Marcia Diamond is a small business owner who handles all the books for her business. Her company just finished a year in which a large amount of borrowed funds were invested into a new building addition as well as numerous equipment and fixture additions. Marcia’s banker requires that she submit semiannual financial statements for his file so he can monitor the financial health of her business. He has warned her that if profit margins erode, making the loan riskier from the bank’s point of view, he might raise the interest rate on the borrowed funds. Marcia knows that her profit margin is likely to decline in this current year. As she posts year-end adjusting entries, she decides to apply the following depreciation rule: All property, plant and equipment would be depreciated using the straight-line method over 50 years with 50% of each asset’s cost representing the residual value. Marcia knows that most of the assets have a useful life of less than 20 years and little or no residual value but says to herself, “I plan on being in business for the next 50 years so that’s my justification.”
1. Identify the decisions managers like Ms. Diamond must make in applying depreciation methods.
2. Is Marcia’s decision an ethical violation, or is it a legitimate decision that managers make in calculating depreciation?
3. How will Marcia’s depreciation rule affect the profit margin of her business?