Question

Francisco Corporation is constructing a new building at a total initial cost of \(10,000,000. The building is expected to have a useful life of 50 years with no residual value. The building’s finished surfaces (e.g., roof cover and floor cover) are 5% of this cost and have a useful life of 20 years. Building services systems (e.g., electric, heating, and plumbing) are 20% of the cost and have a useful life of 25 years. The depreciation in the first year using component depreciation, assuming straight-line depreciation with no residual value, is:

1. \)200,000.
2. \(215,000.
3. \)255,000.
4. None of the above.

Short answer

The correct option is option (c) $255,000.

Step-by-step solution

Meaning of Depreciation

In accounting, depreciation refers to an expense incurred on an intangible asset due to corrosion and abrasion. A firm may adopt various methods for computing depreciation to reflect the true and accurate value of the asset.

Explaining the correct option

Computation of depreciation of finished surfaces:

Cost of asset = Initial cost x Rate covering building surfaces

= $10,000.00 x 5%

= $500,00

Depreciation = $\frac{\mathrm{Original}\mathrm{cost}}{\mathrm{Useful}\mathrm{life}}$

= $\frac{\$500,000}{20}$

= $25,000

Computation of depreciation of service systems:

Cost of asset = Initial cost x Rate covering building service system

= $10,000,000 x 20%

= $2,000, 000

Depreciation = $\frac{\mathrm{Original}\mathrm{cost}}{\mathrm{Useful}\mathrm{life}}$

= $\frac{\$2,000,000}{25}$

= $80,000

Computation of depreciation for the remaining cost of building:

Cost = Initial building cost - Cost of asset of surfaces and service system

= $10,000,000 - $500,000 - $2,000,000

= $7,500,000

Depreciation = $\frac{\mathrm{Original}\mathrm{cost}}{\mathrm{Useful}\mathrm{life}}$

= $\frac{\$7,500,000}{50}$

$150,000

So, the total depreciation is $255,000 ($25,000+80,000+$150,000).

Explaining the incorrect options

Option (a): Depreciation expense of $200,000 only includes the depreciation of the finished surfaces ($25,000) and the depreciation of the remaining cost of the building ($150,000). The depreciation of the service system is omitted.

Option (b): The service system's depreciation expense may be undervalued because the actual depreciation is $80,000 and the incorrect depreciation is $15,000.

Option (d): The depreciation expense for the asset is $255,000, and it is also mentioned in option (c), so options (a), (b), and (d) are incorrect.