CHAPTER 9 Reporting and Analyzing Long-Lived Assets ANSWERS TO QUESTIONS 1. For plant assets, the cost principle states that plant assets are recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use. 2. In a cash transaction, cost is equal to the cash paid. In a noncash transaction, cost is equal to the cash equivalent price paid, which is the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable. 3. The primary advantages of leasing are (1) reduced risk of obsolescence, (2) little or no down payment, (3) shared tax advantages, and (4) reduced recorded assets and liabilities. 4. When only the land is to be used, all demolition and removal costs of the building less any proceeds from salvaged materials are necessary expenditures to make the land ready for its intended use. Any costs for clearing, draining, filling, and grading are also part of the cost of the land. When both the land and building are to be used, necessary costs of the building include remodeling expenditures and the cost of replacing or repairing the roofs, floors, wiring, and plumbing. 5. The potential benefits of leasing are (1) reduced risk of obsolescence (an obvious concern to Kellum), (2) little or no required down payment, (3) shared tax advantages, (4) assets and liabilities are not reported on the balance sheet. 6. You should explain to the president that depreciation is a process of allocating the cost of a plant asset to expense over its service (useful) life in a rational and systematic manner. Recognition of depreciation is not intended to result in the accumulation of cash for replacement of the asset. 7. (a) Salvage value is the expected cash value of the asset at the end of its useful life. (b) Salvage value is used in determining depreciable cost in the straight-line method by subtracting it from the plant asset’s cost. 8. (a) Useful life is expressed in years under the straight-line method and in units of activity under the units-of-activity method. (b) The pattern of periodic depreciation expense over an asset’s useful life is constant under the straight-line method and variable under the units-of-activity method. 9. The effects of the three methods on annual depreciation expense are: Straight-line—constant amount; units-of-activity—varying amount; declining-balance—decreasing amounts. 10. A revision of depreciation is made in current and future years but not retroactively. The rationale is that continual restatement of prior periods would adversely affect the reader’s confidence in the financial statements. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-1 Questions Chapter 9 (Continued) 11. Ordinary repairs are made to maintain the operating efficiency and expected productive life of the asset. Capital expenditures are additions and improvements made to increase efficiency, productive capacity, or expected useful life of the asset. Revenue expenditures are recognized as expenses when incurred; capital expenditures are generally debited to the plant asset affected. 12. In a sale of plant assets, the book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs. 13. The plant asset and related accumulated depreciation should continue to be reported on the balance sheet without further depreciation or adjustment until the asset is retired. Reporting the asset and related accumulated depreciation on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset. In no situation can the depreciation on the plant asset exceed the cost of the plant asset. 14. Tootsie Roll depreciates its buildings over 20 to 35 years and its machinery and equipment over 5 to 20 years. 15. Depreciation and amortization are both concerned with writing off the cost of an asset to expense over the periods benefited. Depreciation refers to allocating the cost of a plant asset to expense and amortization to allocating the cost of an intangible asset to expense. 16. It is true that successful marketing campaigns often benefit multiple accounting periods in the future, enhancing the company’s value, and potentially creating goodwill. However, from an accounting perspective Ralph’s proposal is unacceptable. First of all, accounting standards only allow the recording of “purchased goodwill” that results from the purchase of another business. Internally created goodwill is not allowed to be recorded. Second, marketing expenditures are to be treated as expenses of the period in which they are incurred. They can not be capitalized. It is unethical to capitalize costs simply to boost reported income by spreading the cost over multiple periods. 17. The intern is not correct. If an intangible asset has a limited life, the cost of the asset should be amortized over that asset’s useful life (the period of time when operations are benefited by use of the asset) or its legal life, whichever is shorter. The cost of intangible assets with indefinite lives should not be amortized. 18. The favorable attributes which could result in goodwill include exceptional management, desirable location, good customer relations, skilled employees, high quality products, fair pricing policies, and harmonious relations with labor unions. 19. Goodwill is the value of many favorable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold. 20. Goodwill is recorded only when there is an exchange transaction that involves the purchase of an entire business. Goodwill is the excess of cost over the fair market value of the net assets (assets less liabilities) acquired. The recognition of goodwill without an exchange transaction would lead to subjective valuations which would reduce the reliability of financial statements. 9-2 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) Questions Chapter 9 (Continued) Goodwill is not amortized because it has an indefinite life. It remains at its original value as an intangible asset unless it is considered to be impaired. If it is impaired, it is written down. 21. Research and development costs present several accounting problems. It is sometimes difficult to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, research and development costs are usually recorded as an expense when incurred. 22. Campbell Soup Company’s return on assets ratio is computed as follows: Net income Average total assets = $854 $3,095 = 27.6% 23. The return on assets ratio is closely monitored by management. It is the product of the profit margin ratio and the asset turnover ratio. At first glance, if this new product line has a lower profit margin, then it will reduce the company’s asset turnover ratio. However, it is likely that it will have a higher turnover than the company’s more expensive offerings. As a consequence, it is not possible to know what effect the new product line will have on the company’s return on assets without knowing the expected effect on the company’s asset turnover. 24. (a) Grocery stores usually have a high asset turnover ratio and a low profit margin ratio. (b) Car dealerships normally have a low asset turnover ratio and a high profit margin ratio. 25. Since Aldrich uses the straight-line depreciation method, its depreciation expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method. Benjamin’s depreciation expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Aldrich’s net income will be higher than Benjamin’s in the first few years of the asset’s useful life. 26. Yes, the tax regulations of the IRS allow a company to use a different depreciation method on the tax return than is used in preparing financial statements. Garza Corporation uses an accelerated depreciation method for tax purposes to minimize its income taxes. 27. By selecting a higher estimated useful life, Mane Corp. is spreading the plant asset’s cost over a longer period of time. The depreciation expense reported in each period is lower and net income is higher. Nienstedt’s choice of a shorter estimated useful life will result in higher depreciation expense reported in each period and lower net income. 28. In the operating activities section of the statement of cash flows, depreciation expense (from plant assets) and amortization expense (from intangible assets) are added back to net income to determine net cash provided by operating activities. In the investing section, cash paid to purchase plant assets or intangible assets is shown as a use of cash. If the company sells any of its used plant assets, or if it sells intangibles, it would report the amount of cash received as a source of cash from investing activities. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-3 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures should be included in the cost of the land. Therefore, the cost of the land is $73,400 ($60,000 + $5,000 + $2,100 + $2,800 + $3,500). BRIEF EXERCISE 9-2 The cost of the truck is $26,280 (cash price $24,000 + sales taxes $1,080 + painting and lettering $1,200). The expenditures for insurance and motor vehicle license should not be added to the cost of the truck. BRIEF EXERCISE 9-3 The depreciable cost is $27,000 ($31,000 – $4,000). With a 5-year useful life, annual depreciation is $5,400 ($27,000 ÷ 5). Under the straight-line method, depreciation is the same each year. Thus, depreciation is $5,400 for both the first and second years. BRIEF EXERCISE 9-4 It is likely that management requested this accounting treatment to boost reported net income. Land is not depreciated; thus, by reporting land at $120,000 above its actual value the company increased yearly income by ⎛ $120,000⎞ $6,000 ⎜ ⎟ or the reduction in depreciation expense. This practice is ⎝ 20 years ⎠ not ethical because management is knowingly misstating asset values. BRIEF EXERCISE 9-5 Book value, 1/1/10 ($36,000 – $14,000) ........................................... Less: Salvage value......................................................................... Depreciable cost ............................................................................... Remaining useful life........................................................................ Revised annual depreciation ($20,000 ÷ 2) ..................................... 9-4 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual $22,000 2,000 $20,000 2 years $10,000 (For Instructor Use Only) BRIEF EXERCISE 9-6 (a) Repair Expense......................................................... Cash ..................................................................... 45 (b) Delivery Truck ........................................................... Cash ..................................................................... 400 45 400 BRIEF EXERCISE 9-7 (a) Accumulated Depreciation—Delivery Equipment .............................................................. Delivery Equipment ............................................. 41,000 (b) Accumulated Depreciation—Delivery Equipment .............................................................. Loss on Disposal ...................................................... Delivery Equipment............................................. 38,800 2,200 Cost of delivery equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal 41,000 41,000 $41,000 38,800 2,200 0 $ 2,200 BRIEF EXERCISE 9-8 (a) Depreciation Expense .............................................. Accumulated Depreciation—Office Equipment ... 6,000 (b) Cash ........................................................................... Accumulated Depreciation—Office Equipment ..... Loss on Disposal ...................................................... Office Equipment .............................................. 21,000 48,000 3,000 Cost of office equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal 6,000 72,000 $72,000 48,000* 24,000 21,000 $ 3,000 *$42,000 + $6,000 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-5 BRIEF EXERCISE 9-9 (a) Return on assets ratio = (b) Asset turnover ratio = $3.5 ($30.0 + $29.0)÷2 = 11.9% $21.6 = .73 times ($30.0 + $29.0) ÷ 2 BRIEF EXERCISE 9-10 (a) Amortization Expense—Patent ($150,000 ÷ 5)....... Patent................................................................. 30,000 30,000 (b) Intangible Assets Patent (Net of $30,000 of amortization) .......... $120,000 BRIEF EXERCISE 9-11 NIKE, INC. Partial Balance Sheet As of May 31, 2007 (in millions) Property, plant, and equipment Land........................................................ Buildings................................................ Machinery and equipment .................... Other plant assets ................................. Less: Accumulated depreciation ........ Total property, plant, and equipment ................................... Intangible assets Goodwill ................................................. Patents and trademarks........................ Less: Accumulated amortization ........ Total intangible assets.................. $ 193.8 $ 840.9 1,817.2 767.2 1,940.8 1,484.5 $1,678.3 $ 130.8 $115.5 47.1 68.4 $ 199.2* *Alternatively, many companies would simply show a single line for net intangibles. 9-6 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BRIEF EXERCISE 9-12 To determine net cash provided by operating activities, add depreciation expense and amortization expense to net income: Net cash provided by = $157,000 + $12,000 + $6,000 = $175,000 Operating activities *BRIEF EXERCISE 9-13 The declining-balance rate is 40% (1/5 X 2) and this rate is applied to the book value at the beginning of the year. The computations are: Book Value Year 1 Year 2 $31,000 ($31,000 – $12,400) X Rate = Depreciation 40% 40% $12,400 $ 7,440 *BRIEF EXERCISE 9-14 The depreciation cost per unit is 18 cents per mile computed as follows: Depreciable cost ($27,500 – $500) ÷ 150,000 = $.18 Depreciation expense for each year is as follows: 2009 28,000 miles X $.18 = $5,040 2010 30,000 miles X $.18 = $5,400 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-7 SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 9-1 The following four items are expenditures necessary to acquire the truck and get it ready for use: Negotiated purchase price......................................... Installation of special shelving.................................. Painting and lettering ................................................. Sales tax ...................................................................... Total paid ......................................................... $24,000 1,100 900 1,300 $27,300 Thus, the cost of the truck is $27,300. The payments for the motor vehicle license and for the insurance are operating costs and are expensed over the first year of the truck’s life. DO IT! 9-2 Depreciation expense = Cost – Salvage $15,000 – $1,000 = = $1,750 Useful life 8 years The entry to record the first year’s depreciation would be: Depreciation Expense ........................................................... Accumulated Depreciation........................................... 9-8 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 1,750 1,750 (For Instructor Use Only) DO IT! 9-3 (a) (b) Sale of truck for cash at a gain: Cash............................................................................... Accumulated Depreciation—Truck ............................. Truck ....................................................................... Gain on Sale ........................................................... Sale of truck for cash at a loss: Cash............................................................................... Accumulated Depreciation—Truck ............................. Loss on Sale ................................................................. Truck ....................................................................... 26,000 28,000 50,000 4,000 15,000 28,000 7,000 50,000 DO IT! 9-4 1. 2. 3. 4. 5. Intangible assets Amortization Franchise Research and development costs Goodwill Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-9 SOLUTIONS TO EXERCISES EXERCISE 9-1 (a) The following points explain the application of the cost principle to plant assets. 1. 2. 3. (b) 1. 2. 3. 4. Under the cost principle, the acquisition cost for a plant asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. Cost is measured by the cash paid in a cash transaction, or by the cash equivalent price paid when noncash assets are used in payment. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable. Land Factory Machinery Delivery Truck Land Improvements 5. 6. 7. 8. Delivery Truck Factory Machinery Prepaid Insurance License Expense EXERCISE 9-2 1. 2. 3. 4. 5. 6. 7. 8. 9. 9-10 Factory Machinery Truck Factory Machinery Land Prepaid Insurance Land Improvements Land Improvements Land Building Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) EXERCISE 9-3 (a) (b) Cost of land Cash paid................................................................... Net cost of removing warehouse ($8,200 – $1,700)... Attorney’s fee ............................................................ Real estate broker’s fee............................................ Total .................................................................... $80,000 6,500 1,500 5,000 $93,000 The architect’s fee ($9,100) should be debited to the building account. The cost of the driveways and parking lot ($14,000) should be debited to Land Improvements. EXERCISE 9-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. False. Depreciation is a process of cost allocation, not asset valuation. True. False. The book value of a plant asset may be quite different from its market value. False. Depreciation applies to three classes of plant assets: land improvements, building, and equipment. False. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time. True. False. Recognizing depreciation on an asset does not result in an accumulation of cash for replacement of the asset. True. False. Depreciation expense is reported on the income statement, and accumulated depreciation is reported as a deduction from plant assets on the balance sheet. False. Three factors affect the computation of depreciation: cost, useful life, and salvage value (also called residual value). EXERCISE 9-5 ⎛ $90,000 – $6,000⎞ Straight-line method : ⎜ ⎟ = $10,500 per year. 8 ⎝ ⎠ 2010 depreciation = $10,500 X 4/12 = $3,500 2011 depreciation = $10,500. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-11 EXERCISE 9-6 (a) Type of Asset Cost......................................................... —Accumulated depreciation ................ Book value, 1/1/10.................................. Less: Salvage value.............................. Depreciable cost (1)............................... Building $900,000 –172,000 $728,000 35,000 $693,000 Warehouse $120,000 –23,000 $ 97,000 3,600 $ 93,400 42* 15** Revised remaining useful life in years (2) *(50 – 8) **(20 – 5) Revised annual depreciation (1) ÷ (2) (b) Dec. 31 $16,500 $6,227 Depreciation Expense—Building .......... Accumulated Depreciation— Building .................................... 16,500 (a) Accumulated Depreciation—Delivery Equipment ... Loss on Disposal ..................................................... Delivery Equipment .......................................... 20,000 30,000 (b) Cash .......................................................................... Accumulated Depreciation—Delivery Equipment............................................................ Delivery Equipment .......................................... Gain on Disposal .............................................. 37,000 16,500 EXERCISE 9-7 (c) Cash .......................................................................... Accumulated Depreciation—Delivery Equipment ........................................................... Loss on Disposal ..................................................... Delivery Equipment .......................................... 9-12 Copyright © 2010 John Wiley & Sons, Inc. 50,000 20,000 50,000 7,000 18,000 20,000 12,000 Kimmel, Financial Accounting, 5/e, Solutions Manual 50,000 (For Instructor Use Only) EXERCISE 9-8 Jan. 1 Accumulated Depreciation—Machinery............ Machinery....................................................... 62,000 June 30 Depreciation Expense......................................... Accum. Depreciation—Computer ($39,000 X 1/3 X 6/12)............................... 6,500 Cash ..................................................................... Accumulated Depreciation—Computer ($39,000 X 2/3 = $26,000; $26,000 + $6,500) .... Loss on Disposal [$5,000 – ($39,000 – $32,500)] ........................ Computer ................................................. 5,000 62,000 6,500 32,500 1,500 39,000 Dec. 31 Depreciation Expense......................................... Accumulated Depreciation—Truck [($25,000 – $3,000) X 1/5] .......................... 4,400 31 Cash ..................................................................... Accumulated Depreciation—Truck [($25,000 – $3,000) X 4/5] .............................. Truck....................................................... Gain on Disposal ................................... 9,000 4,400 17,600 25,000 1,600 EXERCISE 9-9 1. Depreciation is the process of allocating the cost of a long-lived asset to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and revenue producing ability does not decline. In addition, the useful life of land is indefinite. Therefore, it would be incorrect for the student to depreciate the land. 2. Goodwill is an intangible asset with an indefinite life. According to generally accepted accounting principles, goodwill is not amortized but reviewed annually for impairment. If a permanent decline in value has occurred the goodwill is written down and an impairment loss is recorded on the income statement. Therefore the amortization entry should be reversed and no decline in value recorded until an impairment in value occurs. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-13 EXERCISE 9-9 (Continued) 3. This is a violation of the cost principle. Because current market values are subjective and not reliable, they are not used to increase the recorded value of an asset after acquisition. The appropriate accounting treatment is to leave the building on the books at its zero book value. EXERCISE 9-10 (a) (b) Asset turnover ratio = $35,214 = 1.51 times ($22,690+ $24,000)÷ 2 Return on assets ratio = $2,016 = 8.6% ($22,690 + $24,000) ÷ 2 EXERCISE 9-11 (a) Without new products With new products Return on assets ratio $600,000 = .12 $5,000,000 $1,350,000 = .09 $15,000,000 Profit margin ratio $600,000 = .06 $10,000,000 $1,350,000 = .08 $18,000,000 Asset turnover ratio $10,000,000 = 2.0 $5,000,000 $18,000,000 = 1.2 $15,000,000 (b) The return on assets ratio declined from 12% to 9%. This means that the company is not generating as much income from each dollar invested in assets. It is common for companies to try to maximize their return on assets, thus top management might not find this proposal very desirable. The new product line would increase the company’s profit margin (the amount of net income generated from each dollar of sales) from 6% to 8%. However, because of the huge investment in new assets that the proposal requires, the asset turnover ratio plummets from 2.0 times down to 1.2 times. 9-14 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) EXERCISE 9-12 (a) ($ in millions) 1. Return on assets $244.9 = 5.7% ($4,312.6 + $4,254.3) ÷ 2 2. Asset turnover $11,408.5 = 2.7 times ($4,312.6 + $4,254.3) ÷ 2 3. Profit margin $244.9 = 2.1% $11,408.5 (b) Profit Margin X Asset Turnover = Return on Assets = 2.1% X 2.7 times = 5.7% (c) Asset turnover and profit margin vary considerably across industries. Therefore, when you have a diverse group of businesses from several industry types combined into one company, such as in Hopson Company, the ability to compare these ratios to other businesses becomes very difficult. Hopson Company would almost need to calculate ratios for each of the separate industry segments to allow for a meaningful analysis. EXERCISE 9-13 Dec. 31 Amortization Expense—Copyright ................. Copyright ($120,000 X 1/8)........................ 15,000 31 Amortization Expense—Patent ....................... Patent ($54,000 X 1/4 X 8/12) .................... 9,000 15,000 9,000 The goodwill would not require an adjusting entry because it has an indefinite life. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-15 EXERCISE 9-14 (a) 1/2/10 Patent......................................................... Cash .................................................... 300,000 Goodwill..................................................... Cash .................................................... (Part of the entry to record purchase of another company) 360,000 Franchise................................................... Cash .................................................... 540,000 Research and Development Expense ..... Cash .................................................... 185,000 Amortization Expense—Patent ($300,000 ÷ 5) ..... Amortization Expense—Franchise [($540,000 ÷ 9) X 6/12] ....................................... Patent................................................................ Franchise.......................................................... 60,000 4/1/10 7/1/10 9/1/10 (b) (c) 300,000 360,000 540,000 185,000 30,000 60,000 30,000 Ending balances, 12/31/10: Patent = $240,000 ($300,000 – $60,000) Goodwill = $360,000 Franchises = $510,000 ($540,000 – $30,000) EXERCISE 9-15 Alliance Atlantis Communications Inc.’s change of accounting policy to amortize broadcast rights will probably increase its reported income. Prior to the change, Alliance Atlantis had amortized broadcast rights over a maximum of two years. Their new policy calls for amortization over the contracted exhibition period. If this is greater than two years, annual amortization expense will decrease and income will increase. A change of this nature will make comparison of financial results with previous years’ difficult. To evaluate the company’s performance one will need to make an adjustment for such changes in estimated lives. 9-16 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) EXERCISE 9-16 (a) A company should depreciate its buildings because depreciation is necessary in order to allocate the cost of the buildings to the periods in which they are in use. This allows the cost of the buildings to be matched against the revenues generated each year in accordance with the matching principle. (b) A building can have a zero book value if it has no salvage value and it is fully depreciated—that is, if it has been used for a period at least as long as its expected life. Because depreciation is used to allocate cost rather than to reflect actual value, it is not at all unlikely that a building could have a low or zero book value, but a substantial market value. (c) Examples of intangibles that might be found on a college campus are franchise of a bookstore chain, license to operate radio station, a patents developed by professors, and a permit to operate a bus service. (d) Typical company or product trade names are: Clothes—Gap, Gitano, Dockers, Calvin Klein, Chaus, Guess. Perfume—Passion, Ruffles, Chanel No. 5, Diamonds. Cars—TransAm, Nova, Prelude, Coupe DeVille, Eclipse. Shoes—Nike, Florsheim, L.A. Gear, Adidas. Breakfast cereals—Cheerios, Wheaties, Frosted Mini-Wheats, Rice Krispies. Trade names and trademarks are reported on a balance sheet if there is a cost attached to them. If the trade name or trademark is purchased, the cost is the purchase price. If it is developed by the enterprise, the cost includes attorney’s fees, registration fees, design costs, successful legal defense costs, and other expenditures directly related to securing the trade name or trademark. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-17 EXERCISE 9-17 10-year life $62,000 Net Income 15-year life $108,000* *$62,000 + ($134,000 – $88,000) Calculation of net cash provided by operating activities: Net income Plus: depreciation expense Net cash provided by operating activities $ 62,000 134,000 $196,000 $108,000 88,000 $196,000 The CEO is correct regarding the impact on net income. By increasing the expected useful life depreciation, expense would be lowered and net income would increase. However, this move would be appropriate only if, in fact, a 15-year life was a better estimate of the expected period of use. The CEO is incorrect in stating that cash provided by operating activities would be increased. Depreciation expense does not use up cash. Therefore, net cash provided by operating activities would be the same no matter what expected life was used. *EXERCISE 9-18 (a) Depreciation cost per unit is $.80 per mile [($136,000 – $8,000) ÷ 160,000]. (b) Computation Years 2010 2011 2012 2013 9-18 End of Year Annual Units of Depreciation Depreciation Accumulated Activity X Cost/Unit = Expense Depreciation 40,000 52,000 41,000 27,000 $.80 .80 .80 .80 Copyright © 2010 John Wiley & Sons, Inc. $32,000 41,600 32,800 21,600 $ 32,000 73,600 106,400 128,000 Kimmel, Financial Accounting, 5/e, Solutions Manual Book Value $104,000 62,400 29,600 8,000 (For Instructor Use Only) *EXERCISE 9-19 (a) Declining-balance method: 2010 depreciation = $90,000 X 25%* X 4/12 = $7,500 Book value January 1, 2011 = $90,000 – $7,500 = $82,500 2011 depreciation = $82,500 X 25% = $20,625. *(1/8) X 2 = 25% (b) Units-of-activity method: ⎛ $90,000– $6,000 ⎞ ⎜ ⎟ =$1.20 per hour 70,000 ⎝ ⎠ 2010 depreciation = 2,900 hours X $1.20 = $3,480. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-19 SOLUTIONS TO PROBLEMS PROBLEM 9-1A Item Land 1 2 3 4 5 6 7 8 9 10 $280,000 9-20 Building Other Accounts $ 6,800 Land Improvements 29,000 Land Improvements 24,000 $ 23,000 2,179 33,000 5,800 Property Tax Expense 640,000 (8,000) $298,179 $696,000 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-2A (a) April May 1 Land ....................................................... 2,200,000 Cash ................................................ 2,200,000 1 Depreciation Expense........................... Accumulated Depreciation— Equipment................................. ($600,000 X 1/10 X 4/12) 20,000 Cash ....................................................... Accumulated Depreciation— Equipment....................................... Equipment................................. Gain on Disposal ...................... 170,000 1 20,000 440,000 600,000 10,000 Cost ........................................... $600,000 Accum. depr.—Equipment ...... 440,000 [($600,000 X 1/10) X 7 + $20,000)] Book value ................................ 160,000 Cash proceeds ......................... 170,000 Gain on disposal ...................... $ 10,000 June 1 Cash ....................................................... 1,800,000 Land................................................. 1,000,000 Gain on Disposal............................ 800,000 July 1 Equipment.............................................. 1,300,000 Cash ................................................ 1,300,000 Dec. 31 31 Depreciation Expense........................... Accumulated Depreciation— Equipment................................. ($500,000 X 1/10) Accumulated Depreciation— Equipment....................................... Equipment................................. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 50,000 50,000 500,000 500,000 (For Instructor Use Only) 9-21 PROBLEM 9-2A (Continued) Cost......................................... Accum. depr.—Equipment ($500,000 X 1/10 X 10) ........ Book value.............................. (b) Dec. 31 31 $500,000 500,000 $ 0 Depreciation Expense ............................ Accumulated Depreciation— Buildings .................................... ($26,500,000 X 1/40) 662,500 662,500 Depreciation Expense ............................ 3,955,000 Accumulated Depreciation— Equipment .................................. 3,955,000 $38,900,000* X 1/10............... $ 1,300,000 X 1/10 X 6/12..... $3,890,000 65,000 $3,955,000 *($40,000,000 – $600,000 – $500,000) (c) RIJO CORPORATION Partial Balance Sheet December 31, 2011 Plant Assets* Land ......................................................... Buildings.................................................. Less: Accumulated depreciation— buildings ...................................... Equipment................................................ Less: Accumulated depreciation— equipment .................................... Total plant assets .............................. $ 4,200,000 $26,500,000 12,762,500 40,200,000 13,737,500 8,085,000 32,115,000 $50,052,500 *See T-accounts which follow. 9-22 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-2A (Continued) Land 12/31/10 04/01/11 3,000,000 2,200,000 12/31/11 Bal. 4,200,000 6/1/10 1,000,000 Buildings 12/31/10 26,500,000 12/31/11 Bal. 26,500,000 Equipment 12/31/10 07/01/11 40,000,000 1,300,000 12/31/11 Bal. 40,200,000 05/01/11 12/31/11 600,000 500,000 Accumulated Depreciation—Buildings 12/31/10 12/31/11 12,100,000 662,500 12/31/11 Bal. 12,762,500 Accumulated Depreciation—Equipment 05/01/11 12/31/11 Copyright © 2010 John Wiley & Sons, Inc. 440,000 500,000 12/31/10 5/1/11 12/31/11 12/31/11 5,000,000 20,000 50,000 3,955,000 12/31/11 Bal. 8,085,000 Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-23 PROBLEM 9-3A Jan. 1 Accumulated Depreciation—Machinery ....... Machinery ................................................. June 30 June 30 71,000 71,000 Depreciation Expense .................................... Accum. Depreciation—Computer ($30,000 X 1/5 X 6/12).......................... 3,000 Cash................................................................. Accumulated Depreciation—Computer........ Computer.................................................. Gain on Disposal ..................................... 10,000 21,000 Cost.................................................................. Accumulated Depreciation—Computer [($30,000 X 1/5) X 3 + $3,000] .................... Book Value ...................................................... Cash Proceeds................................................ Gain on Disposal ............................................ $30,000 3,000 30,000 1,000 21,000 9,000 10,000 $ 1,000 Dec. 31 Depreciation Expense .................................... Accumulated Depreciation—Truck [($31,000 – $3,000) X 1/8].................... 3,500 31 Loss on Disposal ............................................ Accumulated Depreciation—Truck ............... Delivery Truck .......................................... 10,000 21,000 Cost.................................................................. Accumulated Depreciation—Truck [($31,000 – $3,000) X 1/8 X 6] .................. Book Value ...................................................... Proceeds ......................................................... Loss on Disposal ............................................ $31,000 9-24 Copyright © 2010 John Wiley & Sons, Inc. 3,500 31,000 21,000 10,000 0 $10,000 Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-4A (a) Jan. 2 Jan.– June July 45,000 45,000 Research and Development Expense ....... 210,000 Cash ....................................................... 1 Sept. 1 Oct. Patents ......................................................... Cash ....................................................... 1 (b) Dec. 31 31 Patents ......................................................... Cash ....................................................... 20,000 Advertising Expense................................... Cash ....................................................... 40,000 20,000 40,000 Copyright ..................................................... 200,000 Cash ....................................................... Amortization Expense—Patents................ Patents ................................................... [($60,000 X 1/10) + ($45,000 X 1/9) + ($20,000 X 1/20 X 6/12)] 11,500 Amortization Expense—Copyright............ Copyrights ............................................. [($36,000 X 1/10) + ($200,000 X 1/50 X 3/12)] 4,600 (d) 200,000 11,500 (c) Intangible Assets Patents ($125,000 cost less $17,500 amortization) (1) ......... Copyrights ($236,000 cost less $29,800 amortization) (2)..... Total intangible assets................................................... (1) (2) 210,000 4,600 $107,500 206,200 $313,700 Cost ($60,000 + $45,000 + $20,000); amortization ($6,000 + $11,500). Cost ($36,000 + $200,000); amortization ($25,200 + $4,600). The intangible assets of Salmiento Corporation consist of two patents and two copyrights. One patent with a cost of $60,000 is being amortized over 10 years. In addition, legal costs of $45,000 incurred in the successful defense of this patent are being amortized over the remaining useful life, 9 years. The other patent with a cost of $20,000 is being amortized over 20 years. A copyright with a cost of $36,000 is being amortized over 10 years; the other copyright with a cost of $200,000 is being amortized over 50 years. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-25 PROBLEM 9-5A 1. 2. 9-26 Research and Development Expense ........................ 150,000 Patents .................................................................. Patents .......................................................................... Amortization Expense—Patents [$9,500 – ($40,000 X 1/20)]................................ 7,500 Goodwill........................................................................ Amortization Expense—Goodwill ...................... 1,000 Copyright © 2010 John Wiley & Sons, Inc. 150,000 7,500 Kimmel, Financial Accounting, 5/e, Solutions Manual 1,000 (For Instructor Use Only) PROBLEM 9-6A (a) (b) Titus Vane 1. Return on assets ratio $240,000 = 7.3% $3,300,000 $300,000 = 10.0% $3,000,000 2. Profit margin $240,000 = 19.2% $1,250,000 $300,000 = 25.0% $1,200,000 3. Asset turnover ratio $1,250,000 = .38 times $3,300,000 $1,200,000 = .40 times $3,000,000 Based on the asset turnover ratio, Vane Corp. is more effective in using assets to generate sales. Its asset turnover ratio is 5% higher than Titus’s ratio. A factor that inhibits comparing the two companies is the differing composition of total assets for each company. Eighty-two percent [($2,400,000 + $300,000) ÷ $3,300,000] of Titus’s total assets are plant or intangible assets compared to only sixty percent ($1,800,000 ÷ $3,000,000) for Vane. Also, Vane reports no intangible assets. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-27 PROBLEM 9-7A (a) Year Computation Accumulated Depreciation 12/31 2008 2009 2010 2011 MACHINE 1 $84,000* X 1/6 = $14,000 $84,000 X 1/6 = $14,000 $84,000 X 1/6 = $14,000 $84,000 X 1/6 = $14,000 $14,000 28,000 42,000 56,000 *($96,000 – $12,000) 2009 2010 2011 MACHINE 2 $85,000 X 40%* X 6/12 = $17,000 $68,000 X 40% = $27,200 $40,800 X 40% = $16,320 $17,000 44,200 60,520 *(1/5) X 2 2009 2010 2011 MACHINE 3 400 X $2.50a = $ 1,000 4,500 X $2.50 = $11,250 5,000 X $2.50 = $12,500 $ 1,000 12,250 24,750 a ($66,000 – $6,000) ÷ 24,000 (b) 9-28 2009 Depreciation Expense MACHINE 2 $85,000 X 40% X 3/12 = $8,500 2010 $76,500 X 40% Year Copyright © 2010 John Wiley & Sons, Inc. = $30,600 Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) *PROBLEM 9-8A (a) STRAIGHT-LINE DEPRECIATION Computation Depreciable Years Cost X End of Year Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation 2010 $240,000* 2011 240,000 2012 240,000 2013 240,000 25%** 25% 25% 25% $60,000 60,000 60,000 60,000 $ 60,000 120,000 180,000 240,000 Book Value $190,000 130,000 70,000 10,000 *($250,000 – $10,000) **1/4 = 25% DOUBLE-DECLINING-BALANCE DEPRECIATION Computation Book Value Beginning Years of Year X 2010 2011 2012 2013 $250,000 125,000 62,500 31,250 End of Year Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation 50%* 50% 50% 50% $125,000 62,500 31,250 21,250** $125,000 187,500 218,750 240,000 Book Value $125,000 62,500 31,250 10,000 *(1/4) X 2 = 50% **Adjusted so ending book value will equal salvage value. (b) Straight-line depreciation provides the lowest amount for 2010 depreciation expense ($60,000) and, therefore, the highest 2010 income. Over the four-year period, both methods result in the same total depreciation expense ($240,000) and, therefore, the same total income. (c) Double-declining-balance depreciation provides the highest amount for 2010 depreciation expense ($125,000) and, therefore, the lowest 2010 income. Both methods result in the same total income over the four-year period. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-29 PROBLEM 9-1B Item 1 2 3 4 5 6 7 8 9 10 9-30 Land Building Other Accounts $250,000 6,000 32,000 7,100 21,900 40,000 629,500 $36,000 7,300 (12,700) $282,400 Land Improvements Property Tax Expense $691,400 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-2B (a) April May 1 Land ........................................................ 2,630,000 Cash ................................................. 2,630,000 1 Depreciation Expense............................. Accumulated Depreciation— Equipment................................... ($750,000 X 1/10 X 4/12) 25,000 Cash ......................................................... Accumulated Depreciation— Equipment......................................... Equipment................................... Gain on Disposal ........................ 370,000 1 25,000 400,000 750,000 20,000 Cost .............................................. $750,000 Accum. depr.—Equipment ......... 400,000 [($750,000 X 1/10) X 5 + $25,000)] Book value ................................... 350,000 Cash proceeds ............................ 370,000 Gain on disposal ......................... $ 20,000 June 1 Cash ......................................................... 1,800,000 Land................................................... 800,000 Gain on Disposal.............................. 1,000,000 July 1 Equipment................................................ Cash .................................................. 800,000 Depreciation Expense............................. Accumulated Depreciation— Equipment ($470,000 X 1/10)......................... 47,000 Dec. 31 31 Accumulated Depreciation— Equipment......................................... Equipment................................... Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 800,000 47,000 470,000 470,000 (For Instructor Use Only) 9-31 PROBLEM 9-2B (Continued) Cost......................................... Accum. depr.—Equipment ($470,000 X 1/10 X 10) .... Book Value ............................. (b) Dec. 31 31 $470,000 470,000 $ 0 Depreciation Expense .......................... Accumulated Depreciation— Buildings ($28,500,000 X 1/40) ................. 712,500 712,500 Depreciation Expense .......................... 4,718,000 Accumulated Depreciation— Equipment ................................ 4,718,000 ($46,780,000* X 1/10) ........... [($800,000 X 1/10) X 6/12] .... $4,678,000 40,000 $4,718,000 *($48,000,000 – $750,000 – $470,000) (c) KRETSINGER CORPORATION Partial Balance Sheet December 31, 2010 Plant Assets* Land ......................................................... Buildings.................................................. Less: Accumulated depreciation— buildings ...................................... Equipment................................................ Less: Accumulated depreciation— equipment .................................... Total plant assets .............................. $ 5,830,000 $28,500,000 12,812,500 47,580,000 15,687,500 8,920,000 38,660,000 $60,177,500 *See T-accounts which follow. 9-32 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-2B (Continued) Land 12/31/09 4/1/10 4,000,000 2,630,000 12/31/10 Bal. 5,830,000 6/1/10 800,000 Buildings 12/31/09 28,500,000 12/31/10 Bal. 28,500,000 Equipment 12/31/09 7/1/10 48,000,000 800,000 12/31/10 Bal. 47,580,000 5/1/10 12/31/10 750,000 470,000 Accumulated Depreciation—Buildings 12/31/09 12/31/10 12,100,000 712,500 12/31/10 Bal. 12,812,500 Accumulated Depreciation—Equipment 5/1/10 12/31/10 Copyright © 2010 John Wiley & Sons, Inc. 400,000 470,000 12/31/09 5/1/10 12/31/10 12/31/10 5,000,000 25,000 47,000 4,718,000 12/31/10 Bal. 8,920,000 Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-33 PROBLEM 9-3B Jan. 1 June 30 Accumulated Depreciation— Machinery ($52,000 X 1/10 X 10 years) ..... Machinery....................................... 9-34 52,000 Depreciation Expense .......................... Accumulated Depreciation— Computer ($42,000 X 1/7 X 6/12)............... 3,000 Cash....................................................... Accumulated Depreciation— Computer........................................ Computer.................................. Gain on Disposal...................... 23,000 Cost........................................................ Accumulated Depreciation— Computer [($42,000 X 1/7) X 3 + $3,000] ........ Book Value ............................................ Cash Proceeds...................................... Gain on Disposal .................................. Dec. 31 52,000 Depreciation Expense .......................... Accumulated Depreciation— Truck [($30,000 – $3,000) X 1/6]......... Copyright © 2010 John Wiley & Sons, Inc. 3,000 21,000 42,000 2,000 $42,000 21,000 21,000 23,000 $ 2,000 4,500 Kimmel, Financial Accounting, 5/e, Solutions Manual 4,500 (For Instructor Use Only) Problem 9-3B (Continued) Dec. 31 Accumulated Depreciation—Truck [($30,000 – $3,000) X 1/6 X 4] ........ Loss on Disposal .............................. Truck............................................. Cost .................................................... Accumulated Depreciation—Truck [($30,000 – $3,000) X 1/6 X 4] ........ Book Value......................................... Proceeds ............................................ Loss on Disposal .............................. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 18,000 12,000 30,000 $30,000 18,000 12,000 0 $12,000 (For Instructor Use Only) 9-35 PROBLEM 9-4B (a) Jan. 2 Jan.June July Patents........................................................... Cash ......................................................... 27,000 27,000 Research and Development Expense......... 220,000 Cash ......................................................... 220,000 1 Patents........................................................... Cash ......................................................... 12,000 12,000 Sept. 1 Advertising Expense .................................... 110,000 Cash ......................................................... 110,000 Oct. Copyright....................................................... 120,000 Cash ......................................................... 120,000 1 (b) Dec. 31 31 Amortization Expense—Patents ................. Patents ..................................................... [($70,000 X 1/10) + ($27,000 X 1/9) + ($12,000 X 1/20 X 6/12)] 10,300 Amortization Expense—Copyrights ........... Copyrights ............................................... [($48,000 X 1/8) + ($120,000 X 1/50 X 3/12)] 6,600 10,300 6,600 (c) Intangible Assets Patents ($109,000 cost less $17,300 amortization) (1).......... Copyrights ($168,000 cost less $24,600 amortization) (2).... Total intangible assets ................................................... (1) (2) $ 91,700 143,400 $235,100 Cost ($70,000 + $27,000 + $12,000); amortization ($7,000 + $10,300). Cost ($48,000 + $120,000); amortization ($18,000 + $6,600). (d) The intangible assets of Gore Company consist of two patents and two copyrights. One patent with a cost of $70,000 is being amortized over 10 years; an additional $27,000 incurred in successfully defending this patent is being amortized over 9 years. The other patent, obtained at cost of $12,000, is being amortized over 20 years. A copyright with a cost of $48,000 is being amortized over 8 years; the other copyright with a cost of $120,000 is being amortized over 50 years. 9-36 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) PROBLEM 9-5B 1. 2. Research and Development Expense........................ 120,000 Patents ................................................................. Patents.......................................................................... Amortization Expense—Patents [$18,000 – ($96,000 X 1/12)] ............................. 10,000 Goodwill ....................................................................... Amortization Expense—Goodwill ...................... 500 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 120,000 10,000 (For Instructor Use Only) 500 9-37 PROBLEM 9-6B (a) (b) Riverton Salina 1. Return on assets ratio $800,000 = 27% $3,000,000 $900,000 = 33% $2,700,000 2. Profit margin $800,000 = 33% $2,400,000 $900,000 = 36% $2,500,000 3. Asset turnover ratio $2,400,000 = .80 times $3,000,000 $2,500,000 = .93 times $2,700,000 Based on the asset turnover ratio, Salina Corp. is more effective in using assets to generate sales. Its asset turnover ratio is 16% higher than Riverton’s ratio. A factor that inhibits comparing the two companies is the differing composition of total assets for each company. Fifteen percent ($450,000 ÷ $3,000,000) of Riverton’s total assets are intangible assets. Salina has no recorded intangible assets. 9-38 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) *PROBLEM 9-7B (a) Year Computation Accumulated Depreciation 12/31 2009 2010 2011 BUS 1 $90,000 X 25% b = $22,500 $90,000 X 25% = $22,500 $90,000 X 25% = $22,500 $22,500 45,000 67,500 a a $96,000 – $6,000 (1/4) b BUS 2 $135,000 X 50%c $ 67,500 X 50% $ 33,750 X 50% 2009 2010 2011 = $67,500 = $33,750 = $16,875 $ 67,500 101,250 118,125 c (1/4) X 2 BUS 3 26,000 miles X $.65d = $16,900 34,000 miles X $.65 = $22,100 30,000 miles X $.65 = $19,500 2009 2010 2011 d $16,900 $39,000 $58,500 ($100,000 – $9,000) ÷ 140,000 miles = $.65 per mile. (b) Depreciation Expense Year (1) 2009 BUS 2 $135,000 X 50% X 10/12 = $56,250 (2) 2010 $78,750 X 50%e = $39,375 e (1/4) X 2 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-39 *PROBLEM 9-8B (a) STRAIGHT-LINE DEPRECIATION Computation Depreciable Years Cost X 2010 2011 2012 2013 2014 a End of Year Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation $300,000a 300,000 300,000 300,000 300,000 20%b 20% 20% 20% 20% $60,000 60,000 60,000 60,000 60,000 $ 60,000 120,000 180,000 240,000 300,000 Book Value $270,000 210,000 150,000 90,000 30,000 $330,000 – $30,000 1/5 = 20% b DOUBLE-DECLINING-BALANCE DEPRECIATION Computation Book Value Beginning Years of Year X 2010 2011 2012 2013 2014 c $330,000 198,000 118,800 71,280 42,768 End of Year Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation 40%c 40% 40% 40% 40% $132,000 79,200 47,520 28,512 12,768d $132,000 211,200 258,720 287,232 300,000 Book Value $198,000 118,800 71,280 42,768 30,000 (1/5) X 2 = 40% Adjusted so ending book value will equal salvage value. d (b) Straight-line depreciation provides the lower amount for 2010 depreciation expense and, therefore, the higher 2010 income. Over the fiveyear period, both methods result in the same total depreciation expense ($300,000) and, therefore, the same total income. (c) Double-declining-balance depreciation provides the higher amount for 2010 depreciation expense and, therefore, the lower 2010 income. Both methods result in the same total income over the five-year period. 9-40 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) CHAPTER 9 COMPREHENSIVE PROBLEM SOLUTION (a) 1. Equipment.................................................................... 16,800 Cash ....................................................................... 2. Depreciation Expense—Equipment........................... Accumulated Depreciation—Equipment............. 450 Cash ............................................................................. Accumulated Depreciation—Equipment................... Equipment.............................................................. Gain on Disposal [$3,500 – ($5,000 – $2,250)] .... 3,500 2,250 3. Accounts Receivable .................................................. Sales....................................................................... 5,000 Cost of Goods Sold..................................................... Merchandise Inventory ......................................... 3,500 4. Bad Debts Expense ($4,000 – $500) .......................... Allowance for Doubtful Accounts ....................... 3,500 5. Interest Receivable ($10,000 X .08 X 9/12) ................ Interest Revenue ................................................... 600 6. Insurance Expense ($3,600 X 4/6).............................. Prepaid Insurance ................................................. 2,400 7. Depreciation Expense—Building............................... Accumulated Depreciation—Building [($150,000 – $30,000) ÷ 30] ................................... 4,000 8. Depreciation Expense—Equipment........................... Accumulated Depreciation—Equipment [($55,000 – $5,500) ÷ 5] ...................................... 9,900 9. Depreciation Expense—Equipment........................... Accumulated Depreciation—Equipment [($16,800 – $1,800) ÷ 5] X 8/12 ........................... 2,000 10. Amortization Expense—Patents ($9,000 ÷ 9)............ Patent ..................................................................... 1,000 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual 16,800 450 5,000 750 5,000 3,500 3,500 600 2,400 4,000 9,900 2,000 (For Instructor Use Only) 1,000 9-41 COMPREHENSIVE PROBLEM (Continued) 11. Salaries Expense ................................................... Salaries Payable .............................................. 2,200 12. Unearned Rent ($6,000 X 1/3) ............................... Rent Revenue................................................... 2,000 13. Interest Expense .................................................... Interest Payable [($11,000 + $35,000) X .10] ........................... 4,600 14. Income Tax Expense ............................................. Income Tax Payable ........................................ 15,000 9-42 Copyright © 2010 John Wiley & Sons, Inc. 2,200 2,000 4,600 Kimmel, Financial Accounting, 5/e, Solutions Manual 15,000 (For Instructor Use Only) COMPREHENSIVE PROBLEM (Continued) (b) PINKERTON CORPORATION Trial Balance December 31, 2010 Debits $ 14,700 41,800 10,000 600 32,700 1,200 20,000 150,000 71,800 8,000 Cash .................................................................. Accounts Receivable ....................................... Notes Receivable.............................................. Interest Receivable........................................... Merchandise Inventory .................................... Prepaid Insurance ............................................ Land................................................................... Building ............................................................. Equipment......................................................... Patent ................................................................ Allowance for Doubtful Accounts................... Accumulated Depreciation—Building ............ Accumulated Depreciation—Equipment ........ Accounts Payable ............................................ Salaries Payable ............................................... Unearned Rent.................................................. Notes Payable (short-term) ............................. Interest Payable................................................ Notes Payable (long-term)............................... Income Tax Payable ......................................... Common Stock ................................................. Retained Earnings............................................ Dividends .......................................................... 12,000 Sales .................................................................. Interest Revenue .............................................. Rent Revenue ................................................... Gain on Disposal .............................................. Bad Debts Expense.......................................... 3,500 Cost of Goods Sold.......................................... 633,500 Depreciation Expense—Building.................... 4,000 Depreciation Expense—Equipment................ 12,350 Insurance Expense........................................... 2,400 Interest Expense............................................... 4,600 Other Operating Expenses .............................. 61,800 Amortization Expense—Patents ..................... 1,000 Salaries Expense.............................................. 112,200 Income Tax Expense........................................ 15,000 Total ........................................................... $1,213,150 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual Credits $ 4,000 54,000 34,100 27,300 2,200 4,000 11,000 4,600 35,000 15,000 50,000 63,600 905,000 600 2,000 750 $1,213,150 (For Instructor Use Only) 9-43 COMPREHENSIVE PROBLEM (Continued) (c) PINKERTON CORPORATION Income Statement For the Year Ended December 31, 2010 Sales........................................................ Cost of goods sold ................................ Gross profit ............................................ Operating expenses Salaries expense.............................. Other operating expenses............... Depreciation expense—equipment .. Depreciation expense—building .... Bad debts expense .......................... Insurance expense........................... Amortization expense—patents ..... Total operating expenses...................... Income from operations ........................ Other revenues and gains Rent revenue ...................................... Gain on disposal .............................. Interest revenue ............................... Other expenses and losses Interest expense............................... Income before income taxes................. Income tax expense............................... Net income.............................................. $905,000 633,500 271,500 $112,200 61,800 12,350 4,000 3,500 2,400 1,000 197,250 74,250 2,000 750 600 3,350 (4,600) (1,250) 73,000 15,000 $ 58,000 PINKERTON CORPORATION Retained Earnings Statement For the Year Ending December 31, 2010 Retained earnings, 1/1/10........................................... Add: Net income ....................................................... Less: Dividends ......................................................... Retained earnings, 12/31/10 ....................................... 9-44 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual $ 63,600 58,000 121,600 12,000 $109,600 (For Instructor Use Only) COMPREHENSIVE PROBLEM (Continued) (d) PINKERTON CORPORATION Balance Sheet December 31, 2010 Current assets Cash............................................................. $ 14,700 Accounts receivable .................................. $ 41,800 Less: Allowance for doubtful accounts .... 4,000 37,800 Notes receivable......................................... 10,000 Interest receivable...................................... 600 Merchandise inventory .............................. 32,700 Prepaid insurance ...................................... 1,200 Total current assets.............................. 97,000 Property, plant, and equipment Land............................................................. 20,000 Building ....................................................... $150,000 Less: Accum. depr.—building.................. 96,000 54,000 Equipment................................................... 71,800 Less: Accum. depr.—equipment ............. 34,100 37,700 153,700 Total property, plant, and equipment ... Intangible assets Patent .......................................................... 8,000 Total assets....................................................... $258,700 Current liabilities Notes payable (short-term)........................ Accounts payable....................................... Income tax payable .................................... Interest payable .......................................... Unearned rent ............................................. Salaries payable ......................................... Total current liabilities ......................... Long-term liabilities Notes payable (long-term) ......................... Total liabilities .................................................. Stockholders’ equity Common stock ........................................... Retained earnings ...................................... Total liabilities and stockholders’ equity ....... Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual $ 11,000 27,300 15,000 4,600 4,000 2,200 64,100 35,000 99,100 50,000 109,600 159,600 $258,700 (For Instructor Use Only) 9-45 BYP 9-1 FINANCIAL REPORTING PROBLEM (a) At December 31, 2007, total cost of property, plant and equipment was $377,693,000; book value was $201,401,000. (b) Depreciation is calculated by use of the straight-line method over the estimated useful lives of the assets. (c) Depreciation and amortization was: 2007, $15,859,000; 2006, $15,816,000; 2005, $14,687,000. (d) Tootsie Roll’s purchases of property, plant, and equipment were: 2007, $14,767,000; 2006, $39,207,000. (e) Goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment at least annually. The company tested goodwill and trademarks during the fourth quarter of each year. It recorded an impairment in 2005 but none in 2006 or 2007. 9-46 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BYP 9-2 COMPARATIVE ANALYSIS PROBLEM (a) Tootsie Roll $51, 625 1. Return on assets ratio ($812, 725+$791, 639)/2 $51,625 2. Profit margin 3. Asset turnover ratio $497,717 Hershey Foods = 6.4% $214,154 ($4,247,113+$4,157, 565)/2 $214,154 = 10.4% $497,717 ($812,725+ $791,639)÷ 2 $4,946,716 = .62 times = 5.1% = 4.3% $4,946,716 ($4,247,113 + 4,157,565) ÷ 2 = 1.18 times The asset turnover ratio measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Hershey Foods’ asset turnover ratio (1.18) was 90% higher than Tootsie Roll’s (.62) in 2007. Therefore, it can be concluded that Hershey Foods was significantly more efficient than Tootsie Roll during 2007 in utilizing assets to generate sales. This efficiency was partially offset by a profit margin (4.3%) that was significantly lower than Tootsie Roll’s (10.4%). Tootsie Roll is more effective in generating profit from its sales but its lower asset turnover resulted in only a 6.4% return on assets compared to Hershey’s 5.1% return. What this shows is that a company can generate a reasonable return on assets with a lower profit margin, if it has a high turnover ratio. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-47 BYP 9-3 RESEARCH CASE (a) Examples of valuable assets that the article says currently do not show up on a balance sheet include intellectual property, software investments, staff and managerial expertise, research and development, advertising and market research, and business processes. (b) The toy maker Mattel has developed a reputation for quality toys. But Mattel’s stock price fell when concerns arose concerning the safety of its toys. JetBlue had developed a reputation for high quality customer service. But its stock price fell when computer problems stranded thousands of customers, thus tarnishing its reputation. (c) The article suggests that companies that are environmentally and socially responsible are creating intangible assets, not because of ideology, but because they are reducing their exposure to financial risk. For example, they are reducing the probability that they will be sued. Companies that have strategies in place to deal with disasters are creating value relative to those that don’t because they have reduced risk exposure. (d) The United Nations ratified an approach referred to as the triple bottom line (for people, planet and profit) which is to be applied in urban and community accounting. Many companies use an approach internally called the balanced scorecard which places value on factors that improve a company’s profitability but that don’t show up in normal financial measures. (The balanced scorecard is discussed further in managerial accounting courses). 