Fabian Woodworks: Company Purchased A Truck At A Cost

Fabian Woodworks This company purchased a truck at a cost of $12,000. The truck has an estimated residual value of $2,000 and an estimated life of 5 years, or 100,000 hours of operation.

Fabian Woodworks purchased a truck on January 1, 2012, at a cost of $12,000. The truck has an estimated residual value of $2,000 and an estimated useful life of 5 years or 100,000 hours of operation. In 2012, the truck was used for 27,000 hours, and in 2013, it was used for 26,000 hours. The question is: based on this information, which depreciation method will maximize depreciation expense in the year 2012?

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Depreciation accounting is essential for accurately reflecting the wear and tear of long-term tangible assets like trucks over their useful lives. Several methods can be employed to allocate the cost of an asset over its residual life, including straight-line, double-declining balance, and units-of-production methods. Each method has implications for the timing and amount of depreciation expense recognized in the financial statements, particularly in the earliest years of asset use.

The straight-line method evenly distributes the cost minus residual value over the asset’s estimated useful life. It yields a constant annual depreciation expense, regardless of the asset's usage. Conversely, the double-declining balance method accelerates depreciation by applying a double rate of the straight-line percentage to the declining book value each year. The units-of-production method ties depreciation to actual asset utilization, meaning the more the asset is used, the higher the depreciation expense during that period.

In 2012, Fabian Woodworks used the truck for 27,000 hours out of the estimated 100,000 hours of total operation. To determine which method maximizes depreciation expense in 2012, we need to analyze how each method allocates depreciation based on usage and time.

Straight-Line Method

The straight-line depreciation expense is calculated as follows:

  • Cost: $12,000
  • Residual Value: $2,000
  • Useful Life: 5 years
  • Annual Depreciation Expense = (Cost - Residual Value) / Useful Life

Thus,

Annual depreciation = ($12,000 - $2,000) / 5 = $2,000

Assuming straight-line depreciation, the expense for 2012 would be $2,000, regardless of usage.

Double-Declining Balance Method

The double-declining balance method accelerates depreciation early in the asset’s life. The depreciation rate is double the straight-line rate, which is 20% (100% / 5 years). Therefore, the rate becomes 40%. The depreciation expense for 2012 is calculated on the book value at the beginning of the year:

  • Beginning book value: $12,000
  • Depreciation expense = 40% of $12,000 = $4,800

Thus, in 2012, the depreciation expense would be $4,800, which is higher than the straight-line method owing to the accelerated approach.

Units-of-Production Method

This method calculates depreciation based on actual usage. The depreciation expense per hour is determined by:

  • Depreciable amount = Cost - Residual Value = $10,000
  • Depreciation per hour = $10,000 / 100,000 hours = $0.10 per hour

In 2012, with 27,000 hours used:

Depreciation expense = 27,000 hours x $0.10 = $2,700

Comparing the three methods for the year 2012, we observe the following depreciation expenses:

  • Straight-line: $2,000
  • Double-declining balance: $4,800
  • Units-of-production: $2,700

The double-declining balance method yields the highest depreciation expense in 2012, as it is designed to accelerate depreciation in the initial years of an asset's life by applying a higher depreciation rate to the declining book value.

Therefore, the method that will maximize the depreciation expense in 2012 is the double-declining balance method.

Conclusion

Understanding the impact of different depreciation methods is vital to financial reporting and tax strategies. The double-declining balance method provides the greatest depreciation expense early on, which can be advantageous for reducing taxable income in initial years. In contrast, the straight-line method distributes expenses evenly, and units-of-production ties depreciation directly to actual usage. Based on the calculations and usage data provided, the double-declining balance method is the most effective for maximizing depreciation expense in the first year of asset use.

References

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