Bam Year 2 - HydroQual
We see you have another new lease this year for additional shop equipment. You booked this lease as a long-term liability, so we need the same information for this lease as we asked for on the lease for the building. We need the lease term, the interest rate, the fair value of the assets leased, and the useful life of the assets.
Issue(s): The issue is Hydroqual booked the leases as a long-term liability, but they are not disclosing all of the needed information to determine the correct accounting treatments, therefore they need to give us more information on the matter. The company has also not told us if it is a capital or operating lease. Hydroqual stated Yes, Kay negotiated that lease. We are paying an annual lease payment of $3,765 for three years. If we had purchased that equipment it would have cost us well over $20,000 and we certainly wouldve been able to use it for seven years or more. However, we did not want to purchase items that we may not need over the long term depending on the direction. The business goes over the next few years they did not give me an interest rate, but I do know that the total principal amount due on the lease over the three years is $10,750. We will return the assets to the lessor at the end of the lease.
Analysis: Apply the facts of the case study to the rule and provide an in-depth analysis based on the issue. Your analysis should also include supporting schedules, calculations, and correcting journal entries.
Conclusion: State your conclusion(s) based on the results of your analysis and indicate any changes to the financial statements and disclosure notes resulting from the rule. What is the Analysis and conclusion?
HYDROQUAL, INC. STATEMENT OF INCOME FOR THE YEAR ENDING DECEMBER 31, 20X2 \begin{tabular}{|c|c|c|c|c|c|c|} \hline \multicolumn{7}{|c|}{ HYDROQUAL, INC. } \\ \hline \multicolumn{7}{|c|}{ JOURNAL ENTRIES } \\ \hline \multicolumn{7}{|c|}{ DECEMBER 31, 202} \\ \hline J/E# & DATE & ACCT \# & ACCOUNT NAME & & DEBIT & CREDIT \\ \hline 1 & 1/1/2 & 563 & \multicolumn{2}{|c|}{ SERVICE COSTS-INDIRECT-LEASE EXPENSE-SHOP BLDG } & 31,667 & \\ \hline & & 602 & \multicolumn{2}{|l|}{ SELLNG \& ADMIN-LEASE EXPENSE-OFFICE BLDG } & 6,333 & \\ \hline & & 101 & CASH & & & 39,000 \\ \hline & & & \multicolumn{2}{|l|}{ To record and allocate new building lease payment. } & & \\ \hline \multirow[t]{4}{*}{2} & 1/1/2 & 190 & \multicolumn{2}{|l|}{ RIGHT-OF-USE ASSET-LEASE-SHOP EQUIPMENT } & 10,750 & \\ \hline & & 409 & LEASE PAYABLE-SHOP EQUIPMENT & & & 6,985 \\ \hline & & 101 & CASH & & & 3,765 \\ \hline & & & To record new shop equipment lease and first p & yment. & & \\ \hline \multirow[t]{3}{*}{3} & 2/1/2 & 101 & CASH & & 240,000 & \\ \hline & & 401 & LONG-TERM DEBT-NOTES & & & 240,000 \\ \hline & & & To record issuance of long-4erm notes payable. & & & \\ \hline \multirow[t]{3}{*}{4} & 2/1/2 & 181 & VEHICLES & & 240,000 & \\ \hline & & 101 & CASH & & & 240,000 \\ \hline & & & To record purchase of two new trucks. & & & \\ \hline & & & & & & \\ \hline \multirow[t]{4}{*}{5} & & 101 & CASH & & 255,000 & \\ \hline & & 105 & ACCOUNTS RECEIVABLE & & 1,090,500 & \\ \hline & & 505 & SERVICE REVENUE FROM CONTRACTS WII & H CUSTOMERS & & 1,345,500 \\ \hline & & & To record revenue from maintenance contracts. & & & \\ \hline & & & & & & \\ \hline \multirow[t]{5}{*}{6} & & 181 & VEHICLES & & 7,040 & \\ \hline & & 561 & SERVICE COSTS-INDIRECT-SHOP WAGES & & 150,600 & \\ \hline & & 101 & CASH & & & 154,230 \\ \hline & & 305 & WAGES PAYABLE & & & 3,410 \\ \hline & & & To record accrual and payment of