Firms may allocate the acquisition costs over the useful life of the asset using any systematic and rational method. The allocation of cost is charged to depreciation expense (for tangible fixed assets), amortization expense (for intangibles), or depletion expense (for natural resources) and is reported on the income statement
Most firms write off tangible long-lived assets evenly over their useful lives (straight-line method). Some firms write off larger amounts during the early years and smaller amounts in later years (accelerated depreciation methods). Nearly all firmsamortize intangible assets using the straight-line method. Firms generally deplete natural resources using the straight-line method or in proportion to the amount of natural resources consumed (for example, number of board feet of lumber harvested relative to an estimate of the total amount of board feet of lumber in a forest). Regardless of the cost allocation method chosen, the total depreciation over an asset’s life generally does not exceed acquisition costs (except in rare cases when firms revalue such assets to currentfair values). Thus, the various depreciation methods differ only in the timing of expense, not in its total amount over time.
Virtually all U.S. firms use accelerated depreciation methods for tax reporting purposes based on depreciable lives specified in the income tax law, which are usually shorter than the depreciable lives that firms use for financial reporting purposes. In countries where tax laws heavily influence financial reporting (such as Germany, France, and Japan), many firms use accelerated depreciation methods for both financial and tax reporting. Thus, comparisons of U.S. to foreign firms require an assessment of the effects of different depreciation methods and assumptions. To increase comparability, you can restate reported U.S. amounts to an accelerated basis or convert reported amounts for other countries to a straight-line basis
You can place U.S. firms on an accelerated depreciation basis using information in the income tax note.
To illustrate, PepsiCo’s Note 5, ‘‘Income Taxes’’ (Appendix A), reports that the portion of its deferred tax liability attributable to property, plant, and equipment was $2,424 million on December 29, 2012, and $2,466 million on December 31, 2011. A decrease in a deferred tax liability relating to differences in expensing procedure for book and tax purposes indicates that PepsiCo depreciated fixed assets faster for book purposes than for tax purposes in the current year. (This is a rare occurrence for a growing firm). If you want to compare PepsiCo’s profitability and risk to another company (foreign or otherwise) that uses accelerated methods of depreciation, you must convert key amounts for PepsiCo, including the asset PP&E (net) and net income, to an accelerated depreciation method basis or convert those amounts for the comparable firm to a straight-line basis. The following computations demonstrate the former approach, converting PepsiCo’s amounts to an accelerated depreciation basis.
Conversion of PP&E (net) to an accelerated basis (amounts in millions):
Most firms write off tangible long-lived assets evenly over their useful lives (straight-line method). Some firms write off larger amounts during the early years and smaller amounts in later years (accelerated depreciation methods). Nearly all firmsamortize intangible assets using the straight-line method. Firms generally deplete natural resources using the straight-line method or in proportion to the amount of natural resources consumed (for example, number of board feet of lumber harvested relative to an estimate of the total amount of board feet of lumber in a forest). Regardless of the cost allocation method chosen, the total depreciation over an asset’s life generally does not exceed acquisition costs (except in rare cases when firms revalue such assets to currentfair values). Thus, the various depreciation methods differ only in the timing of expense, not in its total amount over time.
Virtually all U.S. firms use accelerated depreciation methods for tax reporting purposes based on depreciable lives specified in the income tax law, which are usually shorter than the depreciable lives that firms use for financial reporting purposes. In countries where tax laws heavily influence financial reporting (such as Germany, France, and Japan), many firms use accelerated depreciation methods for both financial and tax reporting. Thus, comparisons of U.S. to foreign firms require an assessment of the effects of different depreciation methods and assumptions. To increase comparability, you can restate reported U.S. amounts to an accelerated basis or convert reported amounts for other countries to a straight-line basis
You can place U.S. firms on an accelerated depreciation basis using information in the income tax note.
To illustrate, PepsiCo’s Note 5, ‘‘Income Taxes’’ (Appendix A), reports that the portion of its deferred tax liability attributable to property, plant, and equipment was $2,424 million on December 29, 2012, and $2,466 million on December 31, 2011. A decrease in a deferred tax liability relating to differences in expensing procedure for book and tax purposes indicates that PepsiCo depreciated fixed assets faster for book purposes than for tax purposes in the current year. (This is a rare occurrence for a growing firm). If you want to compare PepsiCo’s profitability and risk to another company (foreign or otherwise) that uses accelerated methods of depreciation, you must convert key amounts for PepsiCo, including the asset PP&E (net) and net income, to an accelerated depreciation method basis or convert those amounts for the comparable firm to a straight-line basis. The following computations demonstrate the former approach, converting PepsiCo’s amounts to an accelerated depreciation basis.
Conversion of PP&E (net) to an accelerated basis (amounts in millions):
This latter computation relies on the idea that income is affected by the change in the deferred tax liability amount ($42.0 million), which, when divided by the tax rate, represents the lower tax depreciation expense if an accelerated method is used. If PepsiCo had used the tax method, it would have had a higher pretax income and, hence, a higher tax expense of $42.0 million. Thus, changing PepsiCo’s book depreciation to a tax-based method would increase 2012 net income by $78.0 million, approximately 1.3%.
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