Concept explainers
Computing
Assume Purity Ice Cream Company, Inc., in Ithaca, NY, bought a new ice cream maker at the beginning of the year at a cost of $9,000. The estimated useful life was four years, and the residual value was $1,000. Assume that the estimated productive life of the machine was 16,000 hours. Actual annual usage was 5,500 hours in Year 1; 3,800 hours in Year 2; 3,200 hours in Year 3; and 3,500 hours in Year 4.
Required:
- 1. Complete a separate depreciation schedule for each of the alternative methods. Round your answers to the nearest dollar.
- a. Straight-line.
- b. Units-of-production (use four decimal places for the per unit output factor).
- c. Double-declining-balance.
Method:_________ | |||||
Year | Computation | Depreciation Expense |
Net Book Value | ||
At acquisition | |||||
1 | |||||
2 | |||||
etc. |
2. Assuming that the machine was used directly in the production of one of the products that the company manufactures and sells, what factors might management consider in selecting a preferable depreciation method in conformity with the expense principle?
1. a.
Prepare the depreciation expense schedule under straight-line method.
Explanation of Solution
Straight-line method:
The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset is referred to as straight-line method.
Formula for straight-line depreciation method:
Depreciation expense:
Depreciation expense is a non-cash expense, which is recorded on the income statement reflecting the consumption of economic benefits of long-term asset.
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:
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:
Depreciation schedule under straight-line method:
Year | Computation | Depreciation Expense | Accumulated Depreciation | Net Book Value |
At Acquisition | $9,000 | |||
1 | $2,000 | $2,000 | 7,000 | |
2 | 2,000 | 4,000 | 5,000 | |
3 | 2,000 | 6,000 | 3,000 | |
4 | 2,000 | 8,000 | 1,000 |
Table (1)
b.
Prepare the depreciation expense schedule under units-of-production method.
Explanation of Solution
Units-of-production method:
The depreciation method which assumes that the consumption of economic benefits of long-term asset is based on the production capacity or output is referred to as units-of-production method.
Formula for units-of-production depreciation method:
Depreciation schedule under units-of-production method:
Year | Computation | Depreciation Expense | Accumulated Depreciation | Net Book Value |
At Acquisition | $9,000 | |||
1 | $2,750 | $2,750 | 6,250 | |
2 | 1,900 | 4,650 | 4,350 | |
3 | 1,600 | 6,250 | 2,750 | |
4 | 1,750 | 8,000 | 1,000 |
Table (2)
c.
Prepare the depreciation expense schedule under double-declining-balance method.
Explanation of Solution
Double-declining-balance method:
The depreciation method which assumes that the consumption of economic benefits of long-term asset is high in the early years but gradually declines towards the end of its useful life is referred to as double-declining-balance method.
Formula for double-declining-balance depreciation method:
Depreciation schedule under double-declining-balance method:
Year | Computation | Depreciation Expense | Accumulated Depreciation | Net Book Value |
At Acquisition | $9,000 | |||
1 | $4,500 | $4,500 | $4,500 | |
2 | 2,250 | 6,750 | 2,250 | |
3 | 1,125 | 7,875 | 1,125 | |
4 | 125 | 8,000 | 1,000 |
Table (3)
Note: The net book value of the asset cannot be less than the residual value of such asset. Hence, calculate the depreciation expense as given in the working note below.
Working Note:
Compute depreciation expense in Year 4.
2.
Identify the factors which the management might consider in selecting a preferable depreciation method in conformity with the expense principle.
Explanation of Solution
- If there is an equal consumption of asset during the useful life of the asset and if there is a steady decline in its efficiency every year over its useful life, then the management can prefer straight-line depreciation method.
- If there is high consumption of asset in the early years of useful life and decline in usage towards the end of its useful life and if it perform efficiently in their earlier useful life and earn more revenue than in their later years, then the management can prefer double-declining-balance depreciation method.
- If the asset is not used at a uniform rate from period to period and if its efficiency varies from year to year in accordance with the rate of the output, then the management can prefer units-of-production depreciation method, as the depreciation expense would be better matched with the revenue earned under this method.
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