Assume you work as an assistant accountant in the head office of Netflix. With t

Question

Assume you work as an assistant accountant in the head office of Netflix. With the increasing popularity of online movie streaming, your company has struggled to meet its earnings targets for the year due to the high cost of creating programming content unique to your company. It is important for the company to meet its earnings target this year because the company is renegotiating a bank loan next month that is necessary for international expansion, and the terms of that loan are likely to depend on the company's reported financial success. Also, the company plans to issue more stock to the public in the upcoming year, to obtain additional expansion funds. The chief financial officer (CFO) has approached you with a solution to the earnings dilemma. She proposes that the programming costs which have been capitalized (reported as an asset) be depreciated over a period extended from 4 years to 10 years. She claims that generally accepted accounting principles (GAAP) require estimates like this, so it wouldn't involve doing anything wrong. Question 1: How will the change in depreciation period impact reported net income in the current and future reporting periods? Question 2: Is the CFO correct in stating that GAAP allows changes in estimates? Do you think it appropriate in this situation?

Explanation / Answer

Answer to Question 1.

The programming costs capitalised are proposed to be depreciated over a period of 10 years instead of 4 years. Hence the amount of depreciation which was supposed to be charged in 4 years will now be spread over a larger number of years i.e. 10 which means that depreciation charged each year would reduce substantially in the coming 4 years and depreciation would be charged in the year 5 - 10 (last 6 years) which was not planned earlier. As a result the net income would rise in the coming 4 years while net income would reduce in the year 5-10 due to change in the depreciation policy/estimate.

Answer to Question 2

The GAAP allows changes in estimates but only when the change is as a result of reassessment of expected future benefits of an asset or reassessment of liability. Hence the statement of CFO is generally correct but not in the context of this situation since the change in useful life is done over here with a purpose of increasing the profits to meet the business objectives and since no particular reassessment of expected future benefits carried out.

Hence in my opinion it is not appropriate to do a change in estimate of useful life in this situation.

Further adding a change in estimate requires a disclosure in financial statements with amount of impact in this financial year and future financial years (if any) if there is any material impact on the financial statements. Hence if Netflix still goes ahead with a change in estimate, a disclosure is must for the amounts of impact in the statements, since the impact is material.

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