At the beginning of 2011, the Healthy Life Food Company purchased equipment for

Question

At the beginning of 2011, the Healthy Life Food Company purchased equipment for $42 million to be used in the manufacture of a new line of gourmet frozen foods. The equipment was estimated to have a 10-year service life and no residual value. The straight-line depreciation method was used to measure depreciation for 2011 and 2012.

Late in 2013, it became apparent that sales of the new frozen food line were significantly below expectations. The company decided to continue production for two more years (2014 and 2015) and then discontinue the line. At that time, the equipment will be sold for minimal scrap values.

The controller, Heather Meyer, was asked by Harvey Dent, the company's chief executive officer (CEO), to determine the appropriate treatment of the change in service life of the equipment. Heather determined that there has been an impairment of value requiring an immediate write-down of the equipment of $12,900,000. The remaining book value would then be depreciated over the equipment's revised service life.

The CEO does not like Heather's conclusion because of the effect it would have on 2013 income. “Looks like a simple revision in service life from 10 years to 5 years to me,” Dent concluded. “Let's go with it that way, Heather.”

What is the difference in before-tax income between the CEO's and Heather's treatment of the situation?

Discuss Heather Meyer's ethical dilemma. Do you agree with the ethical perspectives of your classmates? What implications could this have on future Healthy Life Food Company dealings?

Explanation / Answer

The depreciaiton as per heather is

Depreciation =$42mn/10=$4.2 mn

For 2011:$4.2 mn

For 2012:$4.2 mn

Ending book value after 2012= 42-4.2-4.2= $33.6 mn

Impairement in 2013= $12.9 mn

Depreciation for 2014 and 2015 assuming $1mn salvage value

=(20.7-1)/2=$9.85 mn

For 2014= $9.85 mn

For 2015= $9.85 mn

As per CEO treatment:

Depreciation =$42mn/10=$4.2 mn

For 2011:$4.2 mn

For 2012:$4.2 mn

But at end of 2 year policy changed so the new depreciation = (33.6-1)/3= $10.87 for 2013.2014 and 2015.

The change is for

For 2013: 12.9-10.87=$2.03 mn

For 2014=9.85-10.87=($1.02 mn)

For 2015=9.85-10.87=($1.02 mn)

As per CEO it is unethical to not recognize the impairement of assets . As per GAAP and IFRS the impairment of asset is required if recognized and as controller of organization heather is supposed to oppose the CEO as he has to work on the the interest of shareholders and not management.

If company looses the trust of the shareholders it will effect company stock performance and will give negative feedback in market.

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