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Burnley, Understanding Financial Accounting, Second Canadian Edition

CHAPTER 8 LONG-TERM ASSETS

Learning Objectives 1. Identify and distinguish between the various types of long-term assets. 2. Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. 3. Explain why property, plant, and equipment assets are depreciated. 4. Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. 5. Describe and implement changes in depreciation estimates and methods. 6. Explain what it means if property, plant, and equipment assets are impaired. 7. Account for the disposal of property, plant, and equipment. 8. Explain the accounting treatment for intangible assets, including amortization. 9. Explain the accounting treatment for goodwill, including impairment. 10. Assess the average age of property, plant, and equipment; calculate the fixed asset turnover ratio; and assess the results.

_________________________________________________________________________________________________ Solutions Manual 8-1 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

BT

Item

LO

BT

Item

LO

BT

Item LO

BT

Item

LO

BT

Discussion Questions 1.

2

C

7.

3,4

C

13.

5

C

19.

7

C

25.

9

C

2.

3

C

8.

4

C

14.

4

C

20.

4

C

26.

9

C

3.

2

C

9.

4

C

15.

4

C

21.

4

C

27.

9

C

4.

2

C

10.

4

C

16.

4

C

22.

8,9

C

5

3

C

11.

4

C

17.

3

C

23.

8

C

6.

2

AP

12.

4

C

18.

6

C

24.

8

C

17.

8,9

AP

Application Problems 1.

2

K

5.

4

AP

9.

4,7

AP

13.

5

AP

2.

2

AP

6.

4

AP

10.

4,7

AP

14.

5

AP

3.

2

AP

7.

4

AP

11.

4,7

AP

15.

4,5,7

S

4.

4

AP

8.

4,7

AN

12.

4,7

AP

16.

8

AP

User Perspective Problems 1.

2

C

4.

3

C

7.

7

C

10.

6

C

13.

2

C

2.

2

C

5.

2

C

8.

6,9

C

11.

10

AN

14.

2,9

C

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3

C

6.

7

C

9.

2

C

12.

2

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15.

9

C

4.

4

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5.

3

C

Work in Process 1.

3,4

C

2.

3,4

C

3.

4

C

Reading and Interpreting Published Financial Statements 1.

10

AN

2.

8,9

C

3.

10

AN

4.

10

AN

5.

10

AM

AN

4.

4

S

5.

4

E

Cases 1.

2

C

2.

1,2, 4

E

3.

2

_________________________________________________________________________________________________ Solutions Manual 8-2 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

_________________________________________________________________________________________________ Solutions Manual 8-3 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file LO

Learning objective

BT

Bloom's Taxonomy

Difficulty:

K

Knowledge

C

Comprehension

AP

Application

AN

Analysis

S

Synthesis

E

Evaluation

Level of difficulty E

Easy

M

Medium

H

Hard

Time:

Estimated time to complete in minutes

AACSB

Association to Advance Collegiate Schools of Business

CPA CM

Communication

Communication

Ethics

Ethics

Analytic

Analytic

Tech.

Technology

Diversity

Diversity

Reflec. Thinking

Reflective Thinking

CPA Canada Competency Map Ethics

Professional and Ethical Behaviour

PS and DM

Problem-Solving and Decision-Making

Comm.

Communication

Self-Mgt.

Self-Management

Team & Lead

Teamwork and Leadership

_________________________________________________________________________________________________ Solutions Manual 8-4 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

Reporting

Financial Reporting

Stat. & Gov.

Strategy and Governance

Mgt. Accounting

Management Accounting

Audit

Audit and Assurance

Finance

Finance

Tax

Taxation

_________________________________________________________________________________________________ Solutions Manual 8-5 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ8-1

An asset’s (or any accounting element’s) “carrying amount” is its balance in the books of account, and therefore the amount reported in the financial statements. If the asset is land, its carrying amount is likely the same as its cost. However, most items of PP&E, originally recognized and recorded at their cost, are subsequently depreciated on a regular basis and they are then carried at cost less accumulated depreciation. Contra accounts such as Accumulated Depreciation are deducted from the PP&E asset account in determining the PP&E’s carrying amount. Impairment losses, if applicable, are also accumulated in a separate contra account and further reduce the asset’s carrying amount.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-2

When a company acquires a PP&E asset that will provide benefits to the entity over a number of future accounting periods, it wouldn’t be reasonable to deduct the whole cost of that asset from current year’s revenues as a current year expense. The entity still has an economic resource – an asset – at the end of the current year. Therefore, such assets are depreciated to allocate their cost to the accounting periods in which the assets’ economic benefits are used up and that benefit from their use.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-3

Accounting standards require that all costs necessary to acquire equipment, get it in position, and ready it for use be capitalized. These costs would include the invoice price, non-refundable taxes, import duties, legal costs associated with the purchase, shipping costs, installation costs, cost of test runs, and any other costs that meet the criteria.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

_________________________________________________________________________________________________ Solutions Manual 8-6 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

DQ8-4

If a cost incurred is capitalized as part of PP&E, the cost of the asset is increased. It also means that the cost is not expensed, and therefore does not reduce the current period’s net income. Therefore, both the current statement of financial position and the income statement are affected, as are the future statements of financial position and income statements over the useful life of the asset. If capitalized, the cost is spread out over the useful life of the asset, thereby increasing depreciation expense in each future year it is used. At the same time, the carrying amount of the asset on the statement of financial position decreases.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-5

