P7-69B (L earn i ng Obj ec tiv es 1 , 3 , 8: Meas u re and acco u n t f or t he cos t o f a p lan t

P7-69B (Learning Objectives 1, 3, 8: Measure and account for the cost of a plant asset; measure depreciation by three methods; identify the cash-flow advantage of accelerated depreciation for tax purposes) On January 4, 2012, G.L. Brown Co. paid $235,000 for a computer system. In addition to the basic purchase price, the company paid a setup fee of $1,100, $6,200 sales tax, and $37,200 for a special platform on which to place the computer. G.L. Brown management estimates that the computer will remain in service for five years and have a residual value of $24,500. The computer will process 35,000 documents the first year, with annual processing decreasing by 2,500 docu- ments during each of the next four years (that is, 32,500 documents in 2013; 30,000 documents in 2014; and so on). In trying to decide which depreciation method to use, the company president has requested a depreciation schedule for each of the three depreciation methods (straight-line, units-of-production, and double-declining-balance).

▶ Requirements

1. For each of the generally accepted depreciation methods, prepare a depreciation schedule showing asset cost, depreciation expense, accumulated depreciation, and asset book value.

2. G.L. Brown reports to stockholders and creditors in the financial statements using the depreciation method that maximizes reported income in the early years of asset use. For income tax purposes, the company uses the depreciation method that minimizes income tax payments in those early years. Consider the first year G.L. Brown Co. uses the computer.

 

 

Identify the depreciation methods that meet Brown’s objectives, assuming the income tax

authorities permit the use of any of the methods.

3. Cash provided by operations before income tax is $154,000 for the computer’s first year. The income tax rate is 40%. For the two depreciation methods identified in Requirement 2, compare the net income and cash provided by operations (cash flow). Show which method gives the net-income advantage and which method gives the cash-flow advantage.

 

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