1

Financial

Accounting 2 Prepared by

Dr.Eman Salah

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Contents

Part One:

Accounting for Merchandising Operations

P3 Part Two:

Cash and Receivables P34

Part Three:

Property ,plant and equipment P59

Assignment Cases P95

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Part One

Accounting for Merchandising Operations

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Part One

Accounting for Merchandising Operations

MERCHANDISING ACTIVITIES

A merchandising company’s activities differ from those of

a service company.

Merchandise consists of products, also called goods that a

company acquires to resell to customers. A merchandiser earns

net income by buying and selling merchandise. Merchandisers

are often identified as either wholesalers or retailers. A

wholesaler is an intermediary that buys products from

manufacturers or other wholesalers and sells them to retailers or

other wholesalers. A retailer is an intermediary that buys

products from manufacturers or wholesalers and sells them to

consumers. Many retailers sell both products and services.

Service Company

Minus Equals

Merchandiser

Minus Equals Minus Equals

Revenues

Expenses

Net income

Net Sales

Expenses

Net income

Cost

of

goods

sold

Gross

Profit

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Merchandiser’s Income Statement

Net sales . . . . . . . . . . . . . . . . . . . L.E314,700

Cost of goods sold . . . . . . . . . …. (230,400)

Gross profit . . . . . . . . . . . . . . …. 84,300

Expenses . . . . . . . . . . . . . . . . . . . (71,400)

Net income . . . . . . . . . . . . . . . . . L.E 12,900

Reporting Inventory for a Merchandiser

A merchandiser’s balance sheet includes a current asset called

merchandise inventory, an item not on a service company’s balance sheet.

Merchandise inventory, or simply inventory, refers to products that a

company owns and intends to sell. The cost of this asset includes the cost

incurred to buy the goods, ship them to the store, and make them ready

for sale.

Operating Cycle for a Merchandiser

A merchandising company’s operating cycle begins by purchasing

merchandise and ends by collecting cash from selling the merchandise.

The cycle moves from (a) cash purchases of merchandise to (b) inventory

for sale to (c) credit sales to (d) accounts receivable to(e) cash.

Companies try to keep their operating cycles short because assets tied up

in inventory and receivables are not productive. Cash sales shorten

operating cycles.

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Inventory Systems

Cost of goods sold is the cost of merchandise sold to customers during

a period. It is often the largest single expense on a merchandiser’s

income statement. Inventory refers to products a company owns and

expects to sell in its normal operations.

Beginning inventory

+

Net Purchases

=

Merchandise available for sale

-

Ending inventory

=

Cost of goods sold

The merchandise available is either sold (cost of goods sold) or

kept for future sales (ending inventory).

Two alternative inventory accounting systems can be used to

collect information about cost of goods sold and cost of

inventory: perpetual system or periodic system.

The perpetual inventory system continually updates

accounting records for merchandising transactions —

specifically, for those records of inventory available for sale and

inventory sold. The periodic inventory system updates the

accounting records for merchandise transactions only at the end

of a period. Technological advances and competitive pressures

have dramatically increased the use of the perpetual system. It

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gives managers immediate access to detailed information on

sales and inventory levels, where they can strategically react to

sales trends, cost changes, consumer tastes, and so forth, to

increase gross profit. (Some companies use a hybrid system

where the perpetual system is used for tracking units available

and the periodic system is used to compute cost of sales.)

Purchase Discounts

The purchase of goods on credit requires a clear statement of

expected future payments and dates to avoid misunderstandings.

Credit terms for a purchase include the amounts and timing of

payments from a buyer to a seller. Credit terms usually reflect

an industry’s practices. To illustrate, when sellers require

payment within 10 days after the end of the month of the invoice

date, the invoice will show credit terms as “n/10 EOM,” which

stands for net 10 days after end of month (EOM). When sellers

require payment within 30 days after the invoice date, the

invoice shows credit terms of “n/30,” which stands for net 30

days.

The amount of time allowed before full payment is due is called

the credit period. Sellers can grant a cash discount to

encourage buyers to pay earlier. A buyer views a cash discount

as a purchase discount. A seller views a cash discount as a

sales discount. Any cash discounts are described in the credit

terms on the invoice. For example, credit terms of “2/10, n/60”

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mean that full payment is due within a 60-day credit period, but

the buyer can deduct 2% of the invoice amount if payment is

made within 10 days of the invoice date. This reduced payment

applies only for the discount period.

Purchase Returns and Allowances

Purchase returns refer to merchandise a buyer acquires but then

returns to the seller. A purchase allowance is a reduction in the

cost of defective or unacceptable merchandise that a buyer

acquires. Buyers often keep defective but still marketable

merchandise if the seller grants an acceptable allowance. When

a buyer returns or takes an allowance on merchandise, the buyer

issues a debit memorandum to inform the seller of a debit

made to the seller’s account in the buyer’s records.

Transportation Costs and Ownership Transfer

The buyer and seller must agree on who is responsible for

paying any freight costs and who bears the risk of loss during

transit for merchandising transactions. This is essentially the

same as asking at what point ownership transfers from the seller

to the buyer. The point of transfer is called the FOB (free on

board) point, which determines who pays transportation costs

(and often other incidental costs of transit such as insurance).

FOB factory, means the buyer accepts ownership when the

goods depart the seller’s place of business. The buyer is then

responsible for paying shipping costs and bearing the risk of

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damage or loss when goods are in transit. The goods are part of

the buyer’s inventory when they are in transit since ownership

has transferred to the buyer.

Ownership

Transfers

When

Goods

Passed to

Transportation

Costs Paid by

FOB shipping

point

Carrier Buyer

FOB

destination

Buyer Seller

Invoice cost of merchandise purchases . . . . . . . . . . L.E 235,800

Less: Purchase discounts received . . . . . . . . . . . . . . . . (4,200)

Purchase returns and allowances . . . . . . . . . . . . ……..(1,500)

Add: Costs of transportation-in . . . . . . . . . . . . . . ….. . . 2,300

Total cost of merchandise purchases . . . . . . . . .L.E232,400

ACCOUNTING FOR MERCHANDISE SALES

Sales. . . . . . . . . . . . . . . . . . . . . . L.E321,000

Less: Sales discounts . . . . . . . . . . . .4,300

Sales returns and allowances . . . . . .2,000 (6,300)

Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . 314,700

Cost of goods sold . . . . . . . . . . . . . . . . . . . (230,400)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . L.E 84,300

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Sales of Merchandise

Example:

A-Mall sold L.E2,400 of merchandise on credit on November 3.

The revenue part of this transaction is recorded as

Nov. 3

Accounts Receivable . . . . . . . . . . . 2,400

Sales revenue . . . . . . . . . . . . . . . . . . . . 2,400

(Sold merchandise on credit.)

Sales Discounts

Sales discounts on credit sales can benefit a seller by decreasing the delay

in receiving cash and reducing future collection efforts. At the time of a

credit sale, a seller does not know whether a customer will pay within the

discount period and take advantage of a discount. This means the seller

usually does not record a sales discount until a customer actually pays

within the discount period.

Sales Returns and Allowances

Sales returns refer to merchandise that customers return to the seller after

a sale. Many companies allow customers to return merchandise for a full

refund. Sales allowances refer to reductions in the selling price of

merchandise sold to customers. This can occur with damaged or defective

merchandise that a customer is willing to purchase with a decrease in

selling price.

Sales returns and allowances usually involve dissatisfied customers and

the possibility of lost future sales, and managers monitor information

about returns and allowances.

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Difference between periodic and perpetual systems in Recording

Merchandise Transactions

Under a periodic system, purchases, purchase returns and

allowances, purchase discounts, and transportation-in transactions are

recorded in separate temporary accounts. At period-end, each of these

temporary accounts is closed and the Merchandise Inventory account is

updated.

Purchases The periodic system uses a temporary Purchases account that

accumulates the cost of all purchase transactions during each period.

Example: purchase of merchandise for L.E1,200 on credit with terms of

2/10, n/30

Periodic Perpetual

Purchases . . . . . . . . . . . . . . . 1,200 Merchandise Inventory . . . . . . . . . 1,200

Accounts Payable . . . . . 1,200 Accounts Payable. . . . . . . . . 1,200

Purchase Discounts

The periodic system uses a temporary Purchase Discounts account that

accumulates discounts taken on purchase transactions during the period.

If payment in is delayed until after the discount period expires, the entry

is to debit Accounts Payable and credit Cash for L.E1,200 each.

However, if pays the supplier for the previous purchase in within the

discount period, the required payment is L.E1,176 (L.E1,200 X 98%) and

is recorded as

Periodic Perpetual

Accounts Payable . . . . . . . . . 1,200 Accounts Payable . . . . . . . . . . . . . 1,200

Purchase Discounts . . . ……….. 24 Merchandise Inventory . . . . . …………24

Cash . . . . . . . . . . . . . . . . 1,176 Cash . . . . . . . . . . . . . . . . .

.1,176

Purchase Returns and Allowances

Returned merchandise purchased on November 2 because of

defects. In the periodic system, the temporary Purchase Returns and

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Allowances account accumulates the cost of all returns and allowances

during a period. The recorded cost (including discounts) of the defective

merchandise is L.E300

Periodic Perpetual

Accounts Payable . . . . . . . . . 300 Accounts Payable . . . . . . . . . . . . . . 300

Purchase Returns and Allowances . . . . .300 Merchandise Inventory . . . .

300

Transportation-In

Paid a L.E75 freight charge to transport merchandise to its store. In

the periodic system, this cost is charged to a temporary Transportation-In

account.

Periodic Perpetual

Transportation-In . . . . . . . . . 75 Merchandise Inventory . . . . . . . . . 75

Cash . . . . . . . . . . . . . . . 75 Cash . . . . . . . . . . . . . . . . . . . 75 Sales

Under the periodic system, the cost of goods sold is not recorded at the

time of each sale. Sales of L.E2,400 in merchandise on credit (when its

cost is L.E1,600) is:

Periodic Perpetual

Accounts Receivable . . . . . . 2,400 Accounts Receivable . . . . . . . . . . 2,400

Sales . . . . . . . . . . . . . . . 2,400 Sales . . . . . . . . . . . . . . . . . . . 2,400

Cost of Goods Sold . . . . . . . . . . . 1,600

Merchandise Inventory . . . . 1,600

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Sales Returns

A customer returned part of the merchandise, where the returned items

sell for L.E800 and cost L.E600. (Recall: The periodic system records

only the revenue effect, not the cost effect, for sales transactions.)

Periodic Perpetual

Sales Returns and Sales Returns and

Allowances . . . . . . . . . . . . . . 800 Allowances . . . . . . . . . . . . . . . . . . 800

Accounts Receivable . . . 800 Accounts Receivable . . . . . . 800

Merchandise Inventory . . . . . . . . . 600

Cost of Goods Sold . . . . . . . 600

Sales Discounts

To illustrate sales discounts, assume that the remaining L.E1,600 of

receivables has credit terms of 3/10, n/90 and that customer will pay

within the discount period.

Periodic Perpetual

Cash . . . . . . . . . . . . . . . . . . . 1,552 Cash . . . . . . . . . . . . . . . . . . . . . . . 1,552

Sales Discounts (L.E1,600 X .03) 48 Sales Discounts (L.E1,600 X .03) . . . 48

Accounts Receivable . . . 1,600 Accounts Receivable . . . . . . 1,600

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Example:

Prepare journal entries to record the following merchandising transactions

for both the seller (S) and buyer (B).using periodic system

May 4 S sold L.E1,500 of merchandise on account to B, terms FOB

shipping point, n/45, invoice dated May 4.

May 6 B paid transportation charges of L.E30 on the May 4 purchase

from S.

May 8 S sold L.E1,000 of merchandise on account to B, terms FOB

destination, n/30, invoice dated May 8.

May 10 S paid transportation costs of L.E50 for delivery of merchandise

sold to B on May 8.

May 16 S issued S a L.E200 credit memorandum for merchandise

returned. The merchandise was purchased by B on account on May 8.

May 18 S received payment from B for purchase of May 8.

May 21 S sold L.E2,400 of merchandise on account to B, terms FOB

shipping point, 2/10,n/EOM. Transportation costs of L.E100.

May 25 S received payment from B for purchase of May 21.

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SOLUTION

S (Seller) B (Buyer)

May 4 Accounts Receivable—B

Sales

1,500

1,500

Purchases

Accounts

Payable—S

1,500

1,500

May 6 No entry Transportation -in

Cash 30

30

May 8 Accounts Receivable—B

Sales

1,000

1,000

Purchases

Accounts

Payable—S

1,000

1,000

May

10

Transportation-out

Cash

50

50

No entry.

