Question

2. (20 pts) Wellcraft Company purchased a machine on January 1, 2015 for $625,000. The machine has a four year useful life and a salvage value of $25,000. The machine was depreciated using sum of the years digits. On January 1, 2017, two years later, it was determined they should have used straight line depreciation and decided to change to straight line. The useful life was also extended by two years, and the salvage value was reduced to $15,000. Profit for 2015 was $800,000 and for 2016 was $900,000 using sum of the years’ digits depreciation. Prior to depreciation expense in 2017, profits were $200,000.

A. Determine the correct profits for 2015, 2016, 2017

B. Assume Wellcraft used the completed contract method for 2016 but switched to percent of completion in 2017.

                                                                        2016                              2017

Profits under completed contract          $400,000                       $450,000
Profits under percent of completion      $650,000                       $580,000

C. Sean Kowalski, CEO, is paid a bonus of 1% of profits each year. Determine his bonus paid to him in 2017.

Answer 1

Depreciation expense of each year of the useful life of the machine using sum of year’s digits method.

Cost of machine – 625000

Salvage value – 25000

Total = 525000 – 25000 = 600000

Year	Depreciation base	Remaining life	Depreciation fraction	Depreciation expense	Book value
1	600000	4	0.4	240000	385000
2	600000	3	0.3	180000	205000
3	600000	2	0.2	120000	85000
4	600000	1	0.1	60000	25000
		10		600000

Book value at 1 Jan 2017 – 205000

New salvage value – 15000

Remaining life – 4

New depreciation base – 190000

Change of depreciation method is change in the accounting estimate and hence applied accordingly.

Answer A.

Year		2015	2016	2017
Profit before depreciation		1040000	1080000	200000
Depreciation		240000	180000	47500
Profit after depreciation		800000	900000	152500

Answer B

The change in revenue recognition method: From percentage of completion method to completed contract method or vice versa considered as change in accounting policy and hence to be presented with respective application. The effort of such application would be that the change will be reflected in past, present and future period and hence.

In the present case, Well craft used the completed contract method for 2016 but switched to percent of completion in 2017.

Year	2016	2017
Profit under completed contract	400000	450000
Profit under % of completion method	650000	580000
Bonus will be calculated using profit on percentage of completion	6500	5800
Amount already paid last year	4000	0
Amount to be paid in current year	2500	5800
Total	8300