Example 9 from Reading 22 Long-lived assets. I could not understand this one part.
CUTITUP Co., a hypothetical company, purchases a milling machine, a type
of machine used for shaping metal, at a total cost of $10,000. $2,000 was estimated
to represent the cost of the rotating cutter, a significant component of
the machine. The company expects the machine to have a useful life of eight
years and a residual value of $3,000 and that the rotating cutter will need to be
replaced every two years. Assume the entire residual value is attributable to the
milling machine itself, and assume the company uses straight-line depreciation
for all assets.
Assuming replacement of the cutter every two years at a price of $2,000,
what is the total depreciation expense over the eight years if the company does not use the component method?
Solution to 3:
When the component method is not used, the total depreciation expense will also be $13,000 [$875 × 2 years + $1,875 × 6 years].
Please explain the 875 X 2 years + 1875 X 6 years How do we arrive at this?
Thank you for considering my request and responding to the query.
I believe the institute has calculated it, inline with your presentation above, but my understanding is a quite different -
The question requires us to calculate annual depreciation expense over the life provided the company does not use component method.
But in the above presentation, we are using component accounting from 3rd year for depreciation since the cutter has a useful life of 2 years and cost of cutter (2000) is depreciated only for 2 years, which is in contradiction to the questions requirement.
Also at the beginning of year 3 and at every prospective year ends when the company replaces the cutter, it must derecognize cutter component to the extent of (2000-2000/82) = 1500 for 1st instance, (2000-2000/62) = 1333 and such respective amounts, which shall be charged to statement of Income as loss on replacement of component and not as additional depreciation.
I am not sure where am I getting this wrong. If you don’t mind could you please help me on this one?
If we were using component depreciation, then we would have separated the original $10,000 purchase into the cutter ($2,000 over two years, no residual) and the remainder of the machine ($8,000 over eight years, $3,000 residual).
The depreciation in year 3 is depreciation on two separate assets: the original machine (including its cutter), and the new cutter. They’re not separate components; they’re separate assets.
Do you have notes on FSA with such effortless explanations? These kinds of notes would be very helpful, I’m finding FSA to be a tricky topic. If you have these notes could you be so kind to share them?
Please don’t mind me bothering you again and again on the same topic, but I was reconceiving this problem, and had a doubt -
At the end of year 2, a part of the asset is replaced, therefore whether or not we use component accounting, expenditure related to the part being replaced must be wholly written off in year 2 itself. And from next year onwards, the newly replaced item will be depreciated either as a new asset or as a component of asset.
Failing to write off that part of expenditure leads to book expenditure against matching principle.
Could you please solve my doubt?
The expenditure represents a part of asset which is being replaced in current year (most probably sold as scrap) and is not going to be used in the future, therefore that part should not be presented in the statement of financial position as asset.
And since it is not an asset it should be written off completely.
This is my understanding and I would very much like to know from the expert about his views.
I agree that the new asset must be depreciated over its useful life.
But what about the part which was replaced (old replaced part whose useful life is completed)?
The entire expense representing that old part should be written off since it has been replaced.