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Accounting At MacCloud Winery Case Solution

Solution Id Length Case Author Case Publisher
468 1472 Words (5 Pages) David F. Hawkins, Robert S. Kaplan, Gregory S. Miller Harvard Business School : 105081
This solution includes: A Word File A Word File and An Excel File An Excel File

Mike MacCloud acquired the knowledge and experience about wine making by working in operation side of a winery for several years. Therefore, he decided to operate his own winery called MacCloud Winery, and produce his own wine label. For this purpose, he planned to produce his own grapes and decided to plant grapes on four acres of land. He leased a building, loaned some amount from the bank and imported Australian special grapevines. To produce grapes, he also had to spend on fertilizing and water each year. Mike needed to analyze the accounting treatment for each of the relevant transactions and make allowances for any potential diseases. Furthermore, he also has to determine the effect on cash flow due to these transactions.

Following questions are answered in this case study solution:

  1. Should the leased building accounted for as an asset? Should the agreement to pay lease rental be recorded as a liability?

  2. Record the journal entries to account for the bank loan for all 3 years. Assume the loan was made at the beginning of the year and repaid at the end of the year three.

  3. Applying the principles of accrual accounting, how should mike treat the expenditures for land, vines, vine planting, fertilizing and water? Be specific regarding the treatment over time, including amounts, and the rationale for treatment.

  4. How should the potential for vine disease be reflected in the financial statements if the vines are diagnosed with any of the diseases? Does this change if the vines are diagnosed with one of the diseases?

  5. How should Mike account for oak barrels?

  6. How would the transactions in Question 3 and the bank loan be recorded in the winery’s indirect statement of cash flows?

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Case Analysis for Accounting At MacCloud Winery

1. Should the leased building accounted for as an asset? Should the agreement to pay lease rental be recorded as a liability?

The accounting treatment for a leased building is based on the classification of the lease as either an operating lease or a finance lease. The building leased by Mike can be under the financial lease because the total present value of all the lease payments over 10 years is greater than 90 percent of the value of the asset. Exhibit 1 shows that the present value of the building lease is $30,723. This value is greater than $28,800, 90% of the buildings cost.

However, for three very important reasons the building lease should be classified under an operating lease. Firstly, the lease agreement signed by Mike did not mention any transfer of ownership to Mike at the end of the lease period. Hence, as ownership is retained by the lessor, the lease is an operating lease. Additionally, the agreement does not state any bargain purchase options. This means that Mike will not be able to gain ownership of the building after the lease period. The lessor will be responsible for any risk and repairs related to the building. Finally, the lease period of 10 years does not exceed 75% of the useful life of an asset i.e. 30 years.

The fact that the lessor retains risks and the benefits of the ownership of the building classifies this building lease as an operating lease. Therefore, as the lease is an operating lease, the leased building will not be accounted for as an asset.

Under operating lease, the lease payment is treated as an annual rental expense of $5,000, and the lease is not classified as the capital of the firm. Also, as the building lease is treated as a yearly expense, the lease agreement for the annual rent should not be recorded as a liability. However, the agreement of paying $5,000 annually should be disclosed in the notes to the financial statements.

2. Record the journal entries to account for the bank loan for all 3 years. Assume the loan was made at the beginning of the year and repaid at the end of the year three.

Exhibit 2 shows the loan amortization schedule for the loan to be repaid in three years. For calculations, it is assumed that the interest of 10% of the principal and the principal payment of $10,000 is done at the end of each year. It is also assumed that the end of the third year the loan principal is paid in full. Exhibit 3 shows the relevant double entries for each of the three years.

3. Applying the principles of accrual accounting, how should mike treat the expenditures for land, vines, vine planting, fertilizing and water? Be specific regarding the treatment over time, including amounts, and the rationale for treatment.

The land will be treated as a fixed asset under property plant and equipment in the balance sheet. The land values $250,000. As the land is used for grape cultivation, it will be subject to depreciation each year. A decrease in the economic value of land over the years can also give rise to an impairment loss.

The cost of Australia's special grapevines should also be capitalized as the vines are expected to produce an economic benefit for the final product for nearly five years. All the cost relating to the vine to bring it to the specific location and usable condition will be capitalized. Hence, the cost of the vines will include $10,000 per acres to buy the vines, the transportation cost of $2,500 to bring the vines to the current location and the $2,000 per acre planting cost to bring the vines into useable condition. The total cost of the vines would be $50,500 (Exhibit 4). This capitalized cost will be depreciated as the vines begin bearing grapes. This depreciation will be charged in inventory cost once the final product starts selling.

Finally, in order to produce high quality fruits in the future, Mike would have to spend $1,000 per acre for the next five years to fertilize and water the vines. Hence, as this expenditure is done on the vine to bring it to its productive use, the annual cost of fertilizing and water of $4,000 will be capitalized. Similarly, once the high quality grapes start producing, Mike would also have to spend $1,500 per acre every year on fertilizing and water. This $6,000 spent annually will also be capitalized as, without this increased expenditure, the quality of future grape production will be drastically affected. These costs will also be depreciated as soon as the vines start to produce high quality grapes.

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