Chapter 10, Problem 6BP

On January 1, Walker purchased a used machine for $150,000. On January 4, Walker paid $3,510 to wire electricity to the machine and an additional $4,600 to secure it in place. The machine will be used seven years and have an $18,110 salvage value. Straight-line depreciation is used. On December 31, at the end of its sixth year of use, the machine is disposed of.

Required

1. 1. Prepare journal entries to record the machine’s purchase and the costs to ready it for use. Cash is paid for all costs incurred.
2. 2. Prepare journal entries to record depreciation of the machine at December 31 of (a) its first year of operations and (b) the year of its disposal.
3. 3. Prepare journal entries to record the machine’s disposal under each separate situation: (a) it is sold for $28,000 cash; (b) it is sold for $52,000 cash; and (c) it is destroyed in a fire and the insurance company pays $25,000 cash to settle the loss claim.

To determine

Prepare journal entries to record the purchase of machine and other capital expenditures.

Explanation of Solution

Plant assets:

Plant assets refer to the fixed assets, having a useful life of more than a year that is acquired by a company to be used in its business activities, for generating revenue.

Prepare journal entries to record the purchase of machine and other capital expenditures as follows:

Purchase of machinery in cash:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
January, 1	Machinery		150,000
	Cash			150,000
	(To record the machinery purchased in cash)

Table (1)

• Machinery is an asset account and it increases the value of asset by $150,000. Therefore, debit machinery account for $150,000.
• Cash is an asset account and it decreases the value of asset by $150,000. Therefore, credit Cash account for $150,000.

Installation and other capital expenditure:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
January, 2 and 4	Machinery $\left(\$3,510+\$4,600\right)$		8,110
	Cash			8,110
	(To record the capital expenditure incurred for machinery)

Table (2)

• Machinery is an asset account and it increases the value of asset by $8,110. Therefore, debit machinery account for $8,110.
• Cash is an asset account and it decreases the value of asset by $8,110. Therefore, credit Cash account for $8,110.

To determine

Prepare journal entry to record depreciation expense for the following years;

1. a. First year and
2. b. The (sixth) year of its disposal.

Explanation of Solution

Straight-Line Method:

In straight-line deprecation method the asset is used evenly throughout its useful life. This is because the amount of depreciation in straight line remains same for all the years of the useful life of the asset.

1. a. Prepare journal entry to record depreciation expense for first year as follows:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31	Depreciation expense-Machinery (1)		20,000
	Accumulated depreciation-Machinery			$20,000
	(To record depreciation expense incurred at the end of the first year)

Table (3)

• Depreciation expense is an expense account, and it decreases the value of equity. Hence, debit the depreciation expense by $20,000.
• Accumulated depreciation is a contra asset, and it decreases the value of assets. Therefore, credit accumulated depreciation by $20,000.

(b) The year of its disposal:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31	Depreciation expense-Machinery (1)		20,000
	Accumulated depreciation-Machinery			$20,000
	(To record depreciation expense incurred at the end of the sixth  year)

Table (4)

• Depreciation expense is an expense account, and it decreases the value of equity. Hence, debit the depreciation expense by $20,000.
• Accumulated depreciation is a contra asset, and it decreases the value of assets. Therefore, credit accumulated depreciation by $20,000.

Working note:

Compute the depreciation expenses:

$\begin{array}{c}\text{Annual Depreciation}=\frac{\text{Cost of the Asset }-\text{ Residual value}}{\text{Estimated Useful Life of the Asset}}\\ =\frac{\$158,110-\text{\$18,110}}{\text{7 Years}}\\ =\$20,000\end{array}$ (1)

To determine

Prepare journal entries to record the disposal of machinery under the given situation.

