You and your partner own a small data-entry company. You contract with businesses to manually enter data, such as library card catalogs and medical records, into a computer database. Your most significant physical assets are a large office building you own, along with the computer hardware and software necessary for operations. Your business has been running for five years, and you now have 100 employees. Operating cash flow has always been healthy, and you and your partner have been able to withdraw significant amounts of cash from the business. Recently, you have seen growing discontent among your employees because of their low wages and lack of fringe benefits. You and your partner are preparing for the first meeting with an employee grievance committee.
Your partner has taken responsibility for preparing the company’s financial statements. You are embarrassed to admit that this is the first set of financial statements you have ever examined—you have never sought bank financing and all equity funding has come from you and your partner. You are surprised when you first review the statements because they reveal that the company has experienced significant losses in each of its five years of operation.
A closer look at the statements reveals that your partner has used the double declining-balance method of depreciation for your office building and computer equipment. He has also assumed very short useful lives and zero residual values. Your calculations indicate that using the straight-line method with more realistic useful life and residual value assumptions would increase profits dramatically, even to the extent that substantial profits would be reported in each of the first five years of operation.
The meeting with the employee grievance committee is tomorrow. Your partner has been your friend since first grade. What, if anything, should you do?