May

16

Sales Returns &

Allowances

Accounts

Receivable—B

200

200

Accounts

Payable—S

Purchases

Returns &

Allowances

200

200

May

18

Cash

Accounts

Receivable—B

800

800

Accounts

Payable—S

Cash

800

800

May21 Accounts Receivable—B

Sales

2,400

2,400

Purchases

Accounts

Payable—S

2,400

2,400

No entry Transportation –in

Cash 100

100

May25 Cash

Sales Discounts

Accounts

Receivable—B

2,352

48

2,400

Accounts

Payable—S

Cash

Purchases

discount

2,400

2,352

48

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Difference between Cash and trade discount First: Trade discount is issued by deduction in list price.

Cash discount is issued by deduction in payable amount of debtors.

Second: Trade discount is given with the aim to purchase at high

quantity.

Cash discount is given with the aim to get payment fast and before

payment date.

Third: Trade discount is shown as deduction in Invoice.

Cash Discount is not shown as deduction in Invoice.

Fourth: There is no any accounting treatment for trade discount.

There is accounting treatment for cash discount both in vendor and

buyer’s day book.

Fifth: Trade discount is related to quantity of the goods purchased.

Cash Discount is related to the amount of payment but not to

quantity of goods.

Sixth: There is no need to give cash discount with trade discount.

If seller has given trade discount, cash discount can be given after

trade discount.

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EXAMPLE

Hassan made the following transactions:

1/1 Purchased from Ahmed 100 units, price per unit L.E. 50.and

paid cash

2/1 Sold to Aly 10 units price per unit 60 L.E and collected cash.

3/1 Returned 5 units to Ahmed from the purchases of date 1/1.

4/1 Aly returned 2 units.

5/1 Purchased from Karim 50 units, price per unit L.E. 130 With

Trade discount 10%. And 5% cash discount if paid within one

month.

6/1Sold to Kamel goods that value L.E. 40000 and made Trade

discount of 5%, and 5% cash discount if paid within one month.

7/1 Hassan paid the value of goods he purchased on date5/1.

8/1 Kamel paid the amount payable to Hassan.

Required:

a) Journalize the entries in the journal of Hassan.

b) Explain the difference between trade discounts and cash

discounts and their accounting treatment.

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SOLUTION

DATE ITEMS DR. CR.

1/1 Purchases

cash

(cash purchases)

5000

5000

2/1 Cash

Sales

(cash sales)

600

600

3/1 Cash

Purchases return

(Purchases return)

250

250

4/1 Sales return

Cash

(Sales return)

120

120

5/1 Purchases

A/P (Karim)

(credit purchases)

5850

5850

6/1 A/R (Kamel)

Sales

(credit sales)

38000

38000

7/1 A/P (Karim)

Cash

Discount received

(Paid the on account)

5850

5557.5

292.5

8/1 Cash

Discount allowed

A/R (Kamel)

(collected the on account)

36100

1900

38000

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Solved Example Prepare journal entries to record the following merchandising transactions

of ABC Company:

Jan 1: Purchased from X traders 1000 units at L.E100 per unit

under credit terms of 5/10, n/30.

Jan 2: Sold to C 500 units at price L.E 200 per unit under credit

terms of 10/10, n/60.

Jan 4: Received the balance due from C.

Jan 5: Paid the balance due to X traders.

Required: 1) Journalize the above transactions in the journal of ABC

company.

2) Discuss the difference between cash discount and trade

discount.

Jan 1 Purchases A/p

(purchases on account)

100,000 100,000

Jan 2 A/R Sales revenue

(Sales on account)

100,000 100,000

Jan 4 Cash Sales discount

A/R (Collected the receivables and

allowed discount)

90,000 10,000

100,000

Jan 5 A/P Cash

Purchases discount (Paid payables and received

discount)

100,000

95,000 5,000

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Example:

The following information belongs to a store.

Inventory – 1st January 2016

200 units at L.E12 L.E2,400

Purchases during the year 1800 units at L.E12 L.E21,600

Sales during the year 1200 units at L.E24 L.E28,800

Inventory 31 December 800 units at L.E12 L.E9,600

Required: Make journal entries to record the above transactions

using periodic inventory system.

Solution:

Purchases 21,600

Accounts payable 21,600

———————————-

Accounts receivable 28,800

Sales 28,800

———————————-

Inventory – ending 9,600

Cost of goods sold 14,400*

Purchases 21,600

Inventory – beginning 2,400

* [(21,600 + 2,400) – 9,600]

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Solved Example

Given the following information:

Inventory – 1st January 2019, L.E4000

Purchases during the year L.E 50000,Trasportation -in LE

2000,Purchases return L.E600, Purchases discount L.E 3000

Inventory 31 December 2019, L.E 6000.

Required:1) Calculate net purchases

Purchases during the year + L.E 50000,Trasportation -in LE

2000 - Purchases return L.E600 - Purchases discount L.E 3000

= 48400

2)Prepare the end of year journal entry.

31/12

Inventory – ending

Cost of goods sold

Net Purchases

Inventory –

beginning

6000

46400

48400

4000

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Merchandising activities compared with the Manufacturing

Most merchandising companies purchase their inventory

from another business organization in a ready- to - sell

condition, companies that manufacture their inventory, such as

General Motors, Apple Computer, and Boeing Aircraft, are

called Manufactures, rather than the merchandise.

The operating cycle of a manufacturing company is longer

and more complex than that of a merchandising company,

because the first transaction - purchasing merchandise — is

replaced by many transactions involved in manufacturing the

merchandise.

Income statement of a merchandising company

Most merchandisers use a multi-step income statement.

The multi-step income statement is prepared in steps. Important

subtotals are computed as part of the calculation of net income

or net loss. Investors prefer this format because it provides

stepbystep information about the profitability of the business.

This format makes it more useful for managers within the

business as well as investors outside of the business. The

multistep income statement for most merchandisers will contain

most, but not necessarily all, of the following items:

Selling merchandise introduces a new and major cost of

doing business: The cost to the merchandising Company of the

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goods that it resells to its customers. This cost is termed the cost

of goods sold, the cost goods sold is an expense; however, this

item is of such importance to a merchandising company that it is

shown separate from other expenses in the income statement.

Revenue from sales represents the sales price of

merchandise sold to customers during the period.

The cost of goods sold, on the other hand, represents the

cost incurred by the merchandising company in purchasing these

goods from the company’s suppliers.

The difference between revenue from sales and the cost of

goods sold is called gross profit (or gross margin).

Gross profit is a useful means of measuring the

profitability of sales transactions, but it does not represent the

overall profitability of the business.

A merchandising company has many expenses other than

the cost of goods sold. Examples include salaries, rent,

advertising, and depreciation. The company only earns a net

income if its gross exceeds the sum of these other expenses.

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Classified income statement

To this point, we only illustrated unclassified income

statement the unclassified income statement has only two

categories of items, revenues and expenses. Now a classified

income statement will be introduced.

A classified income statement divides both revenues and

expenses into operating items. The statement also separates

operating expenses and administrative expenses.

A classified income statement is also called a multiple-

step income statement.

Note that the income statement has four major sections:

1. Operating revenues.

2. Cost of goods sold.

3. Operating expenses.

4. Non-operating revenues and expense: (other

revenues and other expenses).

The term operating revenues refers to the revenues

Generated by the major activities of the business usually the sale

of products or services or both.

Cost of goods sold is the major expense in merchandising

companies it is common to highlight the amount by which sales

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revenues exceed the cost of goods sold in the top part of the

income statement .The excess of net sales over cost of goods

sold is called gross profit.

Operating expenses for a merchandising company are

those expenses, other than cost of goods sold, incurred in the

normal buying, selling, and administrative functions of a

business. Operating expenses are usually classified as either

selling expenses or administrative expenses.

Selling expenses are those expenses that are incurred in

the selling and marketing efforts. Examples include salaries and

commissions of salespersons, salespersons' travel, delivery,

advertising, rent of sales building, sales supplies used, utilities

for sales building, and depreciation of equipment used in sales.

Administrative expenses are those expenses incurred in

the overall management of a business. Examples include

executive salaries, rent of administrative building, insurance,

administrative supplies used, and depreciation of office

equipment.

Certain operating expenses may be related partly to the

selling function and partly to the administrative function. For

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example, rent, taxes, and insurance on building might be

incurred for both sales purposes and administrative purposes.

Expenses covering both the selling and administrative

functions may be analyzed between the two functions in the

income statement.

Non-operating revenues (other revenues) are revenues

not related to the sale of products or services regularly offered

for sale by business. An example for non-operating revenue is

interest earned on notes receivable by a company.

Non-operating expenses (other expenses) are those not

related to the acquisition and sale of products or services

regularly offered for sale. An example for a non-operating

expense is interest incurred on borrowed money.

Important relationships in the income statement of a

merchandising firm can be summarized in equation forms as

follows:

1. Net sales= Gross sales - Sales discount - Sales returns and

allowances.

2. Cost of goods sold = Beginning inventory + Net cost of

purchases - Ending inventory.

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3. Net cost of purchases =

Net purchases +Transportation-in.

4. Net purchases = Purchases - Purchases discounts

-Purchases returns and allowances.

5. Gross margin = net sales - cost of goods sold.

6. Net income from operations = Gross margin - operating

(selling and administrative) expenses.

7. Net income = Net income from operations + Non-operating

revenue -Non-operating expenses.

28

Example1: the following is the adjusted trial balance for “X” company

On Dec,31,2015

Item Debit Credit

cash 100000

land 200000

Equipment 100000

Accumulated depreciation

equipment 10,000

Accounts Receivable 110,000

Allowance for uncollectible account 10,000

Notes Payable 50,000

expenses 28000

Sales return 2000

Sales discount 1000

Ending inventory 7000

drawings 1000

Cost of goods sold 20000

sales 200000

loan 100000

A/P 50000

capital 149000

Total 569,000 569,000

Required: Prepare the income statement and balance sheet for “X” company.

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Solution:

Income statement:

Item Parts Total Sales 200000

- sales return (2000)

- sales discount (1000)

Net sales 197000

Cost of goods sold (20000)

Gross profit 177000

Total expenses (28000)

Net profit 149000

Balance sheet:

Assets Parts Total Liabilities & O.E Parts Total Cash 100000 loan 100000

Account receivables

Less: Allowance for

uncollectible account

110000

(10,000)

100,000

Notes payable 50000

Ending inventory 7000 A/P 50000

Total current assets 207000 Total current liab. 100000

Land 200000 Total liabilities 200000

Equipment 100000 capital 149000

- accumulated dep. 10000 - drawings 1000

Net fixed assets 290000 + profit 149000

Total O.E 297000

Total assets 497000 Total liabilities &

O.E

497000

30

Example 2

Given the following Adjusted trial balance 31/12/2015:

Cr. Dr. Items

400,000 Land

300,000 Building

120,000 Accumulated Depreciation ( building)

50,000 Cash

22,000 Ending Inventory

23,000 A/R

3,000 Allowance for uncollectible accounts

40,000 A/P

191,000 Cost of goods sold

300,000 Sales

20,000 Sales Discount

134,000 expenses

10,000 Withdrawals

687,000 Capital

1,150,000 1,150,000 Total Required:

1) Prepare income statement.

2) Prepare balance sheet.

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Solution:

Income statement:

Item Parts Total Sales 300000

- sales discount (20000)

Net sales 280000

Cost of goods sold (191000)

Gross profit 89000

Total expenses (134000)

Net loss (45000)

Balance sheet: Assets Parts Total Liabilities &

O.E

Parts Total

Cash 50000 Accounts

payable

40000

Account receivables

Less: Allowance for

ucollectible accounts

Net accounts receivable

23000

(3,000)

20000

Total liabilities 40000

Ending inventory 22000 capital 687000

Total current assets 92000 - drawings (10000)

Land 400000 -loss (45000)

Building 300000 Total O.E 632000

- accumulated

dep.(120000)

Net Building 180000

Total Fixed Assets 580000

Total assets 672000 Total liabilities

& O.E

672000

32

Example: the following is the trial balance for “X” company:

Item Debit Credit

cash 100000

land 200000

equipment 100000

Accounts Receivable 100000

Notes Payable 50000

Rent expenses 5000

salaries 10000

Sales return / purchases return 2000 2000

Sales discount/ purchases

discount 1000 3000

Beginning inventory 10000

Transportation in 2000

Transportation out 3000

drawings 1000

Purchases 20000

sales 200000

loan 100000

A/P 50000

capital 149000

Total 554000 554000

Required: Prepare the income statement and balance sheet for “X” company, if

you know that ending inventory = 7000 and depreciation rate = 10%.

