Chapter 8, Problem 1PSB

Plant asset costs; depreciation methods  C1  P1  
Nagy Company makes a lump-sum purchase of several assets on January 1 at a total cash price of $1,800,000. The estimated market values of the purchased assets are building, $890,000; land, $427,200; land improvements, $249,200; and five trucks, $213,600.
Required

1. Allocate the lump-sum purchase price to the separate assets purchased. Prepare the journal entry to record the purchase.
2. Compute the first-year depreciation expense on the building using the straight-line method, assuming a 12-year life and a $120,000 salvage value.
   Check (2) $65,000
3. Compute the first-year depreciation expense on the land improvements assuming a 10-year life and double-declining-balance depreciation.
   (3) $50,400
Analysis Component

4. Compared to straight-line depreciation, does accelerated depreciation result in payment of less total taxes over the asset’s life?

To determine

Lump Sum Purchase:

When the assets are purchased or bought in a lot in one transaction at a lump sum price that is called lump sum purchase. In lump sum purchase, apportion cost of purchase on the basis of relative market value can be anticipated by appraisal.

Plant Assets:

Plant assets are assets which are tangible in nature and are used in a company’s operations that have a useful life of more than 1 accounting period. Plant assets are also called as plant and equipment assets. They include all the normal cost and reasonable expenditures that are spent to put that particular plant asset to use.

Journal Entries:

Journal entries are the entries that are made in the books of accounts to record every transaction that happens in the business in the chronological order.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

Depreciation:

Depreciation is the amount of decrease in the value of an asset within a set time period due to wear and tear of that particular asset. It helps in readjusting the actual cost of the particular asset o which the depreciation is applied.

Double declining balance method:

It is a method of depreciation in which the rate of depreciation is double the rate of straight line method of depreciation. The amount of depreciation applied to the asset declines every period because book value declines every period.

1.

To prepare: A table to compute the lump sum purchase and to prepare journal entry.

Explanation of Solution

Computation of lump sum purchase:

Particulars	Appraised Value($)	Percentage of total	Apportioned Cost($)
Building	890,000	50%	900,000
Land improvements	249,200	14%	252,000
Land	427,200	24%	432,000
Trucks	213,600	12%	216,000
Total	1,780,000		1,800,000

Table (1)

Record purchase of the assets on January 1^st 2017.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan1	Building		900,000
	Land		432,000
	Trucks		216,000
	Land improvements		252,000
	Cash			900,000
	(To record the purchase of assets)

Table (2)

• Building is an asset account. Building account increases as new building has been purchased. Hence, all the assets are debited as they increases in value.
• Land is an asset account. Land account increases as a new land is purchased and all the assets are debited as a new asset is purchased or if its value increases.
• Vehicle account is an asset account. Vehicles account increases as a new vehicle is purchased and all the assets are debited as a new asset is purchased or if its value increases.
• Land improvements are an asset account. Land improvement account increases as some improvements have been done on land to increase its useful life and all the assets are debited as their value increases.
• Cash account is an asset account. Cash account decreases as the amount paid for the purchase of all assets are made in cash and all the assets are credited as their values decreases.

Working Notes:

Computation of total appraised value:

  $\begin{array}{c}\text{Total}\text{appraised}\text{value}=\left(\begin{array}{c}\text{Appraised}\text{value}\text{of}\text{building}+\text{Appraised}\text{value}\text{of}\text{land}\\ +\text{Appraised}\text{value}\text{of}\text{trucks}\\ +\text{Appraised}\text{value}\text{of}\text{land}\text{improvements}\end{array}\right)\\ =\$890,000+\$427,200+\$213,600+\$249,200\\ =\$1,780,000\end{array}$

Total appraised value is $1,780,000.

Building

Computation of percentage of total of building:

  $\begin{array}{c}\text{Percentage}\text{of}\text{building}=\left(\frac{\text{Appraised}\text{value}\text{of}\text{building}}{\text{Total}\text{Appraised}\text{value}}\right)\times 100\\ =\left(\frac{890,000}{\$1,780,000}\right)\times 100\\ =50\%\end{array}$

Percentage of building is 50%.

Computation of apportioned cost of the building:

  $\begin{array}{c}\text{Apportioned}\text{cost}=\text{Total}\text{cash}\text{price}\times \text{Percentage}\text{of}\text{building}\\ =\$1,800,000\times 50\%\\ =\$900,000\end{array}$

Apportioned cost of the building is $900,000.

