Quiz 9: Plant and Intangible Assets
Business
Q 1Q 1
Cost of Plant Asset
Amigos, Inc., purchased a used piece of heavy equipment for $30,000. Delivery of the e quipment to Amigos' business site cost $750. Expenditures to recondition the equipment and prepare it for use totaled $2,230. The maintenance for the first year Amijo owned the equipment was $1,370. Determine the cost that is the basis for calculating annual depreciation on the equipment.
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Essay
The cost of plant assets includes all expenditures reasonable, necessary and directly attributable for getting the assets to the place of use and into its working condition.
The following table shows the cost of the equipment:
Maintenance charges are a recurring expenditure hence it has not been capitalised as it will be treated as revenue expenses and charge to income statement.
Q 2Q 2
Mickey Gillespie is the controller of Print Technologies, a publicly owned company. The company is experiencing financial difficulties and is aggressively looking for ways to cut.costs.
Suzanne Bedell, the CEO, instructs Gillespie to lengthen from 5 to 10 years the useful life used in computing depreciation on certain special-purpose machinery. Bedell believes that this change represents a substantial cost savings, as it will reduce the depreciation expense on these assets by nearly one-half.
Note: The proposed change affects only the depreciation expense recognized in financial statements. Depreciation deductions in income tax returns will not be affected.
Instructions
a. Discuss the extent to which Bedell's idea will, in fact, achieve a cost savings. Consider the effects on both net income and cash flows.
b. Who is responsible for estimating the useful lives of plant assets?
c. Discuss any ethical issues that Gillespie should consider with respect to Bedell's instructions.
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a. Lengthening the period over which assets are depreciated for financial statement purposes will reduce the annual charges to depreciation expense. This will reduce expenses in the income statement and increase net income. But depreciation is only a computation-it is not "paid" in cash on an annual basis. Therefore, changing the estimated useful lives of plant assets will have no effect upon cash flows, nor does it affect the time period over which the assets are actually used by the company. b. Management is responsible for establishing the estimated useful lives of assets for purposes of calculating depreciation and preparing financial statements. Those lives must be consistent with the actual expected use of the assets. To arbitrarily lengthen the estimated lives of assets for purposes of improving the company's appearance in its financial statements is not appropriate. If the financial statements are subject to audit by a Certified Public Accountant (CPA), the useful lives over which assets are depreciated will be subject to evaluation as part of the audit process. Depreciating assets over longer lives than are supported by the underlying facts (i.e., the period over which the assets are actually being used) will be recognized by the CPA as an arbitrary step that is intended to make the company's financial situation look better, but which is not supported by the facts. In this instance, management will be faced with the dilemma of having to subsequently reverse its decision to depreciate over longer lives, or accept an unfavorable audit opinion on the fairness of the financial statements. c. The ethical issue confronting Gillespie is whether the change in estimated useful lives is reasonable, or whether it will cause the company's financial statements to be misleading. On one hand, the fact that the company is experiencing financial difficulties may well indicate that it will not replace assets as quickly as it did in more prosperous times. On the other hand, if Gillespie knows that these assets must be replaced after only 5 years, the use of a 10-year depreciation life would be misleading to users of the financial statements. In summary, Gillespie must assess the reasonableness of Bedell's instructions. If the change to a 10-year life would not result in the financial statements being misleading, then there is no problem in revising the estimated useful lives. If he believes that this change will result in misleading financial statements, he must refuse to participate in presenting such information Given that he is the controller of the company, he should resign if the CEO insists upon issuing financial statements that he believes to be misleading.
Q 3Q 3
Coca-Cola's distinctive trademark is more valuable to the company than its bottling plants. But the company's bottling plants are listed in the balance sheet, and the famous trademark isn't. Explain.
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Coca-Cola's distinctive trademark is more valuable to the company than its bottling plants. But the company's bottling plants are listed in the balance sheet, and the famous trade mark is not listed, because the cost of developing a trademark or brand name often consist of advertising campaigns, which should be treated as expenses when incurred. If a trademark or brand name is purchased, however, the cost may be substantial. Such cost should be capitalized and amortized to expense over the time period the trademark or brand name is expected to be used. If the use of the trademark is discontinued or its contribution to earnings becomes doubtful, any unamortized cost should be written off immediately.
Q 4Q 4
Assume that you recently applied for a student loan to go to graduate school. As part of the application process, your bank requested a list of your assets. Aside from an extensive CD collection, your only other asset is a pickup truck. You purchased the truck six years ago for $15,000. Its current fair value is approximately $5,000.
a. What factors caused your pickup track to depreciate $10,000 in value?
b. Assume that the bank is willing to lend you money for graduate school. Even with the loan, however, you still need to raise an additional $5,000. Do you think that the bank will lend you $5,000 more for graduate school if you agree to use your truck as collateral? Explain.
c. Assume that the truck has been used solely in a delivery service business that you operated while in college. Would your balance sheet necessarily show $10,000 in accumulated depreciation related to the truck? Explain.
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Q 5Q 5
Determining the Cost of Plant Assets and Depreciation
Hamlet College recently purchased new computing equipment for its library. The following information refers to the purchase and installation of this equipment:
1. The list price of the equipment was $285,000; however, Hamlet College qualified for an "education discount" of $25,000. It paid $50,000 cash for the equipment, and issued a three-month, 9 percent note payable for the remaining balance. The note, plus accrued interest charges of $4,500, was paid promptly at the note's maturity date.
