Assume you are one of three members of the accounting staff working for a small, private company. At the beginning of this year, the company expanded into a new industry by acquiring equipment that will be used to make several new lines of products. The owner and general manager of the company has indicated that, as one of the conditions for providing financing for the new equipment, the company's bank will receive a copy of the company's annual finance statements. Another condition of the loan is that the company's total assets cannot fall below $250,000. Violation of this condition gives the bank the option to demand immediate repayment of the loan. Before making the adjustment for this year's depreciation, the company's total assets are reported at $255,000. The owner has asked you to take a look at the facts regarding the new equipment and "work with the numbers to make sure everything stays onside with the bank."
A depreciation method has yet not been adopted for the new equipment. Equipment used in other parts of the company is depreciated using the double-declining-balance method. The cost of new equipment was $35,000 and the manager estimates it will be worth "at least $7,000" at the end of its four-year useful life. Because the products made with the new equipment are only beginning to catch on with consumers, the company used the equipment to produce just 4,000 units this year. It is expected that, over all four years of its useful life, the new equipment will make a total of 28,000 units.
Required:
1. Calculate the depreciation that would be reported this year under each of the three methods shown in this chapter. Which of the methods would meet the owner's objective?
2. Evaluate whether it is ethical to recommend that the company use the method identified in requirement 1. What two parties are most directly affected by this recommendation? How would each party be benefited or harmed by the recommendation? Does the recommendation violate any laws or applicable rules? Are there any other factors that you would consider before making a recommendation?