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Horngren'S Financial And Managerial Accounting
Found in: Page 543

Short Answer

Western Bank & Trust purchased land and a building for the lump sum of $3,000,000. To get the maximum tax deduction, Western allocated 90% of the purchase price to the building and only 10% to the land. A more realistic allocation would have been 70% to the building and 30% to the land.


1. Explain the tax advantage of allocating too much to the building and too little to the land.

2. Was Western’s allocation ethical? If so, state why. If not, why not? Identify who was harmed.

In the given case the allocation is unethical as the best accounting practice has not been adopted.

See the step by step solution

Step by Step Solution

Step 1: Tax advantage of allocation

Tax is levied on net income after providing for depreciation. Depreciation is levied on property, plant, and equipment but not on land. When assets are purchased at lump sum price then the cost is allocated based on some criteria.

In the given case, more allocation to the building has been done purposely to overvalue the depreciation expense. This would lower the net income and tax expenses would be lower. So, there would be a tax advantage to the company.

Step 2: Ethical issue

No, the Western allocation is not ethical. As per the applicable accounting principle, the estimation and allocation should be based on past experience and best judgment. In the given case, the over-allocation to the building violates the accounting rules.

Furthermore, it would also affect the other financial results too.

The parties who would be harmed by this practice would-be investors, creditors, and lenders.

Most popular questions for Business-studies Textbooks

Top Quality Appliance—Long Beach has just purchased a franchise from Top Quality Appliance (TQA). TQA is a manufacturer of kitchen appliances. TQA marketsits products via retail stores that are operated as franchises. As a TQA franchisee,Top Quality Appliance—Long Beach will receive many benefits, including havingthe exclusive right to sell TQA brand appliances in Long Beach. TQA applianceshave an excellent reputation and the TQA name and logo are readily recognized byconsumers. TQA also manages national television advertising campaigns that benefit the franchisees. In exchange for these benefits, Top Quality Appliance—Long Beachwill pay an annual franchise fee to TQA based on a percentage of sales. The annualfranchise fee is a separate cost and in addition to the purchase of the franchise.

In addition to purchasing the franchise, Top Quality Appliance—Long Beach will alsopurchase land with an existing building to use for its retail store, store fixtures, and officeequipment. The business will purchase appliances from TQA and resell them in its store,primarily to local building contractors for installation in new homes.Following is the chart of accounts for Top Quality Appliance—Long Beach. As a newbusiness, all beginning balances are $0.

Top Quality Appliance—Long Beach

Chart of Accounts

Cash Common Stock

Petty Cash Retained Earnings

Accounts Receivable Dividends

Allowance for Bad Debts Sales Revenue

Merchandise Inventory Interest Revenue

Office Supplies Cost of Goods Sold

Prepaid Insurance Franchise Fee Expense

Interest Receivable Salaries Expense

Notes Receivable Utilities Expense

Land Insurance Expense

Building Supplies Expense

Accumulated Depreciation—Building Bad Debt Expense

Store Fixtures Bank Expense

Accumulated Depreciation—Store Fixtures Credit Card Expense

Office Equipment Depreciation Expense—


Accumulated Depreciation—Office Equipment Depreciation Expense—Store


Franchise Depreciation Expense—Office


Accounts Payable Amortization Expense—


Interest Payable Interest Expense

Notes Payable Cash Short and Over

Top Quality Appliance—Long Beach completed the following transactions during 2018,its first year of operations:

a. Received $500,000 cash and issued common stock. Opened a new checkingaccount at Long Beach National Bank and deposited the cash received from thestockholders.

b. Paid $50,000 cash for a TQA franchise.

c. Paid $200,000 cash and issued a $400,000, 10-year, 5% notes payable for land withan existing building. The assets had the following market values: Land, $100,000;Building, $500,000.

d. Paid $75,000 for store fixtures.

e. Paid $45,000 for office equipment.

f. Paid $600 for office supplies.

