b. Prepare the plant assets section of the balance sheet at the end of the second year of the asset’s useful life under the double-declining-balance method, assuming the truck is the only plant asset owned by Millar, Inc.
c. By which of the three methods is it not possible to determine the actual amount of deprecia- tion expense prior to the end of each year? What uncertainty causes this to be true?
During the current year, Rothchild, Inc., purchased two assets that are described as follows:
Heavy Equipment Purchase price, $275,000.
Expected to be used for 10 years, with a residual value at the end of that time of $50,000.
Expenditures required to recondition the equipment and prepare it for use, $75,000.
Patent
Purchase price, $75,000.
Expected to be used for five years, with no value at the end of that time.
PROBLEM 9.6A Accounting for Goodwill P A G LO6
PROBLEM 9.7A Alternative
Depreciation Methods P
A D LO4
PROBLEM 9.8A Disposal of Plant and Intangible Assets LO2 P
D In D LO3
LO5
wil11048_ch09_384-427.indd 421
wil11048_ch09_384-427.indd 421 11/8/10 7:58 AM11/8/10 7:58 AM
Find more at www.downloadslide.com
Rothchild depreciates heavy equipment by the declining-balance method at 150 percent of the straight-line rate. It amortizes intangible assets by the straight-line method. At the end of two years, because of changes in Rothchild’s core business, it sold the patent to a competitor for $35,000.
Instructions
a. Compute the amount of depreciation expense on the heavy equipment for each of the first three years of the asset’s life.
b. Compute the amount of amortization on the patent for each of the two years it was owned by Rothchild.
c. Prepare the plant and intangible assets section of Rothchild’s balance sheet at the end of the first and second years. Also, calculate the amount of the gain or loss on the patent that would be included in the second year’s income statement.
Problem Set B
Walker Motel recently purchased new exercise equipment for its exercise room. The following information refers to the purchase and installation of this equipment:
1. The list price of the equipment was $40,000; however, Walker qualified for a “special dis- count” of $5,000. It paid $10,000 cash for the equipment, and issued a three-month, 12 percent note payable for the remaining balance. The note, plus accrued interest charges of $750, was paid promptly at the maturity date.
2. In addition to the amounts described in 1, Walker paid sales taxes of $2,100 at the date of purchase.
3. Freight charges for delivery of the equipment totaled $600.
4. Installation and training costs related to the equipment amounted to $900.
5. During installation, one of the pieces of equipment was accidentally damaged by an employee.
It cost the motel $400 to repair this damage.
6. As soon as the equipment was installed, the motel paid $3,200 to print brochures featuring the exercise room’s new, state-of-the-art exercise facilities.
Instructions
a. In one sentence, make a general statement summarizing the nature of expenditures that qualify for inclusion in the cost of plant assets such as exercise equipment.
b. For each of the six numbered paragraphs, indicate which items should be included by Walker in the total cost debited to its Equipment account. Also briefly indicate the proper accounting treatment of those items that are not included in the cost of the equipment.
c. Compute the total cost debited to the motel’s Equipment account.
d. Prepare a journal entry at the end of the current year to record depreciation on the exer- cise equipment. Walker Motel will depreciate this equipment by the straight-line method (half-year convention) over an estimated useful life of five years. Assume a zero residual value.
R&R, Inc., purchased a new machine on September 1, 2009, at a cost of $180,000. The machine’s estimated useful life at the time of the purchase was five years, and its residual value was $10,000.
Instructions
a. Prepare a complete depreciation schedule, beginning with calendar year 2009, under each of the methods listed below (assume that the half-year convention is used):
1. Straight-line.
2. 200 percent declining-balance.
3. 150 percent declining-balance (not switching to straight-line).
b. Which of the three methods computed in part a is most common for financial reporting purposes? Explain.
Problem Set B accounting
PROBLEM 9.1B Determining the Cost of Plant Assets
through
P
thhroughh D LO1
of
g g throroughugh
LO3
PROBLEM 9.2B Comparison of Straight-Line and Accelerated Methods P
C LO3
S A C LO5 S
Confirming Pages
Problem Set B 423
c. Assume that R&R sells the machine on December 31, 2012, for $55,000 cash. Compute the resulting gain or loss from this sale under each of the depreciation methods used in part a. Does the gain or loss reported in the company’s income statement have any direct cash effects? Explain.
