Chapter 8, Problem 6BTN

To determine

Depreciation:

Depreciation is the amount of decrease in the value of an asset within a set time period due to wear and tear of that particular asset. It helps in readjusting the actual cost of the particular asset o which the depreciation is applied.

Double Declining Balance Method:

It is a method of depreciation in which the rate of depreciation is double the rate of straight line method of depreciation. The amount of depreciation applied to the asset declines every period because book value declines every period.

Straight Line Depreciation:

Straight line depreciation is one of the methods of depreciation in which fixed rate of depreciation is provided throughout the course of depreciation on a particular asset.

Units of Production Depreciation Method:

This is a method of depreciation where the depreciation is not applied as straight line and is calculated with respect to the units that a particular asset produces gives.

1.

To Compute: The amount of depreciation.

Explanation of Solution

Given,

Cost of the van is $44,000.

Salvage value is $2,000.

Useful life is 4 years.

Formula to calculate Depreciable cost.

  $\text{Depreciable}\text{Cost}=\text{Cost}\text{of}\text{machine}-\text{Salvage}\text{value}$

Substitute $44,000 as cost of the van and $2,000 as salvage value.

  $\begin{array}{c}\text{Depreciable}\text{cost}=\$44,000-\$2,000\\ =\$42,000\end{array}$

Total depreciable cost is $42,000.

Computation of depreciation amount,

Year	Straight line($)	Units of production($)	Double Declining Balance($)
2015	10,500	8,400	22,000
2016	10,500	12,600	11,000
2017	10,500	14,000	5,500
2018	10,500	7,000	2,750
Total	42,000	42,000	42,000

Table (1)

Working Notes:

Useful years are 4 years.

Total cost is $42,000.

Straight line method

Formula to calculate Depreciation.

  $\begin{array}{c}\text{Depreciation}=\frac{\left(\text{Cost}\text{of}\text{the}\text{asset}-\text{Residual}\text{value}\right)}{\text{Useful}\text{life}}\\ =\frac{\$44,000-\$2,000}{4}\\ =\frac{\$42,000}{4}\\ =\$10,500\end{array}$

Depreciation that will be charged in the 4 years with respect o straight line method is $10,500.

Units of production method.

Year 2015.

Given,

Total miles driven in year 1 are $12,000.

Total cost is $44,000.

Total miles driven are $60,000.

Formula to calculate depreciation with respect to units of production:

  $\begin{array}{c}\text{Depreciation}\text{per}\text{unit}=\frac{\left(\text{Cost}\text{of}\text{the}\text{asset}-\text{Salvage}\text{value}\right)}{\text{Useful}\text{life}\text{in}\text{units}}\\ =\frac{\$44,000-\$2,000}{\$60,000\text{units}}\\ =\frac{\$42,000}{60,000}\\ =0.7\text{per}\text{unit}\end{array}$

Depreciation per unit is 0.7 per miles.

Computation of depreciation,

  $$

  $\begin{array}{c}\text{Depreciation}=\text{Total}\text{miles}\text{driven}\text{in}1\text{st}\text{year}\times \text{Depreciation}\text{per}\text{mile}\\ =\$12,000\times 0.7\\ =\$8,400\end{array}$

Depreciation that will be charged in the first year is $8,400.

Double Declining Balance method.

Given,

Book value of the asset is $44,000.

Useful life is 4 years.

Computation of Depreciation rate.

  $\begin{array}{c}\text{Double}\text{Declining}\text{Depreciation}\text{Rate}=\frac{100\%}{\text{useful}\text{years}}\times 2\\ =\frac{100\%}{4}\times 2\\ 50\%\end{array}$

Double declining depreciation rate is 50%.

Computation of depreciation in the first year:

  $\begin{array}{c}\text{Depreciation}=\text{Cost}\text{of}\text{the}\text{machine}\times \text{Depreciation}\text{rate}\\ =\$44,000\times 50\%\\ =\$22,000.\end{array}$

Depreciation that will be charged in the first year is $22,000.

Year 2016.

Unit of production method

Given,

Miles driven are $18,000.

Depreciation per mile is 0.7 per unit.

Computation of Depreciation,

  $\begin{array}{c}\text{Depreciation}=\text{Total}\text{miles}\text{driven}\text{in}1\text{st}\text{year}\times \text{Depreciation}\text{per}\text{mile}\\ =\$18,000\times 0.7\\ =\$12,600\end{array}$

Depreciation that will be charged in the second year is $12,600.

