Covey Company Purchased A Machine On January 2, 2008

Covey Company Purchased A Machine On January 2 2008 By Pay

Covey Company purchased a machine on January 2, 2008, by paying cash of $350,000. The machine has an estimated useful life of five years (or the production of 600,000 units) and an estimated residual value of $35,000. Required: Determine depreciation expense (to the nearest dollar) for each year of the machine's useful life under (a). straight-line depreciation; and (b). the declining balance method with a 200% acceleration rate. What is the book value of the machine after three years with the declining- balance method and a 200% acceleration rate? What is the book value of the machinery after three years with straight-line depreciation? 4. If the machine was used to produce and sell 130,000 units in 2008, what would the depreciation expense be under the units of production method?

Paper For Above instruction

The purchase of machinery by Covey Company introduces a critical examination of depreciation methods, which are fundamental to accurately reflecting asset reduction over time in financial statements. This analysis compares straight-line and declining balance depreciation methods over a five-year lifespan, incorporating the specific context of unit production during the first year. The purpose is to assess how these different approaches influence book value calculations and to provide insight into the most suitable method for different financial reporting objectives.

Introduction

Depreciation is a systematic allocation of the cost of a tangible asset over its useful life. It is essential for matching the expense of using an asset with the revenue it helps generate, thus providing a realistic picture of a company's financial position. Various depreciation methods exist, each with its advantages and limitations, with straight-line and declining balance being among the most prevalent.

Straight-Line Depreciation

The straight-line method spreads the cost of the asset evenly over its estimated useful life. The formula is straightforward:

Depreciation Expense = (Cost of Asset – Residual Value) / Useful Life

Applying this to Covey's machine:

• Cost = $350,000
• Residual value = $35,000
• Useful life = 5 years

Annual depreciation expense:

($350,000 – $35,000) / 5 = $315,000 / 5 = $63,000

Therefore, each year, Covey recognizes $63,000 as depreciation expense. The book value at the end of three years is calculated by subtracting three years' depreciation from the initial cost:

Book value after 3 years = $350,000 – (3 × $63,000) = $350,000 – $189,000 = $161,000

Declining Balance Method (200% rate)

The declining balance method allows for higher depreciation in earlier years, decreasing over time. At 200% acceleration (double the straight-line rate), the depreciation rate is:

Depreciation rate = 2 / Useful Life = 2 / 5 = 40% per year

Each year's depreciation is calculated by applying this rate to the book value at the beginning of the year. Here are the calculations:

• Year 1: $350,000 × 40% = $140,000
• Book value at end of Year 1: $350,000 – $140,000 = $210,000
• Year 2: $210,000 × 40% = $84,000
• Book value at end of Year 2: $210,000 – $84,000 = $126,000
• Year 3: $126,000 × 40% = $50,400
• Book value at end of Year 3: $126,000 – $50,400 = $75,600

Thus, after three years, the book value of the machine under declining balance depreciation is approximately $75,600.

Comparison of Book Values After Three Years

As calculated, the straight-line method leaves the machine with a book value of $161,000 after three years, reflecting uniform depreciation. Conversely, the declining balance method results in a significantly lower book value of approximately $75,600, due to higher depreciation expenses in early years. This illustrates how declining balance accelerates depreciation, providing tax advantages by decreasing taxable income sooner.

Units of Production Method

The units of production method allocates depreciation based on actual usage. The cost per unit is determined as follows:

Cost per unit = (Cost – Residual Value) / Total Estimated Units

Applying the data:

($350,000 – $35,000) / 600,000 units = $315,000 / 600,000 ≈ $0.525 per unit

In 2008, the machine produced 130,000 units, so the depreciation expense is:

130,000 units × $0.525 ≈ $68,250

Using the units of production method aligns depreciation expense with actual usage, offering a more precise reflection of the asset's consumption in productive activity.

Conclusion

The evaluation of depreciation methods highlights important considerations regarding financial reporting and tax planning. Straight-line depreciation provides simplicity and consistency, beneficial for companies aiming for stable expense recognition. Declining balance depreciation accelerates expense recognition, advantageous for tax purposes and reflecting the higher utility of assets in their initial years. The units of production method offers the most accurate matching between expense and usage, especially relevant for manufacturing equipment where usage varies significantly from year to year. Covey Company's analysis demonstrates the significant differences that depreciation method choice can have on book value, taxable income, and financial statements. Ultimately, the selection depends on the company's strategic priorities and regulatory requirements.

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