Question

EVEN-LI Co. and SOONER Inc. each of the companies buys an identical piece of box-manufacturing equipment at a cost of $3,300, and each estimates the equipment's salvage value of $100. However, each company uses a different method of depreciation. EVEN-LI uses the straight -line method and estimates the useful life of the equipment at 4 years. SOONER uses the double-declining balance method for the first year, switching to straight-line for the remaining years and estimates the useful life of the equipment at 4 years. Assume the following for each company: Revenues in each year were $3,000; expenses, other than depreciation were $1,000. Ignore taxes (0% tax rate) 1) calculate each company's net profit for each of the four years. 2) compare the net profit for the two companies across different years. 3) what are the steps and formulas to solve

Answer 1

Answer 1:

EVEN-LI Co.

SLM depreciation:

Annual depreciation = (Cost - salvage value) / Useful life = (3300 - 100) / 4 = 3200 / 4 = $800

Annual profit each year from Year 1 to 4 = Revenue - Expenses other than depreciation - depreciation

= 3000 - 1000 - 800

= $1,200

SOONER Inc

In year 1, it uses double declining balance(DDB) method;

DDB depreciation rate = 200% / Useful life = 200% / 4 = 50%

Year 1 depreciation = cost * DDB depreciation rate = 3300 * 50% = $1650

Book value at the year 1 = 3300 - 1650 = $1650

From Year 2 to Year 4 it uses SLM depreciation method:

Annual depreciation each year from year 2 to year 4 = (1650 - 100) / 3 = $516.67

Hence:

Net profit in year 1 = 3000 - 1000 - 1650 = $350

Net profit each year from year 2 to year 4 = 3000 - 1000 - 516.67 = $1483.33

Hence:

Answer 2:

Comparison:

As we observe above:

Even-Li uses SLM method and hence its net profit is uniform across 4 years (revenue and other expenses for each year remaining same)

Since Sooner Inc, uses accelerated depreciation method (DDB) in year 1, its net profit is much lower as compared to Even-Li Co. for year 1

But from year 2 to year 4 Sooner's net profit is higher as compared to Even-Li's net profit for respective years.

Answer 3:

Steps and formulas are given in answer 1 above.