Share
Explore BrainMass

Calculating net book value of assets using different methods of depreciation

See the attached file.

QUESTION 1:

A Company purchased equipment for $20,000. Management estimates that the equipment will have a useful life of five years and salvage value of $5,000. Calculate a) net book value of the equipment at the end of the third year using the straight-line method of depreciation; and b) depreciation expense for the second year using the double-declining balance method of depreciation.

SOLUTION 1a:

Straight Line Depreciation = (Cost of Equipment - Salvage Value) / Life of Equipment

Straight Line Depreciation = ($20,000 - $5,000) / 5 years

Straight Line Depreciation = $3,000

Depreciation in 3 years = $3,000 * 3 years

Depreciation in 3 years = $9,000

Net Book Value = Cost of Equipment - Accumulated Depreciation

Net Book Value = $20,000 - $9,000

Net Book Value = $11,000

SOLUTION 1b:

Rate of Depreciation = (1 / Life of Asset) * 2

Rate of Depreciation = (1 / 5years) * 2

Rate of Depreciation = 40%

Year Depreciation Balance
1 $ 8,000.00 $ 12,000.00
2 $ 4,800.00 $ 7,200.00

QUESTION 2:

Analyze accounts receivable and the allowance for doubtful accounts for the following company, and draw some inferences:
2012 2011
Sales $6,700 $7,500
Accounts receivable, net 202 320
Allowance for doubtful accounts 3 12

SOLUTION 2:

The accounts receivable balance in comparison to sales is quite low, thus it implies that company makes more sale on cash basis in comparison to credit sales. The allowance for doubtful accounts is 1.46% and 3.61% of the gross receivables during the year 2012 and 2011 respectively. This means that there are very less bad debts and company is able to recover money from its customers easily.

QUESTION 3:

Analyze the following common size balance sheet:

2012 2011
Current assets:
Cash 3% 5%
Accounts receivable 20 18
Inventory 35 30
Total current assets 58 53

Property, plant and equipment 30 40
Other assets 12 7
Total assets 100% 100%

Current liabilities:
Accounts payable 25% 20%
Short-term debt 38 33
Total current liabilities 63 53

Long-term debt 22 17
Total liabilities 85 70

Stockholders' equity:
Common stock and paid in capital 14 20
Retained earnings 1 10
15 30
Total liabilities and stockholders' equity 100% 100%

SOLUTION 3:

The company maintains reasonable balance between current assets, fixed assets and other assets. But the proportion of inventory in its current assets is quite high and the percentage of cash maintained is low. The percentage of current assets and other assets increased from 2011 to 2012. The proportion of fixed asset decreased by 10% in 2012.

The percentage of liabilities in company's debt structure is very high. In 2011, it was 70% and increased to 85% during the year 2012. In total liabilities, the percentage of current liabilities is 53% and 63% during the year 2011 and 2012 respectively. The proportion of long term debt increased from 17% to 22% during the year 2012.

QUESTION 4:

Consider the following information:

Net income $200
Purchase of property and plant 90
Depreciation expense 50
Payment of cash dividends 25
Cash dividends received on shares recorded as
Equity investments 15
Increase in cash loaned to another company 30
Increase in long-term debt 110
Decrease in inventories 10
Decrease in accounts payable 20
Repurchase of company's shares from a
Major stockholder for cash 100

Calculate cash flow from (used by) operating, investing, and financing activities.

SOLUTION 4:

Particulars Amount

Cash from Operating Activities:
Net Income $ 200.00
Add: Non-Cash Item
Depreciation Expense $ 50.00
Less: Cash dividends received on shares recorded as equity investments $ (15.00)
Working Capital Adjustments
Add: Decrease in Current Assets
Decrease in Inventories $ 10.00
Less: Decrease in Current Liabilities
Decrease in Accounts Payable $ (20.00)
Cash Flows from Operating Activities $ 225.00

Cash from Investing Activities:
Purchase of property and plant $ (90.00)
Increase in Cash loaned to another company $ (30.00)
Cash dividends received on shares recorded as equity investments $ 15.00
Cash Flows from Investing Activities $ (105.00)

Cash from Financing Activities:
Payment of Cash Dividends $ (25.00)
Increase in long-term debt $ 110.00
Repurchase of shares $ (100.00)
Cash Flows from Financing Activities $ (15.00)

QUESTION 5:

Consider the following information:

Current assets $150,000
Current liabilities 50,000
Accounts receivable, net 80,000
Inventories 40,000
Accounts payable 25,000
Net sales 425,000
Cost of goods sold 258,000

Calculate the company's cash conversion cycle.
SOLUTION 5:

Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding

Days Inventory Outstanding = (365 days * Inventory) / Cost of goods sold

Days Inventory Outstanding = (365 * $40,000) / $258,000

Days Inventory Outstanding = 56.59 days

Days Sales Outstanding = (365 days * Accounts Receivable) / Net Sales

Days Sales Outstanding = (365 * $80,000) / $425,000

Days Sales Outstanding = 68.71 days

Days Payables Outstanding = (365 days * Accounts Payable) / Cost of goods sold

Days Payables Outstanding = (365 * $25,000) / $258,000

Days Payables Outstanding = 35.37 days

Cash Conversion Cycle = 56.59 days + 68.71 days - 35.37 days

Cash Conversion Cycle = 89.93 days

QUESTION 6:

Beijing Limited has three divisions: North, Central and South. The following results were for the year ending December 31, 2012:
North Central South
Sales $600,000 $750,000 $500,000
Variable manufacturing costs 240,000 315,000 150,000
Variable selling and administrative costs 132,000 135,000 130,000
Contribution margin 228,000 300,000 220,000
Avoidable fixed costs 150,000 180,000 135,000
Unavoidable fixed costs 125,000 85,000 40,000
Operating income (loss) ($47,000) $35,000 $45,000

The Vice-President of Operations is concerned about the North Division's performance and considering whether it should be closed. If the North Division is closed, sales in the Central and South Divisions will drop by 10%. By how much will the company's overall operating income change if the North Division is closed?

SOLUTION 6:
Present Operating Income of Company = ($47,000) + $35,000 + $45,000

Present Operating Income of Company = $33,000

Calculation of Change in Operating Income:

Particulars Central South Total
Contribution Margin $ 300,000.00 $ 220,000.00 $ 520,000.00
Decrease 10.00% 10.00% 10.00%
Decrease in Contribution Margin $ 270,000.00 $ 198,000.00 $ 468,000.00
Avoidable Fixed Costs $ 180,000.00 $ 135,000.00 $ 315,000.00
$ 250,000.00
Operating Income $ 65,000.00

Change in Operating Income = $65,000 - $33,000

Change in Operating Income = $32,000

QUESTION 7:

Light Manufacturing produces a single product that sells for $16. Variable (flexible) costs per unit equal $11.20. The company expects the total fixed (capacity-related) costs to be $7,200 for the next month at the projected sales level of 20,000 units. In an attempt to improve performance, management is considering a number of alternatives. Suppose Light management believes that a 10% reduction in the selling price will result in a 30% increase in sales. If this proposed reduction in selling price is implemented, what will be the change in profit?

SOLUTION 7:

Particulars Old New
Selling Units 20000.00 26000.00
Selling Price $ 16.00 $ 14.40
Sales $ 320,000.00 $ 374,400.00
Less: Variable Cost $ 224,000.00 $ 291,200.00
Contribution Margin $ 96,000.00 $ 83,200.00
Less: Fixed Cost $ 7,200.00 $ 7,200.00
Profit $ 88,800.00 $ 76,000.00

The net profit will decrease by $12,800.

QUESTION 8:

Able Inc. is considering replacing its existing photocopier with a new one. The new system offers considerable operational savings. Information about the existing and new systems is as follows:
Existing New
Original cost $12,000 $15,000
Annual operating expenses 3,500 2,500
Accumulated depreciation at present 7,000 0
Current salvage value 2,000 15,000
Remaining life 5 years 5 years
Salvage value in 5 years 0 5,000
Annual depreciation 1,000 3,000

Should Able Inc. replace the existing photocopier with the new system?

SOLUTION 8:

Calculation of Operating Cost of both systems:

Particulars Existing New
Annual Operating Expenses $ 3,500.00 $ 2,500.00
Annual Depreciation $ 1,000.00 $ 3,000.00
Total Operating Costs $ 4,500.00 $ 5,500.00

The annual operating cost of new system is greater than existing system; therefore Able Inc. shall not replace the existing photocopier with the new system.

QUESTION 9:

Smith Manufacturing Ltd. applies manufacturing overhead costs to products at a predetermined rate of $100 per direct labor hour. One customer has requested a bid on a special order of 2,000 units of a product. Estimates for this order are: direct materials $100,000; direct labor of 1,000 labor hours @ $25 per hour. What is the bid price for one unit of this special order, including Smith's standard mark-up of 20%?

