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Q8E

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Intermediate Accounting (Kieso)
Found in: Page 586

Short Answer

(Depreciation Computation—Replacement, Nonmonetary Exchange) George Zidek Corporation bought a machine on June 1, 2015, for $31,000, f.o.b. the place of manufacture. Freight to the point where it was set up was $200, and $500 was expended to install it. The machine’s useful life was estimated at 10 years, with a salvage value of $2,500. On June 1, 2016, an essential part of the machine is replaced, at a cost of $1,980, with one designed to reduce the cost of operating the machine. The cost of the old part and related depreciation cannot be determined with any accuracy.

On June 1, 2019, the company buys a new machine of greater capacity for $35,000, delivered, trading in the old machine which has a fair value and trade-in allowance of $20,000. To prepare the old machine for removal from the plant cost $75, and expenditures to install the new one were $1,500. It is estimated that the new machine has a useful life of 10 years, with a salvage value of $4,000 at the end of that time. (The exchange has commercial substance.)

Instructions

Assuming that depreciation is to be computed on the straight-line basis, compute the annual depreciation on the new equipment that should be provided for the fiscal year beginning June 1, 2019. (Round to the nearest dollar.)

Depreciation expense for old machine = $3,140

Depreciation expense for new machine = $3,250

See the step by step solution

Step by Step Solution

Step-by-Step SolutionStep 1: Meaning of Straight-line depreciation

Straight-line depreciation is the simplest way to assess depreciation over time. By allocating identical amounts to the asset's accounting periods over its useful life, it makes the asset's expense predictable along with smoothing net income.

Step 2: Computing annual depreciation by using a straight-line basis

Computing basics of the old machine

June 1, 2015 Purchase

$31,000

Freight

200

Installation

500

Total cost

$31,700

Calculating annual depreciation charge

On June 1, 2016, debit the old machine for $1,980; the revised total cost is $33,680 ($31,700 + $1,980); thus the revised annual depreciation charge is:

Determining book value of old machine

Book value, old machine, June 1, 2019:

$21,340

Less: Fair value

20,000

Loss on exchange

1,340

Cost of removal

75

Total loss

$ 1,415

Note: The above computation is done to determine whether there is a gain or loss from the exchange of the old machine with the new machine and to show how the cost of removal might be reported.

Basic of the new machine

Cash paid

$15,000

The fair value of an old machine

20,000

Installation cost

1,500

The total cost of the new machine

$36,500

Depreciation for the year beginning June 1, 2019

Most popular questions for Business-studies Textbooks

(Depreciation Basic Concepts) Burnitz Manufacturing Company was organized on January 1, 2017. In 2017, it has used in its reports to management the straight-line method of depreciating its plant assets.

On November 8, you are having a conference with Burnitz’s officers to discuss the depreciation method to be used for income tax and stockholder reporting. James Bryant, president of Burnitz, has suggested the use of a new method, which he feels is more suitable than the straight-line method for the needs of the company during the period of rapid expansion of production and capacity that he foresees. Following is an example in which the proposed method is applied to a fixed asset with an original cost of $248,000, an estimated useful life of 5 years, and a salvage value of approximately $8,000.

Year

Year of life used

Fraction rate

Depreciation expense

Accumulated depreciation at the end of year

Book value at the end of Year

1

1

1/15

$16,000

$ 16,000

$232,000

2

2

2/15

32,000

48,000

200,000

3

3

3/15

48,000

96,000

152,000

4

4

4/15

64,000

160,000

88,000

5

5

5/15

80,000

240,000

8,000

The president favors the new method because he has heard that:

  1. It will increase the funds recovered during the years near the end of the assets’ useful lives when maintenance and replacement disbursements are high.
  2. It will result in increased write-offs in later years and thereby will reduce taxes.

Instructions

  1. What is the purpose of accounting for depreciation?
  2. Is the president’s proposal within the scope of generally accepted accounting principles? In making your decision, discuss the circumstances, if any, under which use of the method would be reasonable and those, if any, under which it would not be reasonable.
  3. The president wants your advice on the following issues.
    1. Do depreciation charges recover or create funds? Explain.

(2) Assume that the Internal Revenue Service accepts the proposed depreciation method in this case. If the proposed method were used for stockholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?

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