The University of Hong Kong Midterm Examination

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  • Topic: Depreciation, Generally Accepted Accounting Principles, Revenue
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School of Economics and Finance

FINA1001: Financial Statement Analysis
Second Semester 2009-2010
Dr. Kam-Ming Wan

Midterm Examination (90 minutes)

April 1, 2010 10:40a.m.(12:10p.m.

Candidates may use any self-contained, silent, battery-operated and pocket-sized calculator. The calculator should have numeral-display facilities only and should be used only for the purposes of calculation. It is the candidate’s responsibility to ensure that his calculator operates satisfactorily.

Candidates must record the name and type of their calculators on the front page of their examination scripts.

Name: _______________________

University ID: _______________________

Calculator Brand and Model: _______________________

Grading policies:

1. There are in total five questions.
2. Write your answers in your answer book and start each question on a fresh page. Please write legibly. 3. You must return your exam and answer book or your exam will not be graded. 4. SHOW ALL YOUR STEPS OR NO CREDIT WILL BE GIVEN.

1. (25 points) Analysis of Depreciation

Candy Coffee purchased a professional coffee machine on January 1, 2008. The management provides the following information about the asset and its acquisition:

|Purchase Price |$100,000 | |Residual Value |$20,000 | |Estimated useful Life |4 years | |Estimated service hours | 4,000 | |Estimated production in units | 80,000 cups of coffee |

a) (5 points) Compute the resulting depreciation expenses from 2008 to 2011 using the straight-line and double-declining-balance depreciation methods, respectively.

b) (5 points) Compute the net book value of the coffee machine from 2008 to 2011 using the straight-line and double-declining-balance depreciation methods, respectively.

c) (5 points) Complete the following table under each of the following two depreciation methods: Straight-line and double-declining-balance method.

Assume Candy Coffee has no debt/liability outstanding and the coffee machine is the only depreciable asset for the company. In addition, the corporate tax rate is 20% and the income tax is paid at the end of each year. Last, the market interest rate is 10% per annum. |  |2008 |2009 |2010 |2011 | |Sales |$100,000 |$100,000 |$100,000 |$100,000 | |Cost of goods sold |10,000 |10,000 |10,000 |10,000 | |Depreciation expenses | | | | | |Taxable income | | | | | |Income Tax (@20%) | | | | | |Net Income | | | | |

d) (5 points) In less than 100 words, explain why many companies prefer to adopt the accelerated depreciation method rather than the straight-line depreciation method. [Hint: compute the present value of the deferred tax liability under both depreciation methods]

e) (5...
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