CHAPTER 8
Operating Assets: Property, Plant,
and Equipment, Natural Resources,
and Intangibles
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Learning Outcomes
1. Understand the balance sheet disclosures for
operating assets.
Exercises
Estimated
Time in
Minutes
Level
11*
30
Mod
2. Determine the acquisition cost of an operating asset.
1
10
Easy
3. Explain how to calculate the acquisition cost of assets
purchased for a lump sum.
2
20
Mod
4. Describe the impact of capitalizing interest as part of the
acquisition cost of an asset.
12*
5
Easy
5. Compare depreciation methods and understand the factors
affecting the choice of method.
3
4
12*
20
15
5
Mod
Mod
Easy
5
15
Mod
11*
30
Mod
6
7
15
15
Mod
Mod
13*
10
Mod
10. Describe the proper amortization of intangible assets.
8
13*
15
10
Easy
Mod
11. Explain the impact that long-term assets have on the statement
of cash flows.
9
10
5
5
Mod
Mod
6. Understand the impact of a change in the estimate of the asset
life or residual value.
7. Determine which expenditures should be capitalized as asset costs
and which should be treated as expenses.
8. Analyze the effect of the disposal of an asset at a gain or loss.
9. Understand the balance sheet presentation of intangible assets.
12. Understand how investors can analyze a company’s
operating assets.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
8-1
8-2
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
Learning Outcomes
Problems
and
Alternates
Estimated
Time in
Minutes
Level
1. Understand the balance sheet disclosures for
operating assets.
6*
30
Mod
2. Determine the acquisition cost of an operating asset.
7*
15
Diff
3. Explain how to calculate the acquisition cost of assets
purchased for a lump sum.
1
5
6*
20
40
30
Mod
Diff
Mod
5. Compare depreciation methods and understand the factors
affecting the choice of method.
2
3
6*
7*
8*
10
15
30
15
20
Easy
Mod
Mod
Diff
Mod
6. Understand the impact of a change in the estimate of the asset
life or residual value.
9*
10
Mod
7. Determine which expenditures should be capitalized as asset costs
and which should be treated as expenses.
6*
8*
20
20
Mod
Mod
8. Analyze the effect of the disposal of an asset at a gain or loss.
6*
8*
10*
30
20
35
Mod
Mod
Mod
9. Understand the balance sheet presentation of intangible assets.
6#
11*
30
20
Mod
Diff
10. Describe the proper amortization of intangible assets.
4#
6#
9*
11*
15
30
10
20
Mod
Mod
Mod
Mod
11. Explain the impact that long-term assets have on the statement
of cash flows.
4
5
10*
11*
15
40
35
20
Mod
Diff
Mod
Diff
4. Describe the impact of capitalizing interest as part of the
acquisition cost of an asset.
12. Understand how investors can analyze a company’s
operating assets.
*Exercise, problem, or case covers two or more learning outcomes
# Alternative problem only
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
Learning Outcomes
1. Understand the balance sheet disclosures for
operating assets.
Cases
Estimated
Time in
Minutes
8-3
Level
1*
3*
20
25
Mod
Mod
5
15
Mod
3*
4
6
25
25
10
Mod
Mod
Mod
1*
20
Mod
2
20
Mod
2. Determine the acquisition cost of an operating asset.
3. Explain how to calculate the acquisition cost of assets
purchased for a lump sum.
4. Describe the impact of capitalizing interest as part of the
acquisition cost of an asset.
5. Compare depreciation methods and understand the factors
affecting the choice of method.
6. Understand the impact of a change in the estimate of the asset
life or residual value.
7. Determine which expenditures should be capitalized as asset costs
and which should be treated as expenses.
8. Analyze the effect of the disposal of an asset at a gain or loss.
9. Understand the balance sheet presentation of intangible assets.
10. Describe the proper amortization of intangible assets
11. Explain the impact that long-term assets have on the statement
of cash flows.
12. Understand how investors can analyze a company’s
operating assets.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
8-4
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
QUESTIONS
1. Operating assets include property, plant, and equipment and intangibles. Examples
of assets considered operating assets are buildings, equipment, land, land improvements, patents, copyrights, and goodwill. Operating assets are important to the
long-term future of the company because they are the assets used to produce a
product or service sold to customers. The operating assets allow a company to produce a product efficiently and remain competitive with other firms.
