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Chapter 9. Goosing, Stuffing, and Faking... > Red Flag 2: When Companies Depreciat...

Red Flag 2: When Companies Depreciate Assets over an Unrealistically Long Time

You may think the electrical appliances in your kitchen will last for 5 to 10 years before they either start to break down or look tacky, and you may budget for replacements within that timeframe. Now, say you were suddenly strapped for cash—and it is already year 9: You might well extend the life of the appliances until your finances were back in better health after year 12. Well, companies will sometimes do the same—but they won’t say that they are doing it because they are short of cash. Instead, they will often hide the change in the footnotes to their financial statements. By extending the life of assets—say a fleet of vehicles or seats in a movie theater—to 15 years from 10 years, a company will be able to prop up its earnings because the cost of depreciation will now be spread over the longer period. If the company has discovered a way of keeping that piece of machinery running longer in an efficient manner, there is no problem. Yet, too often, the extension is just an accounting trick to cover up a shortfall somewhere else. One way to see which is the case is to do a comparison with a company’s rivals. If an oil company decides it can depreciate a pipeline over 40 years when everyone else is using 25, it suggests aggressive accounting.


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