Chapter 09 Solutions Manual

© The McGraw-Hill Companies, Inc., 2010Overview

CHAPTER 9

PROPERTY, PLANT AND EQUIPMENT,

INTANGIBLE ASSETS AND NATURAL RESOURCES

Brief LearningExercises Topic Objectives Skills

B. Ex. 9.1 Cost of PPE asset 1, 2 AnalysisB. Ex. 9.2 Straight-line depreciation 3 AnalysisB. Ex. 9.3 3 Analysis

B. Ex. 9.4 Declining-balance depreciation 3 AnalysisB. Ex. 9.5 3, 4 Analysis

B. Ex. 9.6 Disposal of PPE asset 3, 5 AnalysisB. Ex. 9.7 Disposal of PPE asset 3, 5 AnalysisB. Ex. 9.8 Goodwill 6 Analysis, communicationB. Ex. 9.9 Natural resources 7 AnalysisB. Ex. 9.10 Alternative depreciation methods 4 Analysis, communication

Exercises Topic Skills9.1 You as a student 2, 3 Analysis, communication, judgment9.2 Capital vs. revenue expenditure 1, 2 Analysis9.3 Depreciation for partial years 3 Analysis9.4 Accelerated vs. Straight-line 3 Analysis9.5 Real World: Li and Fung Limited 3 Communication, judgment

Depreciation disclosures9.6 Revision of depreciation estimates 3 Analysis9.7 Accounting for trade-ins 5 Analysis9.8 Estimating goodwill 6 Analysis9.9 Real World: Food Lion, Inc. 5, 8 Communication, judgment

Impaired assets9.10 Fair market value and goodwill 1, 6 Communication, judgment9.11 Natural resources 7 Analysis, communication, judgment9.12 Annual report presentations 6, 8 Communication, research9.13 Alternative depreciation methods 4 Analysis9.14 Units-of-output depreciation 4 Analysis9.15 Real World: adidas AG 1, 3 Analysis, communication, research

Examining an annual report

OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES

Straight-line and declining-balance depreciation

Straight-line and units of output depreciation

Learning Objectives

© The McGraw-Hill Companies, Inc., 2010Overview

CHAPTER 9

PROPERTY, PLANT AND EQUIPMENT,

INTANGIBLE ASSETS AND NATURAL RESOURCES

Skills

AnalysisAnalysisAnalysis

Analysis

Analysis, communicationAnalysisAnalysis, communication

SkillsAnalysis, communication, judgmentAnalysisAnalysisAnalysisCommunication, judgment

AnalysisAnalysisAnalysisCommunication, judgment

Communication, judgmentAnalysis, communication, judgmentCommunication, researchAnalysis

Analysis, communication, research

OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL

© The McGraw-Hill Companies, Inc., 2010Overview (2)

Problems

Sets A, B Topic Skills9.1 A,B Cost determination and depreciation Analysis, communication9.2 A,B Straight-line vs. accelerated 3, 5 Analysis

methods9.3 A,B Multiple depreciation issues

9.4 A,B Disposal of PPE assets 5 Analysis, communication9.5 A,B Accounting for intangible assets 6 Communication, judgment9.6 A,B Accounting for goodwill 6

9.7 A,B Alternative Depreciation Methods 4 Analysis, communication9.8 A,B Disposal of PPE and Intangible assets 2, 3, 5 Analysis

Critical Thinking Cases

9.1 Issues involving useful lives 3 Communication, judgment9.2 Departures from IFRS 1 Communication, judgment9.3 3, 4 Communication, judgment

Depreciation disclosures9.4 2 Communication, judgment

9.5 2

Researching R&D expenditures(Internet)

Learning Objectives

1–3

1–3, 5 Analysis, communication, judgment

Analysis, communication, judgment

Real World: Hong Kong and China Gas Company limited Company

Capitalization vs. expense (Ethics, fraud & corporate governance)

Real World: Pharmaceutical companies of student's choice

Communication, research, technology

*Supplemental Topic, “Other Depreciation Methods.”

© The McGraw-Hill Companies, Inc., 2010Description Problems

DESCRIPTIONS OF PROBLEMS ANDCRITICAL THINKING CASES

Problems (Sets A and B)9.1 A,B Edmonds University/Walker Hotel 25 Easy

9.2 A,B Swanson & Hiller,Corp./R & R, Company 45 Medium

9.3 A,B Smart Hardware/Davidson, DDS. 50 Strong

9.4 A,B Hong Developers/Kong Construction 25 Medium

9.5 A,B Black Corporation/Omega Products Corporation 25 Medium

9.6 A,B Kivi Service Stations/Japan Stores 20 Medium

Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers.

Students are required to distinguish between capital and revenue expenditures and compute depreciation expense.

Students must prepare depreciation schedules using both straight-line and accelerated methods. They must also evaluate income and cash flow issues as they relate to depreciation and the disposal of assets.

After determining the cost of a depreciable asset, students are required to prepare depreciation schedules under straight-line and accelerated methods. They must also (1) discuss the use of straight-line for financial purposes and accelerated depreciation for income taxes, (2) interpret the meaning of an asset’s book value, and (3) compute the gain or loss resulting from the disposal of a depreciable asset.

Numerous asset disposal transactions are presented for which students must compute appropriate gains or losses. In addition, students are asked to discuss how gains and losses on the disposal of PPE assets are reported in the income statement, and how the reporting of realized gains and losses differs from the reporting of unrealized gains and losses as illustrated in Chapter 7.

Various transactions must be evaluated in order to determine which result in the recording of an intangible asset and which are treated as expenses of the current period.

Students are asked to compute estimated goodwill using an earnings multiplier approach and a capitalization of excess earnings approach. In addition, they must distinguish between the accounting treatment of purchased goodwill versus the accounting treatment of internally generated goodwill.

© The McGraw-Hill Companies, Inc., 2010Description Problems (2)

9.7 A,B Millar Corp./Wilson Limited 30 Medium

9.8 A,B Oriental Company/Rodgers Company 30 Medium

Students must calculate depreciation for the first two years of an asset's life by three depreciation methods: straight-line, double declining-balance, and units of output. They are asked to prepare the balance sheet presentation of the asset by the DDB method and briefly discuss why the amount of depreciation expense for the units of output method cannot be calculated until the period has ended and the number of km driven is known.

Students are asked to calculate depreciation on two noncurrent assets by different depreciation/amortization methods and then to prepare the balance sheet section for PPE assets at the end of the first and second years the assets are owned. One of the assets is sold in the second year and the amount of the gain or loss on the same must be calculated.

© The McGraw-Hill Companies, Inc., 2010Desc. of Cases

Critical Thinking Cases9.1 Are Useful Lives "Flexible"? 20 Strong

9.2 Departures from IFRS—Are They Ethical? 20 Strong

9.3 Depreciation Policies in Annual Reports 20 Easy

9.4 Capitalization vs. Expense 30 MediumEthics, Fraud & Corporate Governance

9.5 R&D in the Pharmaceutical Industry No time estimateInternet

____________

ETHICS, FRAUD &CORPORATE GOVERNANCE

A look into the responsibilities of management accountants. Do they do as they are told, or is there more to it?

The owner of a closely held business asks the company’s accountant to prepare financial statements that depart from GAAPIFRS, and these statements will be presented to lenders. Is there a problem?

Students are asked to explain who determines a company’s depreciation policies, comment upon the propriety of depreciating different assets by different methods, and explain why accelerated depreciation methods are used for profit tax purposes. Based upon the financial disclosures of a well-known corporation.

Students are asked to explore the management's motivation for capitalizing vs. expensing costs and think about steps that could be taken to prevent employees from doing things that are inconsistent with company policy and code of professional ethics.

An Internet research problem that requires students to research R&D expenditures in the pharmaceutical industry.

*Supplemental Topic, “Other Depreciation Methods.”

© The McGraw-Hill Companies, Inc., 2010Q1-10

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

Coca-Cola’s trademark name was not purchased from another company, but rather was developed internally. Thus, the development costs probably were not material and were treated as revenue expenditures. Even if these costs had been capitalized, any costs associated with this trademark now would be fully amortized, leaving a zero book value.