g. Paid $3,600 for a two-year insurance policy.

h. Purchased appliances from TQA (merchandise inventory) on account for $425,000.

i. Established a petty cash fund for $150.

j. Sold appliances on account to B&B Contractors for $215,000, terms n/30 (cost, $86,000).

k. Sold appliances to Davis Contracting for $150,000 (cost, $65,000), receiving a6-month, 8% note.

l. Recorded credit card sales of $80,000 (cost, $35,000), net of processor fee of 2%.

m. Received payment in full from B&B Contractors.

n. Purchased appliances from TQA on account for $650,000.

o. Made payment on account to TQA, $300,000.

p. Sold appliances for cash to LB Home Builders for $350,000 (cost, $175,000).

q. Received payment in full on the maturity date from Davis Contracting for the note.

r. Sold appliances to Leard Contracting for $265,000 (cost, $130,000), receiving a9-month, 8% note.

s. Made payment on account to TQA, $500,000.

t. Sold appliances on account to various businesses for $985,000, terms n/30(cost, $395,000).

u. Collected $715,000 cash on account.

v. Paid cash for expenses: Salaries, $180,000; Utilities, $12,650

w. Replenished the petty cash fund when the fund had $62 in cash and petty cashtickets for $85 for office supplies.

x. Paid dividends, $5,000.

y. Paid the franchise fee to TQA of 5% of total sales of $2,045,000.


1. Record the transactions in the general journal. Omit explanations.

2. Post to the general ledger.

3. It is a common business practice to reconcile the bank accounts on a monthlybasis. However, in this problem, the reconciliation of the company’s checkingaccount will be done at the end of the year, based on an annual summary.

Reconcile the bank account by comparing the following annual summarystatement from Long Beach National Bank to the Cash account in the generalledger. Record journal entries as needed and post to the general ledger. Usetransaction z as the posting reference.

Beginning Balance, January 1, 2018 $ 0

Deposits and other credits:

$ 500,000





Interest Revenue 1,565 1,859,965

Checks and other debits:

EFT to Bank Checks(1) 125

Checks: 50,000










Bank service charge 2,340 (1,369,465)

Ending balance, December 31, 2018 $ 490,500

Bank Checks is a company that prints business checks (considered a bankexpense) for Top Quality Appliance—Long Beach

4. In preparation for preparing the adjusting entries, complete depreciation schedulesfor the first five years for the depreciable plant assets, assuming the assets werepurchased on January 2, 2018:

a. Building, straight-line, 30 years, $50,000 residual value.

b. Store Fixtures, straight-line, 15 years, no residual value.

c. Office Equipment, double-declining-balance, 5 years, $5,000 residual value.

5. Record adjusting entries for the year ended December 31, 2018:

a. One year of the prepaid insurance has expired.

b. Management estimates that 5% of Accounts Receivable will be uncollectible.

c. An inventory of office supplies indicates $475 of supplies have been used.

d. Calculate the interest earned on the outstanding Leard Contracting notereceivable. Assume the note was received on October 31. Round to the nearestdollar.

e. Record depreciation expense for the year.

f. Record amortization expense for the year on the franchise, which has a10-year life.

g. Calculate the interest owed on the note payable. Assume the note was issued onJanuary 1.

6. Post adjusting entries and prepare an adjusted trial balance.

7. Prepare a multi-step income statement and statement of retained earnings forthe year ended December 31, 2018. Prepare a classified balance sheet as ofDecember 31, 2018. Assume Interest Receivable is a current asset and InterestPayable is a current liability.

8. Evaluate the company’s success for the first year of operations by calculating thefollowing ratios. Round to two decimal places. Comment on the results.

a. Liquidity:

i. Current ratio

ii. Acid-test ratio

iii. Cash ratio

b. Efficiency:

i. Accounts receivable turnover

ii. Day’s sales in receivables

iii. Asset turnover

iv. Rate of return on total assets


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