33

Solution:

Income statement:

Item Parts Parts Total Sales 200000

- sales return 2000

- sales discount 1000

Net sales 197000

C.G.S:

Beginning inventory 10000

Purchases 20000

+ transportation in 2000

Gross purchases 22000

- purchases return 2000

- purchases discount 3000

Net purchases 17000

Cost of goods available for sale 27000

- ending inventory 7000

Cost of goods sold 20000

Gross profit 177000

rent expenses 5000

salaries 10000

transportation out 3000

depreciation expenses (a) 10000

Total expenses 28000

Net profit 149000

Note:

(a) Depreciation expense = fixed assets * depreciation rate.

= 100000 (equipments) * 10/100 = 10000.

34

Balance sheet:

Assets Parts Total Liabilities & O.E Parts Total Cash 100000 loan 100000

Account receivables 100000 Notes payable 50000

Ending inventory 7000 A/P 50000

Total current assets 207000 Total current liab. 100000

Land 200000 Total liabilities 200000

Equipment 100000 capital 149000

- accumulated dep. 10000 - drawings 1000

Net fixed assets 290000 + profit 149000

Total O.E 297000

Total assets 497000 Total liabilities &

O.E

497000

Accumulated dep. = 0 +10000 =10000

35

Part Two

Cash and Receivables

36

Cash and Receivables

Cash and receivables represent two of the most liquid of

assets. Liquidity is an indication of an enterprise’s ability to

meet its obligations as they come due.

Cash Includes coin, currency, bank deposits including checking and

savings accounts, and negotiable instruments such as money

orders, cashiers’ checks, personal checks, and bank drafts.

Restricted cash:

a. Cash restricted for some special purpose (such as the

retirement of bonds) is reported separately in either the

current asset section or the noncurrent asset section of the

balance sheet, depending on the date of availability or

disbursement.

b. The SEC recommends that legally restricted deposits held

as compensating balances against borrowing arrangements be

reported separately in either the current asset section or the

noncurrent asset section, depending on whether the

borrowing arrangement is short-term or long-term .

37

Cash equivalents :

a. This category includes items that are both (1) readily

convertible to known amounts of cash, and (2) so near their

maturity that they present insignificant risk of changes in

interest rates (generally 3 months or less) .

b. Money market funds, money market savings certificates,

certificates of deposit, and similar types of deposits are nearly

"equivalent to cash" in terms of liquidity. However, these

securities usually contain restrictions or penalties on their

conversion to cash. These items should be reported as

temporary investments.

c. Many companies now report these items in a current asset

category called cash and cash equivalents, which includes

cash plus these items .

FUNCTION OF CASH MANAGEMENT

Cash management is concerned with minimizing

unproductive cash balances, investing temporarily excess cash

advantageously and to make the best possible arrangements for

meeting planned and unexpected demands on the firm's

cash.Cash Management must aim to reduce the required level of

cash but minimize the risk of being unable to discharge claims

against the company as they arise. All these aims and motives of

cash management largely depend upon the efficient and

effective functioning of cash management. Cash management

38

functions can be studied under five heads, namely, cash

planning, managing cash flow, controlling cash flow, optimizing

the cash level and investing idle cash. All these functions are

discussed below in details :

1 .Cash Planning Good planning is the very foundation of

attaining success. For any management decision, planning is the

foremost requirement. "Planning is basically an intellectual

process, a menfal pre-disposition to do things in an orderly way,

to think before acting and to act in the light of facts rather than

of a guess." Cash planning is a technique, which comprises of

planning for and controlling of cash. It is a management process

of forecasting the future need of cash, its available resources and

various uses for a specified period. Cash planning, thus, deals at

length with formulation of necessary cash policies and

procedures in order to carry on business continuously and on

sound lines. A good cash planning aims at providing cash, not

only for regular but also for irregular and abnormal

requirements.

2.Managing Cash Flows The heading simply suggests an idea of

managing properly the flow of cash coming inside the business

i.e. cash inflow and cash moving out of the business i.e. cash

outflow. These two are said to be properly managed only, if a

firm succeeds in accelerating the rate of cash inflow together

39

with minimizing the cash outflow. As observed expediting

collections, avoiding unnecessary inventories, improving control

over payments etc. contribute to better management of cash.

Whereby, a business can conserve cash and thereof would

require lesser cash balance for its operations .

3 .Controlling the Cash Flows As forecasting is not an exact

science because it is based on certain assumptions. Therefore,

cash planning will inevitably be at variance with the results

actually obtained. For this reason, control becomes an

unavoidable function of cash management. Moreover, cash

controlling becomes essential as it increases the availability of

usable cash from within the enterprise. As it is obvious that

greater the speed of cash flow cycle, I greater would be the

number of times a firm can convert its goods and ' services into

cash and so lesser will be the cash requirement to finance the

desired volume of business during that period. Furthermore,

every enterprise is in possession of some hidden cash, which if

traced out substantially decreases the cash requirement of the

enterprise .

4 .Optimizing the Cash Level A financial manager should

concentrate on maintaining sound liquidity position i.e. cash

level. All his efforts relating to planning, managing and

controlling cash should be diverted towards maintaining an

optimum level of cash. The foremost need of maintaining

40

optimum level of cash is to meet the necessary requirements and

to settle the obligations well in time. Optimization of cash level

may be related to establishing equilibrium between risk and the

related profit expected to be earned by the company .

5.Investing Idle Cash Idle cash or surplus cash refers to the

excess of cash inflows over cash outflows, which do not have

any specific operations or any other purpose to solve currently.

Generally, a firm is required to hold cash for meeting working

needs facing contingencies and to maintain as well as develop

goodwill of bankers .

The problem of investing this excess amount of cash arise

simply because it contributes nothing towards profitability of the

firm as idle cash precisely earns no returns. Further permanent

disposal of such cash is not possible, as the concern may again

need this cash after a short while. But, if such cash is deposited

with the bank, it definitely would earn a nominal rate of interest

paid by the bank. A much better returns than the bank interest

can be expected if a company deploys idle cash in marketable

securities. There are yet another group of enterprise that neither

invest in marketable securities nor willing to get interest instead

they prefer to deposit excess cash for improving relations with

banks by helping them in meeting bank requirements for

compensating balances for services and loans .

41

Petty Cash Petty Cash

Petty cash refers to small amounts of cash kept on hand in a

business. (The term "petty" comes from "petite or "small.")

There are two reasons to keep petty cash:

•To make change for customers.

•To pay for small purchases which require cash, such as food

for the office lunch or coffee supplies?

Example1: At the beginning of the year a company opened a Petty cash fund for L.E5000. The disbursements from the fund during the year were as follows:

• Transportation L.E 1000.

• Beverage L.E. 1000.

• Utilities L.E. 600.

• Tips L.E. 600

Required:

Journalize the entries related to petty cash given that the end balance was 2000L.E.

Solution Cr. Dr. Items Date

5000

5000 Petty cash

Cash

(Opening petty cash)

1/1

3000

200

3200 Disbursements

cash

Surplus

(Recording disbursements

from petty cash)

31/12

42

Example 2:

A Company issued a check of L.E. 8000 to cashier of petty cash,

Petty cash disbursements were as follows:

3000 Beverage 2000 Transportation

2500 Utilities

Required:

1) Journalize the entries if the Treasure has L.E. 2000.

2) Why do we need to have a petty cash account?

Solution Journal

Cr. Dr. Items Date

8000

8000 Petty cash

Cash

(Opening petty cash)

1/1

6000

1500

7500 Disbursements

cash

Surplus

(Recording disbursements from

petty cash)

31/12

Example 3

A company opened petty cash by L.E 5000 cash and gave it to petty

cashier.Paid L.E1000 Beverage.

Paid L.E 1000 Transportation.

Paid |L.E 500 postage expenses.

The Petty cash fund had L.E 3000 remaining in the petty cash.

Required: Journalize the opening and reimbursement of the petty cash.

Solution

Petty Cash 5000

Cash 5000

To establish a petty cash fund.

Petty disbursements 2500

Cash

Surplus

2000

500 To reimburse the petty cash fund.

43

Receivables

Accounts receivable are oral promises to pay for goods and

services sold .

Notes receivable are written promises to pay a certain sum of

money on a specified future date.

Accounts receivable

Methods of accounting for uncollectible accounts :

a. Direct write-off method—When a specific account is

determined to be uncollectible , Bad Debt Expense is

debited and Accounts Receivable is credited.

b. Allowance method—At the end of each accounting

period an estimate is made of expected losses from

uncollectible accounts. This estimate is debited to Bad

Debt Expense and credited to the Allowance for Doubtful

Accounts.

Methods of estimating bad debt expense under the

allowance method .

(a) Percentage-of-Sales (Income Statement Approach).

Bad debt expense is estimated directly by multiplying a

percentage times credit sales .

(b) Percentage-of-Receivables (Balance Sheet Approach):

First the required ending balance in the Allowance for Doubtful

Accounts is estimated by multiplying a percentage (a single

44

composite rate or an aging schedule) times the ending

outstanding receivables.Then bad debt expense is equal to the

difference between the required ending balance and the existing

balance in the Allowance account.

Bad Debts Allowance Method

The allowance method is one of the two common

techniques of accounting for bad debts, the other being

the direct write-off method. Allowance method is a

better alternative to the direct write-off method

because it is according to the matching principle of

accounting. In allowance method, the doubtful debts

are estimated and bad debts expense is recognized

before the debts actually become uncollectible.

Bad debts expense is recognized early because bad

debts are probable and they can be estimated to a fairly

accurate extent therefore they fulfill the criteria

required for recognition of contingent losses and it is

necessary to recognize bad debts expense.

45

The first step in the allowance method is to pass an

adjusting entry at the end of an accounting period to

recognize estimated bad debts expense. Unlike direct

write-off method, we do not credit accounts receivable

at this stage because it is actually a control account of

many individual debtor accounts and we do not yet not

know which particular debtor will make a default. We

only know the estimated amount of receivables which

are likely to end up uncollected. Therefore a provision

account called allowance for doubtful accounts is

credited in the adjusting entry. Thus:

46

Bad Debts Expense 600

Allowance for Doubtful Accounts 600

The bad debts expense account, just like any other

expense account, is closed to income summary

account of the period. The allowance for doubtful

debts is contra-asset account. It is presented on balance

sheet by subtracting it from accounts receivable as

shown below:

Accounts Receivable L.E15,000

Less: Allowance for Doubtful Accounts (600)

Accounts Receivable, net L.E14,400

Write-off Entry

In the next period, when a debt is actually determined

as uncollectible, the following journal entry is passed

to write it off.

Allowance for Doubtful Debts 70

Accounts Receivable 70

As more and more debts are written off, the balance in

the allowance account decreases.

47

Recovered Bad Debts

When any bad debt is recovered, two journal entries are

passed. The first one reverses the write-off entry and the

second one is a routine journal entry to record collection.

Thus:

Accounts Receivable 70

Allowance for Doubtful Debts 70

Cash 70

Accounts Receivable 70

At the end of next accounting period, bad debts are estimated

again and the balance in the allowance account is adjusted.

48

Example:

The East company begins business on January 1, 2015.

At December 31, 2016, the total accounts receivable of

the company are L.E350,000 out of which, company

estimates that the receivables amounting to L.E4,500 will

turn out to be uncollectible. At February 12, 2016, moon

trader, who is a receivable of L.E1,200, becomes

bankrupt and nothing can be recovered from him. At

December 31, 2016, the accounts receivable show a

balance of L.E475,000. On this date, the company

revises the estimates of its credit losses and

determines that receivables amounting to L.E4,800 will

become uncollectibles.

Required: Prepare:

1. Adjusting entry to recognize uncollectible

accounts expense at December 31, 2015.

2. Entry to write off accounts receivable at

February 12, 2015.

3. An adjusting entry to recognize uncollectible

accounts expense at December 31, 2016.

49

Solution:

(1). Recognition of accounts receivable expense at

December 31, 2015:

Uncollectible accounts expense 4,500

Allowance for doubtful accounts 4,500

(2). Writing off accounts receivable at January 12, 2015:

Allowance for doubtful accounts L.E1,200

Accounts receivable – Moon trader L.E1,200

(3). Recognition of accounts receivable expense at

December 31, 2016:

Uncollectible accounts expense L.E1,500*

Allowance for doubtful accounts L.E1,500

*4,800 – (4,500 – 1,200)

Notice that the estimated uncollectible accounts on

December 31, 2016 are L.E4,800 but allowance for

doubtful accounts has been credited with only L.E1,500.

The reason is that there is already a credit balance of

L.E3,300 (L.E4,500 – L.E1,200) in the allowance for

doubtful accounts. We just need to increase the existing

balance by L.E1,500 to achieve a required balance of

L.E4,800 (L.E3,300 + L.E1,500).

