Question

Phillips Ltd. purchased a machine on 26 March 20X3 for $94,000 and began to use it immediately. The estimated useful life of the machine is 5 years, and it has an expected residual value of $10,100 at that time. Phillips uses straight-line depreciation. Required: 1 & 2. Calculate annual depreciation for 20X3 through 20X8 assuming that depreciation is calculated to the nearest month using three accounting conventions: a. Half-year convention b. Full-first-year convention c. Final-year convention Month Half year Full first year Final year Year 20x3 20X4 20x5 20X6 20X7 20XB 3. Calculate the gain or loss on disposal assuming that the asset is unexpectedly sold for $6,100 at the end of 20X6, using net book value from requirement 1, and then from the three alternatives in requirement 2. Month Half Year Full First Year Final Year Year Proceeds, 20X6 Net book value, 20X6 000

Answer 1

Calculation of Annual Depreciation:

Machine Purchased on 26 March 20X3 for $ 94,000

Estimated Useful Life = 5 Years

Expected Residual Value = $ 10,100

Yearly Depreciation by Straight Line Method: (Cost of Machine – Residual Value)/ Useful Life

= (94,000 – 10,100)/5

= $16,780

HALF YEAR CONVENTION:

The half-year convention states that a fixed asset is assumed to have been in service for one-half of its first year, irrespective of the actual purchase date. The remaining half-year of depreciation is deducted from earnings in the final year of depreciation.

Under the half-year convention, the depreciation for the machine is as follows:

Year 20X3: $ 8,390 ($16,780/2)

Year 20X4: $ 16,780

Year 20X5: $ 16,780

Year 20X6: $ 16,780

Year 20X7: $ 16,780

Year 20X8: $ 8,390 ($16,780/2)

FULL FIRST YEAR CONVENTION:

Full Year will calculate an entire year's depreciation for the first year, REGARDLESS of the month it was placed in service. During the first year, the annual depreciation will be distributed over the number of months (periods) it is in service for the first year.

Under the full first year convention, the depreciation for the machine is as follows:

Year 20X3: $16,780

Monthly Depreciation for year 20X3: $16,780/10 Months = $1,678

Note: As Machine is purchased in March, so Depreciation for the Year 20X3 is evenly Spread over the number of months it is in service that is 10 Months (March to December)

Year 20X4: $ 16,780

Year 20X5: $ 16,780

Year 20X6: $ 16,780

Year 20X7: $ 16,780

Calculation of Gain or Loss on sale of asset for $ 6,100 at the end of 20X6:

Residual Value at the end of 20X6 = $ 10,100

Asset is sold at the end of 20X6 = $ 6,100

So, there is a loss of $ 4,000 ($10,100-$6,100) on sale of asset.