2. The acquisition cost of an asset includes all the costs normally necessary to acquire
the asset and prepare it for its intended use. Acquisition costs include the purchase
price, freight costs, installation costs, taxes paid at the time of purchase, and repairs
made to prepare the asset for use.
3. The acquisition cost of assets purchased as a group should be determined by allocating the purchase price on the basis of the proportions of the fair market values to
the total fair market value.
4. It is important to separately account for the cost of land and building because the
amount allocated to a building represents a depreciable amount, while the amount
allocated to land does not.
5. Interest should be capitalized when an asset is constructed by the acquiring company over time, and the asset is not an item of inventory.
6. The decline in usefulness of an operating asset is related to physical deterioration
factors, such as wear and tear. It is also related to obsolescence and technological
factors and to the repair and maintenance of the asset. The depreciation method
chosen should match the decline in usefulness of the asset to the periods benefited
by the asset after all factors have been taken into account. However, the company is
not required to use the same method for all depreciable assets.
7. The straight-line method is the most popular method of depreciation for several reasons, including its simplicity and ease of application. It is most appropriate for assets
that experience a decline in usefulness related to the passage of time. It may also be
used by companies that wish to report a stable income over time.
8. When the straight-line method is used, the residual value should be deducted from
the acquisition cost to determine the depreciable amount to be allocated over the
useful life of the asset. When the double-declining-balance method is used, the residual value is not deducted. However, the asset should not be depreciated to an
amount that is lower than the residual value.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-5
9. Companies may use one method of depreciation for financial reporting and another
method for tax purposes because the objectives are different. The accountant’s purpose in recording depreciation for financial reporting purposes is to allocate the original cost of the asset to the periods benefited in a manner that matches the decline
in usefulness of the asset. The accountant’s purpose in recording depreciation for
tax purposes is to minimize the amount of income tax that must be paid.
10. If an estimate must be changed, the change in estimate should be recorded prospectively over the remaining life of the asset. Past amounts recorded for depreciation are not changed or altered. The remaining depreciable amount should be recorded over the remaining life of the asset, using the revised estimate or estimates of
residual value and asset life.
11. A capital expenditure is an amount that must be capitalized or added to the value of
the asset. A revenue expenditure is an outlay that should be recorded as an expense in the year incurred. An item should be treated as a capital expenditure if it increases the life or productivity of the asset. Otherwise, the amount should be treated
as a revenue expenditure.
12. The gain or loss on the sale of an asset should be calculated as the difference between the selling price and the book value of the asset as of the date of sale. The
account Gain on Sale of Asset should appear on the income statement in the other
income/expense category.
13. Patents, copyrights, trademarks, and goodwill are examples of intangible assets.
Some companies have a separate category on the balance sheet titled Intangibles
for such assets. Other companies include intangibles in a category titled Long-Term
Assets or in the Other Assets category of the balance sheet.
14. Goodwill represents the difference between the acquisition price paid to acquire a
business and the total of the fair market values of the identifiable net assets acquired. Goodwill can be recorded as an asset only when one company acquires another. It cannot be recorded on the basis of internally generated factors that some
may refer to as goodwill.
15. An argument in favor of expensing R&D is that it allows comparability among firms,
since all firms must record the item as an expense. Also, it is argued that R&D
should be expensed because it is very difficult to determine whether an asset exists
and, if it does exist, what periods are benefited by the asset. On the other hand,
many argue that R&D is an asset and should be recorded on the balance sheet.
They believe that if R&D is not recorded, the balance sheet is seriously understated.
8-6
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
16. The current view of the FASB is that some intangible assets have a limited life and
should be amortized over their legal life or useful life whichever is shorter. However,
some intangible assets are thought to have an “indefinite life” and should not be
amortized. This treatment of intangibles has been debated extensively and many
disagree with the current view. Some would argue that the value of almost all intangible assets eventually becomes diminished and therefore amortization should be
recognized.
17. Amortization should occur over the shorter of the legal life or useful life. For example, a patent has a legal life of 20 years. But if the invention under patent will be useful over only 10 years, then the patent should be amortized over the shorter 10-year
period.
18. If an intangible becomes worthless, the asset should be written off as an expense in
the period when the decline in value occurs. If the intangible continues to have value
but will provide benefit over a period shorter than was originally estimated, the event
should be treated as a change in estimate. The portion of the intangible that is
unamortized should be amortized over the remaining life of the asset.
