Suppose that a major airline extended the useful lives of its Boeing 727-100 aircraft from 16 years to 20 years. As a result, depreciation and amortization expense was decreased by $9,000,000. The company’s financial statements also contained the following data: depreciation expense, $235,518,000 and net income, $42,233,000.
The cost of the Boeing 727-100 aircraft subject to depreciation was $800 million. Residual values were predicted to be 10% of acquisition cost.
Assume a combined federal and state income tax rate of 46% throughout all parts of these requirements.
1. Was the effect of the change in estimated useful life a material difference? Explain, including computations.
2. Examination of the annual report of a competitor airline indicated that the competitor used a 10-year life. Suppose the company making the change in estimate had changed to a 10-year life instead of a 20-year life on its 727-100 equipment. Estimated residual value is 10%. Compute the new depreciation and net income. For purposes of this requirement, assume that the equipment cost $800 million and has been in service 1 year and that reported net income based on a 20-year life was $42,233,000.