Problem 10.1 For Ryder Ltd for 2004, record all necessary entries relating to the selected events described below (see pages 683–4). Use generally accepted accounting principles. The records are still open on 31 December 2004.

The purpose of this problem is to indicate the ‘arbitrariness’ of many of the rules concerning expenses.

1. Accepted practice is that the value of the options is the difference between the higher market price and the option price on the date of measurement. In this case, there is no value, and therefore there is nothing to record. But why would executives take options if there is no value? The executives must work for the company over the next three years in order to be able to exercise the options. If they had not received the options then probably the salary expense for those years would have been higher. Therefore, it can be assumed that the options were given as ‘compensation’ — that is, in lieu of an increase in salary. If this is so, then proper matching calls for the recognition of compensation expense related to the options for the three years.

2. Patent $64 000Cash $64 000

Amortisation Expense 4 000Patent 4 000

The journal entries are simple enough to record, but how does one determine the economic life of eight years? How do we know that a good estimate of the cost of the services provided by the patent is $8000 a year? How do companies arrive at their estimates?

3. Research and Development Expense $140 000Cash, etc. $140 000

Patent 13 600Cash 13 600

Amortisation Expense (3/12 $800 a year) 200Patent 200

As ASRB 1011 supports the expensing of R&D, the patent cost consists only of the legal fees. How does this case compare with the cost and amortisation of the patent in item 2 above? If R&D had been capitalised, the amortisation expense would be $2258 rather than $200.

4. According to ASRB 1013, goodwill is to be amortised for a period not exceeding 20 years. Ryder will therefore be in breach of the ASRB. The entry for 2004 would be:

Dr Amortisation Expense 333

Cr Accumulated Amortisation — Goodwill 333[$80 000/20 1/12]

5. Depreciation Expense of Trucks $18 000Accumulated Depreciation $18 000$35 000 5 trucks = $175 000$175 000 less $25 000 salvage value = $150 000$150 000/1 000 000 miles = $0.15 a mile$0.15 120 000 actual miles = $18 000

Depreciation Expense — Equipment $500 000Accumulated Depreciation $500 000

The amount of depreciation of the trucks was affected by the strike, since the trucks were not used for three months. The amount of depreciation of the equipment was not affected by the strike, because the straight-line method is based on time rather than use. Both methods are acceptable. The depreciation for the trucks could have been on a straight-line basis, and the equipment could have been on the service basis. If so, the depreciation recorded for the trucks and equipment would have been different from that actually recorded. For example, for the trucks, depreciation under straight-line, based on five years, would have been $30 000 instead of $18 000. Both figures are correct, in the sense that both are based on accepted methods of calculation. But the effect on income is quite different.

6. Is this to be capitalised or not? Two factors should be considered. First, when the company estimated the economic life of the building, say, at 20 years, did it expect that the building would be painted in order that it last for 20 years? The answer should be yes; and therefore, the expenditure should be maintenance expense. The second factor has to do with the materiality of the amount. If it is not material, not expensing it confirms the previous conclusion. If material, then capitalising would be acceptable.

Maintenance Expense $20 000Cash or Accounts Payable $20 000

The entry shows the amount to be expensed, but if someone or the company insisted that it be capitalised, it would be difficult to say that capitalisation is incorrect.

7. Extraordinary Loss $50 000Building $50 000

8. 2004 2003 2002

Depreciation — new method $19 200 $24 000 $30 000Depreciation — old method     15   000     15   000     15   000

Decrease in Income $4 200 $9 000 $15 000

Depreciation Expense 4 200Cumulative Effect Due to Change 24 000

Accumulated Depreciation $28 200

Why should the 2004 income be decreased by $24 000 for the effect of the change pertaining to 2003 and 2002? This is not proper matching.

9. Retained Earnings $125 000Cash $125 000

Retained Earnings are adjusted as the suit relates to a period’s transaction.

10. This is a change in estimate.

$300 000/20 years = $15 000 a year$15 000 10 years = $150 000 accumulated depreciation$150 000 book value on 1 Jan. 2004/20 remaining years = $7500 depreciation a year.

Depreciation Expense $7 500Accumulated Depreciation $7 500

Is the amount of $7500 proper matching of depreciation? If the company had correctly determined its estimated life at the very start, depreciation would have been $10 000 a year (= $300 000/30 years).

11. It is conventional to expense advertising expenditures, because of the difficulty of measuring the future benefits. Despite the fact that the benefits are acknowledged, the uncertainty of the length of time would only make allocation arbitrary.

Advertising Expense $200 000Cash of Accounts Payable $200 000

12. For the sake of matching, we are willing to estimate and guess at the future amount of the repair cost. There should be past experience to give us a basis for this estimate.

Warranty Expense $68 000Estimated Liability on Product Warranty $68 000

13. On 31 December 2004, the following entry is to be made:

Loss of Purchase Commitment $90 000Liability from Purchase Commitment $90 000

This is a promise in exchange for a promise. The transaction of purchasing the material will occur in 2005, but because of conservatism we anticipate and record the loss now (7500 tonnes $12 = $90 000). Since the transaction has not occurred yet, the matching principle is violated by recording the loss now. This entry shows that conservatism is more important than matching.

14. (a) Construction in Progress $424 000Cash, Materials, etc. $424 000

(b) Accounts Receivable 350 000Partial Billings 350 000

(c) Cash 310 000Accounts Receivable 310 000

(d) Loss on Long-term Contracts 10 000Construction in Progress (or a liability) 10 000

$424 000 actual costs incurred    106   000 expected costs to complete$530 000 total costs    520   000 contract price$  10 000 loss

Again, because of conservatism the loss is recorded now. According to the completed contract method, there is no revenue until the project is completed; yet, a loss is recorded now when the project is not completed.

15. The new asset has a more objectively determinable fair value; therefore, the loss is calculated as follows:

Value received:fair value of new asset $50 000cash         5   000 $55 000

Value given:book value of old asset     70   000

Loss $15   000

Cash $5 000Machine (new) 50 000Loss on Exchange 15 000Accumulated Depreciation 20 000

Machine (old) $90 000

A loss is always recorded in an exchange of non-monetary assets.

16. The Allowance account is not debited, because this amount is more than an ordinary bad debt. Bad debt expense is for ‘normal’ write-offs. This is not an extraordinary item, because bankruptcy is not unusual in nature.

Bad Debts Expense/Provision for Doubtful Debts $60 000

Accounts Receivable $60 000

17. The building must be recorded, and accumulated depreciation against it should be recorded over the life of the building. But depreciation should be offset in some way, because really there is no ‘cost’ to the company.

2 Jan. 2004 Land $300 000Building $100 000

General Reserve $400 000

31 Dec. 2004 General Reserve 10 000Accumulated Depreciation 10 000

or Depreciation Expense 10 000Accumulated Depreciation 10 000

General Reserve 10 000Extraordinary Revenue 10 000