- CFA Exams
- CFA Level I Exam
- Study Session 8. Financial Reporting and Analysis (3)
- Reading 26. Long-lived Assets
- Subject 3. Depreciation Methods

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**CFA Practice Question**

Best Cycles has invested in a new project and is considering depreciating it under the sinking fund method. Which of the statements below would be CONSISTENT with this depreciation method? Annual cash flows are projected to be level.

A. Net profit would show a varying rate of return on book value.

B. Asset book value will decline by an unequal but a rising amount every year.

C. Pre-tax profit can be calculated using the product of the internal rate of return of the project and the initial cost of the asset.

**Explanation:**Under the sinking fund method, depreciation is based on the amortization formula based on the pre-tax IRR of the project. The annual amount is allocated to depreciation and net profit. As the book value declines, annual depreciation increases at an increasing rate, also lowering asset book value at an increasing rate (or by rising amounts).

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**User Contributed Comments**
2

User |
Comment |
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micheleus |
Could anyone give an example of sinking fund method? |

StJohnDale |
Depr in yr i = Cash Flow from Asset in yr i - (IRR * Book Value at the Beginning of the yr) Depr increase every year to maintain a fixed IRR on the asset |