50

Notes Receivable

Face amount:

The principal amount due that is stated on the face of the

note. The debit balance of the Notes Receivable account is

always equal to the face amount.

Interest rate:

The rate that is stated on the face of the note. This rate is used

to determine the amount of periodic interest payments. A note

may be noninterest-bearing (i.e. have a stated rate of zero) .

Effective (market) rate of interest:

This is the rate that is used to look up present value factors in

order to account for the note at the date of issuance .

Present value:

At the date of issuance, a note is valued at the present value

of the future principal and interest cash flows, discounted at the

market rate of interest. Changes in the market rate of interest

are ignored throughout the remainder of the life of the note .

Discount on notes receivable:

At the date of issuance, this represents the excess of the face

amount of the note over the present value. A discount arises

because the market rate is greater than the stated rate of interest.

Premium on notes receivable:

At the date of issuance, this presents the excess of the present

51

value of the note over the face amount. A premium arises

because the market rate is less than the stated rate. The

Premium on Notes Receivable account has a debit balance .

Example:

On October 1, 2014, the Western company received a 120 day,

5% note from Southern company in the settlement of an account

of L.E45,000. The Western company collected the note

at maturity. The company makes adjusting entries only at the

end of the year.

Required: Prepare journal entries to record the acquisition of

the note, recognition of interest revenue and the collection of the

note at due date.

(1)Acquisition of note:

October 1, 2014

Notes receivable account 45,000

Accounts receivable account –S company 45,000

(2)Recognition of interest revenue:

December 31, 2014

Interest receivable 562.5*

interest revenue 562.5

*(45,000 × .05) × 3/12 = 562.5

52

(3)Collection of note:

January 31, 2015

Cash 45,750

Notes receivable account 45,000

Interest receivable 562.5

Interest revenue 187.5*

*(45,000 × .05) × 1/12 = 187.5

When maker of the note defaults:

The above example illustrates the situation where maker duly

makes the payment. But if maker fails to make the payment at

the date of maturity, the note is said to have been defaulted. A

defaulted note is worthless therefore the amount due from notes

receivable is immediately transferred to accounts

receivable. Suppose, in the above example, the Southern

company fails to make the payment of L.E45,750, the Western

company will make the following entry:

January 31, 2015

Accounts receivable –

Southern company 45,750

Notes receivable account 45,000

Interest receivable 562.5

Interest revenue 187.5

53

Notice that the interest has also been included in the accounts

receivable because it is as valid a claim as the principle amount

of the note.

If the Accounts receivable from the Southern company cannot

be collected, it will be written off against the allowance for

doubtful accounts. Therefore the balance in the allowance for

doubtful accounts should provide for estimated uncollectible

notes receivable as well as uncollectible accounts receivable.

Example:

Shown below are selected transactions of Gulf Corporation

during the month of June:

June 1 Accepted a one year note from Target Company in

settlement of L.E 30,000 accounts receivable due today.The note

face value is L.E32,700, with no mention of interest.

June 10 An account receivable from Sun Co. in the amount of

L.E700 is determined to be ucollectible.

June 15 Made a loan of L.E 120,000 to Baher Co.in exchange

for a three years,8% note.The note is drawn in the face amount

of L.E120,000,with interest and principal due at maturity date.

June 22 Unexpectedly received L.E200 from Farah in full

payment of her account receivable that had previously been

written off as uncollectible.

54

Required:1)Prepare entries in the general journal for June

transactions.2) Prepare month end adjustments

Given that estimated uncollectible accounts total

L.E9000.At the end of May,the allowance for doubtful

accounts had a credit balance of L.E5,710.

In addition to notes from Target Company and from Baher,

Gulf Corporation held other notes receivable totaling

L.E33,000 throughout the month of June.All these other

notes bear interest at an annual rate 10%.(assume 360 days

in a year).

Solution

Date Exp. Dr. Cr.

June 1 N/R

Discount on N/R

A/R

(Received a one year note with interest

included in the face amount)

32,700

2,700

30,000

10 Allowance for doubtful accounts

A/R Sun

(To write off receivable from Sun as

ulcollectible)

700

700

55

15 N/R

Cash

(Made a loan to Baher in exchange

of a note)

120,000

120,000

22 A/R-Farah

Allowance for doubtful accounts

(To reinstate accounts receivable

previously written off)

200

200

22 Cash

A/R-Farah

(To record collection of A/R)

200

200

Adjusting entries

June 30 Uncollectible account expense

Allowance for doubtful accounts

(To increase allowance to9,000)

3,790

3,790

30 Discount on notes receivable

Interest revenue

(To record interest revenue earned

during June on one year note)

225

225

30 Interest receivable

Interest Revenue

( To accrue interest on notes

receivable for June)

675

675

56

Example :

On July 17, 2001, received a L.E12,000, 90-day, 10% note

on account from Adams Co.

Determine:

a) Due date for the note

b) Interest earned during the term of the note

c) Maturity value of the note

Prepare journal entries whether:

d) The note is honored on the maturity date

e) The note is dishonored on the maturity date

Solution

a) Due Date:

Term of the note = 90

Days remaining in July 31 – 17 = 14

Remaining term of the note 76

Days in August 31

Remaining term of the note 45

Days in September 30

Remaining term of the note 15

Since the remaining 15 days are less than the 31 days in

October,the note is due on October 15.

57

b) Interest:

Calculated as Principal X Rate X Time

L.E12,000 x .10 x 90 days/360 days = L.E300

Time is calculated as the term of the note divided by

360 days for the year.

Time is always based on a 360-day year.

c) Maturity Value:

Calculated as Principal + Interest

L.E12,000 + L.E300 = L.E12,300

d) Note is honored:

17/7 Notes receivable 12,000

Accounts receivable 12,000

15/10 Cash 12,300

Notes receivable 12,000

Interest receivable 300

e) Note is dishonored:

17/7 Notes receivable 12,000

Accounts receivable 12,000

15/10 Accounts receivable 12,300

Notes receivable 12,000

Interest receivable 300

58

The difference between the two entries for 10/15 is the

account to be debited.

Example:

Journalize the adjusting entry for accrued interest on

December 31 for the following outstanding notes

receivable. Journalize the receipt of the amount due on the

due date for each note.

a) L.E24,000, 60-day, 10% note dated December 1.

b) L.E12,000, 90-day, 15% note dated October 22.

Solution

a) Interest has been earned for 30 days

Days remaining in December 31 =30 days

Interest earned:

L.E24,000 x .10 x 30 days /360 days = L.E200

31/12 Interest receivable 200

Interest revenue 200

30/1 Cash 24,400

Notes receivable 24,000

Interest revenue for January 200

Interest receivable 200

59

b) Interest has been earned for 30 days

Days remaining in October 31 – October 22 = 9 days

Days in November = 30 days

Days in December = 31 days

Total days to accrue 70 days

Interest earned:

L.E12,000 x .15 x 70 days /360 days = L.E350

31/12 Interest receivable 350

Interest revenue 350

30/1 Cash 12,450

Notes receivable 12,000

Interest revenue for Januar1 100

Interest receivable 350

60

Part Three

Property ,plant and equipment

61

Accounting for Acquisition of Property, Plant, and

Equipment

Like all other assets, property, plant, and equipment are

initially recorded at cost. The cost of an asset includes not only

the purchase price but also any other costs incurred in acquiring

the asset and getting it ready for its intended use.

Examples of these other costs include shipping, installation, and

sales taxes.

Property, plant, and equipment are usually acquired by purchase.

In some cases, assets are acquired by leasing but are accounted

for as assets in much the same way as purchased assets. Plant

and equipment can also be constructed by a business for its own

use. Also, a company can in one transaction purchase several

different assets or even another entire company.

Assets Acquired by Purchase

A company can purchase an asset by paying cash, incurring a

liability, exchanging another asset, or by a combination of these

methods. If a single asset is purchased for cash, the

accounting is relatively simple.

To illustrate, we assume that Wall, Inc., purchases a new truck

for L.E15,096 (purchase price, L.E15,000, less 2% discount for

paying cash, plus sales tax of L.E396).

62

The entry to record this purchase is:

Truck . . . . . . . . . . . . . . . . 15,096

Cash . . . . . . . . . . . . . . . .15,096

(Purchased a delivery truck for L.E15,096)

If the company had issued a note payable for L.E12,000 of the

L.E15,096, the entry would have been:

Truck . . …….. . . . . . . .15,096

Cash . . . . . . . . . . . . . . . . . 3,096

Notes Payable . . . . . . . . .12,000

(Purchased a truck for L.E15,096; paid L.E3,096 cash

and issued a note for L.E12,000.)

The L.E12,000 represents the principal of the note; it does not

include any interest charged by the lendeer. (The interest is

recognized later as interest expense.)

When one long-term operating asset is acquired in exchange for

another, the cost of the new asset is usually set equal to the

market value of the asset given up in exchange.

63

Assets Acquired by Leasing

Leases are often short-term rental agreements in which one

party, the lessee, is granted the right to use property owned by

another party, the lessor. For example,as a student, you may

decide to lease (rent) an apartment to live in while you are

attending college. The owner of the apartment (lessor) will

probably require you to sign a lease specifying the terms of the

arrangement. The lease states the period of time in which you

will live in the apartment, the amount of rent you will pay, and

when each rent payment is due. When the lease expires, you will

either sign a new lease or move out of the apartment, which

would then be rented to someone else.

Companies enter into similar types of lease arrangements. For

example,Sun CO. might decide to lease a building because it

needs additional office space. Assume the company signs a two-

year lease requiring monthly rental payments of L.E1,000.

When the lease expires, the company will either move out of the

building or negotiate a new lease with the owner. Accounting

for this type of rental agreement, called an operating lease, is

straightforward. When rent is paid each month, the company

records the following journal entry:

Rent (or Lease) Expense . . . . . . . . . . . 1,000

Cash . . . . . . . . . . . . . . . . . . . . . . . 1,000

(To record monthly rent of office building.)

64

Some lease agreements, however, are not so simple. Suppose the

company wants to acquire a hotel.Assume that, at the beginning

of the lease term, the present value of the future lease payments

is L.E851,360. Sun company makes the following journal entry

to record the lease:

Leased Property . . . . . . . 851,360

Lease Liability . . . . . . . . . . . . . . . . 851,360

(To record hotel acquired under a 20-year noncancelable

lease.)

This type of lease is called a capital lease because the lessee

records (capitalizes) the leased asset the same as if the asset had

been acquired in an outright purchase. The asset is reported with

Property, Plant, and Equipment on the lessee’s balance sheet.

The lessee also shows the lease liability on the balance sheet as

a long-term liability.

65

When annual lease payments are made, the lessee will not

record the payment as rent expense. Instead, the payment will be

recorded as a reduction in the lease liability, with part of each

payment being interest on the outstanding obligation. To

illustrate, assume that the first payment is made one year after

the lease term begins and includes interest of L.E85,136 and a

L.E14,864 reduction in the liability. The payment is recorded as

follows:

Lease Liability . . . . . . . . . . . . . . . . 14,864

Interest Expense . . . . . . . . . . . . . . .85,136

Cash . . . . . . . . . . . . . . . . . . . . . . . . 100,000

(To record annual lease payment under capital lease.)

Classifying Leases As illustrated, an operating lease is

accounted for as a simple rental, whereas a capital lease is

accounted for as a purchase of the leased asset.

Because the accounting treatment of a lease can have a major

impact on the financial statements, the accounting profession

has established criteria for determining whether a lease should

be classified as an operating or a capital lease. If a lease is

noncancelable and meets any one of the following four criteria,

it is recorded as a capital lease:

1. The lease transfers ownership of the leased asset to the lessee

by the end of the lease term.

66

2. The lease contains an option allowing the lessee to purchase

the asset at the end of the lease term at a bargain price,

essentially guaranteeing that ownership will eventually transfer

to the lessee.

3. The lease term is equal to 75% or more of the estimated

economic life of the asset,meaning that the lessee will use the

asset for most of its economic life.

4. The present value of the lease payments at the beginning of

the lease is 90% or more of the fair market value of the leased

asset. Meeting this criterion means that, in agreeing to make the

lease payments, the lessee is agreeing to pay almost as much as

the cash price to purchase the asset outright.

If just one of the above criteria is met, then the lease agreement

is classified as a capital lease and is accounted for by the lessee

as a debt-financed purchase. A lease that does not meet any of

the capital lease criteria is considered an operating lease.

The four lease criteria outlined above were issued by the FASB

in 1976.

