Problem 18 - Accounting

Question

Equipment acquired on January 3, 2007, at a cost of \(265,500, has an estimated useful life of eight years and an estimated residual value of \)31,500. a. What was the annual amount of depreciation for the years 2007, 2008, and 2009, using the straight-line method of depreciation? b. What was the book value of the equipment on January 1, 2010? c. Assuming that the equipment was sold on January 4, 2010, for \(168,500, journalize the entry to record the sale. d. Assuming that the equipment had been sold on January 4, 2010, for \)180,000 instead of $168,500, journalize the entry to record the sale.

Step-by-Step Solution

Answer

a. $29,250 annually; b. $177,750; c. Record $9,250 loss; d. Record $2,250 gain.

Step 1: Calculate Annual Depreciation

Using the straight-line method, annual depreciation is calculated by subtracting the residual value from the cost and dividing by the useful life. \[ \text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}} = \frac{265,500 - 31,500}{8} = 29,250 \] Thus, the annual depreciation for 2007, 2008, and 2009 is \( 29,250 \).

Step 2: Calculate Book Value on January 1, 2010

The book value is the cost minus the accumulated depreciation up to January 1, 2010. Accumulated depreciation by the end of 2009 is: \[ \text{Accumulated Depreciation} = 29,250 \times 3 = 87,750 \] Book value on January 1, 2010: \[ \text{Book Value} = 265,500 - 87,750 = 177,750 \]

Step 3: Journal Entry for Sale at $168,500

First, calculate the gain or loss. \[ \text{Gain or Loss} = \text{Sale Price} - \text{Book Value} = 168,500 - 177,750 = -9,250 \] This is a loss of \( 9,250 \). The journal entry would be: - Debit: Cash \( 168,500 \) - Debit: Loss on Sale of Equipment \( 9,250 \) - Debit: Accumulated Depreciation \( 87,750 \) - Credit: Equipment \( 265,500 \).

Step 4: Journal Entry for Sale at $180,000

Calculate the gain or loss for this scenario. \[ \text{Gain or Loss} = \text{Sale Price} - \text{Book Value} = 180,000 - 177,750 = 2,250 \] This is a gain of \( 2,250 \). The journal entry would be: - Debit: Cash \( 180,000 \) - Debit: Accumulated Depreciation \( 87,750 \) - Credit: Equipment \( 265,500 \) - Credit: Gain on Sale of Equipment \( 2,250 \).

Key Concepts

Straight-line method

The straight-line method is one of the simplest ways to calculate the depreciation of an asset. It helps in distributing the cost of a fixed asset evenly across its useful life. To determine the annual depreciation using this method, you need to subtract the residual value from the asset's initial cost and divide by its useful life in years.

For example, if an equipment is purchased for \(265,500, with a residual value of \)31,500 and a useful life of 8 years, the formula would be:

• Annual Depreciation = \( \frac{265,500 - 31,500}{8} = 29,250 \)

This means each year, the asset loses $29,250 in value. This method is straightforward because it assigns the same amount of depreciation each year, making it predictable and easy to manage in accounting records.

Book value

The book value of an asset is a critical component in accounting. It represents the net value of the asset on the balance sheet after accounting for depreciation. Essentially, it shows how much has been 'used up' of the asset's value since purchase.

To calculate book value, subtract the accumulated depreciation from the asset's original cost. For instance, if by January 1, 2010, an equipment worth $265,500 has accumulated depreciation of $87,750 over three years, the book value would be:

• Book Value = $265,500 - $87,750 = $177,750

Understanding book value is essential for determining the asset's worth over time and making informed decisions about its future use or sale.

Journal entry

In accounting, a journal entry is used to record financial transactions in a company's accounting records. When it comes to assets like equipment, journal entries track sales, purchases, and any adjustments due to gains or losses.

When equipment is sold, you need to create a journal entry to reflect this transaction. Your entry will account for the following: the cash received, any accumulated depreciation, and recording either a gain or a loss, depending on the sale price relative to the book value. The objective is to ensure all financial records accurately reflect the company’s financial position.

A sample journal entry when equipment with a book value of $177,750 is sold for $168,500 would include:

• Debit Cash: $168,500
• Debit Accumulated Depreciation: $87,750
• Debit Loss on Sale of Equipment: $9,250
• Credit Equipment at Purchase Cost: $265,500

Loss on sale

A loss on the sale occurs when an asset is sold for less than its book value. This situation reflects that the sale did not recover the asset's carrying value as recognized in the books.

To illustrate, if equipment with a book value of $177,750 is sold for $168,500, you calculate the loss as follows:

• Loss = Sale Price - Book Value = $168,500 - $177,750 = -$9,250

This recognizing of a $9,250 loss means that less was received from the sale than what had been accounted for as the asset's worth.

Losses on sales are crucial in financial reporting as they affect a company’s net income and highlight areas where asset utilization or disposition strategies might be revisited.

Gain on sale

When an asset is sold for more than its book value, it results in a gain on sale. This indicates that the asset was sold for a value higher than its recorded worth.

Consider an equipment with a book value of $177,750 sold for $180,000. Here, you can calculate the gain by taking the difference between the sale price and the book value:

• Gain = Sale Price - Book Value = $180,000 - $177,750 = $2,250

Realizing a $2,250 gain signifies the transaction was beneficial financially to the company and reflects positively in the financial statements.

Gains on sales provide insight into effective capital asset management and can enhance a company's overall profitability as reported in financial disclosures.