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ACCTG 471 CASE STUDY – PART 1

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Pennsylvania State University

ACCTG 471: Intermediate Financial Accounting I

 

CASE STUDY – PART 1

This is the first of a two-part case study. You should complete Part 1 of the case study individually; however, you will be able to work in groups of no more than two for Part 2. You should already have the tools to complete Task A, but you may need to wait until we cover future chapters before you are able to complete Task B. Refer to the syllabus for due dates.

Summary

On January 1, 2014, two companies began operations to sell home heating units. Eads Heater, Inc. is located in Eads, Colorado, and Glenwood Heating, Inc. is in Glenwood Springs, Colorado. The companies operate under similar economic conditions and have identical operations during the year. However, the manager of each company makes different accounting choices and estimates when applying Generally Accepted Accounting Principles (GAAP) to prepare the company’s financial statements.

Task A – Initial Transactions

Both companies have completed identical transactions during the first year of operations (2014). The transactions for each company are listed below.

  1. (a)  On January 1, each company issued 26,000 shares of $0.10 par value common stock for $160,000. Both companies commenced operations on this date.

  2. (b)  On January 2, each company borrowed $400,000 by issuing a 20-year, 7% note that specified interest plus $20,000 principal is due September 30 each year, beginning on September 30, 2014.

  3. (c)  On January 3, each company purchased land and a building for $420,000 cash. Both managers allocated $70,000 to the land and $350,000 to the building.

  4. (d)  On January 5, each company purchased equipment at a cost of $80,000. Both purchases were made in cash.

  5. (e)  Each company sells one model of home heating unit, and made the following credit purchases during the year. You may record all the purchases in one transaction.

rev. 5/27/16

Date

January 10 March 14 June 1 September 15 October 30

No. of Units

40 60 20 62 28

Cost per Unit

$1,000 1,100 1,150 1,200 1,300

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ACCTG 471: Intermediate Financial Accounting I Case Study – Part A

  1. (f)  Each company sold 160 units for $398,500 during the year. All sales were on credit. You will only record the sales component of this transaction for now. Management has not yet determined how inventory and cost of goods sold will be valued. Therefore, management will use the periodic inventory system and record cost of goods sold at the end of the year.

  2. (g)  $299,100 was collected during the year on the sales described in (f).

  3. (h)  $213,360 was paid on the purchases made in (e).

  4. (i)  On September 30, the first $20,000 principal payment plus nine months’ interest was made on the note payable described in (b).

  5. (j)  A total of $34,200 was paid for a variety of expenses, such as advertising, supplies, insurance, and wages. These expenses are recorded in an account called “other operating expenses.”

  6. (k)  Dividends of $0.90 per share were paid to common shareholders on December 1.

  7. (l)  Management made an adjusting entry to accrue three months’ interest on the note payable in (b) and (i)

    above.

Requirement

Record journal entries for these transactions (a–l) for Eads’ and Glenwood’s first year of operations. You should record the transactions in such a way that I can clearly follow your process; you may want to record the transactions in T-accounts as well. Although not required, it will likely be helpful to prepare a trial balance after recording the transactions. The following table contains a basic chart of accounts that will be used by either or both companies throughout this case study. However, you will not use all accounts when recording the transactions above.

Assets

Cash
Accounts receivable
Inventory
Land
Building
Equipment
Leased equipment
Allowance for uncollectible accounts Accumulated depreciation—building Accumulated depreciation—equipment Accumulated depreciation—leased equipment

Liabilities

Accounts payable Interest payable Note payable Lease payable

Equity (including revenues & expenses)

Common stock Additional paid-in capital Sales
Cost of goods sold
Bad debt expense Depreciation expense Interest expense
Other operating expenses Rent expense
Income tax expense Dividends
Retained earnings

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Task B – Implementation of Accounting Estimates under GAAP

ACCTG 471: Intermediate Financial Accounting I Case Study – Part A

It is now December 31, 2014, and each manager must make several decisions.

  1. (m)  Each manager must estimate the amount of accounts receivable that will probably not be collected. They make the following estimates:

    Glenwood Heating, Inc. 1% of ending accounts receivable will be uncollectible Eads Heaters, Inc. 5% of ending accounts receivable will be uncollectible

  2. (n)  Neither manager recorded cost of goods sold at the time of sale. They have taken a physical inventory, and now must determine the values of cost of goods sold and ending inventory. They decide to use the following inventory methods:

    Glenwood Heating, Inc. First-in, first-out (FIFO) Eads Heaters, Inc. Last-in, last-out (LIFO)

  3. (o)  Both managers determine that the expected lives and salvage values of the building and equipment owned by each company are as follows:

Useful Life Building 30 years Equipment 08 years

Salvage Value

$50,000 $58,000

It is now time to record depreciation expense for the year. The managers decide to use the following depreciation methods:

Building Glenwood Heating, Inc. Straight-line Eads Heaters, Inc. Straight-line

Equipment

Straight-line Double-declining balance

(p) On January 1, 2014, each company negotiated the use of a large piece of operating equipment. Both managers agreed to a $16,000 payment on December 31, 2014, at which time they would decide the terms for using the equipment in the future. On December 31, when making the payment, the managers negotiated the following terms:

Glenwood Heating, Inc.

Although the owner of the equipment agreed to let Glenwood rent the equipment for $16,000 again next year, he would not guarantee that price beyond 2015. Management decided to rent the equipment on a yearly basis and signed an agreement to pay $16,000 on both December 31, 2014 and December 31, 2015.

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Eads Heaters, Inc.

The owner of the equipment and Eads management negotiated a capital lease agreement. The present value of the lease agreement is $92,000. The contract contained the following details:

Lease term Interest rate Annual payment Payment date

8 years 8% $16,000 December 31

The first two payments of $16,000 are to be allocated to between interest and principal as follows:

Interest December 31, 2014 $7,360 December 31, 2015 $6,670

Principal

$8,640 $9,330

Total

$16,000 $16,000

ACCTG 471: Intermediate Financial Accounting I Case Study – Part A

The manager decides to compute depreciation using straight-line depreciation with a useful life equal to the eight-year lease term and no salvage value.

(q) Both managers are concerned about income taxes. They both realize that companies generally keep a second set of books for tax reporting purposes, but are not sure about the differences between income reported according to GAAP and income as defined by the tax authorities. They also realize that they need to make an estimated tax payment in order to avoid late payment penalties. Both managers talk to their CPAs and are told to pay 25 percent of their GAAP income to the IRS to help avoid late penalties. Thus, each manager estimated a provision for income taxes of 25 percent of their GAAP income and made a payment for that amount to the IRS.

Requirement

Record the last five transactions (m–q) outlined above. Although not required, it will likely be helpful to prepare a trial balance after recording these transactions prior to the preparation of financial statements. Additionally, prepare the following financial statements for each company for the current year (2014):

  1. (1)  income statement (multiple-step)

  2. (2)  statement of cash flows (direct method)

  3. (3)  balance sheet (classified)

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