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Chapter 2 Accounting Systems for Recording Business Transactions

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Chapter 2 Accounting Systems for Recording Business Transactions Powered By Docstoc
					Transparency Master 9-1


                 COST TO ACQUIRE
                  FIXED ASSETS
Advanced Technology, a computer manufacturer,
purchased a machine that applies computer chips to
circuit boards, using a process known as Surface
Mount Technology (SMT). The costs associated with
acquiring the SMT machine are listed below. Where
should each cost be recorded in the accounting
records?
    Purchase price ........................................... $150,000
    Transportation ...........................................    1,200
    Engineer's fee to set up and
       adjust the machine to
       required specifications .........................          2,000
    Electrician's fee to install a new
       power outlet required by
       the SMT machine...................................           800
    Repairs made to wall as a result
       of damage during installation
       of the new power outlet ........................             500
    Cost of chips and circuit board
       used to test the new machine
       before it is used in production.............                 300
    Cost of 3-year service contract
       requiring the manufacturer of
       the SMT machine to make any
       repairs needed, at no cost....................             3,000
Transparency Master 9-2


                  COST TO ACQUIRE
                   FIXED ASSETS
                                   Solution
Advanced Technology, a computer manufacturer, purchased a
machine that applies computer chips to circuit boards, using a
process known as Surface Mount Technology (SMT). The costs
associated with acquiring the SMT machine are listed below. Where
should each cost be recorded in the accounting records?
                                                                     Recorded in
    Purchase price .................................... $150,000    Equipment
    Transportation.....................................     1,200   Equipment
    Engineer's fee to set up and
       adjust the machine to
       required specifications ..................           2,000   Equipment
    Electrician's fee to install a
       new power outlet required
       by the SMT machine.......................              800   Equipment
    Repairs made to wall as a
       result of damage during
       installation of the new
       power outlet ....................................      500   Repair Expense
    Cost of chips and circuit
       boards used to test the
       new machine before it is
       used in production .........................           300   Equipment
    Cost of 3-year service contract
       requiring the manufacturer
       of the SMT machine to make
       any repairs needed, at
       no cost............................................. 3,000   Prepaid Expense
Transparency Master 9-3


            COST OF LAND ACQUIRED
              AS A BUILDING SITE
When land is acquired as a building site, all costs to purchase the
land and prepare it for the new building are considered a cost of the
land.
Indicate whether the following costs should be recorded in the land,
building, or land improvements account.
  Cost                                Explanation
$200,000       Purchase price paid for land and old warehouse build-
               ing. The warehouse building will be torn down, and a
               new manufacturing plant will be erected in its place. The
               land has an appraised value of $125,000; the warehouse
               is appraised at $75,000.
    5,000      Closing costs associated with purchasing the land and
               warehouse.
  20,000       Cost to tear down and remove old warehouse building.
    8,000      Cash received from selling a crane and other
               salvageable materials from the old warehouse.
  11,000       Cost to level the land prior to construction of the new
               building.
  25,000       Cost to excavate land for the foundation of the new building.
  60,000       Fees paid to architect to design the new building.
 540,000       Fees paid to contractor for erecting the new building.
    7,000      Interest paid on construction loan before the building is
               completed.
    5,000      Repair as a result of windstorm damage during
               construction.
  12,000       Cost of parking lot adjacent to the building.
    8,000      Cost of landscaping to beautify building and parking lot.
Transparency Master 9-4


             COST OF LAND ACQUIRED
               AS A BUILDING SITE
                                    Solution
Indicate whether the following costs should be recorded in the land, building, or
land improvements account.
                                              Amount Recorded in
                                                              Land
   Cost          Explanation          Land       Building Improve. Expense
$200,000    Purchase price
            of land and old
            warehouse.               $200,000
   5,000    Closing costs.              5,000
  20,000    Cost to tear down
            old warehouse.             20,000
   8,000    Cash received from
            selling salvageable
            materials from old
            warehouse.                 (8,000)
  11,000    Cost to level land.        11,000
  25,000    Cost to excavate
            land for foundation
            of new building.                     $ 25,000
  60,000    Architect's fees
            for new building.                      60,000
 540,000    Building
            contractor's fees
            for new building.                     540,000
   7,000    Interest paid on
            construction loan
            before the building
            is completed.                           7,000
   5,000    Repair as a result of
            windstorm damage
            during construction.                                          $5,000
  12,000    Cost of parking lot.                             $12,000
   8,000    Cost of landscaping.                               8,000
Transparency Master 9-5



       REVIEW—DEPRECIATION
Assume that you have just accepted a job
that requires you to do a lot of driving.
Because your current car is on its "last leg,"
you have decided to purchase another car.
You estimate that you will drive 20,000 miles
each year. Since you don't like to deal with
major car repairs, you will trade in the car
when it reaches 60,000 miles.

