Accounting at MacCloud Winery

Answer To The Question No: 1

Leases are contracts between the property owners and other parties that allows the leasing party
to use the property for a certain period of time in exchange of money or other assets. There are
usually two types of leases which are capital and operating. The capital lease let’s the lessee to
claim ownership for the certain period and in operating lease the lease is not the owner and has
nothing to do with the ownership and risks or benefits associated with it.

In the case Mike is only entitled to use the building for 10 years where the economic life of the
building is 30 years, so the life of the lease is >75% of the useful life of the asset. Moreover, he
can’t claim ownership of the property. This indicates that the building is an operating lease and it
should not be accounted as an asset. Mike can simply write his journal entry as rent expense of
$5,000 debit each year while paying for the leased building.

If the rent of the leased building is not paid in cash each year, then it should be identified as a
liability. In this case the journal entries would be-
Rent Expense Dr. $5000
Rents Payable Cr. $5000

When Mike would make payment of the leased building the journal entries would be-
Rents Payable Dr. $5000
Cash Cr. $5000
 Answer To The Question No: 2

MacCloud Winery
Journals

Date Accounts Ref Dr Cr

January Cash $180,000
Year 1 Bank Loan $180,000
(To record the issued bank loan)
December Bank Loan $10,000
Year 1 Cash $10,000
(To record payment of installment of the loan)
December Interest Expense $18,000
Year 1 Cash $18,000
(180,000*10%)
(Interest is recorded at 10% annually)
December Bank Loan $10,000
Year 2 Cash $10,000
(To record payment of installment of the loan)
December Interest Expense $17,0000
Year 2 Cash $17,000
((180,000-10,000) *10%)
(Annual 10% interest is recorded)
December Bank Loan $10,000
Year 3 Cash $10,000
(To record payment of installment of the loan)
December Interest Expense $16,000
Year 3 Cash $16,000
((180,000-10,000-10,000) *10%)
(Annual 10% Interest is charged on remainder
loan amount)
December Bank Loan $160,000
Year 3 Cash $160,000
(Lump sum remaining amount of the loan is
paid at the end of third year)
 Answer To The Question No: 3

Applying the principles of accrual accounting the costs must be journalized and recorded in the
books as soon as it occurs. In the winery Mike has made many investments in buying long term
and short terms assets. Along with the assets all the expenses should be recorded accordingly.
Let’s take a deeper look in some of the expenditures-

Land: Five acres of land was purchased at a cost of $250,000. Land is one of the the few plant
property that does not have any depreciation. The land will have the same value over the years
and even might increase in certain cases. There wasn’t any added cost of acquiring the land so
the final amount of land in the balance sheet would be $250,000.

Vines: Mike bought Australian grapevines at a cost of $10,000 per acre of land. Mike is planning
to cultivate in 4 acres leaving 1 acre for winery in future. So, the cost of vines would be
($10,000*4) = $40,000. The vine plants are a long-term asset that will last for decades. The
property, plant and equipment of an organization includes every associated cost that is needed to
function the asset properly. The associated with the vines are the transportation cost which is
$2,500 and planting cost which is ($2,000*4) = $8,000. So, the total amount of vines in the
balance sheet would be $40,000+$2,500+$8,000 = $50,500.

Fertilizing and Water: Mike has to spend $1,000 an acre each year to water and fertilize the
plants for the first five years, so the total cost per year would be $1,000*4= $4,000. From year
six and on he would need to spend $1,500 per acre so the total cost would be $1,500*4=$6,000.
The fertilization and water cost should be recorded in the income statement each year under the
name operating expense.
In accounting any cost or change in the accounts is recorded in the financial statements only after
the incident has occurred. In the case of Black Go syndrome or Pierce’s Disease Mike has not
much to do about it before the losses actually occurs. The best he can do is making a contingency
plan and a pro forma statement that if the losses occurs then he will record it in his books.
However, this will not be included in any of his books until his vines gets infected. It is the risk
of doing business that he has to take. To reduce his risk, he can get insurance for his vines but the
insurance premium will also be affecting his overall cost of production. So, the potential loss
should not be reflected in the financial statements if the vines are not diagnosed with any of the
diseases.

Let’s say if Mikes vines are diagnosed with any of the diseases that will reduce the tenure of his
plants and also reduce the production. He can reduce the life of the vine plants in his books and
show it as obsolete expense. In a normal scenario the vine plants have a life of 100 years but if
they get infected Mike has to reduce the life span of the plants from 100 to 10 in his books and
depreciate it at a higher rate. However, the double declining method of depreciating would more
appropriate for Mike as the pants have a higher chance of getting infected in their early life. The
double declining method of depreciation records the cost of depreciation twice of the straight-
line method.
Mike imported expensive wine barrels from France to mature his wine. These barrels have a total
tenure of 15 years while the first 5 years they are able to produce premium quality wine while the
rest 10 years will be used to procure lower quality wine. After the 15 years of use the barrels
would have a salvage value as they would be sold as charcoal-chips.
Mike should account the oak barrels under property, plant and equipment in the balance sheet as
these are a long-term asset. As the barrels have a total of 15 years of tenure, they must be
depreciated accordingly each year. To calculate depreciation of each year Mike can follow either
straight line method or the double declining method. The barrels in their first 5 years would
produce better quality wine so it would be better to follow the double declining method as it will
reduce the value twice as fast of the straight-line method.

Value of Barrels
120

100

80

60

40

20

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15

Straight Line Double Declining

As we can see in the chart if Mike follows the Straight-line method his barrels would depreciate
at a fixed rate of (100/15) = 6.67%. In the double declining method, his barrels would depreciate
more in the first couple of years with the double percentage of 13.33% compared to the straight-
line method. However, in the end both of the methods meet at a similar point while determining
the salvage value.