Question

At the beginning of Year 1, the company buys box manufacturing equipment for $2,300. The estimated residual value is $100. The estimated useful life is 4 years. As shown below:

Straight line method

Straight line method	Beg Book value	Depreciation expense	Accumulated depreciation	Ending net book value
Yr 1	2300	(2300-100/4) = 550	550	1750
yr 2	1750	550	1100	1200
Yr 3	1200	550	1650	650
Yr 4	550	550	2200	100

Double decline method

Double decline method	Beg Book value	Depreciation expense	Accumulated depreciation	Ending net book value
Yr 1	2300	2300*50% = 1150	1150	1150
yr 2	1150	1150*50% = 575	1725	575
Yr 3	575	575*50% = 288	2013	287
Yr 4	287	187	2200	100

What Are the effects of deprecation methods above have on financial ratios shown below? Assume revenue is $5,000; operating income excluding deprecation is $3,00; and Property, Plant and Equipment (PPE) is the only total asset for the company.

Operating profit margin: Strait-line method. Accelerated method(Double Declining)

-Year 1

-Year 4

Return on Assets:

-Year 1

-Year 4

Asset turnover Ratio:   

-Year 1

-Year 4

Answer 1

	Year-1			Year- 4		Analysis
	St.line depn.	DDB method depn.		St.line depn.	DDB method depn.
Operating Profit margin= Opg. Profit /Revenues
Revenues	5000	5000		5000	5000
Operating income excluding depn.	3000	3000		3000	3000
Less:Depn.	550	1150		550	187
Operating income	2450	1850		2450	2813
Operating Profit margin= Opg. Profit /Revenues	2450/5000=	1850/5000=		2450/5000=	2813/5000=
	49%	37%		49%	56%	Opg.Profit margin as per DDB reduced in initial yrs. & more in later yrs.compared to st.line depn.
				Year- 4
Return on assets(ROA):
Opg. Income(after depn.)/Total assets
Total assets at end of year	1750	1150		100	100
Operating income	2450	1850		2450	2813
ROA	1.4	1.61		24.5	28.13	As net asset balance also decreases more than that under St.line method of depn.ROA is more under DDB than st.line, in both the years.
Asset turnover ratio(ATO):
Revenues/Assets
Revenues	5000	5000		5000	5000
Total assets at end of year	1750	1150		100	100
ATO	2.86	4.35		50	50	Due to more $ depn. under DDB, asset utilisation shows a better figure under the same, than under st.line method. When the asset has reached its salvage value, the asset utilisation, ie. $ revenue earned per $ of asset , is the same under both methods.