Lowell Company Purchased Equipment On January 1, 2006

Lowell Company Purchased Equipment On January 1 2006 For 300000

Lowell Company purchased equipment on January 1, 2006, for $300,000. The equipment was expected to have a useful life of 5 years or 12,000 hours, with a salvage value of $60,000. The equipment was used for 1,975 hours during 2006, 2,875 hours during 2007, 2,600 hours during 2008, 2,975 hours during 2009, and 1,575 hours during 2010. Determine the amount of depreciation expense for the years ended December 31, 2006, 2007, 2008, 2009, and 2010, by the following methods:

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Depreciation is a systematic allocation of the cost of a tangible asset over its useful life. It reflects the expense associated with using an asset over a period, matching the cost with the revenue generated. The key methods for calculating depreciation include the straight-line method, the units of production method, and the declining balance method. In this analysis, we will examine how these three methods apply to Lowell Company’s equipment purchased in 2006, considering its expected useful life, salvage value, and usage hours over five years.

Introduction

Depreciation accounting plays a vital role in portraying a realistic financial position of a company. It affects both the income statement and the balance sheet, influencing profitability and asset valuation. The choice of depreciation method can significantly impact reported earnings and asset book value. Given Lowell Company’s equipment, we will apply the straight-line, units of production, and declining balance depreciation methods to determine annual depreciation expenses from 2006 through 2010.

Asset Characteristics and Assumptions

The equipment was purchased for $300,000 with an estimated salvage value of $60,000 after five years of use. The total useful life is five years, or 12,000 hours, whichever occurs first. The usage over the five-year period varies, with specific hours listed for each year. This variability makes the units of production method particularly suitable, but we will also demonstrate the outcomes of the straight-line and declining balance methods.

Method 1: Straight-Line Depreciation

The straight-line method evenly allocates depreciation over an estimated useful life. The annual depreciation expense is calculated as:

Depreciation Expense = (Cost – Salvage Value) / Useful Life

Applying the figures:

Depreciation expense per year = ($300,000 – $60,000) / 5 = $48,000

This method results in a uniform depreciation expense of $48,000 annually, unaffected by usage hours.

Method 2: Units of Production Method

The units of production method calculates depreciation based on actual usage hours relative to total expected hours. The depreciation per hour is:

Depreciation per hour = (Cost – Salvage Value) / Total Estimated Hours = ($300,000 – $60,000) / 12,000 = $20 per hour

Using this rate, the depreciation expense for each year is:

• 2006: 1,975 hours x $20 = $39,500
• 2007: 2,875 hours x $20 = $57,500
• 2008: 2,600 hours x $20 = $52,000
• 2009: 2,975 hours x $20 = $59,500
• 2010: 1,575 hours x $20 = $31,500

Method 3: Declining Balance Method

The declining balance method accelerates depreciation, applying a fixed percentage to the declining book value of the asset each year. For this scenario, we assume a 40% declining balance rate, which is typical for assets with a 5-year useful life.

The depreciation calculation for each year involves:

Book value at beginning of year x Declining balance rate = Depreciation expense for the year

Initial book value = $300,000

Year 2006:

Depreciation = $300,000 x 40% = $120,000

Remaining book value = $180,000

Year 2007:

Depreciation = $180,000 x 40% = $72,000

Remaining book value = $108,000

Year 2008:

Depreciation = $108,000 x 40% = $43,200

Remaining book value = $64,800

Year 2009:

Depreciation = $64,800 x 40% = $25,920

Remaining book value = $38,880

Year 2010:

Depreciation = $38,880 x 40% = $15,552

Remaining book value = $23,328

Note: Since the residual value is $60,000, the depreciation must be adjusted in the final years to not depreciate below this salvage value. Thus, the depreciation expense in the last year will be limited to prevent book value from dropping below $60,000.

Comparison and Conclusion

The straight-line method produces consistent depreciation expenses of $48,000 annually, regardless of usage. It is suitable for assets with evenly distributed utility. The units of production method ties depreciation directly to asset usage, resulting in varying annual expenses based on actual hours used, which aligns depreciation costs with asset utilization. The declining balance method accelerates depreciation, recognizing higher expenses earlier in the asset’s life, which is often preferred for tax purposes and reflects the higher productivity or obsolescence early in the asset’s life.

Applying these methods to Lowell Company’s equipment provides different perspectives on expense recognition, influencing financial statements and tax planning. The choice depends on the company's strategic accounting policies and operational considerations.

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