John supervisor for the Brown Corporation, is preparing the company\'s income st
ID: 2486654 • Letter: J
Question
John supervisor for the Brown Corporation, is preparing the company's income statement at year-end of 2015. He notes that the company had decided and replaced one of its equipment and lost $60000 on the sale of that equipment which was costs 150000 and its depreciation is $50000. Since the company has sold equipment routinely in the past with amount of $40000, John knows the losses cannot be reported as unusual. He also does not want to highlight it as a material loss since he feels that will reflect poorly on him and the company. He reasons that if the company had recorded more depreciation during the useful life of the assets (increasing the depreciation with 80%), the losses would not be so great. Since depreciation is included among the company's operating expenses, he wants to report the losses along with the company's expenses, where he hopes it will not be noticed.
Required:
1. Is there an earnings management problem in the above case study? If so specify which type of earnings management and Explain the problem in details.
2. If the supervisor record more depreciation during the useful life of the assets in 2015, what is the value of the increase in depreciation, would this be counted as a violation to the generally accepted accounting principles? Identify and discuss the accounting principle that would be violated, if any.
3. Assume that the operating net income for the year 2015 is $300000, what is the effect of the loss on the operating net income before and after increasing depreciation.
4. What is the effect of the proposed accounting treatment on balance sheet of 2015? Specify exactly where the effect will be.
5. What should John do? Discuss in any of financial statement should be reported the losses arising from the sale equipment, specify the section of financial statement.
6. Discuss the negative consequences that might be caused by the earnings management practices.
7. How John proposal will affect the net cash flow from operating activities? Explain and determine the value of the change.
Explanation / Answer
Ans 1) Yes, there is an issue of earning management and It is accounting earning manangement problem. Here the supervisor wants to inflate the depreciatio account so that the loss incurred on the sale of the assets will not have a bigger effect, the loss will be mitigated, which is not right.
Ans 2) Extra depreciation would amount 90000. This will be counted as violation of GAAP, since under GAAp the depreciation can not be charged simply on the wish of super visor. there are the process which one has to follow. The first step is to determine the cost of the assets second step is estimate the life of the assets step 3 is estimate the salvage value and then last step is to choose an appropriate method od dep. and accordibgly calculated dep is charged against that assets.
Ans 3) Before increasing depreciation the net income should be 300000-60000=240000 but after increasing the dep net income will become 300000-40000 (extra dep.) = 260000, but there will not be any loss on sale because the increased dep will 90000 and the value of the assets will be 150000-90000=60000 and the sales price is also same 60000.
Ans 4) Dep will increase hence net profit will reduce by 40000 and the fixed assets will be taken off from balance sheet.
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