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Horngren'S Financial And Managerial Accounting
Found in: Page 543

Short Answer

Question: Jim Reed manages a fleet of utility trucks for a rural county government. He’s been in his job for 30 years, and he knows where the angles are. He makes sure that when new trucks are purchased, the residual value is set as low as possible. Then, when they become fully depreciated, they are sold off by the county at residual value. Jim makes sure his buddies in the construction business are first in line for the bargain sales, and they make sure he gets a little something back. Recently, a new county commissioner was elected with vows to cut expenses for the taxpayers. Unlike other commissioners, this man has a business degree, and he is coming to visit Jim tomorrow.


1. When a business sells a fully depreciated asset for its residual value, is a gain or loss recognized?

2. How do businesses determine what residual values to use for their various assets? Are there “hard and fast” rules for residual values?

3. How would an organization prevent the kind of fraud depicted here?


No gain or loss would recognize on selling the fully depreciable asset at its residual value. Residual value is determined based on experience, and the company can prevent fraud by adopting best practices.

See the step by step solution

Step by Step Solution

Step 1: Definition of Depreciation

The expenses charged to report the decline in the value of the fixed assets acquired by the company are known as depreciation expenses. Such expenses are reported in the statement reporting net income.

Step 2: Recognition of Gain/loss on sale at residual value

The business entity will not report any gain or loss when the asset is sold at its residual value at the end of its useful life. It is so because the gains and losses are recognized when there is a difference between the book value and the sales price of the asset. At the end of the useful life, the asset's book value will be equal to its residual value only; therefore, the business entity neither records gain nor loss.

Step 3: Determination of residual value

There is no hard and fast rule for determining residual value. Residual value is determined based on experience and logical judgment.

Step 4: Prevention of fraud

Anyone can commit fraud in determining the asset's residual value or estimated life prevented by implying the competitor's strategy or adopting the federal depreciation schedule for different classes of assets like MACRS.

Most popular questions for Business-studies Textbooks

Top Quality Appliance—Long Beach has just purchased a franchise from Top Quality Appliance (TQA). TQA is a manufacturer of kitchen appliances. TQA marketsits products via retail stores that are operated as franchises. As a TQA franchisee,Top Quality Appliance—Long Beach will receive many benefits, including havingthe exclusive right to sell TQA brand appliances in Long Beach. TQA applianceshave an excellent reputation and the TQA name and logo are readily recognized byconsumers. TQA also manages national television advertising campaigns that benefit the franchisees. In exchange for these benefits, Top Quality Appliance—Long Beachwill pay an annual franchise fee to TQA based on a percentage of sales. The annualfranchise fee is a separate cost and in addition to the purchase of the franchise.

In addition to purchasing the franchise, Top Quality Appliance—Long Beach will alsopurchase land with an existing building to use for its retail store, store fixtures, and officeequipment. The business will purchase appliances from TQA and resell them in its store,primarily to local building contractors for installation in new homes.Following is the chart of accounts for Top Quality Appliance—Long Beach. As a newbusiness, all beginning balances are $0.

Top Quality Appliance—Long Beach

Chart of Accounts

Cash Common Stock

Petty Cash Retained Earnings

Accounts Receivable Dividends

Allowance for Bad Debts Sales Revenue

Merchandise Inventory Interest Revenue

Office Supplies Cost of Goods Sold

Prepaid Insurance Franchise Fee Expense

Interest Receivable Salaries Expense

Notes Receivable Utilities Expense

Land Insurance Expense

Building Supplies Expense

Accumulated Depreciation—Building Bad Debt Expense

Store Fixtures Bank Expense

Accumulated Depreciation—Store Fixtures Credit Card Expense

Office Equipment Depreciation Expense—


Accumulated Depreciation—Office Equipment Depreciation Expense—Store


Franchise Depreciation Expense—Office


Accounts Payable Amortization Expense—


Interest Payable Interest Expense

Notes Payable Cash Short and Over

Top Quality Appliance—Long Beach completed the following transactions during 2018,its first year of operations:

a. Received $500,000 cash and issued common stock. Opened a new checkingaccount at Long Beach National Bank and deposited the cash received from thestockholders.

b. Paid $50,000 cash for a TQA franchise.

