Question

1. The following information will be used for two questions on the exam:

   On January 1, 2020 Navani Corp. decided to replace the HVAC system in its manufacturing plant because the old HVAC system was no longer adequate. The building was originally purchased for $5,000,000 on January 1, 2010 and has been depreciated using the straight-line method over an estimated 20-year life with zero estimated salvage value. The book value of the old HVAC system is unknown and the new HVAC system cost $500,000. It is estimated that the replacement of the HVAC system will increase the useful life of the building by six additional years. It is not anticipated that the buildings productive output will increase from the replacement.

   Which of the following statements is true?

   		None of the other answer choices is true.
   		Depreciation on the building will not need to be recalculated after the replacement is recorded because the amount capitalized for the new HVAC system is less than 25% of the total cost of the new combined asset.
   		Because the book value of the old HVAC system is unknown, the cost of the replacement HVAC system should be debited to the building account and depreciated over the new remaining useful life of the building.
   		Because the new HVAC system will not increase the quality or quantity of the building's service potential over its remaining life, the replacement of the HVAC system may not be recorded as a capital expenditure.
   		The journal entry to record the replacement of the HVAC system will include a loss on the disposal of the old HVAC system.

Answer 1

Because the book value of the old HVAC system is unknown, the cost of the replacement HVAC system should be debited to the building account and depreciated over the new remaining useful life of the building.

Explanation: When any addition is made to an asset and that addiction increases the capacity of the asset, then the cost for the addition is capitalized. Since, in the given case, the replacement of the HVAC system increased the useful life of the building by six additional years, it's cost will be capitalized along with the building.