Gym Gurus, Inc. Is a fitness chain that has just completed a second year of operations. At the beginning of its first fiscal year, the company purchased fitness equipment at a cost of $600,000 in estimated that the equipment would have a useful life of five years and no residual value. The company uses the straight line depreciation method. The company reported net income for the first two years of operation as follows:
Year Net Income (Loss)
1 $ 50,000
2 (2,000)
Muscleman Mike, the companies chief financial officer has recently run financial models to predict future net income, he expects net losses to continue at $2000 per year for the next three years.
Paul Pressman, the president of Gym Gurus, is concerned about these predictions as he is under pressure from the company’s owner to return the company to year one’s net income levels. If the company does not meet these goals, both Mr. Pressman and Mr. Mike will likely be fired.
Muscleman suggests that the company change the estimated useful life of the fitness equipment to 10 years and increase the equipment estimated residual value to $50,000. This will reduce the depreciation expense and increase net profit.
Discussion Questions:
Evaluate the decisions to change the equipment’s estimated useful life and estimated residual value to improve earnings.
How does this change impact the usefulness of the company’s net income for external decision-makers?
Mr. Mike and Mr. Pressman make the changes are they acting in an ethical manner? Explain.
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