Problem 16 - Accounting

Question

Crane Company purchased and installed carpet in its new general offices on March 30 for a total cost of $12,000. The carpet is estimated to have a 15-year useful life and no residual value. a. Prepare the journal entries necessary for recording the purchase of the new carpet. b. Record the December 31 adjusting entry for the partial-year depreciation expense for the carpet, assuming that Crane Company uses the straight-line method.

Step-by-Step Solution

Answer

The carpet purchase is recorded by debiting "Carpet" and crediting "Cash" for $12,000. The adjusting entry on December 31 records $600 in depreciation using the straight-line method.

Step 1: Journal Entry for Carpet Purchase

To record the purchase of carpet, we need to debit the asset account and credit the cash or accounts payable account. The entry on March 30 is: - Debit "Carpet" (or "Office Furnishings") for $12,000 - Credit "Cash" for $12,000 The journal entry will look like this: | Date | Account | Debit | Credit | |-----------|------------------------|--------|--------| | Mar 30 | Carpet | 12,000 | | | | Cash | | 12,000 |

Step 2: Calculate Depreciation Period

The carpet was purchased on March 30 and the depreciation needs to be calculated from that point until December 31. To find the number of months for depreciation, count from April to December, which gives us 9 months of use in the year.

Step 3: Calculate Annual Depreciation

Use the straight-line depreciation method formula:\[\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}} = \frac{12,000 - 0}{15} = 800\]This means the carpet depreciates by $800 per year.

Step 4: Calculate Partial Year Depreciation

Since the carpet was not used the entire year, calculate the depreciation for 9 months:\[\text{Partial-Year Depreciation} = \text{Annual Depreciation} \times \frac{9}{12} = 800 \times \frac{9}{12} = 600\]So, the depreciation expense for the 9 months is $600.

Step 5: Prepare Adjusting Journal Entry for Depreciation

Now, record the adjusting entry to reflect the depreciation expense by December 31: - Debit "Depreciation Expense" for $600 - Credit "Accumulated Depreciation - Carpet" for $600 The adjusting journal entry on December 31 will be: | Date | Account | Debit | Credit | |-----------|------------------------------------|--------|--------| | Dec 31 | Depreciation Expense | 600 | | | | Accumulated Depreciation - Carpet | | 600 |

Key Concepts

Journal Entries

When a company purchases an asset, like new carpet for an office, it records that transaction using a journal entry. This journal entry method captures financial transactions systematically. It involves at least two accounts—a debit to one account and a credit to another—ensuring that the total debits equal total credits. This keeps the accounting equation balanced.
For instance, Crane Company purchased carpet on March 30 for $12,000. The journal entry would record this by:

• Debiting the 'Carpet' account for $12,000, which increases the asset value in the company's books.
• Crediting the 'Cash' account for $12,000, reflecting the outflow of cash to pay for the carpet.

Each entry captures both what the company gains (the carpet) and what it loses (the cash), offering a complete picture of each transaction.

Depreciation Calculation

Depreciating an asset means allocating its cost over its useful life. It ensures that the expense is recorded in the same period as the revenues it helps generate. For calculation, the straight-line depreciation method is simple and commonly used.
The straight-line method divides the asset's cost evenly across its useful life span, using the formula:\[\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}\]Applying this to the carpet, with a cost of \(12,000, a 15-year useful life, and no residual value:

• Annual Depreciation = \(\frac{12,000}{15} = 800\)

This means the carpet depreciates by \)800 every year. This systematic calculation provides consistent cost allocation over time.

Asset Purchase

Buying a long-term asset, like office carpet, is a critical business transaction. It involves deciding whether the expenditure is for a current or capital asset. Current assets are consumed within a short period, while capital assets, such as the carpet, provide benefits over an extended period.
The purchase involves a significant cash outlay or obligation to pay in the future. With Crane Company, the purchase on March 30 involved a one-time cash outflow of $12,000. The cost reflects in the company’s balance sheet as an increase in asset value.

Adjusting Entries

Adjusting entries are crucial for presenting a company’s financial health accurately. They account for revenues and expenses that have occurred but aren’t yet recorded by the end of an accounting period. These are essential before financial statements are prepared.
For depreciation, the adjusting entry updates the company’s records to reflect the asset's diminished value. For the carpet, this involves an entry for the partial-year depreciation from April to December (9 months) of $600:

• Debit 'Depreciation Expense' for $600, recording the cost of asset use.
• Credit 'Accumulated Depreciation - Carpet' for $600, representing the total depreciation accumulated over time.

Such entries ensure expenses and income match the period they relate to, maintaining the integrity of financial records and reports.