Continuing Case Solution
Chapter 10
Memorandum
To: Eric Conner and Phil Martin, CM2
From: L. Harbach
Re: Equipment Replacement
Date: January 16, 2013
I have analyzed the four options you presented for handling the old equipment,
Option 1: Self-construction of new equipment
Journal Entries
DR CR
Sale of old equipment (JE 1):
Cash
60,000
Accumulated Depreciation Equipment
390,000
440,000
term debt
Construction of new equipment (JE 3):
Equipment (new) 691,300 ($650,000 + $41,300)
$42,680
Continuing Case Solution
$200,000 @ 9% =
$18,000
$308,500 @ 8% =
$24,680
$508,500
$42,680
Actual interest costs = $35,000 + $18,000 + $24,680 = $77,680
Interest expense after considering capitalized interest: = $77,680 –
$41,300 = $36,380
Self-constructing the equipment will allow you to increase the Property, Plant,
and Equipment account, net of accumulated depreciation by $691,300. This
method will also allow you to capitalize the interest costs associated with
Option 2: Exchange the old equipment for new equipment
Journal Entries
DR CR
Equipment
685,000
Continuing Case Solution
Journal Entries
DR CR
Sale of old equipment (JE 1):
Cash
60,000
440,000
Acquisition of equipment (JE 2):
Equipment 683,857
Accounts Payable and Short–
Term Debt
164,000
Long-term Liabilities 519,857
Purchasing new equipment with a non-interest-bearing note will increase the
Option 4: Overhauling the old equipment
Journal Entries
DR CR
Record repair expense (JE 1):
Continuing Case Solution
income will be $313,950. Total liabilities will increase by $417,000, but this
amount is considerably less than the liability increase reflected in the other options. This is an
Qualitative Considerations
It is also important to take into consideration the non-financial elements of
replacing the equipment. New equipment and technology may allow CM2 to
operate more efficiently, but a consequence may be layoffs of skilled labor.