2. In addition to the amounts described in 1, Hamlet paid sales taxes of $15,000 at the date of purchase.
3. Freight charges for delivery of the equipment totaled $1,000.
4. Installation costs related to the equipment amounted to $5,000.
5. During installation, one of the computer terminals was accidentally damaged by a library employee. It cost the college $500 to repair this damage.
6. As soon as the computers were installed, the college paid $4,000 to print admissions brochures featuring the library's new, state-of-the-art computing facilities.
Instructions
a. In one sentence, make a general statement summarizing the nature of expenditures that qualify for inclusion in the cost of plant assets such as computing equipment.
b. For each of the six numbered paragraphs, indicate which items should be included by Hamlet College in the total cost added to its Computing Equipment account. Also briefly indicate the proper accounting treatment of those items that are not included in the cost of the equipment.
c. Compute the total cost added to the college's Computing Equipment account.
d. Prepare a journal entry at the end of the current year to record depreciation on the computing equipment. Hamlet College intends to depreciate this equipment by the straight-line method (half-year convention) over an estimated useful life of five years. Assume a zero residual value.
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Q 6Q 6
Determining the Cost of Plant Assets and Depreciation
Smithfield Hotel recently purchased new exercise equipment for its exercise room. The following information refers to the purchase and installation of this equipment:
1. The list price of the equipment was $42,000; however, Smithfield qualified for a "special discount" of $5,000. It paid $10,000 cash, and issued a three-month, 12 percent note payable for the remaining balance. The note, plus accrued interest charges of $750, was paid promptly at the maturity date.
2. In addition to the amounts described in 1, Smithfield paid sales taxes of $2,100 at the date of purchase.
3. Freight charges for delivery of the equipment totaled $600.
4. Installation and training costs related to the equipment amounted to $900.
5. During installation, one of the pieces of equipment was accidentally damaged by an employee. Smithfield paid $400 to repair this damage.
6. As soon as the equipment was installed, the hotel paid $3,200 to print brochures featuring the exercise room's new, state-of-the-art exercise facilities.
Instructions
a. In one sentence, make a general statement summarizing the nature of expenditures that qualify for inclusion in the cost of plant assets such as exercise equipment.
b. For each of the six numbered paragraphs, indicate which items should be included by Smithfield Hotel in the total cost added to its Equipment account. Also briefly indicate the proper accounting treatment of those items that are not included in the cost of the equipment.
c. Compute the total cost added to the hotel's Equipment account.
d. Prepare a journal entry at the end of the current year to record depreciation on the exercise equipment. Smithfield Hotel plans to depreciate this equipment by the straight-line method (half-year convention) over an estimated useful life of five years. Assume a zero residual value.
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Q 7Q 7
Straight-Line Depreciation
Twin-Cities, Inc., purchased a building for $600,000. Straight-line depreciation was u sed for each of the first two years using the following assumptions: 25-year estimated useful life, with a residual value of $100,000.
a. Calculate the annual depreciation for the first two years that Twin-Cities owned the building.
b. Calculate the book value of the building at the end of the second year.
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Q 8Q 8
Departures from GAAP-Are They Ethical?
Maggie Miller owns Miller Construction Co. The company maintains accounting records for the purposes of exercising control over its construction activities and meeting its reporting obligations regarding payrolls and income tax returns. As it has no other financial reporting obligations, Miller does not prepare formal financial statements.
The company owns land and several other assets with current market values well in excess of their historical costs. Maggie Miller directs the company's accountant, Max O'Shaughnessey, to prepare a balance sheet in which assets are shown at estimated market values. Miller says this type of balance sheet will give her a better understanding of where the business stands. She also thinks it will be useful in obtaining bank loans, as loan applications always ask for the estimated market values of real estate owned.
Instructions
a. Would the financial statements requested by Maggie Miller be in conformity with generally accepted accounting principles?
b. Is Miller Construction under any legal or ethical obligation to prepare financial statements that do conform to generally accepted accounting principles?
c. Discuss any ethical issues that O'Shaughnessey should consider with respect to Miller's request.
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Q 9Q 9
Identify the basic "accountable events" in the life of a depreciable plant asset. Which of these events directly affect the net income of the current period? Which directly affect cash flows (other than income tax payments)?
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Q 10Q 10
Distinguishing Capital Expenditures from Revenue Expenditures
Identify the f ollowing expenditures as capital expenditures or revenue expenditures:
a. Immediately after acquiring a new delivery truck, paid $260 to have the name of the store and other advertising material painted on the vehicle.
b. Painted delivery truck at a cost of $450 after two years of use.
c. Purchased new battery at a cost of $40 for two-year-old delivery truck.
d. Installed an escalator at a cost of $17,500 in a three-story building that had been used for some years without elevators or escalators.
e. Purchased a pencil sharpener at a cost of $15.00.
f. Original life of the delivery truck had been estimated at four years, and straight-line depreciation of 25 percent yearly had been recognized. After three years' use, however, it was decided to recondition the truck thoroughly, including replacing the engine.
