Choice Among Depreciation Methods

Walnut Ridge Production Inc. purchased a new computerized video editing machine at a cost of $450,000. The System has a residual value of $64,000 and an expected life of 5 years.

Required:

1. Compute depreciation expense, accumulated depreciation, and book value for the first 3 years of the machine’s life using the (a) straight-line method and (b) double-declining-balance method.

2. Which method would produce the largest income in the first, second, and third years of the asset’s life?

3. CONCEPTUAL CONNECTION Why might the controller of Walnut Ridge Production be interested in the effect of choosing a depreciation method? Evaluate the legitimacy of these interests.

Concept introduction:

Straight-line Depreciation:

Depreciation is done by allocating the cost of the fixed assets other than land to expense over the useful life of the asset. The most commonly used method of depreciation is straight line method. In this method every year until the useful life of the asset, equal amount of assets cost to depreciation expense is allocated. The formula to calculate straight line depreciation is:

Straight line depreciation = (cost − residual value) / expected useful life

Double declining balance method:

In this method depreciation the book value of an asset declines every year by the constant depreciation rate and hence the depreciation amounts are larger in the initial periods of asset’s life but becomes relatively smaller in the later years. This method is applied for those assets which become obsolete due to technological changes.

Requirement 1:

Compute depreciation expense, accumulated depreciation and book value for the first three years using (a) straight line method and (b) double declining balance method.

Calculation of depreciation expense, accumulated depreciation and book value for the first three years of machine using:

1. Straight line method:

Under straight line method the depreciation expense is calculated using the following formula:

Depreciation expense

= (cost − residual value) / expected useful life

= (450000 − 64000) / 5 = 77200

= (450000 − 64000) / 5 = 77200

The accumulated depreciation is calculated by adding the first year depreciation expense to the second year depreciation expense and so on. The book value is calculated by deducting each year depreciation expense from the cost of the machine...

Concept introduction:

Straight-line Depreciation:

Depreciation is done by allocating the cost of the fixed assets other than land to expense over the useful life of the asset. The most commonly used method of depreciation is straight line method. In this method every year until the useful life of the asset, equal amount of assets cost to depreciation expense is allocated. The formula to calculate straight line depreciation is:

Straight line depreciation = (cost − residual value) / expected useful life

Double declining balance method:

In this method depreciation the book value of an asset declines every year by the constant depreciation rate and hence the depreciation amounts are larger in the initial periods of asset’s life but becomes relatively smaller in the later years. This method is applied for those assets which become obsolete due to technological changes.

Requirement 2:

To explain:

Which method would produce highest income in the first three years of the machine’s useful life?

Concept introduction:

Straight-line Depreciation:

Depreciation is done by allocating the cost of the fixed assets other than land to expense over the useful life of the asset. The most commonly used method of depreciation is straight line method. In this method every year until the useful life of the asset, equal amount of assets cost to depreciation expense is allocated. The formula to calculate straight line depreciation is:

Straight line depreciation = (cost − residual value) / expected useful life

Double declining balance method:

In this method depreciation the book value of an asset declines every year by the constant depreciation rate and hence the depreciation amounts are larger in the initial periods of asset’s life but becomes relatively smaller in the later years. This method is applied for those assets which become obsolete due to technological changes.

Requirement 3:

To explain:

Why the controller of Walnut Ridge Production is interested in the effect of choosing a depreciation method and to evaluate the legitimacy of these interests.