Question

Week 1

Tea Tree Bay Ltd acquires a Gizmo Machine from Jetsons Ltd for the following consideration:

Cash $20,000

Land In the books of Tea Tree Bay Ltd the land is recorded at its cost of $100,000. It has a fair value of $140,000.

Equipment: In the books of Tea Tree Bay Ltd the equipment is recorded at a cost of $50,000. The equipment has an accumulated depreciation balance of $20,000. The fair value of the equipment is $23,000

Assumption of liability

Other associated costs

Tea Tree Bay Ltd also agrees to assume the liability of Jetsons Ltd’s bank loan of $30,000 as part of the Gizmo Machine acquisition.

Tea Tree Bay Ltd also spend $5,000 as the installation cost. Testing cost was $2,500. Transportation cost for the machine was $700.

During first year of operation, the company paid $650 as the maintenance cost for the machine.

Required:

a) Calculate the acquisition cost of the Gizmo Machine that will be used as the base for future

depreciation charge.

b) Provide the journal entries that would appear in Tea Tree Bay Ltd’s books to account for the

acquisition of the Gizmo Machine.

c) Will the maintenance cost be included in the acquisition cost of the machine? Justify your answer.

Answer 1

Answer (a)

Calculation of the acquisition cost of the Gizmo Machine that will be used as the base for future depreciation charge:

Particulars	Calculation	Amount in $
Cash		20,000
Land		140,000
Equipment		23,000
Assumption of Liability		30,000
Other associated cost	$5,000+$2,500+$700	8,200
Acquisition cost of Gizmo Machine		221,200

Answer (b)

In the books of Tea Tree Bay Ltd

              Journal Entries

                                                                                                 (in $)

Date	Particulars	Debit	Credit
	Gizmo Machine A/C                                                   DR.	221,200
	Accumulated Depreciation of equipment A/C      DR.	20,000
	To Cash A/C		20,000
	To Land A/C		100,000
	To Equipment A/C		50,000
	To Jetsons Ltd’s bank loan		30,000
	To installation cost A/C		5,000
	To Testing cost A/C		2,500
	To Transportation Cost A/C		700
	To Profit on exchange of asset A/C		33,000
	(Being Gizmo machine acquired in exchange of assets)

Answer (c)

Asset or capital improvements are undertaken to enhance or improve a business asset that is in use. The cost of the improvement is capitalized and added to the asset’s historical cost on the balance sheet. Since the cost of the improvement is capitalized, the asset’s periodic depreciation expense will be affected, along with other factors used in calculating depreciation.

On the other hand, regular maintenance expenses are made to maintain an asset’s functionality, which are regarded as period costs that are expensed on the income statement and reduce income for the period. An improvement is capitalized and a maintenance charge is expensed from a reporting perspective. Thus, maintenance cost should not be included in the acquisition cost of the machine.

substantial maintenance costs, which are expensed on the income statement and reduce an accounting period’s income.