Question

Deutsche Schnitzel, a producer of high quality German baked goods, adopted IFRS in 2005 with the rest of the European Union. Two years ago, DS replaced all of its machinery and decided to record it at fair value rather than historical cost. The purchase price of the machinery (in U.S. dollars) was $1,100,000. In addition, DS spent $75,000 in shipping and installation. Trial runs, including labor, materials, and applicable overhead, came to $50,000. DS assumes that the interest expense from their current loans for the new machinery was $25,000. Assume that DS uses straight line depreciation. The machinery has a 6 year useful life and a salvage value of $225,000. DS records a full year of depreciation in the year of purchase, regardless of when the purchased the asset.

a. Assuming that DS paid cash for the all costs associated with the purchase of the equipment, make the journal entry to record the historical cost of the new machinery.

b. At the end of that first year, the fair value of the machinery was $975,000. Ignoring taxes, make any necessary journal entries for the first year.

c. At the end of the next year, the fair value of the machinery was $900,000. Ignoring taxes, make any necessary journal entries for the second year.

Answer 1

Calculating total cost of the Machinery
Price = $ 1,100,000
Shipping & Installation = $ 75,000
Trial run, labor = $ 50,000
Interest Expense = $ 25,000
Total Cost = $ 1,250,000

a. Journal for purchase of new machinery

Machinery	1,250,000
Cash		1,250,000
(Purchase of new machinery, all expenses are in cash)

Straight line depreciation method is adopted
Life is 6 years
Salvage value = $225,000
Depreciation for 1st year = (1,250,000 - 225,000) / 6 = 1,025,000/6 = $ 170,833.33
Book value of machinery after charging depreciation = 1250,000 - 170,833.33 = $ 1,079,166.67
Fair value = $ 975,000
Difference (or loss) = 1079,166.67 - 975,000 = $104,166.67

b. Journal for Fair value adjustment at the end of first year

Decrease in Fair Value (Income Statement)	104,166.67
Machinery		104,166.67
(Book value of machinery is adjusted with the Fair Value of it)

c. Value of machinery at the 2nd year = $975,000
Life = 5 years
Salvage value = $ 225,000
Depreciation = (975,000 - 225,000)/5 = $150,000
Book value of machinery after charging depreciation = 975,000 - 150,000 = 825,000
Fair value = $900,000
Difference (or Profit) = 900,000 - 825,000 = 75,000

Machinery	75,000
Increase in Fair value (Income Statement)		75,000
(Book value of machinery is adjusted with the Fair Value of it)