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Q 11Q 11
Comparison of Straight- Line and Accelerated Methods
Swanson Hiller, Inc., purchased a new machine on September 1, 2012 at a cost of $108,000. The machine's estimated useful life at the time of the purchase was five years, and its residual value was $8,000.
Instructions
a. Prepare a complete depreciation schedule, beginning with calendar year 2012, under each of the methods listed below (assume that the half-year convention is used):
1. Straight-line.
2. 200 percent declining-balance.
3. 150 percent declining-balance, switching to straight-line when that maximizes the expense.
b. Which of the three methods computed in part a is most common for financial reporting purposes? Explain.
c. Assume that Swanson Hiller sells the machine on December 31, 2015, for $29,000 cash. Compute the resulting gain or loss from this sale under each of the depreciation methods used in part a. Does the gain or loss reported in the company's income statement have any direct cash effects? Explain.
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Q 12Q 12
Comparison of Straight- Line and Accelerated Methods
R R, Inc., purchased a new machine on September 1, 2013, at a cost of $180,000. The machine's estimated useful life at the time of the purchase was five years, and its expected residual value was $10,000.
Instructions
a. Prepare a complete depreciation schedule, beginning with calendar year 2013, under each of the methods listed below (assume that the half-year convention is used):
1. Straight-line.
2. 200 percent declining-balance.
3. 150 percent declining-balance (not switching to straight-line).
b. Which of the three methods computed in part a is most common for financial reporting purposes? Explain.
c. Assume that R R sells the machine on December 31, 2016, for $58,000 cash. Compute the resulting gain or loss from this sale under each of the depreciation methods used in part a. Does the gain or loss reported in the company's income statement have any direct cash effects? Explain.
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Q 13Q 13
Straight-Line and Declining-Balance Depreciation
Messer Company purchased equipment for $24,000. The company is considering whether t o determine annual depreciation using the straight-line method or the declining-balance method at 150 percent of the straight-line rate. Waller expects to use the equipment for 10 years, at the end of which it will have an estimated salvage value of $4,000. Prepare a comparison of these two alternatives for the first two years Messer will own the equipment.
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Q 14Q 14
The following is a neile accompanying a recent financial statement of International Paper Company :
Plant, Properties, and Equipment
Plant, properties. and equipment are stated at cost less accumulated depreciation.
For financial reporting purposes, the company uses the units-of-production method of depreciating its major pulp and paper mills and certain wood products facilities, and the straight-line method for other plant and equipment.
Annual straight-line depreciation rates for financial reporting purposes are as follows: buildings
percent to 8 percent: machinery and equipment 5 percent to 33 percent: woods equipment 10 percent to 16 percent. For tax purposes, depreciation is computed utilizing accelerated methods.
Instructions
a. Are the depreciation methods used in the company's financial statements determined by current income tax laws? If not, who is responsible for selecting these methods? Explain.
b. Does the company violate the consistency principle by using different depreciation methods for its paper mills and wood products facilities than it uses for its other plant and equipment? If not, what does the principle of consistency mean? Explain.
c. What is the estimated useful life of the machinery and equipment being depreciated with a straight-line depreciation rate of:
1. 5 percent.
2. 33 percent (round to the nearest year).
d. Who determines the useful lives over which specific assets are to be depreciated?
e. Why do you think the company uses accelerated depreciation methods for income tax purposes, rather than using the straight-line method?
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Q 15Q 15
The following expenditures were incurred in connection with a new machine acquired by a metals manufacturing company. Identify those that should be included in the cost of the asset, (a) Freight charges, (b) sales tax on the machine, (c) payment to a passing motorist whose car was damaged by the equipment used in unloading the machine.(d) wages of employees for time spent in installing and testing the machine before it was placed in service, (e) wages of employees assigned to lubricate and make minor adjustments to the machine one year after it was placed in service.
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Q 16Q 16
Depreciation for Partial Years
On August 3, Cinco Construction purchased special-purpose equipment at a cost of $1,000,000. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $50,000.
a. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the straight-line depreciation method (half-year convention).
b. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense.
c. Which of these two depreciation methods (straight-line or double-declining-balance) results in the highest net income for financial reporting purposes during the first two years of the equipment's use? Explain.
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Q 17Q 17
Issues Involving Alternative Depreciation Methods
Hills Hardware purchased new shelving for its store on April 1, 2015. The shelving is expected to have a 20-year life and no residual value. The following expenditures were associated with the purchase:
Instructions
a. Compute depreciation expense for the years 2015 through 2018 under each depreciation method listed below:
1. Straight-line, with fractional years rounded to the nearest whole month.
2. 200 percent declining-balance, using the half-year convention.
3. 150 percent declining-balance, using the half-year convention.
b. Hills Hardware has two conflicting objectives. Management wants to report the highest possible earnings in its financial statements, yet it also wants to minimize its taxable income reported to the IRS. Explain how both of these objectives can be met.
c. Which of the depreciation methods applied in part a will result in the lowest reported book value at the end of 2018? Is book value an estimate of an asset's fair value? Explain.
d. Assume that Hills Hardware sold the old shelving that was being replaced. The old shelving had originally cost $9,000. Its book value at the time of the sale was $400. Record the sale of the old shelving under the following conditions:
1. The shelving was sold for $1,100 cash.
2. The shelving was sold for $175 cash.
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Q 18Q 18
Issues Involving Alternative Depreciation Methods
Davidson, DDS, purchased new furniture for its store on May 1, 2015. The furniture is expected to have a 10-year life and no residual value. The following expenditures were associated with the purchase:
Instructions
a. Compute depreciation expense for the years 2015 through 2018 under each depreciation method listed below:
1. Straight-line, with fractional years rounded to the nearest whole month.
2. 200 percent declining-balance, using the half-year convention.