Explanation of Solution

Prepare journal entries to record the disposal of machinery under the given situation as follows:

1. a.  Machinery sold for $20,000 cash:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash		20,000
	Accumulated Depreciation – Machinery (2)		120,000
	Loss on disposal of Machinery (4)		10,110
	Machinery (3)			$158,110
	(To record the loss on disposal of machinery)

Table (5)

• Cash is an asset, and it increases the value of assets by $20,000. Therefore, debit the cash account with $20,000.
• Accumulated depreciation is a contra asset, and it increases the asset by $120,000. Therefore, debit Accumulated depreciation with $120,000.
• Loss on sale of machinery is loss of the company and it decreases the value of equity by $10,110. Therefore, debit the loss on sale of machinery with $10,110.
• Machinery is an asset, and it decreases the value of assets by $158,110. Therefore, credit machinery account by $158,110.

Working note:

Calculate the accumulated depreciation for 6 years:

$\begin{array}{c}\text{Accumulated Depreciation}=\text{Annual depreciation}\times 5\text{ years}\\ =\$20,000\times 6\text{ years}\\ =\text{\$120,000}\end{array}$ (2)

Calculate the book value of machinery:

$\begin{array}{c}\text{Book value = Purchase cost}+\text{Capital expenditures}\\ =\text{\$150,000}+\text{\$8,110}\\ =\text{\$158,110}\end{array}$ (3)

Calculate the loss on disposal of machinery:

$\begin{array}{c}\text{Loss on disposal = }\left(\begin{array}{l}\text{Book value of machinery (3)}-\text{Accumulated}\\ \text{depreciation (2)}-\text{Sales value}\end{array}\right)\\ =\$158,110-\$120,000-\$28,000\\ =\$10,110\end{array}$ (4)

1. b. Machinery is sold for $52,000 cash:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash		52,000
	Accumulated Depreciation – Machinery (2)		120,000
	Machinery (3)			$158,110
	Gain from sale of machinery (5)			$13,890
	(To record the gain  from disposal of machinery)

Table (6)

• Cash is an asset, and it increases the value of assets by $52,000. Therefore, debit the cash account with $52,000.
• Accumulated depreciation is a contra asset, and it increases the asset by $120,000. Therefore, debit Accumulated depreciation with $120,000.
• Machinery is an asset, and it decreases the value of assets by $158,110. Therefore, credit machinery account by $158,110.
• Gain from sale of machinery is revenue of the company and it increases the value of equity by $13,890. Therefore, debit the loss on sale of machinery with $13,890.

Working note:

Calculate the gain from disposal of machinery:

$\begin{array}{c}\text{Gain from disposal = }\left(\text{Sales value }-\left(\begin{array}{l}\text{Book value of machinery (3)}-\\ \text{ Accumulated depreciation (2) }\end{array}\right)\right)\\ =\$52,000-\left(\$158,110-\$120,000\right)\\ =\$13,890\end{array}$ (5)

1. c. Machinery is destroyed in a fire and the insurance company pays $25,000 cash to settle the loss claim:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash		25,000
	Accumulated Depreciation – Machinery (2)		120,000
	Loss on Fire (6)		13,110
	Machinery (3)			$158,110
	(To record the loss on fire)

Table (7)

• Cash is an asset, and it increases the value of assets by $25,000. Therefore, debit the cash account with $25,000.
• Accumulated depreciation is a contra asset, and it increases the asset by $120,000. Therefore, debit Accumulated depreciation with $120,000.
• Loss on fire is loss of the company and it decreases the value of equity by $13,110. Therefore, debit the loss on fire with $13,110.
• Machinery is an asset, and it decreases the value of assets by $158,110. Therefore, credit machinery account by $158,110.

Working note:

Calculate the loss on disposal of machinery:

$\begin{array}{c}\text{Loss on disposal = }\left(\begin{array}{l}\text{Book value of machinery (3)}-\text{Accumulated}\\ \text{depreciation (2)}-\text{Insurance claim}\end{array}\right)\\ =\$158,110-\$120,000-\$25,000\\ =\$13,110\end{array}$ (6)