Prepare all journal entries relating to the machine and the overhaul for the financial year ended 31 December 2017. If no journal entries are required, state that fact and motivate your answer.

Question

Lux Ltd purchased a machine on 1 January 2014 at a cost of R4 000 000. The machine had an expected economic useful life of 8 years with a residual value of R500 000. In terms of its operating conditions, the machine requires a complete overhaul every 4 years. The estimated cost to overhaul the machine during January 2018 amounts to R500 000. For tax purposes, the machine qualifies for wear and tear allowances, deductible on a straight-line basis over 5 years.

Answer 1

Jan. 1, 2014. Equipment. 4,000,000

Cash 4,000,000

Dec. 31, 2014. Depreciation Expense. 437,500

Accumulated Depreciation. 437,500

Dec. 31, 2015 . Depreciation Expense. 437,500

Accumulated Depreciation. 437,500

Dec. 31, 2016. Depreciation Expense. 437,500

Accumulated Depreciation. 437,500

Dec. 31, 2017 . Depreciation Expense. 437,500

Accumulated Depreciation. 437,500

At Dec. 31, 2017, the book value of the equipment is 4,000,000 - (437,500 X 4) = 2,250,000

On Jan. 1, 2018, you spend 500,000 to overhaul the equipment. That journal entry is:

Jan. 1, 2018. Equipment 500,000

Cash 500,000

The book value of the equipment is now 2,250,000 + 500,000 = 2,750,000

The residual value is still 500,000.

So the depreciable amount as of Jan. 1, 2018 is 2,750,000 - 500,000 = 2,250,000

Depreciation expense as of Dec. 31, 2018, 2019, 2020 and 2021 will be 2,250,000/4 = 562,500

Dec. 31, 2018-2021. Depreciation Expense 562,500

Accumulated Depreciation. 562,500

To check, total debits to Equipment are 4,500,000

Total credits to Accumulated Depreciation are (437,500 x 4) + (562,500 x 4) = 4,000,000

Book value at the end is 4,500,000 - 4,000,000 = the 500,000 residual value