue to happen and may even get worse in the future.

Answer: Jody should require Stanley to use useful lives that mirror the estimated life of the asset. If a change is made, it should be because the asset's life is decreased (such as equipment coming obsolete), not just an arbitrary change. IF Stanley refuses, Jody can give a qualified audit opinion, or an unqualified opinion with an explanatory paragraph outlining the depreciation issue.

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