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# Depreciation questions: Identify decisions that managers like Choi must make in applying depreciation methods.

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Flo Choi owns a small business and manages its accounting. Her company just finished a year in which a large amount of borrowed funds was invested in a new building addition as well as in equipment and fixture additions. Choi's banker requires her to submit semiannual financial statements so he can monitor the financial health of her business. He has warned her that if profit margins erode, he might raise the interest rate on the borrowed funds to reflect the increased loan risk from the bank's point of view. Choi knows profit margin is likely to decline this year. As she prepares year-end adjusting entries, she decides to apply the following depreciation rule: All asset additions are considered to be in use on the first day of the following month. (The previous rule assumed assets are in use on the first day of the month nearest to the purchase date.)

Questions

1. Identify decisions that managers like Choi must make in applying depreciation methods.
2. Is Choi's rule an ethical violation, or is it a legitimate decision in computing depreciation?
3. How will Choi's depreciation rule affect the profit margin of her business?

Part 2

Part A. A machine costing \$210,000 with a four-year life and an estimated \$20,000 salvage value is installed in Calhoon Company's factory on January 1. The factory manager estimates the machine will produce 475,000 units of product during its life. It actually produces the following units: year 1, 121,400; year 2, 122,400; year 3, 119,600; and year 4, 118,200. The total number of units produced by the end of year 4 exceeds the original estimate?this difference was not predicted. (The machine must not be depreciated below its estimated salvage value.)

Need to do:

Prepare a table with the following column headings and compute depreciation for each year (and total depreciation of all years combined) for the machine under each depreciation method.

Year Straight-Line Units-of-Production Double-Declining-Balance

Part B. Calhoon purchases a used machine for \$167,000 cash on January 2 and readies it for use the next day at a \$3,420 cost. On January 3, it is installed on a required operating platform costing \$1,080, and it is readied for operations. The company predicts the machine will be used for six years and have a \$14,600 salvage value. Depreciation is to be charged on a straight-line basis. On December 31, at the end of its fifth year in operations, it is disposed of.

Need to do:
a. Prepare journal entries to record the machine's purchase and the costs to ready and install it. Cash
is paid for all costs incurred.
b. Prepare journal entries to record depreciation of the machine at December 31 of its first year in
operations and at December 31 in the year of its disposal.
c. Prepare journal entries to record the machine's disposal under each of the following separate assumptions:
(i) it is sold for \$13,500 cash; (ii) it is sold for \$45,000 cash; and (iii) it is destroyed
in a fire and the insurance company pays \$24,000 cash to settle the loss claim.

#### Solution Preview

Part 1

I feel like I have a good understanding of ethics and of depreciation but I am still struggling with this problem. Any assistance would be great.

Flo Choi owns a small business and manages its accounting. Her company just finished a year in which a large amount of borrowed funds was invested in a new building addition as well as in equipment and fixture additions. Choi’s banker requires her to submit semiannual financial statements so he can monitor the financial health of her business. He has warned her that if profit margins erode, he might raise the interest rate on the borrowed funds to reflect the increased loan risk from the bank’s point of view. Choi knows profit margin is likely to decline this year. As she prepares year-end adjusting entries, she decides to apply the following depreciation rule: All asset additions are considered to be in use on the first day of the following month. (The previous rule assumed assets are in use on the first day of the month nearest to the purchase date.)

Questions

1. Identify decisions that managers like Choi must make in applying depreciation methods.

2. Is Choi’s rule an ethical violation, or is it a legitimate decision in computing depreciation?

3. How will Choi’s depreciation rule affect the profit margin of her business?

1. When managers acquire new assets a number of decisions relative to depreciation must be made. Specifically, the asset must be assigned a useful life, a salvage value, and a method of depreciation.

2. When assets are placed in use on a day other than the first day of the month an assumption is often made that the assets are placed in use on the first day of the month nearest to the date of the purchase. For example, for assets purchased on the 1st through 15th days of the month, the first day of the month is assumed to be the purchase date. For assets purchased on the 16th through month-end, the first day of the next ...

#### Solution Summary

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