There are three basic “accountable events” in the life of a PPE asset: (1) acquisition, (2) allocation of the acquisition cost to expense, and (3) disposal. The second event, allocation of the acquisition cost to expense, typically has the greatest effect upon profit. However, any gain or loss on disposal also affects profit. The allocation of acquisition cost to expense has no effect upon cash flows (other than income taxes). However, the acquisition of PPE assets requires cash outlays, and disposals often result in cash receipts.

(a) Intangible, (d) held for sale in the regular course of business, and (e) not capable of rendering benefits to the business in the future.

(a) Freight charges, (b) sales taxes on the machine, and (d) wages of employees for time spent in installing and testing the machine before it was placed in service.

A capital expenditure is one that is material in amount and will benefit several accounting periods and is therefore charged to an asset account. A revenue expenditure is assumed to benefit only the current period (or is not material in amount) and is charged to an expense account so that it will be deducted from revenue of the current period in the determination of profit.

If a capital expenditure (acquisition of an asset) is erroneously treated as a revenue expenditure (an expense), expenses of the current year will be overstated and profit, therefore, will be understated. Since this error also results in the failure to record an asset, profit will be overstated in all future periods in which depreciation should have been recognized on the amount that should have been recorded as an asset.

The entire $24,500,000 cost should be charged to the land account. The existing structures are of no value to Metro and soon will be torn down. Thus, the only asset being acquired by Metro is the building site, which is classified as land.

(d) Allocation of the cost of a PPE asset to the periods in which benefits are received.

Yes, depreciation of the building should be continued regardless of rising market value. The building will render useful services for only a limited number of years and its cost should be recognized as expense of those years regardless of fluctuations in market value.

An accelerated depreciation method is one that recognizes greater amounts of depreciation expense in the early years of an asset’s life, and less in the later years. These methods are most widely used in income tax returns because larger deductions for depreciation will reduce both taxable income and the income tax payments due in the immediate future.


11.

The declining-balance method is most widely used in income tax returns.

12.

13.

14.

15. a.

b.

16.

17.

18.

Under the fixed-percentage-of-declining-balance depreciation method, a fixed depreciation rate is applied to the asset’s undepreciated cost. The “fixed-percentage” is a percentage of the straight-line depreciation rate. This percentage is said to be “fixed” because it does not change over the life of the asset. The declining balance is the asset’s undepreciated cost (or book value), which gets lower every year.

Many companies use only the straight-line method of depreciation in their financial statements. However, if permitted by local tax regulation, these companies also may compute depreciation by several other methods for income tax purposes. For example, in the US, they may use MACRS depreciation in their federal income tax returns, and various forms of the declining-balance method in their state income tax returns.

The balance of the Accumulated Depreciation account does not consist of cash. It is an account with a credit balance showing how much of the original cost of a company’s PPE assets has been written off as depreciation expense. Cash is required to pay for new assets, and the cash owned by the company is shown by the asset account Cash.

Two widely used approaches to computing depreciation for a fraction of a year are (1) to round the computation to the nearest full month and (2) the half-year convention, which takes six months of depreciation on all assets (of a given type) acquired during the year. (The half-year convention also requires that six months’ depreciation be recorded in the last year of the asset’s life or year of disposal.)

No; a company may use different depreciation methods for different assets. The principle of consistency means only that once depreciation begins on a given asset, the same method should be applied throughout its useful life.

No; a corporation may not use different depreciation methods in its financial statements and its income tax returns.

The usual method of revising depreciation rates to reflect a changed estimate of useful life is to spread the undepreciated cost over the years of remaining useful life. This results in raising or lowering the annual depreciation charge. In this case, the undepreciated cost is $9,000, that is, cost of $15,000 less accumulated depreciation of $6,000. The revised estimate calls for 8 more years of use, so the new depreciation charge will be $1,125 ($9,000/8 years). It also has the theoretical merit of ensuring that depreciation expense as shown in the income statements over the life of the asset will equal the total depreciable cost of the asset.

Intangible assets are a subcategory of non-current assets which are identifiable nonmonetary assets without physical substance that is controlled by the entity and has future economic benefits. An account receivable of the type described is a current asset and excluded from qualifying as an intangible asset even though it is lacking in physical substance.

The cost of each type of intangible asset should be amortized over the period estimated to be benefited. The straight-line method is generally used for the amortization of intangible assets.


19.

20.

21.

22.

Goodwill is recorded in the accounts only when purchased. The most common example is that of an ongoing business being purchased as an entity by new owners. If the purchase price is in excess of a fair value of the net identifiable assets of the business, the transaction provides objective evidence that goodwill exists and also provides a basis for objective valuation of thisasset.

Depletion in the amount of $100,000,000 should be deducted from revenue in the current year. The other $20,000,000 of costs applicable to the current year’s operations will be included in the valuation of the ending inventory. Costs assigned to inventory represent current assets until the goods are sold, at which time the costs are transferred to the Cost of Goods Sold account.

An asset is “impaired” when the undepreciated cost cannot be recovered either through use or sale. In such situations, the carrying amount of the asset should be reduced (written down) to fair value, which results in the recognition of a loss.

The owner of Walker Security is in error. When the company discontinued use of the trademark, the unamortized cost of this asset should have been written off immediately. A trademark or other intangible should not be carried as an asset after its usefulness has ended.

© The McGraw-Hill Companies, Inc., 2010BE9.1,2,3

SOLUTIONS TO BRIEF EXERCISES

B.Ex. 9.1 Equipment cost: Purchase price $25,000 Delivery 750 Reconditioning 2,230

$27,980

B.Ex. 9.2 Depreciation expense for each of the first two years: ($40,000,000 - $10,000,000)/25 years = 1,200,000

Book value at the end of Year 2: $40,000,000 - ($1,200,000 x 2) = $37,600,000

B.Ex. 9.3 Year 1Straight-line depreciation: ($24,000 - $4,000)/10 years = $2,000

150% declining-balance depreciation: $24,000 x .15 = $3,600

Excess of declining-balance over Straight-line $1,600

Note: Straight-line rate = 100% /10 years = 10% Declining-balance rate = 10% x 1.5 = 15%

Year 2Straight-line depreciation: same as above $2,000

150% declining-balance depreciation: ($24,000 - $3,600) x .15 = $3,060

Excess of declining-balance over Straight-line $1,060

Total cost for purposes of determining annual depreciation

Note: Maintenance for the first year of use is not included in the cost basis for purposes of calculating annual depreciation.

© The McGraw-Hill Companies, Inc., 2010BE9.4,5,6

B.Ex. 9.4 Double-declining balance depreciation: $76,000 x 25% =

$19,000150% declining-balance depreciation: $76,000 x 18.75% = $14,250

$4,750

Declining-balance rates are determined as follows: Straight-line rate: 100%/8 years 12.50% Double declining-balance rate: 12.5 x 2 25.00% 150% declining-balance rate: 12.5 x 1.5 18.75%

B.Ex. 9.5 Straight-line depreciation: ($350,000 - $50,000)/5 years = $ 60,000

Units of Output depreciation; 16,000 km x $4* = $ 64,000 *($350,000 - $50,000)/75,000 km = $4 per km

B.Ex. 9.6 Selling price of equipment $7,200 Book value of equipment sold: Cost $12,000 Less: accumulated depreciation* 6,000 6,000Gain on sale $1,200

*[($12,000 - $2,000)/5 years] x 3 years = $6,000

Excess of double declining-balance over 150% declining-balance

© The McGraw-Hill Companies, Inc., 2010BE9.7,8,9,10

B.Ex. 9.7 Selling price of equipment $8,500 Book value of equipment sold: Cost $27,500 Less: accumulated depreciation* 17,600 9,900 Loss on sale $1,400

*Yr. 1: $27,500 x 40% = $11,000 Yr. 2: ($27,500 - $11,000) x 40% = $6,600 Total Yrs. 1 and 2: $11,000 + $6,600 = $17,600 Double-declining balance rate: Straight-line rate: (100%/5 years) x 2 = 40%

B.Ex. 9.8

B.Ex. 9.9 Cost per ton of mineral to be extracted: ($25,000,000)/10,000 tons = $2,500 per ton

Depletion expense for first year: 1,600 tons x $2,500 = $4,000,000

B.Ex. 9.10 Cost basis for determining depreciation expense under both methods:

$305,000 - $65,000 = $240,000

Yr. 1Units of Output method of depreciation: 10,000 km x $3* per km = $30,000 *$240,000/80,000 km = $3 per km

Double-Declining Balance method of depreciation: $305,000 x 40%* = 122,000

Excess of Double-Declining Balance over Units of Output: $92,000

Goodwill should be recorded at $250,000, the actual amount by which the purchase price of $7,000,000 exceeds the fair value of the assets, less liabilities, to be assumed by Hunt. Higher estimates of the value of the excess that are not objectively supported

*100%/5 years x 2 = 40%

The difference between depreciation by the two methods is so high for two reasons: First, Double-declining balance is an accelerated method and naturally results in higher depreciation in the early years of the asset's life. Second, the truck was actually only driven 10,000 km in the first year, which makes the units of output calculation lower than it would have been had the truck been driven the expected level of 16,000 km (80,000 km/5 years). The Double-declining balance method is not affected by the lower number of km driven.

