Chapter 8, Problem 26AP

a.

To determine

Identify the company which will report the highest amount of net income for Year 1.

Explanation of Solution

Net Income

Net income is the sum total of all the revenues generated in a particular accounting period after deducting cost of goods sold and expenses and losses, such as rent expense, depreciation of that particular accounting period.

Identify the company which will report the highest amount of net income for Year 1.

Net Income for Year 1
	Company A (in $)	Company B (in $)	Company C (in $)
Revenue	40,000	40,000	40,000
Less: Depreciation expense	11,250	25,000	14,850
Net Income	$28,750	$15,000	$25,150

Table (1)

Working Note:

Prepare depreciation schedule under straight-line method for Company A.

Date	Depreciable Cost (in $) (A)	Depreciation Rate (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	45,000	1/4	11,250
Year 2	45,000	1/4	11,250
Year 3	45,000	1/4	11,250
Year 4	45,000	1/4	11,250

Table (2)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$50,000}-\$5,000\\ =\$45,000\end{array}$

Prepare depreciation schedule under double-declining-balance (DDB) method for Company B.

Date	Double-Declining-Balance Depreciation Rate (A)	Book Value (Refer note) (in $) (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	0.50	50,000	25,000
Year 2	0.50	25,000	12,500
Year 3	0.50	12,500	6,250
Year 4	0.50	6,250	1,250

Table (3)

Note:

Book value:

The amount of acquisition cost of less accumulated depreciation as on a particular date is referred to as book value.

Formula for book value:

$\text{Book value = }\left\{\begin{array}{l}\text{Acquisition cost–}\\ \text{Accumulated depreciation}\end{array}\right\}$

Accumulated depreciation:

The total amount of depreciation expense deducted, from the time asset acquired till date, as reported in the account as on a particular date, is referred to as accumulated depreciation.

Formula for accumulated depreciation:

$\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in the previous years+}\\ \text{Depreciation in current year}\end{array}\right\}$

Determine the depreciation rate applied each year.

Useful life = 4 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 50\%}\text{or }\text{.50}\end{array}$

Compute depreciation expense on Year 4.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$50,000–\$5,000–}\left(\text{\$25,000+\$12,500+\$6,250}\right)\\ =\$45,000-\$43,750\\ =\$1,250\end{array}$

Prepare depreciation schedule under units-of-production method for Company C.

Date	Depreciation per unit (A)	Number of miles (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	$0.225	66,000	14,850
Year 2	$0.225	42,000	9,450
Year 3	$0.225	40,000	9,000
Year 4	$0.225	60,000	11,700

Table (4)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$50,000–\$5,000}}{200,000\text{miles}}\\ \text{=}\frac{\text{\$45,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.225}\end{array}$

Compute depreciation expense on Year 4.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$50,000–\$5,000–}\left(\text{\$14,850+\$9,450+\$9,000}\right)\\ =\$45,000-\$33,300\\ =\$11,700\end{array}$

Conclusion

Hence, the company which will report the highest amount of net income for Year 1 is Company A.

b.

To determine

Identify the company which will report the lowest amount of net income for Year 4.

Explanation of Solution

Net Income

Net income is the sum total of all the revenues generated in a particular accounting period after deducting cost of goods sold and expenses and losses, such as rent expense, depreciation of that particular accounting period.

Identify the company which will report the lowest amount of net income for Year 4.

Net Income for Year 4
	Company A (in $)	Company B (in $)	Company C (in $)
Revenue	40,000	40,000	40,000
Less: Depreciation expense	11,250	1,250	11,700
Net Income	$28,750	$38,750	$28,300

Table (5)

Working Note:

Prepare depreciation schedule under straight-line method for Company A.

Date	Depreciable Cost (in $) (A)	Depreciation Rate (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	45,000	1/4	11,250
Year 2	45,000	1/4	11,250
Year 3	45,000	1/4	11,250
Year 4	45,000	1/4	11,250

Table (6)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$50,000}-\$5,000\\ =\$45,000\end{array}$

Prepare depreciation schedule under double-declining-balance (DDB) method for Company B.

Date	Double-Declining-Balance Depreciation Rate (A)	Book Value (Refer note) (in $) (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	0.50	50,000	25,000
Year 2	0.50	25,000	12,500
Year 3	0.50	12,500	6,250
Year 4	0.50	6,250	1,250

Table (7)

Note:

Book value:

The amount of acquisition cost of less accumulated depreciation as on a particular date is referred to as book value.

Formula for book value:

$\text{Book value = }\left\{\begin{array}{l}\text{Acquisition cost–}\\ \text{Accumulated depreciation}\end{array}\right\}$

Accumulated depreciation:

The total amount of depreciation expense deducted, from the time asset acquired till date, as reported in the account as on a particular date, is referred to as accumulated depreciation.

Formula for accumulated depreciation:

$\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in the previous years+}\\ \text{Depreciation in current year}\end{array}\right\}$

Determine the depreciation rate applied each year.

