Zhao Construction Components, Inc., purchased a machine on January 1, 2012, for $240,000. The chief engineer estimated the machine’s useful life to be six years and its salvage value to be zero. The operating cost of this machine is $120,000 per year. By January 1, 2014, a new machine that requires 30 percent less operating cost than the existing machine has become available for $180,000; it would have a four-year useful life with zero salvage. The current market value of the old machine on January 1, 2014, is $100,000, and its book value is $160,000 on that date. Straight-line depreciation is used for both machines. The company expects to generate $320,000 of revenue per year from the use of either machine.
a. Recommend whether to replace the old machine on January 1, 2014. Support your answer with appropriate computations.
b. Prepare income statements for four years (2014 through 2017) assuming that the old machine is retained.
c. Prepare income statements for four years (2014 through 2017) assuming that the old machine is replaced.
d. Discuss the potential ethical conflicts that could result from the timing of the loss and expense recognition reported in the two income statements.