Question

(Clearly present the cash flow diagram(s), equivalency model(s),
assumptions made and detailed calculations)

We are considering the purchase of a minicomputer at a cost of $10,500, with an estimated salvage value of $500 and a projected useful life of four years. Interest is
10%.
Determine:
a. depreciation charges using straight line method

b. depreciation charges using double declining balance method

c. depreciation charges using MACRS method

d. which depreciation method should be used.

Answer 1

Answer to part a:

Using straight line method the depreciation can be calculated as follows : (Cost of asset - salvage value)/useful life of the asset = (10,500-500)/4 = $2,500 per year.

Answer to part b:

Double declining balance method of calculating depreciation: in this method depreciation is calculated as double of the amount coming from straight line method, but instead of using cost of asset, opening written down value of the asset is used each year for calculating depreciation.

So first we calculate the percentage of depreciation to be charged in case of straight line method = 2500/10000 = 25%

So for double declining balance method we will charge depreciation on double of 25% that is 50% of written down value.

So for year 1, depreciation = 10,000*50% = $5,000

For year 2, depreciation = (10,000-5,000)*50% = $2,500

For year 3, depreciation= (10,000-5,000-2,500)*50% = $1,250

For year 4, depreciation shall be the remaining value of asset as it is the last year of it's useful life, depreciation= $1,250

Answer to part c:

MACRS refers to modified accelerated cost recovery system. In this method the depreciation is first calculated using the declining balance method and then switched to the straight line method during the useful life of the asset to finish the depreciation schedule. Hence assuming the switch in this case is made in the third year, depreciation using the MACRS method can be calculated as follows:

For year 1, depreciation= 10,000*25% = $2,500

For year 2, depreciation= (10,000-2,500)*25% = $ 1,875

For year 3, depreciation= (10,000-2500-1875)/2 = $2,812.50

For year 4 depreciation= $2,812.50

Answer to part d:

In this case since the asset is a minicomputer, double declining method of depreciation is the best suited as it charges more cost as depreciation at the start of the useful life of the asset. In today's technological era, computers become outdated very soon and the value of a minicomputer declines very fast with the passage of time. The minicomputer will give more benefit to the company at the start of it's useful life and will slowly become obsolete. Hence double declining balance method is the most suitable method in this case.