Dunkirk Co Case
Information relevant to questions 144–149
The BODs of Dunkirk Co are disappointed by the draft profit for the year ended 30 September 20X3.
The company’s senior accountant has proposed two areas where he believes the reported profit may be improved:
1 A major item of plant that cost $20 million to purchase and install on 1 October 20X0 is being depreciated on a straight-line basis over a five-year period (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 20X2) the senior production manager believed that the plant was likely to last eight years in total (ie from the date of its purchase). The senior accountant has calculated that, based on an eight-year life (and no residual value) the accumulated depreciation of the plant at 30 September 20X3 would be $7.5 million ($20 million / 8 years × 3). In the financial statements for the year ended 30 September 20X2, the accumulated depreciation was $8 million ($20 million / 5 years × 2). Therefore, by adopting an eight-year life, Dunkirk Co can avoid a depreciation charge in the current year and instead credit $0.5 million ($8 million – $7.5 million) to profit or loss in the current year to improve the reported profit.
2 Most of Dunkirk Co’s competitors value their inventory using the average cost (AVCO) basis, whereas Dunkirk Co uses the first in first out (FIFO) basis. The value of Dunkirk Co’s inventory at 30 September 20X3 on the FIFO basis, is $20 million, however on the AVCO basis it would be valued at $18 million. By adopting the same method (AVCO) as its competitors, the senior accountant says the company would improve its profit for the year ended 30 September 20X3 by $2 million. Dunkirk Co’s inventory at 30 September 20X2 was reported as $15 million, however on the AVCO basis it would have been reported as $13.4 million.
144. What is the nature of the change being proposed by the senior accountant in (i) and how should it be applied?