EXERCISES
LO 2
EXERCISE 8-1 ACQUISITION COST
The acquisition cost of the asset should be computed as follows:
List price
Less: Discount
Freight
Pollution device
Architect’s fee
Total acquisition cost
$ 60,000
(1,200)
1,000
2,500
6,000
$ 68,300
Note: Repair costs of $4,000 are not included because they are not normal or necessary to the acquisition.
Insurance cost of $8,000 should be treated as prepaid insurance.
Interest cost of $3,000 is not included unless an asset is constructed over time.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 2
8-7
EXERCISE 8-2 LUMP-SUM PURCHASE
1. The total market value is
Land
Building
Equipment
Total
$200,000
150,000
250,000
$600,000
Amount allocated to each account should be
Land $200,000/$600,000 × $520,000 = $173,333
Building $150,000/$600,000 × $520,000 = $130,000
Equipment $250,000/$600,000 × $520,000 = $216,667
The journal entry would be as follows:
Jan. 1
Land
Building
Equipment
Cash
To record the purchase of assets for
a lump-sum amount.
Assets
+173,333
+130,000
+216,667
–520,000
=
Liabilities
173,333
130,000
216,667
520,000
+
Owners’ Equity
2. The amount of depreciation expense that should be recorded for 2007 is as follows:
Land
= $0
Building$130,000/20 years
= $6,500
Equipment$216,667/20 years = $10,833
3. The assets would appear on the balance sheet as follows:
Long-term assets:
Land
Building
Less: Accumulated depreciation
Equipment
Less: Accumulated depreciation
Total long-term assets
$173,333
$130,000
6,500
$216,667
10,833
123,500
205,834
$502,667
8-8
LO 5
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
EXERCISE 8-3 STRAIGHT-LINE AND UNITS-OF-PRODUCTION METHODS
Depreciation, accumulated depreciation, and book value for the straight-line method
should be as follows:
Year
2007
2008
2009
2010
2011
Depreciation
$10,800*
10,800
10,800
10,800
10,800
Accumulated
Depreciation
$10,800
21,600
32,400
43,200
54,000
Book Value
$49,200
38,400
27,600
16,800
6,000
*($60,000 – $6,000)/5 years = $10,800 per year
The estimated total number of units to be produced is
10,000 + 20,000 + 30,000 + 40,000 + 50,000 = 150,000 units.
Depreciation expense per unit = ($60,000 – $6,000)/150,000 units
= $0.36 per unit
Depreciation, accumulated depreciation, and book value for the units of production
should be as follows:
Year
2007
2008
2009
2010
2011
Depreciation
10,000 × $0.36 = $ 3,600
20,000 × $0.36 =
7,200
30,000 × $0.36 = 10,800
40,000 × $0.36 = 14,400
50,000 × $0.36 = 18,000
Accumulated
Depreciation
$ 3,600
10,800
21,600
36,000
54,000
Book Value
$56,400
49,200
38,400
24,000
6,000
Students may note that the units of production method results in a depreciation pattern
in this exercise that is the opposite of accelerated depreciation. That is appropriate because of the pattern of usage of the asset.
8-9
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 5
EXERCISE 8-4 ACCELERATED DEPRECIATION
1.
Year
2007
2008
2009
2010
2011
Depreciation
40%* × $6,000 = $2,400
40% × 3,600 = 1,440
40% × 2,160 =
864
40% × 1,296 =
518
178**
Accumulated
Depreciation
$2,400
3,840
4,704
5,222
5,400
Book Value
$3,600
2,160
1,296
778
600
*Straight-line rate: 100%/5 years = 20%; double the straight-line rate = 40%.
**Since the asset should not be depreciated below residual value, the amount to be
recorded is $6,000 – $5,222 – $600 = $178.
2. Dec. 31
Depreciation Expense
Accumulated Depreciation
To record depreciation for 2007.
Assets
–2,400
=
Liabilities
2,400
2,400
+
Owners’ Equity
–2,400
3. Koffman may believe that the double-declining-balance method best matches the
decline in usefulness of the asset with the revenues produced by the asset. Koffman
may also choose this method because it allows more depreciation to be taken in the
early years of the asset life and thus delays taxes until the later years.
