John, supervisor for the Brown Corporation, is preparing the company’s income st
ID: 2487206 • Letter: J
Question
John, supervisor for the Brown Corporation, is preparing the company’s income statement at year-end of 2014. 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.
1. What is the effect of the proposed accounting treatment on balance sheet of 2014? Specify exactly where the effect will be.
2. How John proposal will affect the net cash flow from operating activities? Explain and determine the value of the change.
3. 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.
4. Discuss the negative consequences that might be caused by the earnings management practices.
Explanation / Answer
Effect of change in depreciation Current process With Increased depreciation Asset Gross Value 150,000 150,000 Accumulated depreciation before sale 50,000 90,000 Book Value of Asset 100,000 60,000 Sales proceeds from Asset sale 40,000 40,000 Loss on sale of Asset 60,000 20,000 Additional Depreciation expense in P/L 40,000 Reduction in Loss on Asset sale 40,000 1 In Balance sheet the net effect will be nil as the Accumulated depreciation will be first credited with additional $40000 depreciation and the same account will be debited with additional $40000 during asset sale booking. The effect will be in net oprerating expenses where depreciation expense will be increased by $40000,net income from Operating Activities will reduce by $40,000 . Other side of Non operating Income and Expenses the Loss from sale of assets will be reduced by $40000 2 Net Cash flow will show isame results Assume the net income befor adjustement=X Current process With Increased depreciation Net Income X X-40000 +40000 Add Loss from Asset Sale 60,000 20,000 Net Cash flow from operating Activities = X+60000 X+20000 Add Depreciation 40,000 Net Cash flow from Operating Activities = X+60000 X+60000 Additional cash flow from operating Activities - 3 John should not do any adjustement unless there is business reasons to change the depreciation rate of equipment. The loss on sale of assets need to be reported in No operating Income and Loss section of P/L 4 Any change done arbtrarily withou any business logic to hide loss by increasing expenses may create problem in Audit and will make the company vulnerable to earning management accusation . The precednce will be bad for the company and the company must follow consistent accounting policy .
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