AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 1 Property-Plant-Equipment: Module 6 Slide 1 Welcome back everyone. Now that we’ve gone through what straight-line is and seen the calculations, and we’ve gone through what double declining balance, i.e., an accelerated method is and seen the calculations, let’s talk a little bit about comparing the two.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 2 Slide 2 How does the choice of depreciation method, straight-line vs. double declining balance, how does that choice affect your financial statements?AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 3 Slide 3 And in order to understand how they work and compare the two different methods, let’s make one assumption. And we’re going to assume that this is the first year the asset is being depreciated. So we’re going to answer these questions assuming we are in the first year of the asset’s life. And I want to answer these three questions. Number one: which method, straight-line or an accelerated method will show the highest net income? Number two: which method, straight-line or ddb, the accelerated method, will give us an income tax advantage? Number three: which method will show the highest total assets on the year-end balance sheet?AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 4 Slide 4 Let’s start with the very first one. Which method will show the highest amount of net income in the first year of the asset’s life, straight-line or double declining balance? And the answer is straight-line. And the reason, in the first year, the straight-line method records a lower amount of depreciation than the accelerated method. Remember double declining balance is an accelerated method. That means in the very first year of the asset’s life the depreciation expense is very high. And then over time it’ll get smaller and smaller and smaller. Whereas straight-line will start with a smaller amount of depreciation but in each year it will be the exact same amount. So in that very first year, the accelerated method records a higher amount of expense and because the expense is higher the accelerated method results in a lower net income.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 5 So to answer our question which method will show the highest net income, that will be straight-line, because in that first year the straight-line method will show a lower depreciation expense.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 6 Slide 5 Question number two. Which method will result in an income tax advantage in that first year of the asset’s life? The answer is the accelerated method, double declining balance. And the reason is kind of just what we finished saying. In that first year, double declining balance will show a larger amount of expense. It reports a higher depreciation expense in the first year. And the higher the expense the lower the net income. So in that first year the accelerated method will result in a lower amount of net income. Not good except on April 15th because the lower the net income the less you will pay in income taxes. Hence, our accelerated method, our double declining balance method, will result in an income tax advantage in that first year by reporting a higher expense and thus a lower net income.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 7 Slide 6 Question three. Which of these two methods will show the highest total assets on the year-end balance sheet? And the answer is your straight-line method. And the reason, remember, straight-line reports a lower expense in the first year. Because the depreciation is lower in the first year, the accumulated depreciation at the end of the first year is less under the straight-line method. And we know that accumulated depreciation is a contra asset, one that causes our assets to decrease. The accumulated depreciation under straight-line will be lower than the accumulated depreciation under double declining balance at the end of year one. The lower the contra asset the higher the total assets are going to be.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 8 Slide 7 So we’ve seen the basic comparison between the two different approaches, straight-line and the accelerated method. I have a question for you. How would your answers change, how would your answers be different to those three questions if we altered our assumption to the following. Remember what we were assuming. We were in the first year of the asset’s life. Now let’s change the assumption and let’s assume that this is the last year of the asset’s life. This is the very last year in the life of the asset. How would the answers to those three questions change?AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 9 Slide 8 Well let’s see. Which method will result in reporting the highest net income in the last year of the asset’s life? That would be the accelerated method, double declining balance. So it is flipped around. Question two. Which method will result in an income tax advantage in the last year of the asset’s life? Now it’ll be straight-line. Remember, previously in the first year, it was double declining balance. And the kind of the tricky one, number three, which method will end up showing the highest total assets on the year-end balance sheet at the end of the last year? Well the answer is both methods will show the exact same amount of assets.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 10 Slide 9 Here’s why. Straight-line always always records more depreciation in the last year of the asset’s life versus the accelerated method double declining balance. The reason for that, remember, double declining balance will start with a large amount of depreciation and it’ll get smaller and smaller and smaller, whereas straight-line starts with the exact same depreciation and it doesn’t change over the life of the asset. So when we get to the very last year, the depreciation under straight-line will actually be more than the depreciation under double declining balance. So that means for those first two questions the answers flip around. The double declining