© The McGraw-Hill Companies, Inc., 2010E9.1,2

SOLUTIONS TO EXERCISESEx. 9.1 a.

b.

c.

Ex. 9.2 a. Capital expenditureb. Revenue expenditurec. Revenue expenditured. Capital expendituree.

f. Capital expenditure

Two factors have caused the van to depreciate: (1) physical deterioration and (2) obsolescence. The kilometres driven during the past six years have caused wear and tear on all of the van’s major components, including its engine, transmission, brakes, and tires. As these components deteriorate, their fair values, in turn, depreciate. Furthermore, during the time that you have owned the van, innovations have been developed leading to improved fuel economy, higher horsepower, better handling, and more corrosion-resistant materials. These innovations have made the van obsolete in many respects. As the design and engineering technologies associated with the van become more and more outdated, its fair market value will continue to depreciate.

No. It is not likely that the bank will lend you an additional $50,000, even if you agree to pledge your van as collateral. Your van will continue to depreciate in value each year. By the time you begin repayment of your loan, it will be worth less to the bank than its current fair market value.

Depreciation is a process of cost allocation, not a process of valuation. As such, accounting records do not attempt to show the current fair values of business assets. Only by coincidence would the balance sheet show $100,000 in accumulated depreciation on this van.

Revenue expenditure (too small in amount to capitalize regardless of length of useful life)

© The McGraw-Hill Companies, Inc., 2010E9.3

Ex. 9.3 a. b.Straight-Line 200% Declining-Balance

Year (Half-Year Convention) (Half-Year Convention)1 $ 59,375 (1) $ 125,000 (3)2 118,750 (2) 218,750 (4)3 118,750 164,063 4 118,750 123,047 5 118,750 92,285 6 118,750 69,214 7 118,750 52,547 (5)8 118,750 52,547 9 59,375 (1) 52,547

Totals $ 950,000 $ 950,000

(1)(2)(3)(4)(5) Switch to straight-line:

c.

$950,000 ´ 1¤8 ´ 1¤2 = $59,375$950,000 ´ 1¤8 = $118,750$1,000,000 ´ 25% ´ 1¤2 = $125,000($1,000,000 – $125,000) ´ 25% = $218,750

($207,641 – $50,000) ¸ 3 years = $52,547

During the first four years of the asset’s life depreciation expense under the straight-line method is significantly less than it is under the accelerated method. Thus, the straight-line method results in higher profit for these years.


Ex. 9.4

a. (1) Straight-Line ScheduleBook

Year Computation Value2010 $7,000 $7,000 $ 33,000

20101 7,000 14,000 26,000 2012 7,000 21,000 19,000 2013 7,000 28,000 12,000 2014 7,000 35,000 5,000

(2) 200% Declining-Balance ScheduleAccumulated Book

Year Computation Depreciation Value2010 $16,000 $16,000 $ 24,000 2011 9,600 25,600 14,400 2012 5,760 31,360 8,640 2013 3,456 34,816 5,184 2014 $5,184 – $5,000 184 35,000 5,000

(3) 150% Declining-Balance ScheduleAccumulated Book

Year Computation Depreciation Value2010 $12,000 $12,000 $ 28,000 2011 8,400 20,400 19,600 2012 5,880 26,280 13,720 2013* 4,360 30,640 9,360 2014* 4,360 35,000 5,000

* Switch to straight-line

b.

Depreciation Expense

Accumulated Depreciation

$35,000 ´ 1/535,000 ´ 1/535,000 ´ 1/535,000 ´ 1/535,000 ´ 1¤5


$40,000 ´ 40%24,000 ´ 40%14,400 ´ 40%8,640 ´ 40%


$40,000 ´ 30% 28,000 ´ 30% 19,600 ´ 30%

($13,720 – $5,000) ¸ 2 yrs.($13,720 – $5,000) ¸ 2 yrs.

Both accelerated methods result in a higher depreciation expense than the straight-line method in the first two years of the asset’s life. This pattern reverses in years 2011-2013. After four years, 99% of the asset’s total depreciation expense has been recorded under the 200% declining-balance method, as compared to only 88% under the 150% declining-balance method.


Ex. 9.5 a.

b.

c.

No, the use of different depreciation methods in financial statements and in income tax returns does not violate the accounting principle of consistency. The principle of consistency means only that a company should not change from year to year the method used to depreciate a given asset. This principle does not prohibit using a different depreciation method for income tax purposes. Also, the principle does not prevent management from using different depreciation methods to depreciate different assets.

The company probably uses accelerated depreciation methods for income tax purposes because these methods postpone the payment of income taxes. Accelerated depreciation methods transfer the cost of PPE assets to expense more quickly than does the straight-line method. The resulting larger charges to depreciation expense reduce “taxable income” in the current period and, therefore, reduce the amount of income taxes due currently.

Use of accelerated depreciation methods in the financial statements would be more “conservative” than the current practice of straight-line depreciation. Accelerated methods more quickly transfer the costs of PPE assets to expense. Thus, in the immediate future, accelerated depreciation methods produce more conservative (lower) balance sheet amounts of PPE assets and more conservative (lower) measurements of profit.


Ex. 9.6 a. 200611 Jan. Machinery ……………………………………… 90,000

Cash …………………………………… To record purchase of machinery.

31 Dec. Depreciation Expense: Machinery … 6,000Accumulated Depreciation: Machinery

To record depreciation for first year:

2007-200931 Dec. Depreciation Expense: Machinery ………… 6,000

Accumulated Depreciation: Machinery To record depreciation for years 2007-2009

201031 Dec. Depreciation Expense: Machinery …… 3,000

Accumulated Depreciation: Machinery

Cost of machine ……………………………… $ 90,000

Less: Depreciation for 2006-2009 … 24,000

Book value at end of 2009 ………………… $ 66,000

Less: Residual value ………………………… 18,000

Amount to be depreciated over 16 remaining years of new estimated useful life………………………………… $ 48,000

$ 3,000

b.

Ex. 9.7 a.

b. Trade-in allowance …………………………………………………..

Loss on trade-in ……………………………………………………..

c.

($90,000 - $18,000) ´ 1¤12.

To record depreciation for fifth year, based on revised estimate of useful life, determined as follows:

Depreciation per year ($48,000 ¸ 16) ……………………

Several factors may have caused the company to revise its estimate: (1) The equipment may be deteriorating physically more slowly than originally anticipated, (2) the company may not be using the equipment as much as it had previously expected, or (3) new technology that had been anticipated may not have developed as rapidly as expected.

$550,000 ($650,000 less $100,000 trade-in allowance)

Less: Book value ($520,000 - $340,000) ……………………………

The $80,000 loss on trade-in will be reported in Hong Kong's income statement following the computation of income from operations.


90,000

6,000

6,000

3,000

$ 100,000 180,000

$ (80,000)

Several factors may have caused the company to revise its estimate: (1) The equipment may be deteriorating physically more slowly than originally anticipated, (2) the company may not be using the equipment as much as it had previously expected, or (3) new technology that had been anticipated may not have developed

The $80,000 loss on trade-in will be reported in Hong Kong's income statement

© The McGraw-Hill Companies, Inc., 2010E9.8,9,10

Ex. 9.8 Average earnings …………………………………………………………Normal earnings, 15% of $30,000,000 ……………………………Excess earnings …………………………………………………………Goodwill ($900,000 x 5) ………………………………………………Fair value of net identifiable assets …………………………………….Price to be offered for Avery Company. ……………………………

Ex. 9.9 a.

b.

a.

