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Unformatted text preview: 13 12/31/14 b. 50% 50% 50% 50% $40,000 80,000 20,000 80,000 0 80,000 0 80,000 40,000 60,000 60,000 60,000 $80,000 40,000 20,000 20,000 20,000 Since, as demonstrated in part (a), both depreciation methods give rise to the same total amount of depreciation over the fixed asset’s life, the total amount of net income over the asset’s life must also be the same. Therefore, the total amount of taxes will be the same regardless of which depreciation method a company selects. The following shows that the total amount of net income and taxes are the same under the two methods. Straight­line method: Method Year 1 Revenues 100,000 Depreciation exp. 15,000 Other expenses 60,000 Pretax income 25,000 Income taxes Net income 29 $ $ $ $ $ Year 2 100,000 100,000 15,000 15,000 60,000 60,000 25,000 25,000 8,750 8,750 16,250 Year 3 $ $ $ $ $ Year 4 100,000 400,000 15,000 60,000 60,000 240,000 25,000 100,000 8,750 35,000 16,250 Total $ $ 8,750 $ 16,250 $ 16,250 $ 65,000 Double­declining­balance: Method Revenues 100,000 Depreciation exp. Other expenses 60,000 Pretax income 40,000 Income taxes 14,000 Net income 26,000 Year 1 $ $ Year 2 100,000 100,000 40,000 0 60,000 60,000 0 40,000 0 14,000 0 26,000 $ $ $ $ Year 3 $ $ $ $ $ $ Year 4 100,000 400,000 20,000 60,000 60,000 240,000 20,000 100,000 7,000 35,000 13,000 65,000 Total $ 0 $ $ c. The double­declining­balance method is preferred for tax purposes because this method defers tax payments. Under this depreciation method, more depreciation is taken in the early years of an asset’s life than in later years. Increasing depreciation in an asset’s early life reduces taxable income which, in turn, reduces income taxes in the early years of the asset’s life [see part b]. The reduction in income taxes in the early years of the asset’s life is offset by higher taxes in the later years of an asset’s life. However, due to the time value of money, deferring taxes is beneficial. d. Straight­line method: Present Value = $8,750 from part (b) Present Value of an Ordinary Annuity Factor for i = 10% and n = 4 = $8,750 3.16987 (from Table 5) = $27,736.36 Double­declining­balance method: Present Value = ($7,000 Present Value Factor for i = 10% and n = 2) + ($14,000 Present Value Factor for i = 10% and n = 3) + ($14,000 Present Value Factor for i = 10% and n = 4) = ($7,000 0.82645) + ($14,000 0.75131) + ($14,000 0.68301) = $5,785.15 + $10,518.34 + $9,562.14 = $25,865.63 In present value terms, Kimberly Sisters would save $1,870.73 ($27,736.36 – $25,865.63) in taxes on this one asset by selecting the doubledeclining­balance method over the straight­line method. P9–10 (a ) S­L Depreciation (10­year life) Tax Payments: Revenues Depreciation expense Other expenses 30 $ 250,000 (b ) DDB Depreciation 250,000 (40,000)a (80,000)c (140,000) (c) S­L Depreciation (5­year life) $ 250,000 $ (80,000)b (140,000) Net income before taxes $ 30,000 Income taxes Net income (140,000) 70,000 $ (22,400) (9,600) $ 20,400 47,600 30,000 $ (9,600) $ 20,400 $ a $40,000 = ($400,000 – 0) ÷ 10 years b $80,000 = ($400,000 20%) c $80,000 = ($400,000 – 0) ÷ 5 years Bonus Payment: Net income $ 20,400 Bonus percentage Bonus amount Dividend Payment Net income 31 $ 8% 8% $ 1,632 $ 20,400 Dividend percentage Dividend amount 47,600 8% 3,808 $ 1,632 47,600 $ 20,400 $ 75% 75% $ 15,300 20,400 $ 35,700 $ 75% $ 15,300 $ P9–11 a. Drilling Equipment (+A) 800,000 Mobile Home (+A) 54,000 Cash (–A) 854,000 Purchased assets for drilling fields. b. 2011: Depletion (E, –SE) 240,000* Drilling Equipment (or Accumulated Depletion) (–A) 240,000 Depleted drilling equipment. *$240,000 = ($800,000 ÷ 2,000,000 barrels) 600,000 barrels 2012: Depletion (E, –SE) 300,000* Drilling Equipment (or Accumulated Depletion) (–A) 300,000 Depleted drilling equipment. *$300,000 = ($800,000 ÷ 2,000,000 barrels) 750,000 barrels 2013: Depletion (E, –SE) 260,000* Drilling Equipment (or Accumulated Depletion) (–A) 260,000 Depleted drilling equipment. *$260,000 = ($800,000 ÷ 2,000,000 barrels) 650,000 barrels c. 2011: Depreciation Expense (E, –SE) 7,000* Accumulated Depreciation (–A) Depreciated mobile home. 2012: Depreciation Expense (E, –SE) 7,000* Accumulated Depreciation (–A) Depreciated mobile home. 32 7,000 7,000 2013: Depreciation Expense (E, –SE) 7,000* Accumulated Depreciation (–A) Depreciated mobile home. 7,000 *$7,000 = ($54,000 – $5,000) ÷ 7 years P9–11 Concluded Different methods are used to allocate the costs of the drilling equipment and the mobile home based upon the link between the asset and the oil field. The drilling equipment is site­specific. Hence, its useful life is identical to the productive life of the oil field. Under the matching principle, the activity method provides the best matching of the costs with the associated benefits. On the other hand, the mobile home is not site­specific; it has a useful life beyond this oil field. The activity method would not be appropriate for the mobile home because the productive capabilities of future oil fields on which the mobile home may...
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This homework help was uploaded on 03/03/2014 for the course ACCT 5053 taught by Professor Staff during the Fall '08 term at Oklahoma State.

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