Question

*P11-12 (L01,6) EXCEL (Depreciation—SL, DDB, SYD, Act., and MACRS) On January 1, 2016, Locke Company, a small machine-tool manufacturer, acquired for $1,260,000 a piece of new industrial equipment. The new equipment had a useful life of 5 years, and the salvage value was estimated to be $60,000. Locke estimates that the new equipment can produce 12,000 machine tools in its first year. It estimates that production will decline by 1,000 units per year over the remaining useful life of the equipment.

The following depreciation methods may be used: (1) straight-line, (2) double-declining-balance, (3) sum-of-the-years’-digits, and (4) units-of-output. For tax purposes, the class life is 7 years. Use the MACRS tables for computing depreciation.

Instructions

1. (a) Which depreciation method would maximize net income for financial statement reporting for the 3-year period ending December 31, 2018? Prepare a schedule showing the amount of accumulated depreciation at December 31, 2018, under the method selected. Ignore present value, income tax, and deferred income tax considerations.

2. (b) Whichdepreciationmethod(MACRSoroptionalstraight-line)wouldminimizenetincomeforincometaxreportingfor the 3-year period ending December 31, 2018? Determine the amount of accumulated depreciation at December 31, 2018. Ignore present value considerations.

Answer 1

a. Depreciation under staright line would maximise net income for financial statement for the 3-year period ending december 31 2018, depreciation is minimum under the method, Detailed calculation is as under

Straight line method of depreciation						Toal of 3 years depreciation
	Year 1	Year 2	Year 3	Year 4	Year 5
1260000-60000/5	240000	240000	240000	240000	240000	720000
Double Declining balances
	Year 1	Year 2	Year 3	Year 4	Year 5
(100%/5)*2	504000	302400	181440	90720	72576	987840
Balance	756000	453600	272160	181440	108864
Sum of digit	Year 1	Year 2	Year 3	Year 4	Year 5
Depriciation	420000	224000	123200	65707	28473	767200
Depriciation rate	(5/15)	(4/15)	(3/15)	(2/15)	(1/15)
Balance	840000	616000	492800	427093	398620
Unit of output
	Year 1	Year 2	Year 3	Year 4	Year 5
Output	12000	11000	10000	9000	8000
Depriciation	288000	264000	240000	216000	192000	792000
Rate of depreciation 25/p.u

b. Straight line method would also minimise the income tax for 3 year period, detailed calculation is as under

Straight line method of depreciation
	Year 1	Year 2	Year 3	Total of 3 year depreciation
1260000-60000/5	171429	171429	171429	514286
Double Declining balances
	Year 1	Year 2	Year 3
(100%/7)*2	360000	257143	183673	800816
Balance	900000	642857	459184
Sum of digit	Year 1	Year 2	Year 3
Depriciation	315000	202500	132589	650089
Depriciation rate	(7/28)	(6/28)	(5/28)
Balance	945000	742500	609911
Unit of output
	Year 1	Year 2	Year 3
Output	12000	11000	10000
Depriciation	228571	209524	190476	628571
Rate of depreciation 25/p.u