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Case 14-4 Accounting at MacCloud Winery

Mike McCloud worked in the Winery industries for many years and after achieving the

specialization in this field he opted for starting his own winery production business and

launching his own brand. At the beginning of his business he planned to lease a building for

conducting the production processes of the wine and also purchased a land for growing the

grapes. The lease agreement of the building was for 10 years at an annual payment of $5000.

Mike used all his business knowledge and work experience to make his winery business

successful. He also imported an oak barrel that would enable him to make his product quality

above the average quality. In order to keep a record in the books of accounts of McCloud

Winery proper classification of assets, liabilities, expenses and revenues need to be done so

that proper financial statements can be developed. The basic purpose of the research is to

have a look at the Mike McCloud Winery businesss books of accounts. The purpose of this

research is also to find out the classification of a leased building, either the rent paid on the

leased building considered as an asset or liability, what will be the impact of decrease inproduction on the financial statements and how oak barrels will be treated either assets,

liabilities or will come under any other account.

1. Should the leased building be accounted for as an asset?

No, the lease would be considered an operating lease, on which the expense would be

accrued day by day as the asset (building) is used. To determine this is in fact an operating

lease, the life of the lease should be less than 75% of the useful life of the asset being leased.

For instance, this is a 10 year lease, which is less than the economic life of a 30 year asset.

The rental payments would be expensed as incurred and offset by the asset used to make the

rental payments (i.e. cash), the lessor would still hold the benefit of the ownership.

Should the agreement to pay lease rentals be recorded as a liability?

The agreement to pay future lease rental payments on the operating lease would be disclosed

in the footnotes of the financial statements. No liabilities should be recorded. 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 year.

3. Applying the principles of accrual accounting, how should Mike treat the expenditures for

the land, vines, vine planting, fertilizing and water?

Mike should treat the expenditures for the land, vines, vine planting, fertilizing and water

based on key accrual concepts: Conversation, realization and matching.

He could include in the cost (initial value) of assets, all the costs necessary to put an asset

into its productive use. All the expenses incurred in the first 5 years are part of the initial cost

of an asset. Also the transportation cost can be included in the initial cost of an asset.

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4. Without changing your answers to the above questions, considers the following facts:

Mikes greatest concern is that his vines will contract Phylloxera disease, Black Goo

syndrome, or Pierces disease. While these conditions do not kill the vines immediately, they

reduce production of quality grapes by approximately 10 years after contracting the

condition. While Mike will probably be able to avoid Phylloxera by planting genetically

treated vines, incidents of Black Goo and Pierce disease have been increasing over the last

several years and are the most dangerous to vines that are less than three years old.

How should the potential for vine disease be reflected in the financial statements if the vines

have not been diagnosed with any of the diseases? Does this change if the vines are

diagnosed with one of the diseases? Be specific regarding any amounts and the rationale for

these treatments.

Provisions are accounting funds that are set aside in the liabilities side of the balance sheet in

order to be used in the future to cover for possible future costs.