During prior periods the Rocket Company used the double-declining balance method for depreciating its equipment,but in 2010 it decided to switch to the straight-line method.
The equipment was purchased in 2008 for $1,000,000 and had a 10 year life.The
Balance in the accumulated depreciation account for equipment at the beginning of 2010
Was $360,000.How will 2010's net income be changed by switching to the new
Depreciation if Rocket has an effective tax rate of 40%.
A)$ 60,000 smaller
B)$16,800 larger
C)$28,000 larger
D)$40,000 smaller

Question

Quizplus · Accepted Answer

Under the double-declining balance method, the depreciation for the first two years (2008 and 2009) was $360,000. For a 10-year life asset, the straight-line method would depreciate $100,000 per year ($1,000,000 / 10 years). By the end of 2009, two years of straight-line depreciation would have been $200,000, leaving $160,000 more depreciation under the double-declining balance method than if the straight-line method had been used ($360,000 - $200,000). Switching to the straight-line method in 2010, the depreciation expense would be $100,000 for the year, instead of the accelerated method which would have been higher. The difference in depreciation methods reduces the depreciation expense, thus increasing pre-tax income by $160,000 over the remaining life. For 2010 specifically, the depreciation expense is reduced, increasing pre-tax income. The tax effect (40% of the difference) must be considered. The net income for 2010 is larger due to the reduced depreciation expense and the tax effect on the change. The correct calculation for the net income change for 2010 involves understanding the reduced depreciation expense under the straight-line method compared to what it would have been under the double-declining balance method and adjusting for the company's effective tax rate.

During Prior Periods the Rocket Company Used the Double-Declining Balance