67

Calculating and Recording Depreciation

Expense

The second element in accounting for plant and equipment

is the allocation ofan asset’s cost over its useful life. The

matching principle requires that this costbe assigned to expense

in the periods benefited from the use of the asset. The allocation

procedure is called depreciation, and the allocated amount,

recorded in a period-ending adjusting entry, is an expense that is

deducted from revenues in order to determine income. It should

be noted that the asset “plant” normally refers to buildings only;

land is recorded as a separate asset and is not depreciated

because it is usually assumed to have an unlimited useful life.

Accounting for depreciation is often confusing because

students tend to think that depreciation expense reflects the

decline in an asset’s value. The concept of depreciation is

nothing more than a systematic write-off of the original cost of

an asset. The undepreciated cost is referred to as book value,

which represents that portion of the original cost not yet

assigned to the income statement as an expense. A company

never claims that an asset’s recorded book value is equal to its

market value. In fact, market values of assets could increase at

the same time that depreciation expense is being recorded.

68

To calculate depreciation expense for an asset, you need to

know (1) its original cost, (2) its estimated useful life, and (3) its

estimated salvage, or residual value. Salvage value is the amount

expected to be received when the asset is sold at the end of its

useful life . When an asset is purchased, its actual life and

salvage value are obviously unknown. They must be estimated

usually on the basis of experience with similar assets. In some

cases, an asset will have little or no salvage value. If the salvage

value is not significant, it is usually ignored in computing

depreciation.

Several methods can be used for depreciating the costs of assets

for financial reporting.

The straight-line depreciation method assumes that an asset will

benefit all periods equally and that the cost of the asset should

be assigned on a uniform basis for all accounting periods.

If an asset benefits are thought to be related to its productive

output (miles driven in an automobile, for example), the units-

of-production method is usually appropriate

69

To illustrate straight-line and units-of-production depreciation

methods, assume that Sun Company purchased a van on

January1. The following facts apply:

Acquisition cost . . . . . . . . . . . . . . . . . L.E24,000

Estimated salvage value . . . . . . . . . . . L.E2,000

Estimated life:In years . . . . . . . . . . . . . . . .4 years

In miles driven . . . . . . . . . . . . . . . . . . 60,000 miles

The straight-line depreciation method

The straight-line depreciation method is the simplest

depreciation method. It assumes that an asset’s cost should be

assigned equally to all periods benefited. The formula for

calculating annual straight-line depreciation is:

Annual depreciation expense = Cost - Salvage value

Estimated useful life (years)

= L.E 24,000 – L.E 2,000 = L.E5,500 depreciation expense

4 years per year

The entry to record straight-line depreciation each year is:

Depreciation Expense . . . . . . . . . . . .5,500

Accumulated Depreciation,Van . . . . . . . . . . 5,500

To record annual depreciation for the van

70

Depreciation Expense is reported on the income statement.

Accumulated Depreciation is a contra-asset account that is offset

against the cost of the asset on the balance sheet. Book value is

equal to the asset account balance, which retains the original

cost of the asset as a debit balance, minus the credit balance in

the accumulated depreciation account.

At the end of the first year, the acquisition cost, accumulated

depreciation, and book value of the van are presented on the

balance sheet as follows:

Property, Plant, and Equipment:

Van . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L.E24,000

Less: Accumulated depreciation . . . . . . . . . . . ( 5,500)

Book value . . . . . . . . . . . . . . . . . . . . . . . . . . L.E18,500

Units-of-Production Method of Depreciation

The units-of-production depreciation method allocates an

asset’s cost on the basis of use rather than time. This method is

used primarily when a company expects that asset usage will

vary significantly from year to year. If the asset’s usage pattern

is uniform from year to year, the units-of-production method

will produce the same depreciation pattern as the straight-line

method. Assets with varying usage patterns for which this

method of depreciation may be appropriate include automobiles

71

and other vehicles whose life is estimated in terms of number of

miles driven. It is also used for certain machines whose life is

estimated in terms of number of units produced or number of

hours of operating life.

The formula for calculating the units-of-production

depreciation for the year is:

Current year’s depreciation expense=

Number of units produced,X Salvage value - Cost

Total estimated life in hours used, or miles driven

units, hours, or miles during the year

To illustrate, consider Suns’ van, which has an expected life

of 60,000 miles. With the units-of-production method, if the

van is driven 12,000 miles during the first year, the

depreciation expense for that year is calculated as follows:

L.E24,000 – L.E2,000 X 12,000 miles = L.E4,400

60,000 miles

The entry to record units-of-production depreciation at the

end of the first year of the van’s life is:

Depreciation Expense . . . . . . . . . . . 4,400

Accumulated Depreciation, Van . . . . . . . . . . . 4,400

To record depreciation for the first year of the van’s life.

72

Depreciation Schedule with Units-of-Production assuming

that 18,000 miles were driven the second year, 21,000 the

third year, and 9,000 the fourth year.

Book

Value

Accumulated

Depreciation

Depreciation

Expense

Miles

Driven

24,000 - - - Acquisition date

19,600 4,400 4,400 12,000 End of year 1

13,000 11,000 6,600 18,000 End of year 2

5,300 18,700 7,700 21,000 End of year 3

2,000 22,000 3,300 9,000 End of year 4

What if the van lasts longer than four years or is driven for

more than 60,000 miles?

Once the L.E22,000 difference between cost and salvage value

has been recorded as depreciation expense, there is no further

expense to record. Thus, any additional years ormiles are “free”

in the sense that no depreciation expense will be recognized in

connection with them. However, as other vans are purchased in

the future, the initial estimates of their useful lives will be

adjusted to reflect the experience with previous vans.

73

Partial-Year Depreciation Calculations

Thus far, depreciation expense has been calculated on the

basis of a full year. Businesses purchase assets at all times

during the year, however, so partial-year depreciation

calculations are often required. To compute depreciation

expense for less than a full year, first calculate the depreciation

expense for the year and then distribute it evenly over the

number of months the asset is held during the year.

For the units-of-production method midyear purchases do not

complicate the calculations with this method because it involves

number of miles driven, hours flown, and so on, rather than time

periods.

Units-of-Production Method with Natural Resources

Another common use for the units-of-production method is with

natural resources.

Natural resources include such assets as oil wells, timber tracts,

coal mines, and gravel deposits. Like all other assets, newly

purchased or developed natural resources are recorded at cost.

This cost must be written off as the assets are extracted or

otherwise depleted. This process of writing off the cost of

natural resources is called depletion and involves the calculation

of a depletion rate for each unit of the natural resource.

Conceptually, depletion is exactly the same as depreciation; with

74

plant and equipment, the accounting process is called

depreciation, whereas with natural resources it is called

depletion.

To illustrate, assume that Power Company purchases a coal

mine for L.E1,200,000 cash. The entry to record the purchase is:

Coal Mine . . . . . . . . . . . . . . . 1,200,000

Cash . . . . . . . . . . . . . . . .1,200,000

(Purchased a coal mine for L.E1,200,000.)

If the mine contains an estimated 200,000 tons of coal deposits

(based on a geologist’s estimate), the depletion expense for each

ton of coal extracted and sold will be L.E6

(L.E1,200,000/200,000 tons). Here, the unit of production is the

extraction of one ton of coal. If 12,000 tons of coal are mined

and sold in the current year, the depletion entry is:

Depletion Expense . . . . . . . . . . .72,000

Accumulated Depletion, Coal Mine . .72,000

To record depletion for the year: 12,000 tons at L.E6 per ton.

After the first year’s depletion expense has been recorded, the

coal mine is shown on

the balance sheet as follows:

Coal mine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E1,200,000

Less: Accumulated depletion . . . . . . . . . . . . . . . . . (72,000)

Book value . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,128,000

75

But how do you determine the number of tons of coal in a mine?

Because most natural resources cannot be counted, the amount

of the resource owned is an estimate.

The depletion calculation is therefore likely to be revised as new

information becomes available. When an estimate is changed, a

new depletion rate per unit is calculated and used to compute

depletion during the remaining life of the natural resource or

until another new estimate is made.

Repairing and Improving Property, Plant, and

Equipment

Sometime during its useful life, an asset will probably need to

be repaired or improved.

Two types of expenditures can be made on existing assets. The

first is ordinary expenditures for repairs, maintenance, and

minor improvements. For example, a truck requires oil changes

and periodic maintenance. Because these types of expenditures

typically benefit only the period in which they are made, they

are expenses of the current period.

The second type is an expenditure that lengthens an asset’s

useful life, increases its capacity, or changes its use. These

expenditures are capitalized; that is, they are added to the asset’s

cost instead of being expensed in the current period. For

76

example, overhauling the engine of a delivery truck involves a

major expenditure to extend the useful life of the truck. To

qualify for capitalization, an expenditure should meet three

criteria: (1) it must be significant in amount; (2) it should benefit

the company over several periods, not just during the current

one; and (3) it should increase the productive life or capacity of

the asset.

To illustrate the differences in accounting for capital and

ordinary expenditures,

assume that Sun company also purchases a truck for L.E42,000.

This truck has an estimated useful life of eight years and a

salvage value of L.E2,000. The straightline depreciation is

L.E5,000 per year [(L.E42,000 – L.E2,000)/8 years]. If the

company spends L.E1,500 each year for normal maintenance, its

annual recording of these expenditures is:

Repairs and Maintenance Expense . . . .. 1,500

Cash . . . . . . . . . 1,500

(Spent L.E1,500 for maintenance of delivery truck.)

This entry has no effect on either the recorded cost or the

depreciation expense of the truck. Now suppose that at the end

of the sixth year of the truck’s useful life, Sun company

spends L.E8,000 to overhaul the engine. This expenditure will

increase the truck’s remaining life from two to four years, but

will not change its estimated salvage value. The depreciation

77

for the last four years will be L.E4,500 per year, calculated as

shown below.

Depreciation after Overhaul Depreciation after Overhaul

Original cost 42,000 Original cost 42,000

Less salvage value 2,000 Accumulated

depreciation(prior to overhaul)

30,000

Cost to be allocated

(depreciable

amount)

40,000 Remaining book value 12,000

Original life of asset 8 years Capital expenditure (overhaul) 8,000

Original

depreciation per

year (40,000/8)

5,000 New book value 20,000

Usage before

overhaul

6 years Less salvage value 2,000

Accumulated

depreciation prior to

overhaul

30,000 New depreciable amount 18,000

Remaining life 4 years

New annual depreciation

(18,000/4) 4,500

The journal entry to record the L.E8,000 capitalized expenditure

is:

Delivery Truck . . . . . . . . . . . . . . 8,000

Cash . . . . . . . . . . . . . . . . . .. . 8,000

(Spent L.E8,000 to overhaul the engine of the L.E42,000 truck.)

78

Disposal of Property, Plant, and Equipment

Plant and equipment eventually become worthless or are sold.

When a company removes one of these assets from service, it

has to eliminate the asset’s cost and accumulated depreciation

from the accounting records. There are basically three ways to

dispose of an asset: (1) discard or scrap it, (2) sell it, or (3)

exchange it for another asset.

Discarding Property, Plant, and Equipment

When an asset becomes worthless and must be scrapped, its cost

and its accumulated depreciation balance should be removed

from the accounting records. If the asset’s total

cost has been depreciated, there is no loss on the disposal. If, on

the other hand, the cost is not completely depreciated, the

undepreciated cost represents a loss on disposal.

To illustrate, we assume that Sun, Inc., purchases a computer for

l.E15,000.

The computer has a five-year life and no estimated salvage

value and is depreciated on a straight-line basis. If the computer

is scrapped after five full years, the entry to record the

disposal is as follows:

Accumulated Depreciation, Computer . . . . . 15,000

Computer . . . . . . . . . . .. . 15,000

(Scrapped L.E15,000 computer.)

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If Sun, Inc., must pay L.E300 to have the computer dismantled

and removed, the entry to record the disposal is:

Accumulated Depreciation, Computer . . 15,000

Loss on Disposal of Computer . . . . . . . . . . 300

Computer . . . . . .15,000

Cash . . . . .. 300

(Scrapped L.E15,000 computer and paid disposal costs of

L.E300.)

If the computer had been scrapped after only four years of

service (and after L.E12,000 of the original cost has been

depreciated), there would have been a loss on disposal

ofL.E3,300 (including the disposal cost), and the entry would

have been:

Accumulated Depreciation, Computer .12,000

Loss on Disposal of Computer . . . . . . 3,300

Computer . . . . . 15,000

Cash . . . . . . . . . . . 300

(Scrapped L.E15,000 computer and paid disposal costs of

L.E300.)

Don’t think of the losses recognized above as “bad” or gains as

“good.” A loss on disposal simply means that, given the

information we now have, it appears that we didn’t record

enough depreciation expense in previous years. As a result, the

book value of the asset is higher than the amount we can get on

80

disposal. Similarly, a gain means that too much depreciation

expense was recognized in prior years, making the book value of

the asset lower than its actual disposal value.

