Problem 22 - Accounting

Question

On April 1, Senorita's Delivery Services acquired a new truck with a list price of \( 75,000\). Senorita's received a trade-in allowance of \( 15,000\) on an old truck of similar type, paid cash of \( 10,000\), and gave a series of five notes payable for the remainder. The following information about the old truck is obtained from the account in the equipment ledger: cost, \( 48,000\); accumulated depreciation on December 31 , the end of the preceding fiscal year, \( 32,000\); annual depreciation, \( 8,000\). Journalize the entries to record (a) the current depreciation of the old truck to the date of trade-in and (b) the transaction on April 1 for financial reporting purposes.

Step-by-Step Solution

Answer

The gain on trade-in is \(1,000\). Depreciation expense of \(2,000\) is recorded, and the new truck costs \(75,000\) with payments of \(10,000\) cash and \(50,000\) in notes payable.

Step 1: Calculate Current Depreciation of Old Truck

First, determine the number of months from the last fiscal year end (December 31) to the trade-in date (April 1), which is 3 months. Since the annual depreciation is \(8,000\), the monthly depreciation is \(\frac{8,000}{12} = 666.67\). Therefore, the current depreciation for 3 months is \(3 \times 666.67 = 2,000\).

Step 2: Record Depreciation Entry for Old Truck

Journal the adjustment for depreciation to bring it current before the trade-in. The entry is:- Debit: Depreciation Expense \(2,000\)- Credit: Accumulated Depreciation \(2,000\).

Step 3: Determine Book Value of Old Truck

The book value is the cost of the truck minus accumulated depreciation. Given cost is \(48,000\) and accumulated depreciation before current updates was \(32,000\). After registering new depreciation, accumulated depreciation is \(32,000 + 2,000 = 34,000\). Thus, the book value is \(48,000 - 34,000 = 14,000\).

Step 4: Calculate Gain or Loss on Trade-In

The trade-in allowance is \(15,000\). Since the book value is \(14,000\), the company recognizes a gain on trade-in because \(15,000 - 14,000 = 1,000\).

Step 5: Record the Journal Entry for New Truck Acquisition

Record the acquisition of the new truck using the entries:- Debit: Truck (new asset) \(75,000\)- Credit: Cash \(10,000\) (amount paid)- Credit: Notes Payable for the balance \(50,000\) (satisfied by notes)- Credit: Accumulated Depreciation (for old truck) \(34,000\)- Debit: Old Truck \(48,000\) (to remove it from the ledger)- Credit: Gain on Trade-In \(1,000\). This gain is recognized as additional income.

Key Concepts

Depreciation Calculation

Depreciation is a method to allocate the cost of a tangible asset over its useful life. In this exercise, the old truck has been depreciated annually by $8,000. To calculate the current depreciation to the trade-in date, we first need to identify the period from the last fiscal year end (December 31) to the trade-in date (April 1). In this case, that period is 3 months. To find the monthly depreciation, we divide the annual depreciation by the months in a year: \[ \text{Monthly Depreciation} = \frac{8,000}{12} = 666.67 \]The current depreciation for the 3 months is then calculated by multiplying the monthly depreciation by 3:\[ \text{Current Depreciation} = 3 \times 666.67 = 2,000 \]This calculated depreciation will be used in journal entries to adjust the depreciated value of the old truck until the trade-in date.

Asset Disposal

When disposing of an asset such as the old truck, it's important to calculate the asset's book value and make necessary journal entries to remove it from the books. The book value is the original cost of the asset minus its accumulated depreciation up to the current period.For the old truck, the cost is \(48,000, and before adjusting for current depreciation, accumulated depreciation was \)32,000. After adding the current depreciation of \(2,000, the accumulated depreciation totals \)34,000:\[ \text{Book Value} = 48,000 - 34,000 = 14,000 \]Recording the asset disposal involves debiting the accumulated depreciation account and crediting the asset's original cost account to remove it from the books, reflecting the trade-in allowance given for the old truck.

Trade-In Allowance

A trade-in allowance is a deduction given when an old asset is exchanged for a new one. It reduces the purchase price of the new asset. In this problem, the trade-in allowance is $15,000 for the old truck. This figure is contrasted with the book value to determine if there was a gain or loss upon disposal. The trade-in allowance directly decreases the cost of acquiring the new truck, effectively reducing the amount needed to be financed through cash or notes payable. The allowance is an essential part of the journal entries as it influences both the gain or loss recognition and how the new asset acquisition and old asset disposal are documented.

Gain or Loss Recognition

Recognizing a gain or loss occurs when the amount received for a disposed asset differs from its book value. In this scenario, the trade-in allowance is \(15,000, while the book value of the truck is \)14,000, leading to a $1,000 gain:\[ \text{Gain} = 15,000 - 14,000 = 1,000 \]This gain is reported in the financial statements as additional income. It's determined by contrasting the trade-in credit against the truck's book value.To record this, a journal entry credits the Gain on Trade-In account, indicating that the business realized revenue from this transaction. Understanding and documenting these gains or losses helps reflect accurate current financial health and ensures compliance with accounting principles.