Problems - Ch. 8

7.{S}

A. The accounting change applied only to newly acquired property so no restatement of prior year depreciation was required.

B. The trend of depreciation expense will be lower because depreciation expense on older property (accelerated methods) will be declining while depreciation expense on new property (straight-line method) will be lower than it would have been under accelerated methods. The net effect will be to increase reported net income.

8. (M) (A) Buildings

Ratio /Year / 1991 / 1992 / 1993 / 1994
Relative Age = Accum Depr. / Gross Assets / 525/1,942
= 27.03% / 715/2,320
= 30.82% / 865/2,551
= 33.91% / 921/2,544
= 36.20%
Average depreciable life = Gross Assets / Deprec. Exp. / 1,942/68 = 28.6 years / 2,320/80 = 29.0 years / 2,551/92 = 27.7 years / 2,544/20 = 21.2 years
Average age = Accum. Depr. / Deprec. Exp. / 525/68 = 7.7 years / 715/80 = 8.9 years / 865/92 = 9.4 years / 921/120 = 7.7 years

Machinery

Ratio / Year / 1991 / 1992 / 1993 / 1994
Relative Age = Accum. Depr. / Gross Assets / 1,830/3,337
= 54.84% / 2,750/4,513
= 60.94% / 3,326/5,130
= 64.83% / 3,385/5,019
= 67.44%
Average depreciable life = Gross Assets / Deprec. Exp. / 3,337/348
= 9.6 years / 4,513/381 = 11.9 years / 5,130/479= 10.7 years / 5,019/491 = 10.2 years
Average age = Accum. Depr. / Deprec. Exp. / 1,830/348 = 5.3 years / 2,750/381 = 7.2 years / 3,326/479 = 6.9 years / 3,385/491 = 6.9 years

B. Relative age indicates whether a firm's fixed asset base is old or new. If the firm is using straight-line depreciation, relative age is a good indicator of asset age as a percentage of depreciable life. It is not affected by changes in asset mix or the timing of purchases. However, this measure is affected by changes in depreciable lives and estimated salvage values. Atlas Copco's machinery shows an increasing relative age suggesting an aging fixed asset base that may need to be replaced.

The average depreciable life is affected by changes in asset mix and when assets are placed into service. Declining capital expenditures, writeoffs, newer assets with shorter lives, or special (extra) depreciation may have contributed to the significant decline in 1994.

The computation of average age is affected by changes in asset mix and acquisitions & divestitures. In 1994, the average age in years declined for buildings. However, this may be due to lower capital expenditures, writeoffs, or extra depreciation.

However, all measures are useful in comparing a firm with its competitors and enable analysts to better forecast capital expenditures.

Solutions Chapter 8 - P. 1