On February 1, 2010, Par5 paid property taxes on its warehouse for the calendar year 2010 in the amount of $385,000. In the first week of June 2010, Par5 made unanticipated major repairs to its warehouse at a cost of $3,000,000. These repairs will benefit operations for the remainder of the calendar year. Calculate how these expenses should be reflected in Par5's quarterly income statements, dated March 31, 2010, June 30, 2010, September 30, 2010, and December 31, 2010?
To calculate how the expenses should be reflected in Par5's quarterly income statements, we first need to understand the basic principles of accounting.
In accounting, expenses are typically recognized when they are incurred and match against the revenues they generate. There are two main methods of recognizing expenses: the accrual basis and the cash basis.
Under the accrual basis, expenses are recognized when they are incurred, regardless of when the associated cash payment is made. This method focuses on matching expenses with the period in which they help generate revenue. This is the most commonly used method in financial reporting.
Under the cash basis, expenses are recognized only when the associated cash payment is made. This method is simple and straightforward but may not accurately reflect the matching principle of revenue and expenses.
Now let's analyze how the expenses should be reflected in Par5's quarterly income statements:
1. March 31, 2010:
Since the property taxes were paid on February 1, 2010, these expenses can be recognized in the first quarter of 2010 (January 1, 2010, to March 31, 2010) on the accrual basis.
2. June 30, 2010:
The unanticipated major repairs to the warehouse were made in the first week of June 2010. Since these repairs will benefit operations for the remainder of the calendar year, it is reasonable to allocate this expense over the remaining three quarters of the year (July 1, 2010, to December 31, 2010) on the accrual basis. Accordingly, 3/4th (or 75%) of the expense ($3,000,000) should be recognized in the second quarter income statement.
3. September 30, 2010:
The same logic applies here. We allocate 2/4th (or 50%) of the expense ($3,000,000) on the accrual basis for the third quarter (July 1, 2010, to September 30, 2010).
4. December 31, 2010:
For the fourth and final quarter (October 1, 2010, to December 31, 2010), we allocate 1/4th (or 25%) of the expense ($3,000,000) on the accrual basis.
To summarize, the breakdown of the expenses on Par5's quarterly income statements would be as follows:
- March 31, 2010: Property taxes - $385,000
- June 30, 2010: Unanticipated major repairs - $2,250,000 ($3,000,000 x 75%)
- September 30, 2010: Unanticipated major repairs - $1,500,000 ($3,000,000 x 50%)
- December 31, 2010: Unanticipated major repairs - $750,000 ($3,000,000 x 25%)
Please note that the above explanation is based on the assumption that Par5 uses the accrual basis of accounting. If they use the cash basis, the expenses would be recognized in the respective quarters in which the payment is made.