Ex. 9.10 a.

b.

If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its fair value. Failure to do so may cause investors and creditors to draw erroneous conclusions concerning the company’s profitability and future cash flow potential.

The write-down of impaired PPE assets reduces income and the asset’s carrying amount, but has no immediate impact on the company’s cash flows. Thus, such charges against income are considered noncash transactions.Goodwill is the present value of future earnings in excess of normal returns onidentifiable assets. It is important to realize that the valuation of goodwill doesnot attempt to measure past earnings performance. For 30 years Gladstone’sbusiness generated returns in excess of what may be considered normal for asmall service station. However, the competitive threat of a new station comingto town, combined with the potential environmental threat of a leaky storagetank, reduces expectations that future performance will equal or exceed pastperformance. Thus, these issues should reduce, or eliminate completely,Gladstone’s $500,000 estimate of goodwill.

We have all heard the expression, “let the buyer beware.” To a certain extent,buyers have an obligation to exercise due diligence before making majorbusiness decisions. Thus, one could probably argue that Gladstone does nothave an ethical “obligation” to disclose that a new service station will soon bebuilt across the street. The situation involving his potentially leaky tank is adifferent story, however. If he is reasonably certain about the failing conditionof the tank, he may have both an ethical and a legal obligation to disclose thisinformation. Again, however, a potential buyer should exercise due diligenceprior to buying Gladstone’s business to determine whether an environmentalthreat exists.

Note to instructor: Before making large loans to finance business acquisitions, banks normally require that borrowers engage in certain due diligence procedures which, in many situations, include an "environmental audit."


$ 5,400,000 4,500,000 $ 900,000 $ 4,500,000 30,000,000 $ 34,500,000

If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its fair value. Failure to do so may cause investors and creditors to draw erroneous conclusions concerning the company’s profitability and

The write-down of impaired PPE assets reduces income and the asset’s carrying amount, but has no immediate impact on the company’s cash flows. Thus, such charges against income are considered noncash transactions.Goodwill is the present value of future earnings in excess of normal returns onidentifiable assets. It is important to realize that the valuation of goodwill doesnot attempt to measure past earnings performance. For 30 years Gladstone’sbusiness generated returns in excess of what may be considered normal for asmall service station. However, the competitive threat of a new station comingto town, combined with the potential environmental threat of a leaky storagetank, reduces expectations that future performance will equal or exceed pastperformance. Thus, these issues should reduce, or eliminate completely,

We have all heard the expression, “let the buyer beware.” To a certain extent,buyers have an obligation to exercise due diligence before making majorbusiness decisions. Thus, one could probably argue that Gladstone does nothave an ethical “obligation” to disclose that a new service station will soon bebuilt across the street. The situation involving his potentially leaky tank is adifferent story, however. If he is reasonably certain about the failing conditionof the tank, he may have both an ethical and a legal obligation to disclose thisinformation. Again, however, a potential buyer should exercise due diligenceprior to buying Gladstone’s business to determine whether an environmental

Before making large loans to finance business acquisitions, banks normally require that borrowers engage in certain due diligence procedures which, in many situations,


Ex. 9.11 a. Inventory ……………………………………………… 4,000,000Accumulated Depletion: Northern Tiger Mine

b. Property, plant, & equipment:Mining property: Northern Tiger Mine …….. $210,000,000 Less: Accumulated depletion ………………. 4,000,000

c.

d.

Ex. 9.12

Ex. 9.13 a. = $90,000 = $1.8 per km

50,000 km 50,000 km

b.

c.

To record depletion on the Northern Tiger Mine: 50,000 tons mined ´ $80 per ton [($210,000,000 - $10,000,000) ¸ 2,500,000 tons = $80 per ton].

No; the $4,000,000 of depletion of the mine should not all be deducted from revenue during the first year of operations. Since only 40,000 of the 50,000 tons of ore mined were sold, only 80% of the depletion cost ($3,200,000) should be deducted from revenue as part of the cost of goods sold. The remaining 20% of this amount ($800,000) relates to the 10,000 tons of ore still on hand and remains in the inventory account.

The journal entry in part a increases the current ratio, because it reclassifies an amount of PPE assets as inventory, which is a current asset. Thus, current assets are increased. Extracting ore from the ground does make the company more liquid. Mined ore is a more liquid asset than ore that is still in the ground.

The purpose of this exercise is to: (1) show students that gains and losses on disposals can be very material in amount, (2) demonstrate that such gains and losses do not directly involve cash flows and, therefore, are typically shown as adjustments to income in the statement of cash flows, and (3) illustrate that the reasons for disposing of fixed assets may include restructuring activities, damage caused by natural disasters, the need to upgrade manufacturing processes, etc.

$140,000 - $50,000

1,770,000 km ´ $1.8 per km = $3,186,000

Yes. The units-of-output method recognizes more depreciation in periods in which the cars are driven more—which means that the cars are generating more revenue. The straight-line method would recognize the same amount of depreciation expense regardless of how much the automobiles were driven.


4,000,000

Property, plant, & equipment:

$206,000,000

$1.8 per km

No; the $4,000,000 of depletion of the mine should not all be deducted from revenue during the first year of operations. Since only 40,000 of the 50,000 tons of ore mined were sold, only 80% of the depletion cost ($3,200,000) should be deducted from revenue as part of the cost of goods sold. The remaining 20% of this amount ($800,000) relates to the 10,000 tons of ore still on hand and remains in the inventory account.

increases the current ratio, because it reclassifies an amount of PPE assets as inventory, which is a current asset. Thus, current assets are increased.

make the company more liquid. Mined ore is a

The purpose of this exercise is to: (1) show students that gains and losses on disposals can be very material in amount, (2) demonstrate that such gains and losses do not directly involve cash flows and, therefore, are typically shown as adjustments to income in the statement of cash flows, and (3) illustrate that the reasons for disposing of fixed assets may include restructuring activities, damage caused by natural disasters, the need to upgrade

Yes. The units-of-output method recognizes more depreciation in periods in which the cars are driven more—which means that the cars are generating more revenue. The straight-line method would recognize the same amount of depreciation expense


Ex. 9.14 a. The depreciation rate per kilometer is calculated as follows:

($255,000 - $45,000)/(18,000 x 5 years) = $2.3 per km

Depreciation for the first two years is calculated as follows:

Yr. 1 = 16,000 miles x $2.3 = $36,800

Accumulated at Yr. 2 $78,660

b. Depreciation by the straight-line method would have been:

($255,000 - $45,000)/5 years = $42,000 x 2 years = $84,000

Ex. 9.15 a.

b.

c.

Yr. 2 = 18,200 miles x $2.3 = 41,860

Straight-line depreciation would have exceeded units-of-output depreciation by $5,340: $84,000 - 78,660 = $5,340

Note 2, Summary of Significant Accounting Policies, indicates that land, construction in progress, buildings, leasehold improvements, technical equipment and machinery as well as furniture and fittings are stated at cost. Other than land and construction in progress, depreciation is computed utilizing the"straight-line method", except where the "declining-balance method" is more appropriate in light of the actual utilization pattern. Estimated useful lives are 5 to 50 years for buildings/leasehold improvements, and 2 to 10 years for technical equipment and machinery as well as other equipment and furniture and fittings.

Note 2 indicates that subsequent to recognition, all items of property, plant and equipment, except for land and construction in progress, are measured at cost less accumulated depreciation and accumulated impairment losses. The company reviews the carrying amount of financial assets, including property, plant and equipment, for impairment when facts and circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized in the income statement if the carrying amount exceeds the recoverable amount.

The 31 December 2009 balance sheet shows that the carrying amount of PPE is in the amount of €723 million. Since the accumulated depreciation (i.e., the amount of depreciation taken to date) on these assets is €757 million, the gross PPE is thus €1,412 million (excluding €68 million construction in progress). This indicates that the assets are, on average, about 53.6% depreciated (€757 million/€1,412 million) and, accordingly, are in the middle of their estimated useful lives.

© The McGraw-Hill Companies, Inc., 2010P9.1A

SOLUTIONS TO PROBLEMS SET A25 Minutes, Easy PROBLEM 9.1A

EDMONDS UNIVERSITY

a.

b. (1)

(2)

(3)

(4)

equipment.

