On August 3, Cinco Construction purchased special-purpose equipment at a cost of
ID: 2592378 • Letter: O
Question
On August 3, Cinco Construction purchased special-purpose equipment at a cost of $8,155,100. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $19,360. a. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the straight-line depreciation method (half-year convention). b. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense. c. Which of these two depreciation methods (straight-line or double-declining-balance) results in the highest net income for financial reporting purposes during the first two years of the equipment’s use?
Explanation / Answer
a) Depreciation expense=(Original cost-salvage value)/useful life=(8155100-19360)/8=1016968 Year Depreciation expense Book value 1 508484 7646616 (1016968*1/2) (8155100-508484) 2 1016968 6629648 3 1016968 5612680 4 1016968 4595712 5 1016968 3578744 6 1016968 2561776 7 1016968 1544808 8 1016968 527840 9 508484 19356 (Salvage value) b) Depreciation rate=200% of straight line rate=200%*[(1/8 )*100]=25% Depreciation expense=Book value*25% Year Depreciation expense Book value 0 8155100 1 1019388 7135713 (8155100*0.25)*1/2 (8155100-1019388) 2 1783928 5351784 3 1337946 4013838 4 1003460 3010379 5 752595 2257784 6 564446 1693338 7 557993 1135345 8 557993 577352 9 557993 19359 (Salvage value) Note From year 7 onwards switch to straight line method Since depreciaion under diminishing balance method is less than straight line depreciation For year 7 Depreciation under diminishing balance method=1693338*0.25=423335 Depreciation understraight line method=508484 (Half-year ) Depreciation from year 7=(Remaining book value-Salvage value)/Remaining life=(1693338-19360)/3=557993 c) For the first 2 years Depreciation expense is lower under straight line method.Hence this will give higher net income
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