shop wages, & cluding wages ca & to trucks. & \\ \hline \multirow{6}{*}{7} & & & & & & \\ \hline & & 660 & SERVICE COSTS-DIRECT-CREW WAGES & & 351,195 & \\ \hline & & 305 & WAGES PAYABLE & & 15,969 & \\ \hline & & 101 & CASH & & & 359,714 \\ \hline & & 305 & WAGES PAYABLE & & & 7,450 \\ \hline & & & To record accrual and payment of crew woges. & & & \\ \hline \multirow{4}{*}{8} & & & & & & \\ \hline & & 653 & SERVICE COSTS-DIRECT-FUEL & & 40,341 & \\ \hline & & 101 & CASH & & & 40,341 \\ \hline & & & To record purchase and payment of truck fuel. & & & \\ \hline & & & & & & \\ \hline \multirow[t]{3}{*}{9} & & 101 & CASH & & 1,019,600 & \\ \hline & & 105 & ACCOUNTS RECEIVABLE & & & 1,019,500 \\ \hline & & & To record receipts on sccount. & & & \\ \hline \multirow[t]{3}{*}{10} & & 302 & ACCTS PAY-SUPPLERS-OTHER COSTS & & 54,140 & \\ \hline & & 101 & CASH & & & 54,140 \\ \hline & & & To record payment on account. & & & \\ \hline \multirow[t]{3}{*}{11} & & 552 & \multicolumn{2}{|c|}{ SERVICE COSTS-DIRECT-LEASE EXPENSE-TRUCKS } & 22,780 & \\ \hline & & 101 & CASH & & & 22,700 \\ \hline & & & To record rent payment for maintenance trucks. & & & \\ \hline \multirow[t]{3}{*}{12} & & 181 & VEHICLES & & 1,553 & \\ \hline & & 663 & SERVICE COSTS-INDIRECT-LEASE EXPENS & ESHOP BLDG & & 1,563 \\ \hline & & & To capitalize part of shop rent to trucks. & & & \\ \hline & & & & & & \\ \hline \end{tabular} HYDROQUAL, INC. Dealer 2 Option (GAAP vs Non-GAAP) Interest and Depreciation Comparison based on Interest Rate Used Timing of expenses under Schedule 1 (GAAP) \begin{tabular}{lrrr} Year & Depreciation & \multicolumn{1}{c}{ Interest } & \multicolumn{1}{c}{ Total } \\ \hline 202 & $40,431 & $10,007 & $50,437 \\ 203 & 40,431 & 7,726 & 48,157 \\ 204 & 40,431 & 4,103 & 44,534 \\ 205 & 40,431 & 317 & 40,747 \\ 206 & 40,431 & - & 40,431 \\ 207 & 40,431 & - & 40,431 \\ \cline { 2 - 4 } Totals & $242,584 & $22,153 & $264,737 \\ \cline { 2 - 4 } & & & \end{tabular} Qnhadula 2 INan_RAAD Intaraet Datal. Timing of expenses under Schedule 2 (Non-GAAP) Note that the loan payments are on February 1, resulting in 11/12 of the Period 1 interest being expensed in 20X2. Subsequently, a portion of the interest from Periods 1 and 2 must be combined to calculate the correct interest expense for 20X3. Also note that HydroQual uses the full-year convention when calculating depreciation expense, resulting in a full year of depreciation expense in 202, despite the February 2 loan date. HYDROQUAL, INC. BALANCE SHEET DECEMBER 31, 20X2 ASSETS CURRENT ASSETS Cash Accounts receivable Supplies an hand Prepaid insurance Total Current Assets LONG-TERM ASSETS Equipment Accumulated depreciation-equipment Vehicles Accumulated depreciation-vehicles Leased Shop Equipment NOL tax benefit NOL valuation allowance License Total Long-Term Assets TOTAL ASSETS LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES CURRENT LIABILITIES Accounts payable Wages payable Taxes payable Total Current Liabilities LONG TERM LIABILITIES Long-term lease payable Note payable Total Long Term Liabilities Total Liabilities STOCKHOLDERS' EQUITY Common stock Retained earnings Total Stockholders' Equity TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY \begin{tabular}{r} \multicolumn{1}{l}{202} \\ \hline$314,910 \\ 153,500 \\ 6,860 \\ 2,654 \\ \hline 477,924 \\ \hline \end{tabular} \begin{tabular}{cc} & 44,500 \\ & (12,714) \\ & 266,650 \\ & (40,000) \\ & 10,750 \\ & 3,594 \\ & (1,258) \\ & 39,000 \\ \hline & 310,522 \\ \hline & \\ $ & 788,447 \\ \hline \end{tabular} \begin{tabular}{r} $14,303 \\ 10,860 \\ 77,927 \\ \hline 103,089 \\ \hline \end{tabular} \begin{tabular}{r} 6,985 \\ 240,000 \\ \hline 246,985 \\ \hline \end{tabular} 350,074 \begin{tabular}{r} 160,000 \\ 278,372 \\ \hline 438,372 \\ \hline \end{tabular} $788,447 HYDROQUAL, INC. HYDROQUAL, INC. Preliminary Financials 20X2 In early December 20X2, Rick Bailey called Tom Fasbee to tell him that, in addition to meeting several other criteria, HydroQual's loan covenants required annual financial statements be submitted to the bank. Regina Sontag at Midwest American Bank had reminded Rick that the statements must be reviewed by a CPA and that the review and related report should be comparable to what Dunes \& Driftwood had done last year. In addition, the bank requested comparative financial statements, including notes that provide the fair value of all financial instruments and information on major customers. Rick wanted to know if Dunes \& Driftwood would do the work again. Tom said his firm would be delighted to do it. Rick then requested that Tom send out the same person. He indicated that HydroQual's people knew you and had confidence in your ability. Tom indicated that Rick's staffing request would be "no problem." You, of course, were happy to be called on again. You made arrangements with Jerry Loos to obtain financial statements as early as possible in 20X3. You received HydroQual's 20X2 financial statements on Wednesday, January 13. A preliminary review revealed the large crew truck investment made earlier in the year. You decided that a quick stop at Martha Mason's office would be appropriate. Martha represented Dunes \& Driftwood on HydroQual's tax work. You asked Martha how the crew trucks would be depreciated for tax purposes. She indicated that they would be depreciated using the 5-year half year convention Modified Accelerated Cost Recovery System (MACRS) schedule. She also reminded you that the shop equipment purchased last year is being depreciated using the 7-year half year convention MACRS schedule. She also noted that she understood that all items classified as property, plant, and equipment are depreciated to the nearest full year for book purposes. Martha had a number of questions for you on another client, so you completed your conversation over lunch. Before leaving, she reminded you that the MACRS depreciation schedules can be found on the IRS.gov website. You planned to spend the afternoon reviewing HydroQual's preliminary financial statements in detail and get questions to Jerry by Thursday. Jerry then would prepare responses so that you could begin the review on the following Monday. REQUIRED: The journal entries and financial statements prepared by Jerry Loos are attached. The crew truck cost schedule you recommended Jerry prepare is also included. You will find that it is not at all clear how Jerry calculated the numbers on the schedule. Review the client's data and prepare a list of additional information items needed from Jerry. Be sure to include any necessary questions to get the information needed to reconcile each truck schedule number, and to add any needed items. Be as specific as possible and phrase your requests in the form of questions as they normally would be asked of a client. Be sure to provide a written reason that you are asking each question and also provide a reference to the FASB codification where appropriate. Jerry assured you that the bank account has been reconciled and that outstanding checks account for the only reconciling items. He also indicated that all vendor invoices reflecting business through December 31, 20X2 have been booked
