Calculate Depreciation, Carrying Value, And Impact

Calculate depreciation, carrying value, and analyze the impact of different methods

Bao Wao Designs Inc purchased a computerized blueprint printer that will assist in the design and display of plans for factory layouts. The cost of the printer was $22,500, and it is expected to have a useful life of four years. The company expects to sell the printer for $2,500 at the end of four years. The printer is expected to last for 6,000 hours and was used for 1,200 hours in year 1, 1,800 hours in year 2, 2,400 hours in year 3, and 600 hours in year 4.

Compute the annual depreciation and carrying value for the new blueprint printer for each of the four years under each of the following methods: (a) straight-line, (b) production, and (c) double-declining-balance. Additionally, determine the gain or loss if the printer is sold for $12,000 after year 2 under each method. Analyze the patterns of depreciation and carrying value over the four years, and discuss the impact of these methods on profitability and operating cash flows.

Paper For Above instruction

In analyzing the depreciation of Bao Wao Designs Inc.’s computerized blueprint printer, it is essential to understand how different depreciation methods influence the allocation of the asset's cost over its useful life, affecting financial statements and decision-making. The three techniques—straight-line, production, and double-declining-balance—offer varied approaches, each with unique implications on profitability, tax, and cash flow management. This comprehensive analysis provides insights into the calculations and consequences of each method, enabling better strategic choices for accounting practice and financial planning.

1. Calculation of Annual Depreciation and Carrying Values

Assumptions and Data

• Purchase Price (Cost): $22,500
• Salvage Value at end of 4 years: $2,500
• Useful Life: 4 years
• Total expected usage: 6,000 hours
• Actual usage over four years:

• Year 1: 1,200 hours
• Year 2: 1,800 hours
• Year 3: 2,400 hours
• Year 4: 600 hours

(a) Straight-Line Method

Under the straight-line method, depreciation expense is evenly allocated over the asset’s useful life:

Annual Depreciation = (Cost - Salvage Value) / Useful Life

Annual Depreciation = ($22,500 - $2,500) / 4 = $20,000 / 4 = $5,000

Carrying value at the end of each year is the initial cost minus accumulated depreciation.

(b) Production Method

The production method bases depreciation on actual usage relative to total expected usage.

Depreciation per hour = (Cost - Salvage Value) / Total expected hours = ($22,500 - $2,500) / 6,000 = $20,000 / 6,000 = $3.33 per hour

Yearly depreciation expenses:

• Year 1: 1,200 hours * $3.33 = $3,996
• Year 2: 1,800 hours * $3.33 = $5,994
• Year 3: 2,400 hours * $3.33 = $7,992
• Year 4: 600 hours * $3.33 = $1,998

Carrying value at end of each year:

• Year 1: $22,500 - $3,996 = $18,504
• Year 2: $18,504 - $5,994 = $12,510
• Year 3: $12,510 - $7,992 = $4,518
• Year 4: $4,518 - $1,998 = $2,520

(c) Double-Declining Balance Method

The double-declining balance (DDB) method accelerates depreciation, applying double the straight-line rate to the decreasing book value each year.

Rate = 2 / Useful life = 2 / 4 = 50%

Year 1:

• Depreciation = 50% * $22,500 = $11,250
• Carrying value = $22,500 - $11,250 = $11,250

Year 2:

• Depreciation = 50% * $11,250 = $5,625
• Carrying value = $11,250 - $5,625 = $5,625

Year 3:

• Depreciation = 50% * $5,625 = $2,812.50
• Carrying value = $5,625 - $2,812.50 = $2,812.50

Year 4:

• Depreciation should not reduce the book value below the salvage value of $2,500. Since the book value after year 3 is $2,812.50, depreciation expense in year 4 is $2,812.50 - $2,500 = $312.50
• Carrying value = $2,500

2. Gain or Loss on Sale after Year 2 for $12,000 Sale Price

To determine gain or loss, compare sale price to book value at the end of year 2 under each method:

Straight-Line:

• Carrying value after 2 years: $12,500
• Sale Price: $12,000
• Loss = $12,500 - $12,000 = $500

Production:

• Carrying value after 2 years: $12,510
• Sale Price: $12,000
• Loss = $12,510 - $12,000 = $510

Double-Declining Balance:

• Carrying value after Year 2: $5,625
• Sale Price: $12,000
• Gain = $12,000 - $5,625 = $6,375

3. Patterns of Depreciation and Impact Analysis

Analyzing the depreciation patterns reveals distinct impacts on the financial statements and operational considerations. The straight-line method distributes depreciation evenly, providing stable expenses that simplify profitability analysis and tax planning. It maintains consistent carrying values, which can be beneficial for long-term financial stability and management decision-making. However, it does not account for actual usage, potentially misrepresenting the asset's utilization and wear over time.

The production method aligns depreciation expense with actual usage, resulting in more accurate reflection of wear and tear. High-usage years incur higher depreciation, which impacts profitability and tax liabilities correspondingly. The carrying value decreases proportionally to usage, offering a realistic view of asset remaining value. This method is especially suitable for assets whose depreciation is closely tied to activity levels, such as machinery or equipment with variable operation hours.

Double-declining balance accelerates depreciation, significantly lowering book value in early years. This approach recognizes higher wear early on, providing tax advantages through higher depreciation deductions upfront. It also causes a more rapid decline in profitability metrics initially but stabilizes as the asset approaches salvage value. The decreasing book value may also influence decisions on asset replacement and financing.

Impact on Profitability and Operating Cash Flows

The choice of depreciation method directly affects reported profitability. The double-declining balance method results in higher depreciation expenses in early years, reducing net income compared to straight-line or production methods. This can influence performance ratios and evaluation metrics, potentially affecting investor perceptions and managerial incentives.

Regarding operating cash flows, depreciation is a non-cash expense, and all methods impact cash flow indirectly through tax savings. Accelerated methods like double-declining balance allow for higher depreciation deductions early on, reducing taxable income and increasing cash flows due to lower tax payments. Conversely, straight-line depreciation results in steadier, predictable tax liabilities, which might be advantageous for cash flow planning.

In essence, while all methods do not alter total cash flows over the asset's life, their timing significantly influences profitability reporting and tax obligations, which are crucial for strategic financial management. Companies should select a depreciation method aligning with their operational realities and financial objectives, considering the implications for profitability, tax planning, and cash flow stability.

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