CFA Level I · CFA Level I Exam · Analysis of Long-Term Assets
Company X capitalizes a 900,000 cost with a five-year useful life and straight-line depreciation, no salvage value. Company Y expenses an identical 900,000 cost. Both have pre-cost income of 2,000,000 in Year 1, ignoring taxes. Year 1 pretax income for X is higher than Y's by an amount closest to:
X's pretax income is about 720,000 higher. X records only 180,000 of depreciation (900,000 over five years), giving 1,820,000, while Y expenses the full 900,000, giving 1,100,000. The difference of 720,000 reflects the deferral of cost by capitalization.
- A180,000
- B720,000Correct
- C900,000
Explanation
X's Year 1 depreciation is 900,000/5 = 180,000, so X's income is 1,820,000. Y's income is 2,000,000 - 900,000 = 1,100,000. The difference is 720,000. Choosing 180,000 forgets that Y expensed the full amount; 900,000 ignores depreciation.
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