Question

Red Design capitalized $240,000 of costs related to the company’s internal development of a patent on January 1, 2016. The costs were paid in cash. An amortization expense for the patent was reported for the 2016 fiscal year. Red Design estimated this expense at 15% of the original cost. How will these journal entries affect the 2016 financial statements? Show calculations for the monetary impact on net income, assets, liabilities, and shareholder’s equity.

Answer 1

Journal entry to record amortization will be

Amortization expense Debited. 36,000

Accumulated Amortization Credited. 36,000

(To record amortization expense)

The effect of this entry will be as follows:

1. Net Income - Decrease in net income by $36,000

As the amortization expense will be recorded, the expenses would increase resulting in decrease in net income.

2. Assets - Decrease in Assets by $36,000

As accumulated amortization has credit balance, and it is a contra asset account. So it is shown on the asset side as reduction from the gross amount of fixed asset.

3. Liabilities - No effect on liabilities

There will be no effect on liabilities. Accumulated Depreciation has a credit balance but is shown as reduction from gross amount of assets.

4. Shareholders' Equity - Decrease by $36,000

Shareholders' equity will be decreased because, as the net income will decrease so as a result, retained earnings will decrease. And as retained earnings is a part of shareholders's equity, so the shareholders' equity will also get drecreased.