Rizzo Incorporated purchased a new piece of equipment for $300,000 on April 1, 2
ID: 2601597 • Letter: R
Question
Rizzo Incorporated purchased a new piece of equipment for $300,000 on April 1, 2017. The equipment has a useful life of 3 years or 20,000 hours, and the residual value of the equipment is $12,000. The actual hours of use were:
2017 – 7,000
2018 – 8,000
2019 – 4,000
2020 – 1,000
Calculate the depreciation expense for years: 2017, 2018, 2018, and 2020 under the three depreciation methods:
1 – Straight Line depreciation
2 – Double Declining Balance Depreciation
3 – Units of Production Depreciation
What impact does the depreciation method chosen have on the amount of expenses for the company for a given year? How does this in turn impact the company’s net income and taxes owed for that year?
Explanation / Answer
Year
Beginning BV
2017
300000
2018
2019
2020
UNITS OF PRODUCTION METHOD:
Depreciation per hour of equipment usage = (300000-12000)/20000 = $14.40 per hour.
Year
Equipment hours
2017
7000
2018
2019
2020
EXPENSES FOR A GIVEN YEAR:
Depreciation under Straight line is the same for all the years; under DDB method it is very high in the initial years and lower in the
later years; under the units of production method it depends on the production achieved.
As the straight line depreciation is the same amount each year, the charge to net income is the same, and the net income '
does not change due to difference in depreciation amounts in different years. The impact on income tax payable in the form of
tax shield is also uniform for all the years.
Under the DDB, in the earlier years depreciation is very high which will lower the net income and the income tax payable for those
years. The reverse will happen in the later years.
Under the production unit method, the depreciation amount and its impact on net income and taxes payable will differ each year
according to the units produced.
1) STRAIGHT LINE DEPRECIATION: Annual depreciation = (300000-12000)/3 = $ 96,000 Depreciation for 2017 = 96000*9/12 = $ 72,000 Depreciation for 2018 $ 96,000 Depreciation for 2019 $ 96,000 Depreciation for 2020 = 96000*3/12 = $ 24,000 2) DOUBLE DECLINING BALANCE METHOD:Year
Beginning BV
Depreciation % Depreciation Accumulated depreciation Ending BV Rate of depreciation = (100%/3)*2 = 66.67%2017
300000
33.33 99990 99990 200010 With mid year convention 1st year depreciation2018
200010 66.67 133347 233337 66663 rate will be 33.33% as also last year depreciation.2019
66663 66.67 44444 44444 222192020
22219 33.33 7406 7406 14813 3)UNITS OF PRODUCTION METHOD:
Depreciation per hour of equipment usage = (300000-12000)/20000 = $14.40 per hour.
Year
Equipment hours
Depreciation2017
7000
1008002018
8000 1152002019
4000 576002020
1000 14400EXPENSES FOR A GIVEN YEAR:
Depreciation under Straight line is the same for all the years; under DDB method it is very high in the initial years and lower in the
later years; under the units of production method it depends on the production achieved.
As the straight line depreciation is the same amount each year, the charge to net income is the same, and the net income '
does not change due to difference in depreciation amounts in different years. The impact on income tax payable in the form of
tax shield is also uniform for all the years.
Under the DDB, in the earlier years depreciation is very high which will lower the net income and the income tax payable for those
years. The reverse will happen in the later years.
Under the production unit method, the depreciation amount and its impact on net income and taxes payable will differ each year
according to the units produced.
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