Chapter 8, Problem 8.1ECOMP

Case E. Matson Company purchased the following on January 1, 2016:

• Office equipment at a cost of $60,000 with an estimated useful life to the company of three years and a residual value of $15,000. The company uses the double-declining-balance method of depreciation for the equipment.
• Factory equipment at an invoice price of $880,000 plus shipping costs of $20,000. The equipment has an estimated useful life of 100,000 hours and no residual value. The company uses the units-of-production method of depreciation for the equipment.
• A patent at a cost of $330,000 with an estimated useful life of 15 years. The company uses the straight-line method of amortization for intangible assets with no residual value.

The company’s year ends on December 31.

1. 1. Prepare a partial depreciation schedule for 2016, 2017, and 2018 for the following assets (round your answers to the nearest dollar):
   1. a. Office equipment.
   2. b. Factory equipment. The company used the equipment for 8,000 hours in 2016, 9,200 hours in 2017, and 8,900 hours in 2018.
2. 2. On January 1, 2019. Matson altered its corporate strategy dramatically. The company sold the factory equipment for $700,000 in cash. Record the entry related to the sale of the factory equipment.
3. 3. On January 1, 2019. when the company changed its corporate strategy, its patent had estimated future cash flows of $210,000 and a fair value of $190,000. What would the company report on the income statement (account and amount) regarding the patent on January 1, 2019? Explain your answer.

To determine

Prepare a partial depreciation expense schedule for office equipment under double-declining-balance method for 2016, 2017, and 2018.

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				$60,000
2016	$\left(\$60,000-\$0\right)\times \frac{2}{3}$	$40,000	$40,000	20,000
2017	$\left(\$60,000-\$40,000\right)\times \frac{2}{3}$	5,000	45,000	15,000
2018	Fully depreciated	0	45,000	15,000

Table (1)

Note: The net book value of the asset cannot be less than the residual value of such asset. Hence, calculate the depreciation expense as given in the working note below.

Working Note:

Compute depreciation expense in Year 2017.

$\begin{array}{c}\text{Depreciation in 2017 }=\left(\begin{array}{l}\text{Cost–}\\ \text{Accumulated depreciation in 2016–}\\ \text{Residual value}\end{array}\right)\\ =\text{\$60,000–\$40,000–\$15,000}\\ =\$5,000\end{array}$

To determine

Prepare a partial depreciation expense schedule for factory equipment under units-of-production method for 2016, 2017, and 2018.

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				$880,000
2016	$\left(\$880,000+\$20,000\right)\times \frac{8,000\text{ hours}}{100,000\text{ hours}}$	$72,000	$72,000	828,000
2017	$\left(\$880,000+\$20,000\right)\times \frac{9,200\text{ hours}}{100,000\text{ hours}}$	82,800	154,800	745,200
2018	$\left(\$880,000+\$20,000\right)\times \frac{8,900\text{ hours}}{100,000\text{ hours}}$	80,100	234,900	665,100

Table (2)

To determine

Prepare the journal entry to record the sale of the factory equipment.

Explanation of Solution

Straight-line Depreciation:

Under the straight-line method of depreciation, the same amount of depreciation is allocated every year over the estimated useful life of an asset. The formula to calculate the depreciation cost of the asset using the residual value is shown as below:

$\text{Depreciation = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}$

Prepare the journal entry to record the sale of the shelving units.

Date	Account title and explanation	Post ref.	Debit (In $)	Credit (In $)
	Cash		700,000
	Accumulated depreciation (Refer Requirement 1.b.)		234,900
	Gain on disposal (2)			34,900
	Factory equipment			900,000
	(To record the disposal of the factory equipment)

Table (3)

Working Notes:

Calculate the gain (loss) on sale of the equipment.

Sale proceed		$700,000
Cost of the equipment	$900,000
Less: Accumulated depreciation	$234,900
Less: Book value		$665,100
Gain on sale of equipment (2)		$34,900

Table (4)

Record the sale of the shelving units:

• Cash is an asset. Sale of factory equipment increase the cash balance. Thus, cash account is debited.
• Accumulated depreciation is a contra asset. It decreases the asset value. Thus, accumulated depreciation account is debited.
• Gain on disposal is a component of the retained earnings. It increases the retained earnings. Thus, gain on disposal account is credited.
• Factory equipment is the asset. Sale of factory equipment decreases the value of the asset. Thus, factory equipment account is credited.

To determine

Ascertain the amount that the company would report on the income statement regarding the patent on January 1, 2019 and to explain the answer.

Explanation of Solution

Amortization expense:

The expense which reflects the usage of intangible asset by the way of reducing the cost of the asset for the estimated useful definite life is referred to as amortization expense.

Formula for amortization expense:

$\text{Amortization expense}=\text{Cost of intangible asset}\text{×}\frac{1}{\text{Useful life}}$

Asset impairment:

Asset impairment arises when the carrying value of the assets recorded on the balance sheet of the company exceeds its estimated future cash inflows.

Accounting treatment:

The asset impairment is accounted for in the following way:

The purchase value of the asset will be written down to its fair value and it will be recorded as a loss at such value.

Compute amortization expense of patent.

$\begin{array}{c}\text{Amortization expense =}\text{Cost of intangible asset}\text{×}\frac{\text{1}}{\text{Useful life}}\\ \text{= \$330,000×}\frac{\text{1}}{\text{15 years}}\\ \text{= \$22,000}\end{array}$

Compute the net book value of the patent.

Particulars	Amount ($)	Amount ($)
Original cost of the patent		330,000
Less: Accumulated depreciation		66,000
Net Book Value of the patent		$264,000

Table (5)

Compute the amount of impairment loss to be recorded on January 1, 2019.

Particulars	Amount ($)
Book value of patent	264,000
Less: Fair value of patent	190,000
Impairment loss to be recorded on January 1, 2019	$74,000

Table (6)

The book value of the copyright exceeds its estimated future cash inflows. Hence, the asset is impaired, and the company would report an impairment loss of $74,000 on the income statement regarding the patent on January 1, 2019.

Working Note:

Calculate the accumulated depreciation of the patent.

$\begin{array}{c}\text{Accumulated depreciation=}\left(\begin{array}{l}\text{Depreciation expense per year}\times \text{Number}\\ \text{of years the asset has been used}\end{array}\right)\\ \text{=\$}22,000\times 3\text{years }\left(\text{January 2016 to January 2019 }\right)\\ =\$66,000\end{array}$