Question

Required information The following information applies to the questions displayed below.) Three different companies each purchased trucks on January 1 Year 1 for $50,000. Each truck was expected to last four years or 200,000 miles. Salvage value was estimated to be $5.000. All three trucks were driven 66,000 miles in Year 1 42,000 miles in Year 2,40,000 miles in Year 3, and 60,000 miles in Year 4. Each of the three companies earned $40,000 of cash revenue during each of the four years, Company A uses straight-line depreciation, company Buses double declining balance depreciation, and company C uses units of production depreciation. Answer each of the following questions. Ignore the effects of income taxes Required a-1. Calculate the net income for Year 1 a-2. Which company will report the highest amount of net income for Year 1? Complete this question by entering your answers in the tabs below. Required A1 Required A2 Calculate the net income for Year 1. (Round your "Per Unit Cost to 3 decimal places.) Net Income Company A

Answer 1

Solution

A1. Calculation of net income for year 1:

	Company A	Company B	Company C
Net Income, Year 1	$28,750	$16,000	$25,150

Computations:

Company A –

Uses straight line depreciation

Depreciation expense =depreciable base x 1/useful life

Depreciable base = cost – residual value

Cost = $50,000

Salvage value = $5,000

Depreciable base = 50,000 – 5,000 = 45,000

Useful life = 4 years

Depreciation expense = 45,000/4 = $11,250

Cash revenue = $40,000

Less: depreciation expense = 11,250
net income for Year 1 = 28,750

Company B –

Uses double declining balance method:

• depreciation expense:

Depreciation method DDB

Annual depreciation expense = cost x DDB rate

DDB rate = 200% straight line depreciation rate

Straight line depreciation rate = 1/useful life

Useful life = 4 years

Straight line depreciation rate = 1/4 = 25%

DDB rate = 200% x 25% = 50%

Cost = $50,000

Annual depreciation expense, year 1 = 50,000 x 50% = 25,000

Cash revenue = $40,000

Less: depreciation expense = $25,000

Net income for Year 1 = $16,000

Company C –

Uses units-of-production method

Depreciation expense = depreciable base x rate per mile

Depreciable base =

Depreciable base = cost – residual value

Cost = $50,000

Salvage value = $5,000

Depreciable base = 50,000 – 5,000 = 45,000

Depreciation rate = depreciable base/useful life in miles

Expected life in miles = 200,000

Depreciation rate = $45,000/200,000 = $0.225 per mile

Depreciation expense, Year 1 = miles driven x depreciation rate

Miles driven in year 1 = 66,000

Depreciation expense, Year 1 = 66,000 x $0.225 = $14,850

Cash revenue = $40,000

Less: depreciation expense = 14,850

Net income = 25,150

A2. The company that reports the highest amount of net income for Year 1 –

Company A

Net Income = $28,750

B1. Calculation of net income for year 4 –

	Net Income, Year 4
Company A	$28,750
Company B	$36,875
Company C	$26,500

Computations:

Company A –

Annual depreciation expense = $11,250

Depreciation expense for Year 4 = $11,250

Cash revenue = $40,000

Net income = 40,000 – 11,250 = $28,750

Company B –

Book value at end of year 1 = 50,000 – 25,000 = $25,000

Depreciation expense, Year 2 = 25,000 x 50% = $12,500

Book value, EOY 2 = cost – accumulated depreciation

= 50,000 – (25,000 + 12,500) = $12,500

Depreciation expense Year 3 = 12,500 x 50% = $6,250

Book value EOY 3 = 50,000 – (25,000 + 12,500 + 6,250) = $6,250

Depreciation expense Year 4 = 6,250 x 50% = $3,125

Cash revenue = $40,000

Net Income = 40,000 – 3,125 = $36,875

Company C –

Depreciation rate per mile = $0.225

Miles driven in Year 4 = 60,000

Depreciation expense = 60,000 x $0.225 = $13,500

Cash revenue = 40,000

Net income = 40,000 – 13,500 = $26,500

B2. The company that reports the highest net income for Year 4 –

Company B –

Net income = $36,875

C1. Book value on the December 31, Year 3 balance sheet:

