Problem 9 - Accounting

Question

An analysis of the general ledger accounts indicates that office equipment, which cost \(\$ 67,000\) and on which accumulated depreciation totaled \(\$ 22,500\) on the date of sale, was sold for \(\$ 38,600\) during the year. Using this information, indicate the items to be reported on the statement of cash flows.

Step-by-Step Solution

Answer

Cash flow: \( \$38,600 \) from sale (Investing Activities), \(-\$5,900 \) loss in operating activities.

Step 1: Identify the Book Value of the Equipment

Calculate the book value of the equipment at the time of sale by subtracting the accumulated depreciation from the original cost. This is done using the formula: \( \text{Book Value} = \text{Original Cost} - \text{Accumulated Depreciation} \). Here, \( \text{Original Cost} = 67,000 \) and \( \text{Accumulated Depreciation} = 22,500 \).

Step 2: Perform the Book Value Calculation

Substitute the given values into the formula: \( \text{Book Value} = 67,000 - 22,500 = 44,500 \). So, the book value of the equipment is \( \$44,500 \).

Step 3: Determine the Gain or Loss on Sale

To find the gain or loss, subtract the book value of the equipment from the sale price. The formula is: \( \text{Gain/Loss} = \text{Sale Price} - \text{Book Value} \) where \( \text{Sale Price} = 38,600 \).

Step 4: Calculate the Gain or Loss

Using the formula from Step 3: \( 38,600 - 44,500 = -5,900 \). The equipment sold at a loss of \( \$5,900 \).

Step 5: Report on the Cash Flow Statement

The sale of equipment is reported in two parts on the statement of cash flows. First, record the cash received from the sale under "Investing Activities" as \( \\(38,600 \). Second, report the loss on sale of equipment (\( -\\)5,900 \)) in the reconciliation of net income to net cash provided by operating activities.

Key Concepts

Understanding Book Value

When dealing with assets like office equipment, the book value becomes an essential metric. But what exactly is book value? It refers to the value of an asset as recorded on the company's balance sheet, often calculated by taking the original cost of the item and subtracting any accumulated depreciation.
For example, if the original cost of our office equipment is \(67,000 and it has accumulated depreciation of \)22,500, then its book value can be calculated by subtracting the accumulated depreciation from the original cost:

• The formula: \( \text{Book Value} = \text{Original Cost} - \text{Accumulated Depreciation} \)
• Substituting the numbers: \( 67,000 - 22,500 = 44,500 \)

Hence, the equipment's book value is \( \$44,500 \). This calculation helps businesses determine how much the equipment is worth in accounting terms at the time of sale.

Identifying Gain or Loss on Sale

When a company sells an asset, understanding whether it results in a gain or loss is crucial for financial health insights. This boils down to comparing the asset's book value with the sale proceeds.
If the sale price exceeds the book value, it's a gain. Conversely, if the sale price is less, it's a loss. Here’s a simplified way to determine the outcome:

• Use this formula: \( \text{Gain/Loss} = \text{Sale Price} - \text{Book Value} \)
• With the numbers at hand: \( 38,600 - 44,500 = -5,900 \)

The negative figure indicates that the asset was sold at a loss, amounting to \( \$5,900 \). Keeping tabs on gains and losses helps a company assess its investment strategies and asset management effectiveness.

Reporting on Investing Activities

Transactions like the sale of equipment fall under 'investing activities' in the statement of cash flows. This section is vital as it shows the movements of cash related to the acquisition and disposal of an entity's long-term assets.
When you sell an asset, like our office equipment, the cash received (\\(38,600 in this instance) is reported as inflow under investing activities. The loss on the sale, \(-\\)5,900\), isn't directly shown here but is crucial for accurate net income reconciliation.
The investing activities section allows stakeholders to understand how a company's cash is being used in long-term investments, informing decisions about the financial direction and potential growth of the business.