Question

REQUIRED

Post all transactions, adjusting and closing entries for Midnight Oil for the fiscal year ending December 31, 2004.

MIDNIGHT OIL (MO)

Midnight Oil (MO) was formed as a private corporation on January 1, 2003, by Hanna Carins. Although Carins had been making candles in her basement in Port Stanley for years to give as gifts, she had decided to expand her operations in order to generate additional income. Port Stanley, a small town bordered by Lake Erie, was about 30-minutes drive from London, Ontario. The town attracted many tourists to its beaches, making it an ideal locale for the sale of specialty candles. Carins’ second fiscal year had just ended, and she was anxious to discover how profitable it had been.

PRODUCTION PROCESS AND FIXED ASSETS

Carins used several pieces of equipment to manufacture her signature cube candles. The first, a large stove burner, was used to melt the raw, solid wax. Carins had purchased the burner on the first day of operations for $4,500 and had amortized it using the straight-line method over 10 years.¹ The burner worked well until May 1, 2004, when Carins spent $900 to repair the heating mechanism. This unexpected repair was paid for with cash and was expected to add on additional year to the burner’s useful life. Its salvage value would remain the same.

Large pots, used to melt the wax, deteriorated quickly and were amortized using the units-of-output method. Their total original cost was $2,200, with an estimated$200 salvage value after approximately 700 batches. The pots had been used for 275 batches by early November of fiscal 2004 in anticipation of the Christmas season, and on November 8, 2004, Carins decided to scrap all the pots. Carins received $100 from a wrecker for the metal. The following day, Carins purchased new large pots for a total cost of $2,900 cash. She decided to amortize the new pots using the same method of amortization as the old pots (including the original life of 700 batches) buy decided on a $00 salvage value. The new pots were used to make a total of 40 batches from November 9, 2004, to December 31, 2004.

Three moulds were used to form the melted wax into the square shape that Carins had designed. These moulds were amortized using the double-declining-balance method, had useful life of five years and were expected to have a salvage value of $150 each. Each mould had originally cost $1,200, not including transportation costs of $75 each. On the first day of fiscal 2004, each mould had a net book value of $765.

In additional to the office equipment listed on the fiscal 2003 balance sheet (see Exhibit 1), Carins had purchased a new printer for $1,000 on January 1, 2004, to make her invoices look more professional. The printer had been purchased using a 90-day note payable that carried four per cent annual interest and had been paid in full in cash on the maturity date. Carins planned to amortize the printer using the same method as the rest of the office equipment.

MANUFACTURING FACILITY

Originally, Carins had believed she could operate out of her basement, but she quickly realized more space was needed. In early June 2003, Carins began renting a small 500-square-foot workspace in Port Stanley for $450 per month paid with cash on the last day of each month. Upon signing the three-year lease, Carins had been required to pay both first and last month’s rent. The manufacturing area represented 450 square feet, and the remaining space was used for Carins’s office.

Utilities for the rented workspace had totaled $1,100 in fiscal 2004, but Carins had recorded payments by cheques for $1,150. Carins allocated utilities costs based on space occupied. Insurance covering production operation only was purchased annually on January 1 with cash and had cost $800 in fiscal 2003. The premium had increased by 10 per cent in fiscal 2004.

WAGES AND SALARIES

While Carins did perform some of the manufacturing herself, she needed two part-time workers to help make the candles. The part-time employees earned $7.15 per hour, and each had worked 250 hours in fiscal 2004. All wages had been paid in full. Carins had been compensating herself generously ($2,000 per month), and she thought that 50 per cent of her time was spent actually making the candles. On top of her monthly salary, depending on the results for fiscal 2004, Carins would decide whether to issue herself, as the shareholder, a dividend subsequent to year-end.

OTHER DISBURSMENTS

Carins had paid the following miscellaneous costs with cash: $684 for fiscal 2003 income taxes, $260 for the telephone, $500 in promotional materials, and $65 for transportation to customers. MO had also established a petty cash fund for $110 on December 30, 2004.

Carins had required a bank loan to help cover the initial costs of the production equipment and inventory. The loan was listed on the balance sheet and was being paid back in equal annual installments of $500, paid on the first day of the fiscal year beginning January 1, 2004. Carins paid five per cent interest on the loan amount outstanding at the end of each year. Both the loan and the interest were paid with cash.

SALES

All of MO’s customers purchased their candles with cash. By the end of the year, MO had six regular customers whose purchases had totaled $49,000.² Discounts had not been offered in fiscal 2004.

INVENTORIES

Oil, used to coat the moulds, was the only production supply required. Carins had purchased $170 worth of supplies in fiscal 2004 with cash, and she had $25 worth of supplies remaining on December 31, 2004.

