Management’s Depreciation Decision . Great Basin Enterprises, a large holding co

Question

Management’s Depreciation Decision . Great Basin Enterprises, a large holding company, acquired North Spruce Manufacturing, a medium-sized manufacturing business, from its founder who wishes to retire. Despite great potential for development, North Spruce’s income has been dropping in recent years. Great Basin has installed a new management group (including a new controller, Christie Carmichael) at North Spruce and has given the group to expand and revitalize the operations. Management compensation includes a bonus based on net income generated by the North Spruce operations. If North Spruce does not show considerable improvement by the end of the sixth year, Great Basin will consider selling it. The new management immediately makes significant investments in new equipment but finds that new revenues develop slowly. Most of the new equipment will be replaced in to . To defer income taxes to the maximum extent, Ms. Carmichael uses accelerated depreciation methods and the minimum allowable “expected lives” for the new equipment, which average . In preparing financial statements, Ms. Carmichael uses the straight-line depreciation method and expected lives that average for the new equipment. Required: 1.Why did the controller compute depreciation expense on the financial statements as she did? 2.What are the possible consequences of the controller’s decision on the amount of depreciation expense shown on the financial statements if this decision goes unchallenged?

Explanation / Answer

Carmichael's bonus is based on the net income generation from operations and the income has been improving slowly. Thus in order to maintain her bonus Straight line depreciation is being used in the Financial Statement

If her decision goes unchallenged and accelerated depreciation is used than this difference in accounting will lead to Deferred Tax Liability in the Financial Statement

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