Double Declining Balance method.

Computation of book value in year 2:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$44,000-\$22,000\\ =\$22,000\end{array}$

Book value at the beginning of the 2016 year is $22,000.

Computation of depreciation in the second year.

  $\begin{array}{c}\text{Depreciation}=\text{Cost}\text{of}\text{the}\text{machine}\times \text{Depreciation}\text{rate}\\ =\$22,000\times 50\%\\ =\$11,000.\end{array}$

Depreciation that will be charged in the 2016 year is $11,000.

Year 2017.

Unit of production method

Given,

Miles driven are $21,000.

Depreciation per mile is 0.7 per unit.

Computation of Depreciation,

  $\begin{array}{c}\text{Depreciation}=\text{Total}\text{miles}\text{driven}\text{in}1\text{st}\text{year}\times \text{Depreciation}\text{per}\text{mile}\\ =\$21,000\times 0.7\\ =\$14,000\end{array}$

Depreciation that will be charged in the second year is $14,000.

Double Declining Balance method.

Computation of book value in year 2:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$22,000-\$11,000\\ =\$11,000\end{array}$

Book value at the beginning of the 2017 year is $11,000.

Computation of depreciation in the 2017 year.

  $\begin{array}{c}\text{Depreciation}=\text{Cost}\text{of}\text{the}\text{machine}\times \text{Depreciation}\text{rate}\\ =\$11,000\times 50\%\\ =\$5,500.\end{array}$

Depreciation that will be charged in the 2017 year is $5,500.

Year 2018.

Unit of production method

Given,

Miles driven are $10,000.

Depreciation per mile is 0.7 per unit.

Computation of Depreciation,

  $\begin{array}{c}\text{Depreciation}=\text{Total}\text{miles}\text{driven}\text{in}1\text{st}\text{year}\times \text{Depreciation}\text{per}\text{mile}\\ =\$10,000\times 0.7\\ =\$7,000\end{array}$

Depreciation that will be charged in the second year is $7,000.

Double Declining Balance method.

Computation of book value in year 2:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$11,000-\$5,500\\ =\$5,500\end{array}$

Book value at the beginning of the 2018 year is $5,500.

Computation of depreciation in the 2018 year.

  $\begin{array}{c}\text{Depreciation}=\text{Cost}\text{of}\text{the}\text{machine}\times \text{Depreciation}\text{rate}\\ =\$5,500\times 50\%\\ =\$2,750.\end{array}$

Depreciation that will be charged in the 2018 year is $2,750.

2

To determine

To explain: The treatment of annual depreciation.

Explanation of Solution

• The annual depreciation will be calculated annually at the end of the financial period.
• The annual depreciation will be treated as an expense for the company and will come in the debit side of the profit and loss account.

Hence, the annual depreciation will be treated as an expense.

3

To determine

To explain: the impact of depreciation method as compared to van’s life.

Explanation of Solution

• In straight line method the depreciation remains constant throughout the course of life; hence the same amount of depreciation will be deducted from the net income.
• In the unit of production method, it is calculated as peer the miles driven, it is an effective way of applying depreciation and the burden of depreciation expense shift from year to year as per the vehicle used.
• In double declining method the depreciation applied is more in the initial years and very less in the end years and the less amount is deducted at the end years , thereby less expenses is deducted from the net income at the end years of the vehicle.

Hence, the impact of depreciation is different in each method.

4

To determine

To compute: The book value for each year.

Explanation of Solution

Double declining balance method.

Year 2016

Double Declining Balance method.

Computation of book value in year 2016:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$44,000-\$22,000\\ =\$22,000\end{array}$

Book value at the beginning of the 2017 year is $22,000.

Year 2017.

Book value at the beginning of the year 2017 is $22,000.

Double Declining Balance method.

Computation of book value in year 2016:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$22,000-\$11,000\\ =\$11,000\end{array}$

Hence, the book value is $11,000

Year 2018.

Book value at the starting of the year is $11,000.

Double Declining Balance method.

Computation of book value in year 2016:

  $\begin{array}{c}\text{Book}\text{value}=\text{Cost}\text{of}\text{the}\text{asset}-\text{Depreciation}\\ =\$11,000-\$5,500\\ =\$5,500\end{array}$

Hence, the book value is $5,500.

The book value will be reported in the asset side of the balance sheet.

Hence, the book value will be shown in the asset side of the balance sheet.