SL Vs DB Depreciation - Conservatism

CFA Level I
#1

CFA EOC

“Which combination of depreciation methods and useful lives is most conserva- tive in the year a depreciable asset is acquired? A Straight-line depreciation with a short useful life. B Declining balance depreciation with a long useful life. C Declining balance depreciation with a short useful life.”

“C is correct. This would result in the highest amount of depreciation in the first year and hence the lowest amount of net income relative to the other choices.”

Am I missing something? I originally said A because I thought a straight line method has less depreciation in early years therefore it’s depreciation write off is more conservative.

Do they refer to ‘conservatism’ in the sense of Net income? So DB is more conservative because you have lower Net Income ?

#2

I think they are trying to say that the more conservative firms are those that charge higher depreciation expenses during the asset’s earlier years. Conservative as in " you are quick to recongise expenses than revenues "

#3
  • Conservative: lower net income this year: accelerated depreciation vs. straight-line depreciation, shorter useful lives, LIFO vs. FIFO inventory (assuming rising costs), lower discount rate for DB pension plan obligations, and so on
  • Aggressive: higher net income this year: straight-line depreciation vs. accelerated depreciation, longer useful lives, FIFO vs. LIFO inventory (assuming rising costs), higher discount rate for DB pension plan obligations, and so on