Bamenda Bakery: Oven Replacement and Depreciation Judgement
Bamenda Bakery bought a commercial oven on 1 January 20X1 for 2,400,000 FCFA. It is expected to last eight years and to have a residual value of 240,000 FCFA. The bakery's current policy is to charge a full year's depreciation in the year of acquisition and none in the year of disposal, using the straight-line method. On 1 July 20X4 the oven was sold for 1,150,000 FCFA. On 1 October 20X4 a new oven was bought for 3,000,000 FCFA; it has a six-year life and an estimated residual value of 300,000 FCFA. The owner wants to know the depreciation charge for 20X4 and the profit or loss on the old oven. The accountant suggests changing to monthly pro-rata depreciation from 20X4 onwards because the existing policy gives a misleading result in the year of disposal. The owner is worried that a change will alter reported profit and has asked for figures under both policies before deciding.
1. Using the bakery's existing policy, calculate the annual depreciation of each oven, the depreciation expense for 20X4, and the gain or loss on disposal of the old oven. Show the disposal account.
Read the worked answer
Annual depreciation: old oven = (2,400,000 - 240,000)/8 = 270,000 FCFA. New oven = (3,000,000 - 300,000)/6 = 450,000 FCFA.
Under existing policy: old oven is in year of disposal, so no depreciation in 20X4; new oven gets full year. 20X4 depreciation expense = 450,000 FCFA.
Old oven accumulated depreciation at disposal (20X1-20X3) = 3 × 270,000 = 810,000. Carrying amount = 2,400,000 - 810,000 = 1,590,000. Proceeds = 1,150,000. Loss on disposal = 1,590,000 - 1,150,000 = 440,000 FCFA.
Disposal account
| Dr | FCFA | Cr | FCFA |
|---|---|---|---|
| Oven cost | 2,400,000 | Accumulated depreciation | 810,000 |
| Bank/proceeds | 1,150,000 | ||
| Loss to P&L | 440,000 | ||
| Total | 2,400,000 | Total | 2,400,000 |
Reasoning: the loss is the unexpired cost not recovered from the sale.
2. Recalculate the 20X4 depreciation expense and disposal result if depreciation is charged monthly pro-rata from the date of purchase to the date of disposal. Advise the owner, with reasons, whether the change is acceptable and how it should be accounted for.
Read the worked answer
Pro-rata: old oven used 6 months in 20X4: 270,000 × 6/12 = 135,000. New oven used 3 months: 450,000 × 3/12 = 112,500. Total 20X4 depreciation = 247,500 FCFA. Accumulated depreciation on old oven at disposal = 810,000 + 135,000 = 945,000. Carrying amount = 2,400,000 - 945,000 = 1,455,000. Loss = 1,455,000 - 1,150,000 = 305,000 FCFA.
Advice: the pro-rata method better matches depreciation to the period the asset was used and avoids charging a full year for an asset held for only part of the year. However, it is a change in accounting policy/estimate; the owner should apply it consistently from now on, disclose the change and its effect, and not switch back simply to manipulate profit. The existing policy is acceptable only if it is applied consistently and the effect is not material; the pro-rata result is more realistic.