# Accounting homework question

eimer Company and Lingo Company are two proprietorships that are similar in many respects. One difference is that Reimer Company uses the straight-line method and Lingo Company uses the declining-balance method at double the straight-line rate. On January 2, 2009, both companies acquired the following depreciable assets.

Asset
Cost
Salvage Value
Useful Life
Building
\$320,000
\$20,000
40 years
Equipment
110,000
10,000
10 years

Including the appropriate depreciation charges, annual net income for the companies in the years 2009, 2010, and 2011 and total income for the 3 years were as follows.

2009
2010
2011
Total
Reimer Company
\$84,000
\$88,400
\$90,000
\$262,400
Lingo Company
68,000
76,000
85,000
229,000

At December 31, 2011, the balance sheets of the two companies are similar except that Lingo Company has more cash than Reimer Company.

Sally Vogts is interested in buying one of the companies. She comes to you for advice.

Instructions

With the class divided into groups, answer the following.

(a)
Determine the annual and total depreciation recorded by each company during the 3 years.

(b)
Assuming that Lingo Company also uses the straight-line method of depreciation instead of the declining-balance method as in (a), prepare comparative income data for the 3 years.

(c)
Which company should Sally Vogts buy? Why?

 Just Looking Posts: 1,610, Reputation: 2419 Ultra Member #2 Nov 11, 2010, 07:02 PM

To answer this question, you need to understand how to compute the different types of depreciation, and then compare the depreciations to each other and see how the companies would have reported their income if they had used the same method. I can't do the whole problem for you as it is against the rules of the site, but I can guide you along the way.

Part A
You probably understand how to compute straight line depreciation. I will show you just in case, and because it will be the start of computing the declining-balance depreciation. I'll do one of the items, and leave the other for you. I'd be happy to check you calculation if you feel unsure.

\$110,000 Cost of equipment
\$ 10,000 Salvage value
\$100,000 Depreciable amount

Under straight line, you would depreciate \$10,000 per year (\$100,000 divided by 10 years).

Under double declining balance, you see that in straight line you are depreciating 10% (\$10,000 divided \$100,000) of the equipment's value. In double declining, you double that to depreciate 20% of the equipment's book value (i.e. original cost, not adjusted by salvage or \$110,000 at 20%), or \$22,000, in the first year.

In the second year, you would still depreciate \$10,000 under the straight line method. Under double declining balance, we take the book value (i.e. original cost less amount depreciated in year 1, or \$110,000 less the \$22,000 = \$88,000) of \$88,000 and multiply this by the 20% computed above, giving you an amount of \$17,600 for depreciation in year two. You continue this in year three, so you are looking at \$70,400 (\$88,000 less \$17,600) at 20% equals \$14,080.

Note: That's as far as your problem goes, but it's important for you to know that you continue this method until the amount that is computed using the double declining method is less than that under straight line. At that point, you drop double declining and switch to straight line. Also, you never depreciate below the salvage value of \$10,000. I'm just telling you this for future use. It doesn't apply in this problem.

At this point, you need to compute the building depreciation in the same manner.

Part B
They just want you to restate Lingo's income assuming they are using straight line. If you compare the DDB to straight line, you will find the difference that you need to adjust Lingo's income.

Part C
Once you have put the income on comparable terms, you can see which company is more profitable. Knowing this, also consider that Lingo has more cash. Why is this important? If you'd like to make an attempt at answering that, I'll let you know if you are going in the right direction or if there might be more to be addressed. I'll give you a little hint. There's a saying that "Cash is king." Why would that be?
 sxysweetart16 Posts: 5, Reputation: 10 Junior Member #3 Nov 11, 2010, 07:32 PM
Ok I understand what you are saying so if we looking at the building... for the straight line the amount you would depreciate each year would be 7500 (320000-20000)/40, right? And as far as the DDB it would be (320000 * 5%) 16000 for the 1st year, and the 2nd yr would be 15200 (320000-16000) *5% and the 3rd year would be 14440 (288800 *5%) Am I right so far?
As far as part B would I just take the amount the reimer company made (84000) and subtract what Lingo made for net (68000)? Is that the adjusted income they are looking for?
 Just Looking Posts: 1,610, Reputation: 2419 Ultra Member #4 Nov 11, 2010, 07:43 PM

Great job on the depreciation. That is correct.

Part B is asking that you adjust the income to show what it would be if Lingo used straight line. That is, take Lingo's income and add the amount of the difference between the double declining and the straight line. Since straight line depreciation is a lower expense, if Lingo were to adopt that for its financial statements its income would be higher. Does that make sense to you?
 sxysweetart16 Posts: 5, Reputation: 10 Junior Member #5 Nov 11, 2010, 07:53 PM
Um not really, when you say take the difference, its from straight line and DD for year 1 for building and then the difference for the equipment and do that for each year. Then I would have two numbers per year, and then add that to the net income! See how I am confused! Is Lingo income suppose to be higher than Reimer?
 Just Looking Posts: 1,610, Reputation: 2419 Ultra Member #6 Nov 11, 2010, 08:00 PM

In year 1, Lingo had a total of \$38,000 for depreciation (\$22,000 for equipment and \$16,000 for the building) using DDB. If they had used straight line, they would have \$17,500 (\$10,000 + \$7,500). The difference is that they had \$20,500 in additional depreciation. This is the amount that gets added to their income to adjust it in year 1. You are right that Lingo will be higher in Year 1.

Also, Part A asked that you compute total depreciation. Did you do that? In Part A, if I were you I'd show the depreciation for the equipment, the depreciation for the building, and the total of the two. That will make Part B easier.
 sxysweetart16 Posts: 5, Reputation: 10 Junior Member #7 Nov 11, 2010, 08:13 PM
Ohhh OK, I get it! I had done that part of part A I just wasn't using it. Thank you so much for your help!!
 Just Looking Posts: 1,610, Reputation: 2419 Ultra Member #8 Nov 11, 2010, 08:17 PM
Quote:
 Originally Posted by sxysweetart16 Ohhh ok, I get it! I had done that part of part A i just wasn't using it. Thank you so much for your help!!!
You are welcome! It was a pleasure working with you. If you have questions again, or want me to review your Part C, I will be on and off tonight and in the future.
 sxysweetart16 Posts: 5, Reputation: 10 Junior Member #9 Nov 11, 2010, 08:38 PM
For part C, Lingo Company had an adjusted net income of 275,820 N Reimer Company had a net income of 262,400. So wouldn't the perspective buyer want to purchase the Lingo Company because they are more profitable, and because they have more cash on their balance sheet. Right, or am I just going in the wrong direction?
 Just Looking Posts: 1,610, Reputation: 2419 Ultra Member #10 Nov 11, 2010, 08:44 PM
Quote:
 Originally Posted by sxysweetart16 For part C, Lingo Company had an adjusted net income of 275,820 N Reimer Company had a net income of 262,400. So wouldn't the perspective buyer want to purchase the Lingo Company because they are more profitable, and because they have more cash on their balance sheet. Right, or am i just going in the wrong direction?
That is right. To make your answer more complete, you could talk about why having more cash is good. I always went the extra step in school. It builds up over time and you learn so much more.

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