When we say aggressive Revenue recognition that means more amount of revenue to be recognized in the current year rather than later so conservative means less amount of revenue recognition. In the same manner Conservative Expense recognition will means less expense to be considered in the current year Right ?
If I am right then Why I end up giving wrong answer to this below question
Which combination of depreciation methods and useful lives is most conservative in the year a depreciable asset is acquired?
Straight-line depreciation with a short useful life.
Declining balance depreciation with a long useful life.
Declining balance depreciation with a short useful life.
(Institute 207)
Institute, CFA. 2016 CFA Level I Volume 3 Financial Reporting and Analysis. CFA Institute, 07/2015. VitalBook file.
The citation provided is a guideline. Please check each citation for accuracy before use.
Conservative means showing lower net income in the current year and higher net income in future years: slower revenue recognition, faster expense recognition.
Aggressive means showing higher net income in the current year and lower net income in future years: faster revenue recognition, slower expense recognition.
Percentage-of-completion is more aggressive, completed contract is more conservative.
Straight-line depreciation is more conservative _ aggressive _, accelerated depreciation is more aggressive _ conservative _.
Assuming rising costs, FIFO is more aggressive, LIFO is more conservative.
In case of depreciation, using SLM would have same NI over the years, while using Accelerated depn will result to lower net income in the current year and higher net income in future. So Accelerated depn is more conservative accounting policy compared to SLM. I am bit of confused.
SLD is more aggressive while accelerated is more conservative (you are recognizing more expense earlier compared to SLD, resulting in lower Net Income in earlier years, and higher Net Income later on)
Conservative Accounting is defined as showing lower net income in the current year and higher net income in future years , we thus have slower revenue recognition today and faster expense recognition today.
Now judging from today’s point of view:
Let’s say company ABC buys computer equipmen t. Under the accelerated depreciation, in this current period our expenses will be higher than under straigh line, thus our net income in the current year will be lower. In the future at some point (maybe even next period) the depreciation expense under straight line will be higher which is when Net Income will be higher under Accelerated Depreciation.
Thus, if we compare both methods we have:
Accelerated Deprecation: Lower Net Income today (compared to Straight Line Depr.), higher net income later (compared to Straight Line Depr.
Straight Line Depreciaiton: Higher Net Income today (compared to Acc Depr.) lower Net Income later (compared to Acc Depr.)
Take a look at Schweser Notes, Book 3, Reading 33, LOS 33 c. (p.293 in my edition). They have a table there of aggressive and conservative accounting choices and SLD is listed under aggressive and accelerated depreciation is listed under conservative.
If you do change the life to 15 years, then you have to also change the life under the SL method to 15 years. Otherwise you are comparing two different things (if you use different life spans for both methods, you willl of course get conflicting conclusions because you are looking at the effect of increasing the life span, not at the effect of choosing between DDB and STL).
If you use the same life span for both methods, DDB will always result in higher depreciation in the initial years compared the STL. At some point in the future that will reverse. But the DDB will always give you a lower net income in the first years ( again, IF you use the same number of years for both ).
To use your example:
If you use 15 years for the STL, you get: Under SL: 12000/15 = 800. NI = 90000 - 800 = 89200 >88400
The life span is a different story. Increasing the life span is more aggressive as you are lowering the expense in the current period and thus have a higher net income. This applies to both methods, and has nothing to do with which one of them is more aggressive.
Also, the changing the residual does not change the fact that DDB is more aggressive that STL.
Remember that DDB does not use residual value in the initial calculation (we only use it, to tell us when we need to stop depreciating at some point). So even if you set residual to 0 (to make STL more aggressive) you get.
But that is the result of your choice of lifespan, but has nothing to do with DDB vs STL.
We are talking about DDB vs STL, I think we agree about the lifespan so let’s ignore that for now or keep it constant (of course you can make DDB more aggressive by increasing the lifespan, but is the effect of lifespan- you can make anything more aggressive that way).
If we stick to the topic of comparing DDB vs STL, DDB will be more conservative.
Show me a numerical example where DDB results in a higher Net Income in the inital years compared to STL and I will agree with you.