You have found two cars that you are
considering. One is a new car, and you can
purchase it for $18,000. The other is a late-
model used car. The used car has 20,000
miles on it, but it is in excellent condition.
The price of this used car is $11,000.

Using the criteria outlined, what would be
your depreciation cost per year for each
car?
Transparency Master 9-6


     DEPRECIATION CALCULATIONS

     STRAIGHT-LINE AND UNITS-OF-
        PRODUCTION METHODS

Lucianno's Pizza purchased a car to be used
in delivering pizzas. The car cost $14,000. It
will be used for 5 years, after which its
residual value will be about $2,000. In those
5 years, Lucianno's estimates that the car
will be driven 80,000 miles.
1. Calculate depreciation for all 5 years,
   using the straight-line method.
2. Assume that the car was driven 10,000
   miles in year 1, 15,000 in year 2, 18,000 in
   year 3, 20,000 in year 4, and 17,000 in year
   5. Calculate depreciation, using the units-
   of-production method for all 5 years.
Transparency Master 9-7


     DEPRECIATION CALCULATIONS

     STRAIGHT-LINE AND UNITS-OF-
        PRODUCTION METHODS

                          Solution
1. ($14,000  $2,000)/5 years = $2,400 per year

2. ($14,000  $2,000)/80,000 miles = $0.15 per mile

    Year 1:     10,000 miles  $0.15 per mile = $ 1,500
    Year 2:     15,000 miles  $0.15 per mile = 2,250
    Year 3:     18,000 miles  $0.15 per mile = 2,700
    Year 4:     20,000 miles  $0.15 per mile = 3,000
    Year 5:     17,000 miles  $0.15 per mile = 2,550
                                               $12,000
Transparency Master 9-8


     DEPRECIATION CALCULATIONS
     DECLINING-BALANCE METHOD

ABC Marketing recently purchased a
machine that cost $80,000. The machine is
expected to last 4 years and have a residual
value of $6,000.

Calculate the depreciation expense to be
recorded each year under the declining-
balance method.
Transparency Master 9-9


     DEPRECIATION CALCULATIONS
     DECLINING-BALANCE METHOD

                          Solution

Year 1: ($80,000 – $0)       50%    = $40,000
Year 2: ($80,000 – $40,000)  50%    = 20,000
Year 3: ($80,000 – $60,000)  50%    = 10,000
Year 4: ($74,000 – $70,000)          =   4,000
                                       $74,000
Transparency Master 9-10


         CAPITAL AND REVENUE
            EXPENDITURES
                           Capital or       Accounting
  Type of Expenditure      Revenue          Treatment
Addition—enlarging an       Capital     Debit fixed asset
asset or adding a new                   account
feature

Betterment—increasing       Capital     Debit fixed asset
operating efficiency or                 account
capacity

Extraordinary Repairs—      Capital     Debit accumulated
extending the service                   depreciation account
life of an asset

Ordinary Repairs and       Revenue      Debit an expense
Maintenance—                            account
maintaining an
asset in current
working condition
Transparency Master 9-11


         CAPITAL AND REVENUE
            EXPENDITURES
                           Capital or       Accounting
           Stage           Revenue          Treatment
Preliminary - studies &   Revenue       Debit expense
analysis before acquiring               account
a fixed asset is probable

Preacquisition – mgmt.      Capital     Debit fixed asset
has decided to aquire                   account
the fixed asset

Acquisition or Con-        Capital      Debit fixed asset
struction - asset is                    (or Construction in
under construction,                      Progress)
but not yet in use

In-service – asset is
complete & ready for use
    Add new component      Capital     Debit fixed asset
    Replace component      Capital     Debit fixed asset
    Normal repair          Revenue     Debit expense
Transparency Master 9-12



