Assume you work as an assistant accountant in the head office of a DVD movie kiosk business,similar to Coinstar, Inc. With the increasing popularity of online movie rental operations, yourcompany has struggled to meet its earnings targets for the year. It is important for the company tomeet its earnings targets this year because the company is renegotiating a bank loan next month,and the terms of that loan are likely to depend on the company’s reported financial success. Also,the company plans to issue more stock to the public in the upcoming year, to obtain funds forestablishing its own presence in the online movie rental business. The chief financial officer (CFO)has approached you with a solution to the earnings dilemma. She proposes that the depreciationperiod for the stock of reusable DVDs be extended from 3 months to 15 months. She explains thatby lengthening the depreciation period, a smaller amount of depreciation expense will be recordedin the current year, resulting in a higher net income. She claims that generally accepted accountingprinciples require estimates like this, so it wouldn’t involve doing anything wrong.Required:Discuss the CFO’s proposed solution. In your discussion, consider the following questions. Willthe change in depreciation affect net income in the current year in the way that the CFO described?
Assume you work as an assistant accountant in the head office of a DVD movie kiosk business,
similar to Coinstar, Inc. With the increasing popularity of online movie rental operations, your
company has struggled to meet its earnings targets for the year. It is important for the company to
meet its earnings targets this year because the company is renegotiating a bank loan next month,
and the terms of that loan are likely to depend on the company’s reported financial success. Also,
the company plans to issue more stock to the public in the upcoming year, to obtain funds for
establishing its own presence in the online movie rental business. The chief financial officer (CFO)
has approached you with a solution to the earnings dilemma. She proposes that the
period for the stock of reusable DVDs be extended from 3 months to 15 months. She explains that
by lengthening the depreciation period, a smaller amount of depreciation expense will be recorded
in the current year, resulting in a higher net income. She claims that generally accepted accounting
principles require estimates like this, so it wouldn’t involve doing anything wrong.
Required:
Discuss the CFO’s proposed solution. In your discussion, consider the following questions. Will
the change in depreciation affect net income in the current year in the way that the CFO described?
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