Sinario: Long-Term Asset Acquisition Emmett & Gracie (E & G) is considering a si
ID: 2419959 • Letter: S
Question
Sinario: Long-Term Asset Acquisition
Emmett & Gracie (E & G) is considering a significant equipment replacement. E & G would like to replace some of their equipment before December 31, 2016. The equipment originally cost $840,000 and the equipment’s accumulated depreciation balance at the end of 2015 is will be $790,000. At this point the equipment is depreciated to its salvage value. Your long-term asset accountant, Joe, tells you about four equipment options as follows:
1. construct new equipment and sell the old equipment,
2. exchange the old equipment for new equipment that is more efficient,
3. purchase new equipment that is more efficient and sell the old equipment, or
4. overhaul the old equipment.
The estimated life of any new equipment is 7 years.
E & G would like you to analyze option 1 to determine the financial impact of each decision and any non-financial considerations that may result from each decision.
Option 1: Construct the new equipment in-house and sell the old equipment for cash at a fair value of $60,000. E & G would take out a one-year construction loan for $900,000 at the time construction begins at a short-term borrowing rate of 10% for the construction. Anticipated actual expenditures for constructing the equipment are $980,000, and on a weighted-average basis the expenditures are approximately $625,000. The bulk of the $980,000 will be financed with the construction loan, and the balance will be financed through accounts payable. The interest on the short-term note is due and payable by year-end. (Note: Construction is assumed to be completed at year-end of 2016.)
Instructions: (A) Prepare jounral entries in general journal form for option 1 and (B) explain on how option 1 affects the finacial statments and the strengths and weakness of this option.
Explanation / Answer
The Anticipated Expenditure for the construction of Asset = 980000 Since the loan is taken exclusively for Asset, the full value to be taken for intrerest capitalisation The Interest = 900000*10% = 90000 Total value of Asset = 980000+90000 = 1070000 gain on sale of Asset Book value = 50000 & Fair value = $60000 Therefore Gain on Sale = 10000 Journal entries Asset Account Dr 980000 To Cash 980000 Asset Account Dr 90000 To Interest Account 90000 Cash account Dr 60000 To Gain on sale of Asset 50000 To Asset Account 10000 The above decision will result in 1070000 addition to fixed assets & gain of $ 10000. This option if we choose, We need to pay , the organisation must have certain technology & manpower to develop the asset. The advantage is it can customise to its nature of business & requirement.