Cash flow from equipment sales

Silverago Incorporated, an international metals company, reported a loss on the sale of equipment of $2 million in 2010. In addition, the company’s income statement shows depreciation expense of $8 million and the cash flow statement shows capital expenditure of $10 million, all of which was for the purchase of new equipment. Using the following information from the comparative balance sheets, how much cash did the company receive from the equipment sale?

Balance Sheet Item

12/31/2009

12/31/2010

Change

Equipment

$100 million

$105 million

$5 million

Accumulated depreciation—equipment

$40 million

$46 million

$6 million

  1. $1 million.
  2. $2 million.
  3. $3 million.

The correct answer is A, but this just doesn’t make any sense to me…

Can anyone please explain how we get A?

A tricky question because the manner the balance sheet items have been presented. In this case, equipment and its accumulated depreciation are separated in 2 different accounts, so we will start from there:

First, explain the variation of equipment account:

Ending value of equip. = Begining value of equip. + gross investment in equip. - _ Historical value of equip. Sold _ … (1)

Note that we subtract historical value of equipment sold because this account is not net of accumulated depreciation. In fact, it is separated from its accum. dep., so we are facing historical values of equipment right here (the tricky part of this question).

Calculating in (1):

105 = 100 + 10 - X

X = 5 >>> So 5 is the historical value of equipment sold

Now, in order to calculate the price at which the equip was sold, we need to know the Book Value of the equipment sold:

Loss = Price Sold - Book Value of equip sold … (2)

The loss is equal to 2 given the question, so how we get book value of the equipment sold?

Book value of equip sold = Historical value of equip sold - Accumulated depreciation of equip sold

BV = 5 - Accum. depreciation of equip sold … (3)

Where we get accum. depreciation of equip sold now? The question provides the data, so we must crunch the numbers as following:

Accumulated depreciation of the whole account of equipment has grown 6 in 2010, but in the Income Statement, depreciation expense is 8. How is this possible?

The balance sheet is reporting accumulated depreciation of equipment in operations, so not considering the equipment sold, but the income statement must report the depreciation expense of all items as of end of year, so it includes the accumulated depreciation of equipment in operation and equipment sold as an expense in that year. When you sell an asset, you recognize the price of the item sold as an income and its whole accumulated depreciation as expense. In this case, the Accum. Dep. of equipment sold is 8 - 6 = 2

Going back to our BV formula (3):

BV = 5 - 2 = 3

Now, going back to our Loss formula (2):

Loss = Price Sold - BV

-2 = Price Sold - 3

Price Sold = 1

Correct answer is A

It is a hard question btw, so don’t panic. This kind of difficulty is not meant for L1 (as far as I know).

Hope this helps.

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