During the year-end audit of Shere Khan Corporation\'s financial statements for
ID: 2467190 • Letter: D
Question
During the year-end audit of Shere Khan Corporation's financial statements for 2016, you discover the following items: Shere Khan capitalized $57,000 to the Patent account at the beginning of 2015 for the cost of the patent. This amount included $50,000 in R&D; costs. The patent was amortized over a straight line 20 year life in 2015 and 2016. At the beginning of 2016, Shere Khan paid its lawyers $8,000 to successfully defend a patent infringement suit related to the patent in Item 1. Shere Khan debited tins cost to Legal Fees Expense. At the beginning of 2016. Shere Khan purchased a patent for $30,000 from Mogli Company. It recorded the cost in the Patent account and had amortized the cost over the 20 years. However, the purchased patent was protected for only 7 more years as of the beginning of 2016. Required: For each transaction, determine the unpact on total assets, liabilities and shareholders' equity for any errors noted in Shere Khan's accounting as of December 31, 2016. In other words, are total assets, total liabilities, or total shareholders' equity overstated not affected understated, and if yes, by how much? Remember to consider effects from 2015.Explanation / Answer
1. R&D Cost should not be capitalised, so Patents (Asset) account is overstated to the extent R&D cost stands unamortised. As given, amortisation is done based on Straight Line Method considering 20 years of life, so amortisation in 2 years = 50000/20 * 2 = $5,000. So unamortised amount = $45,000 (50000 - 5000). So assets are overstated by $45,000 as of December 31, 2016 and as a result profits are understated by the same amount.
2. Payment to lawyer for successfully defending case for patent infringement is a capital expenditure and must be capitalised. So asstes are understated by $8,000.
3. No effect, as on date of purchase of patent it was not known that it will be protected for 7 years only
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