Question

North Ltd. purchased a building in 2015 for $1,390,000. Straight-line depreciation was used, with a useful life of 40 years and a residual value of $400,000. A full year of depreciation was charged in 2015. In 2018, the company decided to switch depreciation methods to declining balance, using a rate of 10%. The tax rate is 25%.

Required:

1. Assume this is a change in estimate, and calculate 2018 depreciation expense.

	Depreciation expense

2 Assume this is a change in policy, and calculate 2018 depreciation expense and the cumulative effect of the change on 2018 opening retained earnings.

Depreciation expense

Cumulative effect

Answer 1

1)Depreciation expense using straight line method = [cost-residual value]/useful life

                         = [1390000-400000]/40

                         = 990000/40

                         = 24750 per year

Accumulated depreciation for the period : 2015-2017 = 3 years* 24750 = 74250

Carrying value at beginning of 2018 = cost-Accumulated depreciation

                                              = 1390000-74250

                                             = 1315750

So , If it is Assumed to be a change in estimate, then depreciation expense for 2018 =carrying value* Depreciation rate

         = 1315750*10%

         = $ 131575

B) Assume this is a change in policy :

If Declining depreciation method is used from 2015 :

	Depreciation expense	carrying value at end
2015	1390000*10%=139000	1390000-139000= 1251000
2016	1251000*10%= 125100	1251000-125100= 1125900
2017	1125900*10%= 112590	1125900-112590= 1013310
Total Depreciation	376690

Had Declining depreciation method is used ,Depreciation expense will be higher by :Deprecation under declining method -Depreciation under straight line method ( over a 3 year period )

         = 376690 - 74250

          = 302440

i)Depreciation expense for 2018 :Carrying value at end of 2017 under declining method * Depreciation rate

            = 1013310*10%

             = 101331

ii)Cumulative effect = Depreciation adjustment (1-Tax rate)

                     =- 302440 (1-.25)

                    = -226830         (enter as 226830 if needs to be entered as positive value)

Opening Retained earning will decrease by 226830 due to change in policy