Intermediate 1 FSR Project Part #8: Changing Depreciation Method Goal: To practice changing depreciation method. (See Topic Guides A 28, 29, 42, 43). Information: Dover purchased a new storage facility on December 1, 2020. The new building cost $1,910,000. A new member of the accounting team recorded depreciation on the new facility using the straight line method. The manager was impressed with his hard work, since he appropriately used partial year depreciation and used the method correctly. However, she had to remind him Dover uses the sum-of- the-years (SYD) method for buildings. Unfortunately, the mistake in method wasn't corrected before the financial statements were created. At the time of the purchase, the operations manager estimated that the new facility would be used for 10 years and would have a $80,200 salvage value. Dover's management would like to know the effect of your adjustment on the following ratios: Asset Turnover (Net Sales / average total assets) . Current Ratio ROA Assignment: Calculations 1. Make the appropriate journal entries, if any, to account for the change in depreciation method (including any necessary changes to income tax expense) on the new facility ONLY (the rest of the depreciation was appropriately recorded). 2. Make any necessary changes to the financial statements. Critical Thinking 3. Calculate each of the required ratios using the original values (before any changes) and the updated values (after your changes). 4. In practice, most companies use the straight-line depreciation method, typically without any salvage value. How do you think companies justify this decision to their owners and creditors? Do you agree with using only this one method? Defend your answer. 5. After looking over the numbers, you believe that would be better off following the more conservative option of reporting a full year of depreciation. Provide two (2) arguments that you could use to convince the management team that your plan is the most appropriate. Adjusting Journal Entries Correcting Entries Sales Price $1,285,000 Machine 1 Machine 2 Conveyor Belt Storage Facility Mkt Values Percentage Basket Price $486,000 27.0% $346,950 $468,000 26.0% $334,100 $126,000 7.0% $89,950 $720,000 40.0% $514,000 $1,800,000 100.0% $1,285,000 Equipment $771,000 Building $514,000 Cash $1,285,000 To record the purchase of the new set of equipment Loss on Sale Cash Accumulated Depreciation Equipment $3,484 $34,841 $326,675 $365,000 Sale of old machines to make room for new set. Income Tax Payable $1,045 Income Tax Expense $1,045 To record change in taxes due to exchange 30% * $3,484 = $1,045 Dover Co. Multi-Step Income Statement For Year Ended December 31, 2020 Sales Revenue Sales Revenue $53,400,000 Less: Sales Discounts $640,800 Sales Returns $2,536,500 $3,177,300 Net Sales Revenue $50,222,700 Cost of Goods Sold Cost of Goods Sold Gross Profit $29,625,157 $20,597,543 $1,001,250 $190,848 $165,540 $910,083 $2,670,000 $437,213 $5,374,934 Operating Activities Selling Expenses Advertising Expense Bad Debt Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations $2,439,517 $3,204,000 $460,575 $26,366 $206,925 $33,375 $400,500 $6,771,258 $12,146,192 $8,451,351 Other Gains and Losses Rent Revenue Interest Expense Loss on Sale Income from Continuing Operations before Taxes Income Tax Expense Net Income $166,875 ($1,327,345) ($3,484) ($1,163,954) $7,287,397 ($2,235,881) $5,051,516 EPS $ 0.83 3 Dover Co. Balance Sheet As of 12/31/2020 2020 2019 $892,341 $2,670,000 $4,638,000 $4,539,000 ($584,388) ($1,335,000) $5,958,000 $7.476,000 $580,500 $801,000 $667,500 $534,000 $12,151,953 $14,685,000 Current Assets Cash AR Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents Total Assets $2,136.000 $1,602,000 $3,738,000 $2,136,000 $1,602,000 $3,738,000 $5,874,000 $3,738,000 $4,786,000 $4,272,000 $15,358,000 $6,942,000 ($8,217,325) ($5,340,000 $17,800,675 $9,612,000 $801,000 $801,000 $34,491,628 $28,836,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $444,758 $3,204,000 Income Tax Payable $377,534 $534,000 Unearned Revenue $2,321,920 $801,000 Wages Payable $919,900 $667,500 Current Portion of Loan Payable $267,000 $267,000 Total Current Liabilities $4,331,112 $5,473,500 Long-term Debt Loan Payable $1,335,000 $1,602,000 Notes Payable $7,476,000 $4,272,000 Total Long-term Debt $8,811,000 $5,874,000 Total Liabilities $13,142,112 $11,347,500 Stockholders' Equity Common Stock $6,100,000 $6,100,000 ($1 par, $12,200,0 horized, $6, outstanding Additional Paid-In Capital $1,602,000 $1,602,000 Retained Earnings $13,647,516 $9,786,500 Total Stockholders' Equity $21,349,516 $17,488,500 Total Liabilities and Stockholder's Equity $34,491,628 $28,836,000 Dover Co. For Year Ended December 31, 2020 Cash Flow from Operations Net Income $5,051,516 Adjustments: Change in A/R ($849,612) Change in Inventory $1,518,000 Change in Prepaid Insurance $220,500 Change in Prepaid Utilities ($133,500) Depreciation $3,204,000 Change in AP ($2,759,242) Change in Income Tax Payable ($156,466) Change in Unearned Revenue $1,520,920 Change in Wages Payable $252,400 Loss on Sale $3,484 $2,820,484 Net Cash Flow from Operations $7,872,000 Cash Flow from Investments Sale of Equipment Purchase of Land Purchase of Building Purchase of Equipment Net Cash Flow from Investments $34,841 ($2,136,000) ($514,000) ($8,781,000) ($11,396,159) Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($267,000) $3,204,000 ($1,190,500) $1,746,500 Net Increase (Decrease) in Cash Cash, January 1, 2020 Cash, December 31, 2020 ($1,777,659) $2,670,000 $892,341 Intermediate 1 FSR Project Part #8: Changing Depreciation Method Goal: To practice changing depreciation method. (See Topic Guides A 28, 29, 42, 43). Information: Dover purchased a new storage facility on December 1, 2020. The new building cost $1,910,000. A new member of the accounting team recorded depreciation on the new facility using the straight line method. The manager was impressed with his hard work, since he appropriately used partial year depreciation and used the method correctly. However, she had to remind him Dover uses the sum-of- the-years (SYD) method for buildings. Unfortunately, the mistake in method wasn't corrected before the financial statements were created. At the time of the purchase, the operations manager estimated that the new facility would be used for 10 years and would have a $80,200 salvage value. Dover's management would like to know the effect of your adjustment on the following ratios: Asset Turnover (Net Sales / average total assets) . Current Ratio ROA Assignment: Calculations 1. Make the appropriate journal entries, if any, to account for the change in depreciation method (including any necessary changes to income tax expense) on the new facility ONLY (the rest of the depreciation was appropriately recorded). 2. Make any necessary changes to the financial statements. Critical Thinking 3. Calculate each of the required ratios using the original values (before any changes) and the updated values (after your changes). 4. In practice, most companies use the straight-line depreciation method, typically without any salvage value. How do you think companies justify this decision to their owners and creditors? Do you agree with using only this one method? Defend your answer. 