On January 1, 2005, Lynn Corporation acquired equipment at a cost of $600,000. Lynn adopted the double-declining balance method of depreciation for this equipment and had been recording depreciation over an estimated life of eight years, with no residual value. At the beginning of 2008, a decision was made to change to the straight-line method of depreciation for this equipment. Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, net of tax, is ?
$85,313
To calculate the cumulative effect of the accounting change on beginning retained earnings, net of tax, we need to determine the depreciation expense under both depreciation methods for the years 2005-2007 and compare the tax effects.
First, let's calculate the depreciation expense using the double-declining balance (DDB) method for the years 2005-2007:
Year 1:
Depreciation Expense = (Book Value at the beginning of the year) x (2 / Useful Life)
Book Value at the beginning = $600,000
Useful Life = 8 years
Depreciation Expense = $600,000 x (2 / 8) = $150,000
Year 2:
Book Value at the beginning = $600,000 - $150,000 = $450,000
Depreciation Expense = $450,000 x (2 / 8) = $112,500
Year 3:
Book Value at the beginning = $450,000 - $112,500 = $337,500
Depreciation Expense = $337,500 x (2 / 8) = $84,375
Now let's calculate the depreciation expense using the straight-line method for the years 2005-2007:
Depreciation Expense = (Cost - Residual Value) / Useful Life
Cost = $600,000
Residual Value = $0
Useful Life = 8 years
Depreciation Expense = ($600,000 - $0) / 8 = $75,000
Now we can calculate the cumulative effect of the accounting change on beginning retained earnings, net of tax:
Under the DDB method:
Year 1: $150,000
Year 2: $112,500
Year 3: $84,375
Total Depreciation Expense = $150,000 + $112,500 + $84,375 = $346,875
Under the straight-line method:
Year 1: $75,000
Year 2: $75,000
Year 3: $75,000
Total Depreciation Expense = $75,000 + $75,000 + $75,000 = $225,000
The difference in depreciation expense between the two methods for the first three years is $346,875 - $225,000 = $121,875.
Now we need to calculate the tax effect of this difference. Assuming a 30% tax rate, the tax savings will be 30% of $121,875, which is $36,562.50.
Finally, we can determine the net cumulative effect on beginning retained earnings by subtracting the tax savings from the difference in depreciation expense:
Net Cumulative Effect on Beginning Retained Earnings = Difference in Depreciation Expense - Tax Savings
Net Cumulative Effect on Beginning Retained Earnings = $121,875 - $36,562.50 = $85,312.50
Therefore, the cumulative effect of this accounting change on beginning retained earnings, net of tax, is $85,312.50.