During a meeting of top executives of the Alcorn Corporation, a discussion of the current downturn of sales and profits was taking place. Expecting vigorous competition to extend this difficult situation well into the next decade, the executives searched for ways to soften its impact on the financial statements. Attention was focused upon the company controller who was answering inquiries concerning the possibility of changing accounting procedures in order to give shareholders' the "best view from a bad situation". Responding to the inquiries, the controller authoritatively observed: "Alcorn uses a 10-year expected life on its long-term assets and a salvage value equal to 5% of cost in calculating depreciation expense using the straight-line method. This policy was quite conservative in light of the industry average of a 15-year life expectancy and a 10% of cost salvage value. In light of the 3 billion dollars of depreciable assets (net book value), switching to the industry average would certainly improve the measured results of operations." Everyone was thrilled about the possibility of improving measured profits except for one middle-top executive. She questioned whether the switch would be acceptable to the auditor. The controller responded that switching to industry average expectations would not violate GAAP and would be acceptable to the auditor (whose firms depends greatly on Alcorn's account). Alcorn would disclose the change in the footnotes and the effect of this change on accounting estimates in the current year's net income. The questioning executive would not object to the plan to liberalize income measurement, but stated that it has always been known as a most conservative firm. And if things ultimately go from bad to worse, Alcorn may get some negative press concerning the change because of the appearance of delaying disclosure on the income statement of the financial trouble Alcorn is facing. It was decided to change the depreciation policy using the industry average expected life and salvage value. Comment on this change of depreciation measurement in light of generally accepted accounting principles and the problem of appearance. Include the amount of increase in net income caused by this change in depreciation parameters.

Question

Quizplus · Accepted Answer

The Answer of During a meeting of top executives of the Alcorn Corporation, a discussion of the current downturn of sales and profits was taking place. Expecting vigorous competition to extend this difficult situation well into the next decade, the executives searched for ways to soften its impact on the financial statements. Attention was focused upon the company controller who was answering inquiries concerning the possibility of changing accounting procedures in order to give shareholders' the "best view from a bad situation". Responding to the inquiries, the controller authoritatively observed: "Alcorn uses a 10-year expected life on its long-term assets and a salvage value equal to 5% of cost in calculating depreciation expense using the straight-line method. This policy was quite conservative in light of the industry average of a 15-year life expectancy and a 10% of cost salvage value. In light of the 3 billion dollars of depreciable assets (net book value), switching to the industry average would certainly improve the measured results of operations." Everyone was thrilled about the possibility of improving measured profits except for one middle-top executive. She questioned whether the switch would be acceptable to the auditor. The controller responded that switching to industry average expectations would not violate GAAP and would be acceptable to the auditor (whose firms depends greatly on Alcorn's account). Alcorn would disclose the change in the footnotes and the effect of this change on accounting estimates in the current year's net income. The questioning executive would not object to the plan to liberalize income measurement, but stated that it has always been known as a most conservative firm. And if things ultimately go from bad to worse, Alcorn may get some negative press concerning the change because of the appearance of delaying disclosure on the income statement of the financial trouble Alcorn is facing. It was decided to change the depreciation policy using the industry average expected life and salvage value. Comment on this change of depreciation measurement in light of generally accepted accounting principles and the problem of appearance. Include the amount of increase in net income caused by this change in depreciation parameters.

During a Meeting of Top Executives of the Alcorn Corporation