CHAPTER 13 Investments in Noncurrent Operating Assets—Utilization and Retirement MULTIPLE CHOICE QUESTIONS Theory/Definitional Questions 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Purpose of depreciation Depreciation as systematic and rational allocation Information necessary to compute depletion per unit Composite depreciation method Determine fraction for fourth year under five-year SYD Depreciation using SYD method Assumptions of straight-line depreciation DDB ignores salvage value Reporting and disclosure requirements of assets/depreciation Depreciation of natural resources Considerations in determining useful life of intangible asset Straight-line amortization recommended for intangible assets Depreciation method that applies a uniform depreciation rate Forty-year amortization for intangible assets if indefinite benefit Theoretical support for accelerated depreciation Effect of changing the estimate of an asset’s useful life Productive output depreciation same as depletion When sale of depreciable asset results in loss The exchange of similar assets that involves a gain Depreciation expense for the double-declining-balance method Capitalization of legal fees to defend patents Composite and group depreciation both use straight-line Depreciation under productive output, SYD, and DDB-Comparison The exchange of similar assets that involves a loss Carrying amount of group assets upon retirement of one Journal entry for trade of assets MACRS and optional straight-line tax depreciation Computational Questions 28 Computation of DDB depreciation expense 29 Computation of DDB depreciation expense 30 Amortization of organizational costs 235 236 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement Computation of DDB depreciation expense Computation of cost of new product with trade-in Computation of 150% DB accumulated depreciation balance Amortization of trademark Computation of cost of new product with exchange Computation of SYD accumulated depreciation Computation of SYD accumulated depreciation balance Computation of SYD depreciation expense Computation of gain/loss on disposition Computation of SYD depreciation expense Computation of SYD depreciation expense Computation of value of truck on books Computation of SYD depreciation expense Straight-line depreciation expense Computation of recognized profit on exchange Straight-line depreciation expense with extension of life SYD depreciation expense Computation of straight-line depreciation expense Life of assets under straight-line composite method Computation of straight-line depreciation expense Straight-line accumulated depreciation SYD depreciation expense DDB depreciation expense Units-of-production depreciation expense SYD depreciation and the exchange of assets SYD depreciation and the exchange of assets Computation of patent amortization expense Computation of new asset’s value with trade-in Computation of new asset’s value with trade-in Computation of patent amortization expense Computation of trademark amortization expense Computation of depletion charge per ton Computation of new asset’s value with trade-in Computation of depletion included in COGS Computation of depletion rate per ton Computation of new asset’s value with trade-in Value of machine acquired by exchange Computation of gain/loss on disposal Computation of gain on forced sale Computation of loss on machine sale Value of machine acquired by exchange Value of land acquired by exchange Journalize exchange of land Computation of gain on exchange Test Bank, Intermediate Accounting, 14th ed. 237 PROBLEMS 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Computation of expense under DDB, SYD, straight-line, service hours Computation of expense under DDB, SYD, straight-line Computation of composite life and depreciation rate Computation of annual rate and charge under straight-line, service hours, productive-output Computation of amortization for four years Computation of depletion charge Prepare intangible assets section of balance sheet Journalize exchange on both parties' books Journalize exchange on similar, dissimilar assets Journalize exchange on similar, dissimilar assets Recording an impairment loss Recording an impairment loss with goodwill Impairment and revaluation under international accounting standards MACRS computation Impairment of assets MULTIPLE CHOICE QUESTIONS b LO1 1. Depreciation of noncurrent operating assets is an accounting process for the purpose of a. reporting declining asset values on the balance sheet. b. allocating asset costs over the periods benefitted by use of the assets. c. accounting for costs to reflect the change in general price levels. d. setting aside funds to replace assets when their economic usefulness expires. c LO1 2. Which of the following principles best describes the conceptual rationale for the methods of matching depreciation expense with revenues? a. Partial recognition b. Immediate recognition c. Systematic and rational allocation d. Associating cause and effect a LO3 3. Information needed to compute a depletion charge per unit includes the a. estimated total amount of resources available for removal. 238 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement b. amount of resources removed during the period. c. cumulative amount of resources removed. d. amount of resources sold during the period. c LO1 4. The composite depreciation method a. is applied to a group of homogeneous assets. b. is an accelerated method of depreciation. c. does not recognize gain or loss on the retirement of specific assets in the group. d. excludes salvage value from the base of the depreciation calculation. d LO1 5. The sum-of-the-years’-digits method of depreciation is being used for a machine with a five-year estimated useful life. What would be the fraction applied to the cost to be depreciated in the fourth year? a. 4/5 b. 2/5 c. 4/15 d. 2/15 d 6. In order to calculate the third year’s depreciation on an asset using the sum-ofthe-years'-digits method, which of the following must be known about the asset? a. Its acquisition cost b. Its estimated salvage value c. Its estimated useful life d. All the above must be known. LO1 b LO1 7. Which of the following statements is the assumption on which straight-line depreciation is based? a. The operating efficiency of the asset decreases in later years. b. Service value declines as a function of time rather than use. c. Service value declines as a function of obsolescence rather than time. d. Physical wear and tear are more important than economic obsolescence. d LO1 8. A method that ignores salvage value in calculating periodic depreciation expense is the a. productive-output method. b. group composite method. c. sum-of-the-years’-digits method. d. double-declining-balance method. Test Bank, Intermediate Accounting, 14th ed. b LO1 239 9. Which of the following is not required to be reported in the financial statements or disclosed in the accompanying notes? a. Balances of major classes of noncurrent operating assets at the balance sheet date b. Gross historical cost and accumulated amortization for intangible assets at the balance sheet date c. Gross historical cost and accumulated depreciation for tangible noncurrent operating assets at the balance sheet date d. A general description of the cost allocation methods used with respect to major classes of noncurrent operating assets d LO3 10. Which of the following depreciation methods most closely approximates the method used to deplete the cost of natural resources? a. Straight-line method b. Double-declining-balance method c. Sum-of-the-years’-digits method d. Units-of-production method d LO2 11. Which of the following is not a consideration in determining the useful life of an intangible asset? a. Legal, regulatory, or contractual provisions b. Provisions for renewal or extension c. Expected actions of competitors d. Minimum amortization period prescribed by generally accepted accounting principles for all intangible assets b LO2 12. In accordance with generally accepted accounting principles, which of the following methods of amortization is normally recommended for intangible assets? a. Sum-of-the-years’-digits b. Straight-line c. Group composite d. Double-declining-balance c LO1 13. Which of the following depreciation methods applies a uniform depreciation