Question

(Depreciation Computation—Replacement, Nonmonetary Exchange) George Zidek Corporation bought a machine on June 1, 2015, for \(31,000, f.o.b. the place of manufacture. Freight to the point where it was set up was \)200, and \(500 was expended to install it. The machine’s useful life was estimated at 10 years, with a salvage value of \)2,500. On June 1, 2016, an essential part of the machine is replaced, at a cost of \(1,980, with one designed to reduce the cost of operating the machine. The cost of the old part and related depreciation cannot be determined with any accuracy.

On June 1, 2019, the company buys a new machine of greater capacity for \)35,000, delivered, trading in the old machine which has a fair value and trade-in allowance of \(20,000. To prepare the old machine for removal from the plant cost \)75, and expenditures to install the new one were \(1,500. It is estimated that the new machine has a useful life of 10 years, with a salvage value of \)4,000 at the end of that time. (The exchange has commercial substance.)

Instructions

Assuming that depreciation is to be computed on the straight-line basis, compute the annual depreciation on the new equipment that should be provided for the fiscal year beginning June 1, 2019. (Round to the nearest dollar.)

Short answer

Depreciation expense for old machine = $3,140

Depreciation expense for new machine = $3,250

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of Straight-line depreciation

Straight-line depreciation is the simplest way to assess depreciation over time.By allocating identical amounts to the asset's accounting periods over its useful life, it makes the asset's expense predictable along with smoothing net income.

Computing annual depreciation by using a straight-line basis

Computing basics of the old machine

June 1, 2015 Purchase	$31,000
Freight	200
Installation	500
Total cost	$31,700

Calculating annual depreciation charge

$$\begin{gathered} \text{Annual\hspace{0.17em}depreciation\hspace{0.17em}charge}=\frac{\text{Cost\hspace{0.17em}of\hspace{0.17em}asset}-\text{Salvage\hspace{0.17em}value}}{\text{Useful\hspace{0.17em}life}} \\ =\frac{\mathrm{\$}31,700-\mathrm{\$}2,500}{10} \\ =\mathrm{\$}2,920 \end{gathered}$$

On June 1, 2016, debit the old machine for $1,980; the revised total cost is $33,680 ($31,700 + $1,980); thus the revised annual depreciation charge is:

$$\begin{gathered} \text{Annual\hspace{0.17em}depreciation\hspace{0.17em}charge}=\frac{\text{Revised\hspace{0.17em}total\hspace{0.17em}cost}-\text{Salvage\hspace{0.17em}value}-\text{Annual\hspace{0.17em}depreciation\hspace{0.17em}charge}}{\text{Remaining\hspace{0.17em}useful\hspace{0.17em}life}} \\ =\frac{\mathrm{\$}33,680-\mathrm{\$}2,500-\mathrm{\$}2,920}{9} \\ =\mathrm{\$}3,140 \end{gathered}$$

Determining book value of old machine

Book value, old machine, June 1, 2019: $[\mathrm{\$}33,680-\mathrm{\$}2,920-(\mathrm{\$}3,140\times 3)]$	$21,340
Less: Fair value	20,000
Loss on exchange	1,340
Cost of removal	75
Total loss	$ 1,415

Note: The above computation is done to determine whether there is a gain or loss from the exchange of the old machine with the new machine and to show how the cost of removal might be reported.

Basic of the new machine

Cash paid	$15,000
The fair value of an old machine	20,000
Installation cost	1,500
The total cost of the new machine	$36,500

Depreciation for the year beginning June 1, 2019

$$\begin{gathered} \text{Depreciation}=\frac{\text{Cost\hspace{0.17em}of\hspace{0.17em}asset}-\text{Salvage\hspace{0.17em}value}}{\text{Useful\hspace{0.17em}life}} \\ =\frac{\mathrm{\$}36,500-\mathrm{\$}4,000}{10} \\ =\mathrm{\$}3,250 \end{gathered}$$