Question

The XYZ block company purchased a new office computer and other depreciable computer hardware for $12,000. During the third year, the computer is declared obsolete and is donated to the local community college. Using an interest rate of 10%, calculate the PW of the depreciation deductions. Assume that no salvage value was initially declared and that the machine was expected to last 5 years.

1. Double declining balance depreciation
2. 100% bonus depreciation
3. Which method id preferred for determining the firm’s taxes?
4. Which method is preferred for determining the firm’s value?
5. Is using two accounting methods ethical?

Answer 1

Any assets built are always have a wear and tear due its usage as well as age. In accounting statement for recording this wear and tear a percentage (%) of the total investment cost are charged which is called depreciation. In accounting plant assets when put to use depreciation is required to be charged over the useful life of the asset as a percentage (%).This must be treated as cost or expense and debited to the income statement, otherwise the profit will not be correctly assessed and as a result asset amount reported in the balance sheet will also not show the correct figure.

The company purchased a new office computer and other depreciable computer hardware for $12,000 and the machine was expected to last 5 years.

Depreciation to be charged yearly = (Value of new office computer and other depreciable computer hardware - Salvage value)/Useful life = ($12,000 - $0)/5 = $12,000/5 = $2,400 per year

During the third year, the computer is declared obsolete and is donated to the local community college.

Hence, total depreciation for 3 years = $2,400 x 3 = $7,200.

Using an interest rate of 10%, the PW of the depreciation deductions is as follows:

Present Worth = {$2,400 X (1+0.10)^0} + {$2,400 X (1+0.10)^1} + {$2,400 X (1+0.10)^2} = $7,944

Double declining balance depreciation

As explained above since the machine was expected to last 5 years. The rate of depreciation will be @ 20% per year. Hence, double depreciation will be 40%. The double declining balance depreciation will ve as follows:

i) 1^st Year = $12,000 X 40% = $4,800

ii) 2^nd Year =($12,000-$4,800) X 40% = $2,880

iii) 3^rd Year =($12,000-$4,800-$2,880) X 40% = $1,728

iv) 4^th Year =($12,000-$4,800-$2,880-$1,728) X 40% = $1,037

v) 5^th Year =($12,000-$4,800-$2,880-$1,728-$1,037) X 40% = $622

100% bonus depreciation

It is full bonus depreciation i.e. the purchase cost of new office computer and other depreciable computer hardware which is $12,000.

Which method id preferred for determining the firm’s taxes?

MACRS (Modified Accelerated Cost Recovery System) rate is preferred for determining the firm’s taxes since it allows to recover depreciation faster in the initial year and depreciation slower later which is beneficial to firm with respect to tax.

Which method is preferred for determining the firm’s value?   

The method which allows to charge less depreciation should be used which in turn will increase the profit margin.

Is using two accounting methods ethical?

From the explanation as given above it can be concluded that using two accounting methods is ethical due to the following reasons:

a) Any assets built are always have a wear and tear due its usage as well as age. In accounting statement for recording this wear and tear a percentage (%) of the total investment cost are charged which is called depreciation. In accounting plant assets when put to use depreciation is required to be charged over the useful life of the asset as a percentage (%). This must be treated as cost or expense and debited to the income statement on the basis of which the profit will be assessed and the proper refection of asset in the financial statement.

b) The depreciation is required to be charged at a rate which is also required for taxation purpose.