John, a friend of yours, recently started a new car eco-friendly car was business. The business, Eco-Bubbles Car Wash, is a franchise business and the franchise license was purchased by John, from the master franchise holder, Eco Car Washes. Eco-B entered into the following transactions during the month of February 2022:
To provide the necessary car was services, a special machine, which uses patented technology and eco-friendly chemicals to wash the cars, is needed. Having a cost of R15Â 000, the master franchise holder requires all franchisees to purchase this machine. Utilising this machine, it is recommended that for each car wash, R150 for the service to be charged to the customer. Eco-Bubbles Car Wash upon the transfer of the machine from the Master Franchise holder, will enjoy the risks and rewards of ownership. The machine was delivered on 15 February 2022.
John did not have enough cash to purchase the machine, therefore, on behalf of the business he approached Betta Bank to fund the purchase of the machine. The loan is settled through the payment of 4 annual instalments of R4Â 000 per year. The instalment is payable on the anniversary of the loan.
John located a premises to which to operate the business from. The landlord requires a monthly rental of R1 500 to be paid on the 1st of every month in arrears. John agreed to the terms and signed the lease on 2 February 2022. On the same day, the business paid 5 months’ worth of rent to the landlord.
John, who has a little understanding of accounting, approached you to assist him with the following questions:
He was told that as he uses the machine, the value of the machine decreases because of wear and tear. Therefore, John is of the understanding that the machine must be recognised as an expense rather than an Asset. With reference to the conceptual framework and the definition of an Asset only, discuss whether John is correct or not. (11 Marks)
With reference to the loan, discuss whether the loan meets the requirements of a Liability as defined in the conceptual framework. (12 Marks)
With reference to the conceptual framework, discuss how the prepaid rent would be recognised in the financial records, i.e. as an Expense, Income, Asset, or Liability. Journal entries are not required in your discussion. (16 marks)