LO 6
EXERCISE 8-5 CHANGE IN ESTIMATE
1. Depreciation, accumulated depreciation, and book value for the straight-line method
should be as follows:
Year
2007
2008
2009
2010
2011
2012
Depreciation
$ 8,000*
8,000
15,500**
15,500
15,500
15,500
*($80,000 – $8,000)/9 years = $8,000.
**$64,000 – $2,000 = $62,000.
$62,000/4 years = $15,500.
Accumulated
Depreciation
$ 8,000
16,000
31,500
47,000
62,500
78,000
Book Value
$72,000
64,000
48,500
33,000
17,500
2,000
8-10
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
2. Depreciation for 2007 and 2008 was not wrong. The company used the best information available at that time to develop its estimate of depreciation. The information
available in 2009 made it necessary to revise the estimate of depreciation. This illustrates the difference between a change in estimate and a correction of an error.
LO 8
1. July 1
EXERCISE 8-6 ASSET DISPOSAL
Depreciation Expense
Accumulated Depreciation—Asset
To record depreciation of asset.
($60,000 – $6,000)/6 years = $9,000 per year.
$9,000 × 6/12 = $4,500.
Assets
–4,500
July 1
=
Liabilities
+
Cash
Accumulated Depreciation—Asset
Asset
Gain on Sale of Asset
To record sale of the asset.
Assets
+40,000
+22,500
–60,000
=
Liabilities
4,500
4,500
Owners’ Equity
–4,500
40,000
22,500*
60,000
2,500**
+
Owners’ Equity
+2,500
*Accumulated depreciation at time of sale:
Depreciation for 2005 and 2006—($9,000 × 2) $18,000
Depreciation for 2007
4,500
Total
$22,500
**Gain on sale is calculated as follows:
Asset cost
Less: Accumulated depreciation
Book value
Sale price
Gain on sale
$60,000
22,500
$37,500
40,000
$ 2,500
2. The gain or loss should appear in the Other Income category of the income statement to indicate that it is not part of the normal operating activity of the company.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 8
1. July 1
EXERCISE 8-7 ASSET DISPOSAL
Depreciation Expense
Accumulated Depreciation—Asset
To record depreciation to July 1.
($60,000 – $6,000)/6 years = $9,000
per year. $9,000 × 6/12 = $4,500.
Assets
–4,500
July 1
8-11
=
Liabilities
4,500
4,500
+
Cash
Note Receivable
Accumulated Depreciation—Asset
Loss on Sale of Asset
Asset
To record sale of the asset.
Assets
+15,000
+15,000
+22,500
–60,000
=
15,000
15,000
22,500
7,500*
60,000
Liabilities
*The loss on sale is calculated as follows:
Asset cost
Less: Accumulated depreciation
Book value
Sale price
Loss on sale
Owners’ Equity
–4,500
+
Owners’ Equity
–7,500
$60,000
22,500
$37,500
30,000
$ 7,500
2. The gain or loss should appear in the Other Expense category of the income statement to indicate it is not part of the normal operating activity of the company.
LO 10
EXERCISE 8-8 AMORTIZATION OF INTANGIBLES
Trademark is not amortized because it has an indefinite life
Amortization expense
= $0
Accumulated amortization = $0
Patent amortization
Accumulated amortization
= $50,000/10 years = $ 5,000
= $5,000 × 6 years = $30,000
Copyright amortization
Accumulated amortization
= $80,000/20 years = $ 4,000
= $4,000 × 3 years = $12,000
8-12
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 11
EXERCISE 8-9 IMPACT OF TRANSACTIONS INVOLVING OPERATING ASSETS ON
STATEMENT OF CASH FLOWS
Purchase of land: I
Proceeds from sale of land: I
Gain on sale of land: O
Purchase of equipment: I
Depreciation expense: O
Proceeds from sale of equipment: I
Loss on sale of equipment: O
LO 11
EXERCISE 8-10 IMPACT OF TRANSACTIONS INVOLVING INTANGIBLE ASSETS
ON STATEMENT OF CASH FLOWS
Cost incurred to acquire copyright: I
Proceeds from sale of patent: I
Gain on sale of patent: O
Research and development costs: N
(not separately reported as an operating activity)
Amortization of patent: O
MULTI-CONCEPT EXERCISES
LO 1,7
EXERCISE 8-11 CAPITAL VERSUS REVENUE EXPENDITURES
1. The following entries should be made to capitalize costs:
Jan. 1
Building
Cash
To record cost of new conveyor system.