3. 150 percent declining-balance, using the half-year convention.
b. Davidson, DDS, has two conflicting objectives. Management wants to report the highest possible earnings in its financial statements, yet it also wants to minimize its taxable income reported to the IRS. Explain how both of these objectives can be met.
c. Which of the depreciation methods applied in part a resulted in the lowest reported book value at the end of 2018? Is book value an estimate of an asset's fair value? Explain.
d. Assume that Davidson, DDS, sold the old furniture that was being replaced. The old furniture had originally cost $3,000. Its book value at the time of the sale was $400. Record the sale of the old furniture under the following conditions:
1. The furniture was sold for $780 cash.
2. The furniture was sold for $250 cash.
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Q 19Q 19
Declining-Balance Depreciation
Equipment costing $86,000 was purchased by Spence, Inc., at the beginning of the c urrent year. The company will depreciate the equipment by the declining-balance method, but it has not determined whether the rate will be at 150 percent or 200 percent of the straight-line rate. The estimated useful life of the equipment is eight years. Prepare a comparison of the two alternative rates for management for the first two years Spence owns the equipment.
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Q 20Q 20
Capitalization vs. Expense
One of your responsibilities as division manager of an important component of P aramount Industries is to oversee accounting for the division. One of the issues you grapple with on an almost continuous basis is whether particular costs should be expensed immediately or whether they should be capitalized. The company has an accounting policy manual that includes a section on this topic, but it is rather vague in this regard. It simply says that if a cost benefits multiple accounting periods, the cost should be capitalized; otherwise, that cost should be expensed immediately. It also makes a brief reference to materiality by stating that, if a cost is sufficiently small, it should be immediately expensed despite the fact that it may benefit multiple accounting periods. No additional guidance is provided with regard to how these general concepts should be applied.
Over several years you have noticed a tendency of your staff to capitalize rather than expense more costs. While you and your coworkers in the division do not receive a bonus or other direct compensation that is tied to your division's performance, you know that upper management monitors carefully the financial performance of divisions. From time to time in various meetings and in written correspondence, comments are made praising individuals and divisions of the company for their positive financial performance. In fact, within your division you have done the same when you meet with your employees and either compliment them for strong financial performance or express concern about weak financial performance.
Paramount Industries has a code of professional conduct that is discussed with employees when they are hired. Within that code are references to personal integrity and the responsibility of employees to carry out company policy and not engage in activities that benefit themselves at the expense of the company. Like the accounting policies referred to above, there is no guidance on how this general principle might be carried out.
Instructions
a. What behavior may your comments in meetings with your employees, or the comments made to you from upper management, be motivating in terms of the continuous decisions that are being made about capitalizing and expensing costs?
b. What steps might you take to ensure that you and the employees in your division are taking actions that are consistent with the company's accounting policies and code of professional conduct?
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Q 22Q 22
Depreciation Methods
On January 2, 2015, Jatson Corporation acquired a new machine with an estimated u seful life of five years. The cost of the equipment was $40,000 with an estimated residual value of $5,000.
a. Prepare a complete depreciation table under the three depreciation methods listed below. Use a format similar to the illustrations in Exhibits 9-4 , 9-5 , and 9-6. In each case, assume that a full year of depreciation was taken in 2015.
1. Straight-line.
2. 200 percent declining-balance.
3. 150 percent declining-balance with a switch to straight-line when it will maximize depreciation expense.
b. Comment on significant differences or similarities that you observe among the patterns of depreciation expense recognized under each of these methods.
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Q 23Q 23
Disposal of Plant Assets
During the current year, Hitchcock Developers disposed of plant assets in the following transactions:
Instructions
a. Prepare journal entries to record each of the disposal transactions. Assume that depreciation expense on each asset has been recorded up to the date of disposal. Thus, you need not update the accumulated depreciation figures stated in the problem.
b. Will the gains and losses recorded in part a above affect the gross profit reported in Hitchcock's income statement? Explain.
c. Explain how the financial reporting of gains and losses on plant assets differs from the financial reporting of unrealized gains and losses on marketable securities discussed in Chapter 7.
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Q 24Q 24
During the current year, Blake Construction disposed of plant assets in the following transactions:
Instructions
a. Prepare journal entries to record each of the disposal transactions. Assume that depreciation expense on each asset has been recorded up to the date of disposal. Thus you need not update the accumulated depreciation figures stated in the problem.
b. Will the gains and losses recorded in part a above affect the gross profit reported in Blake's income statement? Explain.
c. Explain how the financial reporting of gains and losses on plant assets differs from the financial reporting of unrealized gains and losses on marketable securities discussed in Chapter 7.
