Cost of Land versus Building – Ethics
Tones Company purchased a warehouse in a downtown district where land values are rapidly increasing. Gerald Carter, controller, and Wilma Ankara, financial vice president, are trying to allocate the cost of the purchase between the land and the building. Noting that depreciation can be taken only on the building, Carter favors placing a very high proportion of the cost on the warehouse itself, thus reducing taxable income and income taxes. Ankara, his supervisor, argues that the allocation should recognize the increasing value of the land, regardless of the depreciation potential of the warehouse. Besides, she says, net income is negatively impacted by additional depreciation and will cause the company’s stock price to go down.
Answer the following questions.
- What stakeholder interests are in conflict?
- What ethical issues does Carter face?
- How should these costs be allocated?
Just Response each posted
Hello Professor and Class,
In this discussion scenario, I believe the interests of both Gerald Carter and Wilma Ankara are in conflict. As we have learned that when locating costs of a fixed asset like property, plant, and equipment, a company should use the historical cost or purchased price and not to use the current fair market value due to “historical cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary of its intended use.” (Kieso, Weygant, & Warfield, 2016, p. 504). However, sometimes it is hard to separate the cost of each asset when a company pays altogether with a single lump-sum price, just like in this case the property included the land and warehouse. To determine the cost of each, the company may need to use the market approach technique to observe prices of similar assets and other relevant information in the area to evaluate their own property on the cost basis. Since land values where the warehouse is located are increased rapidly, Carter should not place a very high proportion on the warehouse itself. Besides, in this case, land does not depreciate, so Ankara should not allocate the cost based on the increasing of the land’s price. They can only recognize the gain or loss when the asset is sold. Both Carter’s and Ankara’s plan was unethical because of their dishonesty and that they tried to manipulate the numbers to prevent the company’s stock price going down and to avoid paying income taxes. This would mislead the stockholders and potential investors, and affect the company in the long run by falsifying the income statement. Allocating only the cost of the warehouse is the right way to do and they may consider the ratio of a fair market value of the land and warehouse on the cost basis (Kieso, Weygant, & Warfield, 2016, p. 515).
As stated in our textbook, in Chapter 1, the purpose of financial reporting is to provide useful information regarding the business to present and potential stockholders which include investors, lenders and other creditor’s such as vendors. (Kieso, Waygandt, & Warfield, 2016) In this situation, the stakeholder’s interest’s in conflict would be between the potential investors and the ones already invested.
The ethical issues that Carter faces involve the allocation of the cost of the warehouse and land. What his supervisor, Ankara, is suggesting is not an approved method of valuation since companies are not supposed to base values of assets on anticipated gains or losses regardless of how it affects stock prices or the bottom line. However, Carter is also wrong in wanting to place an inflated value on the building in order to avoid a possible tax increase. A proportionate amount of the entire purchase should be allocated to the building as well as to the land using historical cost in the area as a basis.
According to the situation that has come of the purchase of the building and land I think the interest of the investors and stockholders would be in conflict. The fact that Tones company is misleading the actual value of the land and the building by using a higher depreciation to put on the building in order to get lower taxes. This would benefit the Tones company itself but not the stockholders and investors (Kieso, 2016).
The ethical issue that Carter faces is to choose how he is going to allocate the cost for purchasing the building. It would not be ethical if he did what was just in the best interest of the company by allocating the purchase cost of the land and building so that it would lower the taxes for the company and in turn hurt the stockholders and investors.
In order to allocate these costs, I think Carter should use historical costs or values. By doing this it will measure the cash or cash equivalent price of obtaining the asset. This will ensure that the money is allocated properly, and it will be in the best interest of everyone that is concerned with the property to do so (Kieso, 2016).