Davidson, DDS, purchased new furniture for its store on May 1, 2011. The furniture is expected to have a 10-year life and no residual value. The following expenditures were associated with the purchase:
Cost of the furniture . . . $11,000 Freight charges . . . 375 Sales taxes . . . 550 Installation of furniture . . . 75 Cost to repair furniture damaged during installation . . . 400 Instructions
a. Compute depreciation expense for the years 2011 through 2014 under each depreciation method listed below:
1. Straight-line, with fractional years rounded to the nearest whole month.
2. 200 percent declining-balance, using the half-year convention.
3. 150 percent declining-balance, using the half-year convention.
b. Davidson, DDS, has two conflicting objectives. Management wants to report the highest pos- sible earnings in its financial statements, yet it also wants to minimize its taxable income reported to the IRS. Explain how both of these objectives can be met.
c. Which of the depreciation methods applied in part a resulted in the lowest reported book value at the end of 2014? Is book value an estimate of an asset’s fair value? Explain.
d. Assume that Davidson, DDS, sold the old furniture that was being replaced. The old furniture had originally cost $3,000. Its book value at the time of the sale was $400. Record the sale of the old furniture under the following conditions:
1. The furniture was sold for $600 cash.
2. The furniture was sold for $300 cash.
During the current year, Blake Construction disposed of plant assets in the following transactions:
Jan. 6 Equipment costing $18,000 was given to a scrap dealer at no charge. At the date of disposal, accumulated depreciation on the office equipment amounted to $16,800.
Mar. 3 Blake sold land and a building for $800,000, receiving $100,000 cash and a five-year, 12 percent note receivable for the remaining balance. Blake’s records showed the following amounts: Land, $50,000; Buildings, $680,000; Accumulated Depreciation:
Building (at the date of disposal), $250,000.
Jul. 10 Blake traded in an old truck for a new one. The old truck had cost $26,000, and its accumulated depreciation amounted to $22,000. The list price of the new truck was
$37,000, but Blake received a $12,000 trade-in allowance for the old truck and paid only $25,000 in cash. Blake includes trucks in its Vehicles account.
Sept. 3 Blake traded in its old computer system as part of the purchase of a new system. The old system had cost $12,000, and its accumulated depreciation amounted to $9,000.
The new computer’s list price was $10,000. Blake accepted a trade-in allowance of
$400 for the old computer system, paying $1,000 down in cash and issuing a one-year, 10 percent note payable for the $8,600 balance owed.
Instructions
a. Prepare journal entries to record each of the disposal transactions. Assume that depreciation expense on each asset has been recorded up to the date of disposal. Thus you need not update the accumulated depreciation figures stated in the problem.
b. Will the gains and losses recorded in part a above affect the gross profit reported in Blake’s income statement? Explain.
c. Explain how the financial reporting of gains and losses on plant assets differs from the finan- cial reporting of unrealized gains and losses on marketable securities discussed in Chapter 7.
PROBLEM 9.3B Issues Involving Alternative Depreciation Methods
through
P
thhroughh Is LO1
A D M
g A
throroughugh
LO3
LO5
PROBLEM 9.4B Disposal of Plant Assets
P D A LO5
wil11048_ch09_384-427.indd 423
wil11048_ch09_384-427.indd 423 11/8/10 7:58 AM11/8/10 7:58 AM
Find more at www.downloadslide.com
During the current year, Omega Products Corporation incurred the following expenditures which should be recorded either as operating expenses or as intangible assets:
a. Expenditures were made for the training of new employees. The average employee remains with the company for five years, but is trained for a new position every two years.
b. Omega purchased a controlling interest in a wallpaper company. The expenditure resulted in recording a significant amount of goodwill. Omega expects to earn above-average returns on this investment indefinitely.
c. Omega incurred large amounts of research and development costs in developing a superior product. The company expects that it will be patented and that sales of the resulting products will contribute to revenue for at least 40 years. The legal life of the patent, however, will be only 20 years.
d. Omega made an expenditure to acquire the patent on a whatsa. The patent had a remaining legal life of 10 years, but Omega expects to produce and sell the product for only four more years.
e. Omega spent a large amount to sponsor the televising of the World Series. Omega’s intent was to make television viewers more aware of the company’s name and product lines.
Instructions
Explain whether each of the above expenditures should be recorded as an operating expense or an intangible asset. If you view the expenditure as an intangible asset, indicate the number of years over which the asset should be amortized. Explain your reasoning.
Jell Stores is considering expanding its operations to include the greater Boston area. Rather than build new stores in the Boston area, management plans to acquire existing stores and convert them into Jell outlets.