Useful life = 4 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 50\%}\text{or }\text{.50}\end{array}$

Compute depreciation expense on Year 4.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$50,000–\$5,000–}\left(\text{\$25,000+\$12,500+\$6,250}\right)\\ =\$45,000-\$43,750\\ =\$1,250\end{array}$

Prepare depreciation schedule under units-of-production method for Company C.

Date	Depreciation per unit (A)	Number of miles (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	$0.225	66,000	14,850
Year 2	$0.225	42,000	9,450
Year 3	$0.225	40,000	9,000
Year 4	$0.225	60,000	11,700

Table (8)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$50,000–\$5,000}}{200,000\text{miles}}\\ \text{=}\frac{\text{\$45,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.225}\end{array}$

Compute depreciation expense on Year 4.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$50,000–\$5,000–}\left(\text{\$14,850+\$9,450+\$9,000}\right)\\ =\$45,000-\$33,300\\ =\$11,700\end{array}$

Conclusion

Hence, the company which will report the lowest amount of net income for Year 4 is Company C.

c.

To determine

Identify the company which will report the highest book value on the December 31, Year 3, balance sheet.

Explanation of Solution

Book value:

The amount of acquisition cost of less accumulated depreciation as on a particular date is referred to as book value.

Formula for book value:

$\text{Book value = }\left\{\begin{array}{l}\text{Acquisition cost–}\\ \text{Accumulated depreciation}\end{array}\right\}$

Identify the company which will report the highest book value on the December 31, Year 3, balance sheet.

Book value on December 31, Year 3
	Company A (in $)	Company B (in $)	Company C (in $)
Cost	50,000	50,000	50,000
Less: Accumulated depreciation	33,750	43,750	33,300
Book value	$16,250	$6,250	$16,700

Table (9)

Working Note:

Prepare depreciation schedule under straight-line method for Company A.

Date	Depreciable Cost (in $) (A)	Depreciation Rate (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$	Accumulated Depreciation (in $)
Year 1	45,000	1/4	11,250	11,250
Year 2	45,000	1/4	11,250	22,500
Year 3	45,000	1/4	11,250	33,750

Table (10)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$50,000}-\$5,000\\ =\$45,000\end{array}$

Prepare depreciation schedule under double-declining-balance (DDB) method for Company B.

Date	Double-Declining-Balance Depreciation Rate (A)	Book Value (Refer note) (in $) (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$	Accumulated Depreciation (in $)
Year 1	0.50	50,000	25,000	25,000
Year 2	0.50	25,000	12,500	37,500
Year 3	0.50	12,500	6,250	43,750

Table (11)

Note:

Book value:

The amount of acquisition cost of less accumulated depreciation as on a particular date is referred to as book value.

Formula for book value:

$\text{Book value = }\left\{\begin{array}{l}\text{Acquisition cost–}\\ \text{Accumulated depreciation}\end{array}\right\}$

Accumulated depreciation:

The total amount of depreciation expense deducted, from the time asset acquired till date, as reported in the account as on a particular date, is referred to as accumulated depreciation.

Formula for accumulated depreciation:

$\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in the previous years+}\\ \text{Depreciation in current year}\end{array}\right\}$

Determine the depreciation rate applied each year.

Useful life = 4 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 50\%}\text{or }\text{.50}\end{array}$

Prepare depreciation schedule under units-of-production method for Company C.

Date	Depreciation per unit (A)	Number of miles (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$	Accumulated Depreciation (in $)
Year 1	$0.225	66,000	14,850	14,850
Year 2	$0.225	42,000	9,450	24,300
Year 3	$0.225	40,000	9,000	33,300

Table (12)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$50,000–\$5,000}}{200,000\text{miles}}\\ \text{=}\frac{\text{\$45,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.225}\end{array}$

Conclusion

Hence, the company which will report the highest book value on the December 31, Year 3, balance sheet is Company C.

d.

To determine

Identify the company which will report the highest amount of retained earnings on the December 31, Year 4, balance sheet.

Explanation of Solution

Retained earnings:

The retained earnings statement is that financial statement which shows the amount of net income which is actually retained by the Company on a particular date. These earnings can be utilized by the Company for the reinvestment and to pay its debts.

Hence, the retained earnings for all the companies are the same on the December 31, Year 4, balance sheet, as the total depreciation over the four year period is the same for all the three companies.

e.

To determine

Identify the company which will report the lowest amount of cash flow from operating activities on the Year 3 statement of cash flows.

Explanation of Solution

Statement of cash flows:

This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period.

Cash flows from operating activities:

These refer to the cash received or cash paid in day-to-day operating activities of a company.  In this direct method, cash flow from operating activities is computed by using all cash receipts and cash payments during the year.

Depreciation expense is not a cash outflow item. If the income tax is not considered, all the three companies will report the same amount of cash flow from operating activities on the Year 3 statement of cash flows.