11-12 (DepreciationSL, DDB, SYD, Act., and MACRS) On January 1, 2013, Locke Company, a

small machine-tool manufacturer, acquired for

$1,260,000

a piece of new industrial

equipment. The new equipment had a useful life of

5

years, and the salvage value

was estimated to be

$60,000

. Locke estimates that the new equipment can produce

12,000

machine tools in its first year. It estimates that production will decline by

1,000

units per year over the remaining useful life of the equipment.

The following depreciation methods may be used:

(1) Straight-line,

(2) Double-declining balance,

(3) Sum-of-years'-digits, and

(4) Units-of-output.

For tax purposes, the class life is

7

years.

Ues the MACRS tables for computing depreciation.

(MACRS stands for modified accelerated cost recovery system. MACRS is what is required for tax purposes.)

Instructions:

Prepare the depreciation expense for Locke Company using several straight-line, double declining balance, MACRS and MACRS straight-line option. Sum-of-the-year's-digits and units-of-output methods have been done for you.

(1) Straight-line:

Cost

Amount

Salvage value

Amount

Depreciable value

Formula

Life

Number

Annual depreciation expense

Formula

Year

Depreciation Expense

Accumulated Depreciation

2013

Formula

Formula

2014

Formula

Formula

2015

Formula

Formula

Formula

(2) Double-declining balance:

Year

Depreciation Expense

Accumulated Depreciation

2013

Formula

Formula

2014

Formula

Formula

2015

Formula

Formula

Formula

(3) Sum-of-the-years-digits:

Year

Depreciation Expense

Accumulated Depreciation

2013

$400,000

$400,000

[(5/15) $1,200,000]

2014

320,000

720,000

[(4/15) $1,200,000]

2015

240,000

960,000

[(3/15) $1,200,000]

$960,000

(4) Units-of-output:

Year

Expected Output

Depreciation Expense

Accumulated Depreciation

Cost

$1,260,000

2013

12,000

$288,000

$288,000

Salvage value

60,000

2014

11,000

$264,000

552,000

Depreciable value

1,200,000

2015

10,000

$240,000

792,000

Expected life output

50,000

2016

9,000

$792,000

Unit depreciation expense

$24.00

2017

8,000

Total units

50,000

(5) Which depreciation method (MACRS or optional straight-line) would minimize net income for income tax reporting for the 3-year period ending December 31, 2015? Determine the amount of accumulated depreciation at December 31, 2015. Ignore present value considerations.

6) Think about the expense recognition principle. Under that key principle, expenses are matched to the period in which revenue is recognized. In about five sentences, discuss when you would use each of the methods, if you desired to closely match expense with revenue.

7) General MACRS method: (Values taken from the MACRS rates schedule.)

Total Cost

MACRS Rates (%)

Depreciation Expense

Accumulated Depreciation

2013

1,260,000

14.29%

=

Formula

Formula

2014

1,260,000

24.49%

=

Formula

Formula

2015

1,260,000

17.49%

=

Formula

Formula

Formula

Optional straight-line method (uses half year convention, no salvage values)

Total Cost

Depreciation Rate

Annual Depreciation

Accumulated Depreciation

2013

1,260,000

(1/7 X 1/2)

=

Formula

Formula

2014

1,260,000

1/7

=

Formula

Formula

2015

1,260,000

1/7

=

Formula

Formula

Formula

8) What differences do you notice between general MACRS and straight-line computed in #1 above?

Assume that Locke Company uses straight-line for financial reporting and general MACRS (not optional

straight-line) for tax purposes. How will using MACRS for tax purposes affect the timing of the amount of

taxes that Locke Company pays? Do you think that timing difference should create a liability for Locke?