Edward L. Vincent is CFO of Energy Resources, Inc. The company specializes in the exploration and development of natural gas. It’s near year-end, and Edward is feeling terrific. Natural gas prices have risen throughout the year, and Energy Resources is set to report recordbreaking performance that will greatly exceed analysts’ expectations. However, during an executive meeting this morning, management agreed to “tone down” profits due to concerns that reporting excess profits could encourage additional government regulations in the industry, hindering future profitability. At the beginning of the current year, the company purchased equipment for $4,200,000. The company’s standard practice for equipment like this is to use straight-line depreciation over 12 years using an estimated residual value of $600,000. To address the issue discussed in the meeting, Edward is considering three options. Option 1: Adjust the estimated service life of the equipment from 12 years to 6 years. Option 2: Adjust estimated residual values on the equipment from $600,000 to $0. Option 3: Make both adjustments. Required: 1. Calculate annual depreciation using the company’s standard practice. 2. Calculate annual depreciation for each of the three options and state whether the option would increase or decrease net income. 3. Which option has the biggest effect on net income?
Edward L. Vincent is CFO of Energy Resources, Inc. The company specializes in the exploration and development of natural gas. It’s near year-end, and Edward is feeling terrific. Natural gas prices have risen throughout the year, and Energy Resources is set to report recordbreaking performance that will greatly exceed analysts’ expectations. However, during an executive meeting this morning, management agreed to “tone down” profits due to concerns that reporting excess profits could encourage additional government regulations in the industry, hindering future profitability.
At the beginning of the current year, the company purchased equipment for $4,200,000. The company’s standard practice for equipment like this is to use straight-line depreciation over 12 years using an estimated residual value of $600,000. To address the issue discussed in the meeting, Edward is considering three options. Option 1: Adjust the estimated service life of the equipment from 12 years to 6 years. Option 2: Adjust estimated residual values on the equipment from $600,000 to $0. Option 3: Make both adjustments.
Required:
1. Calculate annual depreciation using the company’s standard practice.
2. Calculate annual depreciation for each of the three options and state whether the option would increase or decrease net income.
3. Which option has the biggest effect on net income?
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