Question

Depreciation and Rate of Return

Burrell Company purchased a machine for $18,000 on January 2, 2016. The machine has an estimated service life of 5 years and a zero estimated residual value. The asset earns income before depreciation and income taxes of $9,000 each year. The tax rate is 30%.

Required:

Compute the rate of return earned (on the average net asset value) by the company each year of the asset's life under the straight-line and the double-declining-balance depreciation methods. Assume that the machine is the company's only asset.

Straight-line method. Do not round intermediate calculations. Round final answers to two decimal places.

2016	%
2017	%
2018	%
2019	%
2020	%

Double-declining-balance depreciation method. Do not round intermediate calculations. Round final answers to two decimal places.

2016	%
2017	%
2018	%
2019	%
2020	%

Answer 1

Under straight line method, depreciation amount would remain same for each of the years.
Calculation of depreciation expense under straight line method
Depreciation expense	(Cost - Salvage value)/Useful life
Depreciation expense	(18000-0)/5
Depreciation expense	$3,600
Thus, annual depreciation expense for each of the 5 years would be $3,600.
Calculation of rate of return earned on average net asset value for each of the year under straight line method.
Rate of return	Net income/Average net asset value
Average net asset value = (Beginning value+Ending value)/2
Calculation of depreciation table to calculate average net asset value
Year	Beginning value	Depreciation expense	Ending value	Average asset
2016	$18,000	$3,600	$14,400	$16,200
2017	$14,400	$3,600	$10,800	$12,600
2018	$10,800	$3,600	$7,200	$9,000
2019	$7,200	$3,600	$3,600	$5,400
2020	$3,600	$3,600	$0	$1,800
Calculation of net income for each of the year
Income before depreciation and tax	$9,000
Less: Depreciation expense	$3,600
Income before tax	$5,400
Tax @ 30%	$1,620
Net income	$3,780
Calculation of rate of return
Year	Net income	Average asset	Rate of return
2016	3780	$16,200	23.33%
2017	3780	$12,600	30.00%
2018	3780	$9,000	42.00%
2019	3780	$5,400	70.00%
2020	3780	$1,800	210.00%
Under double declining depreciation method, the depreciation for each year differs and depreciation amount is calculated based on declining value of asset.
Double declining depreciation rate	2*(1/useful life)
Double declining depreciation rate	2*(1/5)
Double declining depreciation rate	40.00%
Depreciation expense	Beginning balance*Depreciation rate
Calculation of depreciation table to calculate average net asset value
Year	Beginning value	Depreciation expense	Ending value	Average asset
2016	$18,000	$7,200.00	$10,800	$14,400
2017	$10,800	$4,320.00	$6,480	$8,640
2018	$6,480	$2,592.00	$3,888	$5,184
2019	$3,888	$1,555.20	$2,333	$3,110
2020	$2,333	$2,333.12	$0	$1,166
Calculation of rate of return
Year	Income before depreciation and tax	Depreciation expense	Income before tax	Income tax @ 30%	Net income	Average asset	Rate of return
2016	$9,000	$7,200.00	$1,800.00	$540.00	$1,260.00	$14,400	8.75%
2017	$9,000	$4,320.00	$4,680.00	$1,404.00	$3,276.00	$8,640	37.92%
2018	$9,000	$2,592.00	$6,408.00	$1,922.40	$4,485.60	$5,184	86.53%
2019	$9,000	$1,555.20	$7,444.80	$2,233.44	$5,211.36	$3,110	167.55%
2020	$9,000	$2,333.12	$6,666.88	$2,000.06	$4,666.82	$1,166	400.16%