5. After looking over the numbers, you believe that would be better off following the more conservative option of reporting a full year of depreciation. Provide two (2) arguments that you could use to convince the management team that your plan is the most appropriate. Adjusting Journal Entries Correcting Entries Sales Price $1,285,000 Machine 1 Machine 2 Conveyor Belt Storage Facility Mkt Values Percentage Basket Price $486,000 27.0% $346,950 $468,000 26.0% $334,100 $126,000 7.0% $89,950 $720,000 40.0% $514,000 $1,800,000 100.0% $1,285,000 Equipment $771,000 Building $514,000 Cash $1,285,000 To record the purchase of the new set of equipment Loss on Sale Cash Accumulated Depreciation Equipment $3,484 $34,841 $326,675 $365,000 Sale of old machines to make room for new set. Income Tax Payable $1,045 Income Tax Expense $1,045 To record change in taxes due to exchange 30% * $3,484 = $1,045 Dover Co. Multi-Step Income Statement For Year Ended December 31, 2020 Sales Revenue Sales Revenue $53,400,000 Less: Sales Discounts $640,800 Sales Returns $2,536,500 $3,177,300 Net Sales Revenue $50,222,700 Cost of Goods Sold Cost of Goods Sold Gross Profit $29,625,157 $20,597,543 $1,001,250 $190,848 $165,540 $910,083 $2,670,000 $437,213 $5,374,934 Operating Activities Selling Expenses Advertising Expense Bad Debt Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations $2,439,517 $3,204,000 $460,575 $26,366 $206,925 $33,375 $400,500 $6,771,258 $12,146,192 $8,451,351 Other Gains and Losses Rent Revenue Interest Expense Loss on Sale Income from Continuing Operations before Taxes Income Tax Expense Net Income $166,875 ($1,327,345) ($3,484) ($1,163,954) $7,287,397 ($2,235,881) $5,051,516 EPS $ 0.83 3 Dover Co. Balance Sheet As of 12/31/2020 2020 2019 $892,341 $2,670,000 $4,638,000 $4,539,000 ($584,388) ($1,335,000) $5,958,000 $7.476,000 $580,500 $801,000 $667,500 $534,000 $12,151,953 $14,685,000 Current Assets Cash AR Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents Total Assets $2,136.000 $1,602,000 $3,738,000 $2,136,000 $1,602,000 $3,738,000 $5,874,000 $3,738,000 $4,786,000 $4,272,000 $15,358,000 $6,942,000 ($8,217,325) ($5,340,000 $17,800,675 $9,612,000 $801,000 $801,000 $34,491,628 $28,836,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $444,758 $3,204,000 Income Tax Payable $377,534 $534,000 Unearned Revenue $2,321,920 $801,000 Wages Payable $919,900 $667,500 Current Portion of Loan Payable $267,000 $267,000 Total Current Liabilities $4,331,112 $5,473,500 Long-term Debt Loan Payable $1,335,000 $1,602,000 Notes Payable $7,476,000 $4,272,000 Total Long-term Debt $8,811,000 $5,874,000 Total Liabilities $13,142,112 $11,347,500 Stockholders' Equity Common Stock $6,100,000 $6,100,000 ($1 par, $12,200,0 horized, $6, outstanding Additional Paid-In Capital $1,602,000 $1,602,000 Retained Earnings $13,647,516 $9,786,500 Total Stockholders' Equity $21,349,516 $17,488,500 Total Liabilities and Stockholder's Equity $34,491,628 $28,836,000 Dover Co. For Year Ended December 31, 2020 Cash Flow from Operations Net Income $5,051,516 Adjustments: Change in A/R ($849,612) Change in Inventory $1,518,000 Change in Prepaid Insurance $220,500 Change in Prepaid Utilities ($133,500) Depreciation $3,204,000 Change in AP ($2,759,242) Change in Income Tax Payable ($156,466) Change in Unearned Revenue $1,520,920 Change in Wages Payable $252,400 Loss on Sale $3,484 $2,820,484 Net Cash Flow from Operations $7,872,000 Cash Flow from Investments Sale of Equipment Purchase of Land Purchase of Building Purchase of Equipment Net Cash Flow from Investments $34,841 ($2,136,000) ($514,000) ($8,781,000) ($11,396,159) Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($267,000) $3,204,000 ($1,190,500) $1,746,500 Net Increase (Decrease) in Cash Cash, January 1, 2020 Cash, December 31, 2020 ($1,777,659) $2,670,000 $892,341