On January 6, 2010, K.P. Scott Co. paid $245,000 for a computer system. In addition to the basic purchase price, the company paid a setup fee of $800, $6,400 sales tax, and $27,800 for a special platform on which to place the computer. K.P. Scott management estimates that the computer will remain in service for five years and have a residual value of $20,000. The computer will process 45,000 documents the first year, with annual processing decreasing by 2,500 documents during each of the next four years (that is, 42,500 documents in 2011; 40,000 documents in 2012; 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. K.P. Scott 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 K.P. Scott Co. uses the computer. Identify the depreciation methods that meet Scott’s objectives, assuming the income tax authorities permit the use of any of the methods.

3. Cash provided by operations before income tax is $155,000 for the computers first year. The income tax rate is 35%. 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.