Question

(Depreciation—Replacement, Change in Estimate) Greg Maddox Company constructed a building at a cost of \(2,200,000 and occupied it beginning in January 1998. It was estimated at that time that its life would be 40 years, with no salvage value.

In January 2018, a new roof was installed at a cost of \)300,000, and it was estimated then that the building would have a useful life of 25 years from that date. The cost of the old roof was $160,000.

Instructions

1. What amount of depreciation should have been charged annually from the years 1998 to 2017? (Assume straight-line depreciation.)
2. What entry should be made in 2018 to record the replacement of the roof?
3. Prepare the entry in January 2018 to record the revision in the estimated life of the building if necessary.
4. What amount of depreciation should be charged for the year 2018?

Short answer

Answer

1. Depreciation = $55,000
2. Accumulateddepreciation = $300,000
3. No entry required
4. Depreciation = $ $52,800 or $56,000

Step-by-step solution

Meaning of Depreciation 

Depreciation is a branch of accounting that deals with systematically spreading or dividing the cost or other principal value of a fixed assetover its expected useful life by charging regular expenses or revenues.

(a) Explaining the amount that should be charged annually

Determining the depreciation

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Cost}\text{of}\text{asset}-\text{Residual}\text{value}}{\text{Useful} \text{life}}\\ & =& \frac{\$2,200,000}{40}\\ & =& \$55,000\end{array}$

(b) Preparing journal entry 

Date	Particular	Debit ($)	Credit ($)
	Loss on Disposal of Plant Assets	80,000
	Accumulated Depreciation-Buildings	80,000
	Buildings		160,000
	Buildings	300,000
	Cash		300,000

Working note:

Calculation of accumulated depreciation-Building

$\begin{array}{rcl}\text{Depreciation}& =& \text{Cost}\text{of}\text{roof}\times \frac{\text{Useful}\text{life}}{\text{Estimated}\text{life}}\\ & =& \$160,000\times \frac{20}{40}\\ & =& \$80,000\end{array}$

Note: Since the cost of the previous roof is known, the most suitable entry would be to remove it and record a loss on disposal. Another option is to deduct Accumulated Depreciation— Buildings on the basis that the replacement will extend the building's useful life. In this scenario, the entry would be as follows:

Date	Particular	Debit ($)	Credit ($)
	Accumulated Depreciation-Buildings	300,000
	Cash		300,000

(c) Explaining the journal entry

In January 2018, while recording the revision in the estimated life of the building, it was found that no entry is required to be passed in the books of accounts.

(d) Explaining the amount of depreciation that should be charged for the year 2018 

(Assume the cost of the old roof is removed)
Buildings $\left(\$2,20,000-\$160,000+\$300,000\right)$	$2,340,000
Less: Accumulated Depreciation $\left(\$55,000\times 20-\$80,000\right)$	1,020,000
	1,320,000
Remaining useful life	25 years
Depreciation—2018	$ 52,800

Working Notes:

Calculation of Depreciation for 2018

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Building}\text{amount}\text{after}\text{adjustment}}{\text{Useful} \text{life}}\\ & =& \frac{\$1,320,000}{25}\\ & =& \$52,800\end{array}$

There is another option for determining depreciation

(Assume the cost of the new roof is debited to Accumulated Depreciation-Equipment)
Book value of the building prior to the replacement of roof $2,200,000 – ($55,000 X 20)	$1,100,000
Cost of new roof	300,000
	$1,400,000
Remaining useful life	25 years
Depreciation-2018	$ 56,000

Working notes:

Calculation of Depreciation for 2018

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Cost}\text{of}\text{building}\text{after}\text{adjustment}}{\text{Useful}\text{life}}\\ & =& \frac{\$1,400,000}{25}\\ & =& \$56,000\end{array}$