Land improvements

Computation of percentage of total of Land improvements:

  $\begin{array}{c}\text{Percentage}\text{of}\text{land}\text{improvements}=\left(\frac{\text{Appraised}\text{value}\text{of}\text{Land}\text{improvements}}{\text{Total}\text{appraised}\text{value}}\right)\\ \times 100\\ =\left(\frac{\$249,200}{\$1,780,000}\right)\times 100\\ =14\%\end{array}$

Percentage of Land improvements is 14%.

Computation of Apportioned Cost of the Land improvements:

  $\begin{array}{c}\text{Apportioned}\text{cost}=\text{Total}\text{cash}\text{price}\times \text{Percentage}\text{of}\text{land}\text{improvements}\\ =\$1,800,000\times 14\%\\ =\$252,000\end{array}$

Apportioned cost of land improvements is $252,000.

Land

Computation of percentage of total of Land:

  $\begin{array}{c}\text{Percentage}\text{of}\text{land}=\left(\frac{\text{Appraised}\text{value}\text{of}\text{Land}}{\text{Total}\text{appraised}\text{value}}\right)\times 100\\ =\left(\frac{\$427,200}{\$1,780,000}\right)\times 100\\ =24\%\end{array}$

Percentage of Land is 24%.

Computation of apportioned Cost of the Land:

  $\begin{array}{c}\text{Apportioned}\text{cost}=\text{Total}\text{cash}\text{price}\times \text{Percentage}\text{of}\text{land}\\ =\$1,800,000\times 24\%\\ =\$432,000\end{array}$

Apportioned cost of land is $432,000.

Vehicles

Computation of percentage of total of vehicles:

  $\begin{array}{c}\text{Percentage}\text{of}\text{vehicles}=\left(\frac{\text{Appraised}\text{value}\text{of}\text{vehicles}}{\text{Total}\text{appraised}\text{value}}\right)\times 100\\ =\left(\frac{\$213,600}{\$1,780,000}\right)\times 100\\ =12\%\end{array}$

Percentage of vehicles is 12%.

Computation of Apportioned Cost of the vehicles:

  $\begin{array}{c}\text{Apportioned}\text{cost}=\text{Total}\text{cash}\text{price}\times \text{Percentage}\text{of}\text{vehicles}\\ =\$1,800,000\times 12\%\\ =\$216,000\end{array}$

Apportioned cost of vehicles is $216,000.

To determine

To Compute: The depreciation amount on building using straight line depreciation method.

Explanation of Solution

Given,

Cost of building is $900,000.

Salvage value is $120,000.

Useful life is 12 years.

Formula to calculate depreciation:

  $\text{Depreciation}=\frac{\left(\text{Cost}-\text{Residual}\text{value}\right)}{\text{Useful}\text{life}}$

Substitute $477,000 as the cost of the asset, $27,000 as residual value and 15 years as useful life,

  $\begin{array}{c}\text{Depreciation}=\frac{\$900,000-\$120,000}{12}\\ =\$65,000\end{array}$

Depreciation on building is $65,000.

Hence, the depreciation that will be charged on building for the year 2017 is $65,000.

To determine

To Compute: The depreciation amount on the land improvements using double declining method.

Explanation of Solution

Given,

Appraised value of land improvements is 252,000.

Useful life is 10 years.

Formula to calculate the depreciation rate:

  $\text{Double}\text{declining}\text{depreciation}\text{rate}=\frac{100\%}{\text{Useful}\text{years}}\times 2$

Substitute 5 years as useful life in the above formula,

  $\begin{array}{c}\text{Double}\text{declining}\text{depreciation}\text{rate}=\frac{100}{10}\times 2\\ =20\%\end{array}$

The double depreciation rate is 20%.

Formula to calculate depreciation in first year:

  $\text{Depreciation}=\text{Cost}\text{of}\text{the}\text{land}\text{improvements}\times \text{Depreciation}\text{rate}$

Substitute $252,000 as cost of the land improvements and 20% as depreciation rate,

  $\begin{array}{c}\text{Depreciation}=\$252,000\times 20\%\\ =\$50,400\end{array}$

Hence, the depreciation that will be charged is $50,400.

To determine

To identify: Accelerated depreciation results in payment of fewer taxes.

Explanation of Solution

• This statement is not correct that accelerated depreciation reduces that amount of tax rate paid to the government, it doesn’t reduce the taxes as it just provides higher amount of depreciation in the first few years and provides lower depreciation in the later years.
• The Acceleration depreciation just delays the taxes to the forthcoming years.

Hence, the accelerated depreciation does not result in payment of less tax.