Question

Three different companies each purchased trucks on January 1, Year 1, for $60,000. Each truck was expected to last four years or 250,000 miles. Salvage value was estimated to be $5,000. All three trucks were driven 79,000 miles in Year 1, 47,000 miles in Year 2, 51,000 miles in Year 3, and 74,000 miles in Year 4. Each of the three companies earned $49,000 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

1. a-1. Calculate the net income for Year 1.

2. a-2. Which company will report the highest amount of net income for Year 1?

3. b-1. Calculate the net income for Year 4.

4. b-2. Which company will report the lowest amount of net income for Year 4?

5. c-1. Calculate the book value on the December 31, Year 3, balance sheet.

6. c-2. Which company will report the highest book value on the December 31, Year 3, balance sheet?

7. d-1. Calculate the retained earnings on the December 31, Year 4, balance sheet.

8. 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) the net income for Year 1:

Company A

Calculation of Depreciation= ( Cost of Asset - Salvage Value ) / Life of asset

= ( 60000 - 5000 ) / 4

= 55000 /4

Depreciation =13750

Depreciation Rate = (13750 / 55000 )*100

= 25%

Revenue of Company A = $ 49,000
Less: Depreciation = (13750)
Net Income = $ 35,250

Company B

Calculation of Depreciation= Straight line depreciation rate * 2

= 25 * 2

Depreciation Rate = 50 %

Depreciation= 60000 * 50%
= 30,000

Revenue of Company B = $ 49,000
Less: Depreciation = (30000)
Net Income = $ 19,000

Company C

Calculation of Depreciation= ( cost - salvage value ) / estimated life in miles

= 55000 / 250000

Depreciation Rate = 0.22 per miles

Depreciation= 79,000 * 0.22
= 17388

Revenue of Company C = $ 49,000
Less: Depreciation = (17388)
Net Income = $ 31,620

Company A=$ 35,250
Company B=$ 19,000
Company C=$ 31,620

a-2) Company A will have higher amount of net income in year 1

b-1) the net income for Year 4.:

Company A

Revenue of Company A = $ 49,000
Less: Depreciation = (13750)
Net Income = $ 35,250

Company B

Double-declining Deprciation expense for year 4=  

Year 1 = 60000 * 50% = 30000
Year 2 = 30000 * 50% = 15000
Year 3= 15000 * 50% = 7500
Year 4= 7500 -5000 = 2500

Total accumulated depreciation over the useful life of the asset cannot exceed $ 55,000 in this case.

Revenue of Company B = $ 49,000
Less: Depreciation = (2500)
Net Income = $ 46,500

Company C

UOP Depreciation Expense = 0.22 miles * ( 73000) = $ 16,060

Total miles driven cannot exceed the initially estimated 250,000 miles. ( 79,000 + 47,000 + 51,000 + 74,000= 251,000 so if we deduct 1000 from 74000, we get, 73000 that will automatically comes to 250,000)

Revenue of Company C = $ 49,000
Less: Depreciation = (16,060)
Net Income = $ 32,940

Company A=$ 35,250
Company B=$ 46,500
Company C=$ 32,940

b-2) Company C will report the lowest amount of net income for year 4

c-1)  the book value on the December 31, Year 3:

Book Value= Cost of Asset -Depreciation

Company A: Book value = $ 60,000 - ( 13750 x 3 ) = $ 18750

Company B: Book value : $ 60,000 x 50 % x 50 % x 50 % = $ 7500

Company C: Book value : $ 60,000 - ( 79,000 + 47,000 + 51,000) * 0.22 = $ 21,060

c-2)  Company C will report the highest book value on the December 31, year 3 balance sheet

d-1)  the retained earnings on the December 31, Year 4, balance sheet.

Total cash revenue earned over 4 years = $ 49,000 x 4 = $ 196,000

Retained earnings balance as of December 31, year 4 = Total cash earnings- Accumulated Depreciation = $ 196,000- $ 55,000 = $ 141,000.

Accumulated Depreciation of A = 13750 * 4 = 55000
Accumulated Depreciation of B = 30000+15000+7500+2500 = 55000
Accumulated Depreciation of C = (79,000 + 47,000 + 51,000 + 73,000 ) * 0.22 = 55000

So Retained Earning of All the companies will be same.

Company A=$ 141,000
Company B=$ 141,000
Company C=$ 141,000

d-2) All three companies will report the same retained earnings on the December 31, year 4 balance sheet.

e-1) The cash flow from operating activities will be lowest for Company B if income tax rate is not considered.