Jell is evaluating two similar acquisition opportunities. Information relating to each of these stores is presented below:
Carnie’s Mell’s
Estimated normal rate of return on net assets . . . 20% 20%
Fair market value of net identifiable assets . . . $900,000 $980,000 Actual average net income for past five years . . . 250,000 280,000
Instructions
a. Compute an estimated fair value for any goodwill associated with Jell purchasing Carnie’s.
Base your computation upon an assumption that successful stores of this type typically sell at about 10 times their annual earnings.
b. Compute an estimated fair value for any goodwill associated with Jell purchasing Mell’s.
Base your computation upon an assumption that Jell’s management wants to generate a target return on investment of 35 percent.
c. Many of Jell’s existing stores are extremely profitable. If Jell acquires Carnie’s or Mell’s, should it also record the goodwill associated with its existing locations? Explain.
Wilson, Inc., purchased a truck to use for deliveries and is attempting to determine how much depreciation expense would be recognized under three different methods. The truck cost $24,000 and is expected to have a value of $6,000 at the end of its six-year life. The truck is expected to be used at the rate of 15,000 miles in the first year, 20,000 miles in the second and third years, and 12,000 miles in the fourth, fifth, and sixth years.
Instructions
a. Determine the amount of depreciation expense that will be recognized under each of the fol- lowing depreciation methods in the first and second years of the truck’s useful life. A full year’s depreciation will be recognized in the first year the truck is used.
1. Straight-line.
2. Double-declining-balance.
3. Units-of-output (based on miles).
PROBLEM 9.5B Accounting for Intangible Assets under GAAP P
A I LO6
PROBLEM 9.6B Accounting for Goodwill P A G LO6
PROBLEM 9.7B Alternative
Depreciation Methods P
A D LO4
Confirming Pages
Critical Thinking Cases 425
b. Prepare the plant assets section of the balance sheet at the end of the second year in the asset’s useful life under the units-of-output method, assuming the truck is the only plant asset owned by Wilson, Inc.
c. By which of the three methods is it not possible to determine the actual amount of deprecia- tion expense prior to the end of each year? What uncertainty causes this to be true?
During the current year, Rodgers Company purchased two assets that are described as follows:
Heavy Equipment Purchase price, $550,000.
Expected to be used for 10 years, with a residual value at the end of that time of $70,000.
Expenditures required to recondition the equipment and prepare it for use, $120,000.
Patent
Purchase price, $80,000.
Expected to be used for six years, with no value at the end of that time.
Rodgers depreciates heavy equipment by the declining-balance method at 200 percent of the straight-line rate. It amortizes intangible assets by the straight-line method. At the end of two years, because of changes in Rodgers’s core business, it sold the patent to a competitor for $40,000.
Instructions
a. Compute the amount of depreciation expense on the heavy equipment for each of the first three years of the asset’s life.
b. Compute the amount of amortization on the patent for each of the two years it was owned by Rodgers.
c. Prepare the plant and intangible assets section of Rodgers’s balance sheet at the end of the first and second years. Also, calculate the amount of the gain or loss on the patent that would be included in the second year’s income statement.
Critical Thinking Cases
Mickey Gillespie is the controller of Print Technologies, a publicly owned company. The company is experiencing financial difficulties and is aggressively looking for ways to cut costs.
Suzanne Bedell, the CEO, instructs Gillespie to lengthen from 5 to 10 years the useful life used in computing depreciation on certain special-purpose machinery. Bedell believes that this change represents a substantial cost savings, as it will reduce the depreciation expense on these assets by nearly one-half.
Note: The proposed change affects only the depreciation expense recognized in financial state- ments. Depreciation deductions in income tax returns will not be affected.
Instructions
a. Discuss the extent to which Bedell’s idea will, in fact, achieve a cost savings. Consider the effects on both net income and cash flows.
b. Who is responsible for estimating the useful lives of plant assets?
c. Discuss any ethical issues that Gillespie should consider with respect to Bedell’s instructions.
Martin Myers owns Myers Construction Co. The company maintains accounting records for the purposes of exercising control over its construction activities and meeting its reporting obligations regarding payrolls and income tax returns. As it has no other financial reporting obligations, Myers does not prepare formal financial statements.
The company owns land and several other assets with current market values well in excess of their historical costs. Martin Myers directs the company’s accountant, Maureen O’Shaughnessey, to prepare a balance sheet in which assets are shown at estimated market values. Myers says this type of balance sheet will give him a better understanding of where the business stands. He also PROBLEM 9.8B
Disposal of Plant and Intangible Assets P
D LO2
In D LO3
LO5
CASE 9.1 Are Useful Lives
“Flexible”?
