Chapter 8, Problem 8.1CON

Asset Acquisition, Depreciation, and Disposal

Pool Corporation, Inc., is the world's largest wholesale distributor of swimming pool supplies and equipment. Assume Pool Corporation purchased for cash new loading equipment for the warehouse on January 1 of Year 1, at an invoice price of $72,000. It also paid $2,000 for freight on the equipment, $1,300 to prepare the equipment for use in the warehouse, and $800 for insurance to cover the equipment during operation in Year 1. The equipment was estimated to have a residual value of $3,300 and be used over three years or 24,000 hours.

Required:

1. 1. Record the purchase of the equipment, freight, preparation costs, and insurance on January 1 of Year 1.
2. 2. Create a depreciation schedule assuming Pool Corporation uses the straight-line method.
3. 3. Create a depreciation schedule assuming Pool Corporation uses the double-declining-balance method. Round answers to the nearest dollar.
4. 4. Create a depreciation schedule assuming Pool Corporation uses the units-of-production method, with actual production of 8,000 hours in Year 1; 7,400 hours in Year 2; and 8,600 hours in Year 3.
5. 5. On December 31 of Year 2, the equipment was sold for $22,500. Record the sale of the equipment assuming the company used the straight-line method.

To determine

Record the purchase of the equipment, freight, preparation costs, and insurance on January 1 of Year 1.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Accounting rules for Journal entries:

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

Record the purchase of the equipment, freight, preparation costs, and insurance on January 1 of Year 1.

Date	Account Title and Explanation	Debit($)	Credit($)
January 1, Year 1	Equipment	75,300
	Prepaid insurance	800
	Cash		76,100
	(To record the purchase of the equipment, freight, preparation costs, and insurance )

Table (1)

Working Note:

Calculate the purchase price of the Equipment.

$\begin{array}{c}\text{Purchase price of Equipment=}\left[\begin{array}{l}\text{Invoice price + Freight costs+}\\ \text{Preparation costs}\end{array}\right]\\ =\$72,000+\$2,000+\$1,300\\ =\$75,300\end{array}$

Note: The purchase price of the insurance is not included in the purchase price of the equipment as it is not the part of the acquisition cost of the asset. Because it is not the amount paid to purchase the asset, install it, and put it into operations.

Purchase of the equipment, freight, preparation costs, and insurance:

• Equipment is an asset and it is increased. Hence, debit the Equipment account.
• Prepaid Insurance is an asset account, and it is increased. Therefore, debit Prepaid Insurance account.
• Cash is an asset and it is decreased. Therefore, credit Cash account.

To determine

Create depreciation expense schedule under straight-line method.

Explanation of Solution

Straight-line method:

The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset is referred to as straight-line method.

Formula for straight-line depreciation method:

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{×Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{1}{\text{Useful life}}\end{array}$

Depreciation expense:

Depreciation expense is a non-cash expense, which is recorded on the income statement reflecting the consumption of economic benefits of long-term asset.

Accumulated depreciation:

The total amount of depreciation expense deducted, from the time asset acquired till date, as reported in the account as on a particular date, is referred to as accumulated depreciation.

Formula for accumulated depreciation:

$\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in the previous years+}\\ \text{Depreciation in current year}\end{array}\right\}$

Book value:

The amount of acquisition cost of less accumulated depreciation as on a particular date is referred to as book value.

Formula for book value:

$\text{Book value = }\left\{\begin{array}{l}\text{Acquisition cost–}\\ \text{Accumulated depreciation}\end{array}\right\}$

Depreciation schedule under straight-line method:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Net Book Value
At Acquisition				$75,300
1	$\left(\$75,300-\$3,300\right)\times \frac{1}{3}$	$24,000	$24,000	$51,300
2	$\left(\$75,300-\$3,300\right)\times \frac{1}{3}$	24,000	48,000	27,300
3	$\left(\$75,300-\$3,300\right)\times \frac{1}{3}$	24,000	72,000	3,300

Table (2)

To determine

Create depreciation expense schedule under double-declining-balance method.

Explanation of Solution

Double-declining-balance method:

The depreciation method which assumes that the consumption of economic benefits of long-term asset is high in the early years but gradually declines towards the end of its useful life is referred to as double-declining-balance method.

Formula for double-declining-balance depreciation method:

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\left(\begin{array}{l}\text{Book value at the }\\ \text{beginning of the period }\end{array}\right)\text{ × Depreciation rate}\\ \text{= }\left(\text{Cost–Accumulated depreciation}\right)\text{×}\frac{\text{2}}{\text{Useful life}}\end{array}$

Depreciation schedule under double-declining-balance method:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Net Book Value
At Acquisition				$75,300
1	$\left(\$75,300-\$0\right)\times \frac{2}{3}$	$50,200	$50,200	$25,100
2	$\left(\$75,300-\$50,200\right)\times \frac{2}{3}$	16,733	66,933	8,367
3	$\left(\$75,300-\$66,933\right)\times \frac{2}{3}$	5,067	72,000	3,300

Table (3)

To determine

Create depreciation expense schedule under units-of-production method.

Explanation of Solution

Units-of-production method:

The depreciation method which assumes that the consumption of economic benefits of long-term asset is based on the production capacity or output is referred to as units-of-production method.

Formula for units-of-production depreciation method:

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{×Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{\text{Actual production}}{\text{Estimated total production}}\end{array}$

Depreciation schedule under units-of-production method:

Year	Computation	Depreciation Expense	Accumulated Depreciation	Net Book Value
At Acquisition				$75,300
1	$\left(\$75,300-\$3,300\right)\times \frac{8,000\text{ hours}}{24,000\text{ hours}}$	$24,000	$24,000	$51,300
2	$\left(\$75,300-\$3,300\right)\times \frac{7,400\text{ hours}}{24,000\text{ hours}}$	22,200	46,200	29,100
3	$\left(\$75,300-\$3,300\right)\times \frac{8,600\text{ hours}}{24,000\text{ hours}}$	25,800	72,000	3,300

Table (4)

To determine

Record the sale of the equipment assuming the company used the straight-line method.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Accounting rules for Journal entries:

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

Prepare the journal entry related to the depreciation expense of the equipment on December 31 of the Year 2.

Date	Account title and Explanation	Post Ref.	Debit (In $)	Credit (In $)
December 31, Year 2	Depreciation expense		24,000
	Accumulated depreciation			24,000
	(To record the depreciation expense)

Table (5)

• Depreciation expense is a component of retained earnings. It decreases the retained earnings. Thus, depreciation expense is debited.
• Accumulated depreciation is a contra asset which decreases the value of the asset. Increase in accumulated depreciation decreases the asset’s value. Thus, accumulated depreciation on equipment is credited.

Prepare the journal entry related to the disposal of the equipment on December 31 of the Year 2.

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, Year 2	Cash		22,500
	Accumulated depreciation		48,000
	Loss on disposal of equipment      (balancing figure)		4,800
	Equipment			75,300
	(To record the disposal of Equipment)

Table (6)

• Cash is an asset. Sale of equipment increases the cash balance. Thus, debit cash account.
• Accumulated depreciation is a contra asset. It decreases the assets value. Thus, debit accumulated depreciation account.
• Loss on disposal of equipment is a component of retained earnings. Loss on disposal decreases the retained earnings. Thus, debit loss on disposal of equipment account.
• Equipment is an asset. Sale of equipment decreases the assets value. Thus, credit Equipment account.