Chapter 12, Problem 3P

To determine

Prepare an adjusting journal entry and correcting journal entry of Company C for the year ended December 31, 2016.

Explanation of Solution

Patent: Patent is a right that is exclusively granted by the Government to an individual or firm to process or design, to make, use or sell its invention for a limited period. It protects the right of the inventor from doing so by any other individual till the granted period expires.

Prepare an adjusting journal entry and correcting journal entry of Company C for the year ended December 31, 2016 as follows:

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2016	Retained earnings		50,000
	Patents			50,000
	(To record the removal of research and development cost included )

Table (1)

Description:

• Retained earnings are the component of stockholder’s equity and it decreases the value of equity. Therefore, retained earnings account is debited with $50,000.
• Patents are an asset account and it is decreased. Therefore, credit patents account with $50,000.

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2016	Patents		8,000
	Retained earnings			8,000
	(To record the cost of successful defense of patent)

Table (2)

Description:

• A Patent is an asset account and it is increased. Therefore, debit patents account with $8,000.
• Retained earnings are the component of stockholder’s equity and it increases the value of equity. Therefore, retained earnings account is credited with $8,000.

Prepare correcting journal entry for patents:

In this case, the amortization for 2016 is wrongly recorded as $2,850 instead of $750. Hence, the difference amount of $2,100$\left(\$8,000-\$7,200\right)$ (refer working note 1 and 2) is debited to the retained earnings account in order to rectify the error.

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2016	Patents		2,100
	Retained earnings			2,100
	(To record the correct amount of amortization of patent)

Table (3)

Description:

• A Patent is an asset account and it is increased. Therefore, debit patents account with $2,100.
• Retained earnings are the component of stockholder’s equity and it increases the value of equity. Therefore, retained earnings account is credited with $2,100.

Working note (1):

Compute the recorded amount of amortization of patent for 2016:

$\begin{array}{c}\text{Amortization recorded for 2015}=\frac{\text{Capitalized cost of patent}}{\text{Estimated life}}\\ =\frac{\text{\$57,000}}{\text{20 years}}\\ =\text{\$2,850}\end{array}$

Working note (2):

Compute the correct amount of amortization of patent for 2016:

$\begin{array}{c}\text{Correct amortization for 2015}=\frac{\left[\begin{array}{l}\text{Cost of successful defense of patent}\\ +\left(\text{Total cost of patent}-\text{R\&D cost}\right)\end{array}\right]}{\text{Estimated life}}\\ =\frac{\text{\$8,000}+\left(\$57,000-\$50,000\right)}{\text{20 years}}\\ =\text{\$750}\end{array}$

Record the amortization expense for 2016.

In this case, the amortization for 2016 is wrongly recorded as $4,429 instead of $6,322. Hence, the difference amount of $1,893$\left(\$6,322-\$4,429\right)$ is debited to the retained earnings account in order to rectify the error.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
2016	Amortization expense (7)		1,893
	Patents			1,893
	(To record the correct amount of  amortization expense of patent)

Table (4)

• Amortization expense is an expense and decreases the stockholders’ equity. Therefore, debit amortization expense by $1,893.
• Patents are assets and decreases due to amortization expense. Therefore, the Patents account decrease by $1,893.

Working note (3):

Compute the amortization expenses of new patent:

$\begin{array}{c}\text{Amortization expense for 2016 =}\frac{\text{Patent value}}{\text{Number of years }}\\ \text{=}\frac{\text{\$30,000}}{\text{19}}\\ \text{=\$1,579}\end{array}$

Working note (4):

Determine the total amortization expense recorded:

$\begin{array}{c}\begin{array}{l}\text{Total Amortization}\\ \text{expense for 2016}\end{array}\}=\left[\begin{array}{l}\text{Amortization expense for 2016+}\\ \text{Amortization expense of new patent}\end{array}\right]\\ =\$2,850+\text{\$1,579}\\ =\text{\$4,429}\end{array}$

Working note (5):

Compute the amortization expenses of original patent during 2016:

$\begin{array}{c}\begin{array}{l}\text{Amortization expenses}\\ \text{of original patent}\end{array}\}=\frac{\left[\left(\begin{array}{l}\text{Total cost of patent}\\ -\text{R\&D cost}\end{array}\right)-\left(\begin{array}{l}\text{Correct amount of}\\ \text{amortization of patent}\end{array}\right)\right]}{\text{Estimated life}}\\ =\frac{\left(\$57,000-\$50,000\right)-\text{\$750 (2)}}{\text{7 years}}\\ =\text{\$2,036}\end{array}$

Working note (6):

Compute the amortization expenses of new patent:

$\begin{array}{c}\begin{array}{l}\text{Amortization expenses}\\ \text{of new patent}\end{array}\}=\frac{\text{Original cost of new patent}}{\text{Estimated life}}\\ =\frac{\text{\$30,000}}{\text{7 years}}\\ =\text{\$4,286}\end{array}$

Working note (7):

Compute the total correct amount of amortization of patent for 2016:

Particulars	Amount in $
Original patent (2016) (5)	2,036
Add: New patent purchased during the year 2016 (6)	4,286
correct amortization	6,322
Less: Total amortization expense recorded	4,429
Difference amount	1,893

Table (5)