IOMC Adjusting entry by alicejenny


									                 ATW114 (Financial Accounting) 2011/12 Sem I
                   Tutorial 8 (Chapter 8) Long Term Assets

                                     Solutions for:
  S8-11 p.422, S8-12 p.422, P8-30A p.426, P8-46A p.430 & P8-48A p. 431

Discussion Questions: Key Points
  1. The individual who places the order should neither receive goods nor approve payment. If
     those duties were combined, the purchasing agent could buy goods and have them
     shipped to his or her home or side-business. Although kickbacks are always a risk, even
     with segregation of duties, this risk can be reduced with improved segregation of duties.
     Also, the person approving payment should not sign checks or maintain custody of the
     goods purchased. Checks could be written for items not received if duties are not
     segregated at this stage.
  2. The reconciling items associated with the balance per books will require journal entries.
     The company preparing the bank reconciliation upon receipt of the bank statement finds
     out new information that its books did not reflect. Journal entries are necessary in order to
     bring the balance in the cash account in line with the correct cash balance. The company
     has no need or interest in preparing adjusting entries for the bank’s books.
  3. The surest way to eliminate bad debts is to avoid extending credit to customers. Requiring
     customers to pay in cash before receipt of the goods would eliminate bad debts but would
     also reduce the potential customer base. Many businesses cannot or will not conduct
     business that way. So, they would be unwilling to buy from the company.
  4. One of the key principles in GAAP is the matching principle. The matching principle
     requires an entity match expenses with the revenues they helped create. Since extending
     credit is essential for many businesses that wish to attract a broader customer base (see #
     3 above), it follows that the expense associated with credit granting should be matched
     with the sales it helped generate. The allowance method attempts to do this through the
     estimation of the expense and establishment of an allowance at the end of the accounting
     period. The direct write-off method makes no such attempt. By waiting until the account
     is clearly uncollectible, which is often several months after the date that the goods were
     sold or services rendered, the expense is likely to be in a different accounting period than
     the revenue that was recognized.
  5. Allowance for doubtful accounts appears on the balance sheet as a contra-asset. By
     subtracting the allowance from the gross accounts receivable balance, the company
     arrives at an estimate of the amount of cash they expect to collect from customers with
     balances as of the balance sheet date. This gives a more accurate indicator of the true
     amount of accounts receivable.
  6. The percentage of sales method is focused on the relationship between sales and bad
     debts expense, both income statement items, in determining the amount of the adjusting
     entry to bad debts expense. The credit to the allowance account is plugged in to balance
     the entry. Under the aging approach, the focus is in determining the amount by which the
     allowance account would need to be adjusted in order to make the ending balance reflect
     the results of the aging of accounts receivable. Both the allowance and the accounts
     receivable balances are reported on the balance sheet. The debit to bad debt expense in
     the adjusting entry is again plugged in to make the entry balance. The focus is on the
     allowance account determined by its relationship to accounts receivable.
  7. The balance in the allowance account would affect the adjusting entry when using the
     aging analysis approach, for reasons discussed in #6 above.
   8. The net realizable value of accounts receivable does not change when an account is
       written off under the allowance method. The write-off involves a debit to the allowance
       account and a credit to the accounts receivable account being written off. Both the contra-
       asset and asset accounts are decreasing, causing total assets to remain the same.
   9. Three accounts will be credited—the notes receivable account, interest revenue, and
       interest receivable. The interest receivable account was created during the process of
       preparing year-end adjusting entries.
   10. The recession of 2009 was characterized by an unwillingness of banks to loan money.
       This restriction of the flow of capital sent shock waves through businesses. The
       contraction made it harder for companies to earn the type of revenue that they were
       expecting to help them to be able to pay off their debts. All of this caused accounts
       receivable turnover ratios to become lower than they were in previous years when cash
       flowed more freely.

S 8-11 (Page 422)
CAP             a. Purchase price
REV             b. Ordinary recurring repairs
CAP             c. Lubrication before machine is placed in service
REV             d. Periodic lubrication
CAP             e. Major overhaul
CAP             f. Sales tax
CAP             g. Transportation and insurance
CAP             h. Installation
CAP             i. Training of personnel

S 8-12 (Page 422)
   DATE          ACCOUNTS                                      REF.          Dr.           Cr.
Dec.     31      Cash                                                         28,000
                 Accumulated Depreciation, Truck                              16,000
                       Truck                                                                41,000
                       Gain on Sale of Truck                                                 3,000
                 Record the sale of the truck.

Sale price of assets                                                       $28,000
Book value:
            Truck                                                   $41,000
            Less: Accumulated depreciation                          (16,000)
         Gain on sale                                                              $3,000

         E 8-30A (Page 426)

         Balance Sheet:
         Property, plant, and equipment                                  $9,000,000
         Less: Accumulated depreciation, plant and equipment              3,000,000         $6,000,000

         The book value of property, plant, and equipment on December 31, 2010 was $6,000,000.

