On June 1, a machine costing $660,000 with a five-year life and an estimated $50

Question

On June 1, a machine costing $660,000 with a five-year life and an estimated $50,000 salvage value was purchased. It was also estimated that the machine would produce 200,000 units during its life. The actual units produced during its third year of operation were 40,000.

1. Using the depreciation template provided, determine the amount of depreciation expense for the third year under each of the following assumptions:

a. The company uses the straight-line method of depreciation.

b. The company uses the units-of-production method of depreciation.

c. The company uses the double-declining-balance method of depreciation.

2.Assuming straight line depreciation, prepare journal entry for the third year.

3.Assume the company sold the machine at the end of the fourth year for $100,000. Prepare a journal entry for asset disposal in the fourth year.

4. Assume you are the chief accountant of ABC Inc., a sheetrock manufacturer. Determine how you will choose, based on best industry practices, the depreciation method for ABC Inc. to use.

Explanation / Answer

Part 1)

The depreciation under each method is calculated as below:

Straight-Line Method of Depreciation:

Annual Depreciation Expense = (Cost of Machine - Salvage Value)/Estimated Life of Machine

Substituting values in the above formula, we get,

Annual Depreciation Expense = (660,000 - 50,000)/5 = $122,000

The depreciation expense under straight line method would remain constant at $122,000 for the estimated life of the asset.

Depreciation Expense for Year 3 under Straight-Line Method = $122,000

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Units-of-Production Method of Depreciation:

Depreciation Expense for Year 3 under Units-of-Production Method = (Cost - Salvage Value)*(Units Produced in Year 3)/Total Estimated Production

Substituting values in the above formula, we get,

Depreciation Expense for Year 3 under Units-of-Production Method = (660,000 - 50,000)*(40,000/200,000) = $122,000

_____

Double-Declining-Balance Method of Depreciation

Depreciation Rate under Double-Declining Balance = 1/Estimated Life*2 = 1/5*2 = .20*2 = 40%

Now, we can calculate depreciation expense for each year under Double-Declining Balance method as below,

Depreciation Expense (Year 1) under Double-Declining Balance = Cost*Depreciation Rate = 660,000*40% = $264,000

Depreciation Expense (Year 2) under Double-Declining Balance = (Cost - Depreciation Expense for Year 1)*Depreciation Rate = (660,000 - 264,000)*40% = $158,400

Depreciation Expense (Year 3) under Double-Declining Balance = (Cost - Depreciation Expense for Year 1 - Depreciation Expense for Year 2)*Depreciation Rate = (660,000 - 264,000 - 158,400)*40% = $95,040

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Tabular Representation:

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Part 2)

The journal entry for Year 3 under straight-line method is provided as below:

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Part 3)

As the method under which the journal entry has to be posted, I have prepared the journal entry under straight-line method in continuation of Part 2). The journal entry is given as follows:

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Part 4)

The use of depreciation method would generally depend on the nature of asset and the preference of the company. If the company wants to arrive at an accurate value for its asset at any point of time, it should use double-declining-balance method of depreciation. However, if it wants follow a simple and more unified method of accounting, it should use straight-line method of depreciation as it allows a constant amount of depreciation to be charged each year. In the given case, use of straight-line method appears to be more favorable as it would help the company in reducing its taxable income in each year by a constant amount.

Year 3 Depreciation Straight-Line Method $122,000 Units-of-Production Method $122,000 Double-Declining-Balance Method $95,040

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