Q9-31PGA - Horngren'S Financial And Managerial Accounting

Question

Determining asset cost, preparing depreciation schedules (3 methods), and identifying depreciation results that meet management objectives 

On January 3, 2018, Rapid Delivery Service purchased a truck at a cost of \(100,000. Before placing the truck in service, Rapid spent \)3,000 painting it, \(600 replacing tires, and \)10,400 overhauling the engine. The truck should remain in service for five years and have a residual value of $12,000. The truck’s annual mileage is expected to be 32,000 miles in each of the first four years and 8,000 miles in the fifth year—136,000 miles in total. In deciding which depreciation method to use, Andy Sargeant, the general manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-production, and double-declining-balance). 

Requirements 

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value. 

2. Rapid prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. Consider the first year that Rapid uses the truck. Identify the depreciation method that meets the company’s objectives.

Step-by-Step Solution

Answer

Answer

The business entity will prefer to use the straight-line method of depreciation.

Step 1: Definition of Depreciation

The expenses charged for the purpose of reporting the decline in the value of the fixed assets acquired by the company are known as depreciation expenses. Such expenses are reported in the statement reporting net income.

Step 2: Preparation of depreciation schedule by each method

1. Depreciation schedule by straight-line method 

Date	Asset Cost	Depreciation Expenses	Accumulated  Depreciation	Book Value
03-1-2018	$ 114000
12-31-2018		$20,400	$ 40,800	$ 93600
12-31-2019		$20,400	$ 61,200	$ 73,200
12-31-2020		$20,400	$ 81,600	$ 52,800
12-31-2021		$20,400	$ 102,000	$ 32,400
12-31-2022		$20,400	$ 102,000	$ 12,000

Working notes:

1. Calculation of total cost of truck

$$\begin{gathered} Total \cos t=Purchase \cos t+Paintaing \cos t+Fire \cos t+Overhualing \cos t \\ Total \cos t=\$1000,000+\$3,000+\$600+\$10,4000 \\ =\$114,000 \end{gathered}$$       2. Calculation of depreciation amount by straight-line method.

$$\begin{gathered} Depreciation \frac{Cost-Residual value}{Useful life} \\ =\frac{\$114,00-\$12,000}{5} \\ =\$20,400 \end{gathered}$$

1. Depreciation schedule by Units of production method

Date	Cost	Depreciation expenses	Accumulated Depreciation	Book Value
03-01-2018	$114,000
12-31-2018		$24,000	$24,000	$90,000
12-31-2019		$24,000	$48,000	$66,000
12-31-2020		$24,000	$72,000	$42,000
12-31-2021		$24,000	$96,000	$18,000
12-31-2022		$6,000	$102,000	$12,000

Working notes:

1. Calculation of depreciation by units of production method

$$\begin{gathered} Depreciation by units of production=\frac{Cost-Residual value}{Total miles} \\ = \frac{ \$114,000-\$12,000}{136,000} \\ =\$0.75 per mile \end{gathered}$$

1. Depreciation schedule by double-declining balance method

Date	Opening value depreciable base	Depreciation rate	Depreciation expenses	Accumulated depreciation	Book Value
03-01-2018	$114,000	40%
12-31-2018	$114,000	40%	$45,600	$45,600	$68,400
12-31-2019	$68,400	40%	$27,360	$72,960	$41,040
12-31-2020	$41,040	40%	$16,416	$89,376	$24,624
12-31-2021	$24,624	40%	$9,850	$99,226	$14,774
12-31-2022	$14,774	40%	$5,910	$105,136	$8,864

Depreciation rate= 100/Useful life*2

= 100/5*2

=40%

Step 3: Depreciation method meeting the company’s objective

The business entity will use the straight-line method of depreciation in its initial year because it reports the lowest depreciation expense that will meet the company’s objective of higher net income.