         CAPITAL AND REVENUE
            EXPENDITURES
Classify each of the following expenditures as a capital or a
revenue expenditure.
Name the specific account that would be debited to record
each expenditure.
                                                  Account
           Expenditure          Classification     Debited
1. Purchasing a fax machine
2. Adding an air purification
   system to the HVAC system
   in an office building
3. Painting the interior walls
   of an office building
4. Installing an overhead
   crane in a warehouse
5. Replacing the motor of a
   machine
6. Paying for a service call to
   repair photocopy machine
7. Upgrading the processor
   on a PC to allow the computer
   to process data more quickly
Transparency Master 9-13


           CAPITAL AND REVENUE
              EXPENDITURES
                           Solution
Classify each of the following expenditures as a capital or a
revenue expenditure.
Name the specific account that would be debited to record
each expenditure.
                                                  Account
           Expenditure          Classification     Debited
1. Purchasing a fax machine        Capital          Office
                                 Equipment
2. Adding an air purification        Capital    HVAC System
   system to the HVAC system
   in an office building
3. Painting the interior walls      Revenue
   Maintenance
   of an office building                             Expense
4. Installing an overhead             Capital         Crane
   crane in a warehouse
5. Replacing the motor of a          Capital        Machinery
   machine
6. Paying for a service call to     Revenue           Repair
   repair photocopy machine                          Expense
7. Upgrading the processor            Capital       Computer
   on a PC to allow the computer
      Equipment
to process data more quickly
Transparency Master 9-14



                           LEASES
Company A: Purchases a $250,000 asset
that has an estimated 15-year life, after
which time it will have a $10,000 salvage
value. The asset is purchased on credit.
Therefore, Company A records a $250,000
asset and a $250,000 liability.

Company B: Leases the same $250,000
asset for 15 years. At the end of the 15
years, the company has the right to
purchase the asset for $100. Since Company
B does not own the asset, it does not record
the asset on its accounting records. In
addition, it does not recognize any liability
related to the lease.

Is this a fair accounting treatment?
Transparency Master 9-15



         INTERNAL CONTROLS—
             FIXED ASSETS
             Procedures     for   Lap-Top   Computers
                    at Wilson Insurance

Wilson Insurance has just purchased a lap-top
computer for each of its insurance agents. The lap-
tops have been programmed with a variety of financial
information related to Wilson’s insurance policies.
The agents will use the computers in making their
sales presentations to potential clients, and they are
free to use the computers as they wish as long as they
are employed by Wilson.

Your task is to develop internal control procedures for
the lap-top computers. Your procedures should
address how the lap-tops should be issued to the
salespeople and returned to the company at the end
of employment. You may also want to address
procedures for repair and replacement of the lap-tops
and a periodic inventory of the computers.
Transparency Master 9-16


             INTERNAL CONTROLS—
                 FIXED ASSETS
                           Suggested Solution
1. When lap-top computers are purchased, they should be
   tagged with an identification number and recorded in a
   subsidiary ledger. Until issued, the lap-top computers
   should be kept in a locked storage facility.
2. The sales manager (or other authorized employee) should
   be responsible for issuing the computers to the sales
   agents. A record should be maintained showing who
   each computer was issued to.
3. When a computer needs repairs, it should be returned to
   Wilson. Information about the type of repairs made and
   their cost should be entered into the subsidiary ledger. If
   the computer shows evidence of abusive treatment,
   Wilson may require the sales agent to pay for repairs.
4. A manager’s authorization is needed before purchasing
   any new computers or replacing a sales agent’s lap-top.
5. Records should be verified once per year by asking all
   sales agents to bring in their computers for a physical
   inventory.
6. All sales agents are required to return their computers
   immediately upon termination of employment. The
   Payroll Department should be instructed to hold the
   agent's final paycheck until the sales manager verifies
   that the computer has been returned in proper working
   order.
Transparency Master 9-17



             INTANGIBLE ASSETS
                           Definition                  Legal Life
Patents         Exclusive right to produce and       20 years
                sell a product with one or more
                unique features

Copyrights Exclusive right to publish and            Life of author
           sell a literary, artistic, or             + 70 years
           musical composition

Trademarks Exclusive right to use a name,            Indefinite life;
           term, or symbol in identifying            registration
           and marketing a product                   renewed
                                                     every 10 yrs.