         P 8-46A (Page 430)
         Req. 1
                                             Straight-Line Depreciation Schedule
                                                  Depreciation for the Year
              ASSET      DEPRECIATION         DEPRECIABLE       DEPRECIATION           ACCUMULATED          BOOK
  DATE        COST          RATE    ×           COST    =         EXPENSE              DEPRECIATION         VALUE

Year 0       $240,000                                                                                        $240,000

Year 1                         1/5              $220,000                                         $ 44,000     196,000
                                                                          $ 44,000

Year 2                         1/5               220,000                      44,000               88,000     152,000

Year 3                         1/5               220,000                      44,000              132,000     108,000

Year 4                         1/5               220,000                      44,000              176,000      64,000

Year 5                         1/5               220,000                      44,000              220,000      20,000

         Asset cost: $224,000 + $700 + $100 + $12,100 + $3,100 = $240,000
         Straight-line: ($240,000 – $20,000) / 5 years = $44,000
         Req. 1

                                       Units-of-Production Depreciation Schedule
                                                Depreciation for the Year
                  ASSET       DEPRECIATION           NUMBER            DEPRECIATION   ACCUMULATED BOOK
  DATE            COST         PER UNIT ×            OF UNITS     =      EXPENSE      DEPRECIATION VALUE

Year 0            $240,000                                                                           $240,000
Year 1                              $1.10               50,000         $ 55,000           $ 55,000    185,000
Year 2                               1.10               45,000            49,500           104,500    135,500
Year 3                               1.10               40,000            44,000           148,500     91,500
Year 4                               1.10               35,000            38,500           187,000     53,000
Year 5                               1.10               30,000            33,000           220,000     20,000


         Units-of-production: ($240,000 – $20,000) / 200,000 units = $1.10/mile
                              Double-Declining-Balance (DDB) Depreciation Schedule
                                            Depreciation for the Year
               ASSET       DDB                   BOOK       DEPRECIATION ACCUMULATED     BOOK
                         RATE ×                    =

Year 0        $240,000                                                                   $240,000
Year 1                            .40           $240,000         $ 96,000     $ 96,000    144,000
Year 2                            .40            144,000          57,600       153,600     86,400
Year 3                            .40             86,400          34,560       188,160     51,840
Year 4                            .40             51,840          20,736       208,896     31,104
Year 5                                                            11,104       220,000     20,000
DDB rate: (1/5 years × 2) =.40
Depreciation for Year 5: $31,104 – residual value of $20,000 = $11,104
Req. 2

The depreciation method that reports the highest net income in the first year of the equipment’s life is the straight-line method,
which produces the lowest depreciation for that year, $44,000. The method that minimizes income taxes in the first year is the
double-declining-balance method, which produces the highest depreciation amount for that year, $96,000.

Req. 3

                                                                   Method of depreciation
                                           Straight-line           Units of Production      Declining Balance
                  Cost                            $240,000                $240,000                 $240,000
                  Less: Accumulated               (44,000)                (55,000)                 (96,000)

                  Book value at Dec. 31,          $196,000                $185,000                 $144,000
      P 8-48A (Page 431)
      Req. 1

       DATE ACCOUNTS                                          REF.         Dr.          Cr.
            Assets                                                       2,700,000
            Goodwill                                                     2,500,000
                   Liabilities                                                       2,200,000
                   Cash                                                              3,000,000
            Record purchase of Hungry Boy Diners

      Purchase price paid for Hungry Boy Diners
      Market value of Hungry Boy’s assets                     $2,700,000
      Less: Hungry Boy’s liabilities                          (2,200,000)
      Market value of Hungry Boy’s net assets

      Req. 2
      Benny’s Restaurants should measure the current value of its goodwill each year.
      If the goodwill has increased in value, there is nothing to record. But if goodwill’s
      value has decreased, then Benny’s records a loss and writes down the goodwill.

      P 8-47A (Bonus question, optional) (Page 431)

     DATE        ACCOUNTS                                     REF.          Dr.          Cr.
a.               Accumulated Depreciation, Equipment                        23,000
                 Loss on Disposal                                            2,000
                        Equipment                                                           25,000
                 Record the disposition of equipment.

b.               Cash                                                        3,000
                 Accumulated Depreciation, Equipment                        23,000
                       Equipment                                                            25,000
                       Gain on sale of Equipment                                             1,000
                 Record gain on sale of equipment.

c.            Equipment - new                                             30,000
              Accumulated Depreciation, Equipment                         23,000
                    Equipment - old                                                      25,000
                    Cash ($30,000 - $5,000)                                              25,000
                    Gain on Exchange of Equipment *                                       3,000
              Record gain on exchange of equipment.

d.            Equipment - new                                             20,000
              Accumulated Depreciation, Equipment                         23,000
                     Equipment - old                                                     25,000
                     Note Payable ($20,000 - $1,000)                                     19,000
              Loss on Exchange of Equipment **                             1,000
              Record loss on exchange of equipment.

     * Gain on exchange = Trade in value less book value of old equipment = $5,000 -
     ($25,000 - $23,000) = $3,000
     ** Loss on exchange = Book value of old equipment - trade in value = ($25,000 -
     $23,000) - $1,000 = $1,000


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