Question

On 1 January 20X1, Baker Ltd (“BL”) purchases an oven at a cost of $7,800. BL expects the oven to remain useful for four years. At the end of four years, the supplier is willing to take back the oven for $400. BL pays 20% in cash for the oven and finances the remainder with a bank loan obtained on the same day. The bank charges 5% interest on the loan and interest is to be paid subsequently every 1 January. The first interest payment is on 1 January 20X2. The company uses the straight-line method to account for depreciation of the oven.

Required:

(a) Illustrate the accounting described above by preparing journal entries, journal narratives required, for 1 January 20X1 and 31 December 20X1.

(b) At the end of year 20X2, BL disposes the oven to another company for cash of $3,000. Illustrate how gains or losses on disposal of the oven would be different if BL had used the double-declining method to account for the oven’s depreciation? Support your answer with appropriate computations.

Answer 1

(A) Journal entries

Date	Particulars	Debit	Credit
1 January 20X1	Oven	$7,800
	Cash		$7,800
	(Being Purchased oven paid 20% cash and remaining with bank loan taken)
1 January 20X1	Cash	6,240
	Bank loan		6,240
	(Being 80% of cost of oven taken as loan)=$7,800*80%=$
31 December 20X1	Depreciation- Oven	1,850
	Accumulated depreciation- Oven		1,850
	(Being depreciation on oven recorded) Straight line depreciation =( $7,800-400)4 years = $1,850
31 December 20X1	Interest expenses	312
	Interest payable		312
	(Being interest on bank loan) = $6,240 *5% =$

(B) At the end of 31 December 20X2

With straight-line depreciation:

WDV = $7,800 – (1,850*2) = $4,100

Sold at $3,000

Loss = $4,100-3,000 = $1,100

Loss = $1,100

With Double declining method:

Depreciation = 100%/4*2 = 50%

WDV 1^st year = $7,800 – (7,800*50%) = $3,900

WDV 2^nd year = $3,900 – (3,900*50%) = $1,950

Gain = $3,000 – 1,950 = $1,050

Gain = $1,050

With straight-line depreciation, loss is $1,100 but In case of double declining method, gain of $1,050 would be recorded.

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