Sal Shirey is an owner of a small business. His company has recently borrowed a large amount of funds to finance the construction of a large building addition, as well as, the purchase of equipment and machinery. Shirey's banker requires him to submit quarterly financial statements so that he can monitor the financial health of his business. The bank has warned that if profit margins decline, the interest rate on the loan may need to be increased in order to reflect additional risk. Shirey knows that profit may decline this year. As he is preparing the year-end adjusting entries, Sal decides, for depreciation purposes, to treat all long-term asset purchases as though they occurr on the first day of the month following the month of purchase. 1. Is there an ethical issue with the implementation of this rule? If so, what is it?2. When should depreciation first be recorded?3. What impact will Shirey's approach to recording depreciation have on the financial statements?

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Asked Nov 18, 2019
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Sal Shirey is an owner of a small business. His company has recently borrowed a large amount of funds to finance the construction of a large building addition, as well as, the purchase of equipment and machinery. Shirey's banker requires him to submit quarterly financial statements so that he can monitor the financial health of his business. The bank has warned that if profit margins decline, the interest rate on the loan may need to be increased in order to reflect additional risk. Shirey knows that profit may decline this year. As he is preparing the year-end adjusting entries, Sal decides, for depreciation purposes, to treat all long-term asset purchases as though they occurr on the first day of the month following the month of purchase.
1. Is there an ethical issue with the implementation of this rule? If so, what is it?
2. When should depreciation first be recorded?
3. What impact will Shirey's approach to recording depreciation have on the financial statements?

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Expert Answer

Step 1

1.

Yes, there is an ethical issue in the implementation of this rule as it will wrongly enable Person S to reduce the depreciation expenses in the books of accounts. If the amount of depreciation reduces the business’s profit margin will increase. This is an unethical practice because as per IRS depreciation calculation should begin on the service date of the asset i.e. from the date when an asset is placed in service. By treating the long-term asset purchases as though they occur on the first day of the month following the month of purchase Person S is wrongly reducing the amount of depreciation expenses.

Step 2

2.

Depreciation is regularly recorded from the service date onwards, service date can be different from the purchase date of the asset. As per IRS an asset is considered to be placed in service w...

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