Assets
+40,000
–40,000
=
Liabilities
40,000
40,000
+
Delivery Truck
Cash
To record cost of hydraulic lift installed in truck.
Assets
+5,000
–5,000
=
Liabilities
+
Owners’ Equity
5,000
5,000
Owners’ Equity
Note: Some may choose to capitalize the engine overhaul costs of $4,000 and the
window repair costs of $10,000. However, both costs appear to keep the asset in its
normal operating condition and are more properly treated as expenses.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-13
2. The entry to record depreciation should be as follows:
Dec. 31
Depreciation Expense
Accumulated Depreciation—Building
Accumulated Depreciation—Truck
To record 2007 depreciation.
Assets
–9,739
–4,583
=
Liabilities
Original cost
Less: Depreciation for 2005 and 2006
Book value
Plus: Capitalized costs
Depreciable amount
Depreciation per year on building =
$224,000/23 years =
Depreciation per year on truck =
$18,333/4 years =
14,322
9,739
4,583
+
Owners’ Equity
–14,322
Building
$200,000
16,000
$184,000
40,000
$224,000
$
Truck
$20,000
6,667
$13,333
5,000
$18,333
9,739
$ 4,583
3. The assets should appear on the 2007 balance sheet as follows:
Building
Less: Accumulated depreciation
Truck
Less: Accumulated depreciation
Total property, plant, and equipment
LO 4,5
$240,000
25,739
$ 25,000
11,250
$214,261
13,750
$228,011
EXERCISE 8-12 CAPITALIZATION OF INTEREST AND DEPRECIATION
1. $200,000 + $8,000 = $208,000.
2. The amount of depreciation expense for 2007 is zero because the asset was not
completed and put into use until January 1, 2008. The amount of depreciation expense for 2008 is $200,000 + $8,000 – $5,000 = $203,000/20 years = $10,150.
8-14
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
EXERCISE 8-13 RESEARCH AND DEVELOPMENT AND PATENTS
LO 9,10
a. All research and development costs should be treated as an expense. The 2007 income statement should reflect an expense of $20,000.
b. Patent costs should be treated as an asset. The 2007 balance sheet should reflect a
Patent account of $10,000 – ($10,000/5 years) = $8,000.
c. The $8,000 cost of defending the patent should be added to the patent account and
reflected in the 2008 balance sheet.
2007 amortization = $10,000/5 years = $2,000
2008 amortization = $10,000 – $2,000 + $8,000 = $16,000
$16,000/4 years =
$ 4,000
PROBLEMS
LO 3
PROBLEM 8-1 LUMP-SUM PURCHASE OF ASSETS AND SUBSEQUENT EVENTS
1. Relative fair values:
Section 1
Section 2
Section 3
Total
(a)
(b)
(c)
$ 630,000
378,000
252,000
$1,260,000
$1,260,000
1,560,000
1,000,000
1
50%
$630,000
780,000
500,000
Section
2
30%
$378,000
468,000
300,000
50%
30
20
100%
3
20%
$252,000
312,000
200,000
2. The purchase of the land has no effect on total assets. Current assets (cash) declines and long-term assets (land) increases and therefore only the composition of
assets on the balance sheet is changed.
3. Carter would be concerned with the value assigned to each section if it intended to
sell one or two sections and keep others. Carter would want the section it intended
to sell to be assigned the highest value in order to defer a gain. The value assigned
to buildings would be depreciated; therefore, Carter would want more value assigned to the buildings in order to depreciate them and take advantage of the tax
shield.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-15
PROBLEM 8-2 DEPRECIATION AS A TAX SHIELD
LO 5
If the asset is not purchased, the company must pay income tax of $50,000 × 35% =
$17,500.
If the asset is purchased, the company should record depreciation of $20,000 per
year. The amount of income tax the company must pay is $50,000 – $20,000 = $30,000
× 35% = $10,500.
The amount of the depreciation tax shield is the amount of income tax saved by purchase of the asset, or $17,500 – $10,500 = $7,000. The depreciation tax shield can also
be expressed as the amount of depreciation each year times the tax rate, or $20,000 ×
35% = $7,000.