rate each period to an asset’s book value? a. Straight-line b. Units-of-production c. Declining-balance d. Sum-of-the-years’-digits 240 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement b LO2 14. What is the proper time or time period over which to match costs of an intangible asset with revenues if it is likely that the benefit of the asset will last for an indeterminate but very long period of time? a. Fifty years b. Forty years c. Twenty years d. Five years a LO1 15. Which of the following reasons provides the best theoretical support for accelerated depreciation? a. Assets are more efficient in early years and initially generate more revenue. b. Expenses should be allocated in a manner that “smooths” earnings. c. Repairs and maintenance costs will probably increase in later periods, so depreciation should decline. d. Accelerated depreciation provides easier replacement because of the time value of money. c LO4 16. When the estimate of an asset’s useful life is changed, a. depreciation expense for all past periods must be recalculated. b. there is no change in the amount of depreciation expense recorded for future years. c. only the depreciation expense in the remaining years is changed. d. None of the above are true. d 17. Which of the following depreciation methods is computed in the same way as depletion? a. Straight-line b. Sum-of-the-years’-digits c. Double-declining-balance d. Productive-output LO3 d LO6 18. The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were a. less than current market value. b. greater than cost. c. greater than book value. d. less than book value. Test Bank, Intermediate Accounting, 14th ed. 241 c LO6 any 19. When an exchange of similar assets involves a gain, a. the recorded amount of the new asset is the cost of the old asset plus cash paid. b. the recorded amount of the new asset is its fair market value less any cash paid. c. the recorded amount of the new asset is the net book value of the old asset plus any cash paid. d. None of the above are true. c 20. On January 1 Stockton Company acquired a machine with a four-year useful life. Stockton estimates the salvage value of the machine will be equal to ten percent of the acquisition cost. The company is debating between using either the double-declining-balance method or the sum-of-the-years'-digits method of depreciation. Comparing the depreciation expense for the first two years computed using these methods, the depreciation expense for the double-declining-balance method (compared to the sum-of-the-years'-digits method) will match which of the patterns shown below? First Second Year Year a. Lower Lower b. Lower Higher c. Higher Lower d. Higher Higher LO1 b LO2 21. Legal fees incurred in successfully defending a patent suit should be capitalized when the patent has been Internally Purchased from Developed an Inventor a. Yes No b. Yes Yes c. No Yes d. No No a LO1 22. Which of the following utilizes the straight-line depreciation method? Composite Group Depreciation Depreciation a. Yes Yes b. Yes No c. No Yes d. No No 242 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement b LO1 23. A depreciable asset has an estimated 15 percent salvage value. At the end of its estimated useful life, the accumulated depreciation would equal the original cost of the asset under which of the following depreciation methods? ProductiveSum-of-theDoubleOutput Years’-Digits Declining-Balance a. Yes No No b. No No No c. No Yes No d. Yes Yes Yes c LO6 24. When similar assets are exchanged at a loss, the basis of the new asset is usually a. the list price of the new asset. b. the book value of the old asset plus any cash paid on the trade-in. c. the fair market value of the new asset. d. Either b or c. c LO6 a LO6 25. A company using the group depreciation method for its delivery trucks retired one of the trucks after the average service life of the group was reached. Cash proceeds were received from a salvage company. The net carrying amount of these group asset accounts would be decreased by the a. original cost of the truck. b. original cost of the truck less the cash proceeds. c. cash proceeds received. d. cash proceeds received and original cost of the truck. 26. In recording the trade of one asset for another, which of the following accounts is usually debited? a. Accumulated Depreciation—Old Asset b. Cash c. Gain on Exchange of Asset d. None of the above b 27. Which of the following is correct? LO8 a. Use of the MACRS tables requires that salvage value be deducted in computing depreciation deductions. b. Use of the optional straight-line method requires that salvage value not be Test Bank, Intermediate Accounting, 14th ed. 243 considered in computing depreciation deductions. c. The use of both the MACRS tables and the optional straight-line method requires that salvage value be deducted in computing depreciation deductions. d. None of the above are true. b LO1 c LO7 d LO2 28. Dewey Company purchased a machine that was installed and placed in service on January 2, 2001, at a total cost of $480,000. Residual value was estimated at $80,000. The machine is being depreciated over ten years by the double-declining-balance method. For the year 2002, Dewey should record depreciation expense of a. $64,000. b. $76,800. c. $80,000. d. $96,000. 29. On July 1, 2001, Ewell Corporation purchased factory equipment for $100,000. Salvage value was estimated at $4,000. The equipment will be depreciated over ten years using the double-declining-balance method. Counting the year of acquisition as one-half year, Ewell should record 2002 depreciation expense of a. $15,366. b. $16,000. c. $18,000. d. $19,200. 30. Mackay, Inc. was organized late in 2001 and began operations on January 1, 2002. Prior to the start of operations, the following costs were incurred: Attorney’s fees for incorporating........................................... $18,000 State incorporation filing fees................................................ 12,000 Mackay amortizes organization costs over the maximum period allowable under GAAP. How much amortization should Mackay record for the year ended December 31, 2002? a. $750 b $3,600 c. $6,000 d. $30,000 b 31. Luther Soaps purchased a machine on January 1, 2000, for $18,000 cash. 244 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement LO1 The machine has an estimated useful life of four years and a salvage value of $4,700. Luther uses the double-declining-balance method of depreciation for all its assets. What will be the machine’s book value as of December 31, 2001? a. $5,100 b. $4,700 c. $4,500 d. $4,300 c LO6 32. Malone Company traded in an old machine with a book value of $15,000 on a new similar machine. The new machine, which had a cash price of $75,000, was purchased for $64,000 cash plus the old machine. Malone should record the cost of the new machine as a. $64,000. b. $71,000. c. $75,000. d. $79,000. d 33. Overberg Company purchased a machine on January 2, 2001, for $1,000,000. The machine has an estimated useful life of five years and a salvage value of $100,000. Depreciation was computed by the 150% declining-balance method. The accumulated depreciation balance at December 31, 2002, should be a. $360,000. b. $459,000. c. $490,000. d. $510,000. LO1 d LO2 34. Zufelt Company bought a trademark from Basin Corporation on January 1, 2002, for $168,000. An independent consultant retained by Zufelt estimated that the remaining useful life is 50 years. Its unamortized cost on Basin’s accounting records was $84,000. Zufelt decided to write off the trademark over the maximum period allowed. How much should be amortized for the year ended December 31, 2002? a. $1,680 b. $2,100 c. $3,360 d. $4,200 a 35. Jordan Company exchanged a used autograph-signing machine with Rodman Company for a similar machine with less use. Jordan’s old machine originally cost $50,000 and had accumulated depreciation of $40,000, as LO6 Test Bank, Intermediate Accounting, 14th ed. 245 well as a market value of $40,000, at the time of the exchange. Rodman’s old machine originally cost $60,000 and at the time of the exchange had a book value of $30,000 and a market value of $32,000. Rodman gave Jordan $8,000 cash as part of the exchange. Jordan should record the cost of the new machine at a. $8,000. b. $10,000. c. $16,000. d. $32,000. 