Assignment on Financial Accounting - Research Paper Example

Part 'A' Equipment Cost = $100,000 Useful Life = 4 years Salvage Value = $10,000 Double Declining Balance Method Since the useful life is 4 years, hence the factor to be used is 2/4 = 0.5Year 1: Depreciation = (Net Book Value)(Factor) = (100,000)(0.5) = $50,000Hence, depreciation for first year is $50,000, andNew Net Book Value = $100,000 - $50,000 = $50,000Year 2: Depreciation = (Net Book Value)(Factor) = (50,000)(0.5) = $25,000Hence, depreciation for second year is $50,000, andNew Net Book Value = $50,000 - $25,000 = $25,000Year 3: Depreciation = (Net Book Value)(Factor) = (25,000)(0.5) = $12,500Hence, depreciation for third year is $12,500, andNew Net Book Value = $25,000 - $12,500 = $12,500Year 4: Depreciation = (Net Book Value)(Factor) = (12,500)(0.5) = $6,250However, the salvage value is $10,000, hence the depreciation for fourth year will be $2,500 and new net book value will be $10,000 which is also the salvage value of the equipment.2. Straight Line MethodUsing straight line method for depreciation, the depreciation for each year is calculated as:Depreciation = (Cost - Salvage value) / Useful life = (100,000 - 10,000) / 4 = 90,000 / 4 = $22,500Hence depreciation for each year will be $22,500Year 1: Depreciation = $22,500; Net Book Value = $100,000 - $22,500 = $77,500Year 2: Depreciation = $22,500; Net Book Value = $77,500 - $22,500 = $55,000Year 3: Depreciation = $22,500; Net Book Value = $55,000 - $22,500 = $32,500Year 4: Depreciation = $22,500; Net Book Value = $32,500 - $22,500 = $10,000Part 'B'Since, depreciation is charged to the profit of an organization; hence the higher the depreciation expense, the lesser will be the net income.

As seen from above, the depreciation for year 1 using double declining balance method is $50,000 whereas it is $22,500 using straight line method; hence, the straight line method will result in the greatest income for the year ending December 31, 2005.Part 'C'The lower the income of a company, the lower will be the taxes applied on its profits. Since depreciation is a non-cash expense that reduces net income, companies get tax benefits through it. Using straight line method, there is no change in tax amount for depreciation over the years as same amount is being expensed each year, but double declining balance method depreciation allows the company to obtain maximum tax benefits in the early period of an asset's life by charging higher depreciation expenses.

As the asset gets older, the depreciation reduces (as also shown from the calculations above) and hence reduces the impact on tax benefits that the company can obtain. It follows that if the management wants to obtain high tax benefits in the early part of an asset's life, double declining method is preferred over straight line depreciation method.