Question

Week 1 Tea Tree Bay Ltd acquires a Gizmo Machine from Jetsons Ltd for the following consideration: Cash $20,000 Land In the books of Tea Tree Bay Ltd the land is recorded at its cost of $100,000. It has a fair value of $140,000. Equipment: In the books of Tea Tree Bay Ltd the equipment is recorded at a cost of $50,000. The equipment has an accumulated depreciation balance of $20,000. The fair value of the equipment is $23,000 Assumption of liability Tea Tree Bay Ltd also agrees to assume the liability of Jetsons Ltd's bank loan of $30,000 as part of the Gizmo Machine acquisition. Other associated costs Tea Tree Bay Ltd also spend $5,000 as the installation cost. Testing cost was $2,500. Transportation cost for the machine was $700. During first year of operation, the company paid $650 as the maintenance cost for the machine. Required: a) Calculate the acquisition cost of the Gizmo Machine that will be used as the base for future depreciation charge. (3 marks) b) Provide the journal entries that would appear in Tea Tree Bay Ltd's books to account for the acquisition of the Gizmo Machine. (5 marks) c) Will the maintenance cost be included in the acquisition cost of the machine? Justify your answer. (2 marks, maximum 100 words)

Answer 1

a.

Particulars	Fair Value
Cash	20000
Land	140000
Equipment	23000
Value of assumed liability	30000
Total acquisition cost	213000

b.

Account	Debit	Credit
Plant & Machinery - Gizmo Machine	213000
Land		100000
Profit on disposal of land		40000
Bank Loan		30000
Equipment		23000
Cash		20000

c. The amounts which are incurred to bring the asset to its current position are included in the cost of machine. When the life on the asset is extended or the output of the asset is increased, the amounts incurred in such relation are also capitalized. All other costs are to be expensed to profit and loss account. In given case, maintenance costs are not incurred to bring the asset to its current position. Neither it increases the life expectancy nor the output from the asset. Thus it is not included in the cost of asset.