246 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement c LO1 36. XYZ Corporation bought a machine on January 1, 2002. In purchasing the machine, the company paid $50,000 cash and signed an interest-bearing note for $100,000. The estimated useful life of the machine is five years, after which time the salvage value is expected to be $15,000. Given this information, how much depreciation expense would be recorded for the year ending December 31, 2003, if the company uses the sum-of-theyears’-digits depreciation method? a. $45,000 b. $40,000 c. $36,000 d. $34,000 c LO1 37. On January 1, 2002, Carson Company purchased equipment at a cost of $420,000. The equipment was estimated to have a useful life of five years and a salvage value of $60,000. Carson uses the sum-of-the-years’-digits method of depreciation. What should the accumulated depreciation be at December 31, 2002? a. $240,000 b. $288,000 c. $336,000 d. $360,000 c 38. On September 30, 2002, Ira Party Supplies purchased catering equipment for $4,680. The equipment is estimated to have a useful life of eight years and no salvage value. If Ira selected the sum-of-the-years’-digits method, what will be the depreciation expense for 2002? a. $1,040 b. $347 c. $260 d. $130 LO7 d LO6 39. On June 30, 2002, a fire in Oak Company’s plant caused the total loss of a production machine. The machine was being depreciated at $20,000 annually and had a carrying amount of $160,000 at December 31, 2001. On the date of the fire, the fair value of the machine was $220,000, and Pine received insurance proceeds of $200,000 in October 2002. In its income statement for the year ended December 31, 2002, what amount should Oak recognize as a gain or loss on disposition? a. $0 b. $20,000 loss c. $40,000 gain d. $50,000 gain Test Bank, Intermediate Accounting, 14th ed. a LO1 b LO7 247 40. On January 1, 2000, Kalos Co. purchased a new machine for $2,500,000. The new machine has an estimated useful life of five years and the salvage value was estimated to be $250,000. Kalos uses the sum-of-the-years’digits method of depreciation. The amount of depreciation expense for 2002 is a. $450,000. b. $600,000. c. $666,667. d. $750,000. 41. On September 30, 2001, Ira Party Supplies purchased catering equipment for $4,680. The equipment is estimated to have a useful life of eight years and no salvage value. Assuming that the sum-of-the-years’-digits method is used, what will be the depreciation expense for 2002? a. $1,040.00 b. $1,007.50 c. $945.50 d. $910.00 c LO6 42. On December 2, 2001, Part Company, which operates a furniture rental business, traded in a used delivery truck with a carrying amount of $5,400 for a new delivery truck having a list price of $16,000 and paid a cash difference of $7,500 to the dealer. The used truck had a fair value of $6,000 on the date of the exchange. At what amount should the new truck be recorded on Part’s books? a. $10,600 b. $12,900 c. $13,500 d. $16,000 b LO1 43. On January 1, 2002, Carson Company purchased equipment at a cost of $420,000. The equipment was estimated to have a useful life of five years and a salvage value of $60,000. Carson uses the sum-of-the-years’-digits method of depreciation. What should the accumulated depreciation be at December 31, 2001? a. $240,000 b. $288,000 c. $336,000 d. $360,000 a LO1 44. In January, Hunter Corporation entered into a contract to acquire a new machine for its factory. The machine, which had a cash price of $300,000, was paid for as follows: Down payment....................................................................... $ 30,000 Note payable in 10 equal monthly installments.................... 240,000 1,000 shares of Hunter common stock with an agreed value of $50 per share.................................................... 50,000 Total....................................................................................... $320,000 Prior to the machine’s use, installation costs of $8,000 were incurred. The machine has an estimated useful life of ten years and an estimated salvage value of $10,000. What should Hunter record as depreciation expense for the first year under the straight-line method? a. $29,800 b. $30,000 c. $31,000 d. $31,800 b LO6 45. Melvin Motor Sales exchanged a car from its inventory for a computer to be used as a noncurrent operating asset. The following information relates to this exchange that took place on July 31, 2002: Carrying amount of the car.................................................... $30,000 Listed selling price of the car................................................. 45,000 Fair value of the computer.................................................... 43,000 Cash difference paid by Melvin............................................. 5,000 On July 31, 2002, how much profit should Melvin recognize on this exchange? a. $0 b. $8,000 c. $10,000 d. $13,000 b LO4 46. The Bucol Company purchased a tooling machine in 1992 for $120,000. The machine was being depreciated on the straight-line method over an estimated useful life of 20 years, with no salvage value. At the beginning of 2002, when the machine had been in use for ten years, the company paid $20,000 to overhaul the machine. As a result of this improvement, the company estimated that the useful life of the machine would be extended an additional five years. What would be the depreciation expense recorded for the above machine in 2002? a. $4,000 b. $5,333 c. $6,000 d. $7,333 c LO4 47. Tillman Company owns a machine that was bought on January 2, 1999, for $376,000. The machine was estimated to have a useful life of five years and a salvage value of $24,000. Tillman uses the sum-of-the-years’-digits method of depreciation. At the beginning of 2002, Tillman determined that the useful life of the machine should have been four years and the salvage value $35,200. For the year 2002, Tillman should record depreciation expense on this machine of a. $19,200. b. $44,400. c. $59,200. d. $70,400. b 48. Hendricks Construction purchased a crane on January 1, 2001, for $102,750. At the time of purchase, the crane was estimated to have a life of six years and a residual value of $6,750. In 2003, Hendricks determined that the crane had a total useful life of seven years and a residual value of $4,500. If Hendricks uses the straight-line method of depreciation, what will be the depreciation expense for the crane in 2003? a. $16,000 b. $13,250 c. $9,464 d. $8,000 LO4 b LO1 49. At the start of its business, Snell Corp. decided to use the composite method of depreciation and prepared the following schedule of machinery owned. Total Estimated Estimated Life Cost Salvage Value in Years Machine A $275,000 $25,000 20 Machine B 100,000 10,000 15 Machine C 20,000 -5 Snell computes depreciation on the straight-line method. Based on the information presented, the composite life of these assets (in years) should be a. 13.3. b. 16.0. c. 18.0. d. 19.8. c LO4 d LO7 50. A truck that cost $8,000 was originally being depreciated over four years using the straight-line method with no salvage value. If after one year, it was decided that the truck would last an additional four years (or a total of five years), the second year’s depreciation would be a. $2,000. b. $1,000. c. $1,500. d. $2,500. 51. Andrews Manufacturing Company purchased a new machine on July 1, 2001. It was expected to produce 200,000 units of product over its estimated useful life of eight years. Total cost of the machine was $600,000, and salvage value was estimated to be $60,000. Actual units produced by the machine in 2001 and 2002 are shown below. 2001...................................................................... 16,000 units 2002...................................................................... 30,000 units Andrews reports on a calendar-year basis and uses the straight-line method of depreciation, computed to the nearest month. The amount of accumulated depreciation on this machine at December 31, 2002 would be a. $150,000. b. $135,000. c. $112,500. d. $101,250. c LO7 52. Andrews Manufacturing Company purchased a new machine on July 1, 2001. It was expected to produce 200,000 units of product over its estimated useful life of eight years. Total cost of the machine was $600,000, and salvage value was estimated to be $60,000. Actual units produced by the machine in 2001 and 2002 are shown below. 