Question

P11.8B: Jivraj and Juma are accountants at Desktop Computers. Desktop Computers has not adopted the revaluation model for accounting for its property, plant, and equipment. The accountants disagree over the following transactions that occurred during the fiscal year ended December 31, 2021:

Identify elements, assumptions, constraints, and recognition and measurement criteria.

1. Desktop purchased equipment for $60,000 at a going-out-of-business sale. The equipment was worth $75,000. Jivraj believes that the following entry should be made:

   Equipment	75,000
   Cash		60,000
   Gain on Fair Value Adjustment of Equipment		15,000

2. Land costing $90,000 was appraised at $215,000. Jivraj suggests the following journal entry:

   Land	125,000
   Gain on Fair Value Adjustment of Land		125,000

3. Depreciation for the year was $18,000. Since the company's profit is expected to be lower this year, Jivraj suggests deferring depreciation to a year when there is a higher profit.

4. Desktop bought a custom-made piece of equipment for $54,000. This equipment has a useful life of six years. Desktop depreciates equipment using the straight-line method. “Since the equipment is custom-made, it will have no resale value,” Jivraj argues. “So, instead of depreciating it, it should be expensed immediately.” Jivraj suggests the following entry:

   Miscellaneous Expense	54,000
   Cash		54,000

5. Jivraj suggests that the company building should be reported on the balance sheet at the lower of cost and fair value. Fair value is $15,000 less than cost, although it is expected to recover its value in the future.

6. On December 20, 2021, Desktop hired a marketing consultant to design and implement a marketing plan in 2022. The plan will be designed and implemented in three stages. The contract amount is $60,000, payable in three instalments in 2022 as each stage of the plan is completed. Jivraj argues that the contract must be recorded in 2021 because there is a signed contract. Jivraj suggests the following:

   Advertising Expense	60,000
   Accounts Payable		60,000

Instructions

a. For each transaction, indicate why Juma disagrees. Support your answer with reference to the conceptual framework (definition of elements, qualitative characteristics, assumptions, constraints, and recognition and measurement criteria).

b. Prepare the correct journal entry to record each transaction.

Taking It Further  How would your response in part (a) differ if Desktop adopted the revaluation model of accounting for its property, plant, and equipment?

 

Answer 1

Answer 1:

Jivraj is wrong in his assumption, because the cost prinple of accounting states that costs are recorded in the books of accounts on the basis of the actual price paid for the same.

In the above case, even though the equipment was worth $75000 ( it si specified as to how the worth of the equipment was determined), but the cost to Desktop was only $60000, hence it should be recorded at $60000.

Below would be the correct Journal Entry :

Description	Dr	Cr
Equipment	60000
Cash/Accounts Payable		60000

Answer 2:

Land is only fixed asset which does not depreciate in value. However in this case the land was appraised at more than its actual cost price.

Generally accepted accounting principles require balance sheet items to be recorded at cost because the actual cost is verifiable and reliable.

However in the above case the entry proposed by Jivraj is wrong because the appraised value can be considered only if the land is sold. Here any intest by Desktop to sell the kand is not exhibited , so merely passing teh entry to increase the value is land is wrong and not permissible.

Answer 3:

Depreciation as an expense cannot be accounted as and when desired considering the profitability of the company.

This is because the term depreciation implies wear and tear, consumption, of an asset from use, passage of time or obsolescense and means such expense incurred during the year. Hence as per the matching principle of accounting, expenses must be matched and recorded with their respective revenues in the period thet were incurred.

Hence Jivraj's suggestion is not acceptable.

Answer 4:

Jivraj's suggestion is not acceptable.

The asset accquired for $54000 has a useful life of 6 years as stated. Since no salvage value is stated it is assumed to be NIL. Hence depreciation has to be recorded on a yearly basis in the books.

Yearly depreciation would be : $54000/6= $9000 assuming Straight Line method of depreciation

The Journal entry would be as follows:

Description	Dr	Cr
Depreciation Expense	9000
Accumulated Depreciation on asset		9000

$9000 will be treated as an expense in the Profit and Losss Statement and the Accumulated depreciation will be shown as a reduction in the value of the asset in teh Balabce Sheet.

Answer 5:

Jivraj is correct in this case, because the fair value is assumed to be the notional rent which the building can fetch , if rented out.

It is lower than the cost in this case.Journal entry would be:

Description	Dr	Cr
Loss on Fair Value adjustment (building)	15000
Building		15000

Answer 6:

Jivraj is wrong because the contract amount of $60000 entered in to in 2021 represents the value of servcies to be received in future (2022), hence there is no outflow of money in 2021, hence no accounting entry must be recorded.

It can be shown as NOTES to the Financial statements.