Chapter 9, Problem 2AP

a)

To determine

Prepare a complete depreciation schedule, beginning with the current year, under

1. 1) Straight line
2. 2) 200 percent declining balance
3. 3) 150 percent declining balance, switching to straight line when that maximizes depreciation expense.

Explanation of Solution

1. Straight-line Depreciation: Under the straight-line method of depreciation, the same amount of depreciation is allocated every year over the estimated useful life of an asset. The formula to calculate the depreciation cost of the asset using the residual value is shown as below:

$\text{Depreciation cost = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}$

Prepare a complete depreciation table under Straight line:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Book Value
1	$\$100,000\times (1÷5\text{year)}\times \frac{1}{2}$	$10,000	$10,000	$98,000
2	$\$100,000\times (1÷5\text{year)}$	20,000	30,000	78,000
3	$\$100,000\times (1÷5\text{year)}$	20,000	50,000	58,000
4	$\$100,000\times (1÷5\text{year)}$	20,000	70,000	38,000
5	$\$100,000\times (1÷5\text{year)}$	20,000	90,000	18,000
6	$\$100,000\times (1÷5\text{year)}\times \frac{1}{2}$	10,000	100,000	8,000

Table (1)

Calculate the depreciable cost of the equipment:

Cost of the equipment is $108,000 and the residual value of the equipment is $8,000.

Therefore, the depreciable cost of the equipment is $100,000$\left(\$108,000-\$8,000\right)$.

(1)

2. 200 percent declining balance method (Accelerated method): In this method of depreciation, the diminishing value of the asset is taken into consideration for determining the depreciation for the succeeding years.

$\text{200 percent declining-balance = }\left(\text{Cost of the asset}\right)\times \frac{200\%}{\text{Useful Life}}$

Depreciation rate for 200 percent declining balance method:

$\begin{array}{c}\text{Depreciation rate for 200 percent declining-balance = }\frac{200\%}{\text{Useful Life}}\\ =\frac{200\%}{5\text{years}}\\ =40\%\end{array}$

Prepare a complete depreciation table under 200 percent declining balance method:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Book Value
1	$108,000 $\times$ 40% $\times$$\frac{1}{2}$	$21,600	$21,600	$86,400
2	86,400 $\times$ 40%	34,560	56,160	51,840
3	51,840 $\times$ 40%	20,736	76,896	31,104
4	31,104 $\times$ 40%	12,442	89,338	18,662
5	18,662 $\times$ 40%	7,465	96,803	11,197
6	100,000 – 96,803	3,197	100,000	8,000

Table (2)

3. 150 percent declining balance method (Accelerated method): In this method of depreciation, the diminishing value of the asset is taken into consideration for determining the depreciation for the succeeding years.

$\text{150\% declining-balance = }\left(\text{Cost }-\text{Accumulated Depreciation}\right)\times \frac{150\%}{\text{Useful Life}}$

Depreciation rate for 150 percent declining balance method:

$\begin{array}{c}\text{Depreciation rate for 150 percent declining-balance = }\frac{150\%}{\text{Useful Life}}\\ =\frac{150\%}{5\text{years}}\\ =30\%\end{array}$

Prepare a complete depreciation table under 150 percent declining balance method:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Book Value
1	$108,000 $\times$30% $\times$$\frac{1}{2}$	$16,200	$16,200	$91,800
2	91,800 $\times$ 30%	27,540	43,740	64,260
3	64,260 $\times$ 30%	19,278	63,018	44,982
4	44,982 $\times$ 30%	13,495	76,513	31,487
5	($31,487 – $8,000) ÷ 2 years	11,743.5	88,257	19,743
6	($31,487 – $8,000) ÷ 2 years	11,743.5	100,000	8,000

Table (3)

Note: The method of depreciation for the years 5, and 6 are switched to straight line method. For the years 5 and 6, depreciation expense is maximized that is under the 150 percent declining-balance method the depreciation amount is $9,446 and under the straight line method depreciation amount is $11,743.5$\left(\left[\$31,487-\$8,000\right]÷2\text{years}\right)$.

Hence, the depreciation method is switched to straight line method with an amount of $11,743.5 depreciation expense.

b)

To determine

Identify the depreciation method that is most common for financial reporting purposes and explain.

Explanation of Solution

Straight line depreciation method is the most common depreciation method for financial reporting. The main reason for that is, under the straight line method the amount of depreciation expense reported is very less in the initial years as compared to other depreciation methods.

c)

To determine

Compute the resulting gain or loss from the sale of machine under each of the depreciation methods used in requirement (a). Explain that the gain or loss reported in the company’s income statement have any direct cash effect.

Explanation of Solution

Disposal of Assets:

Disposal is an activity of selling the worn-out assets that is no longer in need for the business, in return of some consideration.

Under the straight line method:

Cash proceeds	$29,000
Book value at the end of the fourth year	(38,000)
Loss on disposal	$(9,000)

Table (4)

Under the 200 percent declining balance method:

Cash proceeds	$29,000
Book value at the end of the fourth year	(18,662)
Gain on disposal	$10,338

Table (5)

Under the 150 percent declining balance method:

Cash proceeds	$29,000
Book value at the end of the fourth year	(31,487)
Loss on disposal	$(2,487)

Table (6)

In the income statement, there is no direct cash effect due to the gain or loss of sale of the machine. But, the sale proceed of the machine ($29,000) is having direct cash effect on the income statement.