Case #7 - Is purchasing a car going to tank my net income?
Before getting into the details of depreciation methods, it is useful to have students think a little about why we depreciate long-term assets. The case helps reinforce how accrual accounting matches expenses to revenues and the purpose of matching in the first place. This case should be introduced before discussing depreciation but after you have discussed deferrals (i.e. supplies and prepaid items). It works well at the end of Chapter 3 in IFAB or the end of Chapter 2 in FFAC and Survey. If you wait until the Long Term Assets chapter to cover depreciation (Chapter 8 in IFAB and FFAC, Chapter 6 in Survey), the case works well as an introduction to that chapter.
Learning Objectives: IFAB 1e Ch. 3 LO 5, FFAC 10e Ch. 2 LO 11, Survey 5e Ch 2 LO 11
Implementation: Distribute copies of the case to the class before providing any explanation of deferral topics. Ask students to read the case and individually develop answers. After allowing students time to develop their individual answers, put them into groups to reach consensus on an answer. Also, ask each group to select a spokesperson. Allow groups time to develop answers, then call on some of the spokespersons to share their solutions. As you respond to the student solutions, explain the basic concepts of accounting for depreciation.
Handouts and Solution for Case #7 available on Resources Page
Is purchasing a car going to tank my net income?
On January 1, Year 2, Fitzgerald Rentals, Inc. (FRI) was established when it acquired $24,000 from its owners. FRI immediately paid $24,000 to purchase a car. FRI expected to lease the car to customers over the next four years. At the end of four years, FRI expected to sell the car for $4,000. Leasing revenues were $7,000 cash in Year 2.
Discussion Question: What amount of net income or loss should FRI report on the Year 2 income statement?