There are a number of reasons why it is necessary to allocate the purchase price of a basket purchase to the individual assets. If land and building and equipment are acquired for a single price, the costs are assigned to each component because the cost of the land does not depreciate, and the cost of the equipment and the building probably need to be depreciated over very different periods of time, and perhaps using different methods of depreciation. IFRS requires that depreciation be recognized for asset components using appropriate patterns and reasonable useful lives for each. Also, if some assets are sold and some remain, it is important to be able to determine the cost and carrying amount of those disposed of to properly calculate any resulting gain or loss on disposal. The cost of those assets remaining will also affect the balances reported on the statement of financial position.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

_________________________________________________________________________________________________ Solutions Manual 8-7 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

DQ8-6

The cost of a basket purchase is allocated to the items on the basis of their relative fair values. If there were three items (A, B, and C) purchased for a single price of $1,000 and the fair values of the three items were $300 (A), $400 (B), and $500 (C) then the cost of the three items is allocated as follows: Percentage of Fair Value A: $300 / $1,200 = 25.0% B: $400 / $1,200 = 33.3% C: $500 / $1,200 = 41.7% Cost 25.0% x $1,000 = $250 33.3% x $1,000 = $333 41.7% x $1,000 = $417

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-7

The purpose of depreciation is to allocate the asset’s economic benefits over the periods in which these benefits are expected to be consumed or used up. The allocation is over the asset’s estimated useful life using a rational and systematic method. There are three methods of depreciation. The straight-line method which allocates the costs evenly over the life of the asset, an accelerated method (such as diminishing balance) that allocates more of the asset’s costs early in the life of an asset and less in later years, or a method based on the actual usage of the asset (units-of-activity or units-of-production method). In practice, the straight-line method and the diminishingbalance method are most commonly used.

LO 3,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-8

While the straight-line method is relatively simple to apply, some assets do not provide their benefits equally each accounting period. Therefore, the straight-line method would not be representative of how the company expects to consume the asset’s economic benefits, so another method of depreciation (i.e. diminishing balance or unitsof-production) would be used.

LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

_________________________________________________________________________________________________ Solutions Manual 8-8 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

DQ8-9

Companies should choose the depreciation method that most closely represents the pattern by which the asset’s economic benefits will be consumed or used up. The economic benefits of many assets, such as most buildings for example, are consumed or used up evenly over their useful lives making the straight-line method of depreciation the most appropriate. It is the most commonly used method. However, it is not always obvious which pattern is most appropriate. In some situations, an accelerated depreciation method produces the best allocation of costs as more of the asset’s economic benefits are consumed early in its useful life and less as time goes by. This method allocates larger amounts of depreciation expense in the early years and less in later years. For some assets, it is possible to link the consumption of economic benefits directly with its use. A unit of activity, such as the number of units it can produce or the number of kilometers that can be driven, can be determined and used as the basis for allocating the asset’s cost. In these cases, an activity approach such as units-of-production results in the best allocation of the asset’s costs to the periods in which its economic benefits are being consumed or used up.

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-10

An asset’s residual value is management’s estimate of the net amount that would be received today if the asset were now as old and in the same condition it is expected to be at the end of its useful life. Because depreciation is a process of allocating the cost of an asset to expense over its useful life, any costs expected to be recovered at the end of its useful life should not be part of the depreciation expense. Therefore, the residual value is considered in determining how much cost should be recognized each period as an expense.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

_________________________________________________________________________________________________ Solutions Manual 8-9 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

DQ8-11

Estimated residual value and estimated useful life are used directly in the straight-line method. The estimated residual value is subtracted from the original cost of the asset to determine the depreciable amount of the asset, i.e. the amount of the cost that is to be depreciated over the life of the asset. The depreciable amount is then divided by the asset’s estimated useful life to determine the depreciation expense to be allocated to each period. For the units-of-production method, the estimated residual value is also subtracted from the original cost of the asset to determine its depreciable amount. Rather than determining the estimated useful life in years (as is the case with the straight-line method), it is estimated in terms of the number of units of use or output that the asset will produce (i.e. units, km, hours, tonnes, m 3). Dividing the depreciable amount by the estimated useful life in units determines the depreciation expense per unit. Finally, depreciation expense for the period is calculated by multiplying the depreciation expense per unit by the asset’s actual use or output for the period. Under the diminishing balance method, the estimated useful life is used to determine the depreciation rate. For example, under the double diminishing balance method the rate is equal to: (1/estimated useful life) x 2. This rate is then applied to the asset’s net book value (i.e. cost – accumulated depreciation) to determine depreciation expense for the period. The diminishing-balance method does not explicitly incorporate the estimated residual value in the calculation of depreciation expense. Instead, it is used as a constraint in setting the depreciation schedule. After determining the depreciation expense for the period, the revised net book value is determined and compared to the estimated residual value. As an asset cannot be depreciated below its estimated residual value, for the period in which the net book value falls below the estimated residual value, depreciation expense must be adjusted. The maximum depreciation expense for that period will be equal to the difference between the net book value at the start of the period and the asset’s estimated residual value.

LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

_________________________________________________________________________________________________ Solutions Manual 8-10 Chapter 8 Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Second Canadian Edition

DQ8-12

Some assets have a useful life that is a function of the activity associated with the asset. In this case, a units-of-activity or units-ofproduction approach results in the best allocation of the asset’s economic benefits. The “units” ref...