Problem 21 - Accounting

Question

On October 1, Clear Spring Co., a water distiller, acquired new bottling equipment with a list price of \( 288,750\). Clear Springs received a trade-in allowance of \( 60,000\) on the old equipment of a similar type, paid cash of \( 28,750\), and gave a series of five notes payable for the remainder. The following information about the old equipment is obtained from the account in the equipment ledger: cost, \( 210,000\); accumulated depreciation on December 31 , the end of the preceding fiscal year, \( 137,500\); annual depreciation, \( 12,500\). Journalize the entries to record (a) the current depreciation of the old equipment to the date of trade-in and (b) the exchange transaction on October 1 for financial reporting purposes.

Step-by-Step Solution

Answer

Record depreciation and trade-in, leading to a loss, and confirm notes payable calculated as \( 200,000 \).

Step 1: Calculate Current Depreciation of Old Equipment

To determine the depreciation of the old equipment from the beginning of the year until the date of the trade-in on October 1, we first calculate how many months that covers: January through September, which is 9 months. The annual depreciation is given as \( 12,500 \). Therefore, the depreciation for 9 months is: \( \frac{12,500}{12} \times 9 = 9,375 \).

Step 2: Journalize Current Depreciation

Now that we have the amount of current depreciation, we record it as follows: **Debit: Depreciation Expense** \( 9,375 \) **Credit: Accumulated Depreciation - Equipment** \( 9,375 \).

Step 3: Calculate Book Value of Old Equipment

Book value is calculated as the original cost of the equipment minus the accumulated depreciation. Accumulated depreciation as of January 1 is \( 137,500 \), plus the current year depreciation as of October 1 is \( 9,375 \). Thus, the total accumulated depreciation is \( 137,500 + 9,375 = 146,875 \). Therefore, the book value of the old equipment is \( 210,000 - 146,875 = 63,125 \).

Step 4: Determine Gain or Loss on Trade-In

The trade-in allowance for the old equipment is \( 60,000 \). Compare this with the book value of \( 63,125 \). The difference indicates a loss on disposal of \( 63,125 - 60,000 = 3,125 \).

Step 5: Journalize Trade-In and Acquisition of New Equipment

Record the trade-in and the acquisition of the new equipment:**Debit: Equipment (New)** \( 288,750 \)**Credit: Accumulated Depreciation - Equipment** \( 146,875 \)**Debit: Loss on Disposal of Equipment** \( 3,125 \)**Credit: Equipment (Old)** \( 210,000 \)**Credit: Cash** \( 28,750 \)**Credit: Notes Payable** \( 5 \times \text{Note} \). The value for the notes payable is the remaining balance after using cash and the trade-in allowance, calculated as: \( 288,750 - 60,000 - 28,750 = 200,000 \). Therefore, each note is \( 40,000 \).

Step 6: Calculate and Confirm Notes Payable

To finalize, confirm that five notes payable balances the remainder of the new equipment cost after accounting for the trade-in and cash payment:Total principle for notes payable is \( 200,000 \) or \( 5 \times 40,000 \).

Key Concepts

Depreciation Calculation

Depreciation is a method used in accounting to allocate the cost of tangible assets over their useful lives. Understanding depreciation helps businesses estimate the current value of their assets. In the given exercise, the depreciation calculation for the old equipment was based on the number of months it was used in the current fiscal year before being traded in.
For the Clear Spring Co., the depreciation was calculated for 9 months, from January to September. The annual depreciation was given as \( 12,500 \), leading to a monthly depreciation of \( \frac{12,500}{12} \). For 9 months, the total depreciation was \( \frac{12,500}{12} \times 9 = 9,375 \). This amount reflects the cost expense of the old equipment over the mentioned period.

Financial Reporting

Financial reporting involves disclosing an organization's financial information to external users such as investors, regulators, and creditors. The information is presented through financial statements, including the balance sheet, income statement, and statement of cash flows.
In the context of the Clear Spring Co. exercise, the journal entries used to report the current depreciation and the exchange transaction help provide a transparent view of the company's financial activities. Recording the depreciation ensures that the financial statements accurately reflect the reduction in value of the equipment, while the entries for the trade-in and acquisition convey the details of the new and old asset exchanges. These reports inform stakeholders about the financial health and management of the company's resources.

Equipment Trade-In

An equipment trade-in is a transaction where a company exchanges an old piece of equipment for a new one, usually with a dealer, who applies the trade-in value as a discount against the new equipment's purchase price.
In the example of Clear Spring Co., the trade-in allowance was \( 60,000 \) for the old equipment. This amount was subtracted from the list price of the new equipment. Equipment trade-ins can be an efficient way to upgrade business assets while minimizing the out-of-pocket expense. The entry recording this transaction must consider the total value of the new equipment, the trade-in allowance, any cash payments made, and remaining balances, such as notes payable, to match the financial records.

Loss on Disposal of Equipment

Loss on disposal of equipment occurs when the selling price or trade-in value of an asset is less than its book value. The book value is calculated as the original cost minus accumulated depreciation. In the case of Clear Spring Co., the old equipment had a book value of \( 210,000 - 146,875 = 63,125 \). Since the trade-in value was \( 60,000 \), the loss on disposal is \( 63,125 - 60,000 = 3,125 \).
This loss is recorded in financial statements to reflect the financial loss incurred due to the asset not realizing its full book value upon disposal. Accounting for such losses is crucial for accurately portraying a company's financial performance and ensuring compliance with accounting standards.