11 Depreciation, Impairments, and Depletion CONCEPTS FOR ANALYSIS 11
CONCEPTS FOR ANALYSIS
CA11-1 (Depreciation Basic Concepts) Burnitz Manufacturing Company was organized on January 1, 2017. During 2017, it has used in its reports to management the straight-line method of depreciating its plant assets.
On November 8, you are having a conference with Burnitz’s officers to discuss the depreciation method to be used for income tax and stockholder reporting. James Bryant, president of Burnitz, has suggested the use of a new method, which he feels is more suitable than the straight-line method for the needs of the company during the period of rapid expansion of production and capacity that he foresees. Following is an example in which the proposed method is applied to a fixed asset with an original cost of $248,000, an estimated useful life of 5 years, and a salvage value of approximately $8,000.
…
The president favors the new method because he has heard that:
1. It will increase the funds recovered during the years near the end of the assets’ useful lives when maintenance and replacement disbursements are high.
2. It will result in increased write-offs in later years and thereby will reduce taxes.
Instructions
(a) What is the purpose of accounting for depreciation?
(b) Is the president’s proposal within the scope of generally accepted accounting principles? In making your decision, discuss the circumstances, if any, under which use of the method would be reasonable and those, if any, under which it would not be reasonable.
(c) The president wants your advice on the following issues.
(1) Do depreciation charges recover or create funds? Explain.
(2) Assume that the Internal Revenue Service accepts the proposed depreciation method in this case. If the proposed method were used for stockholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?
CA11-2 WRITING (Unit, Group, and Composite Depreciation) The certified public accountant is frequently called upon by management for advice regarding methods of computing depreciation. Of comparable importance, although it arises less frequently, is the question of whether the depreciation method should be based on consideration of the assets as units, as a group, or as having a composite life.
Instructions
(a) Briefly describe the depreciation methods based on treating assets as (1) units and (2) a group or as having a composite life.
(b) Present the arguments for and against the use of each of the two methods.
(c) Describe how retirements are recorded under each of the two methods.
(AICPA adapted)
CA11-3 (Depreciation—Strike, Units-of-Production, Obsolescence) The following are three different and unrelated situations involving depreciation accounting. Answer the question(s) at the end of each situation.
Situation I: Recently, Broderick Company experienced a strike that affected a number of its operating plants. The controller of this company indicated that it was not appropriate to report depreciation expense during this period because the equipment did not depreciate and an improper matching of costs and revenues would result. She based her position on the following points.
1. It is inappropriate to charge the period with costs for which there are no related revenues arising from production.
2. The basic factor of depreciation in this instance is wear and tear. Because equipment was idle, no wear and tear occurred.
Instructions
Comment on the appropriateness of the controller’s comments.
Situation II: Etheridge Company manufactures electrical appliances, most of which are used in homes. Company engineers have designed a new type of blender which, through the use of a few attachments, will perform more functions than any blender currently on the market. Demand for the new blender can be projected with reasonable probability. In order to make the blenders, Etheridge needs a specialized machine that is not available from outside sources. It has been decided to make such a machine in Etheridge’s own plant.
Instructions
(a) Discuss the effect of projected demand in units for the new blenders (which may be steady, decreasing, or increasing) on the determination of a depreciation method for the machine.
(b) What other matters should be considered in determining the depreciation method? (Ignore income tax considerations.)
Situation III: Haley Paper Company operates a 300-ton-per-day kraft pulp mill and four sawmills in Wisconsin. The company is in the process of expanding its pulp mill facilities to a capacity of 1,000 tons per day and plans to replace three of its older, less efficient sawmills with an expanded facility. One of the mills to be replaced did not operate for most of 2017 (current year), and there are no plans to reopen it before the new sawmill facility becomes operational.
In reviewing the depreciation rates and in discussing the salvage values of the sawmills that were to be replaced, it was noted that if present depreciation rates were not adjusted, substantial amounts of plant costs on these three mills would not be depreciated by the time the new mill came on stream.
Instructions
What is the proper accounting for the four sawmills at the end of 2017?
CA11-4 WRITING (Depreciation Concepts) As a cost accountant for San Francisco Cannery, you have been approached by Phil
Perriman, canning room supervisor, about the 2017 costs charged to his department. In particular, he is concerned about the line item “depreciation.” Perriman is very proud of the excellent condition of his canning room equipment. He has always been vigilant about keeping all equipment serviced and well oiled. He is sure that the huge charge to depreciation is a mistake; it does not at all reflect the cost of minimal wear and tear that the machines have experienced over the last year. He believes that the charge should be considerably lower.
The machines being depreciated are six automatic canning machines. All were put into use on January 1, 2017. Each cost $625,000, having a salvage value of $55,000 and a useful life of 12 years. San Francisco depreciates this and similar assets using double-declining-balance depreciation. Perriman has also pointed out that if you used straight-line depreciation, the charge to his department would not be so great.
Instructions
Write a memo dated January 22, 2017, to Phil Perriman to clear up his misunderstanding of the term “depreciation.” Also, calculate year-1 depreciation on all machines using both methods. Explain the theoretical justification for double-declining-balance and why, in the long run, the aggregate charge to depreciation will be the same under both methods.
CA11-5 ETHICS (Depreciation Choice—Ethics) Jerry Prior, Beeler Corporation’s controller, is concerned that net income may be lower this year. He is afraid upper-level management might recommend cost reductions by laying off accounting staff, including him.
Prior knows that depreciation is a major expense for Beeler. The company currently uses the double-declining-balance method for both financial reporting and tax purposes, and he’s thinking of selling equipment that, given its age, is primarily used when there are periodic spikes in demand. The equipment has a carrying value of $2,000,000 and a fair value of $2,180,000.
The gain on the sale would be reported in the income statement. He doesn’t want to highlight this method of increasing income.
He thinks, “Why don’t I increase the estimated useful lives and the salvage values? That will decrease depreciation
Instructions
Answer the following questions.
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues involved?
(c) What should Prior do?
