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Archie Stanton starts a trucking business on January 1st, 2020. He decides to rent his premises in which to conduct his business and house his trucks. On January 1st he purchases 5 trucks each costing $255,000. Archie believes that the trucks have a useful life of 4 years. He also intends to offer delivery services over very long distances with heavily loaded trucks such that at the end of the 4 years they will each have a residual value of only $6,528. Archie has asked you to advise him on which depreciation method he should adopt for the preparation of his financial statements. He wants to consider the use of either straight-line depreciation or reducing balance depreciation since keeping track of the number of kilometres travelled by each truck will be too onerous for the use of the units of production method. You determine that the correct depreciation rate for the use of the reducing balance method is 60%. Archie has also decided to produce his financial statements on December 31st each year. You come back to Archie with the following tables that show how the Depreciation expense each year and the Carrying Value of the Trucks will vary based on the depreciation method chosen. Delivery Truck Details Cost Price of the trucks 5 trucks @ $255,000 each $1,275,000 Residual value of the trucks 5 trucks @ $6,528 each $32,640 Depreciable Amount of the trucks $1,242,360 Straight-line depreciation each year for 4 years Reducing Balance depreciation rate. $1,242,360/4 = 60% $310,590 Straight-Line Depreciation Allocation of the $1,242,360 Depreciable Amount 1st Jan 2020 31st Dec 2020 31st Dec 2021 31st Dec 2022 31st Dec 2023 $1,275,000 $1,275,000 $1,275,000 $1,275,000 $1.275,000 0 $310,590 $621,180 $931.770 $1,242,360 $1.275,000 $964.410 $653,820 $343,230 $32,640 Cost of Trucks Accumulated Depreciation Carrying Value Annual Depreciation Expense $310,590 $310,590 $310,590 $310,590 Reducing Balance Depreciation Allocation of the $1,242,360 Depreciable Amount Cost of Trucks Accumulated Depreciation Carrying Value 1st Jan 2020 $1,275,000 0 $1,275,000 31st Dec 2020 $1,275,000 $765.000 $510,000 31st Dec 2021 $1,275,000 $1.071.000 $204,000 31st Dec 2022 $1,275,000 $1,193,400 $81,600 31st Dec 2023 $1,275,000 $1.242.360 $32,640 Annual Depreciation Expense $765.000 $306,000 $122,400 $48,960 You advise Archie to adopt the straight-line method since you do expect that the trucks will deliver consistent and reliable service for the 4 years provided that they are regularly serviced and maintained. In your opinion, the reducing-balance method does not adequately reveal the usage of their service potential across the 4 years. Archie agrees with you and adopts the straight-line method for financial reporting purposes. Archie is now looking at his financial statements for the year ended December 31st, 2020 which have been prepared using straight-line depreciation. He has managed to produce an operating profit of $200,000 for the 2020 year. His balance sheet on December 31st, 2020 reveals Net Current Assets of $35,590 and his only Non-current Assets are the trucks described above. He turns to you and says "Wouldn't my Return on Capital Employed (ROCE) have been considerably higher if I had used reducing balance depreciation? After all, the carrying value of my Non-current Assets would have been significantly smaller ($510,000 for reducing balance versus $964,410 for straight-line) meaning that I would have made this operating profit using a smaller quantity of capital, so the ROCE would have been higher?" Question: Is Archie correct? Explain using the depreciation schedules shown above and the information provided from the December 31st financial statements. Would his ROCE be "considerably higher" using the reducing balance method compared with use of the straight-line method which is the one you advised him to adopt? In your answer compute the ROCE under both methods. [Maximum 300 words]
