Question

During 2019 and 2020, Faulkner Manufacturing used the sum-of-the-years’-digits (SYD) method of depreciation for its depreciable assets, for both financial reporting and tax purposes. At the beginning of 2021, Faulkner decided to change to the straight-line method for both financial reporting and tax purposes. A tax rate of 25% is in effect for all years.

For an asset that cost $21,000 with an estimated residual value of $1,000 and an estimated useful life of 10 years, the depreciation under different methods is as follows:

Year	Straight Line				SYD			Difference
2019		$	2,000		$	3,636			$	1,636
2020			2,000			3,273				1,273
		$	4,000		$	6,909			$	2,909

Required
1. Prepare the journal entry that Faulkner will record in 2021 related to the change.
2. Suppose instead that Faulkner previously used straight-line depreciation and changed to sum-of-the-years’- digits in 2021. Prepare the journal entry that Faulkner will record in 2021 related to the change.

Answer 1

As Faulkner Manufacturing follow earlier sum of year digit(SYD) method of Depreciation so Total depreciation charged to P&L 3646+3273= 6909 and company decide to change the method from SYD to straight line method and as per straight line method depreciation for 2019 and 2020 will be 2000+2000=4000

In the above question there are 3 effect as follows

1.Journal entry for above change for financial reporting

2.Tax effect due to change in depreciation method.

2.Journal entry for the current year as per new depreciation method i. e. Straight line method

So in question 1) asked to pass journal entry in 2021 for effect

1.Assets A/c Debit 2909

To Depreciation A/c 2909

(Being excess depreciation charged earlier year now reversee due to change in depreciation method)

2. Current Tax A/c Debit 727.25

To Differed Tax Liability 727.25

(Being differed tax liability created on excess Depreciation charged earlier year @25% on 2909(i.e.6909-4000) refer note 1

3.Journal entry for current year 2021

Depreciation A/c Debit 2000

To Assets A/c 2000

(Being depreciation charged for the FY 2021 as per straight line method) Refer note 3(i)

In 2) question journal entry as follows

1.Depreciation A/c Debit 2909

To Assets A/c 2909

(Being difference depreciation charged due to change in method of depreciation)

2.Deffered Tax Assets A/c Debit 727.25

To current Tax A/c

(Being deffered tax Assets created due to lower depreciation charged earlier year) Refer note 2

3.Depreciation A/c Debit 2545.45

To Assets A/c 2545.45

(Being depreciation charged as per sum of digit method)

Refer note 3(ii)

Notes:-

1.Calculation of Deffered tax assets/liability due to change in method of depreciation

(i)Depreciation as per SYD 6909

(ii)Depreciation as per straight line method 4000

(iii) Difference excess depreciation charged in earlier accounting year due to change depreciation method. I. e. 2909

Tax rate for both 2019 and 2020 @25% on 2909= 727.25 which is nothing but deffered tax liability. As we charged excess depreciation in earlier year due to this tax liability reduced.

2.In second case we charged depreciation Lower than what we are need to be charged as per SYD method 6909-4000=2909 we charged lower depreciation due to this income increased and we had pay more tax. To reduce same we need to create deffered tax assets for the same.

3.Depreciation for year 2021 as per

(i)straight line method as follows

Cost of assets - Residual value of Assets /life of Assets

21000-1000/10

2000

(ii) As per SYD method

Cost of Assets - Residual value of Assets/sum of digit of year

21000-1000/55*7

= 2545.45