(5)

(6)

The cost of property, plant and equipment includes all expenditures that are reasonable and necessary in acquiring the asset and placing it in a position and condition for use in the operation of the business.

The purchase price of $2,500,000 is part of the cost of the equipment. The list price ($2,750,000) is not relevant, as this is not the actual price paid by Edmonds. The $45,000 in interest charges are a charge for borrowing money, not part of the cost of the equipment. These interest charges should be recognized as interest expense over the 90-day life of the note payable.

Sales tax is a reasonable and necessary expenditure in the purchase of PPE assets and should be included in the cost of the equipment.

Freight charges are part of the cost of getting the equipment to a usable location and, therefore, are part of the cost of the equipment.

To be used in university operations, the equipment must first be installed. Thus, normal installation charges should be included as part of the cost of the equipment.

The accidental damage to one of the terminals was not a “reasonable andnecessary” part of the installation process and, therefore, should not be includedin the cost of the equipment. The repairs do not make the equipment any moreuseful than it was before the damage was done. Therefore, the $5,000 cost ofrepairing the damage should be offset against revenue of the current period.(Technically, this amount should be classified as a loss in the current period. Forpractical purposes, however, it probably would be charged to an expense accountsuch as Repairs and Maintenance.)

Advertising is viewed by accountants as a revenue expenditure—that is, charged to expense when the advertising occurs. There is not sufficient objective evidence of future benefit for accountants to regard advertising expenditures as creating an asset.

© The McGraw-Hill Companies, Inc., 2010P9.1A(p.2)

PROBLEM 9.1AEDMONDS UNIVERSITY (concluded)

c. Expenditures that should be debited to the Computing Equipment account:

Purchase price $ 2,500,000 Sales tax 150,000

Freight charges 10,000 Installation charges 50,000 $ 2,710,000

d.General Journal

Dec 31 Depreciation Expense: Computing Equipment 271,000 Accumulated Depreciation: Computer Equip. 271,000

To record depreciation of computing equipment in

the year of acquisition ($2,710,000 cost ÷ 5 years) x 1/2.


45 Minutes, Medium PROBLEM 9.2ASWANSON & HILLER CORPORATION

a. (1) Straight-Line Schedule:Book

Year Computation Value2007 $ 10,000 $10,000 $98,0002008 20,000 30,000 78,0002009 20,000 50,000 58,0002010 20,000 70,000 38,0002011 20,000 90,000 18,0002012 10,000 100,000 8,000

(2) 200% Declining-Balance Schedule:Accumulated Book

Year Computation Depreciation Value2007 $21,600 $21,600 $86,400 2008 34,560 56,160 51,8402009 20,736 76,896 31,1042010 12,442 89,338 18,6622011 7,465 96,803 11,1972012 100,000 – 96,803 3,197 100,000 8,000


Year Computation Depreciation Value2007 $16,200 $16,200 $91,8002008 27,540 43,740 64,2602009 19,278 63,018 44,9822010 13,495 76,513 31,4872011* 11,744 88,257 19,7432012* 11,743 100,000 8,000

* Switch to straight-line



$100,000 ´ 1¤5 ´ 1¤2100,000 ´ 1¤5100,000 ´ 1¤5100,000 ´ 1¤5100,000 ´ 1¤5

100,000 ´ 1¤5 ´ 1¤2


$108,000 ´ 40% x 1¤286,400 ´ 40%51,840 ´ 40%31,104 ´ 40%18,662 ´ 40%


$108,000 ´ 30% x 1¤291,800 ´ 30%64,260 ´ 30%44,982 ´ 30%

($31,487 – $8,000) ¸ 2 yrs.($31,487 – $8,000) ¸ 2 yrs.

© The McGraw-Hill Companies, Inc., 2010P9.2A (P.2)

PROBLEM 9.2A

b.

c. Computation of gains or losses upon disposal:

1. Straight-Line

Cash proceeds $ 28,000 Book value on 31/12/10 (38,000)Loss on disposal $ (10,000)

2. 200% Declining-Balance:

Cash proceeds $ 28,000 Book value on 31/12/10 (18,662)Gain on disposal $ 9,338


Cash proceeds $ 28,000 Book value on 31/12/10 (31,487)Loss on disposal $ (3,487)

SWANSON & HILLER CORPORATION (concluded)

Swanson & Hiller will probably use the straight-line method for financial reporting purposes, as this method results in the least amount of depreciation expense in the early years of the asset’s useful life.

The reported gain or loss on the sale of an asset has no direct cash effects. The only direct cash effect associated with the sale of this machine is the $28,000 received by Swanson & Hiller from the sale of the machine.


50 Minutes, Strong PROBLEM 9.3ASMART HARDWARE

a. Costs to be depreciated include:

Cost of shelving $ 120,000

Freight charges 5,200

Sales taxes 7,800

Installation 27,000

Total cost to be depreciated $ 160,000

(1) Straight-Line Schedule (nearest whole month):

Year Computation2010 $6,000 $6,0002011 8,000 14,0002012 8,000 22,0002013 8,000 30,000

(2) 200% Declining-Balance (half-year convention):Accumulated

Year Computation Depreciation2010 $8,000 $8,0002011 15,200 23,2002012 13,680 36,8802013 12,312 49,192





$160,000 ´ 1¤20 ´ 9¤12 160,000 ´ 1¤20 160,000 ´ 1¤20 160,000 ´ 1¤20


$160,000 ´ 10% ´ 1¤2152,000 ´ 10%136,800 ´ 10%123,120 ´ 10%


$160,000 ´ 7.5% ´ 1¤2154,000 ´ 7.5%142,450 ´ 7.5%131,770 ´ 7.5%


PROBLEM 9.3ASMART HARDWARE


(1) Straight-Line Schedule (nearest whole month):BookValue$154,000

146,000138,000130,000

(2) 200% Declining-Balance (half-year convention):BookValue$152,000

136,800123,120110,808


142,450131,770121,888

© The McGraw-Hill Companies, Inc., 2010P9.3A (P.2)

PROBLEM 9.3ASMART HARDWARE (concluded)

b.

c.

d.

1. Journal entry assuming that the shelving was sold for $12,000:

Cash 12,000Accumulated Depreciation: Shelving 86,000 Shelving 90,000 Gain on Disposal of PPE Assets 8,000

To record sale of shelving for $12,000 cash.

2. Journal entry assuming that the shelving was sold for $2,000:

Cash 2000Accumulated Depreciation: Shelving 86,000Loss on Sale of PPE Asset 2000 Shelving 90,000

To record sale of shelving for $2,000 cash.

Smart may use the straight-line method in its financial statements to achieve the least amount of depreciation expense in the early years of the shelving’s useful life. In its income tax return, Smart may use an accelerated method that will reduce Smart’s taxable income as much as possible in the early year’s of the shelving’s useful life. Thus, management’s goals are really not in conflict.

The 200% declining-balance method results in the lowest reported book value at the end of 2013 ($110,808). Depreciation, however, is not a process of valuation. Thus, the $110,808 book value is not an estimate of the shelving’s fair value at the end of 2013.

A book value of $4,000 means that accumulated depreciation at the time of the disposal was $86,000.


25 Minutes, Medium PROBLEM 9.4AHONG DEVELOPERS

a.

General Journal

10 Feb Loss on Disposal of PPE Assets 2,000

Accumulated Depreciation: Office Equipment 258,000 Office Equipment 260,000 Scrapped office equipment; received no salvage value.

1 Apr Cash 1,000,000 Notes Receivable 8,000,000 Accumulated Depreciation: Building 2,500,000 Land 500,000 Building 5,500,000 Gain on Sale of PPE Assets 5,500,000 Sold land and building for a $1,000,000 cash down- payment and a 5-year, 9% note for the balance.

15 Aug Vehicles (new truck) 390,000 Accumulated Depreciation: Vehicles (old truck) 180,000 Vehicles (old truck) 260,000 Gain on Disposal of PPE Assets 20,000 Cash 290,000 To record trade-in of old truck on new; trade-in allowance exceeded book value by $20,000.

