Chapter - 9 (Manual) PDF

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Chapter 9 Manual for Accounting...

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CHAPTER 9 PLANT AND INTANGIBLE ASSETS OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES Brief Exercises B. Ex. 9.1 B. Ex. 9.2 B. Ex. 9.3

B. Ex. 9.6 B. Ex. 9.7 B. Ex. 9.8 B. Ex. 9.9 B. Ex. 9.10

Topic Cost of plant assets Straight-line depreciation Straight-line and declining-balance depreciation Declining-balance depreciation Straight-line and units of output depreciation Disposal of plant asset Disposal of plant asset Goodwill Natural resources Alternative depreciation methods

Exercises 9.1

Topic You as a student

9.2 9.3 9.4 9.5

Capital vs. revenue expenditure Depreciation for partial years Accelerated vs. Straight-line Real World: H.J. Heinz Company Depreciation disclosures Revision of depreciation estimates Accounting for trade-ins Estimating goodwill Real World: Food Lion, Inc. Impaired assets Fair market value and goodwill Natural resources Annual report presentations Alternative depreciation methods Units-of-output depreciation Real World: Home Depot, Inc. Examining an annual report

B. Ex. 9.4 B. Ex. 9.5

9.6 9.7 9.8 9.9 9.10 9.11 9.12 9.13 9.14 9.15

Learning Objectives 1, 2 3 3

Analysis Analysis Analysis

3 3, 4

Analysis Analysis

3, 5 3, 5 6 7 4

Analysis Analysis Analysis, communication Analysis Analysis, communication

Learning Objectives 2, 3

Skills

1, 2 3 3 3

Skills Analysis, communication, judgment Analysis Analysis Analysis Communication, judgment

3 5 6 5, 8

Analysis Analysis Analysis Communication, judgment

1, 6 7 6, 8 4 4 1, 3

Communication, judgment Analysis, communication, Communication, research Analysis Analysis Analysis, communication, research

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

Problems Sets A, B 9.1 A,B 9.2 A,B 9.3 A,B

Topic Cost determination and depreciation Straight-line vs. accelerated methods Multiple depreciation issues

9.4 A,B 9.5 A,B 9.6 A,B

Disposal of plant assets Intangible assets under GAAP Accounting for goodwill

9.7 A,B 9.8 A,B

Alternative Depreciation Methods Disposal of Plant and Intangible assets

Learning Objectives 1–3 3, 5 1–3, 5 5 6 6 4 2, 3, 5

Skills Analysis, communication Analysis Analysis, communication, judgment Analysis, communication Communication, judgment Analysis, communication, judgment Analysis, communication Analysis

Critical Thinking Cases 9.1 9.2 9.3

9.4 9.5

Issues involving useful lives Departures from GAAP Real World: International Paper Company Depreciation disclosures Capitalization vs. expense (Ethics, fraud & corporate governance) Real World: Pharmaceutical companies of student's choice Researching R&D expenditures (Internet)

3 1 3, 4

Communication, judgment Communication, judgment Communication, judgment

2

Communication, judgment

2

Communication, research, technology

*Supplemental Topic, “Other Depreciation Methods.”

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DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES 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.

Problems (Sets A and B) 9.1 A,B Wilmet College/Walker Motel Students are required to distinguish between capital and revenue expenditures and compute depreciation expense.

25 Easy

9.2 A,B Swanson & Hiller, Inc./R & R, Inc. 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.

45 Medium

9.3 A,B Smart Hardware/Davidson, DDS. 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 straightline 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.

50 Strong

9.4 A,B Ramirez Developers/Blake Construction 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 plant 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.

25 Medium

9.5 A,B Black Corporation/Omega Products Corporation 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.

25 Medium

9.6 A,B Kivi Service Stations/Jell Stores 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.

20 Medium

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Problems (continued) 9.7 A,B

Millar, Inc./Wilson, Inc. 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 miles driven is known.

30 Medium

9.8 A,B

Rothchild, Inc./Rodgers Company Students are asked to calculate depreciation on two long-lived assets by different depreciation/amortization methods and then to prepare the balance-sheet section for plant 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.

30 Medium

Critical Thinking Cases Are Useful Lives "Flexible"? A look into the responsibilities of management accountants. Do they do as they are told, or is there more to it?

20 Strong

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

20 Strong

Depreciation Policies in Annual Reports 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 income tax purposes. Based upon the financial disclosures of a well-known corporation.

20 Easy

Ca p italization vs. Expense Ethics, Fraud & Cor porate Governance 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.

