Question

Use the following data to answer questions in this part:

Balance sheet data 2009
	Company C	JVC
Cash	$1,050	$300
Accounts receivable	3,000	700
Inventory	2,500	800
Fixed assets	4,500	2,400
Investment in JVC	400
Total assets	$11,450	$4,200
Accounts payable	$2,500	$1,200
Long-term debt	3,000	2,200
Equity	5,950	800
Total liabilities and equity	$11,450	$4,200

Income statement 2009
	Company C	JVC
Sales	$15,430	$2,500
Equity in JV earnings	100
COGS	5,000	1,700
Other expenses	7,600	600
Net income	$2,930	$200

Company C uses LIFO method for inventories. The LIFO reserve was $800 for 2008 (ending inventory for 2008 under LIFO was 1,500) and $900 for 2009.

In 2010, Company C purchases a milling machine, a type of machine used for shaping metal, at a total cost of $9,000. $1,500 was estimated to represent the cost of the rotating cutter, a significant component of the machine. The company expects the machine to have a useful life of eight years and a residual value of $1,000 and that the rotating cutter will need to be replaced after three years. The company uses straight-line depreciation for all assets.

Company C purchased a 7% bond, at par, for $10,000 at the beginning of the year 2010. Interest rates have recently increased and the market value clined $1,000.

a)Given the necessary information from the financial statements and footnotes convert 2009 ending inventory and COGS to a FIFO basis. Please explain your calculations.

b)How much depreciation expense would the company report in first year of depreciation if it uses the component method of depreciation, and how much depreciation expense would the company report in the first year if it does not use the component method? Please do not write down just numbers; you are expected to explain your calculation and answer.

c)Using the information about bond purchased in 2010, determine the bond’s effect on Company C’s financial statements under each classification of securities. Please explain your answers. 74

Answer 1

ANSWER A)

INVENTORY ON FIFO BASIS = INVENTORY ON LIFO BASIS + LIFO RESERVE

INVENTORY ON FIFO BASIS OF COMPANY C FOR YEAR 2009 = $2500 + $900 =$3400

EXPLANATION - AS INVENTORY ON LIFO BASIS INVOLVES THAT INVENTORY IS AT OLD PRICES WHICH IS NOT ADJUSTED ACCORDING TO INFLATION, SO STOCK UNDER FIFO BASIS WOULD BE HIGHER AS IT WOULD INVOLVE STOCK AT LATEST PRICES. FOR THIS LIFO RESERVE IS ADDED TO LIFO STOCK WHICH WOULD INCORPORATE CHANGES OF INFLATION.

COGS UNDER FIFO BASIS = COGS UNDER LIFO BASIS - INCREASE IN LIFO RESERVE(CLOSING - OPENING)

COGS ON FIFO BASIS OF COMPANY C FOR YEAR 2009 = $5000 - $(900-800)

= $4900

EXPLANATION - AS COGS IS HIGHER UNDER LIFO METHOD AS THE GOODS SOLD WERE NEW GOODS THAT WERE ADJUSTED ACCORDING TO INFLATION AND UNDER FIFO BASIS THE COGS WOULD BE LESS.HENCE, TO MAKE THE NECESSARY CHANGES WE WOULD REQUIRE TO LESS THE INCREASE IN LIFO RESERVE SO THAT THE CHANGES FOR INFLATION WOULD BE ADJUSTED IN IT.

ANSWER B)

DEPRECIATION UNDER COMPONENT METHOD ACCORDING TO STRAIGHT LINE METHOD

= VALUE OF ASSET - SALVAGE VALUE

LIFE OF ASSET

FOR DEPRECIATION UNDER COMPONENT METHOD THE DEPRECIATION IS CALCULATED SEPERATELY FOR EACH COMPONENT WHICH IS A SIGNIFICANT PART OF ASSET HAVING DIFFERENT LIFE.IN THE GIVEN CASE, ROTATING CUTTER IS A SIGNIFICANT COMPONENT OF MACHINE USED FOR SHAPING METAL HENCE DEPRECIATION FOR ROTATING CUTTER WOULD BE CALCULTED SEPERATELY.

DEPRECIATION FOR ROTATING CUTTER = ( $1500 - $0 )/ 3 = $500 /YEAR

VALUE OF MACHINE WITHOUT ROTATING CUTTER = $9000-$1500 = $7500

DEPRECIATION FOR MACHINE WITHOUR ROTATING CUTTER = ($7500 - $1000) / 8 = $812.5 PER YEAR

TOTAL DEPRECIATION FOR 1ST YEAR = $812.5 + $500 = @1312.5

DEPRECIATION WITHOUT COMPONENT METHOD = VALUE OF WHOLE ASSET - SALVAGE VALUE

LIFE OF ASSET

= ( $9000 - $1000 )/8 = $1000 PER YEAR

UNDER THIS WE DO NOT SPLIT THE ASSETS INTO COMPONENTS AND WE DO NOT CALCULATE DEPECIATION FOR EACH COMPONENT SEPERATELY. WE CALACULATE THE DEPRECIATION ON WHOLE ASSET.

ANSWER C)

BONDS PURCHASED IN 2010 WILL BE SHOWN AS LONG TERM INVESTMENTS IN COMPANY C'S BALANCE SHEET

WHEN WE HOLD BONDS TO MATURITY MEANS WE WILL HOLD IT TILL MATURITY THEN WE SHOW BONDS AT AMMORTIZED COST AND NOT FAIR VALUE SO ANY UNREALISED GAINS OR LOSSES WILL NOT GO TO INCOME STATEMENTS.

IF THESE BONDS ARE HELD FOR SALE MEANS WE ARE NOT SURE WHETHER TO SELL OR NOT THEN WE WILL SHOW BONDS MARKED TO MARKET VALUE AND UNREALISED GAINS OR LOSSES BYPSS THE INCOME STATEMENT.

IF THE BONDS ARE HELD AS TRADING THEN THE BONDS WILL BE SHOWN AT FAIR VALUE BUT THE UNREALISED GAINS OR LOSSES WILL FLOW THROUGH NET INCOME.