SOLUTION 9:

Calculation of bid-price:

Particulars Amount
Direct Materials $ 100,000.00
Direct Labor (1,000 * $25) $ 25,000.00
Overheads (1,000 * $100) $ 100,000.00
Total Cost $ 225,000.00
Add: Mark-Up @ 20% $ 45,000.00
Total Price to be charged $ 270,000.00
Number of units 2000.00
Bid-Price per unit $ 135.00

QUESTION 10:

Ball TV Ltd. currently sells small televisions for $180 per unit. This product has variable costs of $140. Another company is bringing a competing television to market that will sell for $170. Ball management believes it must lower its price to the same amount to compete in the market. Ball's marketing division believes that the new entrant will also cause Ball's sales in this market segment to decrease by 10%. Ball's sales are currently 100,000 televisions per year. What is the target cost per unit if the company wants to maintain its same profit margin in total dollars before the change, and the Marketing division is correct?

SOLUTION 10:

Calculation of Profit Margin before change:

Particulars Amount
Sales Revenue (100,000*$180) $ 18,000,000.00
Variable Cost (100,000*$140) $ 14,000,000.00
Profit $ 4,000,000.00

Particulars Amount
New Sales (in units) 90000.00
Sales Revenue (90,000 * $170) $ 15,300,000.00
Variable Cost $ 11,300,000.00
Profit $ 4,000,000.00

Target Cost per unit = $11,300,000 / 90,000

Target Cost per unit = $125.56

QUESTION 11:

Do-Right Industries developed the following standard costs for direct materials and direct labor to produce gadgets:

Standard quantity Standard price
Direct materials 0.60 kg. $25 per kg.
Direct labor 0.20 hours $18 per hour

During May, Do-Right produced and sold 8,000 gadgets using 5,000 kg. of direct materials at an average cost per kg. of $22.50, and 1,560 direct labor hours at an average wage of $18.20 per hour. What are the direct material and direct labor price and quantity variances for May and what are possible causes of these?

SOLUTION 11:

Direct Material Price Variance = (Standard Price - Actual Price) * Actual Quantity

Direct Material Price Variance = ($25 - $22.50) * 5,000

Direct Material Price Variance = $12,500 Favorable

The direct material price variance is favorable because the actual price at which materials are purchased is lower than standard price.

Standard Quantity = Standard Quantity per unit * Actual Units

Standard Quantity = 0.6 kg * 8,000

Standard Quantity = 4,800 kgs

Direct Material Quantity Variance = (Standard Quantity - Actual Quantity) * Standard Price

Direct Material Quantity Variance = (4,800 - 5,000) * $25

Direct Material Quantity Variance = $5,000 Unfavorable

The direct material quantity variance is unfavorable because the actual quantity used in production is greater than standard quantity.

Direct Labor Price Variance = (Standard Price - Actual Price) * Actual Hours

Direct Labor Price Variance = ($18 - $18.20) * 1,560

Direct Labor Price Variance = $312 Unfavorable

The direct labor price variance is unfavorable because the actual labor rate is greater than standard labor rate.

Standard Hours = Standard Hours per unit * Actual Units

Standard Hours = 0.2 hours * 8,000

Standard Hours = 1,600 Hours

Direct Labor Quantity Variance = (Standard Hours - Actual Hours) * Standard Price

Direct Labor Quantity Variance = (1,600 - 1,560) * $18

Direct Labor Quantity Variance = $720 Favorable

The direct labor quantity variance is favorable because the actual hours used in production are lower than standard hours.

QUESTION 12:

Complete the following flexible budget and suggest one possible explanation for each of the variances.

Master Budget Flexible budget Actual Results Variance
(Fav/Unfav)
Sales volume (in units) 20,000 18,500 18,500 Unfav (Actual Sales < Budgeted Sales)
Sales Revenue $1,050,000 $971,250 $972,000 Fav (Actual Selling price per unit > Budgeted Selling Price per unit)
Variable costs 500,000 $462,500 477,000 Unfav (Actual variable cost per unit > Budgeted variable cost per unit)
Contribution margin 550,000 $508,750 495,000 Unfav (Increase in actual selling price per unit < Increase in actual variable cost per unit)
Capacity-related (fixed) costs 380,000 $380,000 385,000 Unfav (Actual Cost > Budgeted Cost)
Operating profit $170,000 $128,750 $110,000 Unfav (Actual Profits < Budgeted Profits).

Attachments

Solution Preview

See attached. The changes/additions that I have made are in yellow. I have verified your answers and they are correct except as highlighted.

QUESTION 1:

(3 marks) A Company purchased equipment for $20,000. Management estimates that the equipment will have a useful life of five years and salvage value of $5,000. Calculate a) net book value of the equipment at the end of the third year using the straight-line method of depreciation; and b) depreciation expense for the second year using the double-declining balance method of depreciation.

