Finney Container Company has been seeing sales go down for its main product, non-biodegradable plastic cartons. Although some expenses have also reduced in line with the reduced revenues, there has been a decrease in profit because some expenses, such as depreciation, have not declined. The company uses the straight-line depreciation method.
The president, Philip Shapiro, recalling his college accounting classes, instructs his controller to lengthen the estimated asset lives used for depreciation calculations in order to reduce annual depreciation expense and increase profit. The president's compensation includes an annual bonus based on the amount of net profit reported in the income statement.
A processing line of automated plastic-extruding equipment that was purchased for $2.9 million in January 2012 was originally estimated to have a useful life between five and nine years. The refore, the company used the middle of that estimate, or seven years, as the useful life, and a residual value of $100,000, to calculate the annual straight-line depreciation for the first two years. However, the president now wants the equipment's estimated useful life to be changed to nine years (total), and to continue using the straight-line method.
The controller is hesitant to make the change, believing it is unethical to increase profit in this way. The president says, "Hey, the useful life is only an estimate. Besides, I've heard that our competition uses a nine-year estimated life on its production equipment. You want the company results to be competitive, don't you? So maybe we were wrong the first time and now we are getting it right. Or you can tell the auditors that we think may be the equipment will last longer now that we are not using it as much."
Instructions
(a) Who are the stakeholders in this situation?
(b) Is the suggested change in asset life unethical or simply a shrewd business practice by a sharp president?
(c) What would be the impact of the president's proposed change on profit in the year of the change?