Question

Joe is thinking about buying a very good lawn tractor to save the money that he now pays to a lawn service. It will cost $3,000 and Joe expects it to last 10 years, with an average depreciation cost of $300 per year. Joe's wife, who opposes this purchase, feels that Joe will get bored with his tractor in a year. Joe counters by telling her that if he does, he will be able to sell it for about $2,700, which is the purchase price minus first-year depreciation. What do you think about Joe's argument?

Answer 1

Answer:

Depreciation refers to the expense matching against revenue caused from such capital project. It does not mean that after deducting the depreciation for a year the asset has the same market value as of the carrying value.

Here, the cost of tractor being capital asset is $3,000

Depreciation is $300

Carrying book value = $2,700

Now, it does not reflect the market value. Therefore, Joe's argument that now he can sell the tractor at a price of $2,700 is not valid. As he might or might not be able to sell the tractor for same.

Answer 2

The carrying value for the first year after reducing depreciation is $2,700. Therefore, Joe's argument is invalid.

What is depreciation?

Depreciation is the reduction in the value of an asset due to wear and tear, or obsolescence.

The value left after providing depreciation is the carrying value of the asset.

For the given question, the carrying value after 1st year will be:

$\rm Carrying\:value = Cost - Depreciation\\\\\rm Carrying\:value = \ 3,000-\ 300\\\\\rm Carrying\:value = \ 2,700$

Therefore the purchase price minus first-year depreciation is $2,700.

The claim of Joe that he will be able to sell the tractor after 10 years for $2,700 therefore is invalid since further depreciation will reduce the cost below $2,700.

Learn more about depreciation here:

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