PROBLEM 8-3 BOOK VERSUS TAX DEPREICATION
LO 5
1. Year
1
2
3
4
5
6
Straight-Line
–
$ 5,600*
5,600
5,600
5,600
5,600
5,600
$33,600
MACRS
$ 6,720
10,750
6,450
3,870
3,870
1,940
$33,600
=
Difference
$(1,120)
(5,150)
(850)
1,730
1,730
3,660
$
0
*$33,600/6 years = $5,600 per year
2. The president is correct that a total of $33,600 will be deducted as depreciation under either method over the six-year life. However, the memo should stress that all
other things being equal, Griffith should prefer MACRS for taxes, since it results in
the payment of less income tax during the early years in the life of the truck. Money
received earlier is preferable to money received later.
The memo should also stress that it is important to analyze the tax position of
Griffith carefully. A variety of other factors may be important in the choice of a depreciation method for tax purposes.
The memo should also stress to the president that not only is it legal, but also it is
not a violation of GAAP, to use one method of depreciation for the books and a different one for tax purposes. Using straight-line depreciation for the books will tend to
even out the income over the life of the asset and will report higher income in the
earlier years than would be reported if an accelerated method, such as MACRS, is
used.
8-16
LO 11
1.
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
PROBLEM 8-4 DEPRECIATION AND CASH FLOW
O’HARE COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007
Service Revenue
Depreciation Expense
Net Income
$100,000
15,000
$ 85,000
2. The amount of the net cash inflow for 2007 is $100,000.
3. The amount of the net income ($85,000) does not equal the amount of the net cash
inflow ($100,000) because of depreciation expense. Depreciation is an expense on
the income statement but does not involve a cash outlay. For that reason, depreciation must be “added back” to net income to determine the amount of the net cash inflow.
4. If O’Hare develops a cash flow statement using the indirect method, the operating
category should appear as follows:
Cash Flow from Operating Activities:
Net income
Plus: Depreciation
Net cash from operations
LO 11
$ 85,000
15,000
$100,000
PROBLEM 8-5 RECONSTRUCT NET BOOK VALUES USING STATEMENT OF CASH
FLOWS
1. Book value of equipment at time of sale:
Book value
Sales proceeds
Loss (gain) on sale
$
X – $315,000 =
X=
$ 35,000
$ 350,000
Book value of copyright at time of sale:
Book value
Sales proceeds
Loss (gain) on sale
X – $75,000 =
X=
X
315,000
$ 35,000
$
X
75,000
$ (55,000)
$ (55,000)
$ 20,000
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-17
2. Net book value of property, plant, and equipment at December 31, 2006:
Net book value at 12/31/06
Plus purchases during 2007
Less book value of equipment sold during 2007
Less 2007 depreciation
Net book value at 12/31/06
$
X
292,000
(350,000)
(672,000)
$4,459,000
X + $292,000 – $350,000 – $672,000 =
X=
$4,459,000
$5,189,000
3. Net book value of intangibles at December 31, 2006:
Net book value at 12/31/06
Plus payment of legal fees during 2007
Less book value of copyright sold during 2007
Less 2007 amortization
Net book value at 12/31/06
$
X
15,000
(20,000)
(33,000)
$673,000
X + $15,000 – $20,000 – $33,000 =
X=
$673,000
$711,000
MULTI-CONCEPT PROBLEMS
LO 1,3,5,7,8
PROBLEM 8-6 COST OF ASSETS, SUBSEQUENT BOOK VALUES, AND
BALANCE SHEET PRESENTATION
1. Values assigned to each asset:
a. Value at time of purchase: $14,000 + $4,800 = $18,800
b. Allocation of purchase price:
Supplies expense $200/$3,200 × $2,400 =
Office furniture $600/$3,200 × $2,400 =
Equipment $2,400/$3,200 × $2,400 =
$ 150
$ 450
$1,800
c. Value of this Prepaid License Expense: $1,500
d. Cost of truck
Less: accumulated depreciation at time
of sale [(12,000 – 800) × 5/8]
Book value
$12,000
7,000
$ 5,000
8-18
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
2. Depreciation or other expense recorded for each asset during 2007:
a. ($18,800 – $800)/4 years = $4,500
b. Supplies expense
Depreciation of office furniture $450/9 years =
Depreciation of equipment $1,800/4 years =
$150
$ 50
$450
c. $1,500/3 years = $500 × 11/12 = $458
d. Depreciation $11,200/8 years = $1,400 × 8/12 = $933
Book value at the time of sale
Sale price
Loss on sale of truck
3. Balance Sheet Presentation:
Current assets:
Prepaid license expense ($1,500 – $458)
Property, plant, and equipment:
Truck
Office furniture
Equipment
Less: accumulated depreciation
($4,500 + $50 + $450)
Property, plant, and equipment, net
LO 2,5
$5,000
4,800
$ (200)
$ 1,042
$18,800
450
1,800
$21,050
(5,000)
$16,050
PROBLEM 8-7 COST OF ASSETS AND THE EFFECT ON DEPRECIATION
1. $165,000/10 years = $16,500 depreciation. The correct amount of depreciation is
$19,700 [($150,000 + $15,000 + $4,000 + $25,000 + $3,000)/10 years].
