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Chapter 11: Q11-12P (page 595)

On January 1, 2016, Locke Company, a small machine-tool manufacturer, acquired for \(1,260,000 a piece of new industrial equipment. The new equipment had a useful life of 5 years, and the salvage value was estimated to be \)60,000. Locke estimates that the new equipment can produce 12,000 machine tools in its first year. It estimates that production will decline by 1,000 units per year over the remaining useful life of the equipment.

The following depreciation methods may be used:

  1. straight-line,
  2. double-declining-balance,
  3. sum-of-the-years’-digits, and
  4. units-of-output. For tax purposes, the class life is 7 years.

Use the MACRS tables for computing depreciation.

Instructions

  1. Which depreciation method would maximize net income for financial statement reporting for the 3-year period ending December 31, 2018? Prepare a schedule showing the amount of accumulated depreciation at December 31, 2018, under the method selected. Ignore present value, income tax, and deferred income tax considerations.
  2. Which depreciation method (MACRS or optional straight-line) would minimize net income for income tax reporting for the 3-year period ending December 31, 2018? Determine the amount of accumulated depreciation at December 31, 2018. Ignore present value considerations.

Short Answer

Expert verified

Answer

The straight-line method would provide the highest total net income for financial reporting over the three years, as it reports the lowest total depreciation expense. The general MACRS method would minimize net income for income tax purposes for this period.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Straight-Line Depreciation

Straight-line depreciation is the simplest way to assess depreciation over time.By allocating identical amounts to the asset's accounting periods over its useful life, it makes the asset's expense predictable along with smoothing net income.

02

(a1) Calculating depreciation using the straight-line method

Depreciation=Cost of asset−Salvage valueUseful life=$1,260,000−$60,0005=$240,000

Year

Depreciation expense

Accumulated Depreciation

2016

$240,000

$240,000

2017

240,000

$480,000

2018

240,000

$720,000

$720,000

03

(a2) Calculating depreciation using the double-declining-balance

Year

Depreciation Expense

Calculation of depreciation expense

Accumulated Depreciation

2016

$504,000

$504,000

2017

302,400


$806,400

2018

181,440


$987,840

04

(a3) Calculating depreciation using the Sum-of-the-years’-digits

Year

Depreciation Expense

Calculation of depreciation expense

Accumulated Depreciation

2016

$400,000

$400,000

2017

320,000


$720,000

2018

240,000


$960,000

$960,000

05

(a4) Calculating depreciation using the Units-of-output

Year

Depreciation Expense

Calculation of depreciation expense

Accumulated Depreciation

2016

$288,000

$288,000

2017

264,000


$552,000

2018

240,000


$792,000

$792,000

Working notes:

Calculating Unit per output value

Unit per output=Cost of​asset−Salvage valueTotal units produce=$1,260,000−$60,00050,000=$1,200,00050,000=$24 per unit

06

(b) Calculation of General MARCS method






Date

Total Cost

MACRS Rates (%)

Annual Depreciation

Accumulated Depreciation

2016

$1,260,000

14.29

$180,054

$180,054

2017

1,260,000

24.49

308,574

$488,628

2018

1,260,000

17.49

220,374

$709,002

$709,002

Note: Takes rates from the MACRS rates schedule

Optional straight-line method

For the three-year period ending December 31, 2018, the general MACRS approach would have a larger depreciation expenditure ($709,002) than the optional straight-line technique ($450,000). As a result, for this period, the general MACRS technique would minimize net income for tax purposes.

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Most popular questions from this chapter

(Depreciation—Strike, Units-of-Production, Obsolescence) The following are three different and unrelated situations involving depreciation accounting. Answer the question(s) at the end of each situation.

Situation I: Recently, Broderick Company experienced a strike that affected a number of its operating plants. The controller of this company indicated that it was not appropriate to report depreciation expense during this period because the equipment did not depreciate and an improper matching of costs and revenues would result. She based her position on the following points.

1. It is inappropriate to charge the period with costs for which there are no related revenues arising from production.

2. The basic factor of depreciation in this instance is wear and tear. Because equipment was idle, no wear and tear occurred.

Instructions

Comment on the appropriateness of the controller’s comments.

Situation II: Etheridge Company manufactures electrical appliances, most of which are used in homes. Company engineers have designed a new type of blender which, through the use of a few attachments, will perform more functions than any blender currently on the market. Demand for the new blender can be projected with reasonable probability. In order to make the blenders, Etheridge needs a specialized machine that is not available from outside sources. It has been decided to make such a machine in Etheridge’s own plant.

Instructions

  1. Discuss the effect of projected demand in units for the new blenders (which may be steady, decreasing, or increasing) on the determination of a depreciation method for the machine.
  2. What other matters should be considered in determining the depreciation method? (Ignore income tax considerations.)

Situation III: Haley Paper Company operates a 300-ton-per-day kraft pulp mill and four sawmills in Wisconsin. The company is in the process of expanding its pulp mill facilities to a capacity of 1,000 tons per day and plans to replace three of its older, less efficient sawmills with an expanded facility. One of the mills to be replaced did not operate for most of 2017 (current year), and there are no plans to reopen it before the new sawmill facility becomes operational.

In reviewing the depreciation rates and discussing the salvage values of the sawmills that were to be replaced, it was noted that if present depreciation rates were not adjusted, substantial amounts of plant costs on these three mills would not be depreciated by the time the new mill came on stream.

Instructions

What is the proper accounting for the four sawmills at the end of 2017?

Why might a company choose not to use revaluation accounting?

Silverman Company purchased machinery for \(162,000 on January 1, 2017. It is estimated that the machinery will have a useful life of 20 years, salvage value of \)15,000, production of 84,000 units, and working hours of 42,000. During 2017, the company uses the machinery for 14,300 hours, and the machinery produces 20,000 units. Compute depreciation under the straight-line, units-of-output, working hours, sum-of-the-years’-digits, and double-declining-balance methods.

In its 2014 annual report, Campbell Soup Company reports beginning-of-the-year total assets of \(8,113 million, end-of-the-year total assets of \)8,323 million, total sales of \(8,268 million, and net income of \)807 million. (a) Compute Campbell’s asset turnover. (b) Compute Campbell’s profit margin on sales. (c) Compute Campbell’s return on assets using (1) asset turnover and profit margin and (2) net income. (Round to two decimal places.)

(Book vs. Tax (MACRS) Depreciation) Futabatei Enterprises purchased a delivery truck on January 1, 2017, at a cost of \(27,000. The truck has a useful life of 7 years with an estimated salvage value of \)6,000. The straight-line method is used for book purposes. For tax purposes, the truck, having an MACRS class life of 7 years, is classified as 5-year property; the optional MACRS tax rate tables are used to compute depreciation. In addition, assume that for 2017 and 2018 the company has revenues of \(200,000 and operating expenses (excluding depreciation) of \)130,000.

Instructions

  1. Prepare income statements for 2017 and 2018. (The final amount reported on the income statement should be income before income taxes.)
  2. Compute taxable income for 2017 and 2018.
  3. Determine the total depreciation to be taken over the useful life of the delivery truck for both book and tax purposes.
  4. Explain why depreciation for book and tax purposes will generally be different over the useful life of a depreciable asset.
See all solutions

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