Red Corp. constructed a machine at a total cost of $86 million. Construction was

Question

Red Corp. constructed a machine at a total cost of $86 million. Construction was completed at the end of 2012 and the machine was placed in service at the beginning of 2013. The machine was being depreciated over a 11-year life using the straight-line method. The residual value is expected to be $8 million. At the beginning of 2016. Red decided to change to the sum-of-the-years'-digits method. Ignoring income taxes, what will be Red's depreciation expense for 2016? $5.61 million. $7.09 million. $12-60 million. $6.61 million.

Explanation / Answer

Answer:

Depreciaiton expense (Straight- line method) = (Initial cost of the machine - residual value)/ Estimated life of the machine

Straight- line Depreciation expense for Red Corp. = ($86 M - $8 M) / 11 years

= $78 M/ 11 years

= $7.09 M

Accumulated depreciation for 3 years (From 2013 to 2015) = $7.09 M * 3 years = $21.27 M

Calculating Book value of the machine at the beginning of 2016:

Now, we will calculate SYD which is sum of digits of each year of the remaining estimated useful life.

Remaining estimated useful life = 8 years (11 years - 3 years)

SYD = 1+2+3+4+5+6+7+8 = 36

SYD fraction = Remaining useful life of the machine at the beginning of 2016/SYD

SYD fraction = 8 years / 36

Calculation of Depreciation for 2016:

Depreciaiton for 2016 = (Remaining book value at the beginning of 2016 - Residual value) * SYD fraction

Depreciaiton for 2016 = ($64.73 - $8) * 8/36

= $56.73 *8/36

= $12.60 M

Particulars Amount ( in millions) Original cost $                             86.00 Less: accumulated depreciation $                             21.27 Book value at the beginning of 2016 $                             64.73

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