1 Oct Office Equipment (new computer) 80,000 Loss on Trade-in of PPE Assets 35,000 Accumulated Depreciation: Office Equip. (old computer) 110,000 Office Equipment (old computer) 150,000 Cash 15,000 Notes Payable 60,000 Acquired new computer system by trading in old computer, paying part cash, and issuing a 1-year, 8% note payable. Recognized loss equal to book value of old computer ($40,000) minus trade-in allowance ($5,000).

b.

c.

Gains and losses on asset disposals do not affect gross profit because they are not part of the cost of goods sold. Such gains and losses do, however, affect profit reported in a firm’s income statement.

Unlike realized gains and losses on asset disposals, unrealized gains and losses on investment in securities (Gain or Loss on Fair Value Change of Investments) are not generally reported in a firm’s income statement. Instead, they are reported in the balance sheet as a component of shareholders’ equity.


25 Minutes, Medium PROBLEM 9.5ABLACK CORPORATION

a.

b.

c.

d.

e.

Operating expense. Although the training of employees probably has some benefit extending beyond the current period, the number of periods benefited is highly uncertain. Therefore, current accounting practice is to expense routine training costs.

Intangible asset. Goodwill represents the present value of future earnings in excess ofwhat is considered normal. The goodwill associated with Black’s purchase of the vinylflooring company should not be amortized, but is subject to evaluation for impairmentin value.

Operating expense. Because of the uncertainty surrounding the potential benefits of R&D programs, expenditure on research and or on the research phase of an internal project are charged to expense in the period in which these costs are incurred. Expenditure on development and or on the development phase of an internal project can't be recognised as an intangible asset unless they satisfy all the 6 specific recognition criteria as discussed in the chapter. Although this accounting treatment is controversial, it has the benefit of reducing the number of alternative accounting practices previously in use, thereby increasing the comparability of financial statements. If a patent is actually acquired at some time in the future, the costs of acquisition (e.g., registration and legal costs) will be capitalized as an asset and amortized over the estimated useful life, limited to 20 years.

Intangible asset. A patent grants its owner the exclusive right to produce a particular product. If the patent has significant cost, this cost should be regarded as an intangible asset and expensed over the period of time that ownership of the patent will contribute to revenue. In this case, revenue is expected to be earned only over the 6-year period during which the product will be produced and sold.

Operating expense. Advertising costs are regarded as operating expense because of the difficulty in objectively determining the existence or life of any future benefit.


20 Minutes, Medium PROBLEM 9.6AKIVI SERVICE STATIONS

a. Estimated goodwill associated with the purchase of Joe’s Garage:

Actual average profit per year $ 2,200,000 Typical sales multiplier 9.25 Estimated fair value of Joe’s Garage $ 20,350,000 Fair value of identifiable assets of Joe’s Garage (9,500,000)Estimated goodwill of Joe’s Garage $ 10,850,000

b. Estimated goodwill associated with the purchase of Gas N’Go:

Actual average profit per year $ 2,750,000 Normal earnings for Gas N’Go ($9,800,000 x 20%) 1,960,000 Estimated excess earnings of Gas N’ Go $ 790,000 Management assumption of four years excess earnings x 4 Estimated goodwill of Gas N’ Go $ 3,160,000

c. Due to the difficulties in objectively estimating the value of goodwill, it is recorded only when it is purchased. Kivi may actually have generated internally a significant amount of goodwill associated with its existing service stations. However, because there is no way to objectively measure the excess return potential of these stations, any goodwill they have generated should not be recorded in Kivi’s accounting records.


30 Minutes, Medium PROBLEM 9.7AMILLAR CORPORATION

a.

Straight-line:($200,000 - $40,000)/5 years = $32,000 for each of the 1st and 2nd years

Double-declining balance (DDB):$200,000 x 40%* = $80,000 for the 1st year($200,000 - $80,000) x 40%* = $48,000 for the 2nd year*Straight-line rate is 20% (100%/5 years) DDB rate is 20% x 2 = 40%

Units-of-Output:10,000 km x $2* per km = $20,00020,000 km x $2* per km = $40,000*Rate per km = ($200,000 - $40,000)/80,000 km = $2Total kilometers expected = 10,000 + ($20,000 x 2) + (15,000 x 2) = 80,000

b. Truck $200,000 Less: Accumulated depreciation (128,000) $72,000

c.

Depreciation expense for the first two years under the three depreciation methods is determined as follows:

Accumulated depreciation at the end of the second year is the total of depreciation expense for the first two years: $80,000 + $48,000 = $128,000

The units of output method is tied to the km driven rather than calendar time and, as a result, the exact amount of depreciation expense to be recognized each accounting period cannot be determined until the period ends. In the above calculations for the first two years in the truck's life, estimates of the number of km driven were used.


30 Minutes, Medium PROBLEM 9.8AORIENTAL COMPANY

a. Depreciation is calculated on the following amount:

Purchase price $2,750,000 Plus: Expenditures to prepare asset for use 75,0000

$3,500,000

The declining balance rate at 150% of the straight-line is:100%/10 years = 10%; 10% x 1.5 = 15%

Depreciation expense for Year 1:$3,500,000 x 15% = $525,000

Depreciation expense for Year 2:($3,500,000 - $525,000) x 15% = $446,250

Depreciation expense for Year 3:($3,500,000 - $525,000 - $446,250) x 15% = 379,310

b.

c. PPE and intangible asset sections of the balance sheet: Year 1:Equipment $3,500,000

Less: Accumulated depreciation (525,000) $2,975,000 Patent 600,000Total PPE and intangible assets $3,575,000

*$750,000 - $150,000 = $600,000

Year 2 Equipment $3,500,000

Less: Accumulated depreciation (971,250)Total PPE assets $2,528,750

Patent cost $750,000

(300,000)

Book value $450,000 Sales price 350,000

Amortization on the patent is calculated as follows (same for each year:) $750,000/5 years = $150,000

The loss on the sale of the patent, presented in Oriental's Yr. 2 income statement, is calculated as follows:

Accumulated amortization at time of sale


Loss on sale $100,000

© The McGraw-Hill Companies, Inc., 2010P9.1B

SOLUTIONS TO PROBLEMS SET B25 Minutes, Easy PROBLEM 9.1B

WALKER HOTEL

a.

b. (1)

(2)

(3)

(4)

(5)

(6)

The cost of property, plant and equipment includes all expenditures that are reasonable and necessary in acquiring the asset and placing it in a position and condition for use in the operation of the business.

The purchase price of $35,000 ($40,000 - $5,000) is part of the cost of the equipment. The list price ($40,000) is not relevant, as this is not the actual price paid by Walker. The $750 in interest charges are a charge for borrowing money, not part of the cost of the equipment. These interest charges should be recognized as interest expense over the 90-day life of the note payable.

Sales tax is a reasonable and necessary expenditure in the purchase of PPE assets and should be included in the cost of the equipment.

Freight charges are part of the cost of getting the equipment to a usable location and, therefore, are part of the cost of the equipment.

To be used in hotel operations, the equipment must first be installed. Thus,normal installation charges should be included as part of the cost of theequipment.

The accidental damage to the equipment was not a “reasonable and necessary” part of the installation process and, therefore, should not be included in the cost of the equipment. The repairs do not make the equipment any more useful than it was before the damage was done. Therefore, the $400 cost of repairing the damage should be offset against revenue of the current period. (Technically, this amount should be classified as a loss in the current period. For practical purposes, however, it probably would be charged to an expense account such as Repairs and Maintenance.)

Advertising is viewed by accountants as a revenue expenditure—that is, charged to expense when the advertising occurs. There is not sufficient objective evidence of future benefit for accountants to regard advertising expenditures as creating an asset.

© The McGraw-Hill Companies, Inc., 2010P9.1B (p.2)

PROBLEM 9.1BWALKER HOTEL (concluded)

c. Expenditures that should be debited to the Equipment account:

Purchase price $ 35,000 Sales tax 2,100

Freight charges 600 Installation charges 900 Total cost of the equipment $ 38,600

d.

Dec 31 Depreciation Expense: Equipment 3,860 Accumulated Depreciation: Equipment 3,860

To record depreciation of equipment in

the year of acquisition ($38,600 cost ÷ 5 years) x 1/2.


