I.

Hakodat Manufacturing Group was organized January 1, 2019. During 2019, it has used in its reports to management the straight-line method of depreciating its plant assets.

On November 8, you are having a conference with Hakodat's officers to discuss the depreciation method to be used for income tax and shareholder reporting. Tao Chen, president of Hakodat, 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 residual value of approximately 8,000 (amounts in thousands).

Year	Years of Life Used	Fraction Rate	Depreciation Expense	Accumulated Depreciation at End of Year	Book Value at End of Year
1	1	1/15	16,000	16,000	232,000
2	2	2/15	32,000	48,000	200,000
3	3	3/15	48,000	96,000	152,000
4	4	4/15	64,000	160,000	88,000
5	5	5/15	80,000	240,000	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 international financial reporting standards? 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 taxing authorities accept the proposed depreciation method in this case. If the proposed method were used for shareholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?