Chapter 9, Problem 3CP

Analyzing and Recording Long-Lived Asset Transactions with Partial-Year Depreciation

Palmer Cook Productions manages and operates two rock bands. The company entered into the following transactions during a recent year.

January 2		Purchased a tour bus for $80,000 by paying $20,000 cash and signing a $60,000 note due in two years.
January 8		The bus was painted with the logos of the two bands at a cost of $350, on account.
January 30		Wrote a check for the amount owed on account for the work completed on January 8.
February 1		Purchased new speakers and amplifiers and wrote a check for the full $12,000 cost.
February 8		Paid $250 cash to tune up the tour bus.
March 1	Paid $20,000 cash and signed a $190,000 five-year note to purchase a small office building and land. An appraisal indicated that the building and land contributed equally to the total price.
March 31	Paid $90,000 cash to acquire the goodwill and certain tangible assets of Kris’ Myth. Inc. The fair values of the tangible assets acquired were $20,000 for band equipment and $60,000 for recording equipment.

Required:

1. 1. Analyze the accounting equation effects and record journal entries for each of the transactions.

  TIP: Goodwill is recorded as the excess of the purchase price over the fair value of individual assets.

1. 2. For the tangible and intangible assets acquired in the preceding transactions, determine the amount of depreciation and amortization that Palmer Cook Productions should report for the quarter ended March 31. For convenience, the equipment and vehicle are depreciated the same way, using the straight-line method with a useful life of five years and no residual value. The building is depreciated using the double-declining-balance method, with a 10-year useful life and residual value of $20,000.

  TIP: Calculate depreciation from the acquisition date to the end of the quarter.

1. 3. Prepare a journal entry to record the depreciation calculated in requirement 2.

To determine

To indicate: The effect of given transactions, on the accounting equation, and journalize the transactions

Explanation of Solution

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relation between resources or assets of a company and claims of resources to creditors and owners.

Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders' Equity}$

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

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Effect of transaction occurred on January 2:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$20,000)		Notes Payable (+$60,000)
Vehicle (+$80,000)

Table (1)

Prepare journal entry for the transaction occurred on January 2.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	2	Vehicle			80,000
			Cash			20,000
			Notes Payable			60,000
		(To record purchase of equipment)

Table (2)

Description:

• Vehicle is an asset account. Since vehicle is bought, asset account increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.
• Notes Payable is a liability account. Since the amount to be paid increased, liability increased, and an increase in liability is credited.

Effect of transaction occurred on January 8:

Assets	=	Liabilities	+	Stockholders’ Equity
		Accounts Payable (+$350)		Repairs and Maintenance Expense (–$350)

Table (3)

Prepare journal entry for the transaction occurred on January 8.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	8	Repairs and Maintenance Expense			350
			Accounts Payable			350
		(To record expense incurred on account)

Table (4)

Description:

• Repairs and Maintenance Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Accounts Payable is a liability account. Since the amount to be paid increased, liability increased, and an increase in liability is credited.

Effect of transaction occurred on January 30:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$350)		Accounts Payable (–$350)

Table (5)

Prepare journal entry for the transaction occurred on January 30.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	30	Accounts Payable			350
			Cash			350
		(To record payment of on account purchases)

Table (6)

Description:

• Accounts Payable is a liability account. Since the amount to be paid is paid, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Effect of transaction occurred on February 1:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$12,000)
Equipment (+$12,000)

Table (7)

Prepare journal entry for the transaction occurred on February 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
February	1	Equipment			12,000
			Cash			12,000
		(To record purchase of equipment)

Table (8)

Description:

• Equipment is an asset account. Since equipment is bought, asset account increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Effect of transaction occurred on February 8:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$250)				Repairs and Maintenance Expense (–$250)

Table (9)

Prepare journal entry for the transaction occurred on February 8.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
February	8	Repairs and Maintenance Expense			250
			Cash			250
		(To record payment of expense)

Table (10)

Description:

• Repairs and Maintenance Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Effect of transaction occurred on March 1:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$20,000)		Notes Payable (+$190,000)
Land ($105,000)
Building (+$105,000)

Table (11)

Prepare journal entry for the transaction occurred on March 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
March	1	Land			105,000
		Building			105,000
			Cash			20,000
			Notes Payable			190,000
		(To record purchase of land and building)

Table (12)

Description:

• Land is an asset account. Since land is bought, asset account increased, and an increase in asset is debited.
• Building is an asset account. Since building is bought, asset account increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.
• Notes Payable is a liability account. Since the amount to be paid increased, liability increased, and an increase in liability is credited.