Selling Property, Plant, and Equipment

A second way of disposing of property, plant, and equipment is

to sell it. If the sales price of the asset exceeds its book value

(the original cost less accumulated depreciation), there is a gain

on the sale. Conversely, if the sales price is less than the book

value, there is a loss.

To illustrate, we refer again to the L.E15,000 computer. If the

computer is sold for L.E600 after five full years of service,

assuming no disposal costs, the entry to record the sale is:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . .600

Accumulated Depreciation, Computer . 15,000

Computer . . . . . . . . . . . . . . 15,000

Gain on Sale of Computer . . . 600

Sold L.E15,000 computer at a gain of L.E600.

81

Because the asset was fully depreciated, its book value was zero

and the L.E600 cash received represents a gain. If the computer

had been sold for L.E600 after only four years of service, there

would have been a loss of L.E2,400 on the sale, and the entry to

record the sale would have been:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600

Accumulated Depreciation, Computer . 12,000

Loss on Sale of Computer . . . . . . . . . . . . 2,400

Computer . . . . . . . . . . . . . . . . . .15,000

Sold L.E15,000 computer at a loss of L.E2,400.

The L.E2,400 loss is the difference between the sales price of

L.E600 and the book value of L.E3,000 (L.E15,000 –

L.E12,000). The amount of a gain or loss is thus a function of

two factors:

(1) The amount of cash received from the sale.

(2) The book value of the asset at the date of sale. The book

value can vary from the market price of the asset for

two reasons: (1) the accounting for the asset is not

intended to show market value in the financial

statements, and (2) it is difficult to estimate salvage

value and useful life at the outset of an asset’s life.

82

Solved Example:

Property, Plant, and Equipment

The following information relates to a truck:

a. Date truck was purchased, July 1, 2014.

b. Cost of truck:

Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L.E125,000

Paint job . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Sales tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000

c. Estimated useful life of truck, 120,000 miles.

d. Estimated salvage value of truck, L.E27,000.

e. 2016 expenditures on truck:

(1) L.E6,000 on new tires and regular maintenance.

(2) On January 1, spent L.E44,000 to completely rework the

truck’s engine; increased the total life to 200,000 miles but left

expected salvage value unchanged.

f. Miles driven:

2014 . . . . . . . . . . . . . . . . . . . . . . . .11,000

2015 . . . . . . . . . . . . . . . . . . . . . . . 24,000

2016 (after reworking of engine) . . 20,000

2017 . . . . . . . . . . . . . . . . . . . . . . . . 14,000

Required:Record journal entries to account for the following.

(Use the units-of-production depreciation method.)

1. The purchase of the truck.

2. The expenditures on the truck during 2016.

83

3. Depreciation expense for:

a. 2014

b. 2015

c. 2016

d. 2017

Solution

1. Truck Purchase

The cost of the truck includes both the amount paid for it and all

costs incurred to get it in working condition. In this case, the

cost includes both the paint job and the sales tax. Thus, the entry

to record the purchase is:

Truck . . . . . . . . . . . . . . . . . 135,000

Cash . . . . . . . . . . . . . . . . . 135,000

(Purchased truck for cash.)

2. Expenditures

The expenditure of L.E6,000 is an ordinary expenditure and is

expensed in the current year. The engine overhaul is capitalized.

The entries are:

Repairs and Maintenance Expense . 6,000

Cash . . . . . . . . . . . . . . . . 6,000

Recorded purchase of new tires and regular maintenance on

truck.

84

Truck . . . . . . . . . . . . . . . . . . . 44,000

Cash . . . . . . . . . . . . . . . . . . 44,000

Recorded major overhaul to truck’s engine.

3. Depreciation Expense

The formula for units-of-production depreciation on the truck is:

Cost - Salvage value X Number of miles

Total miles expected to be driven driven in any year

Journal entries and calculations are as follows:

a. 2014:

Depreciation Expense . . . . . . . . . . . 9,900

Accumulated Depreciation, Truck . . . . 9,900

(Recorded depreciation expense for 2016.)

b. 2015:

Depreciation Expense . . . . 21,600

Accumulated Depreciation, Truck . . . . . . 21,600

(Recorded depreciation expense for 2017.)

c. 2016:

Depreciation Expense . . . . . 14,600

Accumulated Depreciation, Truck . . . . 14,600

(Recorded depreciation expense for 2018)

85

d. 2017:

Depreciation Expense . . . . . . . . . 10,220

Accumulated Depreciation, Truck . . . . . . 10,220

(Recorded depreciation expense for 2019.)

86

Accelerated Depreciation Methods

Earlier in the chapter, straight-line and units-of-production

depreciation methods were discussed. Both of these methods

allocate the cost of an asset evenly over its life. With straight-

line depreciation, each time period during the asset’s useful life

is assigned an equal amount of depreciation. With units-of-

production depreciation, each mile driven, hour used, or other

measurement of useful life is assigned an equal amount of

depreciation. Sometimes, a depreciation method that does not

assign costs equally over the life of the asset is preferred. For

example, if most of an asset’s benefits will be realized in the

earlier periods of the asset’s life, the method used should assign

more depreciation to the earlier years and less to the later years.

Examples of these “accelerated” depreciation methods are the

decliningbalance and the sum-of-the-years’-digits methods.

These methods are merely ways of assigning more of an asset’s

depreciation to earlier periods and less to later periods.

To illustrate assume that Wall co. purchased a van:

Acquisition cost L.E24,000

Estimated salvage value L.E2,000

Estimated life:

In years 4 years

In miles driven 60,000 miles

87

Declining-Balance Method of Depreciation

The declining-balance depreciation method provides for

higher depreciation charges in the earlier years of an asset’s

life than does the straight-line method.

The declining-balance method involves multiplying a fixed rate,

or percentage, by a decreasing book value. This rate is a

multiple of the straight-line rate. Typically, it is twice the

straight-line rate, but it also can be 175, 150, or 125% of the

straightline rate. Our depreciation of Wall’s van will illustrate

the decliningbalance method using a fixed rate equal to twice

the straight-line rate. This method is often referred to as the

double-declining-balance depreciation method.

Declining-balance depreciation differs from the other

depreciation methods in two respects: (1) the initial computation

ignores the asset’s salvage value, and

(2) a constant depreciation rate is multiplied by a decreasing

book value. The salvage value is not ignored completely

because the depreciation taken during the asset’s life cannot

reduce the asset’s book value below the estimated salvage

value.

88

The double-declining-balance (DDB) rate is twice the straight-

line rate, computed as follows:

1 X 2 = DDB rate

Estimated life (years)

This rate is multiplied times the book value at the beginning of

each year (cost _ accumulated depreciation) to compute the

annual depreciation expense for the year. If the 150% declining

balance were being used instead, the 2 in the rate formula would

be replaced by 1.5 and so on for any other percentages.

To illustrate, the depreciation calculation for the van using the

200% (or double) declining-balance method is:

Straight-line rate 4 years = 1/4 = 25%

Double the straight-line rate 25% X 2 = 50%

Annual depreciation 50% X undepreciated cost (book value)

89

Depreciation Schedule with Double-Declining-

Balance Depreciation

Computation Annual

Depreciation

Expense

Accumulated

Depreciation

Book

Value

Acquisition

date

- - - L.E24,000

End of year

1

L.E24,000 X 0.50 12,000 12,000 12,000

End of year

2

12,000 X 0.50 6,000 18,000 6,000

End of year

3

6,000 X 0.50 3,000 21,000 3,000

End of year

4

1,000 22,000 2,000

22,000

In year 4, depreciation expense cannot exceed L.E1,000 because

the book value cannot be reduced below salvage value.

If applied the declining-balance method to depreciate the van

on the basis of 150% of the straight-line rate, the fixed rate

would have been 37.5%, computed as follows:

25% X 1.50 = 37.5%. Using the 37.5% fixed rate, the annual

depreciation of th van would have been as follows:

First year: L.E24,000 X 37.5% = L.E9,000

Second year: L.E24,000 – L.E9,000 = L.E15,000 X37.5%

=L.E5,625

Third year: L.E15,000 – L.E5,625 = 9,375 X37.5%= L.E3,516

90

Fourth year:

L.E9,375- L.E3,516 =L.E5,859- L.E2,000 salvage value

= L.E3,859

Since a total book value of L.E5,859 remains at the end of year

3, the remaining book value less the estimated salvage value is

expensed in year 4.

Sum-of-the-Years’-Digits Method of Depreciation

Like the declining-balance method, the sum-of-the-years’-

digits (SYD) depreciation method provides for a

proportionately higher depreciation expense in the early years of

an asset’s life. It is therefore appropriate for assets that provide

greater benefits in their earlier years (such as trucks, machinery,

and equipment)as opposed to assets that benefit all years equally

(as buildings do). The formula for calculating SYD is:

Number of years of

life remaining at

beginning of year

X(Cost -Salvage value) = Depreciation expense

Sum-of-the-years’-digits

The numerator is the number of years of estimated life

remaining at the beginning of the current year. The van, with a

four-year life, would have four years remaining at the beginning

of the first year, three at the beginning of the second, and so on.

The denominator is the sum of the years of the asset’s life. The

91

sum of the years’ digits for the van is 10 (4 +3 +2 + 1). In other

words, the numerator decreases by one year each year,

whereas the denominator remains the same for each year’s

calculation of depreciation.

Also note that the asset’s cost is reduced by the salvage value in

computing the annual depreciation expense as is done for the

straight-line method but not for the decliningbalance method.

The depreciation on the van for the first two years is:

First year: 4/10 X (L.E24,000 - L.E2,000) =L.E8,800

Second year: 3/10 X (L.E24,000 -L.E2,000) =L.E6,600

Depreciation Schedule with Sum-of-the-Years’-Digits

Depreciation

Annual

Depreciation

Expense

Accumulated

Depreciation

Book

Value

Acquisition

date

- - L.E24,000

End of year

1

8,800 8,800 15,200

End of year

2

6,600 15,400 8,600

End of year

3

4,400 19,800 4,200

End of year

4

2,200 22,000 2,000

22,000

92

When an asset has a long life, the computation of the

denominator (the sum-of-theyears’-digits) can become quite

long. There is, however, a simple formula for determining

the denominator. It is:

n(n + 1) where n is the life (in years) of the asset

2

Given that the van has a useful life of four years, the formula

works as follows:

4(5) /2 =10

Solved Example:

The following information relates to a truck:

a. Date truck was purchased, July 1, 2006.

b. Cost of truck:

Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E125,000

Paint job . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Sales tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7,000

c. Estimated useful life of truck, eight years.

d. Estimated salvage value of truck, L.E27,000.

e. 2008 expenditures on truck:

(1) L.E6,000 on new tires and regular maintenance.

(2) On January 1, spent L.E44,000 to completely rework the

truck’s engine. As a result

of the engine work, the remaining life of the truck is increased to

nine years, but

93

the expected salvage value remains the same.

Required:

Record journal entries to account for the following. (Use the

sum-of-the-years’-digits depreciation method.)

1. The purchase of the truck.

2. Depreciation expense for:

a. 2006

b. 2007

c. 2008

3. The expenditures on the truck during 2008.

Solution

1. Truck Purchase

The cost of the truck includes both the amount paid for it and all

costs incurred to get it in working condition. In this case, the

cost includes both the paint job and the sales tax. Thus,

the entry to record the purchase is:

Truck . . . . . . . . . . . . . . . . 135,000

Cash . . . . . . . . . . . . . . . . . 135,000

Purchased truck for cash.

2. Depreciation Expense

The formula for sum-of-the-years’-digits depreciation on the

truck is: Number of years of

life remaining at

beginning of year

X(Cost -Salvage value) = Depreciation expense

Sum-of-the-years’-digits

94

Depreciation for the three years is calculated as follows:

2006: 8/36 X(L.E135,000 - L.E27,000) =L.E24,000;

L.E24,000 X1/2 year = L.E12,000

2007: 7.5/36 X (L.E135,000- L.E27,000) =L.E22,500

2008:9/45X[(L.E135,000+L.E44,000)- (L.E12,000+L.E22,500)-

L.E27,000]=L.E23,500

The depreciation entries are:

a. 2006:

Depreciation Expense . . . . . . . . . . . . . 12,000

Accumulated Depreciation, Truck . . . . .12,000

Recorded depreciation expense for 2006.

b. 2007:

Depreciation Expense . . . . . . . . . .22,500

Accumulated Depreciation, Truck .22,500

Recorded depreciation expense for 2007.

c. 2008:

Depreciation Expense . . . . . . . . . . . . . 23,500

Accumulated Depreciation, Truck . . . 23,500

Recorded depreciation expense for 2008.

