At the beginning of 2014, the New
Food Company purchased equipment for $42 million to be used in the manufacture
of a new line of gourmet frozen foods. The equipment was estimated to have a
10-year service life and no residual value. The straight-line depreciation
method was used to measure depreciation for 2014 and 2015.
Late in 2016, it became apparent
that sales of the new frozen food line were significantly below expectations.
The company decided to continue production for two more years (2017 and 2018)
and then discontinue the line. At that time, the equipment will be sold for
minimal scrap values.
The controller, Shannon Jones, was
asked by Jerry Dent, the company's chief executive officer (CEO), to determine
the appropriate treatment of the change in service life of the equipment. Shannon
determined that there has been an impairment of value requiring an immediate
write-down of the equipment of $12,900,000. The remaining book value would then
be depreciated over the equipment's revised service life.
The CEO does not like Shannon’s
conclusion because of the effect it would have on 2016 income. “Looks like a
simple revision in service life from 10 years to 5 years to me,” Dent
concluded. “Let's go with it that way, Shannon.”
- What is the difference in before-tax income between the
CEO's and Shannon’s treatment of the situation?
- Discuss Shannon’s ethical dilemma and give her advice
on how to handle this situation.