c. Paid $200,000 cash and issued a $400,000, 10-year, 5% notes payable for land withan existing building. The assets had the following market values: Land, $100,000;Building, $500,000.

d. Paid $75,000 for store fixtures.

e. Paid $45,000 for office equipment.

f. Paid $600 for office supplies.

g. Paid $3,600 for a two-year insurance policy.

h. Purchased appliances from TQA (merchandise inventory) on account for $425,000.

i. Established a petty cash fund for $150.

j. Sold appliances on account to B&B Contractors for $215,000, terms n/30 (cost, $86,000).

k. Sold appliances to Davis Contracting for $150,000 (cost, $65,000), receiving a6-month, 8% note.

l. Recorded credit card sales of $80,000 (cost, $35,000), net of processor fee of 2%.

m. Received payment in full from B&B Contractors.

n. Purchased appliances from TQA on account for $650,000.

o. Made payment on account to TQA, $300,000.

p. Sold appliances for cash to LB Home Builders for $350,000 (cost, $175,000).

q. Received payment in full on the maturity date from Davis Contracting for the note.

r. Sold appliances to Leard Contracting for $265,000 (cost, $130,000), receiving a9-month, 8% note.

s. Made payment on account to TQA, $500,000.

t. Sold appliances on account to various businesses for $985,000, terms n/30(cost, $395,000).

u. Collected $715,000 cash on account.

v. Paid cash for expenses: Salaries, $180,000; Utilities, $12,650

w. Replenished the petty cash fund when the fund had $62 in cash and petty cashtickets for $85 for office supplies.

x. Paid dividends, $5,000.

y. Paid the franchise fee to TQA of 5% of total sales of $2,045,000.


1. Record the transactions in the general journal. Omit explanations.

2. Post to the general ledger.

3. It is a common business practice to reconcile the bank accounts on a monthlybasis. However, in this problem, the reconciliation of the company’s checkingaccount will be done at the end of the year, based on an annual summary.

Reconcile the bank account by comparing the following annual summarystatement from Long Beach National Bank to the Cash account in the generalledger. Record journal entries as needed and post to the general ledger. Usetransaction z as the posting reference.

Beginning Balance, January 1, 2018 $ 0

Deposits and other credits:

$ 500,000





Interest Revenue 1,565 1,859,965

Checks and other debits:

EFT to Bank Checks(1) 125

Checks: 50,000










Bank service charge 2,340 (1,369,465)

Ending balance, December 31, 2018 $ 490,500

Bank Checks is a company that prints business checks (considered a bankexpense) for Top Quality Appliance—Long Beach

4. In preparation for preparing the adjusting entries, complete depreciation schedulesfor the first five years for the depreciable plant assets, assuming the assets werepurchased on January 2, 2018:

a. Building, straight-line, 30 years, $50,000 residual value.

b. Store Fixtures, straight-line, 15 years, no residual value.

c. Office Equipment, double-declining-balance, 5 years, $5,000 residual value.

5. Record adjusting entries for the year ended December 31, 2018:

a. One year of the prepaid insurance has expired.

b. Management estimates that 5% of Accounts Receivable will be uncollectible.

c. An inventory of office supplies indicates $475 of supplies have been used.

d. Calculate the interest earned on the outstanding Leard Contracting notereceivable. Assume the note was received on October 31. Round to the nearestdollar.

e. Record depreciation expense for the year.

f. Record amortization expense for the year on the franchise, which has a10-year life.

g. Calculate the interest owed on the note payable. Assume the note was issued onJanuary 1.

6. Post adjusting entries and prepare an adjusted trial balance.

7. Prepare a multi-step income statement and statement of retained earnings forthe year ended December 31, 2018. Prepare a classified balance sheet as ofDecember 31, 2018. Assume Interest Receivable is a current asset and InterestPayable is a current liability.

8. Evaluate the company’s success for the first year of operations by calculating thefollowing ratios. Round to two decimal places. Comment on the results.

a. Liquidity:

i. Current ratio

ii. Acid-test ratio

iii. Cash ratio

b. Efficiency:

i. Accounts receivable turnover

ii. Day’s sales in receivables

iii. Asset turnover

iv. Rate of return on total assets


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