Question

gain or loss, and determine ent should be replaced P7 AA (LO 5), S Service Writing At the beginning of last year (2019), Richter Condos installed a mechanized clevator for its tenants. The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator's speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked Problems: Set A 7-35 e company's accountant to provide him with cost data on the company's elevator. This information is resented below. Old Elevator New Elevator Purchase price $120,000 $160,000 Estimated salvage value 0 0 Estimated useful life 5 years 4 years Depreciation method Straight-line hs Straight-line Annual operating costs other than depreciation: Variable $ 35,000 S 10.000 Fixed 23.000 8.500 Annual revenues are $240,000, and selling and administrative expenses are $29.000, regardless of which elevator is used. If the old elevator is replaced now, at the beginning of 2020. Richter Condos will be able to sell it for $25.000 Instructions a. Determine any gain or loss if the old elevator is replaced b. Prepare a 4-year summarized income statement for each of the following assumptions: 1. The old elevator is retained 2. The old elevator is replaced. c. Using incremental analysis, determine if the old elevator should be replaced d. Write a memoto Ron Richter explaining why any gain or loss should be ignored in the decision to replace the old elevator b. 2. NI $539.000 NI increase $23.000

Answer 1

Solution a. Depreciation on old Elevator = (Purchase Price - Salvage Value) / life of asset ($120,000 - 0)/5 $ 24,000.00 Value of Old elevator After Depreciation = $ 120,000 - $ 24000 96,000.00 Selling Price of Old elevator = Loss on sale of Old elevator = $ 25,000.00 $ 96000 - $25000 $ 71,000.00 Depreciation on New Elevator = ($160,000 - 0) / 4 = $ 40,000.00 Solution b.1 The Old elevator is retained $ 9,60,000.00 Revenues ($240,000 x 4 years) Less costs: Variable costs ($ 35000 x 4) Fixed Costs ($ 23000 x 4) Selling & Aministrative ($ 29000 x 4) Depreciation ($ 24000 x 4) $ 1,40,000.00 $ 92,000.00 $ 1,16,000.00 96,000.00 $ $ 4,44,000.00 Net Income $ 5,16,000.00 Solution b.2 The Old elevator is replaced $ 9,60,000.00 Revenues ($240,000 x 4 years) Less costs: Variable costs ($ 10000 x 4) Fixed Costs ($ 8500 x 4) Selling & Aministrative ($ 29000 x 4) Depreciation ($ 40000 x 4) Operating Income Less: Loss on Old elevator $ 40,000.00 $ 34,000.00 $ 1,16,000.00 $ 1,60,000.00 $ 3,50,000.00 $ 71,000.00 Net Income $ 5,39,000.00

Solution b.2 The Old elevator is replaced $ 9,60,000.00 Revenues ($240,000 x 4 years) Less costs: Variable costs ($ 10000 x 4) Fixed Costs ($ 8500 x 4) Selling & Aministrative ($ 29000 x 4) Depreciation ($ 40000 x 4) Operating Income Less: Loss on Old elevator $ 40,000.00 $ 34,000.00 $ 1,16,000.00 $ 1,60,000.00 $ 3,50,000.00 $ 71,000.00 Net Income $ 5,39,000.00 Solution c. Incremental Analysis Particulars Variable Operating costs Fixed Operating costs New elevator Cost Salvage on Old elevator Totals Retain Old Replace Old Net Income Increase Elevator Elevator (Decrease) $ 1,40,000.00 $ 40,000.00 $ 1,00,000.00 $ 92,000.00 $ 34,000.00 $ 58,000.00 $ $ 1,60,000.00 $ -1,60,000.00 $ -25,000.00 $ 25,000.00 $ 23,000.00 Solution d. To: Ron Richer From: Accountant Date: Jan, 2020 Subject: Exclusion of Gain or Loss on replacement of Elevator This to explain that the loss attributable on sale of Old elevator for $25000 having a book value of $96000 come to $71000. This loss is in the nature of Capital loss, hence should not be considered as a part of decision making of replacing the old elevator.