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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Replace equipment

A machine with a book value of $250,000 has an estimated six-year life. A proposal is offered to sell the old machine for $320,000 and replace it with a new machine at a cost of $390,000. The new machine has a six-year life with no residual value. The new machine would reduce annual direct labor costs from $75,000 to $61,000. Prepare a differential analysis dated October 3 on whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2).

To determine

Differential Analysis: Differential analysis refers to the analysis of differential revenue that could be gained or differential cost that could be incurred from the available alternative options of business.

To Prepare: The differential analysis to decide whether to continue with the old machine or to replace it.

Explanation

A company has two alternatives to either continue with an old machine or to sell the old machine for $320,000 and get it replaced with a new machine for $390,000. The company would incur the labor charges of $450,000 for 6 years on continuing with the old machine and the labor charges of $366,000 for 6 years on replacing the old machine. This clearly shows a decrease in the costs by $14,000 if the company replaces the machine instead of continuing it; hence the old machine should be replaced.

Working Note:

Calculate the direct labor for 6 years on continuing with the old machine...

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