Depreciation methods of the printing equipment, straight line, units-of-product and reducing balance

Question 1

Recording non-current asset transactions, exchange, disposal and revaluation The accounts of Harvey Pty Ltd (Harvey) include Land, Buildings and Equipment. Harvey has a separate accumulated depreciation account for each asset. During the 2016 financial year, the business completed the following transactions: 2015 July 1 Traded in printing equipment with accumulated depreciation of $80 000 (cost of $120 000) for similar new printing equipment with a cash cost of $186 000. Harvey received a trade-in allowance of $50 000 on the old equipment and paid the remainder in cash. 2016 Jan 1 Sold a building that cost $550 000 and that had accumulated depreciation of $250 000 up to 30 June 2015. Harvey received $100 000 cash, with the balance of $200 000 as a loan receivable.

Depreciation is calculated on a straight-line basis. The building has a 40-year useful life and a residual value of $50 000. Jan 31 Purchased land and a building for a lump-sum payment of $300 000. An independent expert valued the land at $105 000 and the building at $210 000. Jun 29 Revalued the recently purchased land to a figure of $105 000. The building wasn’t revalued. Jun 30 Recorded depreciation as follows: Printing Equipment has an expected useful life of 1 million units of output or 10 years and an estimated residual value of $20 000. Depreciation is units of production. During the year, Harvey produced 150 000 units of output. 2 / 3 Depreciation on buildings is straight line. The new building has a 40-year useful life and a residual value equal to $50 000.

Required:

1. Record the transactions in Harvey’s journal. Journal entries should have relevant date, narration. Show all workings separately. (8 marks)

2. Compare the depreciation methods of the printing equipment, i.e. straight line, units-of-product and reducing balance, answer the following questions (in about 150 words each question):

a) Which depreciation method produces the highest profit in year 1? In year 6? If it’s not the same profit for each year, why not? (2 mark)

b) Which depreciation method would the business prefer for tax purposes? Why?

c) Which method would the business prefer for reporting to bankers and creditors? Why? What if the business wanted to change methods after two years? (2 marks)

Question 2 McLaren’s Kids, a non-profit organization that provides aid to low-income families and special-needs children. They have some investments, including a commercial building. The building is on a 30-year, 5% mortgage. The mortgage requires monthly payments of $3 000. McLaren’s bookkeeper is preparing financial statements for the board and, in doing so, lists the mortgage balance of $287 000 under current liabilities because the board hopes to be able to pay the mortgage off in full next year. If McLaren’s pays according to the mortgage agreement, $20 000 of the mortgage principal will be paid next year.

Required: The board members call you, their trusted accounting adviser, to advise them on how McLaren’s Kids should report the mortgage on its balance sheet. The board would also like to know the effect of too much debt on their stakeholders. Provide your recommendation and discuss the reason for your recommendation. (About 500 words) (6 marks)