C A
“ LO3
CASE 9.2 Departures from GAAP—Are They Ethical?
C D G LO1
wil11048_ch09_384-427.indd 425
wil11048_ch09_384-427.indd 425 11/8/10 7:58 AM11/8/10 7:58 AM
Find more at www.downloadslide.com
thinks it will be useful in obtaining bank loans, as loan applications always ask for the estimated market values of real estate owned.
Instructions
a. Would the financial statements requested by Martin Myers be in conformity with generally accepted accounting principles?
b. Is Myers Construction under any legal or ethical obligation to prepare financial statements that do conform to generally accepted accounting principles?
c. Discuss any ethical issues that O’Shaughnessey should consider with respect to Myers’s request.
The following is a note accompanying a recent financial statement of International Paper Company :
Plant, Properties, and Equipment
Plant, properties, and equipment are stated at cost less accumulated depreciation. Expenditures for betterments are capitalized, whereas normal repairs and maintenance are expensed as incurred. The units-of-production method of depreciation is used for major pulp and paper mills, and the straight- line method is used for other plants and equipment. Annual straight-line depreciation rates are, for buildings—2ẵ percent to 8ẵ percent, and for machinery and equipment—5 percent to 33 percent.
Instructions
a. Are the depreciation methods used in the company’s financial statements determined by cur- rent income tax laws? If not, who is responsible for selecting these methods? Explain.
b. Does the company violate the consistency principle by using different depreciation methods for its paper mills and wood products facilities than it uses for its other plant and equipment?
If not, what does the principle of consistency mean? Explain.
c. What is the estimated useful life of the machinery and equipment being depreciated with a straight-line depreciation rate of:
1. 5 percent.
2. 33 percent (round to the nearest year).
Who determines the useful lives over which specific assets are to be depreciated?
d. Why do you think the company uses accelerated depreciation methods for income tax pur- poses, rather than using the straight-line method?
One of your responsibilities as division manager of an important component of Roxby Industries is to oversee accounting for the division. One of the issues you grapple with on an almost continu- ous basis is whether particular costs should be expensed immediately or whether they should be capitalized. The company has an accounting policy manual that includes a section on this topic, but it is rather vague in this regard. It simply says that if a cost benefits multiple accounting periods, the cost should be capitalized; otherwise, that cost should be expensed immediately. It also makes a brief reference to materiality by stating that, if a cost is sufficiently small, it should be immediately expensed despite the fact that it may benefit multiple accounting periods. No additional guidance is provided with regard to how these general concepts should be applied.
Over several years you have noticed a tendency of your staff to capitalize rather than expense more costs. While you and your coworkers in the division do not receive a bonus or other direct compensation that is tied to your division’s performance, you know that upper management moni- tors carefully the financial performance of divisions. From time to time in various meetings and in written correspondence, comments are made praising individuals and divisions of the company for their positive financial performance. In fact, within your division you have done the same when you meet with your employees and either compliment them for strong financial performance or express concern about weak financial performance.
Roxby Industries has a code of professional conduct that is shown to employees when they are hired. Within that code are references to personal integrity and the responsibility of employees to carry out company policy and not engage in activities that benefit themselves at the expense of the company. Like the accounting policies referred to above, there is no guidance on how this general principle might be carried out.
CASE 9.3
Depreciation Policies in Annual Reports C
LO3 in D LO4 i
CASE 9.4 Capitalization vs.
Expense C C E LO2
Confirming Pages
Critical Thinking Cases 427
Instructions
a. What behavior may your comments in meetings with your employees, or the comments made to you from upper management, be motivating in terms of the continuous decisions that are being made about capitalizing and expensing costs?
b. What steps might you take to ensure that you and the employees in your division are not tak- ing actions that they should not take in light of the company’s accounting policies and code of professional conduct?
The pharmaceutical industry spends billions of dollars each year on research and development.
Rather than capitalize these R&D expenditures as intangible assets, companies are required to charge them to expense in the year incurred.
Perform a keyword search of Pharmaceutical Companies using the search engine of your choice (e.g., Yahoo, Google).
Your search will result in a list of companies that research and develop pharmaceutical products.
Select three of these companies and obtain their 10-K reports using the SEC’s EDGAR system or going directly to the Web sites of the companies you choose.
Instructions
a. For each of the companies you selected, determine:
1. Total R&D expense for the most current year.
2. Total R&D expense as a percentage of total operating costs and expenses.
3. Total R&D expense as a percentage of net sales.