On January 1, 2016, Webb Construction Company overhauled four cranes resulting i

Question

On January 1, 2016, Webb Construction Company overhauled four cranes resulting in a slight increase in the life of the cranes. Such overhauls occur regularly at two-year intervals and have been treated as maintenance expense in the past. Management is considering whether to capitalize this year’s $22,000 cash cost in the Cranes asset account or to expense it as a maintenance expense. Assume that the cranes have a remaining useful life of two years and no expected salvage value. Assume straight-line depreciation.

A.Determine the amount of additional depreciation expense Webb would recognize in 2016 and 2017 if the cost were capitalized in the Cranes account.

B.Determine the amount of expense Webb would recognize in 2016 and 2017 if the cost were recognized as maintenance expense.

C.Determine the effect of the overhaul on cash flow from operating activities for 2016 and 2017 if the cost were capitalized and expensed through depreciation charges.

D.Determine the effect of the overhaul on cash flow from operating activities for 2016 and 2017 if the cost were recognized as maintenance expense.

Explanation / Answer

A.Determine the amount of additional depreciation expense Webb would recognize in 2016 and 2017 if the cost were capitalized in the Cranes account. In case the maintenance expense of $ 22,000 is capitalised, an amount of $ 11,000 per year would be recognised in 2016 and 2017 as additional depreciation. B.Determine the amount of expense Webb would recognize in 2016 and 2017 if the cost were recognized as maintenance expense. In case the expenses are treated as maintenance costs, $ 22,000 would be expensed out in 2016 and no costs would be expensed in 2017. C.Determine the effect of the overhaul on cash flow from operating activities for 2016 and 2017 if the cost were capitalized and expensed through depreciation charges. In case the costs were capitalised and depreciated, the effects on the cash flow would be : In 2016 Capitalisation of $ 22,000 - Treated as outflow from investing activities Depreciation of $ 11,000 - Add back to Net Profit while working cash flow from operating activities In 2017 Depreciation of $ 11,000 - Add back to Net Profit while working cash flow from operating activities D.Determine the effect of the overhaul on cash flow from operating activities for 2016 and 2017 if the cost were recognized as maintenance expense. In case the expenses are treated as maintenance costs, while working out the cash flow from operating activities, no effect whatsoever would appear in the statement of cash flows, since the net profit is worked out after reducing regular expenses, which would include this maintenance cost also.

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