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An asset for drilling was purchased and placed in service by a petroleum production company. Its cost basis is $60,000, and it has an estimated market value of $12,000 at the end of an estimated useful life of 14 years. Compute the depreciation amount in the third year and book value at the end of the fifth year of life using SL method and 200% DB method with switchover to SL. Which method should the company use

Answer :

jepessoa

Answer:

purchase price $60,000

estimated useful life 14 years

residual value $12,000

depreciation expense using straight line method:

using straight line = ($60,000 - $12,000) / 14 = $3,428.57

depreciation during year 3 = $3,428.57

book value at end of year 5 = $60,000 - ($3,428.57 x 5) = $42,857.15

depreciation expense using SL method and 200% DB method with switchover to SL:

year 1 = $60,000 x 2 x 1/14 = $8,571.43

year 2 = $51,428.57 x 2 x 1/14 = $7,346.94

year 3 = $44,081.63 x 2 x 1/14 = $6,297.38

year 4 = $37,784.25 x 2 x 1/14 = $5,397.75

year 5 = $32,386.50 x 2 x 1/14 = $4,626.64

book value at end of year 5 = $27,759.86

Since the depreciation expense using double balance with switchover to straight line is higher during the first years, then the company should use that method. One extra dollar in depreciation expense = one less dollar in taxable income. It is usually better pay less taxes today than tomorrow.

anthougo

1. The computation of the depreciation expense in the third year and the book value at the end of year 5 is as follows:

                                      Straight-line        Double-Declining

Third year Depreciation   $3,429                   $6,302

Book value, 5th year      $42,855                 $27,737

2. The company should choose the method that meets its requirements, especially with regard to the usage of the drilling machine.

Data and Calculations:

Cost of drilling machine = $60,000

Estimated salvage value = $12,000

Depreciable amount = $48,000

Estimated useful life = 14 years

Straight-line Method:

Annual depreciation expense = $3,429 ($48,000/14)

Accumulated depreciation, year 5 = $17,145 ($3,429 x 5)

Net book value, year 5 = $42,855 ($60,000 - $17,145)

Double-declining-balance Method:

Depreciation rate = 14.3% (100/14 x 2)

Year        Depreciation                       Net Book Value

Year 1     $8,580 ($60,000 x 14.3%)    $51,420 ($60,000 - $8,580)

Year 2    $7,353 ($51,420 x 14.3%)     $44,067 ($51,420 - $7,353)

Year 3    $6,302 ($44,067 x 14.3%)    $37,765 ($44,067 - $6,302)

Year 4    $5,400 ($37,765 x 14.3%)    $32,365 ($37,765 - $5,400)

Year 5    $4,628 ($32,365 x 14.3%)    $27,737 ($32,365 - $4,628)

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