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Effect of depreciation expense on financial statements

Three different companies each purchased a machine on January 1, 2005, for $54,000. each machine was expected to last five years or 200,000 hours. Salvage value was estimated to be $4,000. All three machines were operated for 50,000 hours in 2005, 55,000 hours in 2006, 40,000 hours in 2007, 44,000 hours in 2008, and 31,000 hours in 2009. Each of the three companies earned $30,000 of cash revenue during each of the five years. Company A uses straight-line depreciation, company B uses double-declining-balance depreciation, and company C uses units-of-production depreciation.

Required

a. Which company will report the highest amount of net income for 2005?

b. Which company will report the lowest amount of net income for 2007?

c. Which company will report the highest book value on the December 31,2007, balance sheet?

d. Which company will report the highest amount of retained earnings on the December 31, 2008, balance sheet?

e. Which company will report the lowest amount of cash flow from operating activities on the 2007 statement of cash flows.

Solution Preview

The answers are in the attached excel file. Please refer to them.
Three different companies each purchased a machine on January 1, 2005, for $54,000.  each machine was expected to last five years or 200,000 hours.  Salvage value was estimated to be $4,000.  All three machines were operated for 50,000 hours in 2005, 55,000 hours in 2006, 40,000 hours in 2007, 44,000 hours in 2008, and 31,000 hours in 2009.  Each of the three companies earned $30,000 of cash revenue during each of the five years.  Company A uses straight-line depreciation, company B uses double-declining-balance depreciation, and company C uses units-of-production depreciation.  

We first calculate the depreciation using Straight line (SL), double declining balance (DDB) and units of production

Cost= $54,000
Salvage Value= $4,000
Life= 5 years

Company A: Straight line:
Annual depreciation using SL= (Cost - Salvage Value) / Life= $10,000 =($54,000 - $4,000) / 5

Number of years Depreciation expense Book value at the end of the year Explanation
1 $10,000 $44,000 =$54,000 - $4,000
2 $10,000 $34,000 =$44,000 - $10,000
3 $10,000 $24,000 =$34,000 - $10,000
4 $10,000 $14,000 =$24,000 - $10,000
5 $10,000 $4,000 =$14,000 - ...

Solution Summary

Determinnes the effect of depreciation expense calculated using straight-line depreciation method, double-declining-balance depreciation method, and units-of-production depreciation method on financial statements.

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