Question

Computing Depreciation Expense.

Equipment costing $810,000, with an expected scrap value of $100,000 and an estimated useful life of six years, was purchased on January 1 of the current year.

Required: Calculate the depreciation expense for the first two years of the asset’s useful life using (a) the straight-line method and (b) the double-declining balance method. Which method would you prefer to use for (a) income tax purposes and (b) financial reporting purposes? Why?

Please show all steps.

Answer 1

a) Depreciation Under Straight line Method:-

Calculation of Depreciable Base = Equipment Cost - Salvage Value

= $810,000 - $100,000

= $710,000

Estimated Useful Life is 6 years

So, Depreciation Amount will be

$710,000/6

= $118,333/year.

Under Straight Line Method depreciation for the 1st year is $118,333

2nd year is also $118,333

Total depreciation umder straight line method for 2 Years = $118,333+$118,333

= $236,666

b) Depreciation Under Double Declining Balancing Method :-

For that we have to find out at what % the amount depreciated under straight line method and then that % should be multiplied by 2

We have already founded that the depreciation under straight line method is $118,333 and the depreciable base is $710,000

so the % depreciated = ($118,333/$710,000)*100

= 16.67%

We can also find it by 1/6

Where 1 represents 1st year and 6 represents useful life of the equipment.

So the % depreciated is 16.67

So the double declining rate is 16.67*2 = 33.34%

Depreciation amount under Double Declining Balancing Method

For year 1 = $810,000 * 33.34%

= $270,054

For year 2 = ($810,000 - $270,054) * 33.34%

= $539,946 * 33.34%

= $180,017.

For Income Tax Purpose Double Declining Balancing Method is preferred because it increase the expense so as the profit will also be less so we need to pay only less amount as tax expenses.

For Financial Reporting Straight Line Method is preferred because under the straight line method depreciation expense is less than compared to double declining balancing method so the profit will higher in the Financial Statements.