Economist worldwide have predicted that here 2018 and 2019 would experience a slowdown in the entire economy as the business of sunshine Limited is dependent on the disposable income of people their business is also expected to have negative impact of economic slowdown. Thus the management of sunshine Limited feels that the profit of the firm is likely to decline in 2018 and 2019.
In order to maintain consistency in reporting profit the management of the firm has decided to suddenly change the depreciation method by which company is depreciating its asset. Company has decided to change its depreciation method from straight line to sum of years digits method. This change would incur more depreciation expense in the initial years of asset acquisition and subsequently the depreciation in the latter year of asset acquisition would be lower in comparison to the straight-line depreciation method.
This change of depreciation method by the accounting department of sunshine Limited would initially decrease the profit due to increase in expense which would be compensated against the higher profit and lower expense in the future years. Christie, A.A. and Zimmerman, J.L., 1994
Impact of change in depreciation method
In order to change the depreciation method accompany will have to file IRS form 3115 which is basically an application which is required for change in accounting method. While filing an application for change in accounting method a company should give a proper justification with all the supporting documents and evidences which would prove that the significant amount of their assets are going to depreciate heavily in the initial years of asset acquisition. Christie, A.A. and Zimmerman, J.L., 1994
A company can also the multiple assets in their filing of form 3115. Once the application is filed by the company for change in depreciation method it is up to the IRS to accept or reject the application of the company, once the application for the change in depreciation method is accepted by IRS the company can change its depreciation method but why changing a depreciation method a company is required to mention a footnote in their annual report which would announce the change in depreciation method and will also give proper reasoning for making that change in the depreciation method. Soderstrom, N. S., & Sun, K. J. (2007)
Laws and regulation regarding change in accounting principle
There are several changes in depreciation which are considered as not accounting method changes as per the RTGS section 1.4 46 we have certain rules which provide temporary regulation that considers accounting method change will not be a part of and significant adjustment for the useful life of a asset which is being depreciated or amortizedfor which the depreciation will be determined. The second rule states that when there is a certain adjustment in a usable life of an asset and where change of accounting method is not applied to rules of change in accounting will apply regardless of the situation in which the adjustment will be initiated by IRS or the company. This will only result in adjustment in the useful life of an asset which cannot be considered as a accounting method change. Thrd revocation of depreciation which is timely valid or the election of depreciation is not considered as change in accounting method. However from the beginning of 2002 and 2010 tax payer required to file an amended return stop v is the rule which states that if there is a change in service state of a sizable on depreciable asset that changed in the server state is not considered as an change of accounting method also the change in convention of ammeter is able or depreciable asset is also not considered as change of accounting method because the final regulations define the example for the change in service date the change in service date is not accounting change and it is important to note that adjustment in this case is neither required and non it is permitted by the rules. Jackson, S.B., Liu, X.K. and Cecchini, M., 2009
The IRS has issued an order to obtain an automatic permission to change the accounting method in order to change their depreciation or amortisation methods. If there is a certain case where a company might be using impermissible accounting method in order to calculate depreciation on certain asset class and if company now wants to switch on from in permissible depreciation calculation method to the permissible calculation method of depreciation they could change the method of theirs depreciation calculation bye obtaining and automatic consent for the change in accounting method. Clikeman, P.M., 2003
If certain property which is going to be depreciated is being transformed in a certain transaction and in such transaction Trance 3 is being treated as a transfer for the suitability in computation of assets depreciation allowance with respect to so much of the bases in the transfer is hands I will not be larger than adjusted basis of depreciation in transfers hand, then the transferee come under such circumstances good file for the change in automatic accounting method. Jackson, S.B., Liu, X.K. and Cecchini, M., 2009.
This financial fraud could have significant impact on the future sustainability of the company because this financial fraud can be easily detected by the auditors while analysing the financial statements. Auditor can identify this fraud by doing the careful analysis of each and every expense present in the financial statement. Herrmann, D., & Inoue, T. (1996).
Once the auditor is analysing each and every line item of profit and loss statement given by the sunshine Limited he would be able to identify that there is substantial reduction in depreciation assets without Bing a significant reduction in the fixed asset of the company.
Auditor can easily calculate that a company has applied a fixed line depreciation method in the previous year and now they have decided to change the depreciation method without informing the shareholders. Once the auditor will make his report public Sunshine Limited and its management could face severe embarrassment along with Unity legal action which will further destroy the value of the firm. Herrmann, D., & Inoue, T. (1996).
Sunshine Limited even decides to convince the auditor and they are able to make sure that the auditor's report is not made public but still non reporting of change in depreciation method will still be considered as financial fraud and since even the auditor is silent about it this would even be considered as a big offence. Christie, A.A. and Zimmerman, J.L., 1994
Several companies including the Giants like Enron has faced such scandals of the manipulation in the financial statements, these manipulations in the financial statements led to the downfall of gigantic companies and are never sustainable in the long run. Herrmann, D., & Inoue, T. (1996).
Once the management of sunshine will prepare a proper report with the substantial backup of their study the shareholders will be able to understand that decline in the profits in the future years is due to no fault of the management and there will be no questions raised on the performance of the management. Clikeman, P.M., 2003
Management of sunshine should understand that the value of the firm is defined by all future cash flows to the form discounted at cost of capital and by doing a financial fraud they would be compromising with all the future cash flows of the firm which could significantly reduce the value of the firm. Clikeman, P.M., 2003
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Herrmann, D., & Inoue, T. (1996). Income smoothing and incentives by operating condition: An empirical test using depreciation changes in Japan. Journal of International Accounting, Auditing and Taxation, 5(2), 161-177.
Clikeman, P. M., & LEMON, W. M. (2010). Called to account: Fourteen financial frauds that shaped the American accounting profession. The Accounting Review, 85(5), 1811-1814.
Soderstrom, N. S., & Sun, K. J. (2007). IFRS adoption and accounting quality: a review. European Accounting Review, 16(4), 675-702.
Benston, G.J., Bromwich, M. and Wagenhofer, A., 2006. Principles?versus rules?based accounting standards: the FASB's standard setting strategy. Abacus, 42(2), pp.165-188.
Christie, A.A. and Zimmerman, J.L., 1994. Efficient and opportunistic choices of accounting procedures: Corporate control contests. Accounting Review, pp.539-566.
Clikeman, P.M., 2003. Where auditors fear to tread: internal auditors should be proactive in educating companies on the perils of earnings management and in searching for signs of its use. Internal Auditor, 60(4), pp.75-80.