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Question: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?

Step by step solution

01

Definition of Depreciation

The expenses charged to report the decline in the value of the fixed assets acquired by the company are known as depreciation expenses. Such expenses are reported in the statement reporting net income.

02

Recognition of Gain/loss on sale at residual value

The business entity will not report any gain or loss when the asset is sold at its residual value at the end of its useful life. It is so because the gains and losses are recognized when there is a difference between the book value and the sales price of the asset. At the end of the useful life, the asset's book value will be equal to its residual value only; therefore, the business entity neither records gain nor loss.

03

Determination of residual value

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

04

Prevention of fraud

Anyone can commit fraud in determining the asset's residual value or estimated life prevented by implying the competitor's strategy or adopting the federal depreciation schedule for different classes of assets like MACRS.

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