MO used the weighted-average-cost method of inventory valuation to determine the value of wax at year-end. Carins had started fiscal 2004 with 20 kilogram of wax, had purchased 310 kilograms,³ and counted only five kilograms on hand on December 31, 2004. Glaxen Inc. was MO’s only supplier. Glaxen shipped FOB destination and demanded cash on delivery. Carins remembered that a shipment had been ordered for 24 kilograms on December 27. The shipment had cost $245 but had not yet arrived in Port Stanley. Wax covered rope wicks were also included in the raw materials account. No purchases had been made in the year, and Carins estimated $11 worth of wicks remained on hand.

Some candles were partially completed at the end of December 31, 2004. Carins estimated that an allocation of $120 of her salary had five hours of part-time work had been spent manufacturing the candles, and that $40 of raw materials had been used so far. Carins used direct labor dollars as the proxy for determining partial factory overhead.

Finally, Carins had counted 70 finished candles in the small storage area and had no record of any damaged candles.

MO paid corporate tax at a rate of 20 per cent.

REQUIRED

Post all transactions, adjusting and closing entries for Midnight Oil for the fiscal year ending December 31, 2004.

¹Carins expected a salvage value of $500 at the end of the burner’s useful life

²Representing 4,640 candles

³For a total cost of $936

Exhibit 1
BALANCE SHEET (as at December 31, 2003)
ASSETS
Current assets:
Cash	$12,607
Prepaid rent	450
Inventory1	378
Production supplies	20
Total current assets		$ 13,455
Fixed Assets:
Office equipment 2	3,750
Less: Accumulated amortization office equipment	375	3,375
Production equipment	10,525
Less: Accumulated amortization production equipment	2,544	7,981
Total assets		$24,811
LIABILITIES AND SHAREHOLDER’S EQUITY
Liabilities:
Accounts payable3		$200
Income tax payable4		684
Long-term loan		4,800
Total liabilities		5,684
Shareholder’s equity:
Common stock		10,000
Retained earnings		9,127
Total shareholder’s equity		19,127
Total liabilities and shareholder’s equity		$24,811

¹Raw materials – wax ($30); raw materials – wicks ($23); finished goods ($95, representing 30 candles).

^2The office equipment was amortized using the straight-line method over 10 years with no salvage value

³Relates to utilities used but not paid as at year-end.

⁴MO paid corporate income tax at a rate of 20 per send.

Answer 1

Journal Entries
PRODUCTION PROCESS AND FIXED ASSETS
Burner		Dr	4500
Cash		Cr		4500
Repair & Maintenance		Dr	900
Cash		Cr		900
Cash		Dr	100
Loss on sale of pots		Dr	1314
Pots		Cr		1414
Total costs	2200
W/off till now	786
(2200-200)/700*275
WDV	1414
Pots		Dr	2900
Cash		Cr		2900
Depreciation		Dr	166
Pots		Cr		166
Total costs	2900
Dep. For the period	166
(2900)/700*40
WDV	2734
Depreciation		Dr	738
Moulds		Cr		738
WDV as on 01.01.2004 (Assuming including transportation in WDV)	2295
Less: Salvage value	450
Depreciable Value	1845
Useful life	5
rate of depreciation under double declining method	100/5*2
	40
Depreciation	1845*40%
	738
Printer		Dr	1000
4% Notes Payable		Cr		1000
Interest		Dr	10
4% Notes Payable		Dr	1000
Cash		Cr		1010
Value of Notes payable	1000
Rate of interest	4%
Interest	1000*4%*90/365
	10
Depreciation		Dr	1000*10%
Printer		Cr		100
MANUFACTURING FACILITY
Rent		Dr	450
Prepaid Rent		Dr	450
Cash		Cr		900
Manufacturing Utilities Expense		Dr	1100*450/500=990
Office Utilities Expense			1100*450/500=110
Prepaid Utility Expense		Dr	50
Bank		Cr		1150
Insurance		Dr	800*110%
Cash		Cr		880
WAGES AND SALARIES
Wages		Dr	250*7.15*2
Cash		Cr		3575
Salaries		Dr	1000
Wages		Dr	1000
Cash		Cr		2000
OTHER DISBURSMENTS
Income tax payable4		Dr	684
Telephone Expenses		Dr	260
Promotional Expenses		Dr	500
Outward Freight		Dr	65
Petty Cash Fund		Dr	110
Cash		Cr		1619
Bank Loan		Dr	260
Interest		Dr	4800*5/100=240
Cash		Cr		500
SALES
Cash		Dr	49000
Sales		Cr		49000
INVENTORIES
Inventory		Dr	170
Vendor		Cr		170
Cost of goods sold		Dr	170-25=145
Inventory		Cr		145
Work in progress		Dr	160
Direct Material		Cr		40
Wages		Cr		120