CASE STUDY ON REVISING DEPRECIATION ESTIMATES

ACCTG 14
CN 3004

SUBMITTED BY: DONNA MAE A. SINGSON

 REVISING DEPRECIATION ESTIMATES
Typically, a shift in an asset's anticipated useful life or its projected salvage
value. The depreciation expense for the current year and following years is frequently
affected by the modification. Depreciation expense is calculated by estimating a number
of factors that may vary or require adjustment over the asset's lifetime owing to internal
or external influences. As a result of a change in any of these estimates, the business
will be required to incorporate the change in a prospective manner beginning on the
date of revision and continuing forth. Previous periods are not adjusted for change in
estimates.
Estimates that may need revision are:
Useful life of asset: the period for which asset is expected to stay operational
may change
Depreciation rate: if the rate of cashflows (benefits) from the asset has increased
or decreased, entity may have to adjust depreciation rate to match up.
Residual value of asset: the value entity is expecting to recover at the end of
useful life by scrapping or recycling the asset may be different than expected.
This will change the depreciable value of asset.
Factors that may invoke revision of above estimates can be internal to entity or
external.
Internal factors include:
Change in use and application of asset working for longer hours, used by
untrained workers.
New information obtained that is different from previous estimates and
expectations
Damage resulting in shorter useful life
External factors include:
Market value has reduced significantly that will eventually change salvage value of
asset. Technological advancement as new equipment is available or restrictions by
government may force entity to abandon the asset sooner than expected.
Accounting for change in depreciation related estimates
Because it is a change in estimate, it will be accounted for prospectively, from the
date of modification through the end of the asset's useful life. In previous years'
computations, no changes were performed. The procedure is straightforward. Calculate
the depreciation charge based on revised estimates and the starting net book value of
the asset (carried forward value of the asset from the previous year prior to
modification).
 Final Output (problem)
Revising depreciation estimates
Hard Bodies Co. is a fitness chain that has just completed its second year of
operations. At the beginning of its first fiscal year, the company purchased fitness
equipment at a cost of $600,000 and estimated that the equipment would have a useful
life of five years and no residual value. The company uses the straight-line depreciation
method. The company reported net income for the first two years of operations as
follows:
Year Net Income (Loss)
1 $50,000
2 (2,000)
Mike Gambit, the company's chief financial officer (CFO), has recently run
financial models to predict future net income, and he expects net losses to continue at
per year for the next three years. James Steed, the president of Hard Bodies, is
concerned about these predictions, as he is under pressure from the company's owner
to return the company to Year 1 net income levels, If the company does not meet these
goals, both he and Mike will likely be fired. Mike suggests that the company change the
estimated useful life of the fitness equipment to 10 years and increase the equipment's
estimated residual value to $50,000. This will reduce depreciation expense and
increase net income.
QUESTIONS:
1.Evaluate the decision Co change the equipment's estimated useful life and
estimated residua! Value to improve earnings. How does this change impact the
usefulness of the company's net income for external decision makers?
ANSWERS
It is very important to apply the fundamental qualitative characteristics of financial
statements which are verifiability, timeliness, understandability, comparability.
And most especially it should be faithfully presented. Financial reports must have
faithful depiction as a basic feature in order to be relevant for economic decision-
making. Good financial reports assist in making educated economic decisions
that improve resource allocation efficiency. In words and numbers, general
purpose financial reports depict economic occurrences. Financial data must not
only be relevant, but it must also accurately represent the phenomena it purports
to describe in order to be valuable. faithful representation refers to the depiction
of an economic phenomenon's substance rather than only its legal form.
 The expense is minimized, while the net revenue is inflated, thus deceiving
financial statement users into making incorrect decisions. The financial statement
that shows net income does not accurately reflect what happened. It professes to
represent and is misleading in the sense that it encourages decision-makers to
invest in the company business. The company's usefulness will be questioned
because management's calculations do not accurately reflect the economic
benefits and liabilities of the asset used to boost the company's net income.
QUESTION
2.If Mike and James make the change, are they acting in an ethical manner?
Explain.
ANSWERS
Accepting a position in a corporation, they must not only meet the needs of their
clients, but also act in the public interest. A professional accountant should
observe and follow the ethical obligations of their profession when operating in
the public good. Accounting professionals must follow the rules and regulations
that govern their domains and bodies of work as a matter of ethics. Avoiding
behaviors that could harm the profession's reputation is a legitimate expectation
that business partners and others should have. However, in this case Mike and
James make the change and they are obviously not acting in an ethical manner.
They should follow the core values of integrity, objectivity, professional
competence and due care, confidentiality, and professional behavior to be
ethically compliant. They are directly breaking Integrity and Objectivity by
making the adjustments. Integrity was shattered because they were not honest
and forthright in their professional and business dealings by attempting to
manipulate net income and costs. Objectivity is also important. They were
infringed upon in the sense that they permitted bias to overcome their business
judgments in order to present greater numbers. a higher net income and lower
expenditure.
Recommendations
Depreciation moves the asset's costs from the balance sheet to the income
statement's expenses throughout the asset's useful life. Depreciation is a method of
allocating resources to achieve the matching principle. It is not a method for determining
an asset's fair market value. And professionals should always consider and remember
to act on an ethical manner because it is very important not just in the company but for
yourself as well. James and Mike should make their research more about the
company’s problem and make decision that would fix the problem. Also, they could
collect the past data of company in order for them to compare and can get some
information that would help them not to make an impulsive decision.
 Depreciation allows businesses to recoup the cost of an asset they purchased.
Instead of collecting the purchase price immediately, the technique allows corporations
to cover the whole cost of an asset over its lifetime. This enables businesses to replace
future assets with the right amount of revenue.