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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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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 6 years 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 8 to 10 years. 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 5 years. In preparing financial statements, Ms. Carmichael uses the straight-line depreciation method and expected lives that average 12 years for the new equipment.

Required:

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?

To determine

Introduction:

Depreciation expense should be considered at the time of calculating net profit so, that the company gets the correct profit and loss in the current financial year.

To discuss:

What types of the possible consequence of the controller’s decision on the amount of depreciation expense shown on the financial statement if this decision goes unchallenged?

Explanation

When a company purchases an old company which is not a profit making then the existing company purchase old company for the purpose of increasing its own capacity.

But right now the company wants that old asset will not be used in this company so new assets will be purchased and depreciation will be charged as per new policy, old machine lif...

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