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Q 25Q 25
Straight-Line and Units-of-Output Depreciation
Finx, Inc., purchased a truck for $40,000. The truck is expected to be driven 15,000 miles p er year over a five-year period and then sold for approximately $5,000. Determine depreciation for the first year of the truck's useful life by the straight-line and units-of-output methods if the truck is actually driven 16,000 miles. (Round depreciation per mile for the units-of-output method to the nearest whole cent.)
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Q 26Q 26
R D in the Pharmaceutical Industry
The pharmaceutical industry spends billions of dollars each year on research and development. Rather than capitalize these R D expenditures as intangible assets, companies are required to charge them to expense in the year incurred.
Perform a keyword search of Pharmaceutical Companies using the search engine of your choice (e.g., Yahoo, Google).
Your search will result in a list of companies that research and develop pharmaceutical products. Select three of these companies and obtain their l0-K reports using the SEC's EDGAR system or going directly to the Web sites of the companies you choose.
Instructions
a. For each of the companies you selected, determine:
1. Total R D expense for the most current year.
2. Total R D expense as a percentage of total operating costs and expenses.
3. Total R D expense as a percentage of net sales.
4. The percentage by which operating income would have increased had the entire R D expenditure been recorded as an intangible asset instead of being charged to expense.
b. Using information from the l0-K reports, summarize briefly the kinds of drugs being researched and developed by each of these companies. To a potential investor, which company appears to be the most innovative and promising? Explain.
Internet sites are time and date sensitive. It is the purpose of these exercises to have you explore the Internet. You may need to use the Yahoo! search engine https/www.yahoo.cem (or another favorite search engine) to find a company's current Web address.
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Q 27Q 27
If a capital expenditure is erroneously treated as a revenue expenditure, will the net income of the current year be overstated or understated? Will this error have any effect on the net income reported in future years? Explain.
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Q 28Q 28
A recent annual report of H. J. Heinz Company includes the following note:
Deprecialion: For financial reporting purposes, depreciation is provided on the straight-line method over the estimated useful lives of the assets. Accelerated depreciation methods generally are used for income tax purposes.
a. Is the company violating the accounting principle of consistency by using different depreciation methods in its financial statements than in its income tax returns? Explain.
b. Why do you think that the company uses accelerated depreciation methods in its income tax returns?
c. Would the use of accelerated depreciation in the financial statements be more conservative or less conservative than the current practice of using the straight-line method? Explain.
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Q 29Q 29
Accounting for Intangible Assets
During the current year, Reddick Corporation incurred the following expenditures which must be recorded either as operating expenses or as intangible assets:
a. Expenditures were made for the training of new employees. The average employee remains with the company for five years, but is trained for a new position every two years.
b. Reddick purchased a controlling interest in a vinyl flooring company. The expenditure resulted in the recording of a significant amount of goodwill. Reddick expects to earn above-average returns on this investment indefinitely.
c. Reddick incurred large amounts of research and development costs in developing a dirt-resistant carpet fiber. The company expects that the fiber will be patented and that sales of the resulting products will contribute to revenue for at least 25 years. The legal life of the patent, however, will be only 20 years.
d. Reddick made an expenditure to acquire the patent on a popular carpet cleaner. The patent had a remaining legal life of 14 years, but Reddick expects to produce and sell the product for only six more years.
e. Reddick spent a large amount to sponsor the televising of the Olympic Games. Reddick's intent was to make television viewers more aware of the company's name and its product lines.
Instructions
Explain whether each of the above expenditures should be recorded as an operating expense or an intangible asset. If you view the expenditure as an intangible asset, indicate the number of years over which the asset should be amortized, if any. Explain your reasoning.
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Q 30Q 30
Accounting for Intangible Assets
During the current year, Delta Products Corporation incurred the following expenditures which should be recorded either as operating expenses or as intangible assets:
a. Expenditures were made for the training of new employees. The average employee remains with the company for five years, but is trained for a new position every two years.
b. Delta purchased a controlling interest in a wallpaper company. The expenditure resulted in recording a significant amount of goodwill. Management expects to earn above-average returns on this investment indefinitely.
c. Delta incurred large amounts of research and development costs in developing a superior product. The company expects that it will be patented and that sales of the resulting products will contribute to revenue for at least 40 years. The legal life of the patent, however, will be only 20 years.
d. Delta made an expenditure to acquire the patent on a product identified as a "whatsa." The patent had a remaining legal life of 10 years, but Delta expects to produce and sell the product for only four more years.
e. Delta spent a large amount to sponsor the televising of the World Series. Management's intent was to make television viewers more aware of the company's name and product lines.
Instructions
Explain whether each of the above expenditures should be recorded as an operating expense or an intangible asset. If you view the expenditure as an intangible asset, indicate the number of years over which the asset should be amortized. Explain your reasoning.
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Q 31Q 31
Disposal of Plant Asset
Alexander Company purchased a piece of equipment for $14,000 and depreciated it for three years over a five-year estimated life with an expected residual value at the end of five years of $2,000. At the end of the third year, Alex decided to upgrade to equipment with increased capacity and sold the original piece of equipment for $7,500. Calculate the gain or loss on the disposal at the end of the third year.