Goodwill        Intangible asset that results        Indefinite life
                from superior location,
                product quality, reputation, or
                managerial skills; evidenced
                when a company is purchased
                at a price that is higher than the
                market value of its net assets
                (assets minus liabilities)
Transparency Master 9-18



             INTANGIBLE ASSETS
Intangible                 Accounting Treatment

Patents                    Amortized over useful life
& Copyrights               (not legal life)


Trademarks                 Not amortized; value is
& Goodwill                 written down if impaired
Transparency Master 9-19


    DEPRECIATION, DEPLETION,
AMORTIZATION—THREE WORDS THAT
  REPRESENT THE SAME CONCEPT

Depreciation, depletion, and amortization all represent the process of
allocating the cost of a long-term asset to expense over its useful life.

    Applies to             Journal Entry to Record      Methods Used
DEPRECIATION
Fixed assets          Depreciation Expense       Straight-line,
(i.e., machinery,       Accumulated Depreciation Units-of-production,
buildings)                                       Declining-balance

DEPLETION
Natural resources Depletion Expense                  Units-of-production
(i.e., mineral      Accumulated Depletion
deposits, metal
ore)

AMORTIZATION
Intangible assets     Amortization Expense           Straight-line
(patents &              Patents or
copyrights)             Copyrights
Transparency Master 9-20


 BALANCE SHEET PREPARATION
Use the following accounts to prepare the
Assets section of the balance sheet for Georgia
Electronics Co. as of December 31, 20—.
    Cash .................................................... $105,000
    Accounts Receivable ......................... 180,000
    Allowance for Doubtful Accounts ....                        14,000
    Land (where office building is
       located) ..........................................      55,000
    Merchandise Inventory...................... 260,000
    Prepaid Insurance ..............................            29,000
    Buildings............................................. 300,000
    Office Equipment ............................... 140,000
    Patents ................................................    75,000
    Goodwill ..............................................     25,000
    Accumulated Depreciation—
       Buildings........................................ 115,000
    Accumulated Depreciation—Office
       Equipment......................................          36,000
    Undeveloped Land (held for invest-
       ment purposes) .............................             50,000
Transparency Master 9-21


                                BALANCE SHEET PREPARATION
                                                                               Solution
                                                                         Georgia Electronics Co.
                                                                          Partial Balance Sheet
                                                                           December 31, 20—
Current assets:
    Cash ........................................................................................................               $ 105,000
    Accounts receivable ..............................................................................              $ 180,000
     Less allowance for doubtful accounts. ............................................                                14,000    166,000
    Merchandise inventory..........................................................................                              260,000
    Prepaid insurance..................................................................................                           29,000
       Total current assets .........................................................................                                       $   560,000
Property, plant, and equipment:
    Land ........................................................................................................               $ 55,000
    Buildings ................................................................................................      $ 300,000
     Less accumulated depreciation ........................................................                           115,000    185,000
    Office equipment ...................................................................................            $ 140,000
     Less accumulated depreciation ........................................................                            36,000    104,000
       Total property, plant, and equipment .............................................                                                       344,000
Intangible assets:
    Patents ....................................................................................................                $ 75,000
    Goodwill..................................................................................................                    25,000
       Total intangible assets.....................................................................                                             100,000
Investments:
    Undeveloped land ..................................................................................                                         50,000
Total assets .................................................................................................                              $1,054,000
Transparency Master 9-22


              Ratio of Fixed Assets to
                 Long-Term Liabilities

                           2000 2001 2003 2004

Company A                  2.4   2.4   2.1   2.3

Company B                  1.8   1.9   2.4   2.6
Transparency Master 9-23


    DEPRECIATION CALCULATIONS
  SUM-OF-THE-YEARS-DIGITS METHOD

                           Solution
Year 1:       ($80,000 – $6,000)      4/10   = $29,600
Year 2:       ($80,000 – $6,000)      3/10   = 22,200
Year 3:       ($80,000 – $6,000)      2/10   = 14,800
Year 4:       ($80,000 – $6,000)      1/10   =   7,400
                                                $74,000

				
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