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    Depreciation and Ethics

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    Flo Choi owns a small business and manages the accounting. Her company just finished a year in which a large amount of borrowed funds was invested in a new building addition as well as in equipment and fixture additions. Choi's banker requires her to submit semiannual financial statements 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 to reflect the increased loan risk form the bank's point of view. Choi knows profit margin is likely to decline this year. As she prepares year-end adjusting entries, she decides to apply the following depreciation rule: All asset additions are considered to be in use on the first day of the following month. (The previous rule assumed assets are in use on the first day of the month nearest to the purchase date.)

    a. Identify decisions that managers like Choi must make in applying depreciation methods.

    b. Is Choi's rule an ethical violation, or is it a legitimate decision in computing depreciation?

    c. How will Choi's depreciation rule affect the profit margin of her business?

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    Solution Preview

    a. Identify decisions that managers like Choi must make in applying depreciation methods.

    In applying depreciation methods, Choi would have to make the following decisions -
    1. The useful life of the asset ( the time period over which the asset is to be depreciated)
    2. The salvage value of the asset ( the value that will be left after the useful life is over)
    3. The depreciation method to use (there are different methods ...

    Solution Summary

    The solution explains how a change in depreciation rule impacts the profits of the firm.