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Chapter 11
Accounting in Action: CM 2
In Chapter 10, you helped CM 2 evaluate alternatives for replacing or overhauling the old
equipment. Recall that the original cost of the equipment was $440,000 and it was
depreciated over an eight-year life. CM 2 used the double-declining-balance method to
depreciate these assets and estimated a residual value of $50,000. The equipment is now
fully depreciated to its salvage value of $50,000.
Going forward, Conner and Martin are questioning the accounting for depreciation. They
argue that they don't think it is necessary to record depreciation expense on the income
statement because it does not involve a cash outlay. In addition, they do not see the
necessity for reducing the equipment value on the balance sheet. They wonder whether
CM 2 should just stop depreciating its equipment from this point forward.
Instructions
(a)
Research to your textbook for accounting guidance regarding depreciation.
Determine the following concerning depreciation: (1) What is the general concept
underlying depreciation? (2) How does depreciating an asset portray a more realistic
picture of both the performance of the company and its financial position? (3) What is the
effect on CM 2 's financial statements if Conner and Martin decide not to depreciate the
equipment? Write a memo to Conner and Martin addressing these issues.
(b) Use a computer spreadsheet to prepare a depreciation schedule for the old equipment
over its eight-year life, using the double-declining-balance method. Record the journal
entry for depreciation that would be made in the third year of the equipment's useful life.
(c)
Write a short report to explain the merits of an accelerated depreciation
method, such as double-declining-balance. In your answer address the following issues:
Does the type of company or industry have anything to do with the choice of depreciation
method selected? What effect does matching have on the decision to use doubledeclining-balance depreciation versus straight-line depreciation?
(d)
At the next management team meeting, Conner and Martin express some
concern that any new equipment acquired to replace the old equipment may become
obsolete within the next two to five years. A number of popular-press articles have
recently discussed the increasing number of asset impairments occurring in their industry.
Conner and Martin therefore want to know how the accounting rules for impairments
would apply to any new equipment. Refer to your text to determine the guidance for on
impairments including the timing and calculation of the amount under both models and
recommend which should be used at CM 2.Recall that Conner and Martin think that
expenses that do not involve cash outflow should not be recorded; be sure you describe
the reasons for recording impairments.
Additional Activities: Extend your accounting knowledge
You recall from one of your class discussions that asset impairments could be
used to “manage earnings.” Search the Internet for recent stories in the business press
about asset impairments and earnings management. Prepare a memo explaining how
earnings might be managed through asset impairments.