On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,653,800. The useful life...

On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,653,800. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $61,540. a. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the straight-line depreciation method (half-year convention). b. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense. c. Which of these two depreciation methods (straight-line or double-declining-balance) results in the highest net income for financial reporting purposes during the first two years of the equipment’s use?

Expert Solution

a) Depreciation per year under straight line method -

($7,653,800-$61,540)/8 = $949,033

Since half year convention is used, the depreciation in the first year will be $949,033/2 = $474,516

b) Depreciation rate under 200% double declining method =

200%/8 = 25%. First year only half the depreciation will be considered

The annual impact of both methods is given below -

Years	Straight Line Method			Declining Balance Method			Declining Balance Method with Switch
	Opening Balance	Depreciation	Closing Balance	Opening Balance	Depreciation @ 25%	Closing Balance	Opening Balance	Depreciation	Closing Balance
1	7,653,800	474,516	7,179,284	7,653,800	956,725	6,697,075	7,653,800	956,725	6,697,075
2	7,179,284	949,033	6,230,251	6,697,075	1,674,269	5,022,806	6,697,075	1,674,269	5,022,806
3	6,230,251	949,033	5,281,219	5,022,806	1,255,702	3,767,105	5,022,806	1,255,702	3,767,105
4	5,281,219	949,033	4,332,186	3,767,105	941,776	2,825,329	3,767,105	741,113	3,025,992
5	4,332,186	949,033	3,383,154	-			3,025,992	741,113	2,284,879
6	3,383,154	949,033	2,434,121	-			2,284,879	741,113	1,543,766
7	2,434,121	949,033	1,485,089	-			1,543,766	741,113	802,653
8	1,485,089	949,033	536,056	-			802,653	741,113	61,540
9	536,056	474,516	61,540	-

The switch over to straight line method will happen in year 4 as the depreciation under straight line method will be higher than declining balance method. The balance depreciation after the switch will be -

Book value at end of Year 3 = $ 3,767,105

Residual value = $61,540

No of years left = 5

Depreciation = (3,767,105 - 61,540)/5 = $741,113

For the first 2 years using declining balance method will result in higher net income as the annual depreciation is higher than in straight line method.

ekkarill92 answered 1 year ago

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