45 Minutes, Medium PROBLEM 9.2BR & R, COMPANY

a. (1) Straight-Line Schedule:Book

Year Computation Value2007 $17,000 $17,000 $163,0002008 34,000 51,000 129,0002009 34,000 85,000 95,0002010 34,000 119,000 61,0002011 34,000 153,000 27,0002012 17,000 170,000 10,000


Year Computation Depreciation Value2007 $36,000 $36,000 $144,0002008 57,600 93,600 86,4002009 34,560 128,160 51,8402010 20,736 148,896 31,1042011 12,442 161,338 18,6622012 18,662 – 10,000 8,662 170,000 10,000


Year Computation Depreciation Value2007 $27,000 $27,000 $153,0002008 45,900 72,900 107,1002009 32,130 105,030 74,9702010 22,491 127,521 52,4792011 15,744 143,265 36,7352012 36,735 – 10,000 26,735 170,000 10,000



$170,000 ´ 1¤5 ´ 1¤2170,000 ´ 1¤5170,000 ´ 1¤5170,000 ´ 1¤5170,000 ´ 1¤5

170,000 ´ 1¤5 ´ 1¤2


$180,000 ´ 40% × 1¤2144,000 ´ 40%86,400 ´ 40%51,840 ´ 40%31,104 ´ 40%


$180,000 ´ 30% × 1¤2153,000 ´ 30%107,100 ´ 30%74,970 ´ 30%52,479 × 30%

© The McGraw-Hill Companies, Inc., 2010P9.2B (P.2)

PROBLEM 9.2BR & R, COMPANY (concluded)

b.

c. Computation of gains or losses upon disposal:

1. Straight-Line

Cash proceeds $ 55,000 Book value on 31/12/10 61,000 Loss on disposal $ (6,000)


Cash proceeds $ 55,000 Book value on 31/12/10 31,104 Gain on disposal $ 23,896


Cash proceeds $ 55,000 Book value on 31/12/10 52,479 Gain on disposal $ 2,521

R & R, Company will probably use the straight-line method for financial reporting purposes, as this method results in the least amount of depreciation expense in the early years of the asset’s useful life.

The reported gain or loss on the sale of an asset has no direct cash effects. The only direct cash effect associated with the sale of this machine is the $55,000 received by R & R, Company from the buyer.


50 Minutes, Strong PROBLEM 9.3BDAVIDSON, DDS


Cost of furniture $ 110,000

Freight charges 3,750

Sales taxes 5,500

Installation 750

Total cost to be depreciated $ 120,000

(1) Straight-Line (nearest whole month):

Year Computation2010 $8,000 $8,0002011 12,000 20,0002012 12,000 32,0002013 12,000 44,000







$120,000 ´ 1/10 ´ 8/12$120,000 ´ 1/10$120,000 ´ 1/10$120,000 ´ 1/10


$120,000 ´ 20% ´ 1¤2108,000 ´ 20%86,400 ´ 20%69,120 ´ 20%


$120,000 ´ 15% ´ 1¤2111,000 ´ 15%94,350 ´ 15%80,200 ´ 15%


PROBLEM 9.3BDAVIDSON, DDS


(1) Straight-Line (nearest whole month):BookValue$112,000

100,00088,00076,000


86,40069,12055,300


94,35080,20068,170

© The McGraw-Hill Companies, Inc., 2010P9.3B (P.2)

PROBLEM 9.3BDAVIDSON, DDS (concluded)

b.

c.

d.

1. Journal entry assuming that the furniture was sold for $6,000:Cash 6,000 Accumulated Depreciation: Furniture 26,000 Furniture 30,000 Gain on Disposal of PPE Assets 2,000

To record sale of furniture for $,0600 cash.

2. Journal entry assuming that the furniture was sold for $3,000:Cash 3,000 Accumulated Depreciation: Furniture 26,000 Loss on Sale of PPE Asset 1,000

Furniture 30,000

To record sale of furniture for $3,000 cash.

Davidson's may use the straight-line method in its financial statements to achieve the least amount of depreciation expense in the early years of the furniture’s useful life. In its income tax return, Davidson may use an accelerated method thatwill reduce Davidson's taxable income as much as possible in the early year's of the furniture's useful life. Thus management's goals are really not in conflict.

The 200% declining-balance method results in the lowest reported book value at the end of 2013 ($55,300). Depreciation, however, is not a process of valuation. Thus, the $55,300 book value is not an estimate of the furniture’s fair value at the end of 2013.

A book value of $4,000 means that accumulated depreciation at the time of the disposal was $26,000.


25 Minutes, Medium PROBLEM 9.4BKONG CONSTRUCTION

a.

General Journal

6 Jan Loss on Disposal of PPE Assets 12,000

Accumulated Depreciation: Office Equipment 168,000 Office Equipment Scrapped equipment; received no salvage value.

3 Mar Cash 1,000,000 Notes Receivable 7,000,000 Accumulated Depreciation: Building 2,500,000 Land Building Gain on Sale of PPE Assets Sold land and building for a $1,000,000 cash down- payment and a 5-year, 12% note for the balance.

10 Jul Vehicles (new truck) 370,000 Accumulated Depreciation: Vehicles (old truck) 220,000 Vehicles (old truck) Gain on Disposal of PPE Assets Cash To record trade-in of old truck on new; trade-in allowance exceeded book value by $80,000.

3 Sep Office Equipment (new computer) 100,000 Loss on Trade-in of PPE Assets 26,000 Accumulated Depreciation: Office Equip. (old computer) 90,000 Office Equipment (old computer) Cash Notes Payable Acquired new computer system by trading in old computer, paying part cash, and issuing a 1-year, 10% note payable. Recognized loss equal to book value of old computer ($30,000) minus trade-in allowance ($4,000).

b.

c.

Gains and losses on asset disposals do not affect gross profit because they are not part of the cost of goods sold. Such gains and losses do, however, affect profit reported in a firm’s income statement.

Unlike realized gains and losses on asset disposals, unrealized gains and losses on investment in securities (Gain or Loss on Fair Value Change of Investments) are not generally reported in a firm’s income statement. Instead, they are reported in the balance sheet as a component of shareholders’ equity.


PROBLEM 9.4BKONG CONSTRUCTION

a.General Journal

180,000 500,000 6,800,000 3,200,000 260,000 80,000 250,000 120,000 10,000 86,000

Gains and losses on asset disposals do not affect gross profit because they are not part of the cost of goods sold. Such gains and losses do, however, affect profit reported in a firm’s income

Unlike realized gains and losses on asset disposals, unrealized gains and losses on investment in securities (Gain or Loss on Fair Value Change of Investments) are not generally reported in a firm’s income statement. Instead, they are reported in the balance sheet as a component


25 Minutes, Medium PROBLEM 9.5BOMEGA PRODUCTS CORPORATION

a.

b.

c.

d.

e.

Operating expense. Although the training of employees probably has some benefit extending beyond the current period, the number of periods benefited is highly uncertain. Therefore, current accounting practice is to expense routine training costs.

Intangible asset. Goodwill represents the present value of future earnings in excess ofwhat is considered normal. It is subject to assessment for impairment invalue.

Operating expense. Because of the uncertainty surrounding the potential benefits of R&D programs, expenditure on research and or on the research phase of an internal project are charged to expense in the period in which these costs are incurred. Expenditure on development and or on the development phase of an internal project can't be recognised as an intangible asset unless they satisfy all the 6 specific recognition criteria as discussed in the chapter. Although this accounting treatment is controversial, it has the benefit of reducing the number of alternative accounting practices previously in use, thereby increasing the comparability of financial statements. If a patent is acquired in the future, the acquisition costs (e.g., registration and legal costs) will be capitalized and amortized over the patent's useful life, limited to 20 years.

Intangible asset. A patent grants its owner the exclusive right to produce a particular product. If the patent has significant cost, this cost should be regarded as an intangible asset and expensed over the period of time that ownership of the patent will contribute to revenue. In this case, revenue is expected to be earned only over the 4-year period during which the product will be produced and sold.

Operating expense. Advertising costs are regarded as operating expense because of the difficulty in objectively determining the existence or life of any future benefit.


