Question

Company A uses an accelerated depreciation method while Company B uses the straight-line method. All other things being equal, during the first few years of the asset's use, Company B will show which of the following compared to Company A?
a. A smaller fixed asset turnover ratio and a larger gain on asset disposal.
b. A larger fixed asset turnover ratio and a smaller gain on asset disposal.
c. A smaller fixed asset turnover ratio and a smaller gain on asset disposal.
d. A larger fixed asset turnover ratio and a larger gain on asset disposal.

Answer 1

Answer:

d. A larger fixed assets turnover ratio and a larger gain on asset disposal

Explanation:

Accelerated depreciation is a method of depreciation whereby the book value of an asset is rapidly depreciated or reduced i.e at an accelerated rate.

This method usually minimizes taxable income in the initial years as a higher amount of depreciation is claimed.

Fixed assets turnover ratio refers to what percentage of net sales is attributable to an entity's fixed assets. It is expressed as:

$\frac{Net\ Sales}{Average\ Fixed\ Assets}$

Gain on sale of asset disposal = Sale value - Book Value

Book Value =  Cost less accumulated depreciation till date

As can be seen, Average fixed assets balance would reduce thereby increasing fixed assets turnover ratio.

Similarly, due to higher depreciation charged, Book Value would be comparatively less, which would lead to larger gain on assets disposal in the initial years.