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Q 32Q 32
Shoppers' Market purchased for $265,000 a site on which it planned to build a new store. The site consisted of three acres of land and included an old house and two barns. County property tax records showed the following appraised values for this property: land, $160,000; buildings, $40,000. Indicate what Shoppers' should do with this $265,000 cost in its financial statements, and explain your reasoning.
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Q 33Q 33
Revision of Depreciation Estimates
Swindall Industries uses straight-line depreciation on all of its depreciable a ssets. The company records annual depreciation expense at the end of each calendar year. On January 11, 2011, the company purchased a machine costing $90,000. The machine's useful life was estimated to be 12 years with an estimated residual value of $18,000. Depreciation for partial years is recorded to the nearest full month.
In 2015, after almost five years of experience with the machine, management decided to revise its estimated life from 12 years to 20 years. No change was made in the estimated residual value. The revised estimate of the useful life was decided prior to recording annual depreciation expense for the year ended December 31, 2015.
a. Prepare journal entries in chronological order for the above events, beginning with the purchase of the machinery on January 11, 2011. Show separately the recording of depreciation expense in 2011 through 2015.
b. What factors may have caused the company to revise its estimate of the machine's useful life?
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Q 34Q 34
Kivi Service Stations is considering expanding its operations to include the greater Dubuque area. Rather than build new service stations in the Dubuque area, management plans to acquire existing service stations and convert them into Kivi outlets.
Kivi is evaluating two similar acquisition opportunities. Information relating to each of these service stations is presented below:
Instructions
a. Compute an estimated fair value for any goodwill associated with Kivi purchasing Joe's Garage. Base your computation upon an assumption that successful service stations typically sell at about 9.25 times their annual earnings.
b. Compute an estimated fair value for any goodwill associated with Kivi purchasing Gas N' Go. Base your computation upon an assumption that Kivi's management expects excess earnings to continue for four years.
c. Many of Kivi's existing service stations are extremely profitable. If Kivi acquires Joe's Garage or Gas N' Go. should it also record the goodwill associated with its existing locations? Explain.
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Q 35Q 35
Accounting for Goodwill
Jell Stores is considering expanding its operations to include the greater Portsmouth area. Rather than build new stores in Portsmouth, management plans to acquire existing stores and convert them into Jell outlets.
Jell is evaluating two similar acquisition opportunities. Information relating to each of these stores is presented below:
Instructions
a. Compute an estimated fair value for any goodwill associated with Jell purchasing Missy's. Base your computation upon an assumption that successful stores of this type typically sell at about 10 times their annual earnings.
b. Compute an estimated fair value for any goodwill associated with Jell purchasing Mell's. Base your computation upon an assumption that Jell's management wants to generate a target return on investment of 35 percent.
c. Many of Jell's existing stores are extremely profitable. If Jell acquires Missy's or Mell's, should it also record the goodwill associated with its existing locations? Explain.
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Q 36Q 36
Disposal of Plant Asset
Taylor Company purchased equipment for $27,500. It depreciated the equipment over a five-year life by the double-declining-balance method until the end of the second year, at which time the asset was sold for $8,300. Calculate the gain or loss on the sale at the end of the second year.
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Q 37Q 37
Should depreciation continue to be recorded on a building when ample evidence exists that the current market value is greater than original cost and that the rising trend of market values is continuing? Explain.
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Q 38Q 38
Accounting for Trade-ins
Willis B us Service traded in a used bus for a new one. The original cost of the old bus was $52,000. Accumulated depreciation at the time of the trade-in amounted to $34,000. The new bus cost $67,000, but Mathews was given a trade-in allowance of $10,000.
a. What amount of cash did Mathews have to pay to acquire the new bus?
b. Compute the gain or loss on the disposal for financial reporting purposes.
c. Explain how the gain or loss would be reported in the company's income statement.
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Q 39Q 39
Alternative Depreciation Methods
Thaxton, Inc., purchased a truck to use for deliveries and is attempting to determine how much depreciation expense would be recognized under three different methods. The truck cost $20,000 and is expected to have a value of $4,000 at the end of its five-year life. The truck is expected to be used at the rate of 10,000 miles in the first year, 20,000 miles in the second and third years, and 15,000 miles in each of the fourth and fifth years.
Instructions
a. Determine the amount of depreciation expense that Thaxton should expect to recognize under each of the following depreciation methods in the first and second years of the truck's useful life. A full year's depreciation will be recognized in the first year the truck is used.
1. Straight-line.
2. Double-declining-balance.
3. Units-of-output (based on miles).
b. Prepare the plant assets section of the balance sheet at the end of the second year of the asset's useful life under the straight-line method, assuming the truck is the only plant asset owned by Thaxton, Inc.
c. By which of the three methods is it not possible to determine the actual amount of depreciation expense prior to the end of each year? What uncertainty causes this to be true?
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Q 40Q 40
Alternative Depreciation Methods
Haywood, Inc., purchased a truck to use for deliveries and is attempting to determine how much depreciation expense would be recognized under three different methods. The truck cost $24,000 and is expected to have a value of $6,000 at the end of its six-year life. The truck is expected to be used at the rate of 15,000 miles in the first year, 20,000 miles in the second and third years, and 12,000 miles in each of the fourth, fifth, and sixth years.