95

3. Expenditures

The first expenditure of L.E6,000 is an ordinary expenditure and

is expensed in the current year. The L.E44,000 expenditure is

capitalized because it lengthens the truck’s life. The

entries are:

Repairs and Maintenance Expense . . . . 6,000

Cash . . . . . . . . . . . . . 6,000

(Recorded purchase of new tires and regular maintenance on

truck.)

Truck . . . . . . . . . . . . . . . 44,000

Cash . . . . . . . . . . . . . . .. 44,000

(Recorded major overhaul of truck engine.)

96

Assignment Cases

97

Assignment Cases

Part one

Case 1: Complete:

Case 2: Journalize the following merchandising transactions using periodic

inventory system.

1. On November 1, purchased merchandise for L.E1,400 on credit with

terms of 2/5, n/30,FOB shipping point; invoice dated November 1.

2. On November 5, paid cash for the November 1 purchase.

3. On November 7, discovered and returns L.E100 of defective

merchandise purchased on November 1 for a cash refund.

4. On November 10, paid L.E80 cash for transportation costs with the

November 1 purchase.

5. On November 13, sold merchandise for L.E1,500 on credit.

a b c d e

Sales 60,000 42,500 36,000 ? 23,600

Cost of goods sold:

Merchandise inventory (beginning) 6,000 17,050 7,500 7,000 2,560

Total cost of merchandise

purchases

36,000 ? ? 32,000 5,600

Merchandise inventory (ending) ? (2,700) (9,000) (6,600) ?

Cost of goods sold 34,050 15,900 ? ? 5,600

Gross profit ? ? 3,750 45,600 ?

Expenses 9,000 10,650 12,150 2,600 6,000

Net income (loss) ? 15,950 (8,400) 43,000 ?

98

6. On November 16, the customer returned merchandise from the

November 13 transaction. The returned items sell for L.E200.

Case 3 A company reports the following sales related information: Sales (gross)

of L.E100,000; Sales discounts of L.E2,000; Sales returns and allowances

of L.E8,000; Sales salaries expense of L.E5,000. Prepare the net sales

portion only of this company’s multiple-step income statement.

Case 4 Prepare journal entries to record the following merchandising transactions

of S Company, which applies the periodic inventory system.

Aug. 1 Purchased merchandise from A Company for L.E6,000 under

credit terms of 1/10, n/30,FOB destination, invoice dated August 1.

Aug. 5 Sold merchandise to L Corp. for L.E4,200 under credit terms of

2/10, n/60, FOB destination, invoice dated August 5.

Aug. 8 Purchased merchandise from W Corporation for L.E5,300 under

credit terms of 1/10, n/45,FOB shipping point, invoice dated August 8.

Aug. 10 L returned merchandise from the August 5 sale that and been

sold forL.E700.

Aug. 12 After negotiations with W Corporation concerning problems

with the merchandise purchased on August 8, S received a credit

memorandum from W granting a price reduction of L.E800.

Aug. 15 Received balance due from L Corp. for the August 5 sale less the

return on August 10.

Aug. 18 Paid the amount due W Corporation for the August 8 purchase

less the price reduction granted.

99

Aug. 19 Sold merchandise to T Co. for L.E3,600 under credit terms of

1y10, ny30, FOB shipping point, invoice dated August 19. The

merchandise had cost L.E2,500.

Aug. 22 T requested a price reduction on the August 19 sale because the

merchandise did not meet specifications. S sent T a L.E600 credit

memorandum to resolve the issue.

Aug. 29 Received from T cash payment for the amount due from the

August 19 sale.

Aug. 30 Paid to A Company the amount due from the August 1 purchase.

Case 5 Multiple Choice

1. A company has L.E550,000 in net sales and L.E193,000 in gross profit.

This means its cost of goods sold equals

a. L.E743,000

b. L.E550,000

c. L.E357,000

d. L.E193,000

e. L.E(193,000)

2. A company purchased L.E4,500 of merchandise on May 1 with terms

of 2/10, n/30. On May 6, it returned L.E250 of that merchandise.

On May 8, it paid the balance owed for merchandise, taking any discount

it is entitled to. The cash paid on May 8 is

a. L.E4,500

b. L.E4,250

c. L.E4,160

d. L.E4,165

e. L.E4,410

100

3. A company has cash sales of L.E75,000, credit sales of L.E320,000,

sales returns and allowances of L.E13,700, and sales discounts of

L.E6,000. Its net sales equal

a. L.E395,000

b. L.E375,300

c. L.E300,300

d. L.E339,700

e. L.E414,700

Case 6:

Ahmad made the following transactions:

1/1 Purchased from Ali 50 units, price per unit L.E. 90.

10/1 Purchased from Tamer 40 units, price per unit L.E. 30,

Trade discount 10%. And 5% cash discount if paid within one

month.

12/1Sold to Kamel goods that value L.E. 40000 and made

Trade discount of 5%, and 5% cash discount if paid within one

month.

15/1Returned 5 unit to Ahmed from the purchases of date 1/10.

24/1 Ahmad paid the value of goods he purchased on date10/1.

28/1 Kamel paid the amount payable to Ahmad.

Required: a) Journalize the entries in the journal of Ahmad.

b) Explain the difference between trade discounts and

cash discounts and their accounting treatment.

Case7:

The following transactions occurred between Mai and Dina:

1/1/2010Mai Corporation sold 4000 units to Dina store at a price of

L.E100 per unit with 10% Trade discount and 5% cash discount if paid

within two months.

10/2/2010 Dina returned 300 units to Mai.

25/2/2008 Dina paid the remaining balance.

Required: a) Show the previous transactions in both the journal of Mai

and the journal of Dina.

b) Discuss the difference between trade discount and cash

discount.

101

Case8:

The following transactions occurred at S trader:

1/1/2012 Sold 2000 units to K at a price of L.E 40 per unit with

terms5/12, n/30.

2/1/2012 One of the customers will not be able to pay 5000 L.E awed to

S.

10/1/2012 collected the amount receivable from K.

20/1/2012 purchased1000 units at a price of 50 L.E per unit with trade

discount 10% and paid cash.

22/1/ 2012 returned 20 units from the purchases date 20/1.

1/2/2013 purchased 500 units at price100 L.E by a 30 days 10% note

payable

Required: a) Show the previous transactions in the journal of S trader.

b) Discuss the difference between trade discount and cash

discount.

Case9:

Show the journal entries Related to the following transactions carried by

Moon Trade:

1/1 Purchased from Noor Trade 300 units, price per unit L.E. 20 on

account with trade terms 2/10,n/20

2/1 Sold to Sun Trade 100 units price per unit 30 L.E cash with trade

discount 10%.

5/1 Paid the amount payable to Noor Trade.

3/2 Returned 5 units to Ahmed from the purchases of date 1/1.

4/3 Light traders who owed Moon traders 4000 L.E has gone out of

business and will not be able to pay.

102

6/6 Light traders paid 1000 of the amount that was written off on 4/3.

10/6 Sold to Hana trader goods for 100000 L.E by issuing a 60 day 12%

note.

Case 10

Choose

1. Which account does a merchandiser use that a service

company does not use?

a. Cost of goods sold

b. Inventory

c. Sales revenue

d. All of the above

2. The two main inventory accounting systems are the

a. perpetual and periodic.

b. purchase and sale.

c. returns and allowances.

d. cash and accrual.

3. Alex Electrical , Inc. purchased inventory for L.E2,000 and

also paid L.E125 freight to have the inventory delivered. Alex

Electrical, Inc. returned L.E500 of the goods to the seller and

later took a 2% purchase discount. What is the final cost of the

inventory that Alex Electrical, Inc. kept?

a. L.E2,083

b. L.E2,085

c. L.E1,595

d. L.E1,593

103

4. Bronz, Inc. had sales of L.E180,000 and sales returns of

L.E22,000. Cost of goods sold was L.E110,000. How much

gross profit did Bronz, Inc. report?

a. L.E48,000

b. L.E70,000

c. L.E92,000

d. L.E158,000

Case 11 Sun, Inc. purchased L.E8,000 of inventory from the Pool, Inc. on

account, terms of 2/10, n/30. Some of the goods are damaged in

shipment, so Sun, Inc. returns L.E1,100 of the merchandise to the Pool,

Inc. How much must Sun, Inc. pay the Pool, Inc. Journalize the following

transactions, using the periodic inventory system, for Sun, Inc.

Explanations are not required. a. Purchase of the goods b. Return of the

damaged goods c. Payment for the goods within the discount period

Case 12 Journalize the following transactions, using the periodic inventory

system, for a store.

a. Purchased L.E8,700 of merchandise on account, terms 2/10, n/30, FOB

shipping point.

b. Paid L.E175 to the freight company for the delivery of the merchandise

purchased.

c. Paid for the inventory purchased in Part a within the discount period .

Case 13 Journalize the following transactions

a. Sold L.E55,000 of merchandise on account, terms 2/15, n/30.

b. Received payment for the goods within the discount period.

104

Case 14 Suppose Baher sells merchandise on account, terms 2/10, n/45, for

L.E750 ,on May 17. Later he received L.E225 of goods as sales returns

on May 21. The customer paid the balance due on May 26. Journalize

these transactions, using the periodic inventory system.

Case 15

Accounts Payable L.E19,500

Unearned Revenue 2,000

supplies 33,000

Inventory 37,000

Accounts Receivable 6,000

Wages Payable 1,500

Note Payable, Long-Term 28,000

Accumulated Depreciation,equipment 4,500

Equipment 25,000

Capital 22,900

land 87,000

Building 5,200

Cash 24,000

Accumulated Depreciation, Building 6,200

Prepaid Rent 15,000

compute the following amounts:

a. Total current assets

b. Total current liabilities

c. Book value of fixed assets

d. Total long-term liabilities

105

Case 16 The accounting records reflected the following amounts at the

end of August .Prepare income statement,and balance sheet.

L.E3,500 Cash

3,700 Total Operating Expenses

4,500 Accounts Payable

5,200 capital

2,300 loan

1,700 Inventory

1,900 expenses

19,500 Cost of GoodsSold 6,100 Equipment, Net 1,900 Accounts payable 28,000 Net Sales Revenue 2,900 Accounts Receivable

106

Case 17

The account balances are presented in random order:

3,700 Cash

13,700 Equipment

4,500 Accounts Payable

48,800 Capital

10,000 Long-Term Notes Payable

18,200 General Expenses

1,100 Wages Payable

900 Supplies

125,000 Building

4,800 Sales returns and allowances

800 Prepaid rent

1,700 Ending inventory

136,400 Cost of Goods Sold

6,100 Accumulated Depreciation, Equipment

1,900 Unearned Revenues

423,500 Sales Revenue

3,200 Accounts Receivable

18,500 Accumulated Depreciation, Building

37,000 Notes Payable (Long-Term)

34,000 Interest expense

2,200 Sales Discounts

26,800 Selling Expenses

Required: 1. Prepare income statement.

2. Prepare a classified balance sheet.

107

Case 18

Given the following adjusted trial balance:

Cash 15,000

Accounts Receivable 37,300

Inventory 18,500

Supplies 900

Equipment 68,000

Accumulated Depreciation,

Equipment

8,000

Accounts Payable 12,900

Unearned Sales Revenue 5,300

Note Payable, Long-Term 15,000

Capital 83,300

Dividents 22,000

Sales Revenue 193,200

Sales Returns and Allowances 8,700

Sales Discounts 2,600

Cost of Goods Sold 103,400

Selling Expense 25,200

General Expense 16,100

Total 317,700 317,700

Required:

1. Prepare income statement.

2. Prepare a classified balance sheet.

108

Case 19

Given the following adjusted trial balance On Dec,31,2018

Items Debit Credit

Cash 200,000

Land 250,000

Machines 138,000

Accumulated depreciation Machines 22,000

Accounts Receivable 110,000

Loan 200,000

Accounts Payable 65,000

Expenses 50,000

Sales return 5,000

Sales discount 10,000

Ending inventory 10,000

Drawings 5,000

Cost of goods sold 70,000

Sales revenue 286,000

Capital 275,000

Total 848,000 848,000

Required: Prepare the income statement and balance sheet .

Case 20: The following transactions occurred between Mai and Dina:

1/1/2010Mai Corporation sold 4000 units to Dina store at a price of

L.E100 per unit with 10% Trade discount and 5% cash discount if paid

within two months.

10/2/2010 Dina returned 300 units to Mai.

25/2/2010 Dina paid the remaining balance.

Required: a) Show the previous transactions in both the journal of Mai

and the journal of Dina.

b) Discuss the difference between trade discount and cash

discount.

