Problem 18 - Accounting

Question

Equipment acquired on January 3,2005 , at a cost of \( 147,500\), has an estimated useful life of eight years and an estimated residual value of \( 17,500\). a. What was the annual amount of depreciation for the years 2005,2006 , and 2007, using the straight-line method of depreciation? b. What was the book value of the equipment on January 1,2008 ? c. Assuming that the equipment was sold on January 2, 2008, for \( 95,000\), journalize the entry to record the sale. d. Assuming that the equipment had been sold on January 2, 2008, for \( 100,000\) instead of \( 95,000\), journalize the entry to record the sale.

Step-by-Step Solution

Answer

a. $16,250 annually; b. $98,750; c. Debit Cash $95,000, Loss $3,750; d. Debit Cash $100,000, Gain $1,250.

Step 1: Determine Depreciation Expense Using Straight-Line Method

To find the annual depreciation expense using the straight-line method, first determine the depreciable amount, which is the difference between the cost of the equipment and its residual value. Then, divide this amount by the useful life.Cost of Equipment = \( 147,500 \)Residual Value = \( 17,500 \)Useful Life = 8 yearsDepreciable Amount = Cost - Residual Value = \( 147,500 - 17,500 = 130,000 \)Annual Depreciation Expense = \( \frac{130,000}{8} = 16,250 \).

Step 2: Calculate Book Value at the End of Each Year

To find the book value at the end of each year, subtract the accumulated depreciation from the original cost. For each year (2005, 2006, and 2007), add another year of depreciation.Book Value at End of 2005 = Cost - (Depreciation Expense * 1 year) = \( 147,500 - 16,250 = 131,250 \)Book Value at End of 2006 = Cost - (Depreciation Expense * 2 years) = \( 147,500 - 32,500 = 115,000 \)Book Value at End of 2007 = Cost - (Depreciation Expense * 3 years) = \( 147,500 - 48,750 = 98,750 \).

Step 3: Determine Book Value on January 1, 2008

Since the book value at the end of each year is determined by subtracting the total accumulated depreciation from the cost, the book value on January 1, 2008, will be the same as at the end of 2007.Book Value on January 1, 2008 = \( 98,750 \).

Step 4: Record Sale of Equipment for $95,000

To record the sale, evaluate if there's a gain or loss by comparing the sale price to the book value:Sale Price = \( 95,000 \)Book Value on January 1, 2008 = \( 98,750 \)Loss = \( 98,750 - 95,000 = 3,750 \)Journal Entry:- Debit Cash \( 95,000 \)- Debit Accumulated Depreciation \( 48,750 \)- Debit Loss on Sale \( 3,750 \)- Credit Equipment \( 147,500 \).

Step 5: Record Sale of Equipment for $100,000

To record the sale at a different sale price, compute whether there is a gain or loss:Sale Price = \( 100,000 \)Book Value on January 1, 2008 = \( 98,750 \)Gain = \( 100,000 - 98,750 = 1,250 \)Journal Entry:- Debit Cash \( 100,000 \)- Debit Accumulated Depreciation \( 48,750 \)- Credit Equipment \( 147,500 \)- Credit Gain on Sale \( 1,250 \).

Key Concepts

Book Value Calculation

The book value of an asset is an essential part of understanding its financial standing over time. To compute this, we begin by using the asset's initial purchase price and then progressively decrease this amount by the accumulated depreciation. Depreciation is the systematic reduction in the recorded cost of an asset over its useful life.
Let's put this into practice using an example. If machinery was purchased for \( 147,500 \) and had accumulated depreciation of \( 48,750 \) over three years using the straight-line method, the book value as of January 1, 2008, would be:

• Cost of the equipment: \( 147,500 \)
• Accumulated depreciation: \( 48,750 \)
• Book Value Calculation: \( 147,500 - 48,750 = 98,750 \)

This figure represents the un-depreciated portion of the asset that remains on the company's books and gives insight into its remaining economic value. Understanding this helps in assessing whether the asset is still viable for use or if it should be replaced.

Journal Entries

Journal entries are the nuts and bolts of accounting, recording every financial transaction within a company's books. Each entry affects at least two accounts - one with a debit and another with a credit. When an asset is sold, journal entries are crucial for recording the transaction accurately.
Let's illustrate this with a scenario where equipment is sold. Assume the equipment, initially purchased for \( 147,500 \), is sold for \( 95,000 \):

• Debit Cash \( 95,000 \) - this reflects the cash received from the sale.
• Debit Accumulated Depreciation \( 48,750 \) - restating the cumulative depreciation reduces the asset's value.
• Debit Loss on Sale \( 3,750 \) - calculated as the difference between the book value \( 98,750 \) and the sale price \( 95,000 \).
• Credit Equipment \( 147,500 \) - removing the equipment's cost from the books as it has been disposed of.

Accurately recording these entries ensures the financial statements reflect the true financial position and performance, maintaining transparency and effectiveness in accounting records.

Depreciable Assets

Depreciable assets are those long-term resources owned by a company that have a useful life exceeding one year and lose value over time. This loss happens due to wear and tear, obsolescence, or other forms of degradation. Common examples include machinery, vehicles, and office equipment.
Such assets are significant because they are subjected to depreciation - an accounting method of allocating the tangible asset's cost over its useful life. This allocation method aims to match the asset's expense with the revenue it helps generate each period.
The annual depreciation expense can be calculated by subtracting the asset's residual value from its cost and dividing by its useful life. For instance:

• Initial cost: \( 147,500 \)
• Residual value: \( 17,500 \)
• Estimated useful life: 8 years
• Depreciable amount: \( 147,500 - 17,500 = 130,000 \)
• Annual depreciation expense: \( \frac{130,000}{8} = 16,250 \)

This systematic allocation aids in achieving more accurate accounting by spreading the cost of a depreciable asset over its expected period of usefulness.

Accumulated Depreciation

Accumulated depreciation is the total depreciation of an asset that has been recorded up to a specific date. It represents the cumulated wear and tear an asset experiences and is deducted from the asset's initial cost on the balance sheet to determine its book value.
For example, if equipment initially worth \( 147,500 \) has experienced depreciation of \( 16,250 \) annually over three years, the accumulated depreciation would be:

• Annual depreciation: \( 16,250 \)
• Years depreciated: 3
• Accumulated Depreciation: \( 16,250 \times 3 = 48,750 \)

Accumulated depreciation is essential for assessing the real value of an asset at any point over its useful life. It helps investors and stakeholders understand how much of the asset's value has been utilized and how much remains.