Question

Jim Reed manages a fleet of utility trucks for a rural county government. He’s 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 “hard and fast” rules for residual values?

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

Short answer

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

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.

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.

Prevention of fraud

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