Two companies are considering the buying of new equipment costing $200 000. The Frugal Company's Balance Sheet shows Accumulated Depreciation on Machinery & Equipment of $300 000 and the Spendthrift Company's Balance Sheet shows Accumulated Depreciation on Machinery & Equipment of $100 000.

From the above information, which company is in a better position to purchase the new equipment for cash? Give reasons for your answer.

From what I can understand, Frugal company is in a better position because they have accumulated depreciation of $300,000 , and depreciation is also deducted from the profits to buy new machinery for the firm to replace the old one. SO, Frugal company has enough cash reserved to make the purchase.

You cannot determine a thing about who can afford to do what just based on their accumulated depreciation. The fact that depreciated is deducted from profits means nothing, because it's not related to cash flow. It's just an expense put onto the income statement, but no cash is paid for depreciation.

One of them can be higher than the other for numerous reasons. One, if the equipment is exactly the same cost on their books, one may have purchased the equipment more years ago and has therefore accumulated more depreciation at this point in time. Two, one of the pieces of equipment could have been a much higher cost to begin with, and therefore more is getting depreciated. And three, the equipment could be the same cost and have been depreciated for the same number of years, but they are using two different depreciation methods. Maybe one company already has more equipment to depreciate than the other company. I could go on...

The company in the best position to buy new equipment is the one who can actually afford to buy it and make the payments on it, which involves cash flow, and an accumulated depreciation account for another piece of equipment is completely irrelevant to that. And that's not even taking into consideration whether the company needs the equipment or whether it makes any sense to buy it. (Although the question didn't actual ask that.)

One company could be a lot bigger than the other, and their financial position could be entirely different, regardless of the accumulated depreciation on their books.

Unless there is much more information available that you haven't posted, there is no information here to actually answer the question and it's a nonsense question. If some instructor is trying to just "get you to think," they're trying to make you think about things that are not realistic and are making you think about things in an entirely wrong manner.

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Originally Posted by hellsailor

From what i can understand, Frugal company is in a better position because they have accumulated depreciation of $300,000 , and depreciation is also deducted from the profits to buy new machinery for the firm to replace the old one. SO, Frugal company has enough cash reserved to make the purchase.

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Depreciation is not the setting aside of cash reserves in order to purchase new equipment. How much as been depreciated on an income statement has nothing to do with cash flows. The money was spent when the original equipment was purchased and it's a sunk cost. How much as been depreciated will not and cannot affect that.

What happens if the Cost of Sales is understated ?

ethnec, stop tagging onto the back of other people's questions. Especially twice.