The Wong family incorporated Alberta Wholesale Limited (AWL) on January 1, 20X1

Question

The Wong family incorporated Alberta Wholesale Limited (AWL) on January 1, 20X1 when the company issued common shares to several family members for cash. After obtaining mortgage financing, the company constructed a warehouse and began a food wholesale business.
The company has a small accounting staff that recorded transactions throughout the year. The company’s CEO knows that cash is correct because she has reviewed the bank reconciliation. However, she was unable to hire a professionally trained CFO and is concerned that the draft financial statements prepared by her staff (Exhibit I), which are prepared using IFRS, may have errors including the final calculation of income tax expense based on a 30% income tax rate.
The CEO has hired you to correct any accounting errors made by her staff by:
1. Providing a memo listing any adjusting entries that the company needs to make along with comments explaining why the company recorded items incorrectly and how and why the company should have recorded the transaction along with supporting calculations relating to adjustments. You should have at least one adjusting journal entry (you may need several entries for some issues) for each of the following issues. If an issue deals with more than one transaction, try to have an adjusting entry for each transaction within the issue.

Issue 1
AWL depreciates the warehouse using the straight-line method assuming no residual value and a useful life of 25 years. The company has opted to use the revaluation method (gross not proportional) on real estate and has obtained an appraisal of these assets from an independent appraiser. The appraiser estimated the fair value of the land at $1,800,000 and the warehouse at $13,000,000 as at December 31, 20X1.

Issue 2
The company purchased equipment costing $1,800,000 during the first week of May when the warehouse opened. All equipment has no residual value and an estimated life of 8 years. On October 1, the company sold equipment costing $240,000 for $175,000 cash. AWL bought other equipment costing $200,000 on July 1, 20X1. For equipment, the company uses the straight-line method.

Explanation / Answer

Issue 1- Solution:-

Under IFRS, the company can claim depreciation either on cost model or revaluation model. However, since land has an infinite life, it is not considered as a Depreciable Asset. Since, the Company has adopted Revaluation model for Land, it is Incorrect since Land cannot be depreciated. With respect to Warehouse, it can be depreciated on straight line basis over the useful life of the Asset ie. 25years and any subsequent revaluation is to be credited to Other comprehensive Income and accumulated under the heading "Revaluation Surplus" unless it represents a reversal of revaluation decrease of same Asset.

With reference to the Question, the Warehouse is to be depreciated over the Life of the Asset ie. 25years and in subsequent year if it is revalued then the following entry is to be passed:-

Warehouse A/c Dr. $1,30,00,000

To Other Comprehensive Income Cr. 1,30,00,000

Issue 2- Solution:-

On the purchase of the Asset as per IFRS, the asset will be recorded at cost and the entry will be as follows:-

Equipment A/c dr. $ 18,00,000

To Cash/ Bank A/c cr. $ 18,00,000

On sale of Asset the following entry will be passed:-

Cash/ Bank dr. $ 1,75,000

Profit and Loss A/c dr. $ 52,500

To Equipment A/c cr. $ 2,27,500

Note- Equipment of $ 2,40,000 will be depreciated for 5 months, since it was sold after that and it is assumed that it was purchased on May 1st. The calculation goes as follows

Depreciation per year on 2,40,000 will be (2,40,000/8= 30,000 every year) and out of that deprecition for 5 months will be $30,000*5/12=$12,500 and hence depreciated value will be $2,40,000-$12,500=$2,27,500

At the end of the year the following entry of depreciation will be passed:-

Provision of Depreciation A/c dr. 2,07,500

To Equipment A/c cr. 2,07,500

Note:- Calculation of depreciation goes as follows-

From $18,00,000 depreciation on $2,40,000 has been calculated above as $12,500 and for the rest, ie. ($18,00,000-$2,40,000)=$15,60,000 will be ($15,60,000/8years=$1,95,000)

Therefore Total Depreciation will be $1,95,000 + $12,500= $2,07,500

In the Next year when another asset is purchased then the following entry will be passed in July 1, 20X1

Equipment A/c dr. $ 2,00,000

To Cash/ Bank cr. $ 2,00,000

At the end of the year the following depreciation entry will be passed:-

Provision for Depreciation A/c dr. $2,16,430  

To Equipment A/c cr. $2,16,430

Note- Calculation of above goes as follows-

For Asset costing $15,60,000, depreciation of $1,95,000 has already been calculated above and the Asset purchased for $ 2,00,000 will be depreciated over 7years and since it was purchased in July, depreciation will be for 9months, ie. ($200000/7*(9/12)=$21,430) and hence the total depreciation will be $2,16,430

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