2000

Craig Brown, a mechanic, is planning to open his own car repair shop. He has selected the location, the kinds of cars that he will service, and the number of people that he will employ. However, he needs some help with the capitalization of the machines that he needs to buy, and how he has to depreciate these assets. He approaches you, an accountant friend, to help him understand the fundamentals of capitalization of expenses, the various depreciation methods, and the impact of this depreciation expense related to his assets on the financial statements. You use a former client and other businesses in the industry to prepare a report explaining these concepts to him.

Part 1A

• Explain to Craig the following:
  • Why it is it important to distinguish between expenses that need to be capitalized and expenses that need to be expensed.
  • What the underlying fundamental concept is that governs what expenses should be capitalized and what should be expensed.
  • Give an example of a company that experienced financial difficulty because of capitalizing expenses that should have been expensed.
• The ABC car repair shop, a former client of yours, purchased a machine on January 1, 20X1, at a net cost of $65,000. At the end of the 4-year life, it expected that the machine would have a salvage value of $1,000. It also estimated that the machine would run for 13,000 hours during its 4-year life. The company’s fiscal year ends on December 31. Using the following information, compute depreciation for this machine for each of the 4 years using each of the following methods:
  • Straight-line method
  • Sum-of-years method
  • Double-declining method
  • Units-of-production

• The ABC car repair shop purchased a machine in 20X1 at a cost of $20,000. The tractor was sold for $2,000 in 20X3. Depreciation recorded through the disposal totaled $16,000.
  • Prepare the journal entry to record the sale.
  • If the machine was sold for $10,000, what will the entry be?
• The ABC car repair shop traded a new machine for an older model. The old model’s book value was $150,000 (original cost $350,000, less $200,000 accumulated depreciation) and its fair value was $200,000. ABC paid $40,000 to complete the exchange.
  • Prepare the journal entry to record the exchange.

Part 1B

Research the annual reports of various companies to find examples of the following, and explain the meaning of your findings to Craig:

• Equity securities: Find a company that has investments and equity securities listed on its balance sheet.
  • Cite the source of the statement(s).
  • Look at the footnotes to the financial statements and comment on its holdings in equity securities.
  • Explain how this information is used by an investor.
• Cumulative effect: This has an impact on shareholders equity. Find a company that has an impact on their financial statements because of cumulative effect.
  • Cite the source of the statement(s).
  • Explain its footnotes.
  • Explain how this information is used by an investor.
• Leases: Find a company that has leases.
  • Cite the source of the statement(s).
  • Examine its footnotes. See if it has capital leases or operating leases. What is the difference in the presentation in the financial statements? Provide an explanation of the notes to financial statements about leases.

Part 2

Identify, analyze, and record accounting error corrections.

• Find a company that has accounting changes or correction of errors in its annual report.
  • Cite the source of the statement(s).
  • Discuss the footnote that explains the accounting change.
  • Explain the net impact on the financial statements.
• In 20X0, ABC company purchased machine for $300,000 that had a useful life of 5 years, with a salvage value of $50,000 at the end its life. Depreciation was calculated over 2 years on straight-line basis. In 20X2, it determined that the total life should be 10 years with the salvage value of $5,000 at the end its life.
  • Prepare the entry to correct the depreciation for 20X1.
  • Prepare the entry to record the depreciation for 20X2.