OCTOVAN CONSTRUCTION, INC. Changes in Depreciation Accounting and Long-Term Construction Contract Accounting C10-41 Octovan Construction, Inc. is a small privately held construction company. Over 60 percent of its revenue is derived from the design and construction of industrial and residential septic systems. Octovan's earn- ings have steadily declined over the past several years while its working capital and debt to equity ratio have deteriorated. Octovan is investigating operational and financial strategies to mitigate these trends. In reviewing its accounting policies, Octovan believes that changes are warranted for depreciation accounting and long-term construction contract accounting. In prior years, Octovan reported depreciation for both tax and financial reporting purposes based on the modified accelerated cost recovery system (MACRS) as provided for by the Internal Revenue Service code. However, for the current year, Octovan changed its method of depreciation accounting for financial reporting purposes to obtain a better matching of revenue and expense. The newly adopted method provides for depreciation by the double-declining- balance method using longer useful lives. The estimated useful lives of the assets are as follows: Category Motor vehicles Machinery and equipment Office furniture and equipment Buildings and leasehold improvements Life 3-5 years 5-10 years 7-10 years 18-35 years The effect of this change is to reduce beginning of the year accumulated depreciation $250,000 and to reduce current year depreciation expense $100,000. Tax depreciation will continue to exceed book depre- ciation for the next several years. Octovan also changed its method of accounting for long-term construction contracts. In previous periods, revenue was recognized whenever customers were billed for both tax and financial reporting. The timing of billings was specified in each contract. Now for financial reporting purposes, Octovan has adopted the percentage-of-completion method of accounting for long-term construction contracts in order to obtain a better matching of revenue and expense. The effect of this change increases costs and estimated earnings on uncompleted contracts (not yet billed) by $200,000 as of the beginning of the current year and increases current year revenues by $80,000. Octovan is planning on reporting both of these changes prospectively in the current year financial state- ments. Octovan's effective federal tax rate is 30 percent for the current and prior years. Octovan does not anticipate a change in its future effective federal tax rate. Required 1. Discuss whether you agree with Octovan's plans for financial reporting as of the current year-end. 2. If you disagree with any of Octovan's plans in question 1, discuss your recommendation for finan- cial reporting. Be specific as to financial statement impact and presentation.

Changes in Depreciation Accounting and Long-Term Construction Contract Accounting Octovan Construction, Inc, is a small privately held construction company. Over 60 percent of its revenue is derived from the design and construction of industrial and residential septic systems. Octovan's earnings have steadily declined over the past several years while its working capital and debt to equity ratio have deteriorated. Octovan is investigating operational and financial strategies to mitigate these trends. In reviewing its accounting policies, Octovan believes that changes are warranted for depreciation accounting and long-term construction contract accounting. In prior years, Octovan reported depreciation for both tax and financial reporting purposes based on the modified accelerated cost recovery system (MACRS) as provided for by the Internal Revenue Service code. However, for the current year, Octovan changed its method of depreciation accounting for financial reporting purposes to obtain a better matching of revenue and expense. The newly adopted method provides for depreciation by the double-decliningbalance method using longer useful lives. The estimated useful lives of the assets are as follows: The effect of this change is to reduce beginning of the year accumulated depreciation $250,000 and to reduce current year depreciation expense $100,000. Tax depreciation will continue to exceed book depreciation for the next several years. Octovan also changed its method of accounting for long-term construction contracts. In previous periods, revenue was recognized whenever customers were billed for both tax and financial reporting. The timing of billings was specified in each contract. Now for financial reporting purposes, Octovan has adopted the percentage-of-completion method of accounting for long-term construction contracts in order to obtain a better matching of revenue and expense. The effect of this change increases costs and estimated earnings on uncompleted contracts (not yet billed) by $200,000 as of the beginning of the current year and increases current year revenues by $80,000. Octovan is planning on reporting both of these changes prospectively in the current year financial statements. Octovan's effective federal tax rate is 30 percent for the current and prior years. Octovan does not anticipate a change in its future effective federal tax rate. Required 1. Discuss whether you agree with Octovan's plans for financial reporting as of the current year-end. 2. If you disagree with any of Octovan's plans in question 1, discuss your recommendation for financial reporting. Be specific as to financial statement impact and presentation