CFA Practice Question

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CFA Practice Question

Ashley Company has decided to change its method of depreciation from the straight-line method to the double-declining method. The change will be only for financial reporting purposes, and applicable to newly acquired assets only. Which of the following is true when comparing the double-declining method to the straight-line method?

A. Income will be higher in the years following the change.
B. Return on assets will be higher in the years following the change.
C. In the year of the change, income will be lower.
D. Stockholders' equity will be higher.
Correct Answer: C

The accelerated method will have a higher depreciation and will thus lower assets, net income, and stockholders' equity in the earlier years. The effect on assets is normally less than the effect on net income, so the return on assets will be lower.

User Contributed Comments 10

User Comment
stranger a, b and d all point towards higher income but in the current year the income will be lower since there will be higher depn compared to straight line method
morpheus918 In the early years only!
tony1973 as the change is applicable to newly acquired assets only, this is surely one of the "early years".
o123 hmm...in the early years the DDB will reduce NI 'certainly', you cant be certain that this effect will be reversed in the following years since the old assets will still be SL (therefore A, B are inaccurate).
Khadria Using DDB method, in the first few years, depreciation will be more and hence income will be less but afterwards, depreciation cost will be less than what is calculated from Straiht Line method and hence income will be more than what can be received from the SLM.

TRY with an example: Asset = 40000$, Life = 5 yrs, Salvage Value = 0 (to keep it simple)

SLM = 20% of the cost each year
DDM = 40% of the book value each year

SLM = 8000$ each year
Ist year - DDM = 16000 > SLM hence income is less
IInd year - DDM = 24000 * .4 = 9600 > SLM
IIIrd year - DDM = 14400 *.4 = 5760 < SLM

After IIRd year, DDM will give less depreciation cost than the SLM and hence income will be more compare to what can be got from the SLM.
missmalik why not A is correct, as for as changing from SL to DDB is concered, I think it will increase dep expense in response Income will be lower. but Following year income will increase....isnt it true
quanttrader more depreciation expense in year of change = lower income
johntan1979 I suppose this change is prospective instead of retrospective, since there won't be any cumulative effect of changes in accounting principles, right?
vatsal92 Yes, Johntan1979. You're right.
sshetty2 A is not correct because of the line pertaining to 'newly acquired assets only'... the effects on net income in later years are ambiguous because you don't know how much or how many new assets the firm will acquire, and, if they acquire more new assets, income will take a hit because they would be depreciating these assets at an accelerated pace... per the notes
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