2001...................................................................... 16,000 units 2002...................................................................... 30,000 units Andrews reports on a calendar-year basis and uses the sum-of-the-years’digits method of depreciation, computed to the nearest month. The amount of depreciation expense for this machine in 2002 would be a. $135,000. b. $125,000. c. $112,500. d. $105,000. a LO7 53. Andrews Manufacturing Company purchased a new machine on July 1, 2001. It was expected to produce 200,000 units of product over its estimated useful life of eight years. Total cost of the machine was $600,000, and salvage value was estimated to be $60,000. Actual units produced by the machine in 2001 and 2002 are shown below. 2001...................................................................... 16,000 units 2002...................................................................... 30,000 units Andrews reports on a calendar-year basis and uses the double-decliningbalance method of depreciation, computed to the nearest month. The amount of depreciation expense for this machine in 2002 would be a. $131,250. b. $118,125. c. $112,500. d. $101,250. c LO7 54. Andrews Manufacturing Company purchased a new machine on July 1, 2001. It was expected to produce 200,000 units of product over its estimated useful life of eight years. Total cost of the machine was $600,000, and salvage value was estimated to be $60,000. Actual units produced by the machine in 2001 and 2002 are shown below. 2001...................................................................... 16,000 units 2002...................................................................... 30,000 units Andrews reports on a calendar-year basis and uses the units-of-production method of depreciation. The amount of depreciation expense for this machine in 2002 would be a. $124,200. b. $90,000. c. $81,000. d. $74,520. a LO6 d LO6 55. On January 1, 2001, Herschel Locks Corporation purchased drilling equipment for $11,500. The equipment has an estimated useful life of four years and a salvage value of $200. Given this information, if Herschel uses the sumof-the-years’-digits method of depreciation and then trades the equipment for new, dissimilar equipment with a fair market value of $16,000 on December 31, 2002, and pays $8,000 cash in the exchange, the new equipment should be recorded at a. $16,000. b. $12,475. c. $11,590. d. $8,110. 56. On January 1, 2001, Herschel Locks Corporation purchased drilling equipment for $11,500. The equipment has an estimated useful life of four years and a salvage value of $200. Assuming that Herschel uses the straight-line method of depreciation, if it trades the equipment for new similar equipment with a list price of $15,500 on December 31, 2002, and pays $4,050 in the exchange, the new equipment should be recorded at a. $15,500. b. $11,450. c. $9,850. d. $9,900. c LO4 57. Pastel Co. purchased a patent on January 1, 1999, for $714,000. The patent was being amortized over its remaining legal life of 15 years expiring on January 1, 2008. During 2002, Pastel determined that the economic benefits of the patent would not last longer than 10 years from the date of acquisition. What amount should be charged to patent amortization expense for the year ended December 31, 2002? a. $47,600 b. $71,400 c. $81,600 d. $142,800 b LO6 58. Hartwell Trucking traded a used truck with a book value of $1,700 and a fair market value of $2,300 for a new similar truck with a list price of $17,800. Hartwell agreed to pay $13,000 in cash for the exchange in addition to giving up the used truck. At what amount should the new truck be recorded? a. $17,800 b. $15,300 c. $14,700 d. None of the above c LO6 59. Monier Carpet traded cleaning equipment with a cost of $17,000 and accumulated depreciation of $3,250 for new similar equipment with a fair market value of $11,500. Monier should record the new equipment at a. $14,750. b. $13,750. c. $11,500. d. $7,500. b LO2 60. During 1997, Volvo Machine Company spent $352,000 on research and development costs for an invention. This invention was patented on January 2, 1998, at a nominal cost that was expensed in 1998. The patent has a legal life of 17 years and an estimated useful life of 8 years. In January 2002, Volvo paid $32,000 for legal fees in a successful defense of the patent. Amortization for 2002 should be a. $2,462. b. $8,000. c. $32,000. d. $52,000. c LO2 61. On January 1, 1998, Barry Company purchased for $600,000, a trademark with an estimated useful life of 16 years. In January 2002, Barry paid $90,000 for legal fees in a successful defense of the trademark. Trademark amortization expense for the year ended December 31, 2002, should be a. $37,500. b. $43,125. c. $45,000. d. $90,000. b LO3 62. Joseph Company acquired a tract of land containing an extractable natural resource. Joseph is required by the purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 2,500,000 tons and that the land will have a value of $1,000,000 after restoration. Relevant cost information follows: Land....................................................................................... $9,000,000 Estimated restoration costs................................................... 1,500,000 What should be the depletion charge per ton of extracted material? a. $4.00 b. $3.80 c. $3.60 d. $3.20 c LO6 63. Bunker Construction Company recently exchanged an old truck, which cost $108,000 and was one-third depreciated, and paid $70,000 cash for a used crane having a current fair value of $130,000. At what amount should the crane be recorded on the books of Bunker? a. $70,000 b. $108,000 c. $130,000 d. $142,000 c LO3 64. In January 2002, Vance Mining Corporation purchased a mineral mine for $7,200,000 with removable ore estimated by geological surveys at 4,320,000 tons. The property has an estimated value of $720,000 after the ore has been extracted. Vance incurred $2,160,000 of development costs preparing the property for the extraction of ore. During 2002, 540,000 tons were removed and 480,000 tons were sold. For the year ended December 31, 2002, Vance should include what amount of depletion in its cost of goods sold? a. $720,000 b. $810,000 c. $960,000 d. $1,080,000 a LO3 65. In 2001, Newman Company paid $1,000,000 to purchase land containing a total estimated 160,000 tons of extractable mineral deposits. The estimated value of the property after the mineral has been removed is $200,000. Extraction activities began in 2002, and by the end of the year, 20,000 tons had been recovered and sold. In 2003, geological studies indicated that the total amount of mineral deposits had been underestimated by 25,000 tons. During 2003, 30,000 tons were extracted, and 28,000 tons were sold. What is the depletion rate per ton (rounded to the nearest cent) in 2003? a. $4.24 b. $4.32 c. $4.85 d. $5.19 b LO6 66. In January 2002, Bevis Company exchanged an old machine, with a book value of $156,000 and a fair value of $160,000, and paid $40,000 cash for a similar used machine having a fair value of $200,000. At what amount should the machine acquired in the exchange be recorded on Bevis’ books? a. $156,000 b. $196,000 c. $200,000 d. $204,000 c LO6 67. Ellis Construction Company recently exchanged an old truck, which cost $108,000 and was one-third depreciated, and paid $70,000 cash for a similar truck having a current fair value of $130,000. At what amount should the truck be recorded on the books of Ellis? a. $70,000 b. $108,000 c. $130,000 d. $142,000 b 68. Post Company’s depreciation policy on machinery and equipment is as follows: LO7 • • • • A full year’s depreciation is taken in the year of an asset’s acquisition. No depreciation is taken in the year of an asset’s disposition. The estimated useful life is five years. The straight-line method is used. On June 30, 2002, Post sold for $230,000 a machine acquired in 1999 for $420,000. The accumulated depreciation for this machine was $216,000 at December 31, 2001, and the original estimated salvage value was $60,000. How much gain or (loss) on the disposal should Post record in 2002? a. A $14,000 gain b. A $26,000 gain c. A $26,000 loss d. A $34,000 loss d LO6 69. On July 1, Phoenix Corporation, a calendar-year company, received a condemnation award of $150,000 as compensation