9-48 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BYP 9-4 INTERPRETING FINANCIAL STATEMENTS (All dollar data are in millions of dollars.) (a) Percentage change in sales: 2005 to 2007 ($1,654.5 – $1,460.2) ÷ $1,460.2 = 13.3%. Percentage change in net income: 2005 to 2007 (60.5 – $37.0) ÷ $37.0 = 63.5%. (b) Gross profit rates: 2005 2006 2007 ($1,460.2 – $443.2) ÷ $1,460.2 = 69.6%. ($1,584.8 – $469.7) ÷ $1,584.8 = 70.4%. ($1,654.5 – $482.1) ÷ $1,654.5 = 70.9%. The increase in the gross profit rate contributed to the rise in earnings from 2005 to 2007. From 2005 to 2007 the gross profit rate increased only slightly from 69.6% to 70.9%. (c) Profit margin ratio (Percentage of net income to net sales): 2005 2006 2007 $37.0 ÷ $1,460.2 $54.8 ÷ $1,584.8 $60.5 ÷ $1,654.5 = 2.5%. = 3.5%. = 3.7%. Profit margin ratio increased from 2.5% to 3.5% from 2005 to 2006. This large increase was followed in 2007 with a slight increase from 3.5% to 3.7%. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-49 BYP 9-4 (Continued) (d) You would expect the return on assets ratio to improve with a 50% decrease in the number of new restaurant openings. Return on assets: 2006 2007 $54.8 ÷ [($1,150.9 + $1,185.1) ÷ 2] = 4.7%. $60.5 ÷ [($1,185.1 + $1,197.0) ÷ 2] = 5.1%. Total assets increased less than $12 million between 2006 and 2007. This small increase in total assets, combined with a rise in profit margin explains the slight increase in the return on assets. 9-50 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BYP 9-5 A GLOBAL FOCUS (a) In the United States, goodwill is the amount of the purchase price in excess of the fair value of the net assets purchased. This is the same method used in the United Kingdom for determining the initial amount to be recorded as goodwill. (b) The notes to the financial statements indicate that “In prior years goodwill has been deducted from reserves in the period of acquisition.” What this means, essentially, is that when the acquisition of another company resulted in the recording of goodwill, the acquiring company simply wrote the goodwill off against its stockholders’ equity in the year of the acquisition. By doing this, the goodwill never affected net income. (c) Under the new standard the company is not allowed to write goodwill off against stockholders’ equity in the year of acquisition. If goodwill is considered to have a finite life, the company is supposed to amortize the goodwill over the expected life of the goodwill. However, the company can still avoid charging any amortization expense by assuming that the goodwill has an “indefinite economic life.” (d) In the United States, goodwill is not amortized because it is considered to have an indefinite life. If a company in the United Kingdom assumes that its goodwill has a finite life, it must amortize the goodwill over the finite life. Otherwise it is assumed to have an indefinite life, and is handled very similar to US GAAP in that it is not amortized. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-51 BYP 9-6 FINANCIAL ANALYSIS ON THE WEB Answers will vary depending on the company chosen by student. 9-52 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BYP 9-7 DECISION MAKING ACROSS THE ORGANIZATION (a) (in thousands) Proposed results Proposed results Current results without cannibalization with cannibalization $12,000 Return on assets ratio $100,00 = .12 0 $13,500 $100,000 = .135 $12,000 $100,000 = .12 Profit margin ratio $12,000 = .27 $45,000 $13,500 = .225 $60,000 $12,000 = .24 $50,000 Asset turnover ratio $45,000 $100,00 = .45 0 $60,000 $100,000 = .60 $50,000 $100,000 = .50 (b) If there is no cannibalization, return on assets increases from 12% to 13.5%. This occurs even though the profit margin decreases from 27% to 22.5% because the asset turnover ratio increases significantly, from .45 times to .60 times. However, if there is cannibalization, the return on assets remains unchanged at 12% because the increase in the asset turnover ratio is offset by the decrease in the profit margin ratio. (c) Yes, there are other alternatives. Here are some examples. 1. Increase spending on marketing in an effort to increase sales of high end product, without offering the new, low-end product line. If this was successful it would increase the asset utilization, thus increasing the asset turnover and return on assets. 2. Consider marketing the new line under a different name, so as to minimize the cannibalization. This might substantially increase the marketing costs, and therefore reduce the profit margin ratio. But the benefit of reducing cannibalization might make up for the increased marketing costs. 3. If neither of 1. or 2. seems feasible, they should consider closing a plant. This would increase the asset turnover ratio and return on assets ratio. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-53 BYP 9-8 COMMUNICATION ACTIVITY Answers will depend on the position selected by the student. Some points that should be considered include: 1. Some relatively small companies may spend less on R&D because they must expense these costs. However, the vast majority of companies realize that for continued growth and stability, R&D expenditures are a high priority regardless of how they are recorded for accounting purposes. Requiring companies to expense R&D costs instead of allowing them to be capitalized could leave U.S. companies at a competitive disadvantage as compared to non-U.S. companies. U.S. companies may be more reluctant to invest millions of dollars on research and development since the costs would negatively impact their financial statements in the short-run. 2. 9-54 The tangible future benefits of R&D costs may not be realized for several years, if ever. Conversely, the purchase of a long-lived asset (i.e., equipment, building) will provide benefits immediately as well as in future years. The conservatism concept dictates that when reasonable doubt exists, a company should choose the option that has the least favorable affect on income. Expensing R&D costs is an example of applying the conservatism concept. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) BYP 9-9 ETHICS CASE (a) The stakeholders in this situation are: Danny Fort , president of Clean Air Anti-Pollution Company. Steve Penny, controller. The stockholders of Clean Air Anti-Pollution Company. Potential investors in Clean Air Anti-Pollution Company. (b) The intentional misstatement of the life of an asset or the amount of the salvage value is unethical for whatever the reason. There is nothing unethical per se about changing the estimates used for the life of an asset or of an asset’s salvage value if the change is an attempt to better match cost and revenues and is a better allocation of the asset’s depreciable cost over the asset’s useful life. In this case, it appears from the controller’s reaction that the revision in the life is intended only to improve earnings which would be unethical. The fact that the competition uses a longer life for its equipment is not necessarily relevant. The competition’s maintenance and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Clean Air Anti-Pollution Company. (c) Income before income taxes in the year of change is increased $155,000 ($387,500 – $232,500) by implementing the president’s proposed changes. Old Estimates Asset cost .............................................................. Estimated salvage................................................. Depreciable cost ................................................... Depreciation per year (1/8) ................................... $3,500,000 400,000 3,100,000 $ 387,500 Revised Estimates Asset cost .............................................................. Estimated salvage................................................. Depreciable cost ................................................... Depreciation taken to date ($387,500 X 2)........... Remaining life in years ......................................... Depreciation per year ($2,325,000 ÷ 10) .............. Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual $3,500,000 400,000 3,100,000 775,000 2,325,000 10 years $ 232,500 (For Instructor Use Only) 9-55 BYP 9-10 ALL ABOUT YOU ACTIVITY (a) 1 c 2 b 3 a 4 d 5 c (b) For the most part, the value of a brand is not reported on a company’s balance sheet. Most companies are required to expense all costs related to the maintenance of a brand name. Also any research and development that went into the development of the related product is generally expensed. The only way significant costs related to the value of the brand are reported on balance sheet is when a company purchases another company that has a significant tradename (brand). In that case, given an objective transaction, companies are able to assign value to the brand and report it on the balance sheet. A conservative approach is used in this area because the value of the brand can be extremely difficult to determine. It should be noted that international rules permit companies to report brand values on their balance sheets. 9-56 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only)