Please help with this question. What is the meaning of accounting principle? Thanks in advance! On January 1, 2005, JME Corporation changed from the straight line method to an accelerated method of depreciation. Under the accelerated method, the accumulated depreciation through December 31, 2004, was $600,000 higher than if the straight line method had been used. JME’s income tax rate is 40%. What is the cumulative effect of this change in accounting principle? A) $360,000. B) $240,000. C) $600,000. D) $0.
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An accounting principle is the thing a company follows in order to construct its financial statements. With regard to depreciation, there are several “principles” or “methods” that a company might use: straight-line or accelerated depreciation methods. Assuming we are just talking about the “accumulated depreciation” entry on the balance sheet (no other entries are mentioned), the difference will simply be the difference between the old method and the new method. So the cumulative effect on accumulated depreciation is C) $600,000.
srbnow Wrote: ------------------------------------------------------- > Straight line method, accelerated method of > depreciation are the Accounting Principles. > > I think the correct answer is D, $0 because the > effect is only prospective and no changes are made > in retrospect. Thats why some companies use > Accelrated in beginning and when depreciation from > accelrated reduces they switch to Straight line 
When a company changes the way in which it derives a certain number, it has changed one of its accounting principles. A change in accounting principle requires the firm to retroactively adjust their financial statements so as to provide comparability across time periods.
Yup, you are correct…
This is the answer as per schweser (there is no explanation given): The correct answer was A) $360,000. 600,000 × (1 − 0.4) = 360,000. Any thoughts?
cfa_newyorker Wrote: ------------------------------------------------------- > This is the answer as per schweser (there is no > explanation given): > The correct answer was A) $360,000. > 600,000 × (1 − 0.4) = 360,000. > > Any thoughts? So the actual question was this: “What is the cumulative effect ON NET INCOME of this change in accounting principle?” In this case, just as with any other income statement item that is pre-tax, we multiply it by 1-T to find the affect of it on NI. Over the previous periods, all IE has been $600,000 higher than was previously reported. Let’s pretend that all that accumulated depreciation happened in 2004: 2004 income statement with S-L depreciation: EBITDA = $5,000,000 Depreciation = $1,000,000 EBT = $4,000,000 NI = (4,000,000 * 1-T) = $2,400,000 2004 income statement with accelerated depreciation: EBITDA = $5,000,000 Depreciation = $1,600,000 EBT = $3,400,000 NI = (3,400,000 * 1-T) = $2,040,000 As you can see, 2,400,000 - 2,040,000 = 360,000. This holds with our calculation above. In reality, the sum of the differences of all previous periods (going as far back as the purchase date of the oldest asset on the balance sheet) would have to be reported on the income statement. This sum will equal 360,000, but it can be calculated much quicker by simply multiplying the net change in depreciation by 1-T.
Thanks Hockey for the great explanation. The question seems to be incomplete and I wonder if we will get any questions like this in the exam!