Julio Sanchez manages the cutting department of Guzman Timber Company. He purchased a tree-cutting machine on January 1, 2011, for $400,000. The machine had an estimated useful life of five years and zero salvage value, and the cost to operate it is $90,000 per year. Technological developments resulted in the development of a more advanced machine available for purchase on January 1, 2012, that would allow a 25 percent reduction in operating costs. The new machine would cost $240,000 and have a four-year useful life and zero salvage value. The current market value of the old machine on January 1, 2012, is $200,000, and its book value is $320,000 on that date. Straight-line depreciation is used for both machines. The company expects to generate $224,000 of revenue per year from the use of either machine.

Required

a. Recommend whether to replace the old machine on January 1, 2012. Support your answer with appropriate computations.

b. Prepare income statements for four years (2012 through 2015) assuming that the old machine is retained.

c. Prepare income statements for four years (2012 through 2015) assuming that the old machine is replaced.

d. Discuss the potential ethical conflicts that could result from the timing of the loss and expense recognition reported in the two income statements.