FRA - Depreciation on total assets Question

CFA Level I FRA
#1

A company understates year-end depreciation. AS compared to the properly stated year-end results, what effect will this understatement have on the company’s asset turnover ratio?

  1. no impact

  2. decrease

  3. increase.

So i’ll go through how i was thinking this question. Please correct me if anything is wrong or there is a better way to think this through:

asset turnover = sales/ assets

Since depreciation is understated, then assets will be overstated.

If assets, goes down in a formula example. starts at : If Asset turnover is 5. (10 sales/2 assets.)

If assets goes to 1. (10 sales/1 assets) = asset turnover of 10.

So the companys asset turnover ratio increases.

The answer is decrease. Am i just not reading th equestion correctly? Since it says as compared to the properly stated year end results…?

Thanks!!!

#2

if you understate depreciation, your asset goes up. not down.

For example if you have asset worth $10 and your depreciation is $5 at year end assets are $5

now if you understate depreciation say $3, your year end assets are $7

which will make asset turnover decrease.

#3

Depreciation too low ==> asset value too high ==> sales/assets too low.