Instructions
a. Determine the amount of depreciation expense that would be recognized under each of the following depreciation methods in the first and second years of the truck's useful life. A full year's depreciation will be recognized in the first year the truck is used.
1. Straight-line.
2. Double-declining-balance.
3. Units-of-output (based on miles).
b. Prepare the plant assets section of the balance sheet at the end of the second year in the asset's useful life under the units-of-output method, assuming the truck is the only plant asset owned by Haywood, Inc.
c. By which of the three methods is it not possible to determine the actual amount of depreciation expense prior to the end of each year? What uncertainty causes this to be true?
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Q 41Q 41
Hunt Company is considering purchasing a competing company in order to expand its market share. Estimates of the excess of the value of the individual assets, less liabilities to be assumed, range from $50.000-$60.000. depending on the manner in which that excess is calculated. Hunt believes it can purchase the competitor for a direct cash outlay of $700,000, which is only $25,000 more than the value of the individual assets less the liabilities that Hunt will assume. Assuming Hunt makes the purchase for $700,000. at what amount should goodwill be recorded? Briefly explain your answer.
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Q 42Q 42
Explain what is meant by an accelerated depreciation method. Are accelerated methods more widely used in financial statements or in income tax returns? Explain.
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Q 43Q 43
During the past several years the annual net income of Avery Company has averaged $540,000. At the present time the company is being offered for sale. Its accounting records show the book value of net assets (total assets minus all liabilities) to be $2,800,000. The fair value of Avery's net identifiable assets, however, is $3,000,000.
An investor negotiating to buy the company offers to pay an amount equal to the fair value for the net identifiable assets and to assume all liabilities. In addition, the investor is willing to pay for goodwill an amount equal to the above-average earnings for five years.
On the basis of this agreement, what price should the investor offer? A normal return on the fair value of net assets in this industry is 15 percent.
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Q 44Q 44
Depreciation and Disposal of Plant and Intangible Assets
During the current year, Rothchild, Inc., purchased two assets that are described as follows:
Rothchild depreciates heavy equipment by the declining-balance method at 150 percent of the straight-line rate. It amortizes intangible assets by the straight-line method. At the end of two years, because of changes in Rothchild's core business, it sold the patent to a competitor for $30,000.
Instructions
a. Compute the amount of depreciation expense on the heavy equipment for each of the first three years of the asset's life.
b. Compute the amount of amortization on the patent for each of the two years it was owned by Rothchild.
c. Prepare the plant and intangible assets section of Rothchild's balance sheet at the end of the first and second years. Also, calculate the amount of the gain or loss on the patent that would be included in the second year's income statement.
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Q 45Q 45
Depreciation and Disposal of Plant and Intangible Assets
Rodgers depreciates heavy equipment by the declining-balance method at 200 percent of the straight-line rate. It amortizes intangible assets by the straight-line method. At the end of two years, because of changes in Rodgers's core business, it sold the patent to a competitor for $38,000.
Instructions
a. Compute the amount of depreciation expense on the heavy equipment for each of the first three years of the asset's life.
b. Compute the amount of amortization on the patent for each of the two years it was owned by Rodgers.
c. Prepare the plant and intangible assets section of Rodgers's balance sheet at the end of the first and second years. Also, calculate the amount of the gain or loss on the patent that would be included in the second year's income statement.
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Q 46Q 46
Miller Mining acquired rights to a tract of land with the intent of extracting from the land a valuable mineral. The cost of the rights was $2,500,000 and an estimated 10.000 tons of the mineral are expected to be extracted. Assuming that 1.600 tons of the mineral are actually extracted in the first year, determine the amount of depletion expense that should be recognized for that year.
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Q 47Q 47
One accelerated depreciation method is callcd fixed- percentage-of-declining-balance. Explain what is meant by the terms "fixed-percentage" and "declining-balance." For what purpose is this method most widely used?
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Q 48Q 48
The Write-Down of Impaired Assets
For several years, a number of Food Lion, Inc., grocery stores were unprofitable. The company closed some of these locations. It was apparent that the company would not be able to recover the cost of the assets associated with the closed stores. Thus, the current value of these impaired assets had to be written down.
A note in the financial statements indicated that the company tests assets for impairment when. circumstances indicate that an impairment may exist. For impairment testing, each store is considered a cash-generating unit. Stores with potential impairments are tested by comparing their carrying value with their recoverable amounts.
a. ?Explain why Food Lion wrote down the current carrying value of its unprofitable stores.
b. ?Explain why the write-down of impaired assets is considered a noncash expense.
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Q 49Q 49
Alternative Depreciation Methods
M. C. J ones purchased a truck for $30,500 to be used in his business. He is considering depreciating the truck by two methods: units-of-output (assuming total miles driven of 80,000) and double-declining balance (assuming a five-year useful life). The truck is expected to be sold for approximately $6,500 at the end of its useful life. Prepare a comparison of the first year's depreciation expense that would be recognized by Jones under these methods, assuming the truck was actually driven 10,000 miles in the first year. Briefly state why the difference between the two is so great.
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Q 50Q 50
Evaluate the following quotation: "We shall have no difficulty in paying for new plant assets needed during the coming year because our estimated outlays for new equipment amount to only $80,000, and we have more than twice that amount in our accumulated depreciation account at present."
