Question

Equiptment with a ten-year estimated useful life and no slavage value is sold at the end of the third year of its useful life. How would using the striaght-line method of depreciation instead of the double-declining balance method of depreciation affact the gain on the sale of the equiptment?

Answer 1

Answer

Let’s assume that cost of Equipment is x

Straight Line Method

Depreciation Rate = 1/ Useful life

= 1/10

Depreciation Rate = 10%

Depreciation for 3 Years = Cost * Depreciation Rate * 3 Years

= x * 10% * 3

= 0.3x

Total depreciation for 3 Years = 0.3x

Double Declining Balance Method

Rate of Depreciation under Straight Line Method = 10%

Rate under Double Declining Balance = 2 * 10%

= 20%

Depreciation = Book Value * Rate

Depreciation for Year 1

= x * 20%

Depreciation for Year 1= 0.2x

Depreciation for Year 2

= (x – 0.2x) * 20%

= 0.8x * 20%

Depreciation for Year 2 = 0.16x

Depreciation for Year 3

= (0.8x – 0.16x) * 20%

Depreciation for Year 3 = 0.128x

Total Depreciation = 0.2x + 0.16x + 0.128x

Total Depreciation for 3 Years under Double Declining Balance Method = 0.488x

Total depreciation for 3 Years under Straight Line Method = 0.3x

So depreciation under Double Declining balance method is more than the Straight Line Method.

So the higher the depreciation, lower the book value and Higher Gain on Sale

And

Lower the depreciation, Higher the book Value and Lower gain on sale.

Conclusion

If we are using Straight Line Method, the depreciation will be less compared to Double declining balance method and this will result in High Book Value and Low Gain on Sale of Equipment.