Problem 29 - Accounting

Question

On April 1, Gyminny Delivery Services acquired a new truck with a list price (fair market value) of \(150,000. Gyminny received a trade-in allowance of \)30,000 on an old truck of similar type and paid cash of \(120,000. The following information about the old truck is obtained from the account in the equipment ledger: cost, \)96,000; accumulated depreciation on December 31, the end of the preceding fiscal year, \(64,000; annual depreciation, \)16,000. Assuming the exchange has commercial substance, 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.

Step-by-Step Solution

Answer

Record depreciation expense of $4,000 and a gain of $2,000 on the truck exchange.

Step 1: Calculate Current Year Depreciation

The fiscal year ends on December 31. From January 1 to the trade-in date on April 1, is three months. The annual depreciation is \(16,000\), so the depreciation for three months is \(16,000 \times \frac{3}{12} = 4,000\).

Step 2: Record Depreciation Expense

Record the current year depreciation of the old truck up to April 1. The journal entry is:- Debit Depreciation Expense: \(4,000\)- Credit Accumulated Depreciation: \(4,000\)This updates the accumulated depreciation on the old truck.

Step 3: Update Accumulated Depreciation Account

Update the accumulated depreciation for the old truck by adding the current year's depreciation.- Previous accumulated depreciation: \(64,000\)- Current year depreciation: \(4,000\)- Total accumulated depreciation: \(68,000\)The accumulated depreciation now is \(68,000\).

Step 4: Calculate Book Value of Old Truck

Calculate the book value of the old truck at the time of trade-in:\[\text{Book value} = \text{Cost} - \text{Accumulated depreciation} = 96,000 - 68,000 = 28,000\]The book value of the old truck is \(28,000\).

Step 5: Calculate Gain or Loss on Trade-In

Determine the gain or loss by comparing the book value with the trade-in allowance:- Trade-in Allowance: \(30,000\)- Book Value: \(28,000\)Since the trade-in allowance is greater than the book value, there is a gain of \(2,000\).

Step 6: Record Journal Entry for Truck Exchange

Record the transaction for acquiring the new truck and disposing of the old truck:- Debit New Truck: \(150,000\)- Credit Old Truck: \(96,000\)- Credit Accumulated Depreciation: \(68,000\)- Credit Cash: \(120,000\)- Credit Gain on Disposal: \(2,000\)This completes the exchange transaction.

Key Concepts

Depreciation Calculation

Depreciation is an accounting concept used to allocate the cost of a tangible asset over its useful life. It is important to understand the depreciation calculation because it impacts the financial statements by reducing the asset's book value each year.

When calculating depreciation, businesses often use the straight-line method. This method divides the cost of the asset, minus any salvage value, evenly over the asset's useful life. In our example, Gyminny Delivery Services is depreciating a truck with an annual depreciation of \(16,000\).

To find the depreciation for part of a year, such as when an asset is sold or traded mid-year, you calculate the depreciation for each month and then multiply by the number of months the asset has been in use. Here, from January to April, the truck accrued 3 months of depreciation, which equates to \(16,000 \times \frac{3}{12} = 4,000\). This calculation helps stakeholders understand the asset's decline in value over time.

Book Value of Assets

The book value of an asset is essentially its net value on the balance sheet. It is calculated by subtracting accumulated depreciation from the asset's original cost.

The book value is crucial for determining how much an asset is actually worth at any point in time. In the Gyminny Delivery scenario, the initial cost of the old truck was \(96,000\). Over time, it had accumulated depreciation of \(68,000\), leaving a book value of \(28,000\) by the time it was traded in.

This book value helps determine if an asset is being undervalued or overvalued in financial records. Maintaining accurate book values is important for both financial analysis and making strategic decisions about asset replacement or disposal. Regular updates ensure that users of financial statements have accurate and relevant data.

Gain or Loss on Disposal

When a company disposes of an asset, it's vital to calculate the gain or loss on that disposal. This is found by comparing the asset's book value to the trade-in or sale proceeds received.

In our case, Gyminny received a trade-in allowance of \(30,000\) for the old truck. The book value was \(28,000\), which means the trade-in allowance exceeded the book value, resulting in a gain of \(2,000\).

This gain is recorded in the financial statements and will impact the company's net income. A gain indicates that the asset's market value was higher than its recorded book value, which can be a positive indication of asset management efficacy. It is important in decision-making about asset trades or sales.

Trade-in Allowance

A trade-in allowance is the amount a seller credits towards the purchase of a new asset when an old asset is exchanged. This practice lowers the cash needed for the new acquisition and can provide a financial advantage if the trade-in allowance is more than the old asset's book value.

In Gyminny's case, they received a \(30,000\) trade-in allowance for the old truck, thus reducing the cost they needed to pay upfront for the new truck. Understanding how trade-in allowances work can help companies manage their cash flows more effectively and make strategic decisions about when and how to update their assets.

When negotiating trade-ins, it is beneficial for companies to aim for allowances that exceed the old asset’s book value, contributing positively to their financial standing by recording a gain rather than a loss. Thus, trade-in allowances play a pivotal role in asset management and financial planning.