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Q 51Q 51
Bill Gladstone lias owned and operated Gladstone's Service Station for over 30 years. The business. which is currently the town's only service station, has always been extremely profitable. Gladstone recently decided that he wanted to sell the business and retire. His asking price excecds the fair market value of its net identifiable assets by nearly $50,000. Gladstone attributes this premium to the above-normal returns that the service station has always generated.
Gladstone recently found out about two issues that could have a profound effect upon the future of the business: (1) A well-known service station franchise will be built across the street from his station in approximately 18 months, and (2) one of his underground fuel tanks may have developed a very slow leak.
a. How might these issues affect the $50,000 in goodwill that Gladstone included in his selling price?
b. Assume that Gladstone is not disclosing this information to potential buyers. Does he have an ethical obligation to do so? Defend your answer.
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Q 52Q 52
Explain two approaches to computing depreciation for a fractional period in the year in which an asset is purchased. (Neither of your approaches should require the computation of depreciation to the nearest day or week.)
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Q 53Q 53
Salter Mining Company purchased the Northern Tier Mine for $21 million cash. The mine was estimated to contain 2.5 million tons of ore and to have a residual value of $1 million.
During the first year of mining operations at the Northern Tier Mine, 50,000 tons of ore were mined, of which 40,000 tons were sold.
a. Prepare a journal entry to record depletion during the year.
b. Show how the Northern Tier Mine, and its accumulated depletion, would appear in Salter Mining Company's balance sheet after the first year of operations.
c. Will the entire amount of depletion computed in part a be deducted from revenue in the determination of income for the year? Explain.
d. Indicate how the journal entry in part a affects the company's current ratio (its current assets divided by its current liabilities). Do you believe that the activities summarized in this entry do. in fact, make the company any more or less liquid? Explain.
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Q 54Q 54
Over what period of time should the cost of various types of intangible assets be amortized by regular charges against revenue? (Your answer should be in the form of a principle or guideline rather than a specific number of years.) What method of amortization is generally used?
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Q 55Q 55
Locate an annual report in your library (or some other source) that includes a large gain or loss on the disposal of fixed assets. Report to the class the amount of the gain or loss and where in the company's income statement it is reported. Describe how the gain or loss is reported in the company's statement of cash flows. Summarize any discussion in the footnotes concerning the cause of the disposal.
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Q 56Q 56
Mineral World recognizes $20 depletion for each ton of ore mined. During the current year the company mined 600,000 tons but sold only 500,000 tons, as it was attempting to build up inventories in anticipation of a possible strike by employees. How much depletion should be deducted from revenue of the current year?
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Q 57Q 57
Units-of-Output Method
During the current year, Central Auto Rentals purchased 60 new automobiles at a c o st of $14,000 per car. The cars will be sold to a wholesaler at an estimated $5,000 each as soon as they have been driven 50,000 miles. Central Auto Rentals computes depreciation expense on its automobiles by the units-of-output method, based on mileage.
a. Compute the amount of depreciation to be recognized for each mile that a rental automobile is driven.
b. Assuming that the 60 rental cars are driven a total of 1,570,000 miles during the current year, compute the total amount of depreciation expense that Central Auto Rentals should recognize on this fleet of cars for the year.
c. In this particular situation, do you believe the units-of-output depreciation method achieves a better matching of expenses with revenue than would the straight-line method? Explain.
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Q 58Q 58
Explain the meaning of an impairment of an asset. Provide several examples. What accounting event should occur when an asset has become substantially impaired?
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Q 59Q 59
Units-of-Output Depreciation Method
Sexton Company acquired a truck for use in its business for $26,500 in a cash transaction. T he truck is expected to be used over a five-year period, will be driven approximately 18,000 miles per year, and is expected to have a value at the end of the five years of $4,800.
a. Compute the amount of depreciation that will be taken in the first two years of the truck's useful life if the actual miles driven are 16,000 and 18,200, respectively. Round the depreciation per mile to the nearest whole cent.
b. How does the amount of accumulated depreciation at the end of the second year compare with what it would have been had the company chosen the straight-line depreciation method?
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Q 60Q 60
Several years ago Bennet Security purchased for $150,000 a well-known trademark for padlocks and other security products. After using the trademark for three years, Bennet Security discontinued it altogether when the company withdrew from the lock business and concentrated on the manufacture of aircraft parts. Amortization of the trademark at the rate of $7,500 a year is being continued on the basis of a 20-year life, which the owner says is consistent with accounting standards. Do you agree? Explain.
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Q 61Q 61
Using the Home Depot, Inc. , Financial Statements to Determine Depreciation Methods Used
The Home Depot financial statements and related material appear in Appendix A at t he end of this textbook. Use this to answer the following questions and indicate where in the financial statements you found the information.
a. What depreciation method does Home Depot use for buildings, furniture, fixtures, and equipment? What are the useful lives over which these assets are depreciated?
b. From the notes to Home Depot 's financial statements, what can you learn about the company's policy regarding impairment of plant assets?
c. Locate Home Depot 's balance sheet and find the section entitled "Property and Equipment, at cost." As of February 3, 2013, determine the amount of the company's investment in property and equipment and the amount of depreciation taken to date on those assets. Are these assets, as a whole, near the beginning or end of their estimated useful lives? Explain your answer.
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