American Movieplex, a large movie theater chain, leases most of its theater faci

Question

American Movieplex, a large movie theater chain, leases most of its theater facilities. In conjunction with recent operating leases, the company spent $28 million for seats and carpeting. The question being discussed over breakfast on Wednesday morning was the length of the depreciation period for these leasehold improvements. The company controller, Sarah Keene, was surprised by the suggestion of Larry Person, her new assistant.

Keene: Why 25 years? We've never depreciated leasehold improvements for such a long period.

Person: I noticed that in my review of back records. But during our expansion to the Midwest, we don't need expenses to be any higher than necessary.

Keene: But isn't that a pretty rosy estimate of these assets' actual life? Trade publications show an average depreciation period of 12 years.

Reflect on the following: How would increasing the depreciation period affect American Movieplex's income?

Who would be affected if Person's suggestion is followed?

Does revising the estimate pose an ethical dilemma?

Do you agree with your classmates' opinions?

Explanation / Answer

Part A)

An increase in the depreciation period will result in a lower amount of depreciation to be deducted every year, which in turn will result in the net income to higher than what it should actually be. In other words, an increase in depreciation period will cause the expenses to be understated (than what they should be) and net income to get overstated (than what it should be). For Instance, using a straight line method of depreciation, the annual depreciation expense over a period of 25 years would be $1.12 million ($28/25), while it would be be $2.33 million per year, if the average depreciation period is taken as 12 years. This would mean that the net income would get overstated by $1.21 million (2.33 - 1.12) every year.

___________

Part B)

The direct impact of Person's suggestion would be on the financial statements of the company. Since, the depreciation period would be increased, the net income would get overstated representing an incorrect financial position of the company (as the acceptable depreciation period is 12 years). The financial statements are frequently used by various stakeholders such as investors, employees, government authorities, creditors, banks and financial institutions. Any change in the accounting methods/principles would have an impact on these parties.

___________

Part C)

Yes, revising the estimate would pose an ethical dilemma, as lower depreciation would result in increased income for the company. This decision/suggestion may be viewed as an approach to make the financial statements more attractive and viable. It is also possible that reporting of actual depreciation may indicate loss for the company in any year. This kind of a situation would give rise to ethical dilemma.

___________

Part D)

This part cannot be answered without knowing the opinions of classmates. It is a subjective question.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.