	Book Value EOY 3
Company A	$16,250
Company B	$6,250
Company C	$16,700

Computations:

Company A –

Book value = cost – accumulated depreciation

Annual depreciation expense = $11,250

Accumulated depreciation at EOY 3 = 3 x $11,250 = $33,750

Book value = 50,000 – 33,750 = $16,250

Company B –

Book value = cost – accumulated depreciation

Book value at end of year 1 = 50,000 – 25,000 = $25,000

Depreciation expense, Year 2 = 25,000 x 50% = $12,500

Book value, EOY 2 = cost – accumulated depreciation

= 50,000 – (25,000 + 12,500) = $12,500

Depreciation expense Year 3 = 12,500 x 50% = $6,250

Book value EOY 3 = 50,000 – (25,000 + 12,500 + 6,250) = $6,250

Company C –

Book value at end of year 1 = 50,000 – 14,850 = $35,150

Depreciation expense, Year 2 = 42,000 miles x $0.225 per mile = $9,450

Book value, EOY 2 = cost – accumulated depreciation

= 50,000 – (14,850 + 9,450) = $24,300

Depreciation expense Year 3 = 40,000 miles x $0.225 per mile = $9,000

Book value EOY 3 = 50,000 – (14,850 + 9,450 + 9,000) = $16,700

C2. The company that reports the highest book value at end of year 3 –

Company C reports highest book value at end of year 3 –

Book value = $16,700

D1. Retained earnings at end of Year 4 –

	Retained Earnings
Company A	$115,000
Company B	$114,125
Company C	$113,200

Computations:

Retained earnings at December 31, Year 4 = net income Year 1 + net income Year 2 + net income Year 3

Company A –

Net income for year 1 = 28,750

Depreciation, Year 2 = 11,250

Net income for year 2 = 40,000 – 11,250 = 28,750

Depreciation Year 3 = 11,250

Net income for year 3 = 40,000 – 11,250 = 28,750

Depreciation year 4 = 11,250

Net income for year 4 = 40,000 – 11,250 = 28,750

Retained earnings, December 31 balance sheet year 4 = 28,750 x 4 = $115,000

Company B –

Net income year 1 = $16,000

Depreciation expense year 2 = 25,000 x 50% = 12,500

Net income year 2 = 40,000 – 12,500 = $27,500

Depreciation expense year 3 = 12,500 x 50% = $6,250

Net income year 3 = 40,000 – 6,250 = $33,750

Depreciation expense year 4 = 6,250 x 50% = $3,125

Net income year 4 = $40,000 – 3,125 = $36,875

Retained earnings, Year 4 December 31, balance sheet = 16,000 + 27,500 + 33,750 + 36,875 = $114,125

Company C –

Net income year 1 = $25,150

Depreciation expense year 2 = 42,000 miles x $0.225 = $9,450

Net income year 2 = 40,000 – 9,450 = $30,550

Depreciation expense year 3 = 40,000 miles x $0.225 = $9,000

Net income year 3 = 40,000 – 9,000 = 31,000

Depreciation expense year 4 = 60,000 miles x $0.225 = $13,500

Net income year 4 = 40,000 – 13,500 = $26,500

Retained earnings year 4 December 31 balance sheet = 25,150 + 30,550 + 31,000 + 26,500 = $113,200

D2. The company that reports the highest amount of retained earnings on the December 31, Year 4 balance sheet –

Company A

Retained earnings = $115,000

E. company that would report the lowest amount of cash flow from operating activities on the year 3 statement of cash flows :

The cash flow from operating activities would be $40,000 for Year 3 if income tax is not considered.

Depreciation expense is a non-cash expense and non-cash flow item.

So, all the three companies would report $40,000 as cash flow from operating activities.