CFA Practice Question

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CFA Practice Question

The accelerated depreciation method is appealing for all of the following reasons EXCEPT that ______
A. it reflects the physical deterioration of a physical asset more realistically.
B. it enables a company to better cope with the effects of inflation on assets' replacement values.
C. it smoothens out the total of depreciation and repair and maintenance costs over time.
Explanation: None of the accounting depreciation methods represent the actual physical depreciation of the underlying asset. They are all assumptions made for convenient allocation of an asset's purchase price over the economic life of the asset. The accelerated depreciation method generates greater present value of tax savings over the straight-line method.

User Contributed Comments 9

User Comment
antarctica does accelerated method smooth out the total depreciation and repair and maintenance costs over time?
jam99003 yes it is assumed more repairs will be necessary in the later years, and these expenses will add to the lower dep. exp. in those years from acc. dep. Thus, smoothing out total expenses over the life of the asset.
future233 Hi, Jam99003, It was a good explaination.
achu A is clearly the answer, but "smoothing" might not be the best word to describe the depreciation effect. It's more like "better reflecting reality."
ml42085 What about heavy machinery? Or a computer....
alit86 C seems wrong as well - accelerated depreciation does not smooth out earnings as well as normal depreciation - because you record higher depreciation expense in the early years.
acemaj How is B correct?
dan1987 acemaj -> i also but B, i can only assume that since (in theory)net income will be higher in the later years under accelerated. Since your generating higher income closer to when the asset will need replacing. Under straight line you will have to invest that difference at a rate = to inflation. However this is assuming that a) the company makes the same or better revenues in the future and that the tax rates have not gone up
CJPerugini @dan1987 you are giving off the appearance that you are generating higher income when the asset needs replacing. Depreciation is an imaginary linear expense. Accelerated depreciation behaves nonlinearly and lets you pretend like you're incurring even more expenses than straight line in the earlier years. That being said, taxable income goes down and you are giving less cash to the man in earlier years.

Cash now weighs more than cash later.
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