Chapter 10, Problem 10.5P

Acquisition costs; journal entries

• LO10–1, LO10–3, LO10–6, LO10–8

Consider each of the transactions below. All of the expenditures were made in cash.

1. The Edison Company spent $12,000 during the year for experimental purposes in connection with the development of a new product.

2. In April, the Marshall Company lost a patent infringement suit and paid the plaintiff $7,500.

3. In March, the Cleanway Laundromat bought equipment. Cleanway paid $6,000 down and signed a noninterest-bearing note requiring the payment of $18,000 in nine months. The cash price for this equipment was $23,000.

4. On June 1, the Jamsen Corporation installed a sprinkler system throughout the building at a cost of $28,000.

5. The Mayer Company, plaintiff, paid $12,000 in legal fees in November, in connection with a successful infringement suit on its patent.

6. The Johnson Company traded its old machine with an original cost of $7,400 and a book value of $3,000 plus cash of $8,000 for a new one that had a fair value of $10,000. The exchange has commercial substance.

Required:

Prepare journal entries to record each of the above transactions.

To determine

Property, Plant, and Equipment:

Property, Plant, and Equipment refers to the fixed assets, having a useful life of more than a year that is acquired by a company to be used in its business activities, for generating revenue.

To prepare: Thejournal entry, to record all the transaction.

Explanation of Solution

(1)

Record the expense incurred for experimental purpose in connection with development of a new product.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Research and development expense		12,000
	Cash			12,000
	(To record the expense incurred for research and development)

Table (1)

• Research and development expense is an expense, which is increased by $12,000. An increase in expense decreases the stockholders’ equity. Hence, debit Research and development expense account with $12,000.
• Cash is an asset account, which is decreased by $900. Therefore credit cash account with $900.

(2)

Record the legal fees expenses.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Legal fees expense		7,500
	Cash			7,500
	(To record the expense incurred for a suit)

Table (2)

• Legal fees expense is an expense, which is increased by $7,500. An increase in expense decreases the stockholders’ equity. Hence, debit Legal fees expense account with $7,500.
• Cash is an asset account, which is decreased by $7,500. Therefore credit cash account with $7,500.

(3)

Prepare an entry to capitalize the cost of equipment.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Equipment		23,000
	Discount on notes payable (Balancing figure)		1,000
	Notes payable			18,000
	Cash			6,000
	(To record the purchase of equipment on discount)

Table (3)

• Purchase of new equipment increases the (equipment account) asset account. Hence, debit equipment account with $23,000.
• Company C has signed a non-bearing interest note of $18,000, whose maturity period is 9 months. This increases the liability of the company. Hence, credit notes payable account with $18,000.
• Cash is an asset account and it is decreased by $6,000, since Company C has paid $6,000 as down payment. Therefore, credit Cash account with $6,000.
• The cost of equipment is $23,000, but the sum of down payment and notes payable is $22,000 $\left(\$6,000+\$18,000\right)$. The balance amount of $1,000 $\left(\$23,000-\$22,000\right)$ is a debit balance, which represents discount on purchase of equipment.

(4)

Prepare an entry to capitalize the cost of sprinkler system.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Building-sprinkler system		28,000
	Cash			28,000
	(To record the increase in the value of building  upon the installation of sprinkler system)

Table (4)

• Installation of sprinkler system throughout the building increases the value of the building.  Building is an asset account. Hence, debit Building-sprinkler system account with $28,000.
• Cash is an asset account and it is decreased by $28,000, since Corporation J has spent $28,000 to install the sprinkler system. Hence, credit cash account with $28,000.

(5)

Prepare an entry to capitalize legal fees for successful defense of patent.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Patent		12,000
	Cash			12,000
	(To record the purchase of equipment on discount)

Table (5)

• Payment of legal fees in connection with a successful infringement suit on the patent increases the value of the patent.  Patent is an asset account. Hence, debit patent account with $12,000.
• Cash is an asset account and it is decreased by $12,000, as Company M has spent to meet the legal expense of $28,000 in connection with a successful infringement suit on the patent. Hence, creditcash account with $12,000.

(6)

Prepare an entry to record the exchange of old machine for new machine, which has commercial substance.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Machine – New		10,000
	Accumulated depreciation – Machine $\left(\begin{array}{l}\text{Original cost \$7,400}-\\ \text{Book value \$3,000}\end{array}\right)$		4,400
	Loss on trade-in (Balancing figure)		1,000
	Cash			8,000
	Machine  – Old			7,400
	(To record the exchange of old machine for new machine, which has commercial substance

Table (6)

Nonmonetary Exchange

Exchange of non-monetary assets for another non-monetary asset is known as nonmonetary exchange.

Exchange has commercial substance:

If an exchange (Example: exchange of land for another non-monetary asset other than land) is likely to have a change in the future cash flows, then it is known as exchange has commercial substance. In this case, an exchange of non-monetary assets, which have commercial substance, is recorded at its fair value, and then resulted gain or loss must be recognized by determining the difference between the fair value and book value.