Question

Assume Southern Coper Corporation (SCCO) acquired mining equipment for $100,000 cash on January 1,2016. The equipment had an expected useful life of four years and zero salvage value. SCCO calculates depreciation using the SL method over the remaining expected useful life in all cases. On dec.31, 2016 after recognizing deprecation for the year,  SCCO learns that new equipment now offered on market makes the purchased equipment partially obsolete.     The market value of the equipment on Dec.31, 2016, reflecting this obsolescence, is $60,000. The expected useful life does not change. On Dec,31, 2017, the market value of the equipment is $48,0000. SCCO sells the equipment on Jan. 1, 2019 for 26,000

Required:

Assume for this part that SCCO accounts for the equipment using Historical cost adjusted for depreciation and impairment losses. Using the analytical framework discussed, indicate the effects of the following events on BS and IS.

Acquisition of the equipment foe cash on Jan.1,2016.

Depreciation for 2016

Impairment loss for 2016

Depreciation 2017

Depreciation 2018

Sale of equipment on January 1,2019.

Assume that SCCO accounts for the equipment using current fair market values adjusted for depreciation and impairment losses (with changes in fair values recognized in net income). Using the analytical framework discussed, indicate the effects of the following events on BS and IS

1. Acquisition of the equipment foe cash on Jan.1,2016.

            2. Depreciation for 2016

            3. Impairment loss for 2016

            4. Depreciation 2017

            5. Recognition of unrealized holding gain or loss for 2017

            6. Depreciation 2018

            7. Recognition of unrealized holding gain or loss for 2018

            8. Sale of equipment on January 1, 2019.

C.  After the equipment is sold, why is retained earning on Jan. 1, 2019, equal to negative   

      $74,000 in both cases despite having shown a different pattern of expenses, gains,

      and losses over time?

Question Number 2

Effect of Valuation Method for Monetary Asset on Balance Sheet and Income

Statement.

Assume Walmart acquires a tract of land on Jan.1, 2016, for $100,000 cash. On Dec. 31,  2016, the current market value of the land is $150,000. On Dec. 31,2017, the current market value of land is 120,000 The firm sells the land on Dec.31, 2018, for $180,000 cash.

Assume that Walmart has accounted for the value of the land at acquisition cost and sells land on Dec. 31, 2018, for a two year note receivable with present value of $180,000 instead of for cash, the note bears interest at 8% and requires cash payments of $100,939 on Dec. 31, 2019 and 2010. Interest rates for notes of this risk level increase to 10% on Dec.31, 2019, resulting in a market value for the note date of $ 91,762.

Required

Ignore income taxes. Indicate the effect on BS and IS of the preceding information for 2018, 2019, and 2020 under each of the following valuation methods.

Valuation of the note at the present value of future cash flows using the historical market interest rate of 8% (Approach 1):

Valuation of the note at the present value of future cash flows, adjusting the note to fair  

value upon changes in market interest rates and including unrealized gains and losses in      net income (Approach 2).

Why is retained earning on Dec.31, 2020, equal to $101,878 in both cases despite the reporting of different amounts of net income each year?

Answer 1

Acquisition of asset on jan 2016.

1.Asset - dr $100000

to cash $100000

this transaction only affects the balance sheet

2.depreciation for 2016 SL method

(100000-salvage value)/ 4yrs = $25000depreciation of $25000 is an expense in the Income and expenditure statement and depreciation of 25000 is reduced from asset value of $100000 on 31dec 2016. WDV of asset in BS IS 100000-25000=$75000

3.Market value of asset on 31 dec 2016 is $ 60000. WDV of asset as on 31dec 2016 is $ 75000. Hence impairment loss = 75000-60000= $5000 impairment loss will be shown as a loss in Income statement and asset book value will be reduced in the balance sheet

4. depreciation for 2017

wdv of asset as on 1Jan 2017 = $ 60000

remaining life of asset =3 years

depreciation on SL method for 2017 = 60000/3= $20000 Depreciation is calculated on the new carrying cost of the impaired asset for the remaining useful life of the asset

6. Depreciation 2018

wdv of asset as on 1 JAN 2018 =60000-20000= $40000

depreciation on SL method for 2018 = $20000

sale of asset on jan 1 2019

wdv on 1 Jan 2019 = 40000-20000= $ 20000

sale price = $ 26000

profit on sale of assert = 26000-20000=$6000

this profit on sale will be reflected as income in Income statement. and asset will be nil in balance sheet as it is sold.

if SCCo accounts for asset according to current market value then workings for depreciation of 2016 and impairment loss for 2016 remain same as above.

4. depreciation for 2017

market value on 31dec 2017= $ 48000( i have assumed that amount given in the question $ 480000 is a typo and taken it as $ 48000) .

depreciation on SL method= 48000/2 yrs( remaining useful life)=$ 24000

4. unrealized gain for 2017

WDV of asset on 31 dec 2017 = $ 40000

market value on 31 dec 2017 = $ 48000

5.unrealized gain = 48000-40000= $ 8000

this gain is reflected in the Income statement

6. depreciation 2018 = $ 24000

8. sale of asset on 1 jan 2019

WDV on 1 Jan 2019 = nil

sale price = $26000

profit = $ 26000 to be recognized as income in the income statement . balance sheet will show nil asset