Chapter 9, Problem 3PB

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

Randy’s Restaurant Company (RRC) entered into the following transactions during a recent year.

April 1	Purchased a new food locker for $5,000 by paying $1.000 cash and signing a $4,000 note due in six months.
April 2	Installed an air-conditioning system in the food locker at a cost of $3,000, purchased on account.
April 30	Wrote a check for the amount owed on account for the work completed on April 2.
May 1	A local carpentry company repaired the restaurant’s front door, for which RRC wrote a check for the full $120 cost.
June 1	Paid $9,120 cash for the rights to use the name and store concept created by a different restaurant that has been successful in the region. For the next four years, RRC will operate under the Mullet Restaurant name, with the slogan “business customers in the front, and partiers in the back.”

Required:

1. 1. Analyze the accounting equation effects and record journal entries for each of the transactions.
2. 2. For the tangible and intangible assets acquired in the preceding transactions, determine the amount of depreciation and amortization that Randy’s Restaurant Company should report for the quarter ended June 30. For convenience, the food locker and air-conditioning system are depreciated as a group using the straight-line method with a useful life of five years and no residual value.
3. 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 April 1:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$1,000)		Notes Payable (+$4,000)
Equipment (+$5,000)

Table (1)

Prepare journal entry for the transaction occurred on April 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
April	1	Equipment			5,000
			Cash			1,000
			Notes Payable			4,000
		(To record purchase of equipment)

Table (2)

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.
• 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 April 2:

Assets	=	Liabilities	+	Stockholders’ Equity
Equipment (+$3,000)		Accounts Payable (+$3,000)

Table (3)

Prepare journal entry for the transaction occurred on April 2.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
April	2	Equipment			3,000
			Accounts Payable			3,000
		(To record purchase of equipment)

Table (4)

Description:

• Equipment is an asset account. Since equipment is bought, asset account increased, and an increase in asset 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 April 30:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$3,000)		Accounts Payable (–$3,000)

Table (5)

Prepare journal entry for the transaction occurred on April 30.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
April	30	Accounts Payable			3,000
			Cash			3,000
		(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 May 1:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$120)				Repairs and Maintenance Expense (–$120)

Table (7)

Prepare journal entry for the transaction occurred on May 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
May	1	Repairs and Maintenance Expense			120
			Cash			120
		(To record payment of expense)

Table (8)

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 June 1:

Assets	=	Liabilities	+	Stockholders’ Equity
Cash (–$9,120)
Franchise Rights (+$9,120)

Table (9)

Prepare journal entry for the transaction occurred on June 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
June	1	Franchise Rights			9,120
			Cash			9,120
		(To record purchase of licensing rights)

Table (10)

Description:

• Franchise Rights is an asset account. Since franchise rights are 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 June 30

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.

Amortization expense: The expense which reflects the usage of intangible asset by the way of reducing the cost of the asset over the estimated useful definite life, is referred to as amortization expense.

Formula for amortization expense:

$\text{Amortization expense}=\text{Cost of intangible asset}\text{×}\frac{1}{\text{Useful life}}$

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:

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

Determine the depreciation expense for the equipmentfor 3 months (from April1 to June 30) under double-declining-balancemethod, if cost of equipment is $8,000, useful life is 5 years, and accumulated depreciation is $0.

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense}\end{array}\}=\text{Depreciable cost }\text{× Depreciation rate}\\ \text{= }\left(\text{Cost–Residual value}\right)\text{×}\frac{1}{\text{Useful life}}\times \text{Time period }\\ =\left(\$8,000–\$0\right)\times \frac{1}{\text{5 years}}\times \frac{3}{12}\\ =\$400\end{array}$

Determine amortization expense for 1 month (from June 1 to June 30), if cost of franchise right is $9,120, and useful life is 4 years.

$\begin{array}{c}\text{Amortization expense =}\left\{\begin{array}{l}\text{Cost of intangible asset}\text{×}\\ \frac{\text{1}}{\text{Useful life}}\text{× Time period}\end{array}\right\}\\ \text{= \$9,120 × }\frac{\text{1}}{\text{4 years}}\times \frac{1}{12}\\ \text{= \$190}\end{array}$

To determine

To journalize: The entries for depreciation expense and amortization expense

Explanation of Solution

Prepare journal entry for the depreciation expense and amortization expense as on June 30 (Refer to Requirement (2) for the expense values).

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
June	30	Depreciation Expense			400
		Amortization Expense			190
			Accumulated Depreciation–Equipment			400
			Accumulated Amortization			190
		(To record depreciation expense)

Table (11)

Description:

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