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Effect of Depreciation and Amortization methods on profits

Marcia Diamond is a small business owner and handles all the books for her business. Her company just finished a year when a large amount of borrowed funds were invested into a new building addition as well as numerous equipment and fixture additions. Marcia's banker requires that she submit semiannual financial statements for his file so he can monitor the financial health of her business. He has warned her that if profit margins erode he might raise the interest rate on the borrowed funds since this means the loan is riskier from the bank's point of view. Marcia knows profit margin is likely to decline in this current year. As she posts year-end adjusting entries she decides to apply the following amortization rule: All capital additions for the current year are considered put into service the first day of the following month.


Identify the decisions managers like Ms. Diamond must make in applying amortization methods.
Is Marcia's decision an ethical violation or is it a legitimate decision that managers make in computing amortization?
How will Marcia's amortization rule affect the profit margin of her business?

Solution Preview

First, the assumptions made:

1. The term amortization includes depreciation on the building and equipment.
2. Tax methods for depreciation and amortization are outside the scope of this problem, other than for reference

The two issues facing Ms. Diamond when deciding about how to write off capital additions are method and life. Although alternative methods can substantially affect the amount of expense on the income statement, the assigned life of an asset can have an even greater ...

Solution Summary

The 324 word solution discusses the selection of depreciation method and life, and how those decisions impact the income statement. The solution allows for the latitude business owners have, but also how tax methods can differ from book methods.