On January 3, 2014, Wong Enterprises, Inc., paid $300,000 for equipment used in manufacturing automotive supplies. In addition to the basic purchase price, the company paid $1,000 transportation charges, $300 insurance for the equipment while in transit, $11,000 sales tax, and $3,000 for a special platform on which to place the equipment in the plant. Wong Enterprises, Inc., management estimates that the equipment will remain in service for five years and have a residual value of $40,000. The equipment will produce 60,000 units the first year, with annual production decreasing by 5,000 units during each of the next four years (i.e., 55,000 units in year 2; 50,000 units in year 3; and so on for a total of 250,000 units). In trying to decide which depreciation method to use, Wong Enterprises, Inc., requested a depreciation schedule for each of the three depreciation methods (straight-line, units-of-production, and double-declining balance).
Part A: For each depreciation method, prepare a depreciation schedule showing asset cost, depreciation expense, accumulated depreciation, and asset book value for each year of the asset's life. For the units-of-production method, round depreciation per unit to three decimal places.
Part B: Wong Enterprises, Inc., prepares financial statements using the depreciation method that reports the highest income in the early years of asset use. For income tax purposes, the company uses the depreciation method that minimizes income taxes in the early years. Consider the first year of Wong Enterprises, Inc., uses the equipment. Identify the depreciation methods that meet Wong Enterprises' objectives, assuming the income tax authorities permit the use of any method.
Part A
Step 1: Determine cost of the equipment:
Step 2: Determine the depreciable base for straight-line and units of activity methods.
Purchase price - residual value = depreciable cost
Step 3: Determine amount of depreciation expense per year under straight-line.
Step 4: Depreciation schedule using straight-line.
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Year
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Depreciable cost
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Depreciation rate
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Annual depreciation expense
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Accumulated depreciation - end of year
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Book Value - end of year
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2014
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2015
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2016
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2017
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2018
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Step 5: Depreciation schedule using units of activity
Depreciable base / total units of activity = depreciation expense per unit of activity
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Year
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Units of activity
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Rate per unit
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Annual depreciation expense
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Accumulated depreciation - end of year
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Book value - end of year
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2014
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60,000
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2015
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55,000
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2016
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50,000
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2017
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45,000
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2018
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40,000
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*$50 rounding error
Step 6: Depreciation schedule using double-declining balance (DDB)
Rate of depreciation using DDB is twice straight-line rate
Straight-line rate = 1/number of years of useful life X 2 = DDB rate =
DDB doesn't use salvage value.
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Year
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Depreciable base
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Rate of depreciation
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Annual depreciation expense
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Accumulated depreciation - end of year
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Book value - end of year
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2014
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2015
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2016
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2017
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2018
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Can't depreciate below residual value, therefore in 2018 depreciation is the amount that will cause the book value to equal the residual value
Discussion of which methods to use to maximize net income and to minimize taxes.
Part B
Wong Enterprises, Inc., prepares financial statements using the depreciation method that reports the highest income in the early years of asset use. For income tax purposes, the company uses the depreciation method that minimizes income taxes in the early years. Consider the first year of Wong Enterprises, Inc., uses the equipment. Identify the depreciation methods that meet Wong Enterprises' objectives, assuming the income tax authorities permit the use of any method.