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Assignment Exercise 8–1: FIFO and LIFO Inventory

Study the FIFO and LIFO explanations in the chapter.

Assignment Exercise 8–2: Inventory Turnover

Study the “Calculating Inventory Turnover” portion of the chapter closely, whereby the cost of goods sold divided by the average inventory equals the inventory turnover.

Example 8A: Depreciation Concept

Assume that Metropolis Health System (MHS) purchased equipment for $200,000 cash on April 1 (the first day of its fiscal year). This equipment has an expected life of 10 years. The salvage value is 10% of cost. No equipment was traded in on this purchase.

Straight-line depreciation is a method that charges an equal amount of depreciation for each year the asset is in service. In the case of this purchase, straight-line depreciation would amount to $18,000 per year for 10 years. This amount is computed as follows:

• Step 1. Compute the cost net of salvage or trade-in value: 200,000 less 10% salvage value or 20,000 equals 180,000.
• Step 2. Divide the resulting figure by the expected life (also known as estimated useful life): 180,000 divided by 10 equals 18,000 depreciation per year for 10 years.

Accelerated depreciation represents methods that are speeded up, or accelerated. In other words a greater amount of depreciation is taken earlier in the life of the asset. One example of accelerated depreciation is the double-declining balance method. Unlike straight-line depreciation, trade-in or salvage value is not taken into account until the end of the depreciation schedule. This method uses book value, which is the net amount remaining when cumulative previous depreciation is deducted from the asset’s cost. The computation is as follows:

• Step 1. Compute the straight-line rate: 1 divided by 10 equals 10%.
• Step 2. Now double the rate (as in double-declining method): 10% times 2 equals 20%.
• Step 3. Compute the first year’s depreciation expense: 200,000 times 20% equals 40,000.
• Step 4. Compute the carry-forward book value at the beginning of the second year: 200,000 book value beginning Year 1 less Year 1 depreciation of 40,000 equals book value at the beginning of the second year of 160,000.
• Step 5. Compute the second year’s depreciation expense: 160,000 times 20% equals 32,000.
• Step 6. Compute the carry-forward book value at the beginning of the third year: 160,000 book value beginning Year 2 less Year 2 depreciation of 32,000 equals book value at the beginning of the third year of 128,000.
  • — Continue until the asset’s salvage or trade-in value has been reached.
  • — Do not depreciate beyond the salvage or trade-in value.

Practice Exercise 8–I: Depreciation Concept

Assume that MHS purchased equipment for $600,000 cash on April 1 (the first day of its fiscal year). This equipment has an expected life of 10 years. The salvage value is 10% of cost. No equipment was traded in on this purchase.

Assignment Exercise 8–3: Depreciation Concept

Assume that MHS purchased two additional pieces of equipment on April 1 (the first day of its fiscal year), as follows:

• 1. The laboratory equipment cost $300,000 and has an expected life of = years. The salvage value is 5% of cost. No equipment was traded in on this purchase.
• 2. The radiology equipment cost $800,000 and has an expected life of 7 years. The salvage value is 10% of cost. No equipment was traded in on this purchase.

Example 8B: Depreciation

This example shows straight-line depreciation computed at a five-year useful life with no salvage value. Straight-line depreciation is the method commonly used for financing projections and funding proposals.

Example 8C: Depreciation

This example shows straight-line depreciation computed at a five-year useful life with a remaining salvage value of $10,000. Note the difference in annual depreciation between Example 8B and Example 8C.

Example 8D: Depreciation

This example shows double-declining depreciation computed at a five-year useful life with no salvage value. As is often the case with a five-year life, the double-declining method is used for the first three years and the straight-line method is used for the remaining two years. The double-declining method first computes what the straight-line percentage would be. In this case 100% divided by five years equals 20%. The 20% is then doubled. In this case 20% times 2 equals 40%. Then the 40% is multiplied by the remaining balance to be depreciated. Thus 60,000 times 40% for year one equals 24,000 depreciation, with a remaining balance of 36,000. Then 36,000 times 40% for year two equals 14,400 depreciation, and 36,000 minus 14,400 equals 21,600 remaining balance, and so on.

Now note the difference in annual depreciation between Example 8B, using straight-line for all five years, and Example 8D, using the combined double-declining and straight-line methods.

Practice Exercise 8–II: Depreciation

Compute the straight-line depreciation for each year for equipment with a cost of $50,000, a five-year useful life, and a $5,000 salvage value.

Assignment Exercise 8–4: Depreciation

Set up a purchase scenario of your own and compute the depreciation with and without salvage value.

Assignment Exercise 8–5: Depreciation Computation: Units-of-Service

Study the “Units of Service” portion of the chapter closely.