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:

1. construct new equipment and sell the old equipment,
2. exchange the old equipment for new equipment that is more efficient,
3. purchase new equipment that is more efficient and sell the old equipment, or
4. 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.

Write a brief memo on how each option affects the financial statements. Include your journal entry(ies) in the body of your memo for each option. Discuss the strengths and weaknesses of each option.

Debits Credits Date Option 1 Particulars Construct the new equipment in-house and sell the old equipment for cash at a fair value of $60,000. $ 60,000 12/31/2018 Bank Equipment Profit & Loss "To record the old equipment sold and profit on sale accounted for" $ $ 50,000 10,000 $ 500,000 1/1/2019 Bank Construction Loan "To record construction loan received" $ 500,000 $ 580,000 12/31/2019 New Equipment Bank Notes Payable "To record construction of new equipment completed" $ $ 500,000 80,000 $ 58,000 12/31/2019 New Equioment Construction Loan Notes Payable "To record interest on construction loan and notes payable Capitalized to the new equipemnt at year end" $ $ 50,000 8,000 Option 2 Exchange the equipment for a similar piece of equipment with a fair value of $600,000. $ 600,000 1/1/2019 New Equipment Old Equipment Notes Payable "To record rxchange of old equipemnt with a new equipent and balance exchange proce to be paid by notes" $ 60,000 $ 540,000 $ 54,000 12/31/2019 New Equipment Notes Payable "To record interest on notes payable for one year @ 10% capitalized" $ 54,000 $ 130,800 12/31/2019 Depreciation Provision for Depreciation "To record depreciation for the first year accounted for considiring useful life of 5 year" $ 130,800 Option 3 Purchase the new equipment by giving a non-interest-bearing note $ 60,000 12/31/2018 Bank Old Equipment Profit & Loss "To record old equipment disposition and profit on sale of old equipment" $ $ 50,000 10,000 $ 600,000 1/1/2019 New Equipment Notes Payable "To record new equipment purchased through Non interest" $ 600,000 $ 120,000 12/31/2019 New Equipment Provision for Depreciation "To record provision of Depreciation" $ 120,000 $ 120,000 12/31/2019 New Equipment Provision for Depreciation "To record depreciation for the first year accounted for" $ 120,000 Option 4 Overhaul the existing equipment $ 490,000 1/1/2019 Repair & Maintenance Loan "To record overhaul expenses accured for old equipment" $ 490,000 $ 49,000 12/31/2019 Interest On Loan Profit & Loss To record interest on loan of $490,000 @10% $ 49,000