Chapter 10, Problem 52EP

a.

To determine

Pass adjusting entries for the year ended as on December 31, 2017.

Explanation of Solution

Adjusting Entries:

Adjusting entries are passed for a relevant period to record adjustments of various transactions appearing in trial balance that occurred during a particular period.

1.

Adjustment entry for machinery wrongly charged to patents is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Machinery		17,000
	Patents			17,000
	(To rectify theimprovement to machinery wrongly charged to patents.)

Table (1)

• Machinery is an asset and it is increased by $17,000. Therefore, machinery account is debited with $17,000.
• A patent is an asset and it is decreased by $17,000. Therefore, patent account is credited with $17,000.

Adjustment entry for amortization of patents is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Cost of Goods Sold		4,0001
	Patents			4,0001
	(To record amortization of patents.)

Table (2)

• Cost of goods sold is an expense and it is increased by $4,000. Therefore,cost of goods sold accountis debited with $4,000.
• A patent is an asset and it is decreased by $4,000. Therefore, patent account is credited with $4,000.

2.

Adjustment entry for unearned revenue is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Licensing Agreement No. 2		1,000
	Revenue Received in Advance			1,000
	(To record revenue earned in advance.)

Table (3)

• Licensing agreement is an asset and it is increased by $1,000. Therefore, licensing agreement no-2 is debited with $1,000.
• Revenue received in advance is an income and it is increased by $1,000. Therefore, revenue received in advance account is credited with $1,000.

3.

Adjustment entry for loss caused due to explosionis given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Retained Earnings		30,0002
	Licensing Agreement No-1			30,0002
	(To record the loss.)

Table (4)

• Retained Earnings is a liability and it is decreased by $30,000. Therefore, retained earnings account is debited with $30,000.
• Licensing agreement no.1 is an asset and it is decreased by $30,000. Therefore, licensing agreement no.1 account is credited with $30,000.

4.

Adjustment entry for amortization of licensing agreement no-2 is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Cost of Goods Sold		5,0003
	Licensing Agreement No-2			5,0003
	(To record the amortization of licensing agreement no-2.)

Table (5)

• Cost of goods sold is an expense and it is increased by $5,000. Therefore, cost of goods sold account is debited with $5,000.
• Licensing agreement no-2 is an asset and it is decreased by $5,000. Therefore, licensing agreement no-2 account is credited with $5,000.

5.

Adjustment entry for amount wrongly included in goodwillis given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Retained Earnings		24,000
	Goodwill			24,000
	(To rectify the amount wrongly charged to goodwill.)

Table (6)

• Retained earnings are liability and it is reduced by $24,000. Therefore, retained earnings account is debited with $24,000.
• Goodwill is an asset and it is reduced by $24,000. Therefore, goodwill account is credited with $24,000.

6.

Adjustment entry for amortization of leasehold improvement is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Amortization Expense-Current Year		1,5004
	Amortization Expense-Error Correction		1,5004
	Leasehold Improvement	`		3,0004
	(To record current and past years amortization amounts.)

Table (7)

• Amortization is an expense and it is reduced by $1,500 each for current year and past year. Therefore, amortization account is debited with $3,000.
• Leasehold improvement is an asset and it is reduced by $3,000. Therefore, leasehold improvement account is credited with $3,000.

Adjustment entry for equipment and taxes is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Equipment		8,500
	Real Estate Taxes		2,500
	Leasehold Improvement	`		11,000
	(To record equipment and real estate taxes correctly.)

Table (8)

• Equipment and accounts receivable (non trade) is an asset and it is increased by $8,500 and $2,500 each. Therefore, equipment by $8,500 and accounts receivable by $2,500 is debited.
• Leasehold improvement is an asset and it is reduced by $11,000. Therefore, leasehold improvement account is credited with $11,000.

7.

Adjustment entry for amount wrongly capitalized is given below:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Retained Earnings		29,000
	Organizational Expenses			29,000
	(To write off the organizational expenses wrongly capitalized.)

Table (9)

• Retained earnings are liability and it is reduced by $29,000. Therefore, retained earnings account is debited with $29,000.
• Organizational expense is an expense and it is increased by $29,000. Therefore, organizational expenses account is credited with $29,000.

Working Notes:

1. Calculation of amortized value:

$\begin{array}{c}\text{Amortised}\text{Value}=\frac{\text{Value}\text{of}\text{Patents}}{\text{Number}\text{of}\text{Years}}\\ =\frac{\$68,000}{17\text{years}}\\ =\$4,000\end{array}$

2. Calculation of reduction in expected revenue:

$\begin{array}{c}\text{Reduction}\text{in}\text{Expected}\text{Revenue}=60\%\times \text{Licensing}\text{Agreement}\text{No}\text{.1}\\ =\frac{60}{100}\times \$50,000\\ =\$30,000\end{array}$

3. Calculation of amortized value:

$\begin{array}{c}\text{Amortised}\text{Value}=\frac{\text{Value}\text{of}\text{Patents}}{\text{Number}\text{of}\text{Years}}\\ =\frac{\$50,000}{10\text{years}}\\ =\$5,000\end{array}$

4. Calculation of amortized value:

$\begin{array}{c}\text{Amortised}\text{Value}=\frac{\text{Value}\text{of}\text{amortized}\text{expense}}{\text{Number}\text{of}\text{Non-Renewable}\text{Years}}\\ =\frac{\$15,000}{10\text{years}}\\ =\$1,500\end{array}$

b.

To determine

Discuss the substantive audit procedures performed for testing the transactions.

Explanation of Solution

Audit Procedures:

An explicit procedure performed by an auditor to obtain evidence and examine those evidences during an audit engagement is called audit procedure.

The substantive audit procedures performed by an auditor are as follows:

• Assessment of patent agreements and credentials procedure should be performed.
• Examine the licensing agreement and match the amount credited in bank accounts for reconciliation.
• Insurance agreement should be vouched and evidences should be obtained in respect to damage caused due to natural phenomena.
• Re compute the amortization values to examine the transaction.
• Calculate the amount of goodwill and perform other relevant accounting treatment for goodwill.
• Verify the documents that are related to equipment and real estate taxes and also recalculate the amortization value.
• Examine the vouchers of organizational expenses. Also, the retained earnings account should be inspected.