Last year (2013), Richter Condos installed a mechanized elevator for its tenants

Question

Last year (2013), Richter Condos installed a mechanized elevator for its tenants. The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator's speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked the company’s accountant to provide him with cost data on the company’s elevator. This information is presented below.

Explanation / Answer

In replace or retain problems, the equipment which is to be replaced is already installed and all the expenses on purchase of that equipment are sunk cost. So, depreciation on the asset to be replaced is not to be considered in the income statement and depreciation value for comparison purpose will be nil.

On the other hand, a fresh Investment in a new asset due to decision making involves considering depreciation as part of income statement as it is a result of inclusion of a new asset in replacement of the old one and net loss or gain on sale of old asset is to be included to compare the net benefit of replacement.

(1)

If old elevator is retained, the income statement will be as follows:

So, net income is $ 152,231

If old elevator is replaced,

Written down value of old elevator at the beginning of 2014

= Purchase value - Depreciation of one year

= $ 99,750 - 99,750/5

= $ 99,750 - 19,950

= $ 79,800

Loss on Sale

= Written down Value - Sale value

= $ 79,800 - $ 25,854

= $ 53,946

The income statement on replacement is presented below:

So, net income is $ 98117.50

So, the old elevator should not be replaced.

Particulars Amount $ Sales 240,172 Less Costs: Variable Costs 35,403 Fixed Costs 23,706 Selling and Administrative 28,832 Depreciation 0 Net Income 152,231

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