Question

On January 1, 2016, SugarBear Company acquired equipment costing $150,000, which will be depreciated on the assumption that the equipment will be useful for five years and have a residual value of $12,000. The estimated output from this equipment is as follows: 2016 - 15,000 units; 2017 - 24,000 units; 2018 - 30,000 units; 2019 - 28,000 units; 2020 - 18,000 units. The company is now considering possible methods of depreciation for this asset.

Required:

a.) Calculate what the depreciation expense would be for each year of the asset's life, if the company chooses:

i.) The straight-line method

ii.) The units-of-production method

iii.) The double-diminishing-balance method

b.) Briefly discuss the criteria that a company should consider when selecting a depreciation method.

Answer 1

a)

Calculation of Depreciation expense for each year :

1)

Straight line Depreciation methods:

Straight line Depreciation Expense for each year = (Cost of Asset – Residual value)/useful life

= ($150000 –$ 12000)/5 = 138000/5 =$ 27600

Depreciation expense for Year 1 to Year 5 = $27600

2)

The units – of production methods:

Units of Production methods =

(Cost of Asset – Residual value)*Current year output/Total estimated output

Total estimated output = 15000+24000+30000+28000+18000 = 115000

Depreciation expense in 2016 = (150000 – 12000)*15000/115000 = 138000*15000/115000 = $18000

Depreciation expense in 2017 = (150000 – 12000)*24000/115000 = 138000*24000/115000 =$28800

Depreciation expense in 2018 = (150000 – 12000)*30000/115000 = 138000*30000/115000 = $36000

Depreciation expense in 2019 = (150000 – 12000)*28000/115000 = 138000*28000/115000 =$33600

Depreciation expense in 2020 = (150000 – 12000)*18000/115000 = 138000*18000/115000 =$21600

3)

Double Declining Balance Methods:

Double Declining Balance Methods = Cost of Asset*Double Declining Rate

Double Declining Rate = 100/useful life*2 = 100/5*2 = 40%

Depreciation expense in 2016 = $150000*40% = $60000

Depreciation expense in 2017 = ($150000 - $60000)*40%=$90000*40% = $36000

Depreciation expense in 2018 = ($90000 - $36000)*40%=$54000*40% = $21600

Depreciation expense in 2019 = ($54000 - $21600)*40%=$32400*40% = $12960

Depreciation expense in 2020 = ($32400 - $12960)*40%=$19440*40% = $7776 but restricted to residual value i.e. Depreciation expense in 2020 = 19440 – 12000 = $7440.

b)

The following are the criteria that a company should consider while selecting a depreciation method:

1) Type of assets : Selection of depreciation method widely depends on type of assets. If the value of asset is not decreasing or slightly decreased then we will use straight line method and if value of asset decreases every year then we will use written down value method.

2) Legal provision: If law expressly provide the specific method of depreciation to be used then we will use such method only.

3) Financial reporting: Depreciation method should be choosen in such a manner that it perfectly stands on the matching principle of accounting.

4) Inflation: In case of inflationary environment, different accelerated method of depreciation are used.