CASE STUDY: TOPIC 4 (II) DEPRECIATION AND DERECOGNITION

Phuong has decided to go ahead with the purchase of the group of assets he had located in the previous case study as it will allow him to diversify his production but limit the amount he needs to borrow to achieve this.

The journal entries below represent Phuong's purchase of the assets.

July 1: Inventory 6,000 DEBIT, Sauce unit 15,028 DEBIT, Bottling plant 20,332 DEBIT, Warehouse & Land 53,040 DEBIT, Sundry Creditor/cash 94,400 Credit (to record the acquisition of this group of assets)

Phuong has reviewed the other assets he currently owns and has compiled the following information as at 30 June this year (prior to making this acquisition)

Oven 2,000 Debit, Acc. Dep'n Oven 526 Credit, Office Equip 600 Debit, Acc. Dep'n Off Equip 99 Credit, Refrigerator 2,500 Debit, Acc. Dep'n Refrigerator 694 Credit, Delivery Van 27,500 Debit.

Depreciation for these assets is calculated by the straight-line method. The oven is expected to have a useful life of 10 years with a scrap value of $300. The refrigerator is expected to be useful for 10 years with a scrap value of $250, and the office equipment is expected to last 5 years and have no residual value. Phuong is happy to keep using this data for the foreseeable future. The Delivery Van will have a residual value of $2000 and a useful life of 5 years.

Phuong has asked for your help on how to depreciate the assets he has recently acquired.

Required

1. Discuss which methods of depreciation would be appropriate for the new assets acquired given the following information

A) The inventory is in good condition and Phuong believes there is no risk of obsolescence in the foreseeable future.

B) The Bottling Plant is capable of cleaning and filling 160,000 bottles. It is expected the plant will last for another 6 years at which stage it should have a scrap value of $332.

C) The sauce unit is an older model. Phuong has checked with some of his associates and they believe the equipment should run for at least 7 more years but in 4 years it will become technically obsolete. After 4 years it will only be able to be sold as scrap for $778.

D) The warehouse is in very good condition and should last at least 10 years at which time it could be knocked down for a cost of $3,000 and the land could be sold for an estimated $80,000.

Make sure you include arguments for the methods you have chosen for the above assets in your answer.

2. Following some further discussions with Phuong it has been decided that the following depreciation methods will be employed

A. Bottling Plant - Units of Use Method based on the information provided above. Usage is 16,000 bottles in the first year of use and 26,000 bottles in the following year

B. Sauce Unit Reducing Balance at a rate of 45%.

C. Warehouse Straight Line Rate based on the information provided above and assuming the fair value of the land accounted for 60% of the cost of the package.

Show the General Journal entries to record the depreciation expense on all assets Phuong now has control of for this year.

3. Due to changes in legislation Phuong can no longer use his refrigerator. The gasses it emits are considered Toxic and Phuong must dispose of this unit. The government is offering a $300 compensation payout to encourage people to dispose of their refrigerators in a safe way. After all the help you have given him Phuong has calculated the following

Refrigerator- 2,500

Accumulated Dep- 919 1,581

As the government will only pay him $300 Phuong is quite angry that he will now have to record a loss of more than $1000. Phuong thinks you have done a horrible job of teaching him about depreciation. Explain to Phuong why the figures he has calculated are correct and remind him of the purpose of depreciation and the incorrect association he has made with the current market value.

4. Explain whether purchased Goodwill should be depreciated or not. Outline and compare the pre - January 2005 treatment of Goodwill with current requirements.

5. Now Phuong has taken over he believes his reputation as manager has increased the value of the business. He would like his balance sheet to reflect this fact and has asked you to make the appropriate entries.

Unfortunately it has become obvious that Phuong had forgotten one of the key things he learned in his study at UniSA about decision making. In deciding to purchase the Standard Diesel Delivery Van Phuong did not adequately assess his goals or consider all of the consequences involved with purchase. While the van itself operates well Phuong has realised there is a strong consumer desire for environmentally friendly products and a number of Phuongs clients are concerned about the pollution his van produces.

It has become clear to Phuong now that he would have been better off purchasing the EcoFood Electric Van. Given that he will now be disposing of the diesel van Phuong has re-evaluated the usefulness of the rest of his assets and also provided you with the following information based on the calculations he had performed to the end of the last financial year. Phuong will continue to use the depreciation rates established in this case study.

oven	2,000
Acc. Dep'n Oven		696	1,304
Office Equip	600
Acc. Dep'n Off Equip		219	381
Refrigerator	2,500
Acc. Dep'n Refrigerator		919	1,581
Delivery Van	27,500
Accumulated Depreciation Delivery Van		5,100	21,900
Sauce Unit	15,028
Accumulated Depreciation Sauce Unit		6,762.60	8,265.40
Bottling Plant	20,332
Accumulated Depreciation Bottling Plant		2,000	18, 332
Warehouse	24,216
Accumulated Depreciation Warehouse		2,421.60	21,794.40

In addition to trading in the delivery van, Phuong also needs to account for the disposal of the refrigerator which is now illegal and he has decided that he is not making efficient use of the oven at present and has arranged to exchange it with another business that can make use of it for a second hand laptop that he can track his various booking with. The details of the transactions are listed on the next page.

Required

6. Provide the General Journal entires for Phuongs disposal of the assets as per the transactions listed below, using the net method of recording disposals. The net method does not account for the Carrying Amount and Proceeds from sale separately, instead showing only the Gain/Loss.

A. As Phuong stated in the last case study he was only able to receive $300 for his obsolete Refrigerator. The removal took place on July 2.

B. On September 15 Phuong was able to make a satisfactory trade in for his old delivery van and took control of his new. The new Van has a list price of $32,000, but Phuong needed some modifications made in order for him to use it in the same way as his old van. Phuong was able to reuse the GPS Navigation Unit but had to arrange for new suspension and specially designed electric refrigeration and heating unit. The cost of these additional items was $7,800. Phuong has maintained his old van well and was able to arrange for a trade-in of $20,000 on that van.

C. Phuong is also quite excited by the fact he has managed to get what he believes is a real bargain on the second hand laptop. He has checked out similar models on E-Bay and found they are all selling for approximately $2100. Phuong has also managed to establish that the market value of his oven is only $500 at present and he is looking forward to recording a nice little profit on this transaction. The exchange will take place on December 28.

7. Show the General Journal entries to record the depreciation expense on all assets Phuong now has control of at the end (30 June) of this year.

A. The new EcoFood Electric Van is able to track the exact number of kilometres travelled on each trip by linking up with the GPS system and download that data to Phuongs new laptop. As a result Phuong has decided to use the units of production method to depreciate the van. After getting some expert advice Phuong believes that the van will be able to travel and average of 15,000 km each year for the next 6 years. At that time he should be able to sell the van for $3,800.By June 30 Phuong had travelled 8,320 km.

B. The laptop being second hand and only having a short useful life Phuong has decided to depreciate it rather quickly using the diminishing balance at a rate of 30%.