(Assume all purchases are made in cash unless otherwise stated and that KLP has a December 31st fiscal year-end)
KLP Corp. specializes in servicing and repairing diesel engines and restoring cars for clients. Kris, the CEO, began financing operations on January 1, 2013, with an initial personal investment of $250,000. The corporation immediately spent $30,000 cash on an initial deposit for a garage and office to base its operations, signing a $200,000 10-year 4% mortgage for the remainder of the payment. The mortgage is a special mortgage with interest payable on January 1 of each year and the entire principal due upon maturity (both the garage and office have a useful life of 30 years). KLP also used $75,000 of cash to purchase equipment that Kris estimated can be reused in repairs and restorations for up to 5 years, as well as $10,000 of garage supplies (oil, lubricant, auto parts) that are single-use in the ordinary course of repairs and restorations. The garage supplies were purchased on credit with a supplier that extended KLP terms that allow Kris to pay at the end of the three months. KLP purchased a computer for $2,300 as well as a $200 software system that helps him keep track of client service request, invoices and bookkeeping for the business—the computer is assessed to be usable for three years and the software relevant for the companies needs for two years. Finally, KLP Corp. prepaid $36,000 for a three-year insurance contract covering the business for common protections. All of these purchases took place during the month of January with KLP Corp. officially opening for business on February, 1 2013.
During the first three months of business, February to April, KLP Corp. performed repairs amounting to $80,000 in sales and restorations for $5,000 in sales. $55,000 of these revenues were paid in cash with $30,000 paid for on credit by a local business who signed a contract to use KLP’s services on credit terms. These services used up $7,500 of garage supplies. KLP Corp. paid off the original order of garage supplies that it had purchased on credit and placed a second order for $25,000 of garage supplies that were shipped by the end of April. KLP Corp. signed a payable for these garage. On April 30, KLP Corp. spent $2,000 developing and filing the proper legal fees for a company trademark and placed a $24,000 cash prepayment for 12 months of advertising to increase sales.
During the next eight months, KLP Corp. performed $280,000 of repairs and $15,000 of restorations. Again, $245,000 of these sales were paid in cash, while $50,000 were paid in credit by local businesses with credit agreements. KLP had collected $60,000 cash on these credit sales by the end of the year. Kris had $9,500 of garage supplies remaining after performing repairs and restorations over the eight months and paid off $22,000 of its outstanding payable. At the end of year, KLP assessed its bad debt expense at $4,500. KLP uses straight-line depreciation on all its fixed assets. No impairment was deemed necessary on its trademark. KLP Corp. faces a 40% marginal tax rate.
On January 1, 2014, William, a financial broker, became Kris’ partner, investing $250,000 in the business. KLP expanded its garage by purchasing a neighboring garage bay for $50,000 cash and hiring employees to accommodate its expanding clientele. KLP also ordered $50,000 worth of garage supplies on credit with payment due at June 1, 2014. KLP did not renew its advertising contract, believing that it had established a name. KLP paid all taxes that were due from the prior fiscal year.
By June 1, KLP’s sales had exceeded expectations with its repairs, registering $300,000 in repairs and $17,500 in restorations, using $45,000 of garage supplies. $250,000 of these were paid in cash and $67,500 paid on credit. KLP sold equipment originally purchased for $15,000 that had accumulated $4,000 of depreciation for $9,000 cash. KLP replaced the sold equipment with a $30,000 new machine on June 1 and made repairs to some preexisting equipment for $10,000. Also on this date, Kris and William reached a mutual decision to discontinue its flagging restorations segment of business. Again, KLP paid off its existing accounts payable and purchased another $30,000. KLP also established a new prepaid contract with a local company, agreeing to repairs its trucks over a period of one year for $150,000 paid on June 1, the contract entitles the customer to unlimited repairs over the period. Also on June 1, William invested $75,000 in debt securities and $40,000 in equity securities. William suggested KLP Corp. hold $50,000 of the debt securities as held to maturity and the remaining $25,000 debt securities as available for sale (all debt securities had a maturity of 20 years and were issued at par, indicating no premium or discount, both issues have a 3% stated rate payable January 1 of each year). The equity securities were all classified as trading securities.
William correctly suggests the following journal entry for these securities:
Trading Securities – Equity Securities 40,000
Available for Sale Securities – Debt Securities 25,000
Held-to-Maturity Securities – Debt Securities 50,000
In the final seven months of business, KLP performed $425,000 of repairs and $11,500 in restorations, all of these services were paid in cash and used up $25,000 of supplies. KLP paid off all outstanding supply contracts and collected $45,000 of its credit sales. It assessed its bad debt expense at $3,000 for the year. The additional garage space is being depreciated over 29 years (to match the useful life of the original space). The additional equipment purchased this year is expected to last only three years. KLP paid its employees $90,000 for their services and promised a $10,000 bonus on January 1, 2015. William and Kris withdrew $20,000 each at the end of the year. The available for sale securities had an unrealized net loss of $2,000 in value and the trading securities had an unrealized net gain of $4,500 in value, while its held-to-maturity securities had an unrealized net gain of $1,000.
Its discontinued restorations segment has a net book value of $30,000 and had an assessed fair market value of $23,000 on December 31 and remains unsold (the drop in the fair market value relative to the book value is due to some of KLP’s equipment). William assessed that the discontinued division had revenues of $11,500 after the decision to discontinue and attributed 10% of all operating expenses to the operating of the discontinued division after the decision to discontinue.
William provided the following entry to record the impairment of the division and the closure of the AFS loss account (since he realizes you, as their bookkeeper, have not had Intermediate II just yet!):
Impairment Loss 7,000
Accumulated Depreciation-Equipment 3,000
Accumulated Other Comprehensive Income 1,300
Deferred Tax Asset 700
Unrealized Holding Loss on Available for Sale 2,000
After some finagling by William, KLP Corp. faces an effective tax rate of 35%.
Provide journal entries, closing entries and adjusting entries for 2013 and 2014. (14 pts)
Provide an unadjusted trial balance for 2013 and 2014. (4 pts)
Describe any difference between recording KLP’s equipment and KLP’s supply accounts. Why is it important to make this distinction (address how these differences affect affect adjusting entry and financial statements)? (2 pts)
Provide a balance sheet for 12/31/13 and 12/31/14 and an income statement for the years 2013 and 2014. (16 pts)
If KLP believed its new machinery, added in 2014, would bring in 70% of its revenue generating ability in the first year and 15% in the years thereafter, would you suggest straight-line depreciation? What alternatives are available? (hint: consider the matching principle and use it to explain your response) (4 pts)
Provide a statement of cash flows for 2013 and 2014. (20 pts)