20 Minutes, Medium PROBLEM 9.6BJAPAN STORES

a. Estimated goodwill associated with the purchase of Carnie's:

Actual average profit per year $ 2,500,000 p/e ratio multiplier 10 Estimated fair value of Carnie's $ 25,000,000 Fair value of identifiable assets of Carnie's (9,000,000)Estimated goodwill of Carnie's $ 16,000,000

b. Estimated goodwill associated with the purchase of Mell's:

Actual average profit per year $ 2,800,000 Normal earnings for Mell's ($9,800,000 x 20% = $1,960,000) 1,960,000 Estimated excess earnings of Mell's $ 840,000 Divided by management's desired return on investmentsEstimated goodwill of Mell's 2,400,000

c.

÷ 35%

Due to the difficulties in objectively estimating the value of goodwill, it is recorded only when it is purchased. Japan may actually have generated internally a significant amount of goodwill associated with its existing stores. However, because there is no way to objectively measure the excess return potential of these stores, any goodwill they have generated should not be recorded in Japan’s accounting records.


30 Minutes, Medium PROBLEM 9.7BWILSON LIMITED

a.

Straight-line:($240,000 - $60,000)/6 years = $30,000 for each of the 1st and 2nd years

Double-declining balance (DDB):$240,000 x 33%* = $79,200 for the 1st year($240,000 - $79,200) x 33%* = $53,060 for the 2nd year*Straight-line rate is 16.7% (100%/6 years) DDB rate is 16.7% x 2 = 33%

Units-of-Output:14,000 km x $2* per km = $28,00020,000 km x $2* per km = $40,000*Rate per km = ($240,000 - $60,000)/90,000 km = $2Total km expected = 14,000 + (20,000 x 2) + (12,000 x 3) = 90,000

b. Truck $240,000 Less: Accumulated depreciation (68,000) $172,000

c.

Depreciation expense for the first two years under the three depreciation methods is determined as follows:

Accumulated depreciation at the end of the second year is the total of depreciation expense for the first two years: $28,000 + $40,000 = $68,000

The units of output method is tied to the km driven rather than calendar time and, as a result, the exact amount of depreciation expense to be recognized each accounting period cannot be determined until the period ends. In the above calculations for the first two years in the truck's life, estimates of the number of km driven were used.


30 Minutes, Medium PROBLEM 9.8BRODGERS COMPANY

a. Depreciation is calculated on the following amount:

Purchase price $5,500,000 Plus: Expenditures to prepare asset for use 1,200,000

$6,700,000

The declining balance rate at 200% of the straight-line is:100%/10 years = 10%; 10% x 2 = 20%

Depreciation expense for Year 1:$6,700,000 x 20% = $1,340,000

Depreciation expense for Year 2:($6,700,000 - $1,340,000) x 20% = $1,072,000

Depreciation expense for Year 3:($6,700,000 - $1,340,000 - $1,072,000) x 20% = $857,600

b.

c. PPE and intangible asset sections of the balance sheet: Year 1:Equipment $6,700,000

Less: Accumulated depreciation (1,340,000) $5,360,000 Patent 666,667Total PPE and intangible assets $6,026,667

*$800,000 - $133,333 = $666,667

Year 2 Equipment $6,700,000

Less: Accumulated depreciation (2,412,000)Total PPE assets $4,288,000

Patent cost $800,000

(266,666)

Book value $533,334 Sales price 400,000

Amortization on the patent is calculated as follows (same for each year:) $800,000/6 years = $133,333

Loss on the sale of the patent, presented in Rodgers' Yr. 2 income statement, is calculated as follows:

Accumulated amortization at time of sale ($133,333 x 2)


Loss on sale $133,334

© The McGraw-Hill Companies, Inc., 2010Case 9.1

SOLUTIONS TO CRITICAL THINKING CASES

20 Minutes, Strong CASE 9.1ARE USEFUL LIVES "FLEXIBLE"?

AN ETHICS CASE

a.

b.

c.

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 profit. But depreciation is only a computation—it is not “paid” in cash on an annual basis. Therefore, changing the estimated useful lives of PPE 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.

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.

The ethical issue confronting Ho 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 Ho 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, Ho 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.


20 Minutes, Strong CASE 9.2

a.

b.

c.

DEPARTURES FROM IFRS—ARE THEY ETHICAL?

It depends on whether Myers chooses the cost model or the revaluation model as its accounting policy after initial recognition. If Myers choose the cost model as its accounting policy after initial recognition, IFRS requires these assets to be shown at cost less the related accumulated depreciation and accumulated impairment losses. If Myers choose the revaluation model as its accounting policy after initial recognition, IFRS requires these assets to be shown at revalued amount (being the fair value at the date of the revaluation) less any subsequent accumulated depreciation, and any accumulated impairment losses.

Yes. Myers is a company established under the Hong Kong Companies Ordinace and has obligations to issue financial statements conforming to IFRS (which is the same as IFRS).

The question facing Lau is whether users of the company’s balance sheet might assume that it was prepared in conformity with IFRS or HKFRS. In this case, they could be misled.


20 Minutes, Easy CASE 9.3 DEPRECIATION POLICIES IN ANNUAL REPORTS

a.

b.

c. (1)

(2)

d.

The depreciation methods used in financial statements are determined by management, not by income tax law.

No—different depreciation methods may be used for different assets. The principle of consistency only means that a company should not change from year to year the method used to compute depreciation expense on a particular asset. This principle does not prohibit using different methods for different assets, or using different depreciation methods in income tax returns.

20% (a useful life of 5 years is equivalent to writing off 1/5 of the asset’s cost each year, indicating a 20% straight-line depreciation rate ).

7% (a useful life of 15 years is equivalent to writing off 1/15 of the asset’s cost each year, indicating a 7% straight-line depreciation rate ).

The useful lives over which assets are to be depreciated are determined by management. However, if the company is audited by a CPA firm, the auditors will review these estimates of useful lives to determine that they are reasonable.

Accelerated depreciation methods transfer the costs of PPE assets to expense more quickly than does the straight-line method. These larger charges to depreciation expense reduce the amount of “taxable income” in the early years in the asset's life and, therefore, reduce the amount of income taxes currently due.


15 Minutes, Medium CASE 9.4 CAPITALIZATION VS. EXPENSE

ETHICS, FRAUD & CORPORATE GOVERNANCE

a.

b. There are a number of steps that you might take, including the following:

1.

2.

3.

4.

Employees, including yourself, may be applying the generally stated policies in a mannerthat improves the appearance of your division's performance. They (and you) may noteven realize this is being done, or it may be intentional. A consistent pattern ofcapitalizing costs that should be expensed, or costs that are in a "gray area" betweenthose that should be capitalized and those that should be expensed can have a significantpositive impact when accumulated over weeks, months, or even an entire year.Everybody likes to be praised for their good work, and to take steps to put oneself in aposition to receive such praise is natural. The current policies and code of conduct ofShanghai Industries, while well-meaning, do not appear to be effective in requiring certain policies to be followed in making decisions, such as those related to capitalizing or expensing certain costs.

Meet with employees periodically to remind them of company policy, including the code of professional conduct.

Work with your superiors to develop more specific policies, with examples, regarding the capitalization and expensing of certain costs. While you will probably not be able to anticipate every possible cost that may be incurred in the future, you should be able to develop more definite guidelines and, perhaps, provide examples that will give you and your employees a clearer indication of the intent of the accounting policy and how management intends that policy to be implemented.

Develop more specific materiality guidelines for applying capitalization and expense rules. For example, many companies establish a specific dollar amount and any cost below that amount is expensed, regardless of whether it benefits only a single accounting period or multiple periods. This amount will, of course, vary from company to company, or from division within a company, based on size, frequency of transactions, and other factors.

As a supervisor yourself, find ways to recognize individual and/or group performance among your employees that do not encourage them to take steps that may not be in their best long-term interests or those of the company.


No time estimate CASE 9.5R & D EXPENDITURES

INTERNET

A keyword search of Pharmaceutical Companies will result in an extensive list of firms. The list will include extremely profitable industry giants whose R&D expenditures typically amount to 15% to 25% of total costs and expenses. In addition, many smaller companies whose primary business activity is researching and developing new drugs will be listed. The R&D expenditures of these firms can amount to as much as 75% to 90% of total costs and expenses. Many of these companies will report very little (if any) sales activity, as all of their products are still in the development stage. Once they have developed a promising new drug, these smaller companies are usually acquired by large pharmaceutical firms which have the financial resources to manufacture and distribute the new drug on a large-scale basis.

Chapter 09 Solutions Manual

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