Chapter 8, Problem 26BP

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	30,000	30,000	30,000
Less: Depreciation expense	11,600	25,600	14,500
Net Income	$18,400	$4,400	$15,500

Table (1)

Working Notes:

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	58,000	1/5	11,600
Year 2	58,000	1/5	11,600
Year 3	58,000	1/5	11,600
Year 4	58,000	1/5	11,600
Year 5	58,000	1/5	11,600

Table (2)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$64,000}-\$6,000\\ =\$58,000\end{array}$

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	0.40	64,000	25,600
Year 2	0.40	38,400	15,360
Year 3	0.40	23,040	9,216
Year 4	0.40	13,824	5,530
Year 5	0.40	8,294	2,294

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 = 5 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 40\%}\text{or }\text{.40}\end{array}$

Compute depreciation expense on Year 5.

$\begin{array}{c}\text{Depreciation on Year 5}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 5}\end{array}\right)\\ =\text{\$64,000–\$6,000–}\left(\text{\$25,600+\$15,360+\$9,216+\$5,530}\right)\\ =\$58,000-\$55,706\\ =\$2,294\end{array}$

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

Date	Depreciation per unit (A)	Number of hours (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	$0.29	50,000	14,500
Year 2	$0.29	55,000	15,950
Year 3	$0.29	40,000	11,600
Year 4	$0.29	44,000	12,760
Year 5	$0.29	31,000	3,190

Table (4)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$64,000–\$6,000}}{200,000\text{hours}}\\ \text{=}\frac{\text{\$58,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.29 per hour}\end{array}$

Compute depreciation expense on Year 5.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$64,000–\$6,000–}\left(\text{\$14,500+\$15,950+\$11,600+\$12,760}\right)\\ =\$58,000-\$54,810\\ =\$3,190\end{array}$

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 3.

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 3.

Net Income for Year 3
	Company A (in $)	Company B (in $)	Company C (in $)
Revenue	30,000	30,000	30,000
Less: Depreciation expense	11,600	9,216	11,600
Net Income	$18,400	$20,784	$18,400

Table (5)

Working Notes:

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	58,000	1/5	11,600
Year 2	58,000	1/5	11,600
Year 3	58,000	1/5	11,600
Year 4	58,000	1/5	11,600
Year 5	58,000	1/5	11,600

Table (6)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$64,000}-\$6,000\\ =\$58,000\end{array}$

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	0.40	64,000	25,600
Year 2	0.40	38,400	15,360
Year 3	0.40	23,040	9,216
Year 4	0.40	13,824	5,530
Year 5	0.40	8,294	2,294

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 = 5 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 40\%}\text{or }\text{.40}\end{array}$

Compute depreciation expense on Year 5.

$\begin{array}{c}\text{Depreciation on Year 5}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 5}\end{array}\right)\\ =\text{\$64,000–\$6,000–}\left(\text{\$25,600+\$15,360+\$9,216+\$5,530}\right)\\ =\$58,000-\$55,706\\ =\$2,294\end{array}$

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

Date	Depreciation per unit (A)	Number of hours (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$
Year 1	$0.29	50,000	14,500
Year 2	$0.29	55,000	15,950
Year 3	$0.29	40,000	11,600
Year 4	$0.29	44,000	12,760
Year 5	$0.29	31,000	3,190

Table (8)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$64,000–\$6,000}}{200,000\text{hours}}\\ \text{=}\frac{\text{\$58,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.29 per hour}\end{array}$

Compute depreciation expense on Year 5.

$\begin{array}{c}\text{Depreciation on Year 4}=\left(\begin{array}{l}\text{Asset cost–Residual value}-\\ \text{Accumulated depreciation in Year 4}\end{array}\right)\\ =\text{\$64,000–\$6,000–}\left(\text{\$14,500+\$15,950+\$11,600+\$12,760}\right)\\ =\$58,000-\$54,810\\ =\$3,190\end{array}$

Conclusion

Hence, the company which will report the lowest amount of net income for Year 3 is Company A and 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	64,000	64,000	64,000
Less: Accumulated depreciation	34,800	50,176	42,050
Book value	$29,200	$13,824	$21,950

Table (9)

Working Notes:

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	58,000	1/5	11,600	11,600
Year 2	58,000	1/5	11,600	23,200
Year 3	58,000	1/5	11,600	34,800

Table (10)

Calculate the depreciable cost.

$\begin{array}{c}\text{Depreciable cost=Cost of the asset}-\text{Residual value}\\ \text{=\$64,000}-\$6,000\\ =\$58,000\end{array}$

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	0.40	64,000	25,600	25,600
Year 2	0.40	38,400	15,360	40,960
Year 3	0.40	23,040	9,216	50,176

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 = 5 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{4 years}}\text{ × 2}\\ \text{= 40\%}\text{or }\text{.40}\end{array}$

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

Date	Depreciation per unit (A)	Number of hours (B)	Depreciation expense (in $)$\left(\left(\text{C}\right)=\left(\text{A}\right)\times \left(\text{B}\right)\right)$	Accumulated depreciation (in $)
Year 1	$0.29	50,000	14,500	14,500
Year 2	$0.29	55,000	15,950	30,450
Year 3	$0.29	40,000	11,600	42,050

Table (12)

Compute depreciation per unit.

$\begin{array}{c}\text{Depreciation per unit =}\frac{\text{ Asset cost – Residual value}}{\text{Estimated units of total production}}\\ \text{=}\frac{\text{\$64,000–\$6,000}}{200,000\text{hours}}\\ \text{=}\frac{\text{\$58,000}}{200,000\text{miles}}\\ \text{= \$0}\text{.29 per hour}\end{array}$

Conclusion

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

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 company which will report the highest amount of retained earnings on the December 31, Year 4, balance sheet is Company A. However, the retained earnings for all the companies will be the same at the end of the asset’s five-year life, as the total depreciation over the five 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.