Chapter 9, Problem 1CC

Accounting for the Use and Disposal of Long-Lived Assets

Nicole’s Getaway Spa (NGS) purchased a hydrotherapy tub system to add to the wellness programs at NGS. The machine was purchased at the beginning of the year at a cost of $7,000. The estimated useful life was five years and the residual value was $500. Assume that the estimated productive life of the machine is 13,000 hours. Expected annual production was year 1, 3,100 hours; year 2, 2,500 hours; year 3, 3,400 hours; year 4, 2,200 hours; and year 5, 1,800 hours.

Required:

1. 1. Complete a depreciation schedule for each of the alternative methods.
   1. a. Straight-line.
   2. b. Units-of-production.
   3. c. Double-declining-balance.
2. 2. Assume NGS sold the hydrotherapy tub system for $2,100 at the end of year 3. Prepare the journal entry to account for the disposal of this asset under the three different methods.
3. 3. The following amounts were forecast for year 3: Sales Revenues $42,000; Cost of Goods Sold $33,000; Other Operating Expenses $4,000; and Interest Expense $800. Create an income statement for year 3 for each of the different depreciation methods, ending at Income before Income Tax Expense. (Don’t forget to include a loss or gain on disposal for each method.)

To determine

Prepare the 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:

Figure (1)

To determine

Prepare the depreciation expense schedule under units-of-production

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:

Figure (2)

To determine

Prepare the 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:

Figure (3)

Note:

Compute depreciation expense in Year 5.

$\begin{array}{c}\text{Depreciation in Year 5 }=\left(\begin{array}{l}\text{Cost–}\\ \text{Accumulated depreciation in Year 4–}\\ \text{Residual value}\end{array}\right)\\ =\text{\$7,000–\$6,093–\$500}\\ =407\end{array}$

To determine

Prepare the journal entries for the sale of equipment under three methods

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.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Prepare journal entry for the sale of building, under straight-line method.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Cash			2,100
		Accumulated Depreciation			3,900
		Loss on Disposal			1,000
			Equipment			7,000
		(To record sale of equipment)

Table (1)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Accumulated Depreciation–Building is a contra-asset account. Since the building is sold, the accumulated depreciation balance is reversed to reduce the balance in the account; hence, the account is debited.
• Loss on Disposal is an expense account. Since losses and expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Building is an asset account. Since building is sold, asset account decreased, and a decrease in asset is credited.

Working Notes:

Determine the gain on sale.

Step 1: Compute book value on the date of sale.

$\begin{array}{c}\text{Book value = Cost–Accumulated depreciation}\\ \text{= \$7,000–\$3,900}\\ \text{= \$3,100}\end{array}$

Step 2: Compute gain (loss) on sale.

$\begin{array}{c}\text{Gain }\left(\text{Loss}\right)\text{= Sale proceeds – Book value}\\ \text{= \$2,100 – \$3,100}\\ \text{= \$}\left(\text{1,000}\right)\end{array}$

Prepare journal entry for the sale of building, under units-of-production method.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Cash			2,100
		Accumulated Depreciation			4,500
		Loss on Disposal			400
			Equipment			7,000
		(To record sale of equipment)

Table (2)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Accumulated Depreciation–Building is a contra-asset account. Since the building is sold, the accumulated depreciation balance is reversed to reduce the balance in the account; hence, the account is debited.
• Loss on Disposal is an expense account. Since losses and expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Building is an asset account. Since building is sold, asset account decreased, and a decrease in asset is credited.

Working Notes:

Determine the gain on sale.

Step 1: Compute book value on the date of sale.

$\begin{array}{c}\text{Book value = Cost–Accumulated depreciation}\\ \text{= \$7,000–\$4,500}\\ \text{= \$2,500}\end{array}$

Step 2: Compute gain (loss) on sale.

$\begin{array}{c}\text{Gain }\left(\text{Loss}\right)\text{= Sale proceeds – Book value}\\ \text{= \$2,100 – \$2,500}\\ \text{= \$}\left(\text{400}\right)\end{array}$

Prepare journal entry for the sale of equipment, under double-declining-balance method.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Cash			2,100
		Accumulated Depreciation			5,488
			Equipment			7,000
			Gain on Disposal			588
		(To record sale of truck)

Table (3)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Accumulated Depreciation–Equipment is a contra-asset account. Since the equipment is sold, the accumulated depreciation balance is reversed to reduce the balance in the account; hence, the account is debited.
• Equipment is an asset account. Since equipment is sold, asset account decreased, and a decrease in asset is credited.
• Gain on Disposal is a revenue account. Since gains and revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Determine the gain on sale.

Step 1: Compute book value on the date of sale.

$\begin{array}{c}\text{Book value = Cost–Accumulated depreciation}\\ \text{= \$7,000–\$5,488}\\ \text{= \$1,512}\end{array}$

Step 2: Compute gain (loss) on sale.

$\begin{array}{c}\text{Gain}\left(\text{Loss}\right)\text{ = Sale proceeds – Book value}\\ \text{= \$2,100 – \$1,512}\\ \text{= \$588}\end{array}$

To determine

Prepare the income statement of NG Spa for the Year 3, under three depreciation methods

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare income statement for NG Spa for the Year 3.

NG Spa
Income Statement
For Year 3
Particulars	Straight-Line	Units-of-Production	Double-Declining-Balance
Sales revenue	$42,000	$42,000	$42,000
Cost of goods sold	33,000	33,000	33,000
Gross profit	9,000	9,000	9,000
Operating expenses:
Depreciation expense	$1,300	$1,700	$1,008
Other operating expenses	4,000	4,000	4,000
Loss (Gain) on disposal	1,000	400	(588)
Total operating expenses	6,300	6,100	4,420
Income from operations	2,700	2,900	4,580
Interest expense	800	800	800
Income before income tax expense	$1,900	$2,100	$3,780

Table (4)