Suppose you are an investment advisor and are looking at two companies to recommend to your clients, Blue Orchid Enterprises and Fast Track Systems. The two companies are virtually identical, and both have been in operation for one year. In early January 2020, both companies purchased equipment costing $183,000, with a 10-year estimated useful life and a $10,000 residual value. Blue Orchid uses the straight-line depreciation method. Fast Track uses the double- declining-balance method. Both companies' trial balances at December 31, 2020, included the following: Net Sales Revenue $ 870,000 Cost of Goods Sold 410,000 Operating Expenses (other than depreciation) 200,000 Requirements 1. Prepare both companies' income statements using their desired method of depreciation. You must show both Income statements. 2. Write a letter to address the following questions for your clients: Which company appears to be more profitable? Which company would you prefer to invest in? Why? Is one method of depreciation better than the other? VWhy would you use either method?
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
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