Chapter 8, Problem 8AE

To determine

Prepare income statements, balance sheets, and statements of cash flows for year 1 and Year 2.

Explanation of Solution

Double-declining-balance method:

It is an accelerated method of depreciation under which the depreciation declines in each successive year until the value of asset becomes zero. Under this method, the book value (original cost less accumulated depreciation) of the long-term asset is decreased by a fixed rate. It is double the rate of the straight-line depreciation.

T-account:

T-account is the form of the ledger account, where the journal entries are posted to this account. It is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.

Income statement:

Income statement is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

Balance is the financial statement that reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Statement of cash flows:

Statement of cash flows is one among the financial statement of a Company statement that

Shows aggregate data of all cash inflows and cash outflows that is received and paid by the Company from its ongoing business operations.

T-accounts are prepared as follows:

Cash
Year 1                         150,000			120,000
	72,000
Bal.	102,000
Year 2                          83,000
Bal.	185,000

Equipment
Year 1                        120,000
Bal.		120,000

Accumulated Depreciation
Year 1			40,000 (2)
Year 2		Bal.	40,000
			26,667   (2)
		Bal.	66,667

Common Stock
Year 1			150,000
		Bal.	150,000

Retained Earnings
Year 1 Cl.                    40,000		Cl.	72,000
		Bal.	32,000
Year 2 Cl.                    26,667		Cl.	83,000
		Bal.	88,333

	Sales Revenue
	Year 1 Cl.            72,000			72,000
	Year 2	Cl.           83,000	Bal.	0
				83,000
			Bal.		0

Depreciation Expense
Year 1                         40,000 (2)		Cl.	40,000
Bal.                                      0		Cl.	26,667
Year  2                        26,667 (2)26,667
Bal.                                      0

Prepare income statement, balance sheets, and statements of cash flows for year 1 and year 2 using vertical format.

Company GM
Financial Statements
Income Statements	Year 1	Year 2
Sales Revenue	$72,000	$83,000
Depreciation Expense	($40,000)	($26,667)
Net Income	$32,000	$56,333
Balance Sheets	Year 1	Year 2
Assets:
Cash	$102,000	$185,000
Equipment	$120,000	$120,000
Accumulated Depreciation	($40,000)	($66,667)
Total Assets	$182,000	$238,333
Stockholders’ Equity
Common Stock	$150,000	$150,000
Retained Earnings	$32,000	$88,333
Total Stockholders’ Equity	$182,000	$238,333
Statements of Cash Flows	Year 1	Year 2
Cash Flows From Operating Activities:
Inflow from Customers	$72,000	$83,000
Cash Flows From Investing Activities:
Outflow to Purchase Equipment	($120,000)	$0
Cash Flows From Financing Activities:
Inflow from Stock Issue	$150,000	$0
Net Change in Cash	$102,000	$83,000
Add: Beginning Cash Balance	$0	$102,000
Ending Cash Balance	$102,000	$185,000

Table (1)

Working notes:

Calculate the Double-declining-balance rate:

$\begin{array}{c}\begin{array}{l}\text{Double-declining-balance}\\ \text{rate}\text{per}\text{year}\end{array})\text{=}\text{Straight}\text{line}\text{depreciation}\text{rate}\text{per year}\text{×}\text{2}\\ \text{=}\text{0}\text{.16667}\text{×}\text{2}\\ \text{=}\text{0}\text{.3334}\end{array}$ (1)

Note: Straight line depreciation rate = $\frac{\text{1}}{\text{6years}}\text{=0}\text{.16667}$ per year

Calculate the depreciation expense (double-declining-balance method) of equipment for year 1 and year 2:

Year	Book value at the beginning $\left(\text{ Cost of purchase}-\text{Accumulated}\text{depreciation}\right)$	×	Double-declining-balance rate (1)	×	Annual depreciation expense
Year 1	($120,000-$0)	×	0.3334	×	$40,000
Year 2	($120,000-$40,000)	×	0.3334	×	$26,667

Table (2) (2)