Effect of transaction occurred on March 31:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$90,000)
Equipment ($80,000)
Goodwill (+$10,000)

Table (13)

Prepare journal entry for the transaction occurred on March 31.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
March	31	Equipment			80,000
		Goodwill			10,000
			Cash			90,000
		(To record acquisition of equipment and goodwill)

Table (14)

Description:

• Land is an asset account. Since land is bought, asset account increased, and an increase in asset is debited.
• Building is an asset account. Since building is bought, asset account increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

To determine

The depreciation expense and amortization expense as on March 31

Explanation of Solution

Depreciation expense: Depreciation expense is a non-cash expense, which is recorded on the income statement reflecting the consumption of economic benefits of long-term asset.

Straight-line method: The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset, is referred to as straight-line method.

Formula of depreciation expense under straight-line method:

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{× Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{1}{\text{Useful life}}\end{array}$

Double-declining-balance method: The depreciation method which assumes that the consumption of economic benefits of long-term asset is high in the early years but gradually declines towards the end of its useful life, is referred to as double-declining-balance method.

Formula for double-declining-balance depreciation method:

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\left(\begin{array}{l}\text{Book value at the }\\ \text{beginning of the period }\end{array}\right)\text{× Depreciation rate}\\ \text{= }\left(\text{Cost–Accumulated depreciation}\right)\text{×}\frac{\text{2}}{\text{Useful life}}\end{array}$

Determine the depreciation expense for the vehiclefor 3 months (from January2 to March 31) under straight-linemethod, if cost of vehicle is $80,000, useful life is 5 years, and residual value is $0.

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{× Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{1}{\text{Useful life}}\times \text{Time period }\\ =\left(\$80,000–\$0\right)\times \frac{1}{\text{5 years}}\times \frac{3}{12}\\ =\$4,000\end{array}$

Determine the depreciation expense for the equipmentfor 2 months (from February 1 to March 31) under straight-linemethod, if cost of equipment is $12,000, useful life is 5 years, and residual value is $0.

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{× Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{1}{\text{Useful life}}\times \text{Time period }\\ =\left(\$12,000–\$0\right)\times \frac{1}{\text{5 years}}\times \frac{2}{12}\\ =\$400\end{array}$

Determine the depreciation expense for the buildingfor 1 month (from March 1 to March 31) under double-declining-balancemethod, if cost of building is $105,000, useful life is 10 years, and accumulated depreciation is $0.

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{× Depreciation rate}\\ \text{= }\left(\begin{array}{l}\text{Cost–}\\ \text{Accumulated depreciation}\end{array}\right)\text{×}\frac{2}{\text{Useful life}}\times \text{Time period }\\ =\left(\$105,000–\$0\right)\times \frac{2}{\text{10 years}}\times \frac{1}{12}\\ =\$1,750\end{array}$

The intangible assets would be amortized over their useful life or definite life or limited life, and those with unlimited life are not amortized. Goodwill has unlimited life and hence, could not be amortized.

To determine

To journalize: The entries for depreciation expense computed in Requirement (2)

Explanation of Solution

Prepare journal entry for the depreciation expense reported on March 31 (Refer to Requirement (2) for the expense values).

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
March	31	Depreciation Expense–Vehicle			4,000
		Depreciation Expense–Equipment			400
		Depreciation Expense–Building			1,750
			Accumulated Depreciation–Vehicle			4,000
			Accumulated Depreciation–Equipment			400
			Accumulated Depreciation–Building			1,750
		(To record depreciation expense)

Table (15)

Description:

• Depreciation Expense–Vehicle is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Depreciation Expense–Equipment is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Depreciation Expense–Building is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Accumulated Depreciation–Vehicle is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.
• Accumulated Depreciation–Equipment is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.
• Accumulated Depreciation–Building is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.