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home / study / business / accounting / questions and answers / abc corp. purchases equipment for $500,000 on account ... Question ABC Corp. purchases equipment for $500,000 on account on July 1, 2014. Their fiscal year ends on December 31. If they Debit Equipment Expense for $500,000 and Credit Accounts Payable for $500,000, is this correct? Discuss why or why not, and, if not, what is the correct entry? Also, discuss the effects on the financial statements, specifically assets and net income under both scenarios. As a manager, what types of motivating factors would make you want to record it as an immediate expense or capitalize the purchase?

Explanation / Answer

ABC Corporation All Amounts in $ The entry debiting Equipment Expense for $ 500,000 and Crediting Accounts Payable for $ 500,000 is not correct. Equipment purchased is in the nature of a capital asset, which will provide long-term benefits to the Company. Hence, it should be debited to Equipment reflected under "Fixed Assets". The credit to Accounts Payable of $ 500,000 is correct. Under Scenario I, the Assets of the Company will be undervalued by $ 500,000 and similarly, the profits for the year will also be undervalued by $ 500,000. Under Scenario II, Fixed Assets of the Company will be increased by $ 500,000, and the Net Profits for the year will only be proportionately reduced by the amount of depreciation charged for the year. Capitalisation can take place, as explained above, if the asset purchased provides long-term benefits for the working of a Company's operations. On the other hand, in case the expense is in the nature of regular maintenance of an already existing asset, or just a modification thereto, it can be expensed out.

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