Question

Three different companies each purchased trucks on January 1, Year 1, for $72,000. Each truck was expected to last four years or 200,000 miles. Salvage value was estimated to be $7,000. All three trucks were driven 67,000 miles in Year 1, 42,000 miles in Year 2, 40,000 miles in Year 3, and 62,000 miles in Year 4. Each of the three companies earned $61,000 of cash revenue during each of the four years. Company A uses straight-line depreciation, company B uses double-declining-balance depreciation, and company C uses units-of-production depreciation. Answer each of the following questions. Ignore the effects of income taxes. Required a-1. Calculate the net income for Year 1. a-2. Which company will report the highest amount of net income for Year 1? b-1. Calculate the net income for Year 4. b-2. Which company will report the lowest amount of net income for Year 4? c-1. Calculate the book value on the December 31, Year 3, balance sheet. c-2. Which company will report the highest book value on the December 31, Year 3, balance sheet? d-1. Calculate the retained earnings on the December 31, Year 4, balance sheet. d-2. Which company will report the highest amount of retained earnings on the December 31, Year 4, balance sheet? e. Which company will report the lowest amount of cash flow from operating activities on the Year 3 statement of cash flows?

Answer 1

a-1	Net income=Cash revenue-Depreciation expense
	Company A:
	Depreciation expense=(Cost-Salvage value)/Useful life=(72000-7000)/4=$ 16250
	Net income=61000-16250=$ 44750
	Company B:
	Depreciation rate=2*(1/Useful life)=2*(1/4)=2*0.25=0.50=50%
	Depreciation expense=Book value at the beginning of the year*50%=72000*50%=$ 36000
	Net income=61000-36000=$ 25000
	Company C:
	Depreciation expense per mile=(Cost-Salvage value)/Useful life in miles=(72000-7000)/200000=$ 0.325 per mile
	Depreciation expense=Miles driven in year 1*Depreciation expense per mile=67000*0.325=$ 21775
	Net income=61000-21775=$ 39225
a-2.	Company A will report the highest amount of net income for Year 1
b-1.	Net income=Cash revenue-Depreciation expense
	Company A:
	Depreciation expense=(Cost-Salvage value)/Useful life=(72000-7000)/4=$ 16250
	Net income=61000-16250=$ 44750
	Company B:
	Depreciation schedule:

Year	Beginning Book value	Depreciation rate	Depreciation expense	Ending book value
	a	b	c=a*b	d=a-c
Year 1	72000	50%	36000	36000
Year 2	36000	50%	18000	18000
Year 3	18000	50%	9000	9000
Year 4	9000	50%	4500	4500

	Depreciation expense for year 4=$ 4500
	Net income=61000-4500=$ 56500
	Company C:
	Depreciation expense=Miles driven in year 4*Depreciation expense per mile=62000*0.325=$ 20150
	Net income=61000-20150=$ 40850
b-2.	Company C will report the lowest amount of net income for Year 4
c-1	Book value on the December 31, Year 3=Cost-Depreciation from year 1 to Year 3
	Company A:
	Depreciation from year 1 to Year 3=16250*3=$ 48750
	Book value on the December 31, Year 3=72000-48750=$ 23250
	Company B:
	Depreciation from year 1 to Year 3=36000+18000+9000=$ 63000
	Book value on the December 31, Year 3=72000-63000=$ 9000
	Company C:
	Depreciation schedule:

Year	Depreciation expense per mile	Miles driven	Depreciation expense
	a	b	a*b
Year 1	0.325	67000	21775
Year 2	0.325	42000	13650
Year 3	0.325	40000	13000
Year 4	0.325	62000	20150

	Depreciation from year 1 to Year 3=21775+13650+13000=$ 48425
	Book value on the December 31, Year 3=72000-48425=$ 23575
c-2	Company C will report the highest book value on the December 31, Year 3, balance sheet
d-1.	Retained earnings on December 31,Year 4=Total cash revenue for 4 years-Total depreciation for 4 years
	Total cash revenue for 4 years=61000*4=$ 244000
	Company A:
	Total depreciation for 4 years=16250*4=$ 65000
	Retained earnings on December 31,Year 4=244000-65000=$ 179000
	Company B:
	Total depreciation for 4 years=36000+18000+9000+4500=$ 67500
	Retained earnings on December 31,Year 4=244000-67500=$ 176500
	Company C:
	Total depreciation for 4 years=21775+13650+13000+20150=$ 68575
	Retained earnings on December 31,Year 4=244000-68575=$ 175425
d-2.	Company A will report the highest amount of retained earnings on the December 31, Year 4, balance sheet
e.	Cash flow from operating activities includes cash revenues only.
	Depreciation will not be included.
	Hence,three companies will report the same amount of cash flow from operating activities ($ 61000)