Question

Marigold Company purchased Machine #201 on May 1, 2017. The following information relating to Machine #201 was gathered at the end of May. Price $122,400 Credit terms 2/10, n/30 Freight-in $ 1,152 Preparation and installation costs $ 5,472 Labor costs during regular production operations $15,120 It is expected that the machine could be used for 10 years, after which the salvage value would be zero. Marigold intends to use the machine for only 8 years, however, after which it expects to be able to sell it for $2,160. The invoice for Machine #201 was paid May 5, 2017. Marigold uses the calendar year as the basis for the preparation of financial statements. Compute the depreciation expense for the years indicated using the following methods. Depreciation Expense

(1) Straight-line method for 2017 $

(2) Sum-of-the-years'-digits method for 2018 $

(3) Double-declining-balance method for 2017 $

Suppose Kate Crow, the president of Marigold, tells you that because the company is a new organization, she expects it will be several years before production and sales reach optimum levels. She asks you to recommend a depreciation method that will allocate less of the company’s depreciation expense to the early years and more to later years of the assets' lives. What method would you recommend?

Answer 1

Solution

Marigold Corporation

1. Computation of depreciation expense

• Straight line method for 2017

Cost of machine –

Price = $122,400

2% cash discount = $2,448

Net price = $119,952

Add: freight in            $1,152

Installation costs         $5,472

Total cost                    $126,576

Less: salvage value      $2,160

Depreciable base         $124,416

Useful life                   8 years

Annual depreciation    124,416/8 = $15,552

Depreciation for 8 months (May 1 – Dec 31) in 2017 = 15,552 x 8/12 = $10,368

• Sum of years digits method for 2018

Depreciation expense = (remaining useful life of asset)/sum of the years’ digits x depreciable base

Sum of the years’ digits for 8 years = 36

Remaining useful life for 2018 = 7 years

Depreciation expense = 7/36 x $124,416 = $24,192

-double declining balance method for 2017

Depreciation expense = costx 200%x 1/8 years

= $126,576 x 2 x 1/8 = $31,644

Depreciation expense for 8 months in 2017 (May 1 – Dec 31) = 31,644 x 8/12 = $21,096

1. The optimal method is units of production or activity method.
2. explanation - since the comapny expects some time before production and sales reach optimal levels, the adoption of units of production method would allocate annual depreciation based on number of units produced. Hence, if the company produces lesser number of units in initial years, the depreciation expense would also be proportionately lesser.
3. unlike other methods such as straight line method, which charges uniform depreciation expense for all years in the useful life of hte asset and the double declining balance method, which charges higher depreciation in the early years, units of production method is the optimal method for Marigold Corporation.