Problem: The Pablo Paving Company purchased a new bulldozer for $ 250,500 at the

Question

Problem: The Pablo Paving Company purchased a new bulldozer for $ 250,500 at the beginning of Year 1. It is estimated that the residual value will be 25,000 and have a useful life of 6 years. The Bulldozer is expected to last 10,000 hours. In year 1 it was used 1,800 hours, in year 2 it was used 2000 hours; year 3, 2,500 hours; 1,500 hours in year 4; 1,200 hours in year 5; and 1,000 hours in year 6.

Required:

1) Compute the annual depreciation and carrying value for the new crane for each of the 6 years under each of the following methods: a) Straight-line, b) production, c) double declining- balance. Round percentage to 2 decimal places (for example, like this: 22.22 %).

2) If the crane is sold for $ 250,000 at the end of year 3, what is the gain/loss under each of the three methods?

3) How does each method affect the firm’s profitability? Please explain this as clearly as possible.

Explanation / Answer

Part 1)

a)

Straight Line Method

The depreciation as per straight line method can be calculated as follows:

Annual Depreciation = (Cost - Salvage Value)/Estimated Life = (250,500 - 25,000)/6 = $37,583.33

The annual depreciation and book value under straight line is calculated with the use of following table:

___________

b)

Production Method

To calculate depreciation under units of production method, we need to determine the depreciation per hour (here unit is hour). The depreciation per hour can be calculated as follows:

Depreciation Per Hour = (Cost - Salvage Value)/Total Estimated Hours = (250,500 - 25,000)/10,000 = $22.55

The depreciation for each of the 6 years has been calculated with the use of following table:

________

The book value for each year has been calculated with the use of following table:

___________

c)

Double Declining Method

The depreciation rate under double declining method is calculated as follows:

Depreciation Rate under Straight Line Method = Annual Depreciation/(Cost - Salvage Value)*100 = 37,583.33/(250,500 - 25,000)*100 = 16.66%

Depreciation Rate under Double Declining Method = Depreciation Rate under Straight Line Method*2 = 16.66%*2 = 33.33%

The depreciation and book value for each of the 6 years has been calculated with the use of following table:

___________

Part 2)

The gain/loss under each method has been calculated as follows:

Gain under Straight Line Method = Sales Value - Book Value at the End of Year 3 = 250,000 - 137,750 = $112,250

_______

Gain under Production Method = Sales Value - Book Value at the End of Year 3 = 250,000 - 108,435 = $141,565

_______

Gain under Double Declining Method = Sales Value - Book Value at the End of Year 3 = 250,000 - 74,233.36 = $175,766.64

___________

Part 3)

The depreciation under double declining method is the highest (as evident from calculations above). The profitability will be higher in the initial years for straight line method and will keep getting lower with each year because of a constant amount of depreciation. However, in case of double declining method, initial years will report lower profits as higher amount of depreciation will get charged in the beginning years. The profits will be higher for later years as the amount of depreciation will keep on reducing with each passing year. Under production method, the depreciation will be based on the usage and the profits will be adjusted accordingly.

Year Annual Depreciation Accumulated Depreciation Book Value (Cost - Accumulated Depreciation) 1 37,583.33 37,583.33 (37,583.33) 212,916.67 2 37,583.33 751,66.67 (37,583.33*2) 175,333.33 3 37,583.33 112,750 (37,583.33*3) 137,750.00 4 37,583.33 150,333.33 (37,583.33*4) 100,166.67 5 37,583.33 187,916.67 (37,583.33*5) 62,583.33 6 37,583.33 225,500 (37,583.33*6) 25,000.00 (same as salvage value)

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