MANAGEMENT'S DEPRECIATION DECISION. Great Basin Enterprises, a large holding company, acquired North Spruce Manufacturing, a medium-size manufacturing business, from its founder, who wishes to retire. Despite great potential for development, North Spruce’s income has been dropping in recent years. Great Basin installs a new management group (including a new controller) at North Spruce and gives the group 6 years to expand and revitalize the operations; management compensation includes a bonus based on net income generated by the North Spruce operations.

If North Spruce does not show considerable improvement by the end of the sixth year, Great Basin will consider selling it. The new management immediately makes significant investments in new equipment but finds that new revenues develop slowly. Most of the new equipment will be replaced in 8 to 10 years. To defer income taxes to the maximum extent, the controller uses accelerated depreciation methods and the minimum allowable expected lives for the new equipment, which average 5 years. In preparing financial statements, the controller uses straight-line depreciation and expected lives that average 12 years for the new equipment.

REQUIRED:
1. Why did the controller compute financial statement depreciation as he or she did?
2. What are the possible consequences of the controller’s decision on financial statement depreciation if it goes unchallenged?