On January 1, 2009, Piper Co., purchased a machine (its only depreciable asset) for $300,000.The machine has a five-year life, and no salvage value.Sum-of-the-years'-digits depreciation has been used for financial statement reporting and the elective straight-line method for income tax reporting.Effective January 1, 2012, for financial statement reporting, Piper decided to change to the straight-line method for depreciation of the machine.Assume that Piper can justify the change.
Piper's income before depreciation, before income taxes, and before the cumulative effect of the accounting change (if any), for the year ended December 31, 2012, is $250,000.The income tax rate for 2012, as well as for the years 2009-2011, is 30%.What amount should Piper report as net income for the year ended December 31, 2012?

Question

Quizplus · Accepted Answer

Under the sum-of-the-years'-digits method, the depreciation expense for the machine is as follows:

Year 1: (5/15) x $300,000 = $100,000
Year 2: (4/15) x $300,000 = $80,000
Year 3: (3/15) x $300,000 = $60,000
Year 4: (2/15) x $300,000 = $40,000
Year 5: (1/15) x $300,000 = $20,000

Total depreciation expense for 2009-2011 = $100,000 + $80,000 + $60,000 = $240,000

In 2012, since Piper changed to the straight-line method, the depreciation expense is:

($300,000 - 0) / 5 = $60,000

Therefore, total depreciation expense for 2009-2012 = $240,000 + $60,000 = $300,000

For tax purposes, the depreciation expense for 2012 is still calculated using the sum-of-the-years'-digits method, which means that the tax depreciation expense for 2012 is $40,000.

Piper's income before income taxes for 2012 is $250,000, and the tax rate is 30%. Therefore, income taxes payable is:

$250,000 - $40,000 = $210,000
$210,000 x 30% = $63,000

Net income for 2012 is:

$250,000 - $60,000 - $63,000 = $127,000

However, since there was a change in accounting principle, Piper needs to disclose the cumulative effect of the accounting change on its financial statements. To calculate this, we need to compare the total depreciation expenses under both methods:

Sum-of-the-years'-digits depreciation for 2009-2011 = $240,000
Straight-line depreciation for 2009-2012 = $60,000 x 4 + $300,000 = $540,000

The difference is $540,000 - $240,000 = $300,000. This is the cumulative effect of the accounting change.

To calculate the net income after the cumulative effect of the accounting change, we subtract the effect from the previously calculated net income:

$127,000 - $300,000 = ($173,000)

However, since the cumulative effect is negative, it is reported as a loss, which means that net income for the year ended December 31, 2012 is:

$127,000 - $173,000 = ($46,000) or $154,000 (rounded to nearest thousand)