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Chapter 9: Q1FC (page 543)

Jim Reed manages a fleet of utility trucks for a rural county government. He’s been in his job for 30 years, and he knows where the angles are. He makes sure that when new trucks are purchased, the residual value is set as low as possible. Then, when they become fully depreciated, they are sold off by the county at residual value. Jim makes sure his buddies in the construction business are first in line for the bargain sales, and they make sure he gets a little something back. Recently, a new county commissioner was elected with vows to cut expenses for the taxpayers. Unlike other commissioners, this man has a business degree, and he is coming to visit Jim tomorrow.

Requirements

1. When a business sells a fully depreciated asset for its residual value, is a gain or loss recognized?

2. How do businesses determine what residual values to use for their various assets? Are there “hard and fast” rules for residual values?

3. How would an organization prevent the kind of fraud depicted here?

Short Answer

Expert verified

At residual value there would be no gain or loss on the sale of the asset. Residual value is determined based on past experience and by adopting best practices any fraud can be prevented.

Step by step solution

01

Gain/loss on sale at residual value

When assets are sold at their residual value there would be no gain or loss on the sale of the asset. This is so because the difference between the book value and the accumulated depreciation is the residual value that is being received in the firm of cash.

02

Determination of residual value

There is no hard and fast rule for determining residual value. Residual value is determined based on past experience and logical judgment.

03

Prevention of fraud

The fraud in the determination of residual value or estimated life of the asset can be prevented by implying the competitor’s strategy or by adopting the federal depreciation schedule for different classes of assets like MACRS.

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Most popular questions from this chapter

Question: Determining asset cost, preparing depreciation schedules (3 methods), and identifying depreciation results that meet management objectives

On January 3, 2018, Speedy Delivery Service purchased a truck at a cost of \(67,000. Before placing the truck in service, Speedy spent \)3,000 painting it, \(1,200 replacing tires, and \)3,500 overhauling the engine. The truck should remain in service for five years and have a residual value of $5,100. The truck’s annual mileage is expected to be 20,000 miles in each of the first four years and 12,800 miles in the fifth year—92,800 miles in total. In deciding which depreciation method to use, Alec Rivera, the general manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-production, and double-declining-balance).

Requirements

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value.

2. Speedy prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. Consider the first year that Speedy uses the truck. Identify the depreciation method that meets the company’s objectives.

Question:Western Bank & Trust purchased land and a building for the lump sum of $3,000,000. To get the maximum tax deduction, Western allocated 90% of the purchase price to the building and only 10% to the land. A more realistic allocation would have been 70% to the building and 30% to the land.

Requirements

1. Explain the tax advantage of allocating too much to the building and too little to the land.

2. Was Western’s allocation ethical? If so, state why. If not, why not? Identify who was harmed.

Determining the cost of assets Lawson Furniture purchased land, paying \(65,000 cash and signing a \)250,000 note payable. In addition, Lawson paid delinquent property tax of \(5,000, title insurance costing \)4,000, and \(9,000 to level the land and remove an unwanted building. The company then constructed an office building at a cost of \)400,000. It also paid \(54,000 for a fence around the property, \)12,000 for a sign near the entrance, and $8,000 for special lighting of the grounds. Requirements

  1. Determine the cost of land, land improvements, and building.
  2. Which of these assets will Lawson depreciate?

How is gain or loss determined when disposing of plant assets? What situation constitutes a gain? What situation constitutes a loss?

Computing the asset turnover ratio Biagas, Inc. had net sales of \(55,600,000 for the year ended May 31, 2018. Its beginning and ending total assets were \)52,800,000 and $98,500,000, respectively. Determine Biagas’s asset turnover ratio for year ended May 31, 2018.
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