1. Should The Leased Building Be Accounted As An Asset?

Managerial Accounting 07/03/2012 McCloud Winery – Questions

1. Should the leased building be accounted as an asset? No, the lease would be considered an operating lease, on which the expense would be accrued day by day as the asset (building) is used. To determine this is in fact an operating lease, the life of the lease should be less than 75% of the useful life of the asset being leased. For instance, this is a 10 year lease, which is less than the economic life of a 30 year asset. The rental payments would be expensed as incurred and offset by the asset used to make the rental payments (i.e. cash), the lessor would still hold the benefit of the ownership. Should the agreement to pay lease rentals be recorded as a liability? The agreement
Applying the principles of accrual accounting, how should Mike treat the expenditures for the land, vines planting, fertilizing and water? Be specific regarding the treatment over time, including amounts and the rationale for the treatments. All expenditures should be assigned to cost centers like fermentation, aging, etc. The costs associated with manufacturing/producing the wine should be capitalized until the vine is sold, when the selling transaction happens, the costs should be expensed (COGS). For instance, the special grapevines brought from Australia (inventoriable cost) at $50,000 ($10,000 x5 acres) should be capitalized over the time that is taking the vine to be ready for production ($50,000/5yrs= $10,000). Labor, which is a direct inventoriable cost (i.e. the extra help hired to plant the vines at $2,000 per acre x5= $10,000) should be capitalized over 5 years. Land should be capitalized over the useful life of the asset. Fertilizer and water should be expensed as they are incurred. 4. How should the potential for vine disease be reflected in the financial statements if the vines have not been diagnosed with any of the diseases? The potential vine disease would be considered a loss contingency, which involves a risk of possible loss and damaged of property, depending on the occurrence of one or more future events (vine disease). It should be only disclosed in the financial statements footnotes, not accrued. Since, there is no information available
Does this change if the vines are diagnosed with the disease? In order to accrue for a loss contingency (liability), two conditions are needed, the future event is likely to occur and the amount of the loss should be reasonably estimated. In this case, the disease has already been diagnosed (1st condition met) and the amount of the loss has been estimated at 50% of the production of the grapes (2nd condition met). Therefore, an accrual is needed. 5. How should Mike account for the oak barrels? Oak barrels should be considered capital assets and therefore capitalized. When the barrels are sold at the end of their useful life, the remaining value of the asset would be expensed. 6. How would the transactions in question 3 and the bank loan be recorded in winery's indirect statement of cash flows? The outflows paid as “interest on loan” are considered part of the operating activities. The issuance of the $180.000 loan would be an inflow of cash used to purchase land. Therefore, it is a financing activity. The repayment of the loan (principal only) is considered an outflow of cash in the financing section of the SCF. The land is an outflow of cash on the investing activities section of the SCF. The purchase of the vine is an outflow of cash on the operating activities. Vine planting is an outflow of cash and therefore recorded as