On January 2, year 1 Link Co. purchased a manufacturing machine for $864,000. Th
ID: 2334584 • Letter: O
Question
On January 2, year 1 Link Co. purchased a manufacturing machine for $864,000. The machine has an eight year estimated life and a $144,000 estimated salvage value. Link expects to manufacture 1,800,000 units over the life of the machine.
During year 2, Link manufactured 300,000 units. During year 2, Link purchased an office building and the land on which it is located by paying $800,000 cash and assuming an existing mortgage of $200,000. The property is assessed at $960,000 for realty tax purposes, of which 60% is allocated to the building.
During year 2, Link leased construction equipment under a 7-year capital lease requiring annual year-end payments of $100,000. Link's incremental borrowing rate is 9%, while the lessor's implicit rate, which is not known to Link, is 8%. Present value factors for an ordinary annuity for seven periods are 5.21 at 8% and 5.03 at 9%. Fair value of the equipment is $515,000.
During year 2, Link paid $50,000 and gave a plot of undeveloped land with a carrying amount of $320,000 and a fair value of $450,000 to Club Co. in exchange for a plot of undeveloped land with a fair value of $500,000. The land was carried on Club's books at $350,000. This transaction has commercial substance.
For each depreciation method listed in the table below, calculate depreciation expense for year 2 (the second year of ownership) for the machine purchased on January 2, year 1. Click in the associated cell and enter the appropriate value. Round all amounts to the nearest whole number.
Method Amount
Straight-line
Double-declining-balance
Sum-of-the-years'-digits
Units of production
2. Calculate the amount to be recorded for each item in the table below and enter the value in the associated cell.
Round all numbers to the nearest whole number.
Item Amount
Building
Leased equipment
Land received from Club on Link's books
Land received from Link on Club's books
Explanation / Answer
Depreciation is the process of allocating a fixed assets cost to expense over its useful life.It does not represent a cash transaction, but it indicates how much of an asset's value has been used up over time.
1) Straight line depreciation method allocates an equal amount of depreciation to each year. Every year amount of depreciation remains same.The equation to find yearly depreciation is as follows:
Straight line depreciation expense / year = (Cost - Residual value) / Estimated useful life in years
Given in problem that cost of machine is $8,64,000 useful life is 8 years and residual value is $1,44,000.
Straight line depreciation expense / year =($864,000 - $144,000) / 8
Straight line depreciation expense / year = $90,000
Therefore, depreciation expense on machine for year 2 will be $90,000.
2) Double-declining-balance method is also known as accelerated depreciation method. This method writes off more depreciation near start of an asset’s life and less at end. It multiplies the asset’s decreasing book value by a contact rate that is twice the straight line depreciation rate.
DDB depreciation = [2 * (Book value at the beginning of the year) ] / Estimated useful life in years
Therefore, for first year the depreciation on machine will be as follows:
DDB depreciation = (2 * $864,000) / 8
DDB depreciation = $216,000
Therefore, at end of first year the book value of machine after deducting depreciation will be as follows
Book value of machine at end of first year = $864,000 - $216,000
Book value of machine at end of first year = $648,000
Now, for second year the depreciation will be as follows:
DDB depreciation = (2 * $648,000) / 8
DDB depreciation = $162,000
So, on basis of double declining deprecation method the second year depreciation will be $162,000.
3) Sum-of-years'-digit depreciation method allocates higher amount of depreciation in earlier years of assets useful life and lesser depreciation in later life. The formula is as follows:
SYD depreciation = [(Cost - Residual value) * Remaining useful life at beginning of year ] / Sum of each year of the estimated useful life
Given that machine has estimated useful life of 8 years. So, at beginning of year 1 estimated useful life is 8 years, for 2nd year estimated useful life is 7 years and for subsequent year estimated useful life will be 6,5,4,3,2,1. The total of each year of the estimated useful life is 36.
The remaining useful life at beginning of year 2 will be 7 years because for 1 year machine has been used. Therefore depreciation for year 2 on machine is as follows:
Depreciation = [($864,000 - $144,000) * 7] / 36
SYD depreciation = $140,000
Therefore, sum-of-years'-digit depreciation for year 2 will be $140,000.
4) Units-of-production method allocates a fixed amount of depreciation to each unit of output. The equation to find depreciation is as follows:
Units-of-production depreciation = (Cost - Residual value) / Estimated useful life in units
Given that machine can produce 1,800,000 units during its life time. So, depreciation will be
Units-of-production depreciation/ unit = ($864,000 - $144,000) / 1,800,000
Units-of-production depreciation / unit = $0.4/ unit
During second year, machine produced 300,000 units and per unit depreciation expense is of $0.4. Therefore, total depreciation for year 2 is $ 120,000 (300,000 units * $0.4).
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