2. (20 pts) Wellcraft Company purchased a machine on January 1, 2015 for $625,00
ID: 2530427 • Letter: 2
Question
2. (20 pts) Wellcraft Company purchased a machine on January 1, 2015 for $625,000. The machine has a four year useful life and a salvage value of $25,000. The machine was depreciated using sum of the years digits. On January 1, 2017, two years later, it was determined they should have used straight line depreciation and decided to change to straight line. The useful life was also extended by two years, and the salvage value was reduced to $15,000. Profit for 2015 was $800,000 and for 2016 was $900,000 using sum of the years’ digits depreciation. Prior to depreciation expense in 2017, profits were $200,000.
A. Determine the correct profits for 2015, 2016, 2017
B. Assume Wellcraft used the completed contract method for 2016 but switched to percent of completion in 2017.
2016 2017
Profits under completed contract $400,000 $450,000
Profits under percent of completion $650,000 $580,000
C. Sean Kowalski, CEO, is paid a bonus of 1% of profits each year. Determine his bonus paid to him in 2017.
Explanation / Answer
Depreciation expense of each year of the useful life of the machine using sum of year’s digits method.
Cost of machine – 625000
Salvage value – 25000
Total = 525000 – 25000 = 600000
Year
Depreciation base
Remaining life
Depreciation fraction
Depreciation expense
Book value
1
600000
4
0.4
240000
385000
2
600000
3
0.3
180000
205000
3
600000
2
0.2
120000
85000
4
600000
1
0.1
60000
25000
10
600000
Book value at 1 Jan 2017 – 205000
New salvage value – 15000
Remaining life – 4
New depreciation base – 190000
Change of depreciation method is change in the accounting estimate and hence applied accordingly.
Answer A.
Year
2015
2016
2017
Profit before depreciation
1040000
1080000
200000
Depreciation
240000
180000
47500
Profit after depreciation
800000
900000
152500
Answer B
The change in revenue recognition method: From percentage of completion method to completed contract method or vice versa considered as change in accounting policy and hence to be presented with respective application. The effort of such application would be that the change will be reflected in past, present and future period and hence.
In the present case, Well craft used the completed contract method for 2016 but switched to percent of completion in 2017.
Year
2016
2017
Profit under completed contract
400000
450000
Profit under % of completion method
650000
580000
Bonus will be calculated using profit on percentage of completion
6500
5800
Amount already paid last year
4000
0
Amount to be paid in current year
2500
5800
Total
8300
Year
Depreciation base
Remaining life
Depreciation fraction
Depreciation expense
Book value
1
600000
4
0.4
240000
385000
2
600000
3
0.3
180000
205000
3
600000
2
0.2
120000
85000
4
600000
1
0.1
60000
25000
10
600000
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