Question

1. (20 pts) A pharmaceutical company purchased a machine with a life of six years and used the double-declining-balance method of depreciation. If the company had used the straight-line method of depreciation, how would the income statement in year 6 have differed? 2. (20 pts) A camera company has enough capacity to produce 20,000 cameras per year for mobile phones. This year it is producing 10,000 cameras and is planning to produce 15,000 next year. How would the unit and total manufacturing costs change if this plan is implemented, other things being equal?

Answer 1

1. As per Double Declining Balance method of Depreciation, Depreciation is based on 2 times straight line rate on beginning book value of asset. Due to double rate of depreciation, higher amount of depreciation is provided in earlier years of life of asset as compared to straight line method. In straight line method, equal amount of depreciation is charged every year over the useful life of the asset.
Since sixth year is the last year of life of asset, most of the depreciation would have already been provided under Double Declining balance method in initial years, so depreciation for sixth year will be comparatively lower under double declining balance method as compared to Straight line method.

If company would have used straight line method of depreciation, income for the 6th year would have been lower, due to higher depreciation expense in straight line method for last year of assets life.

2.
Manufacturing costs consists of variable costs and fixed costs. Fixed costs remain same within relevant range of production and doesnot change with change in output.
When 10000 cameras are produced, fixed overhead is divided among 10000 units leading to higher fixed cost per unit thereby higher manufacturing cost per unit. Variable costs will increase according to number of units produced.

When production is increased to 15000 cameras, total manufacturing cost will increase to the extent of variable costs only, fixed costs remains same. Since fixed overhead costs remain same, with increase in production fixed overhead will be divided among more number of units leading to lower fixed cost per unit, thereby lower manufacturing cost per unit.