Question

On January 1, Year 1, Webb Construction Company overhauled four cranes, resulting in a slight increase in the life of the cranes. Such overhauls occur regularly at two-year intervals and have been treated as a maintenance expense in the past. Management is considering whether to capitalize this year’s $28,420 cash cost in the Cranes asset account or to expense it as a maintenance expense. Assume that the cranes have a remaining useful life of two years and no expected salvage value. Assume straight-line depreciation.

Required
a. Determine the amount of additional depreciation expense Webb would recognize in Year 1 and Year 2 if the cost were capitalized in the Cranes account.
b. Determine the amount of expense Webb would recognize in Year 1 and Year 2 if the cost were recognized as maintenance expense.
c. Determine the effect of the overhaul on cash flow from operating activities for Year 1 and Year 2 if the cost were capitalized and expensed through depreciation charges.
d. Determine the effect of the overhaul on cash flow from operating activities for Year 1 and Year 2 if the cost were recognized as maintenance expense.

Answer 1

a.

Depreciation under Straight line would be equal for all years

Depreciation under straight-line method=(Cost-Salvage value)/Useful life=(28420-0)/2=$ 14210

Additional depreciation expense:

Year 1

14210

Year 2

14210

b.

Expense will be recognized in the year expense is incurred.In this case, only in year 1.

Maintenance expense:

Year 1

28420

Year 2

0

c.

Depreciation will have no effect on cashflow from operating activities since depreciation is a non-cash expense

d.

In year 1,

Maintenance expense will reduce the cashflow from operating activities by $ 28420

In year 2,

Maintenance expense will have no effect on cashflow from operating activities since maintenance expense for year 2 is 0.