ACCT495 Final Project Part 2 Fall 2019 Assignment

Long-Term Asset Acquisition

Bruce and Emmett (B & E) is considering a significant equipment replacement. B & E would like to replace some of their equipment before December 31, 2019. The equipment originally cost $500,000 and the equipments accumulated depreciation balance at the end of 2019 is will be $450,000. At this point the equipment is depreciated to its salvage value.

Your long-term asset accountant, Boris, tells you about four equipment options as follows:

- construct new equipment and sell the old equipment,

- exchange the old equipment for new equipment that is more efficient,

- purchase new equipment that is more efficient and sell the old equipment, or

- overhaul the old equipment.

The estimated life of any new equipment is 5 years.

All loans would start as of January 1, 2019

B & E would like you to analyze the four options to determine the financial impact of each decision and any non-financial considerations that may result from each decision. Additional information about each option is presented below:

Option 1: Construct the new equipment in-house and sell the old equipment for cash at a fair value of $60,000. B & E would take out a one-year construction loan for $500,000 at the time construction begins at a short-term borrowing rate of 10% for the construction Anticipated actual expenditures for constructing the equipment are $580,000. The bulk of the $580,000 will be financed with the construction loan, and the balance will be financed through accounts payable. The interest on the short-term note is due and payable by year-end. (Note: Construction is assumed to be completed at December 31,2019.)

Option 2: Exchange the equipment for a similar piece of equipment with a fair value of $600,000. The fair value of the old equipment is $60,000. B & E can borrow $540,000 on a one-year, 10% note. the balance will be funded with an accounts payable arrangement with the supplier. (Assume the exchange has commercial substance.)

Option 3: Purchase the new equipment by giving a non-interest-bearing note with five payments of $120,000 to the supplier (starting on the first day of notes term and each year thereafter) and selling the old equipment for $60,000 cash. The first $120,000 payment would be made in late December 2019. The prevailing interest rate for obligations of this nature is 10%.

Option 4: Overhaul the existing equipment. The following expenses are anticipated under this approach: (1) The normal annual cost for lubrication and replacement of minor parts to maintain the integrity of the exterior body would be $30,000. (2) The cost of re-wiring interior components in an overhaul would be $150,000. (3) Replacing old worn components would cost $100,000 with associated labor costs of $210,000 for installation. The overhaul is estimated to extend the useful life of the equipment another four years. (The present equipments original useful life was eight years, starting January 1, 2014) The costs will be financed through the end of 2019 with a one-year loan at a 10% interest rate.

(D) At the next management team meeting, Bruce & Emmett express some concern that any new equipment acquired to replace the old equipment may become obsolete within the next three to six years. Bruce & Emmett want to know how the accounting rules for impairments would apply to any new equipment. Research the accounting literature (e.g., access the FASB Codification), to determine the official guidance for information on impairments including the timing and calculation of the amount. Be sure you describe the reasons for recording impairments and how recording any impairment actually can benefit the financial statements.

Here are the journal entries

Table 1

Journal Entries for Option 1

Date	Accounts	Debit	Credit
12/31/18	Bank	60,000
	Equipment		50,000
0	Profit / Loss		10,000
1/1/19	Bank	500,000
	Construction Loan		500,000
12/31/19	New Equipment	580,000
	Bank		500,000
	Notes Payable		80,000
12/31/19	New Equipment	58,000
	Construction Loan		50,000
	Notes Payable		8,000

Note: Example journal entries if B&E decided to take out a one-year note for $580,00 that had a 10 percent interest rate so that they could build the new equipment while selling the old equipment for cash.

Table 2

Journal Entries for Option 2

Date	Accounts	Debit	Credit
1/1/19	New Equipment	600,000
	Old Equipment		60,000
	Notes Payable		540,000
12/31/19	New Equipment	54,000
	Notes Payable		54,000
12/31/19	Depreciation	130,800
	Provision for Depreciation		130,800

Note: Example journal entries if B&E decided to take out a one-year note for $540,000 with a 10 percent interest rate and then exchange their old equipment, valued at 60,000 for a piece of new equipment.

Table 3

Journal Entries for Option 3

Date	Accounts	Debit	Credit
12/31/18	Bank	60,000
	Old Equipment		50,000
	Profit / Loss		10,000
1/1/19	New Equipment	600,000
	Notes Payable		600,000
12/31/19	Notes Payable	120,000
	Bank		120,000
12/31/19	New Equipment	120,000
	Provision for Depreciation		120,000

Note: Example journal entries if B&E decided to take out a non-interest-bearing note that has five payments of $120,000 with a 10 percent interest rate, while also selling their old equipment for $60,000.

Table 4

Journal Entries for Option 4

Date	Accounts	Debit	Credit
1/1/19	Repair & Maintenance Expenses	490,000
	Loan		490,000
12/31/19	Interest on Loan	49,000
	Profit / Loss		49,000

Note: Example journal entries if B&E decided to overhaul the equipment and take out a one-year loan for the maintenance fees with a 10 percent interest rate which would then extend the machines life by an additional four years.