SOLUTION 1a:

Straight Line Depreciation = (Cost of Equipment - Salvage Value) / Life of Equipment

Straight Line Depreciation = ($20,000 - $5,000) / 5 years

Straight Line Depreciation = $3,000

Depreciation in 3 years = $3,000 * 3 years

Depreciation in 3 years = $9,000

Net Book Value = Cost of Equipment - Accumulated Depreciation

Net Book Value = $20,000 - $9,000

Net Book Value = $11,000

SOLUTION 1b:

Rate of Depreciation = (1 / Life of Asset) * 2

Rate of Depreciation = (1 / 5years) * 2

Rate of Depreciation = 40%

Year Depreciation Balance
1 $ 8,000.00 $ 12,000.00
2 $ 4,800.00 $ 7,200.00

QUESTION 2:

Analyze accounts receivable and the allowance for doubtful accounts for the following company, and draw some inferences:
2012 2011
Sales $6,700 $7,500
Accounts receivable, net 202 320
Allowance for doubtful accounts 3 12

SOLUTION 2:

The accounts receivable balance in comparison to sales is quite low, thus it implies that company makes more sale on cash basis in comparison to credit sales. The allowance for doubtful accounts is 1.46% and 3.61% of the gross receivables during the year 2012 and 2011 respectively. This means that there are very less bad debts and company is able to recover money from its customers easily.

The accounts receivable balance as percentage of total sales has declined from 4.27% of sales in 2011 to 3.01% in 2012 indicating that the company has been able to expedite the realization of its debtors and reduce its investment therein. It indicates improvement in collection process.

The allowance for doubtful accounts has declined significantly in 2012 as compared to 2011. It indicates that there was lower bad debt expense provision for 2012 and a write-off of some uncollectible accounts receivables. The analysis indicates that there is a tighter control and monitoring over credit period offered as also more effective screening of customers to whom credit period is provided, both of which have contributed to lower allowance for doubtful accounts.

QUESTION 3:

Analyze the following common size balance sheet:

2012 2011
Current assets:
Cash 3% 5%
Accounts receivable 20 18
Inventory 35 30
Total current assets 58 53

Property, plant and equipment 30 40
Other assets 12 7
Total assets 100% 100%

Current liabilities:
Accounts payable 25% 20%
Short-term debt 38 33
Total current liabilities 63 53

Long-term debt 22 17
Total liabilities 85 70

Stockholders' equity:
Common stock and paid in capital 14 20
Retained earnings 1 10
15 30
Total liabilities and stockholders' equity 100% 100%

SOLUTION 3:

The current ratio of the company has worsened in 2012 as compared to 2011. It has declined from 1.00 in 2011 to 0.92 in 2012 indicating liquidity concerns. The major contributors appear to be increase in inventory and increase in short term debt. All other components of current assets and current liabilities have also deteriorated.

The decline in shareholders' equity indicate that during 2012, there was stock repurchase as also excessive losses or high dividend payments as indicated by decline in retained earnings. Both these have contributed to increase in long term and short-term debt.

A 25% decline in the value of property, plant and equipment also does not augur well for the company. Apart from depreciation, such significant decline could also mean sale of fixed assets to overcome short-term liquidity concerns.

The company maintains reasonable balance between current assets, fixed assets and other assets. But the proportion of inventory in its current assets is quite high and the percentage of cash maintained is low. The percentage of current assets and other assets increased from 2011 to 2012. The Current Asset of the company in 2011 and 2012 is 53% and 58% and Current Liability of the company in 2011 and 2012 is 63% and 53% .Both the time the company is having negative working capital which indicates that the company liquidity condition is not good.

The percentage of liabilities in company's debt structure is very high. In 2011, it was 70% and increased to 85% during the year 2012. In total liabilities, the percentage of current liabilities is 53% and 63% during the year 2011 and 2012 respectively. The proportion of long term debt increased from 17% to 22% during the year 2012. The retained earnings of the company in 2011 were 9% and in 2012 is 1% which is indicating the worst signal about the financial condition of the company.

QUESTION 4:

Consider the following information:

Net income $200
Purchase of property and plant 90
Depreciation expense 50
Payment of cash dividends 25
Cash dividends received on shares recorded as
Equity investments 15
Increase in cash loaned to another company 30
Increase in long-term debt 110
Decrease in inventories 10
Decrease in accounts payable 20
Repurchase of company's shares from a
Major stockholder for cash 100

Calculate cash flow from (used by) operating, investing, and financing activities.

SOLUTION 4:

Particulars Amount

Cash from Operating Activities:
Net Income $ 200.00
Add: Depreciation Expense $ 50.00
Working Capital Adjustments
Add: Decrease in Current Assets
Decrease in Inventories $ 10.00 ...

Solution Summary

The solution discusses calculating net book value of assets using different methods of depreciation.

$2.19