Question

If a firm uses straight line depreciation instead of accelerated depreciation, the effect on the following ratios will be: (CFA Adapted):

PP&E (Fixed Asset) Turnover = Sales divided by Fixed Assets

Liabilities to Equity = Liabilities divided by Equity

Group of answer choices

a.PP&E Turnover will be higher and Liabilities to Equity will be lower

b.PP&E Turnover will be lower and Liabilities to Equity will be lower

c.PP&E Turnover will be lower and Liabilities will be higher

d.PP&E Turnover will be the same and Liabilities will be lower

e.PP&E Turnover will be lower and Liabilities to Equity will be the same

PP&E Turnover will be higher and Liabilities to Equity will be higher

Answer 1

OPTION B-----PP&E Turnover will be lower and Liabilities to Equity will be Lower.

When Straight Line depreciation is used instead of Accelerated Depreciation then Net Book value of Assets will be higher comparitively which lowers the Fixed Assets Turnover Ratio, since Fixed Assets Turnover = Sales/Fixed Assets. When denominator is high then Fixed Asset Turnover will be LOWER comparitively.

Effect on Liabilities Equity Ratio-------- Under Straight Line,lower depreciation is charged as compared to accelerated method, hence net income will be higher in this case which adds up to retained earnings for Equity. Hence Equity will be higher. Liabilities Equity Ratio =Liabilities/ Equity. When denominator is high, liabilities equity ratio will LOWER.