Question

On January 1, 2020, Creative Accounting (CA) Company capitalized $500,000 of costs it incurred to internally develop a patent. CA Company paid these costs in cash. It reported an amortization expense in the 2020 fiscal year for the patent. CA Company estimated the amortization expense for 2020 for the patent to be one tenth of the original cost. What is the effect of these journal entries on 2020 financial statements? Specifically, calculate the numerical impact on Net Income, Assets, Liabilities and shareholders’ equity

Answer 1

Solution :

Journal Entry as on January 1, 2020:

Patent Account Dr $500,000

To Cash Account $500,000

Patent amortized over 10 years based on its original Cost. There for amortisation expense as on 31st December 2020 will be :

$500,000/10 = $50,000

Journal Entry as on 31st December, 2020:

Amortisation Expense Dr $50,000

To Accumulated amortization $50,000

Profit & Loss Account Dr $50,000

To Amortization Expense $50,000

Note:

1. On recognition of patent, that is as on 01.01.2020 there will be no impact on Value of Asset, Since Patent Asset increasing by value of $500,000 and Cash Asset decreasing by Value of $500,000.

2. As on 31.12.2020 due to amortisation, Net Income will decrease by $50,000.

3.Since due to amortization there is a decrease in Net Income, Value of Shareholder's Equity will also decrease by the same amount.That is $50,000.

That is annual amortization expense reduce Net Income on the Income Statement and which also reduces Shareholder's Equity in Balance Sheet.