Question

Difficulty: Very hardDepreciation Methods and Calculations

On 1 April 2023, Zenith Manufacturing Company purchased a machine for ₦800,000₦800,000 and paid an additional ₦100,000₦100,000 for its installation. The company depreciates machinery at 20%20\% per annum using the reducing balance method, calculated on a pro-rata monthly basis. The financial year ends on 31 December. On 31 December 2025, the machine was traded in for a newer model valued at ₦1,200,000₦1,200,000, with Zenith paying a net cash balance of ₦750,000₦750,000. What is the profit or loss on disposal of the old machine?

  1. Loss of ₦39,600₦39,600Answer
  2. B
    Profit of ₦39,600₦39,600
  3. C
    Loss of ₦14,800₦14,800
  4. D
    Loss of ₦10,800₦10,800

Answer

Loss of ₦39,600₦39,600
The total cost of the machine includes its purchase price (₦800,000₦800,000) plus installation (₦100,000₦100,000), giving ₦900,000₦900,000. Depreciating by 20%20\% reducing balance yields ₦135,000₦135,000 for 9 months in 2023, ₦153,000₦153,000 in 2024, and ₦122,400₦122,400 in 2025. This leaves a net book value of ₦489,600₦489,600. The part-exchange allowance given for the old machine is ₦1,200,000−₦750,000=₦450,000₦1,200,000 - ₦750,000 = ₦450,000. Comparing the allowance of ₦450,000₦450,000 to the carrying value of ₦489,600₦489,600 results in a loss on disposal of ₦39,600₦39,600.

Step-by-Step Solution

1
Determine total initial cost of the machine
Initial Cost = ₦800,000+₦100,000=₦900,000₦800,000 + ₦100,000 = ₦900,000
Installation costs are capital expenditure and must be added to the purchase price of non-current assets.
2
Calculate depreciation for 2023 (9 months from 1 April to 31 December)
Depreciation (2023) = ₦900,000×20%×912=₦135,000₦900,000 \times 20\% \times \frac{9}{12} = ₦135,000
Net Book Value at 31/12/2023 = ₦900,000−₦135,000=₦765,000₦900,000 - ₦135,000 = ₦765,000
The asset was held for only 9 months in the first year.
3
Calculate depreciation for 2024 (Full year)
Depreciation (2024) = ₦765,000×20%=₦153,000₦765,000 \times 20\% = ₦153,000
Net Book Value at 31/12/2024 = ₦765,000−₦153,000=₦612,000₦765,000 - ₦153,000 = ₦612,000
Applying 20%20\% to the reducing net book value.
4
Calculate depreciation for 2025 up to date of disposal (Full year)
Depreciation (2025) = ₦612,000×20%=₦122,400₦612,000 \times 20\% = ₦122,400
Net Book Value at 31/12/2025 = ₦612,000−₦122,400=₦489,600₦612,000 - ₦122,400 = ₦489,600
Determining carrying value immediately prior to trade-in.
5
Calculate part-exchange allowance and resulting profit or loss on disposal
Part-Exchange Allowance = Value of new machine - Cash paid = ₦1,200,000−₦750,000=₦450,000₦1,200,000 - ₦750,000 = ₦450,000
Profit / (Loss) = Allowance - Net Book Value = ₦450,000−₦489,600=−₦39,600₦450,000 - ₦489,600 = -₦39,600 (Loss of ₦39,600₦39,600)
A loss occurs when the trade-in allowance is less than the net book value of the asset.

Key Concept

Reducing Balance Depreciation with Partial Year Acquisition and Asset Trade-in Disposal
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