Burnitz Manufacturing Company was organized on January 1, 2025. During 2025, it has used in its internal reports the straight-line method of depreciating its plant assets.

On November 8, you are having a conference with Burnitz’s officers to discuss the depreciation method to be used for income tax and external (GAAP) reporting. James Bryant, president of Burnitz, has suggested the use of a new method, which he feels is more suitable than the straight-line method for the needs of the company during the period of rapid expansion of production and capacity that he foresees. Following is an example in which the proposed method is applied to a fixed asset with an original cost of $248,000, an estimated useful life of 5 years, and a salvage value of approximately $8,000.

The president favors the new method because he has heard that:

1. It will increase the funds recovered during the years near the end of the assets’ useful lives when maintenance and replacement disbursements are high.

2. It will result in increased write-offs in later years and thereby will reduce taxes.

Instructions

a. What is the purpose of accounting for depreciation?

b. Is the president’s proposal within the scope of generally accepted accounting principles? In making your decision, discuss the circumstances, if any, under which use of the method would be reasonable and those, if any, under which it would not be reasonable.

c. The president wants your advice on the following issues.

1. Do depreciation charges recover or create funds? Explain.

2. Assume that the Internal Revenue Service accepts the proposed depreciation method in this case. If the proposed method were used for stockholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?

Transcribed Image Text:

Years of Year Life Used 12345 1 2 W N 3 4 45 5 Fraction Rate 1/15 2/15 3/15 4/15 5/15 Depreciation Expense $ 16,000 32,000 48,000 64,000 80,000 Accumulated Depreciation at End of Year $ 16,000 48,000 96,000 160,000 240,000 Book Value at End of Year $ 232,000 200,000 152,000 88,000 8,000