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

In starting the asset had useful life of 10 years so Depreciation=42 million/10=$4.2 million

For 2011 & 2012 it will be charged 4.2 million each year

Noo thebook value of asset is $33.2 million and total service life is 3 years left

So the correct treatment is 33.2/3=$11.07 million for next three years.

According to Heather it shouldbe impaired in 2013 by $12.9 million that means there would be increase in expense that means decrease in income by ($19.67-11.07=$8.6 million) calculation as follows 12.9 million for impairment and $6.77 will be charged against depreciation totalling $19.67 million.according to CEO It will be $11.07 million in 2013.

Sos dilemma is that he should impaired the asset or should charge depreciation according to Straight line method.

According to accounting principles if there is change in estimate of the useful life of the asset than it should be estimated with best possible information. So if the asset life is reduced than for that current period and future periods it should be reestimated.If Heather impair the asset by $ 12.9 million than the remaining value of tha asset is $20.3 million and it would be depreciated for $6.77 for three years. So in future there will be increase in profit by $11.07-6.77=$4.3 million

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