Question

On January 1,2020, Velio Company, a tool manufacturer, acquired new industrial equipment for $4 million. The Problel new equipment had a useful life of four mates that the new equipment can produce by 1,000 units per year over the remaining useful life of the equipment. and the residual value was estimated to be $400,000. Velio esti- Analyzing the Effect o Depreciation Method years, on Financial Statemer 14,000 tools in its first year. Production is then estimated to decline Results LO9 The following depreciation methods are under consideration: (I) double-declining, (2) straight-line, (3) sum-of-the-years'-digits, and (4) units-of-production Required a. Which depreciation method would result in maximum income for financial statement reporting for the three- year period ending December 31, 2022? Prepare a schedule showing the amount of accumulated deprecia tion at December 31, 2022, under the method selected. Ignore present value, income tax, and deferred in- come tax considerations in the answer b. Which depreciation method would result in minimum income for tax reporting for the three-year period ending December 31, 2022? (Assume that all four methods are allowable for tax purposes.) AICPA adapted

Answer 1

Total depreciable value of the machine is $4m - $400k = $3,600,000

A useful life of 4 years means per year depreciation to be 3,600,000/4 = $900,000 per year, ie, 900,000/4,000,000 = 22.5% straight line depreciation rate.

a.

Double Declining Method
Year	Net Book Value	Depreciation (@45%)
2020	4,000,000	1,780,000
2021	2,220,000	987,900
2022	1,232,100	548,285
		3,316,185

Straight Line Method
Year	Net Book Value	Depreciation
2020	4,000,000	900,000
2021	3,100,000	900,000
2022	2,200,000	900,000
		2,700,000

Sum of the year digit Method
Year	Depreciation Base	Remaining useful life	Depreciation fraction	Depreciation
2020	3,600,000	4	4/10	1,440,000
2021	3,600,000	3	3/10	1,080,000
2022	3,600,000	2	2/10	720,000
2023	3,600,000	1
		10		3,240,000

Units of Production Method
Year	Units	Depreciation Base	Depreciation (Depreciation Base/50,000 X Units for the year)
2020	14,000	3,600,000	1,008,000
2021	13,000	3,600,000	936,000
2022	12,000	3,600,000	864,000
2023	11,000	3,600,000
	50,000		2,808,000

Based on above, straight line method will give maximum income for all three years combined as it has the lowest accumulated depreciation. On individual year basis, the method having lowest depreciation in respective year will give maximum income.

b.

For tax purposes, the method resulting in highest accumulated depreciation will result in minimum income tax, which in our case is double declining method. Again, On individual year basis, the method having highest depreciation in respective year will give minimum income tax.