Question 1. Luca Hanson owns Luca's Limousine, which operates a fleet of limousines and shuttle buses. Upon reviewing the most recent financial statements, Luca became confused over the recent decline in net income. He called his accountant and asked for an explanation. The accountant told Luca that the numerous repairs and maintenance expenses, such as oil changes, cleaning, and minor engine repairs, had totaled to a large amount. Further, because several drivers were involved in accidents, the fleet insurance premiums had also risen sharply. Luca told his accountant to simply capitalize all the expenses related to the vehicles, rather than expensing them. These capitalized repair costs could then be depreciated over the next 10 to 20 years. By capitalizing those expenses, the net income would be higher, as would property and equipment assets; therefore, both the income statement and balance sheet would look better. His accountant, however, disagreed because the costs were clearly routine maintenance and because they did not extend the fleet's useful life. Luca then told his accountant that the estimated useful life of the vehicles needed to be changed from 5 years to 15 years to lower the amount of depreciation expense. His accountant responded that capitalizing costs that should be expensed and extending the estimated lives of assets just to increase the reported net income was unethical and wrong. Luca said that it was his business and therefore demanded that the financial statement be changed to show more net income. As a result, the accountant told Luca to pick up his files and find another accountant. What ethical concerns did the accountant have? If the total amount of repairs and mainte-nance was so large, couldn't a case be made that the amount should be capitalized? Is it unethical to change the estimated life of an asset? Was it unethical for the accountant to sever the business relationship? Do you have any suggestions on how the disagreement can be resolved?

Question 2. Transco, Inc., was the largest company in the state specializing in rebuilding automobile transmissions. Every transmission rebuilt by the business was covered by a nine-month warranty. The owner, Don Adams, was meeting with his accountant to go over the yearly financial state-ments. While reviewing the balance sheet, Don became puzzled by the large amount of current liabilities reported, so he asked his accountant to explain it. The accountant said that most of the current liabilities were the result of accruals, such as the estimated warranty payable, some addi-tional wages payable, and interest accrued on the note owed to the bank. The employees were not actually paid until the first week of the new year, so some of their wages had to be recorded and properly matched against revenues in the current period. Also, several months of interest expense had to be accrued on a bank loan. However, the largest amount of the accrued liabilities was due to the estimated warranty expense. Don asked whether the wages payable and the interest payable could be removed because they would be paid off shortly after the year ended. The accountant stated that accrued liabili-ties had to be properly recognized in the current accounting period, and thus they could not be removed. Don agreed but then asked about the large accrued liability based on the estimated warranty amounts. Again, the accountant stated that in previous years the actual warranty cost had been about 4 percent of the total sales and therefore, in the current year, the estimate was accrued at 4 percent. Don then informed the accountant that a new conditioning lubricant had been added to each transmission rebuilt, which dramatically reduced the amount of rebuilt transmissions being returned under warranty. As a result, Don strongly felt that the warranty estimate should be reduced to only 3 percent of total sales and the accrued warranty liability and related expense would thereby also be reduced. The accountant argued that the only reason Don wanted to reduce the estimated percentage was to improve the financial statements, which would be unethical and inappropriate.

1. What is the impact of accrued liabilities on the fnancial statements? Should the accrued liabilities for wages and interest payable be removed from the balance sheet?
2. Does Don have a valid reason for wanting to reduce the estimated warranty liabil-ity? Are the accountant's concerns valid?
3. What ethical issues are involved?