Question

Capital Expenditures, Depreciation, and Disposal

Merton Company purchased a building on January 1, 2015, at a cost of $367,000. Merton estimated that its life would be 25 years and its residual value would be $11,000.

On January 1, 2016, the company made several expenditures related to the building. The entire building was painted and floors were refinished at a cost of $19,000. A federal agency required Merton to install additional pollution control devices in the building at a cost of $48,000. With the new devices, Merton believed it was possible to extend the life of the building by six years.

In 2017, Merton altered its corporate strategy dramatically. The company sold the building on April 1, 2017, for $396,000 in cash and relocated all operations to another state.

Required:

1. Determine the depreciation that should be on the income statement for 2015 and 2016.
Indicate the effect on financial statement items by selecting "–" for decrease (or negative effect), "+" for increase (or positive effect) and "NE" for No Entry (or no effect) on the financial statement.

2. Explain why the cost of the pollution control equipment was not expensed in 2016.

1. The asset was capitalized because it provided a current year tax advantage.
2. Since the pollution control equipment has an unknown life, the asset was capitalized.
3. Since the pollution control equipment extended the life of the asset, the asset was capitalized.
4. Extending the life of the asset makes no difference on whether to expense or capitalize, so the company chose to capitalize it for lower taxes in the current year.

3. What amount of gain or loss did Merton record when it sold the building? Do not round intermediate calculations.

What amount of gain or loss would have been reported if the pollution control equipment had been expensed in 2016?

Answer 1

Answer :-

1. The depreciation that should be on the income statement for 2015 and 2016 :-

Depreciation expense for the year 2015 :-

Steps
Cost of building	$367,000
LESS : Residual value	$11,000
Cost ( Depreciable )	$356,000	$367,000 - $11,000
Useful years	25
Depreciation expense	$14,240	$356,000 divided by 25

Depreciation expense for the year 2016 :-

Step 1 :-
Cost of building	$367,000
LESS :Depreciation expenses (2015)	$14,240
Book value	$352,760	$367,000 - $14,240
ADD : Additional Cost	$48,000
Revised cost	$400,760	$352,760 + $48,000
Step 2 :-
Revised cost	$400,760
LESS : Residual value	$11,000
Cost ( Depreciable )	$389,760	$400,760 - $11,000
Revised Useful years	30
Depreciation expense	$12,992	$389,760 divided by 30

Note :- Useful life of building = 25 years - 1 year = 24 years. Then, installation useful years = 6 years .

24 + 6 years = 30 years.

2. The cost of the pollution control equipment was not expensed in 2016 because it increases the life by six years so it is capitalized asset's cost and it is benefial for the assets.

Which is Option C is correct

Option A is incorrect because it doesn't provided a current year tax advantage.

Option B And D is also incorrect because they have no choice and no role as pollution control in unknown life .

3. (A)  Amount of gain or loss did Merton record when it sold the building :-

Revised cost	$400,760
LESS : Depreciation expenses for 2016	$12,992
Book value on jan 2017	$387,768	$400,760-$12,992
LESS : Depreciation expenses for 2017	$3,248
Book value on Apr 2017	$384,520	$387,768-$3,248
Sale of building	$396,000
Profit / Gain on sale	$11,480	$396,000 - $384,520

Working note :- Depreciation expenses for 2017 = $12,992 /12 months * 3 months ( Jan to Mar ) = $3247.99.

(B)  Amount of gain or loss would have been reported if the pollution control equipment had been expensed in 2016 :-

Cost of the building	$367,000
LESS : Depreciation expenses for 2015 and 2016	$27,232	$12,992 +$14,240
Book value on jan 2017	$339,768	$367,000-$27,232
LESS : Depreciation expenses for 2017	$3,248
Book value on Apr 2017	$336,520	$339,768 - $3,248
Sale of building	$396,000
Profit / Gain on sale	$59,480	$396,000 - $336,520