Question

Facts:

On April 1, 2020, Bert's Baseball Company purchased equipment for $66,000. The company expected the equipment to last four years or 6,000 hours, with an estimated salvage value of $6,000 at the end of the useful life. The equipment was used 1,000 hours during 2020.

1. What amount of depreciation expense will Bert's Baseball Company record in 2020 using the straight-line method of depreciation?

2. What amount of depreciation expense will Bert's Baseball Company record in 2020 using the units-of-activity method of depreciation?

3. In your opinion, is it ethical for a company to change depreciation methods for the sole purpose of maximizing profitability (increasing net income)? Why or why not? Explain.

Answer 1

1. The straight line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset.

Computation of depreciation expense as per SLM for the year 2020:

Particulars		Equipment
		$
Purchase Price	A	66,000
Estimated Salvage value	B	6,000
Value to be depreciated in its useful life	C=A-B	60,000
Useful Life of Asset (in Years)	D	4
Depreciation value per year as per SLM	E=C/D	15,000

As the company used the equipment only for the 9 months in Year 2020, therefore depreciation expense = $15,000 * 9 months/12 months = $11,250.

2. Under units of activity method, hourly rate of depreciation is calculated. The cost of the asset (less residual value if any) is divided by the estimated working hours. The actual depreciate for any given period depends upon the working hours during that year.

Working Hour Depreciation = (Cost of Asset - Residual Value) / Total expected working hours

Working Hour Depreciation rate = ($66,000-$6,000)/6,000 hours = $10 per hour.

Depreciation Expense = Working Hour Depreciation rate x working hours in the year

Therefore, depreciation expense for the Year 2020 = $10 * 1,000 hours = $10,000.

3. No, it is not ethical for a company to change depreciation methods for the sole purpose of maximizing profitability. Depreciation is the expense shown to comply with the matching principles. The method of depreciation which shows the most accurate depreciation as per the consumption of the company should be used.

Only when the company realizes that there is a change in the consumption pattern or some issues in the depreciation method used before, only then the depreciation methods should be changed.

So it is not a healthy practice to change the depreciation method to maximize profitability.