Prophet Manufacturing Limited was organized on January 1, 2014. During 2014, it used the straight-line method of amortizing its plant assets in its reports to management.
As the company's controller, on November 8 you are having a conference with Prophet's officers to discuss the depreciation method to be used for income tax and for reporting to shareholders. Fred Peretti, president of Prophet, has suggested using a new method that he feels is more suitable than the straight-line method for the company’s current needs during what he foresees will be a period of rapid expansion of production and capacity. The following is an example
in which the proposed method is applied to a capital asset with an original cost of $248,000, an estimated useful life of five years, and a residual value of approximately $8,000:
The president favours the new method because of the following claims that he has heard about it:
1. It will increase the funds that are recovered during the years near the end of the assets' useful life when maintenance and replacement disbursements are high.
2. It will result in increased writeoffs in later years when the company is likely to be in a better operating position.
Draft a response to Fred Peretti that explains the purpose of depreciation, and whether the method that has been suggested qualifies as a generally accepted accounting method. Identify the circumstances, if any, that would make using the method reasonable and those, if any, that would make using it unreasonable. Also respond to his statement that depreciation charges recover or create funds.

  • CreatedSeptember 18, 2015
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