Question

Question: Determining asset cost, preparing depreciation schedules (3 methods), and identifying depreciation results that meet management objectives

On January 3, 2018, Speedy Delivery Service purchased a truck at a cost of \(67,000. Before placing the truck in service, Speedy spent \)3,000 painting it, \(1,200 replacing tires, and \)3,500 overhauling the engine. The truck should remain in service for five years and have a residual value of $5,100. The truck’s annual mileage is expected to be 20,000 miles in each of the first four years and 12,800 miles in the fifth year—92,800 miles in total. In deciding which depreciation method to use, Alec Rivera, the general manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-production, and double-declining-balance).

Requirements

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value.

2. Speedy prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. Consider the first year that Speedy uses the truck. Identify the depreciation method that meets the company’s objectives.

Short answer

Answer

The business entity must elect thestraight-line method to meet the objective.

Step-by-step solution

Definition of Straight-Line Method

The method of calculating the depreciation under which each year of the useful life of the asset reports the same depreciation is known as the straight-line method. The depreciation method under this method is calculated using salvage value, cost, and useful life.

Depreciation schedule

a. Depreciation schedule by the straight-line method

Date	Asset Cost	Depreciation Expenses	Accumulated Depreciation	Book Value
03-1-2018	$74,700
12-31-2018	$74,700	$13,920	$13,920	$60,780
12-31-2019	$60,780	$13,920	$27,840	$46,860
12-31-2020	$46,860	$13,920	$41,760	$32,940
12-31-2021	$32,940	$13,920	$55,680	$19,020
12-31-2022	$19,020	$13,920	$69,600	$5,100

Working notes:

1. Calculation of total cost of truck

$$\begin{gathered} Total cost= Purchase cost+ painting cost+tires cost+overhauling cost \\ =\$67,000+\$3,000+\$1,200+\$3,500 \\ =\$74,700 \end{gathered}$$

2. Calculation of depreciation amount by the straight-line method

$$\begin{gathered} Depreciation=\frac{Cost-Residual value}{Useful life} \\ =\frac{\$74,700-\$5,100}{5} \\ =\$13,920 \end{gathered}$$

2. Depreciation schedule by Units of production method

Date	Cost	Depreciation expenses	Accumulated Depreciation	Book Value
03-1-2018	$74,700
12-31-2018	$74,700	$15,000	$15,000	$59,700
12-31-2019	$59,700	$15,000	$30,000	$44,700
12-31-2020	$44,700	$15,000	$45,000	$29,700
12-31-2021	$29,700	$15,000	$60,000	$14,700
12-31-2022	$14,700	$9,600	$69,600	$5,100

Working notes:

1. Calculation of depreciation by units of production method

$$\begin{gathered} Depreciation by Units of production=\frac{Cost-Residual value}{Totalmiles} \\ =\frac{\$74,700-\$5,100}{92,800} \\ =\$0.75 per mile \\ Depreciation expense for first four years=20,000\times \$0.75 \\ =\$15,000 \\ Depreciation expense for fifth year=12,800\times \$0.75 \\ =\$9,600 \end{gathered}$$

c. Depreciation schedule by double-declining balance method

Date	Opening value depreciable base	Depreciation rate	Depreciation expenses	Accumulated depreciation	Book Value
03-1-2018	$74,700				$74,700
12-31-2018	$74,700	40%	$29,880	$29,880	$44,820
12-31-2019	$44,820	40%	$17,928	$47,808	$26,892
12-31-2020	$26,892	40%	$10,756.8	$58,564.8	$16,135.2
12-31-2021	$16,135.2	40%	$6,454.08	$65,018.88	$9,681.12
12-31-2022	$9,681.12	40%	$3,872.448	$68,891.33	$5,808.672

$$\begin{gathered} Depreciation rate=\frac{100\%}{Usefullife}\times 2 \\ =\frac{100\%}{5}\times 2 \\ =40\% \end{gathered}$$

Depreciation method meeting the company’s objective

The lowest depreciation in the initial years is reported under a straight-line method that will give a higher net income. Therefore, the business entity must elect the straight-line method to achieve the objective