Bob & Robin, Inc., purchased a new machine on October 1, 2001, at a cost of $144
ID: 2487185 • Letter: B
Question
Bob & Robin, Inc., purchased a new machine on October 1, 2001, at a cost of $144,000. The machine’s estimated useful life at the time of the purchase was 6 years, and its residual value was $12,000.
Instructions
a. Prepare a complete depreciation schedule, beginning with calendar year 2001, under each of the methods listed below (assume that the half-year convention is used):
1. Straight-line.
2. 200% declining-balance.
3. 150% declining-balance (not switching to straight-line).
b. Which of the three methods computed in part a is most common for financial reporting purposes? Explain.
c. Assume that Bob & Robin sell the machine on December 31, 2004, for $40,000 cash. Compute the resulting gain or loss from this sale under each of the depreciation methods used in part a. Does the gain or loss reported in the company’s income statement have any direct cash effects? Explain.
Explanation / Answer
a)
Straight line depreciation = (144000 - 12000) / 6 = $22000
200% declining rate = (1/6) * 2 = 33.33%
150% declining rate = (1/6) * 1.5 = 25%
Note:
The half-year convention for depreciation is the depreciation schedule that treats all property acquired during the year as being acquired exactly in the middle of the year. This means that only half of the full-year depreciation is allowed in the first year, with the remaining balance being deducted in the final year of the depreciation schedule, or the year that the property is sold.
Note:
In double declining and 150% declining method the depreciation for the last years has been adjusted to make the WDV of the asset at the end of the 6 years equal to the salvage value of the asset.
b)
The most commonly used method for calculating depreciation under generally accepted accounting principles, or GAAP, is the straight line method. This method is the simplest to calculate, results in fewer errors, stays the most consistent and transitions well from company-prepared statements to tax returns.
c.
The gain or loss reported in the income statement is either deducted (if there is a gain)or added (if there is a loss) to the net profit to arrive at the net cash flow from operating activites.