On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,536,100. The useful life...

On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,536,100. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $66,920.

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

(1) Straight-line:
Cost	$ 7,536,100.00
Less: Salvage value	$ 66,920.00
Depreciable Cost	$ 7,469,180.00

Depreciation Rate = 1/8	13%
Annual depreciation expense	$ 933,647.50


	Computation
Year	Depreciable cost		Depreciation Rate		Depreciation Expense	Accumulated Depreciation	Ending Book Value
1	$ 7,469,180.00	X	6%	=	$ 466,823.75	$ 466,823.75	$ 7,002,356.25
2	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 1,400,471.25	$ 6,068,708.75
3	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 2,334,118.75	$ 5,135,061.25
4	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 3,267,766.25	$ 4,201,413.75
5	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 4,201,413.75	$ 3,267,766.25
6	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 5,135,061.25	$ 2,334,118.75
7	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 6,068,708.75	$ 1,400,471.25
8	$ 7,469,180.00	X	13%	=	$ 933,647.50	$ 7,002,356.25	$ 466,823.75
9	$ 7,469,180.00	x	6%		$ 466,823.75	$ 7,469,180.00	$ -
					$ 7,469,180.00
(2) Double-declining balance:
Double declining depreciation rate = 1/8 x 2	25%

	Computation
Year	Beginning book value		Depreciation Rate		Depreciation Expense	Accumulated Depreciation	Ending Book Value
1	$ 7,536,100.00	X	13%	=	$ 942,012.50	$ 942,012.50	$ 6,594,087.50
2	$ 6,594,087.50	X	25%	=	$ 1,648,521.88	$ 2,590,534.38	$ 4,945,565.63
3	$ 4,945,565.63	X	25%	=	$ 1,236,391.41	$ 3,826,925.78	$ 3,709,174.22
4	$ 3,709,174.22	X	25%	=	$ 927,293.55	$ 4,754,219.34	$ 2,781,880.66
5	$ 2,781,880.66	X	25%	=	$ 695,470.17	$ 5,449,689.50	$ 2,086,410.50
6	$ 2,086,410.50	X	25%	=	$ 521,602.62	$ 5,971,292.13	$ 1,564,807.87
7	$ 1,564,807.87	X	25%	=	$ 391,201.97	$ 6,362,494.09	$ 1,173,605.91
8	$ 1,173,605.91	X	25%	=	$ 293,401.48	$ 6,655,895.57	$ 880,204.43
9	$ 880,204.43	X	92%	=	$ 813,284.43	$ 7,469,180.00	$ 66,920.00
					$ 7,469,180.00
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?
Straight line Depreciation method results in the highest net income because it has lower depreciation expenses	Depreciation Expense for 1st and 2nd year
(1) Straight-line:	$ 1,400,471.25
(2) Double-declining balance:	$ 2,590,534.38

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