Hornberger Company has demonstrated a consistently increasing earnings trend over the past 10 years. Stockholders have come to expect this steady increase, and management has gone to great lengths to emphasize the smooth growth pattern associated with Hornberger’s earnings. At the year-end board of directors meeting, you, as the chief financial officer, present to the board the preliminary results for the year just ended. These results indicate a slight decline in both income from operations and net income when compared to the previous year. The chairman of the board quickly reviews the firm’s earnings history and then suggests the following items for consideration.
(a) Increase the estimated useful life of the company’s plant facilities from 15 to 25 years.
(b) Change the firm’s estimate of bad debts from 4% of credit sales to 2.5% of credit sales.
(c) Change the firm’s amortization period for amortizable intangibles from the industry average of 10 years to 40 years.
These changes will result in income for the period that is slightly higher than that reported for the past year and will continue the upward trend. The board votes on the proposed changes and instructs you to revise the income statement to reflect the changed estimates. How would each of these changes be reported in the current year’s annual report to shareholders? Why would the chairman of the board suggest changing accounting estimates rather than accounting principles? As the accountant, do you have a responsibility to review management’s estimates for reasonableness and to evaluate the motives behind management’s decision to change an accounting estimate?