2. ABC Company has purchased equipment as follows: - Land for $1,500,000 on Janu

Question

2. ABC Company has purchased equipment as follows: - Land for $1,500,000 on January 1t, 20x8 - Building of $500,000 on March 1t, 20X8, useful life of 40 years - Equipment of $200,000 on April 1t, 20x8, with salvage value of $20,000, useful life of5 years Prepare depreciation based on the Straight Line Method and then compare based on the Double-Declining Balance Method. Analyze and compare the two proposed depreciation schedules and provide your insight on the advantages and disadvantages of both.

Explanation / Answer

Land is a non-depreciable asset. Therefore, no depreciation will be calculated on it.

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Straight Line Method:

Annual Depreciation on Building and Equipment as per Straight Line Method is Calculated as below:

Building = (Cost - Salvage Value)/Estimated Life = (500,000 - 0)/40 = $12,500

Equipment = (Cost - Salvage Value)/Estimated Life = (200,000 - 20,000)/5 = $36,000

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Depreciation Schedule under Straight Line Method for Building is given as below:

Building:

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Depreciation Schedule Straight Line Method for Equipment is given as below:

Equipment:

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Double Declining Method:

The depreciation rate for each asset under double declining method is arrived as below:

Building = 1/Estimated Life*2 = 1/40*2 = 5%

Equipment = 1/Estimated Life*2 = 1/5*2 = 40%

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Depreciation Schedule under Double Declining Method for Building is given as below:

Building:

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Notes:

1) Depreciation for the year is calculated at the rate of 5% on the preceeding year's book value.

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Depreciation Schedule under Double Declining Method for Equipment is given as below:

Equipment:

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Notes:

1) Depreciation for the year is calculated at the rate of 40% on the preceeding year's book value.

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Advantages and Disadvantages of Each Method:

Based on the above calculations, it can be seen that it is relatively easier to calculate the value of depreciation under the straight line method as it allocates a fixed amount of depreciation each year as compared to double declining method. However, this method doesn't seem to be appropriate as the value of the asset decreases over time. Therefore, the amount of depreciation should also reduce with the passage of time.

Double declining method, on the other hand, is time consuming and complex. However, it results in higher depreciation expense in the initial years, thereby, reducing the company's taxable income which in turn results in lower tax liability for the company. This method is suitable for assets with long duration (such as building in this case) as it provides for higher depreciation expense in the beginning years of the asset.

Year Depreciation 2008 10,417 (12,500*10/12) 2009 12,500 2010 12,500 2011 12,500 2012 12,500 2013 12,500 2014 12,500 2015 12,500 2016 12,500 2017 12,500 2018 12,500 2019 12,500 2020 12,500 2021 12,500 2022 12,500 2023 12,500 2024 12,500 2025 12,500 2026 12,500 2027 12,500 2028 12,500 2029 12,500 2030 12,500 2031 12,500 2032 12,500 2033 12,500 2034 12,500 2035 12,500 2036 12,500 2037 12,500 2038 12,500 2039 12,500 2040 12,500 2041 12,500 2042 12,500 2043 12,500 2044 12,500 2045 12,500 2046 12,500 2047 12,500 2048 2,083 (12,500*2/12)

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