Question

Nicole’s Getaway Spa (NGS) purchased a hydrotherapy tub system to add to the wellness programs at NGS. The machine was purchased at the beginning of the year at a cost of $7,000. The estimated useful life was five years and the residual value was $500. Assume that the estimated productive life of the machine is 13,000 hours. Expected annual production was year 1, 3,100 hours; year 2, 2,500 hours; year 3, 3,400 hours; year 4, 2,200 hours; and year 5, 1,800 hours. A.Assume NGS sold the hydrotherapy tub system for $2,100 at the end of year 3.B.The following amounts were forecast for year 3: Sales Revenues $42,000; Cost of Goods Sold $33,000; Other Operating Expenses $4,000; and Interest Expense $800. Create an income statement for year 3 for each of the different depreciation methods, ending at Income before Income Tax Expense. (Don't forget to include a loss or gain on disposal for each methodC. Complete a depreciation schedule for each of the alternative methods.
A) Straight-line.
B) Units-of-production.
C) Double-declining-balance.

Answer 1

Answer:

The question has asked to first create the income statement with the gain/loss on sale of asset and then find for depreciation. However, in order to create the income statement, we require the gain/loss on sale of asset and to do this, we require the depreciation. Hence, the order has been slightly changed but titled easily for your convenience (1. Depreciation 2. Sale of Asset 3. Income statement. Please refer explanation.

Explanation:

1. DEPRECIATION

1.A. Straight-line depreciation:

It is the simplest method of calculating depreciation and believes that the asset's value depreciates equally every year.

Depreciation per year = (Cost of asset - salvage value) / number of useful life years.

Depreciation for Year 1 : (7000 - 500) / 5 = $1300

Depreciation for Year 2: (7000 - 500) / 5 = $1300

Depreciation for Year 3 : (7000 - 500) / 5 = $1300

1. B. Units of Production/ Activity based depreciation:

Activity based depreciation is whereby an asset is depreciated based on the asset’s activity such as the number of hours worked or the number of units produced, during a particular period of time. Activity based depreciation per year is calculated as:

[(Cost - Salvage value) x activity performed during the period] / Total estimated life activity of the asset

Year 1 Depreciation : (7000-500) x (3100 / 13000) = $1550

Year 2 Depreciation : (7000-500) x (2500 / 13000) = $1250

Year 3 Depreciation : (7000-500) x (3400 / 13000) = $1700

1.C. Double-declining balance Method:

This is where the asset's value is depreciated at twice the rate than the straight line method. The depreciation amounts would be higher in the early years of the asset's life and gradually reduce towards the end. Hence, it does not mean that the depreciation amount would be higher than the straight line basis.

Straight Line depreciation per year = 1/5* x 100 = 20%

*as it is useful for five years

Hence double-depreciation value = 20% x 2 = 40%

It is calculated as depreciation rate x book value of asset at the beginning of the period

OR (Cost of Asset - Accumulation Depreciation) x Depreciation rate

Depreciation for Year 1 : 7000 x 40% = $2800

Accumulated Depreciation : $2800

Depreciation for Year 2 : (7000 - 2800) x 40% = $1680

Accumulated Depreciation: $2800 + $1680 = $4480

Depreciation for Year 3 : (7000 - $4480) x 40% = $1008

2. GAIN OR LOSS ON SALE OF ASSET

2.A. Straight-line depreciation :

Accumulated Depreciation at the end of Year 3 : $1300 x 3 = $3900

Cost of asset at the end of Year : $7000 - $3900 = $3100

Asset was sold for $2100 while its net book value was $3100. This means that the asset was sold for LESS than what it was worth and hence is a LOSS on sale of asset.

Gain/Loss on sale of asset : Sale Price - Net book value

Loss on sale : $2100 - $3100= ($1000)

2.B. Units of Production method :

Accumulated depreciation at the end of the Year 3 : $1550 + $1250 + $1700 = $4100

Cost of asset at the end of Year 3 : $7000 - $4500 = $2500

Asset was sold for $2100 while its net book value was $2500. This means that the asset was sold for LESS than what it was worth and hence is a LOSS on sale of asset.

Gain/Loss on sale of asset : Sale Price - Net book value

Loss on sale : $2100 - $2500= ($400)

2.C. Reducing balance method :

Accumulated depreciation at the end of Year 3 : $2800 + $1680 + $1008 = $5488

Cost of asset at the end of Year 3 : $7000 - $5488 = $1512

Asset was sold for $2100 while its net book value was $1512. This means that the asset was sold for MORE than what it was worth and hence is a GAIN/PROFIT on sale of asset.

Gain/Loss on sale of asset : Sale Price - Net book value

Gain on sale : $2100 - $1512= $588

3. INCOME STATEMENT

Income statement with gain/loss on sale of asset using straight line depreciation, units of production method and reducing balance method has been provided in attached tables 1, 2 and 3 respectively.