for the forced sale of a plant located on company property that stood in the path of a new highway. On this date, the plant building had a depreciated cost of $75,000 and the land cost was $25,000. On October 1, Phoenix purchased a parcel of land for a new plant site at a cost of $62,500. Ignoring income taxes, Phoenix should report in its income statement for the year ended December 31 a gain of a. $0. b. $12,500. c. $37,500. d. $50,000. c 70. The John Company purchased a machine on November 1, 1993, for $148,000. At the time of acquisition, the machine was estimated to have a useful life of ten years and an estimated salvage value of $4,000. John has recorded monthly depreciation using the straight-line method. On July 1, 2002, the machine was sold for $13,000. What should be the loss recognized from the sale of the machine? a. $4,000 b. $5,000 c. $10,200 d. $13,000 LO6 d LO6 71. In January 2002, Butz Company exchanged an old machine, with a book value of $156,000 and a fair value of $140,000, and paid $40,000 cash for a similar used machine having a list price of $200,000. At what amount should the machine acquired in the exchange be recorded on Butz’s books? a. $200,000 b. $196,000 c. $184,000 d. $180,000 b LO6 73. Eagle Company owns a tract of land that it purchased in 1999 for $200,000. The land is held as a future plant site and has a fair market value of $280,000 on July 1, 2002. Hall Company also owns a tract of land held as a future plant site. Hall paid $360,000 for the land in 2001 and the land has a fair market value of $380,000 on July 1, 2002. On this date, Eagle exchanged its land and paid $100,000 cash for the land owned by Hall. At what amount should Eagle record the land acquired in the exchange? a. $280,000 b. $300,000 c. $320,000 d. $380,000 b LO6 74. A company owns a piece of land that originally cost $10,000 and has a fair market value of $8,000. It is exchanged along with $5,000 cash for another piece of land having a fair value of $13,000. The proper journal entry to record this transaction is a. Land (new)............................................................ 15,000 Land (old)......................................................... 10,000 Cash................................................................. 5,000 b. Land (new)............................................................ 13,000 Loss on Exchange................................................. 2,000 Land................................................................. 10,000 Cash................................................................. 5,000 c. Land (new)............................................................ 18,000 Land (old)......................................................... 10,000 Cash................................................................. 5,000 Gain on Exchange........................................... 3,000 d. Land (new)............................................................ 13,000 Retained Earnings................................................. 2,000 Land (old)......................................................... 10,000 Cash................................................................. 5,000 d LO6 75. In October 2002, Daryl Company exchanged a used packaging machine having a book value of $240,000 for a dissimilar new machine and paid a cash difference of $30,000. The market value of the used packaging machine was determined to be $280,000. In its income statement for the year ended December 31, 2002, how much gain should Daryl recognize on this exchange? a. $0 b. $10,000 c. $30,000 d. $40,000 PROBLEMS Problem 1 Burton Excavating purchased a bulldozer on June 1, 2002. information regarding this asset and its acquisition is available: Cost .......................................................................................... Residual value.......................................................................... Estimated useful life................................................................. Estimated service hours........................................................... The following $380,000 $30,000 8 years 60,000 The bulldozer was operated for a total of 6,100 hours in 2002 and 8,200 hours in 2003. It is company policy to take a half-year’s depreciation on all assets in the year of acquisition. Compute the depreciation expense for 2002 and 2003 under each of the following methods: (1) (2) (3) (4) Double-declining-balance Sum-of-the-years’-digits Straight-line Service hours (round rate to the nearest cent) Solution 1 LO7 (1) Double-declining-balance (200%) 2002: 2003: 25% x $380,000 x ½ = 25% ($380,000 - $47,500) = $47,500 $83,125 (2) Sum-of-the-years’-digits: [8(8+1)/2] = 36 2002: 2003: (8/36 x $350,000 x 1/2) = (8/36 x $350,000 x 1/2) = (7/36 x $350,000 x 1/2) = $38,889 $38,889 34,028 $72,917 (3) Straight-line 2002: 2003: ($350,000/8) x ½ = $350,000/8 = $21,875 $43,750 (4) Service hours ($350,000) Depreciation expense per hour = ($350,000/60,000) = $5.83 (rounded) 2002: 2003: 6,100 x $5.83 = 8,200 x $5.83 = $35,563 $47,806 Problem 2 On May 1, 2002, Reginald Inc. purchased equipment at a cost of $280,000. The equipment has an estimated salvage value of $12,000 and is being depreciated over an estimated life of six years. The company’s policy is to recognize depreciation to the nearest whole month. Compute the charge for depreciation on this equipment for the years ended December 31, 2002 and 2003, under the following methods: (1) Double-declining-balance (2) Sum-of-the-years’-digits (3) Straight-line Solution 2 LO7 (1) Double-declining-balance 2002: 2003: $280,000 x 33 1/3% x 8/12 = $62,222 ($280,000 - $62,222) x 33 1/3% = $72,593 (2) Sum-of-the-years’-digits: [6(7)/2] = 21 2002: 2003: $268,000 x 6/21 x 8/12 = $268,000 x 6/21 x 4/12 = $268,000 x 5/21 x 8/12 = $51,048 $25,524 42,540 $68,064 (3) Straight-line 2002: 2003: $268,000/6 x 8/12 = $268,000/6 = $29,778 $44,667 Problem 3 The following is a schedule of machinery owned by Martin Manufacturing Company. Estimated Estimated Total Salvage Life in Cost Value Years Machine A $ 600,000 $110,000 20 Machine B 315,000 30,000 10 Machine C 84,000 0 15 Machine D 107,000 7,000 5 $1,106,000 Martin computes depreciation on the straight-line basis. Based on the information presented, compute the: (1) Composite life of these assets (in years). (2) Composite depreciation rate. Solution 3 LO1 Asset A B C D Cost $ 600,000 315,000 84,000 107,000 $1,106,000 Salvage Value $110,000 30,000 0 7,000 $147,000 (1) $959,000/$78,600 = 12.20 years (2) $78,600/$1,106,000 = 7.11% Problem 4 Depreciable Cost $490,000 285,000 84,000 100,000 $959,000 Estimated Annual Life Depreciation 20 $24,500 10 28,500 15 5,600 5 20,000 $78,600 Hearsa Manufacturing Inc. purchased a new machine on January 2, 2002, that was built to perform one function on its assembly line. Data pertaining to this machine are: Acquisition cost...................................................................... Residual value....................................................................... Estimated service life: Years................................................................................ Service hours................................................................... Production output............................................................. $330,000 $30,000 5 250,000 300,000 Using each of the following methods, compute the annual depreciation rate and charge for the years ended December 31, 2002 and 2003: (1) Straight-line (2) Service hours (assume 32,000 hours for 2002 and 36,000 hours for 2003). (3) Productive-output (assume 31,000 units for 2002 and 37,000 units for 2003). Solution 4 LO1 (1) Straight-line: 2002: ($330,000 - $30,000)/5 = 2003: $60,000 $60,000 (2) Service hours: ($330,000 - $30,000)/250,000 = $1.20 per hour depreciation rate 2002: $1.20 x 32,000 = $38,400 2003: $1.20 x 36,000 = $43,200 (3) Productive-output: ($330,000 - $30,000)/300,000 = $1.00 per unit depreciation rate 2002: $1.00 x 31,000 = $31,000 2003: $1.00 x 37,000 = $37,000 Problem 5 The Fitzsimmons Company applied for and received numerous patents at a total cost of $286,500 at the beginning of 1999. It is assumed the patents will be useful evenly during their full legal lives. At the beginning of 2001, the company paid $48,600 in legal fees for successful defense in a patent infringement suit. At the beginning of 2002, information became available that caused the company to reduce the remaining life of the patents to five years. Calculate the amortization expense for the years 1999, 2000, 2001, and 2002. Round to the nearest dollar. Solution 5 LO2 1999: $286,500/17 = $16,853 2000: $286,500/17 = 2001: Acquisition cost Less: amortization to date Carrying value Successful defense New carrying value Remaining life = 15 years $301,394/15 = $286,500 33,706 $252,794 48,600 $301,394 Carrying value, Jan. 1, 2001 Amortization for 2001 Carrying value, Jan. 1, 2002 $301,394 20,093 $281,301 2002: Remaining life = 5 years $281,301/5 = $16,853 $20,093 $56,260 Problem 6 In 2001, Silverspur Mining Inc. purchased land for $5,600,000 that had a natural resource supply estimated at 4,000,000 tons. When the natural resources are removed, the land has an estimated value of $640,000. The required restoration cost for the property is estimated to be $800,000. Development and road construction costs on the land were $560,000, and a building was constructed at a cost of $88,000 with an estimated $8,000 salvage value when all the natural resources have been extracted. During 2002, additional development costs of $272,000 were incurred, but additional resources were not discovered. Production for 2001 and 2002 was 700,000 tons and 900,000 tons, respectively. Compute the depletion charge for 2001 and 2002. (Include depreciation on the building, if any, as a depletion charge.) Round depletion charge to the nearest cent. Solution 6 LO3 Acquisition costs.................................................................... $5,600,000 Restoration costs................................................................... 800,000 Residual value--land.............................................................. (640,000) Development costs................................................................ 560,000 Building ................................................................................. 88,000 Salvage value--building......................................................... (8,000) $6,400,000 $6,400,000/4,000,000 tons = $1.60 per ton 2001: 2002: 700,000 tons x $1.60 = Original cost Additional costs--2002 Estimated depletion--2001 Balance subject to depletion $1,120,000 $6,400,000 272,000 6,672,000 (1,120,000) $5,552,000 $5,552,000/3,300,000 tons = $1.68 per ton (rounded) 900,000 tons x $1.68 = $1,512,000 Problem 7 Information concerning Thomas Corporation’s intangible assets is as follows: Thomas incurred $352,000 of experimental and development costs in its laboratory to develop a patent that was granted on January 2, 2002. Legal fees and other costs associated with registration of the patent totaled $65,600. Thomas estimates that the useful life of the patent will be eight years. A trademark was purchased from Johnson Company for $160,000 on July 1, 1999. Expenditures for successful litigation in defense of the trademark totaling $40,000 were paid on July 1, 2002. Thomas estimates that the useful life of the trademark will be 20 years from the date of acquisition. Prepare a schedule showing the intangible assets section of Thomas’ balance sheet at December 31, 2002. Solution 7 LO2 Thomas Corporation Balance Sheet (partial) December 31, 2002 Patent, net of accumulated amortization of $8,200..................... Trademark, net of accumulated amortization of $29,176............ ** $ 57,400 * 170,824 $ 228,224 * Patent Capitalized cost of patent at January 2, 2002......................... Amortization ($65,600/8 years)...................................................... Balance: December 31, 2002................................................. ** Trademark Cost of Trademark..................................... Amortization (July 1, 1999 - Dec. 31, 2001) ($160,000/20 x 2 1/2)................................ Amortization (Jan. 1, 1999 - June 30, 2002) ($8,000 x 1/2).......................................... Cost of successful defense........................ Cost $160,000 $ 65,600 (8,200) $ 57,400 Accumulated Amortization $20,000 4,000 40,000 $200,000 Amortization (July 1, 2002 - Dec. 31, 2002) [($200,000 - $24,000)/17] x ½...................... $24,000 5,176 $200,000 $29,176 Deduct accumulated amortization............. 29,176 Trademark balance.................................... $170,824 Problem 8 Riley Company owns a machine that cost $560,000, has a book value of $240,000, and an estimated fair value of $480,000. Fizzer Company has a machine that cost $720,000, has accumulated depreciation of $400,000, and an estimated fair value of $640,000. The machines of both companies are of the same type and perform the same function. Riley and Fizzer, both in the same line of business, trade assets and Riley pays Fizzer cash of $160,000. (1) Record the exchange on Riley Company’s books. (2) Record the exchange on Fizzer Company’s books. Solution 8 LO6 (1) Riley Company’s books Machinery................................................................... Accumulated Depreciation......................................... Machinery........................................................... Cash................................................................... Gain on Exchange of Asset................................ 640,000 320,000 560,000 160,000 240,000 * * Because cash equals 25% or more of the fair value of the exchange. (2) Fizzer Company’s books Cash............................................................................ Machinery................................................................... Accumulated Depreciation......................................... Machinery........................................................... Gain on Exchange of Asset................................ * Cost.......................................................................... Accumulated depreciation........................................ Book value................................................................ Fair value.................................................................. Gain.......................................................................... 160,000 480,000 400,000 720,000 320,000 * $720,000 400,000 $320,000 640,000 $320,000 Problem 9 The Chase Company exchanged equipment costing $240,000 with accumulated depreciation of $90,000 for equipment owned by Jones Corporation. The Jones equipment cost $330,000 with accumulated depreciation of $120,000. The fair value of both pieces of equipment was $300,000. Provide the necessary entries to record the transaction on both companies’ books assuming: (1) The assets exchanged are similar and Chase and Jones are in the same line of business. (2) The assets exchanged are dissimilar. Solution 9 LO6 (1) Chase: Jones: (2) Chase: Jones: Equipment.................................................. Accumulated Depreciation......................... Equipment............................................. 150,000 90,000 Equipment.................................................. Accumulated Depreciation......................... Equipment............................................. 210,000 120,000 Equipment.................................................. Accumulated Depreciation......................... Equipment............................................. Gain on Exchange of Equipment.......... 300,000 90,000 Equipment.................................................. Accumulated Depreciation......................... Equipment............................................. Gain on Exchange of Equipment.......... 300,000 120,000 240,000 330,000 240,000 150,000 330,000 90,000 Problem 10 Seaver Inc. exchanged a machine costing $400,000 with accumulated depreciation of $280,000 for a machine from the Goodin Company. Goodin paid $20,800 cash in addition to its machine (which cost $200,000 with accumulated depreciation of $68,000) for the Seaver machine. The Goodin machine has a fair value of $160,000. Provide the necessary entries to record the transactions on both companies’ books assuming the machines are similar and Seaver and Goodin are in the same line of business. Solution 10 LO6 Goodin: Machinery........................................................... Accumulated Depreciation................................. Machinery................................................... Cash........................................................... 152,800 68,000 200,000 20,800 Seaver: Machinery........................................................... Accumulated Depreciation................................. Cash................................................................... Machinery................................................... Gain on Exchange of Machinery................ 