Early one Wednesday afternoon, Ken and Larry studied in the dormitory room they shared at Fogelman College. Ken, an accounting major, was advising Larry, a management major, regarding a project for Larry's Business Policy class. One aspect of the project involved analyzing the 2010 annual report of Craft Paper Company. Though not central to his business policy case, a footnote had caught Larry's attention.
Beginning in 2010, the Company revised the estimated average useful lives used to compute depreciation for most of its pulp and paper mill equipment from 16 years to 20 years and for most of its finishing and converting equipment from 12 years to 15 years. These revisions were made to more properly reflect the true economic lives of the assets and to better align the Company's depreciable lives with the predominant practice in the industry. The change had the effect of increasing net income by approximately $55 million.
“If I understand this right, Ken, the company is not going back and recalculating a lower depreciation for earlier years. Instead they seem to be leaving depreciation overstated in earlier years and making up for that by understating it in current and future years,” Larry mused. “Is that the way it is in accounting? Two wrongs make a right?”
What are the two wrongs to which Larry refers? Is he right?