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Chapter 9: Q1FC (page 543)

Jim Reed manages a fleet of utility trucks for a rural county government. He鈥檚 been in his job for 30 years, and he knows where the angles are. He makes sure that when new trucks are purchased, the residual value is set as low as possible. Then, when they become fully depreciated, they are sold off by the county at residual value. Jim makes sure his buddies in the construction business are first in line for the bargain sales, and they make sure he gets a little something back. Recently, a new county commissioner was elected with vows to cut expenses for the taxpayers. Unlike other commissioners, this man has a business degree, and he is coming to visit Jim tomorrow.

Requirements

1. When a business sells a fully depreciated asset for its residual value, is a gain or loss recognized?

2. How do businesses determine what residual values to use for their various assets? Are there 鈥渉ard and fast鈥� rules for residual values?

3. How would an organization prevent the kind of fraud depicted here?

Short Answer

Expert verified

At residual value there would be no gain or loss on the sale of the asset. Residual value is determined based on past experience and by adopting best practices any fraud can be prevented.

Step by step solution

01

Gain/loss on sale at residual value

When assets are sold at their residual value there would be no gain or loss on the sale of the asset. This is so because the difference between the book value and the accumulated depreciation is the residual value that is being received in the firm of cash.

02

Determination of residual value

There is no hard and fast rule for determining residual value. Residual value is determined based on past experience and logical judgment.

03

Prevention of fraud

The fraud in the determination of residual value or estimated life of the asset can be prevented by implying the competitor鈥檚 strategy or by adopting the federal depreciation schedule for different classes of assets like MACRS.

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Most popular questions from this chapter

Computing the asset turnover ratio Biagas, Inc. had net sales of \(55,600,000 for the year ended May 31, 2018. Its beginning and ending total assets were \)52,800,000 and $98,500,000, respectively. Determine Biagas鈥檚 asset turnover ratio for year ended May 31, 2018.

Determining asset cost, preparing depreciation schedules (3 methods), and identifying depreciation results that meet management objectives

On January 3, 2018, Rapid Delivery Service purchased a truck at a cost of \(100,000. Before placing the truck in service, Rapid spent \)3,000 painting it, \(600 replacing tires, and \)10,400 overhauling the engine. The truck should remain in service for five years and have a residual value of $12,000. The truck鈥檚 annual mileage is expected to be 32,000 miles in each of the first four years and 8,000 miles in the fifth year鈥�136,000 miles in total. In deciding which depreciation method to use, Andy Sargeant, the general manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-production, and double-declining-balance).

Requirements

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value.

2. Rapid prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. Consider the first year that Rapid uses the truck. Identify the depreciation method that meets the company鈥檚 objectives.

Determining the cost of an asset

Highland Clothing purchased land, paying \(96,000 cash and signing a \)300,000 note payable. In addition, Highland paid delinquent property tax of \(1,100, title insurance costing \)600, and $4,600 to level the land and remove an unwanted building. Record the journal entry for purchase of the land.

During 2018, Lora Company completed the following transactions:

Jan. 1 Traded in old office equipment with book value of \(55,000 (cost of \)129,000 and accumulated depreciation of \(74,000) for new equipment. Lora also paid \)55,000 in cash. Fair value of new equipment is \(116,000. Assume the exchange had commercial substance.

Apr. 1 Sold equipment that cost \)12,000 (accumulated depreciation of \(1,000 through December 31 of the preceding year). Lora received \)7,100 cash from the sale of the equipment. Depreciation is computed on a straightline basis. The equipment has a five-year useful life and a residual value of \(0.

Dec. 31 Recorded depreciation as follows:

Office equipment is depreciated using the double-declining-balance method over four years with a \)7,000 residual value.

Record the transactions in the journal of Lora Company.

In 150 words or fewer, explain the different methods that can be used to calculate depreciation. Your explanation should include how to calculate depreciation expense using each method.
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