In: Accounting
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?
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 |
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