106,195 280,000 20,800 400,000 6,995 * * [$20,800/($20,800 + $160,000)] x ($180,800 - $120,000) = $6,995 Problem 11 Johnson Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated using the straight-line method with a 20-year useful life and 10% residual value. Johnson’s operations have experienced significant losses for the past 2 years and, as a result, the company has decided that the equipment should be evaluated for possible impairment. The management of Johnson Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is $240,000. No goodwill was associated with the purchase of the equipment. (1) Determine if an impairment loss should be recognized. (2) Determine the amount of the loss and prepare the journal entry to record the loss. (3) How would your answer to (1) change if the fair value of the building was $500,000? Solution 11 LO5 (1) Annual depreciation for the equipment has been $45,000 ($1,000,000 $100,000)/20 years. Current book value of the equipment is: Original cost........................................................ $1,000,000 Accumulated depreciation ($45,000 x 8 years). 360,000 Book value.......................................................... $ 640,000 The book value of $640,000 is compared to the undiscounted sum of the future cash flows to determine whether the equipment is impaired. The sum of the future cash flows is less, so an impairment loss should be recognized. (2) The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book value of the equipment and its fair value. The impairment loss would be recorded as follows: Accumulated Depreciation--Equipment ...........................360,000 Loss on Impairment of Equipment.....................400,000 Equipment ($1,000,000 - $240,000).......... 760,000 (3) The answer to (1) is unaffected by the fair value of the asset. The existence of an impairment loss is determined solely by using the undiscounted sum of estimated future cash flow, not the fair value of the asset. Problem 12 Johnson Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated using the straight-line method with a 20-year useful life and 10% residual value. Johnson’s operations have experienced significant losses for the past 2 years and, as a result, the company has decided that the equipment should be evaluated for possible impairment. The management of Johnson Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is $240,000. Goodwill of $80,000 was associated with the purchase of the equipment. (1) Determine if an impairment loss should be recognized. (2) Determine the amount of the loss and prepare the journal entry to record the loss. Solution 12 LO5 (1) Annual depreciation for the equipment has been $45,000 ($1,000,000 $100,000)/20 years. Current book value of the equipment is: Original cost........................................................ $1,000,000 Accumulated depreciation ($45,000 x 8 years). 360,000 Book value.......................................................... $ 640,000 In addition to the book value of the equipment, the remaining book value of the goodwill is computed as follows: Original cost........................................................$80,000 Accumulated amortization: ($80,000/20 = $4,000; $4,000 x 8)............ 32,000 Book value..........................................................$48,000 The total book value of $688,000 ($640,000 + $48,000) is compared to the undiscounted sum of the future cash flows of $560,000 ($80,000 x 7years) to determine whether the equipment is impaired. The sum of the future cash flows is less, so an impairment loss should be recognized. (2) The impairment loss is equal to the $448,000 ($688,000 - $240,000) difference between the book value of the equipment and its fair value. The impairment loss would be recorded as follows: Accumulated Depreciation--Equipment ............ 360,000 Loss on Impairment of Equipment..................... 448,000 Equipment ($1,000,000 - $240,000).......... Goodwill...................................................... 760,000 48,000 Problem 13 Johnson Company is located in Hong Kong and uses international accounting standards. Johnson Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated using the straight-line method with a 20-year useful life and 10% residual value. Johnson’s operations have experienced significant losses for the past 2 years and, as a result, the company has decided that the equipment should be evaluated for possible impairment. The management of Johnson Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is $240,000. No goodwill was associated with the purchase of the equipment. Johnson Company has chosen to recognize increases in the value of long-term operating assets in accordance to the allowable alternative under IAS 16. (1) Determine if an impairment loss should be recognized. (2) Determine the amount of the loss and prepare the journal entry to record the loss. (3) What journal entry should Johnson Company make if the fair value of the building was $980,000? 270 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement Solution 13 LO5 (1) Annual depreciation for the equipment has been $45,000 ($1,000,000 $100,000)/20 years. Current book value of the equipment is: Original cost........................................................ $1,000,000 Accumulated depreciation ($45,000 x 8 years). 360,000 Book value.......................................................... $ 640,000 According to IAS 36, the existence of impairment is determined by comparing book value of $640,000 to the fair value of $240,000. The fair value is lower, so an impairment loss should be recognized. In this case, the determination of the existence of an impairment loss is based on is based on a comparison of book value and fair value; under U.S. GAAP, the test is based on a comparison of book value and the undiscounted sum of future cash flows. (2) The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book value of the equipment and its fair value. The impairment loss would be recorded as follows: Accumulated Depreciation--Equipment ............ 360,000 Loss on Impairment of Equipment..................... 400,000 Equipment ($1,000,000 - $240,000).......... 760,000 (3) Since the fair value of $980,000 is greater than the book value of $640,000, Johnson Company will recognize $340,000 ($980,000 - $640,000) as an upward asset revaluation. The upward revaluation is recorded as follows: Accumulated Depreciation--Equipment............. 360,000 Revaluation Equity Reserve....................... Equipment ($1,000,000 - $980,000).......... 340,000 20,000 Problem 14 The McCloud Company purchased a new piece of factory equipment on May 20, 2002, for $40,000. For income tax purposes, the equipment is classified as a 7-year asset. Since the tax life is similar to the estimated economic life of the asset, McCloud decides to use tax depreciation for financial reporting purposes. The equipment is not expected to have any residual value at the end of the 7 years. Prepare a depreciation schedule for the life of the asset using the MACRS method of cost recovery. Test Bank, Intermediate Accounting, 14th ed 271 Solution 14 LO8 Depreciation Schedule Cost Computation Recovery Amount Asset Book Value $40,000 2002 $40,000 x .2857 x ½ $5,714 34,286 2003 $34,286 x .2857 9,796 24,490 2004 $24,290 x .2857 6,997 17,493 2005 $17,493 x .2857 4,998 12,495 2006 $12,495 x .2857 3,569 8,926 2007 $ 8,926 ÷ 2.5* 3,570 5,356 2008 $ 5,356 ÷ 1.5 3,570 1,786 2009 1,786 -0Switched to straight-line depreciation since depreciation of $3,570 exceeds the double-declining-balance depreciation of $2,550 ($8,926 x . 