30 Medium

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

No time estimate Medium

____________ *Supplemental Topic, “Other Depreciation Methods.”

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1. 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, they would be amortized over a period of 40 years or less. Thus, any costs associated with this trademark now would be fully amortized, leaving a zero book value. 2. There are three basic “accountable events” in the life of a plant 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 net income. However, any gain or loss on disposal also affects net income. The allocation of acquisition cost to expense has no effect upon cash flows (other than income taxes). However, the acquisition of plant assets requires cash outlays, and disposals often result in cash receipts. 3. (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. 4. 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 net income. 5. 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 net income, therefore, will be understated. Since this error also results in the failure to record an asset, net income 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. 6. The entire $245,000 cost should be charged to the land account. The existing structures are of no value to Shoppers’ Market, and soon will be torn down. Thus, the only asset being acquired by Shoppers’ is the building site, which is classified as land. 7. 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. 8 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.

© The McGraw-Hill Companies, Inc., 2010 Q1-8

9 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. The declining-balance method is most widely used in income tax returns. 10. 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 plant 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. 11. 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.) 12. 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. 13. Depletion in the amount of $10,000,000 should be deducted from revenue in the current year. The other $2,000,000 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. 14. An asset is “impaired” when the undepreciated cost cannot be recovered either through use or sale. In such situations, the carrying value of the asset should be reduced (written down) to fair value, which results in the recognition of a loss. 15. 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., 2010 Q9-12

SOLUTIONS TO BRIEF EXERCISES B.Ex. 9.1

Equipment cost: Purchase price Delivery Reconditioning Total cost for purposes of determining annual depreciation

$25,000 750 2,230

$27,980

Note: Maintenance for the first year of use is not included in the cost basis for purposes of calculating annual depreciation. B.Ex. 9.2

Depreciation expense for each of the first two years: ($400,000 - $100,000)/25 years = $12,000 Book value at the end of Year 2: $400,000 - ($12,000 x 2) = $376,000

B.Ex. 9.3

Year 1 Straight-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 2 Straight-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

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B.Ex. 9.4

Double-declining balance depreciation: $76,000 x 25% = $19,000 150% declining-balance depreciation: $76,000 x 18.75% = $14,250 Excess of double decliningbalance over 150% decliningbalance

$4,750

Declining-balance rates are determined as follows: Straight-line rate: 100%/8 years 12.50% 25.00% Double declining-balance rate: 12.5 x 2 18.75% 150% declining-balance rate: 12.5 x 1.5 B.Ex. 9.5

Straight-line depreciation: ($35,000 - $5,000)/5 years =

$6,000

Units of Output depreciation: 16,000 miles x $0.40 * = $6,400 * ($35,000 - $5,000)/75,000 miles = $0.40 per mile B.Ex. 9.6

Selling price of equipment Book value of equipment sold: Cost Less: accumulated depreciation * Gain on sale

$7,200 $12,000 6,000

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

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6,000 $1,200

B.Ex. 9.7

Selling price of equipment Book value of equipment sold: Cost Less: accumulated depreciation* Loss on sale

$8,500 $27,500 17,600

9,900 $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

Goodwill should be recorded at $25,000, the actual amount by which the purchase price of $700,000 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.

B.Ex. 9.9

Cost per ton of mineral to be extracted: ($2,500,000)/10,000 tons = $250 per ton Depletion expense for first year: 1,600 tons x $250 = $400,000

B.Ex. 9.10

Cost basis for determining depreciation expense under both methods: $30,500 - $6,500 = $24,000 Yr. 1 Units of Output method of depreciation: 10,000 miles x $0.30* per mile = *$24,000/80,000 miles = $0.30 per mile Double-Declining Balance method of depreciation: $30,500 x 40%* = Excess of Double-Declining Balance over Units of Output: *100%/5 years x 2 = 40%

$3,000

12,200 $9,200

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 miles 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 miles (80,000 miles/5 years). The doubledeclining balance method is not affected by the lower number of miles driven.

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SOLUTIONS TO EXERCISES Ex. 9.1

a.

Two factors have caused the truck to depreciate: (1) physical deterioration and (2) obsolescence. The miles driven during the past six years have caused wear and tear on all of the truck’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 truck, innovations have been developed leading to improved fuel economy, higher horsepower, better handling, and more corrosion-resistant materials. These innovations have made the truck obsolete in many respects. As the design and engineering technologies associated with the truck become more and more outdated, its fair market value will continue to depreciate.

b. No. It is not likely that the bank will lend you an additional $5,000, even if you agree to pledge your truck as collateral. Your truck 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.

Ex. 9.2

c.

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 $10,000 in accumulated depreciation on this truck.

a. b. c. d. e.

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

f.

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Ex. 9.3 Year 1 2 3 4 5 6 7 8 9 Totals

(1) (2) (3) (4) (5)

c.

a. Straight-Line (Half-Year Convention) $ 59,375 (1) 118,750 (2) 118,750 118,750 118,750 118,750 118,750 118,750 59,375 (1) $ 950,000

b. 200% Declining-Balance (Half-Year Convention) $ 125,000 (3) 218,750 (4) 164,063 123,047 92,285 69,214 52,547 (5) 52,547 52,547 $ 950,000

$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 Switch to straight-line: ($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 st...