Chemalite Case Assignment

Journal Entries Date Account Title 2-Jan-03 Cash Patent Common Stock 15-Jan-03 Legal Fees, etc. Cash Debit 500,000 7,500 7,500 15-Jun-03 Machinery Cash 62,500 24-Jun-03 Materials Inventory Cash 75,000 J-D (1) J-D (2) J-D (3) J-D (4) J-D (5) J-D (6) J-D (7) 62,500 75,000 Prototype Expense Cash 23,750 Cash Accounts Receivable Sales 685,000 69,500 Materials Inventory Cash 175,000 Advertising Expense Cash Mfg Labor & Overhead Salaries & Core Expenses Cash Machinery Cash Cash Loans Payable Interest Expense Loans Payable Cash 31-Dec-03 Depreciation Expense Accumulated Depreciation Credit 375,000 125,000 23,750 754,500 175,000 22,500 22,500 350,000 80,000 430,000 150,000 150,000 50,000 50,000 750 50,000 50,750 10,625 10,625 31-Dec-03 Materials Expense Materials Inventory 31-Dec-03 Patent Amortization Expense Patent 195,000 195,000 25,000 25,000 T-Accounts 2-Jan-03 15-Jan-03 15-Jun-03 24-Jun-03 J-D (1) J-D (2) J-D (3) J-D (4) J-D (5) J-D (6) J-D (7) J-D (7) Balance 15-Jan-03 Cash 375,000 7,500 62,500 75,000 23,750 685,000 175,000 22,500 430,000 150,000 50,000 50,750 $113,000 Legal fees, etc. 7,500 7,500 J-D (2) Balance Accounts Receivable 69,500 69,500 J-D (5) Balance Mfg labor and Overhead 350,000 350,000 15-Jun-03 J-D (6) Balance Machinery 62,500 150,000 212,500 Patent 2-Jan-03 31-Dec03 Balance 125,000 25,000 100,000 J-D (4) Balance Advertising Expense 22,500 22,500 J-D (5) Balance Salaries and Corp Expenses 80,000 80,000 24-Jun-03 J-D (3) 31-Dec03 Balance Materials inventory 75,000 175,000 195,000 55,000 Materials Expense (cost of goods sold) 31-Dec03 Balance 195,000 195,000 J-D (1) Balance Prototypes Expense 23,750 23,750 Loans Payable J-D (7) 50,000 J-D (7) Balance J-D (7) Balance 50,000 0 Interest Expense 750 750 Common Stock 500,000 500,000 2-Jan-03 Balance 31-Dec-03 Balance Patent Amortization Expense 25,000 25,000 Sales 754,500 754,500 J-D (2) Balance 31-Dec-03 Balance Depreciation Expense 10,625 10,625 Accumulated Depreciation 31-Dec-03 Balance Analysis 10,625 10,625 A. A decrease in cash is not necessarily a loss for the business. Especially in the early stages of fundraising, some outlays of cash in the present are vital in order to have the resources necessary to make more money in the future. For example, Chemalite’s “$7,500 in legal fees, charter costs, and printing expenses associated with the incorporation of the company” as well as “$62,500 [to build] the machinery that would be used to produce the first commercial models of Chemalite” are important expenses in establishing the corporation and preparing to create products that will produce future economic revenues and other benefits (pp. 1). B. Most of the expenses during the last half of 2003 were attributable to normal business operations that contribute to future economic benefits. For example, advertising expenses are important in gaining exposure for a new product, which often leads to more sales in the future. Money spent on machinery and material inventory are necessary expenses to produce more units of product, and thereby generate more revenues in the future. Finally, there was a small sum of money still owed by a large purchaser that was not paid in full by the end of this period, resulting in a lower cash balance. Ultimately, this $117,000 decrease in the cash balance for Chemalite is not a significant problem, as these “losses” went towards other assets and essential expenses. C. No, an increase in value of the prototypes should not be recorded in the financial statements. It is standard practice in accounting to record entries at their historical cost. This means that transactions are recorded at their original cost to the entity. Recording a change in market value would go against this principle. D. The argument to record prototypes as an asset on the balance sheet is based in the idea that the prototype would likely lead to a commercial product that will generate revenues in the future. Some would argue that a company should capitalize the cost of a prototype when it is for a commercially viable, sellable product. Furthermore, the cost of a prototype would likely fall above the company’s cash cutoff for capitalization, so it would be able to go on the balance sheet should the company decide to do so. However, others believe that prototypes should be recorded as an expense on the income statement. This would be an accurate way to record the cost as an integral part of the research and development process without assigning it any quantifiable future benefit. A crucial part of this argument is that, by the nature of a prototype, it is difficult to assess if/when this expense would lead to future economic benefits.