2857). Year Problem 15 A recently issued FASB standard requires that an impairment loss be recognized if the sum of the expected future net cash inflows (undiscounted and without interest charges) is less than the carrying value of the asset. The amount of the impairment loss recognized is the amount by which the carrying amount of the asset exceeds the fair value of the asset. Provide examples of events or changes in circumstances that indicate that the recoverability of the carrying amount of an asset may have been impaired. Evaluate the recognition criterion proposed by the FASB, specifically addressing the issue of using the undiscounted sum of the future net cash flows. Solution 15 LO5 The following are examples of events or changes in circumstances that may indicate that the carrying amount of an asset may not be recoverable: a. A significant decrease in the market value of an asset. b. A significant change in the extent or manner in which an asset is used. c. A significant adverse change in legal factors or in the business climate that affects the value of an asset. 272 Chapter 13 Investments in Noncurrent Operating Assets—Utilization and Retirement d. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset. e. associated A projection or forecast that demonstrates continuing losses with an asset. The use of the sum of the expected future net cash flows (undiscounted and without interest charges) as a criterion for impairment appears to contradict modern theories both of accounting and finance. The time value of money should be considered at a minimum as an element of cost recovery. The FASB, however, believes that including the time value of money in the test for impairment poses some significant problems. The first is the difficulty of associating the actual outstanding debt with individual assets. The only practical application would be the use of an incremental borrowing rate which may result in a very close approximation of the present values of the cash flows. The second problem relates to the fact that each entity has a different incremental borrowing rate because different entities have different debt capacities. The result of these entity-unique borrowing rates is that different present values would result for similar impaired assets because the assets are owned by different entities having different debt capacities. The FASB’s solution of using the sum of the expected future net cash flows (undiscounted and without interest charges) avoids not only the problems associated with the discount rate but also the necessity of projecting the timing of cash flows. This approach uses information that is generally available to the entity and allows a more expeditious evaluation of an asset’s compliance with the established recognition criterion. Test Bank, Intermediate Accounting, 14th ed CHAPTER 13 -- QUIZ A 273 Name _________________________ Section ________________________ T F 1. The cost of property less the expected residual value, if any, is called the depreciable base. T F 2. Depreciation is the systematic and rational allocation of asset cost over the periods benefitted by the use of the asset. T F 3. The residual (salvage) value of an asset is defined as the estimated amount that can be realized upon retirement of the asset. T F 4. The physical factors limiting the lives of noncurrent operating assets are inadequacy and obsolescence. T F 5. The FASB requires disclosure of both cost and accumulated depreciation for property on the balance sheet or notes to the financial statements. T F 6. The modified accelerated cost recovery system (MACRS) is an example of a group rate depreciation method. T F 7. Composite depreciation is not an allowable depreciation method under generally accepted accounting principles. T F 8. The sum-of-the-years’-digits method is an example of a decreasing-charge depreciation method. T F 9. In the sum-of-the-years’-digits method, residual value is not used in the computations of depreciation expense. T F 10. Straight-line depreciation assumes equal usefulness in each time period, and the periodic charge is not affected by asset productivity or efficiency variations. CHAPTER 13 -- QUIZ B Name _________________________ Section ________________________ T F 1. Under ACRS and MACRS, no depreciation is recognized on acquisitions during the year, but depreciation for a full year is recognized on retirements. T F 2. Most companies use the straight-line depreciation method for financial reporting purposes. T F 3. Decreasing-charge methods of depreciation are reasonable approaches to cost allocation when the benefits provided by an asset increase and maintenance and repair costs decrease as the asset gets older. T F 4. When group depreciation is used and an asset is retired from the group, no gain or loss is recognized. T F 5. When applying the composite depreciation method, a new rate is usually calculated each period based on the assets currently included in the group. T F 6. According to APB Opinion No. 17, the straight-line method of amortization should be applied unless a company demonstrates that another systematic method is more appropriate. T F 7. When similar assets are exchanged, at least part of any gain can always be deferred as long as the assets are also for a similar line of business. T F 8. When buildings and improvements are constructed in connection with the removal of natural resources and their usefulness is limited to the duration of the project, the depreciation should be recognized on an output basis similar to the one used for the natural resource itself. T F 9. The acquisition cost of wasting assets includes the purchase price and developmental costs, such as drilling costs, sinking mine shafts, and constructing roads. T F 10. Adjustments for the change in estimated useful lives of both property, plant, and equipment and intangible assets are reported as a cumulative effect of a change in accounting principle. 274 CHAPTER 13 -- QUIZ C A. B. C. D. E. F. G. H. I. J. Name _________________________ Section ________________________ Composite depreciation Straight-line depreciation Time factor Sum-of-the-years’-digits depreciation Cost recovery period Amortization Indicated loss Physical factor Depreciation Similar assets K. L. M. N. O. P. Q. R. S. Involuntary conversion Unit depreciation Declining-balance depreciation Current cost Residual value Natural resources Use factor Impairment Group depreciation Select the term that best fits each of the following definitions and descriptions. Indicate your answer by placing the appropriate letter in the space provided. _____ 1. A depreciation method providing decreasing periodic charges for depreciation by applying a constant percentage to a declining asset book value. _____ 2. Periodic cost allocation process for intangible assets. _____ 3. A method under which like assets are grouped together and depreciation is computed for the group rather than for individual assets. _____ 4. The depreciation method that recognizes equal periodic depreciation charges for each year of an asset’s life. _____ 5. Retirement of assets caused by uncontrollable events such as fire, earthquake, flood, or condemnation. _____ 6. Most popular depreciation methods, such as straight-line and declining-balance, are based on this factor. _____ 7. Estimated amount that can be realized upon the retirement of an asset. _____ 8. A factor related to the use of an asset that limits its useful life. _____ 9. The units-of-production method is the most common depreciation method emphasizing this factor. _____ 10. A method under which dissimilar assets are aggregated and depreciation is computed for the aggregation based on a weighted average life expectancy. _____ 11. A period of time defined by tax legislation over which the cost of noncurrent operating assets may be allocated against revenue. _____ 12. The excess of the book value over the market value of the asset given up in an exchange of assets. ____13. Periodic cost allocation process for tangible noncurrent operating assets for financial reporting purposes. _____ 14. Unexpected reduction in the value of an asset that significantly reduces its current 275 value below its value reported on the financial statements. _____ 15. Wasting assets such as oil, gas, timber, and ore deposits are all examples. CHAPTER 13 -- QUIZ SOLUTIONS Quiz A 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. T T T F T F F T F T Quiz B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Quiz C F T F T F T F T T F 1. M 2. F 3. S 4. B 5. K 6. C 7. O 8. H 9. Q 10. A 11. E 12. G 13. I 14. R 15. P 276 (This page is left blank intentionally.)