Case 21: A Company issued a check of L.E. 11000 to cashier of petty cash,

Petty cash disbursements were as follows:

2000 Beverage 3000 Transportation

3500 Utilities

Required:

1) Journalize the entries if the Treasure has L.E. 2000.

2) What are the benefits of having a petty cash?

109

Case 22: Journalize the following transactions in the journal of Masa

Merchandizer:

31/12/2017 the balance of A/R was L.E200,000 and estimated

uncollectible 5% of A/R.

1/1/2018 Masa sold 4000 units on credit to Golden traders at a

price of L.E200 per unit with 5% Trade discount and credit

terms 10/20,n/60.FOB destination.Transportation cost was

L.E300.

10/1/2018Golden traders returned 500 units to Masa.

15/1/2018Golden traders paid the remaining balance.

10/3/2018 Masa purchased 500 units from King traders at L.E

100 per unit with credit term 5/20,n/30.FOB

distination.Transportation cost was L.E 100.

15/3/2018 paid the amount owed to king traders.

10/4/2018 L.E 6000 of A/R was written off.

11/5/2018 collected L.E 3000 of the A/R that were previously

written off.

31/12/2018 The allowance for uncollectible account expense

had credit balance of 2,000and balance of A/R was 300,000

where management estimates uncollectible 5%.

Required: Show the previous transactions in the journal of

Masa.

110

Part Two

Case 1:

GiGi Company establishes a L.E400 petty cash fund on

September 9. On September 30, the fund shows L.E166 in cash

along with receipts for the following expenditures:

transportation-in, L.E32; postage expenses, L.E113; and

miscellaneous expenses, L.E87. The petty cashier could not

account for a L.E2 shortage in the fund.

Prepare )1) the September 9 entry to establish the fund and (2) the

September 30 entry .

Case 2 Abraham Company uses a petty cash system. The fund was

established on March 1 with a balance of L.E150. During March

the following petty cash receipts were found in the Petty cash

box. Receipt Amount

Stamp Inventory L.E35

Freight-out 19

Miscellaneous Expense Travel Expense 20

Miscellaneous Expense 11

The fund contained L.E58 in cash at the end of March .

Required:

Journalize the entries in March petty cash fund.

111

Case 3:

At the beginning of the year a company opened a Petty cash fund for L.E3000, at the end of the year the fund contained L.E 400. The disbursements from the fund during the year were as follows:

• Transportation L.E 800.

• Beverage L.E. 1000.

• Postage due L.E. 600.

• Flowers L.E. 400.

• Tips L.E. 600

Required:

a) Write up the petty cash book and journalize. b) Why is it appropriate to have both a cash book and a petty cash book in a large

organization?

Case 4:

A Company issued a check of L.E. 11000 to cashier of petty cash,

Petty cash disbursements were as follows:

2000 Beverage 3000 Transportation

3500 Utilities

Required:

1) Journalize the entries if the Treasure has L.E. 2000.

2) What are the benefits of having a petty cash?

CASE 5:

A Company issued a check of L.E. 8000 to cashier of petty cash,

Petty cash disbursements were as follows:

3000 Beverage 2000 Transportation

2500 Utilities

Required:

1) Journalize the entries if the Treasure has L.E. 2000.

2) Why do we need to have a petty cash account?

112

Case 6: Journalize the following transactions assuming the allowance method is

used to account for uncollectible receivables.

14/5 Received 75% of the L.E20,000 balance owed by Webb Co., a

bankrupt business. Wrote off remainder as uncollectible.

20/6 Reinstated the account of Zorn Co., which had been written off in

the preceding year as uncollectible. Received L.E5,225 cash as full

payment of Zorn’s account.

27/7 Wrote off the L.E2,500 balance owed by Schmich, Inc. which had

no assets.

31/12 Based on an analysis of Accounts Receivable, it is determined that

L.E11,500 will become uncollectible. The balance in Allowance for

Doubtful Accounts on December 31 prior to adjustment is L.E200 credit.

Determine the following:

a) The balance in Allowance for Doubtful Accounts after adjustment.

b) The Net Realizable Value of Accounts Receivable if the balance of

Accounts Receivable is L.E62,000.

c) Redo the entry for 12/31and questions a) and b) if the percent of

sales method had been used to estimate uncollectible accounts

expense at the rate of ½ of 1% of net sales of L.E2,000,000.

113

Case 7: Journalize the following transactions

a) 9/12 Received a L.E30,000, 12%, 120-day note on account.

b) 10/9 Received a L.E15,000, 10%, 60-day note on account.

c) 11/15 Received an L.E18,000, 15%, 30-day note on account.

d) 12/8 Received the amount due on the note of October 9.

e) 12/15 The note of November 15 was dishonored.

f) 12/31 Accrued interest on the note of September 12.

114

Case 8: At the end of the year, two similar companies were in the process

of calculating bad debt expense for the year. Each company had

credit sales of L.E1,000,000 and a debit balance in Allowance for

Uncollectible Accounts of L.E2,000 before any year-end

adjustment. The balance of Accounts Receivable is L.E180,000.

Company A estimates that 5% of accounts receivable will not be

collected over the next

year Determine the following:

a) The uncollectible accounts expense for the year.

b) The adjusting entry to be made of December 31.

c) The balance in Allowance for Doubtful Accounts after

adjustment.

Company B estimates that 5% of credit sales will not be collected

over the next year

Determine the following:

d) The uncollectible accounts expense for the year.

e) The adjusting entry to be made of December 31.

f) The balance in Allowance for Doubtful Accounts after

adjustment.

115

Case 9:

The following transactions were carried by Noor Trader

Jan 1: Purchased from Sun traders 6000 units at L.E120 per unit with

trade discount 5%, under credit terms of 10/10, n/30.FOB shipping point,

and L.E 200 was costs of transportation.

Jan 2: Sold to Moon Traders 1500 units at price L.E 200 per unit with

trade discount 10% under credit terms of 20/10, n/60.

Jan 3: Moon traders returned 100 units from units sold to them on Jan 2.

Jan 5: Noor traders returned 200units from units Purchased on Jan 1.

Jan 8: Received the balance due from Moon Traders.

Jan 9: Paid the balance due to Sun traders.

Required: Journalize the above transactions in the journal of Anwar

Trader.

116

Part Three

Case 1:

Act Company acquired a new machine in order to expand its

productive capacity.

The costs associated with the machine purchase were as follows:

Purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E25,000

Installation costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

Cost of initial testing . . . . . . . . . . . . . . . . . . . . . . . . . . 900

Sales tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,563

1. Make the journal entry to record the acquisition of the

machine. Assume that all costs were paid in cash.

2. Make the journal entry to record the acquisition of the

machine. Assume that Act Company signed a note payable for

the L.E25,000 purchase price and paid the remaining costs in

cash.

117

Case 2 Fady Company decided to purchase a new floor-polishing

machine for its shop. The machine costs L.E45,000 and has an

estimated 15-year life and no salvage value.

Fady Company made the following additional expenditures with

respect to this purchase:

Sales tax . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E2,000

Delivery costs (FOB shipping point) . . . . . . . . 1,000

Assembly cost . . . . . . . . . . . . . . . . . . . . . . . . . 1,400

Painting of machine to match the decor . . . . . . . 600

1. What is the cost of the machine to Fady Company?

2. What is the amount of the first full year’s depreciation if Fady

uses the straight-line method?

118

Case 3

Photography Company purchased a new car on July 1, 2008, for

L.E26,000. The estimated life of the car was five years or

110,000 miles, and its salvage value was estimated to be

L.E1,000. The car was driven 9,000 miles in 2008 and 24,000

miles in 2009.

1. Compute the amount of depreciation expense for 2008 and

2009 using the following

methods:

a. Straight-line.

b. Units-of-production.

2. Which depreciation method more closely reflects the used-up

service potential of the car?

Case 4

Paint Company has a giant paint mixer that cost L.E31,500 plus

L.E400 to install.

The estimated salvage value of the paint mixer at the end of its

useful life in 15 years is estimated to be L.E1,900. Paint

estimates that the machine can mix 850,000 cans of paint during

its lifetime. Compute the second full year’s depreciation

expense, using the following methods:

1. Straight-line.

2. Units-of-production, assuming that the machine mixes 51,000

cans of paint during the second year.

119

Case 5:

Prepare entries in the books of Samara, Inc., to reflect the

following. (Assume cash transactions.)

1. Purchased a machine to be used by the firm in its

production process.

Invoice price . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E45,000

Cash discount taken . . . . . . . . . . . . . . . . . . . . . . . . . 900

Installation costs . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,200

Sales tax on machine . . . . . . . . . . . . . . . . . . . . . . . . .1,800

2. Performed normal periodic maintenance on the machine at a

cost of L.E200.

3. Added to the machine a part costing L.E400, which is

expected to increase the machine’s useful life.

120

121

Case 6:

Concrete Company has a truck that it wants to sell. The truck

had an original cost of L.E80,000, was purchased four years

ago, and was expected to have a useful life of eight years with

no salvage value.

Using straight-line depreciation, and assuming that depreciation

expense for four full years has been recorded, prepare journal

entries to record the disposal of the truck under each of the

following independent conditions:

1. Concrete Company sells the truck for L.E45,000 cash.

2. Concrete Company sells the truck for L.E38,000 cash.

3. The old truck is wrecked and Concrete Company hauls it to

the junkyard.

Case 7:

The company used cash to purchase a machine. The price on

the machine is L.E35,000, but the company received a 2%

discount. It also paid L.E2,150 in sales tax for the purchase.

Make the necessary journal entry to record this transaction.

assume the company borrowed L.E15,000 of the purchase price

from a bank. Make the necessary journal entry to record this

transaction.

122

Case 8:

On January 1, XYZ Company entered into a lease for equipment

rental. The company agreed to pay L.E4,500 per year for ten

years. The present value of all ten lease payments is L.E27,651.

Assuming the company classified the lease as an operating

lease, make the necessary journal entry to record the payment of

the first year’s rent expense for the equipment. The first lease

payment is made at the end of the year.

Case 9:

On January 1, XYZ Company entered into a lease for equipment

rental. The company agreed to pay L.E4,500 per year for ten

years. The present value of all ten lease payments is L.E27,651.

Assuming the company classified the lease as a capital lease,

make the necessary journal entry to record the acquisition of the

equipment. The first lease payment is made at the end of the

year.

123

Case 10: Big Oil Company, which prepares financial statements on a

calendar-year basis, purchased new drilling equipment on July

1, 2009. A breakdown of the cost follows:

Cost of drilling equipment . . . . . . . . . . . . L.E125,000

Cost of cement platform . . . . . . . . . . . . . . . . . .35,000

Installation charges . . . . . . . . . . . . . . . . . . . . 22,000

Freight costs for drilling equipment . . . . . . . . .3,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . L.E185,000

Assuming that the estimated life of the drilling equipment is 20

years and its salvage value is L.E10,000:

1. Record the purchase on July 1, 2009.

2. Assume that the drilling equipment was recorded at a total

cost of L.E140,000. Calculate the depreciation expense for 2009

using the following methods:

a. Sum-of-the-years’-digits.

b. Double-declining-balance.

c. 150% declining-balance.

3. Prepare the journal entry to record the depreciation for 2009

in accordance with part (2)a.

124

Case 11

A Company purchased a new machine on Jan. 1, 2017, for

L.E300,000. The estimated life of the machine was ten years and

maximum production capacity 200,000 units, and its salvage

value was estimated to be L.E40,000. The machine produced

20,000 units in 2017 and 30,000 units in 2018.

Required: 1)Compute the amount of depreciation expense for

2017 and 2018 using the following methods:a. Straight-line.

b. Units-of-production.

2) compare between the two methods.

125

Module Objectives: 1 -State the basic objectives of cash management.

2- Prepare bank reconciliation and explain its purpose.

3- Describe the operation of a petty cash fund.

4- Prepare estimates of uncollectible accounts receivable, write

off uncollectible and record any later recoveries.

5 – Understand difference between periodic and perpetual

inventory systems.

6- Understand different methods for calculating depreciation.

Module Items

• Cash transactions

• Marketable securities transactions

• Accounts receivable & notes receivable

• Inventories

• Plant and equipment & depreciation

Student Assessment:

• 20% term work (participation – quizzes – assignments)

• 20% mid term exam

• 60% final exam

126

Reference

Bettner, Whittington ,

Meigs&Meigs, Accounting, The Basis for Business Decisions,

Tenth Edition , Mc Grow Hill 1996 .

Code in the MTI Library: MGMT:B 1722

Chapters:5,9,11

W. Steve Albrecht, Earl K. Stice, and James D. Stice

Financial Accounting, 10e,2008