Chapter 8, Problem 7BE

a.

To determine

Record the events in general journal format and post to T-accounts.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Accounting rules for Journal entries:

• To record increase balance of account: Debit assets, expenses, losses and credit liabilities, capital, revenue and gains.
• To record decrease balance of account: Credit assets, expenses, losses and debit liabilities, capital, revenue and gains.

T-account:

T-account is the form of the ledger account, where the journal entries are posted to this account. It is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.

The components of the T-account are as follows:

a)      The title of the account

b)      The left or debit side

c)      The right or credit side

Straight-line Depreciation:

Under the straight-line method of depreciation, the same amount of depreciation is allocated every year over the estimated useful life of an asset. The formula to calculate the depreciation cost of the asset using the residual value is shown as below:

$\text{Depreciation = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}$

Record the events in general journal format.

Event	Account title and Explanation	Post ref	Debit  (in $)	Credit (in $)
1.	Cash		20,000
	Common Stock			20,000
	(To record the issue of the common stock)
2.	Equipment–Ice Cream machine		20,000
	Cash			20,000
	(To record the purchase of equipment)
3.	Cash		36,000
	Sales Revenue			36,000
	(To record  the sales revenue)
4.	Salaries Expense		21,000
	Cash			21,000
	(To record salaries expense)
5.	Operating Expenses		6,000
	Cash			6,000
	(To record operating expenses)
6.	Depreciation Expense		3,000
	Accumulated Depreciation  (1)			3,000
	(To record depreciation expense )

Table (1)

Working note:

Calculate the depreciation expense on Ice cream machine.

$\begin{array}{c}\text{Depreciation expense = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}\\ =\frac{\left(\$20,000-\$5,000\right)}{5\text{years}}\\ =\frac{\$15,000}{5}\\ =\$3,000\end{array}$ (1)

Post the events to T-accounts as follows:

Cash
1.	20,000	2.	20,000
3.	36,000	4.	21,000
		5.	6,000
Balance                9,000

Equipment–Ice cream machine
2.	20,000
Balance              20,000

Accumulated Depreciation
		6.	3,000
		Balance           3,000

Common Stock
		1.	20,000
		Balance         20,000

Service Revenue
		3.	36,000
		Balance         36,000

Operating Expense
5.	6,000
Balance                6,000
Salaries Expense
4.	21,000
Balance              21,000

Depreciation Expense
6.	3,000
Balance                3,000

b.

To determine

Determine the amount of depreciation expense that Shop S would report on the Year 2 income statement.

Explanation of Solution

Straight-line Depreciation:

Under the straight-line method of depreciation, the same amount of depreciation is allocated every year over the estimated useful life of an asset. The formula to calculate the depreciation cost of the asset using the residual value is shown as below:

$\text{Depreciation = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}$

Calculate the depreciation expense on Ice cream machine.

$\begin{array}{c}\text{Depreciation expense = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}\\ =\frac{\left(\$20,000-\$5,000\right)}{5\text{years}}\\ =\frac{\$15,000}{5}\\ =\$3,000\end{array}$

Hence, the amount of depreciation expense that Shop S would report on the Year 2 income statement is $3,000.

c.

To determine

Determine the amount of accumulated depreciation that Shop S would report on the December 31, Year 2, balance sheet.

Explanation of Solution

Accumulated depreciation:

The total amount of depreciation expense deducted, from the time asset acquired till date, as reported in the account as on a particular date, is referred to as accumulated depreciation.

Formula for accumulated depreciation:

$\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in the previous years+}\\ \text{Depreciation in current year}\end{array}\right\}$

Calculate the accumulated depreciation on December 31, Year 2.

$\begin{array}{c}\text{Accumulated depreciation = }\left\{\begin{array}{l}\text{Depreciation expense in Year 1+}\\ \text{Depreciation in Year 2}\end{array}\right\}\\ =\$3,000+\$3,000\\ =\$6,000\end{array}$

Hence, the amount of accumulated depreciation that Shop S would report on the December 31, Year 2, balance sheet is 6,000.

d.

To determine

Identify whether the cash flow from operating activities would be affected by depreciation in Year 2.

Answer to Problem 7BE

No, the cash flow from operating activities would not be affected by depreciation in Year 2.

Explanation of Solution

Cash flows from operating activities:

These refer to the cash received or cash paid in day-to-day operating activities of a company.  In the direct method, cash flow from operating activities is computed by using all cash receipts and cash payments during the year. In the indirect method, some amounts are to be adjusted from the Net Income to calculate the net cash provided from operating activities.

Depreciation is a non-cash expense. It is added to net income while preparing the statement of cash flows under the indirect method. During the preparation of net income, the depreciation is not considered as an expense but as a non-cash expense. That is, each year when depreciation expense is recorded in the financial statements, no cash payment is made actually. Therefore, it is again added back to the net income in the preparation of cash flows under the indirect method.