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AccountingIntermediate Accounting: Reporting And Analysis3rd Edition

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Chapter 11, Problem 6E
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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Depreciation and Rate of Return Burrell Company purchased a machine for $20,000 on January 2, 2019. The machine has an estimated service life of 5 years and a zero estimated residual value. The asset earns income before depreciation and income taxes of $10,000 each year. The tax rate is 21%.

Required:

Compute the rate of return earned (on the average net asset value) by the company each year of the asset’s life under the straight-line and the double-declining-balance depreciation methods. Assume that the machine is the company’s only asset. (Round all calculations to the nearest dollar and the rate of return to two decimals.)

To determine

Ascertain the rate of return earned by company B for each year under double declining method and straight line method.

Explanation

Straight-line depreciation method: The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset is referred to as straight-line method.

Double-declining-balance method: The depreciation method which assumes that the consumption of economic benefits of long-term asset is high in the early years but gradually declines towards the end of its useful life is referred to as double-declining-balance method.

Ascertain the rate of return earned by company B for each year under straight line method as follows:

YearNet Income (2)  (a)  Average Book Value (b) (3)  Rate of Return (a÷b)
2019$4,740 $18,000 26.33%
20204,74014,00033.86%
20214,74010,00047.4%
20224,7406,00079%
20234,7402,000237%

Table (1)

Working note (1):

Compute the depreciation expenses:

Depreciation expenses=Acquisition cost – Residual valueUseful life =$20,000−$05 years=$4,000 per year

Working note (2):

Compute the net income:

ParticularsAmount ($)
Income before depreciation10,000
Less: Depreciation expense (1)4,000
Income before income taxes6,000
Income tax expense ($6,000×21100)1,260
Net income4,740

Table (2)

Working note (3):

Calculate the average book value of the asset for each year:

YearBook Value (A)Depreciation (B)Ending Book Value (C=A−B)Average Book Value(A+C2)
2019$20,000 $4,000 (1) $16,000 $18,000
2020$16,000$4,000 (1)  $12,000 $14,000
2021$12,000$4,000 (1)  $8,000$10,000
2022$8,000$4,000 (1)  $4,000$6,000
2023$4,000$4,000 (1)  02,000

Table (3)

Note: Ending book value for the previous year is considered as the beginning book value for the current year.

Ascertain the rate of return earned by company B for each year under double declining method as follows:

YearNet Income (6)  (a)  Average Book Value  (7) (b)   Rate of Return (a÷b)×100
2019$1,580$16,0009.88%
20204,1089,60042.79%
20215,6255,76097.66%
20226,5353,456189.09%
20235,8521,296451.54%

Table (4)

Working note (4):

Compute the double declining rate:

Useful life = 5 years

Depreciation rate=100%5 years×2=40%

Working note (5):

2019:

Depreciation expense=Aquisition cost of equipment×Depreciation Rate (4)=$20,000×40100=$8,000

2020:

Depreciation expense=[Aquisition cost of equipment−Depreciation expense for 2019]×Depreciation Rate (4

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