Question

In: Accounting

On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,377,200. The useful life...

On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,377,200. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $10,940.

a. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the straight-line depreciation method (half-year convention).

b. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense.

c. Which of these two depreciation methods (straight-line or double-declining-balance) results in the highest net income for financial reporting purposes during the first two years of the equipment’s use?

Solutions

Expert Solution

a. Computation of Depreciation expense to be recognized each calender year under Straight Line Depreciation Method :-
Depreciation Expense = Depreciable Amount
Useful Life
Depreciable Amount = Cost - Salvage value
a Cost = $                       7,377,200
b Salvage value (residual value) = $                            10,940
c Depreciable Amount (a-b) = $                       7,366,260
Useful life (in years) = 8
Annual Depreciation Expense = $7,366,260
8 years
= $920,782.50
Year Straight Line Method (Half Year Convention)
Calculation Depreciation Expense
1 Half year depreciation = 920782.50 * 1/2 460391.25
2 Full year depreciation 920782.50
3 Full year depreciation 920782.50
4 Full year depreciation 920782.50
5 Full year depreciation 920782.50
6 Full year depreciation 920782.50
7 Full year depreciation 920782.50
8 Full year depreciation 920782.50
9 Half year depreciation = 920782.50 * 1/2 460391.25
b. Computation of the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense :-
Double (200%) Declining Balance Method of Depreciation
Double Declining Balance Depreciation = 2 × Straight line Depreciation rate × Book value at the beginning of the year
Cost = $                                      7,377,200
Salvage value = $                                          10,940
Useful life = 8
Straight line Depreciation Rate = 100
8
= 12.50%
Double (200%) Declining Balance Depreciation Rate = 2 * 12.50% = 25%
Annual Period Depreciation for the period End of Period
Beginning of Period Book Value Depreciation Rate Depreciation Expense Accumulated Depreciation Book Value
a b c d = b*c e f = b-d
1 7,377,200 25% * 1/2 = 12.50% $                                    922,150.00 $                    922,150.00 $                 6,455,050
2 6,455,050 25% $                                 1,613,762.50 $                 2,535,912.50 $                 4,841,288
3 4,841,288 25% $                                 1,210,321.88 $                 3,746,234.38 $                 3,630,966
4 3,630,966 25% $                                    907,741.41 $                 4,653,975.78 $                 2,723,224
5 2,723,224 25% $                                    680,806.05 $                 5,334,781.84 $                 2,042,418
6 2,042,418 SLM $                                    677,159.39 $                 6,011,941.23 $                 1,365,259
7 1,365,259 SLM $                                    677,159.39 $                 6,689,100.62 $                    688,099
8 688,099 SLM $                                    677,159.39 $                 7,366,260.01 $                     10,940
Year 5 Double Declining depreciation = 22723224 * 25% = $680,806.05
SLM depreciation = 22723224 - 10940 = 2712284.22 / 4 years = $678071.05
Since Double Declining Depreciation is higher, so $680806.05 is charged as depreciation.
Year 6 Double Declining depreciation = 2042418* 25% = $510,604.54
SLM depreciation = 2042418 - 10940 = 2712284.22 / 3 years = $677159.39
Since Straight Line Depreciation is higher, so $677159.39 will be charged as depreciation in 6th year , 7th and 8th year.
c. Straight Line method results in the highest net income for financial reporting purposes during the first two years of the equipment's use since depreciation under SLM is lower than depreciation under double declining balance during first two years as shown below:-
Year Straight Line Method (Half Year Convention) Double Declining Method (Half Year Convention)
Calculation Depreciation Expense Depreciation Expense
1 Half year depreciation = 920782.50 * 1/2 460391.25 $                                    922,150.00
2 Full year depreciation 920782.50 $                                 1,613,762.50
3 Full year depreciation 920782.50 $                                 1,210,321.88
4 Full year depreciation 920782.50 $                                    907,741.41
5 Full year depreciation 920782.50 $                                    680,806.05
6 Full year depreciation 920782.50 $                                    677,159.39
7 Full year depreciation 920782.50 $                                    677,159.39
8 Full year depreciation 920782.50 $                                    677,159.39
9 Half year depreciation = 920782.50 * 1/2 460391.25 $                                                 -  
Total $                   7,366,260.00 $                                 7,366,260.01

Feel free to ask any clarification, if required. Please provide feedback by thumbs up, if satisfied. It will be highly appreciated. Thank you.


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