Question - John supervisor for the Brown Corporation, is preparing the company's income statement at year-end of 2015. He notes that the company had decided and replaced one of its equipment and lost $60000 on the sale of that equipment which was costs 150000 and its depreciation is $50000. Since the company has sold equipment routinely in the past with amount of $40000, John knows the losses cannot be reported as unusual. He also does not want to highlight it as a material loss since he feels that will reflect poorly on him and the company. He reasons that if the company had recorded more depreciation during the useful life of the assets (increasing the depreciation with 80%), the losses would not be so great. Since depreciation is included among the company's operating expenses, he wants to report the losses along with the company's expenses, where he hopes it will not be noticed.
Requirement:
1. Is there an earnings management problem in the above case study? If so specify which type of earnings management and Explain the problem in details.
2. If the supervisor record more depreciation during the useful life of the assets in 2015, what is the value of the increase in depreciation, would this be counted as a violation to the generally accepted accounting principles? Identify and discuss the accounting principle that would be violated, if any.
3. Assume that the operating net income for the year 2015 is $300000, what is the effect of the loss on the operating net income before and after increasing depreciation.
4. What is the effect of the proposed accounting treatment on balance sheet of 2015? Specify exactly where the effect will be.