Scenario

Due to rising costs and falling revenues in the restaurant supply sector in which your company manufactures and distributes pasta products, your boss, the Chief Financial Officer (CFO) has asked you to capitalize the following expenditures rather than show them as expenses, in order to report higher net earnings to the shareholders:

  1. Salaries for several workers dedicated to designing, building, and installing new production equipment.
  2. Rent on current warehouse (month-to-month rental).
  3. Interest expense incurred on financing for a new warehouse under construction.
  4. Architect and engineering fees on the new warehouse under construction.
  5. Repairs and maintenance on the company fleet of vehicles (mostly large trucks).
  6. Property taxes on existing sales and production buildings.
  7. Property taxes on vacant unused land.
  8. Property taxes on land upon which the new warehouse is being constructed.

In addition, the CFO has asked you to use a 50-year useful life to depreciate the new building and the equipment when they come online later in the year, and 20 years for any vehicles, using straight-line depreciation for both.

However, the company controller, who reports to the CFO, wants you to expense all these items and to use an accelerated cost recovery method and much shorter useful lives in order to create a net-operating-loss carryback that could result in a tax refund from prior years, creating much-needed cash flow.

Discussion Questions

  • How would you balance the desires of the controller and the CFO?
  • Which expenses are properly capitalized and which are properly expensed in the current period?
  • How would you determine the useful lives of the capitalized assets?
  • What ethical issues do you see in this scenario?