Question

Assume that a company buys land with a building on it for $1,500,000. At the time of purchase the company planned to tear the old building down and build a new building. The cost to tear down and dispose of the old building was $150,000 and they sold some material for $25,000. The cost to build the new building was $5,500,000 and the cost to grade the lot and landscape was $600,000. It is expected the life of the building is 25-40 years with a salvage value of $2,000,000 to $3,000,000.

Discussion Questions:

1. If management desired the smallest depreciation possible over the next five (5) years, what recommendation would you make? Support your recommendation by calculations. Why might the company want to do this?

2. If management desired the largest depreciation possible over the next five (5) years, what recommendation would you make? Support your recommendation by calculations. Why might the company want to do this?

3. Imagine that this company came to you before undertaking this project and presented a proposal outlining the information provided above. What problems or concerns would you have raised for the company to consider?

Answer 1

1. If the company wants lower depreciation during the initial years, then units of production method would be the most ideal. Because during the starting years there won't be much production and as a result if units of production method is used, the depreciation would lower.
2. If the company wants higher depreciation during the initial years, then double declining balance method would be the ideal method of depreciation because in this the depreciation during the initial years would be the highest and thereafter it will be in a decreasing trend.
3. The company came to me fir suggestions and I will be like everything is already fine with their proposal except for the estimation of salvage value, as there is land involved after 25 to 40 years the value might be higher than that expected by the company.