- CFA Exams
- CFA Level I Exam
- Study Session 8. Financial Reporting and Analysis (3)
- Reading 26. Long-lived Assets
- Subject 3. Depreciation Methods
CFA Practice Question
At the end of 2015, a firm changes its depreciation method from the double-declining balance method to the straight-line method. The firm only has one asset, a building that cost $4,000,000 and has a salvage value of $200,000 after a life of 20 years. The tax rate is 20%. The asset was purchased in January of 2013. What will be the effect of the change on 2015 net income resulting from 2013 and 2014?
A. $440,000 increase
B. $380,000 increase
C. $304,000 increase
Explanation: The effect on income will be the change in depreciation expense this year and the cumulative effect of the change on prior years. The straight-line depreciation for two years is $380,000 (2 x $190,000) and the double-declining depreciation for two years is $760,000 ($400,000 + $360,000). The cumulative effect before taxes would be $380,000 ($760,000 - $380,000). After the taxes, the effect on the income of 2015 resulting from the change in 2013 and 2014 depreciation is a $304,000 increase, resulting from the change from a method with larger depreciation expense to a method with smaller depreciation expense.
User Contributed Comments 8
| User | Comment |
|---|---|
| annex | I thought it dosen't allow the method to be changed for old assets? though I got the answer right if the change is permissible. |
| danlan | Should consider the tax effect,thus we get 380000*(1-20%)=304000 |
| LIEJON | Can anyone explain how we get 360.000 in the second year for the accel. method? Why not 400.000 again? |
| LordHux | (4000k - 400k)*(2/20), I think this is it |
| Saibot | If you have TI BA PLus 2, it does it for you: press 2nd depr, then select the method by pressing 2nd + enter - go to DB. = 200 should already be given ( double declining). then enter 4 Mio for CST and 20 for LIF. then you already see 400 K under DEP. then go to YR and press CPT , it ll show the next year, and so on... |
| bani007 | The change in the method of depreciation should be applied prospectively not retrospectively |
| Hishy | I thought a change in depreciation method is simply a change in accounting estimate and therefore requires no restatement? |
| Hishy | @LIEJON - DDB is a constant percentage of depn every year, but the actual amount of depn changes every year. DDB also ignores salvage value. So 2/20 = 10%. Year 1 = 4m * 40% = 400,000 Year 2 = (4m-400k)*40% = 360,000 |