Most managers have significant discretion in choosing their accounting policies.

Most managers have significant discretion in choosing their accounting policies. The managers of some companies choose sets of policies that are relatively "conservative"; others choose sets that are relatively "liberal." Conservatism results in delay of the recognition of some revenues or gains and/or acceleration of the recognition of some expenses or losses. Liberal accounting policies do the opposite. The effect of conservatism is that profits are reported later than they would have been had more liberal accounting policies been adopted.
Most managers have significant discretion in choosing their accounting policies.

1. Assume that at least some rewards for the management team (and, hence, also other employees) are based on performance measured in terms of accounting income and returns on net assets. Also assume that all of these airlines are growing; that is, they are adding to their fleet size.
What are the behavioral implications of each of the three depreciation-related accounting policy choices: (1) depreciation patterns (i.e., straight-line vs. accelerated, (2) estimated useful lives, and (3) residual values? Consider, at a minimum, the effects of each of these choices on decisions regarding:
a. Replacements of aircraft in service;
b. Pricing, assuming that prices are at least somewhat dependent on costs;
c. Evaluations of routes or lines of business;
d. Evaluations of managers, assuming that negotiated budgets provide the primary standards of performance.
2. Assume that in a particular U.S. airline company there is a conflict between the benefits of conservatism vs. liberalism in depreciation accounting. That is, for this company conservatism in depreciation accounting is greatly preferred for financial reporting purposes (for whatever reason) but for internal purposes the company would be better off if the policies were more liberal, or vice versa. Would you recommend to the managers of this company that they adopt a third set of books? That is, should they maintain one set of books for financial accounting purposes, another set for tax purposes, and a third set for the purposes of running the business?
3. If the managers of a particular airline do not want to maintain a third set of books, should they tend to be conservative or liberal in their aircraft depreciation accounting? Explain.


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