Problem: Long-Term Asset Acquisition

Emmett & Gracie (E & G) is considering a significant equipment replacement. E & G would like to replace some of their equipment before December 31, 2016. The equipment originally cost $840,000 and the equipments accumulated depreciation balance at the end of 2015 is will be $790,000. At this point the equipment is depreciated to its salvage value.Your long-term asset accountant, Joe, 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 7 years.

E & G would like you to analyze option 1 to determine the financial impact of each decision and any non-financial considerations that may result from each decision.

Option 1:Construct the new equipment in-house and sell the old equipment for cash at a fair value of $60,000. E & G would take out a one-year construction loan for $900,000 at the time construction begins at a short-term borrowing rate of 10% for the construction. Anticipated actual expenditures for constructing the equipment are $980,000, and on a weighted-average basis the expenditures are approximately $625,000. The bulk of the $980,000 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 year-end of 2016.)

Instructions: (A) Prepare jounral entries in general journal form for option 1 and (B) explain on how option 1 affects the finacial statments and the strengths and weakness of this option.