Question

Suarez Inc. purchased machinery on January 1, 2020, at a cost of $500,000. The estimated useful life of the machinery is 4 years with an estimated value at the end of the period of $50,000. During its life, the machine is expected to produce 20,000 units. The company is considering different depreciation methods that could be used for financial reporting methods. The company forecasts that 6,000 units will be manufactured in 2020, 5,000 units in 2021, 4,000 units in 2022, and 5,000 units in 2023.

Requirements
(a) Prepare separate depreciation schedules for the machinery using straight-line method, double declining balance method, and the productive output method. Use the following format for each method: Straight Line Year Depreciation Expense Accumulated Depreciation BookValue At Acquisition 12/31/20 12/31/21 12/31/22 12/31/23 Double Declining balance method Year Depreciation Expense Accumulated Depreciation BookValue At Acquisition 12/31/20 12/31/21 12/31/22 12/31/23 Productive output method Year Depreciation Expense Accumulated Depreciation BookValue At Acquisition 12/31/20 12/31/21 12/31/22 12/31/23
(b) Which method results in the highest reported 2020 income? In the highest reported net income over the 4-year period.
(c) Which method results in the highest asset value in 2020.
(d) As the CFO of Suarez Inc. which method would you recommend that the company adopt and why?

Answer 1

The best production method based on the costs of labor and capital is Method 1, both before and after the rise in labor costs from $100/unit to $200/unit. It results in the lowest total production cost in both scenarios.

Step-by-step explanation:

In evaluating the best production method, the total costs associated with labor and capital must be considered. Initially, with labor costing $100/unit and capital costing $400/unit, the total cost for each method would be:

• Method 1: (50 units of labor * $100) + (10 units of capital * $400) = $5,000 + $4,000 = $9,000
• Method 2: (20 units of labor * $100) + (40 units of capital * $400) = $2,000 + $16,000 = $18,000
• Method 3: (10 units of labor * $100) + (70 units of capital * $400) = $1,000 + $28,000 = $29,000

Under these circumstances, Method 1 is the most cost-effective with a total production cost of $9,000.

If the cost of labor increases to $200/unit, the total costs will change as follows:

• Method 1: (50 units of labor * $200) + (10 units of capital * $400) = $10,000 + $4,000 = $14,000
• Method 2: (20 units of labor * $200) + (40 units of capital * $400) = $4,000 + $16,000 = $20,000
• Method 3: (10 units of labor * $200) + (70 units of capital * $400) = $2,000 + $28,000 = $30,000

Even with the rise in labor cost, Method 1 remains the cheapest option at $14,000. Therefore, Method 1 should be used irrespective of the change in labor cost.