Question

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On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,092,800. The useful life...

On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,092,800. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $52,490. 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?

Expert Solution

a) depreciation under SLM = cost of asset - salvage value / useful life of assets

so given in question that-

cost of equipment = $7092800

useful life = 8 years

salvage value = $52490

so depreciation per year = (7092800-52490)/8 = $ 880038.75

due to half year convention -

instead of depreciating the full $880038.75 in year one, the half year convention exp., or $ 880038.75/2 =$ 440019.375 in year one should be recognized.

in years 2 through 8 company expenses $ 880038.75 and then in year 9 company exp. the final $ 440019.375.

the half year convention extends the no. of years the assets is depreciated, but the extension provides a more accurate matching of exp. to revenues.

b) under 200% declining balcnce method -

rate of depreciation = (1/recovery period) x 2

so rate will be = 1/8 years x 2

= 0.125 x 2 = 0.25 or 25%

year 1: $ 7092800 x 25% = $ 1773200 depreciation for the this year

but to reflect the half year convention divide 1773200 by 2 to get $ 886600 as the amount of the first year.

year 2: (7092800-886600) x 25% = $1551550 depreciation for the second year

year 3: (7092800 - 886600 - 1551550 ) x 25% = $ 1163662.5 depreciation for the third year

year 4: ( 7092800 - 886600 - 1551550 - 1163662.5 ) x 25% = $ 872746.875

here is the switch back the straight line method as the amount depreciated double declining balance would be less than under straight line method

we have to switch to slm in this year.

now from the 4th year we have to calculate deprciation which as under

cost = 7092800

accumulated depreciation under declining method upto 3 years = 886600+1551550+1163662.5= 3601812.5

value of asset as on begining of the 4 th year = 7092800 - 3601812.5 = 3490987.5

remaing life of assets = 8 - 3 = 5 years

so depreciation under fouth year will be = (3490987.5 - 52490)/ 5years = $687699.5

for the last

4th to 8th year deprciaton will be $ 687699.5 per year

c) depreciation under both methods for first 2 years as under-

year	depreciation under slm	depreciation under declining method
1	$ 440019.375	$ 886600
2	$ 880038.75	$ 1551550

total

$ 1320058.125

$ 2438150

as depreciation under slm method is less than declinming method for two yesrs so net income will increase or highest if we follow slm basis depreciation due to having less value than declining method. it will result in increase neet income.

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