CPA AustraliaACCOUNTING 5.2

Provide the journal entries for each of the above issues:

1) Sterling's insurance company sent a bill for additional insurance premiums of $350. This bill covers from the December 15 delivery date until the annual policy expires on March 31, 20X7. This bill was paid and the amount expensed. The cost of the policy used should be added to the cost of the asset under construction.

2. Many of the manufacturers whose products Sterling carries provide a warranty. Sterling also provides an additional warranty on several lines/items. Based on experience over the years, the warranty costs average 0.25% of total sales. The provision is accrued quarterly but has not been recorded yet for the fourth quarter of 20X6; fourth-quarter sales were $3,280,000.

3. The accounting staff determined that expenses for the fourth quarter included $6,905 of costs directly attributable to warranty work, bringing the total warranty costs paid by Sterling during 20X6 to $27,311. These costs for the fourth quarter have been charged to the wages, salaries, and benefits account. Warranty costs for the first three quarters are properly recorded.

 

4. In January 20X6, Sterling purchased land for storage of industrial waste and surplus manufacturing plant supplies, paying $1,500,000. The terms of the permit require Sterling to restore the property for any decontamination from oils, solvents, or other contaminants. Sterling hired an appraiser to provide an estimate of the decommissioning costs; the appraisal report projects decommissioning costs to be $850,000. The discount rate for the obligation is 4%. Sterling expects to use the land for 25 years. Management believes that use of the land for waste and surplus storage will not affect the value of the land once the storage site has been decommissioned and restored as required. The appraisal report supports this view. Sterling began using the land for its intended purpose in January 20X6. In reviewing the trial balance, you notice that the land purchase was recorded, but that the related decommissioning obligation has not been recorded.

5. A competitor, ABC Ltd., is suing Sterling for misuse/unauthorized use of ABC's customer list. Sterling hired a former ABC employee, who ABC alleges took its customer list to Sterling. Sterling's legal advisors have estimated that there is a 65% probability that ABC will be successful in its lawsuit. The legal firm believes that if it is successful, there is a 20% probability that ABC will be awarded $500,000, a 55% probability of a $300,000 award, and a 25% chance of a $250,000 award. 

Answer to question no 1. : Sterling's insurance company sent a bill for additional insurance premiums of $350. This bill covers from the December 15 delivery date until the annual policy expires on March 31, 20X7. This bill was paid and the amount expensed. The cost of the policy used should be added to the cost of the asset under construction.

The company has paid insurance expenses but the same was for an asset under construction and hence should be capitalised with the asset under construction. The Journal entry will be :

Asset under construction...............dr $350

to Insurance Expense a/c $ 350

(being insurance expense wrongly charged to revenue capitalised with asset under construction)

Answer to question no 2 : Many of the manufacturers whose products Sterling carries provide a warranty. Sterling also provides an additional warranty on several lines/items. Based on experience over the years, the warranty costs average 0.25% of total sales. The provision is accrued quarterly but has not been recorded yet for the fourth quarter of 20X6; fourth-quarter sales were $3,280,000.

Sales for 4th quarter = $ 3280000

Warranty provision = .25%

Warranty expense = .25% * 3280000 = $ 8200

The journal entry will be :

Warranty expense ..........dr $ 8200

to Provision for warranty $ 8200.

(being provision for warranty created).

Answer to question no 3 : The accounting staff determined that expenses for the fourth quarter included $6,905 of costs directly attributable to warranty work, bringing the total warranty costs paid by Sterling during 20X6 to $27,311. These costs for the fourth quarter have been charged to the wages, salaries, and benefits account. Warranty costs for the first three quarters are properly recorded.

The journal entry will be :

Provision for Warranty a/c..............dr $ 6905

to wages, salaries, and benefits account $ 6905

(being wages, salaries, and benefits account wrongly charged for warranty expense, now rectified).

Answer to question no 4 : In January 20X6, Sterling purchased land for storage of industrial waste and surplus manufacturing plant supplies, paying $1,500,000. The terms of the permit require Sterling to restore the property for any decontamination from oils, solvents, or other contaminants. Sterling hired an appraiser to provide an estimate of the decommissioning costs; the appraisal report projects decommissioning costs to be $850,000. The discount rate for the obligation is 4%. Sterling expects to use the land for 25 years. Management believes that use of the land for waste and surplus storage will not affect the value of the land once the storage site has been decommissioned and restored as required. The appraisal report supports this view. Sterling began using the land for its intended purpose in January 20X6. In reviewing the trial balance, you notice that the land purchase was recorded, but that the related decommissioning obligation has not been recorded.

Project Decommissioning Cost = $ 850000.

Discount rate = 4%

Period = 25 years

Hence, Present value of decommissioning liability = 850000 / (1.04)^25 = $ 318850 (approx)

As per Accounting Standards, present value of decommission liability must be capitalised with asset cost. the journal entry will be :

Land a/c.................dr $ 318850

to Provision for Decommissioning Liability $ 318850

( being provision for decommissioning liability made)

Answer to question no 5 : A competitor, ABC Ltd., is suing Sterling for misuse/unauthorized use of ABC's customer list. Sterling hired a former ABC employee, who ABC alleges took its customer list to Sterling. Sterling's legal advisors have estimated that there is a 65% probability that ABC will be successful in its lawsuit. The legal firm believes that if it is successful, there is a 20% probability that ABC will be awarded $500,000, a 55% probability of a $300,000 award, and a 25% chance of a $250,000 award. 

As per the Accounting standards, a provision must me made for a law suit if it is probable that there will be a loss. Probable implies more often than not and mathematically is given by more than 50% chance of loss. In the given case, there is 65% probability of loss and hence, provision must men made. The expected loss = (20% * 500000 + 55% * 300000 + 25% * 250000) = $ 327500.

The journal entry will be :

Legal Expenses / Lawsuit expenses .....................dr $ 327500

to Provision for Lawsuit Liability $ 327500

(being provision for lawsuit liability booked)