2. Reported income in year 1 is $51,500 ($100,000 – $16,500 – $25,000 – $4,000 –
$3,000). Reported income should be $80,300 ($100,000 – $19,700).
3. A cost is the amount incurred to acquire an asset or pay an expense, and an expense is the amount of an expired asset or a cost that is incurred to generate revenue.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-19
PROBLEM 8-8 CAPITAL EXPENDITURES, DEPREICATION, AND DISPOSAL
LO 5,7,8
1. The entry to record depreciation for 2006 is
Dec. 31
Depreciation Expense
Accumulated Depreciation—Building
To record depreciation for 2006.
($364,000 – $14,000)/25 = $14,000.
Assets
–14,000
=
Liabilities
14,000
14,000
+
Owners’ Equity
–14,000
The entries for 2007 are
Jan. 1
Repairs Expense
Cash, Payables, etc.
To record repairs in 2007.
Assets
–21,000
Jan. 1
=
Liabilities
21,000
21,000
+
Owners’ Equity
–21,000
Building
Cash
To record pollution control equipment.
Assets
+42,000
–42,000
=
Liabilities
42,000
42,000
+
Owners’ Equity
The depreciation for 2007 should be calculated as follows:
Original cost
Less: 2006 depreciation
Less: residual value
Plus 2007 capitalized costs
Depreciable amount
Remaining asset life
Depreciation $378,000/30 years =
Dec. 31
$364,000
(14,000)
(14,000)
42,000
$378,000
30 years
$ 12,600
Depreciation Expense
Accumulated Depreciation—Building
To record depreciation for 2007.
Assets
–12,600
=
Liabilities
12,600
12,600
+
Owners’ Equity
–12,600
8-20
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
2. The pollution control equipment extended the life of the asset and should be capitalized rather than expensed. It is difficult to determine whether Merton would rather
expense or capitalize the equipment. If the company can expense the equipment for
tax purposes, it would normally desire to do so.
3. Original cost of building
Pollution device capitalized
Less: 2006 depreciation
2007 depreciation
Book value 1/1/2008
Less: 2008 depreciation ($12,600 × 3/12)
Book value at sale
Sale proceeds
Gain on sale
$364,000
42,000
(14,000)
(12,600)
$379,400
3,150
$376,250
392,000
$ 15,750
If the pollution equipment had been expensed (and original life of 25 years was used
for depreciation purposes):
Original cost
Less: Accumulated depreciation ($14,000 × 2 1/4 years)
Book value at 4/1/2008
Sale proceeds
Gain on sale
LO 6,10
$364,000
31,500
$332,500
392,000
$ 59,500
PROBLEM 8-9 AMORTIZATION OF INTANGIBLE, REVISION OF RATE
1. The $85,000 should be recorded as an expense. The $11,900 should be capitalized
in a patent account.
2. Reynosa should record $595 of amortization expense each fiscal year: a total of
$2,975 ($595 per year × 5 years) = $2,975.
$11,900/20 years = $595.
3. Reynosa should record a loss of $8,925 the year ended September 30, 2008.
Original cost of patent
Less: depreciation for 5 years
Book value, 10/1/07
$11,900
2,975
$ 8,925
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 8,11
8-21
PROBLEM 8-10 PURCHASE AND DISPOSAL OF OPERATING ASSET AND
EFFECTS ON STATEMENT OF CASH FLOWS
1. Partial statements of cash flows for 2007:
Cash flows from operating activities:
Net income
Plus depreciation expense
Cash flows from investing activities:
Purchase of machinery
Partial statements of cash flows for 2008:
Cash flows from operating activities:
Net income
Plus: Depreciation expense
Loss on sale of machinery
Cash flows from investing activities:
Purchase of machinery
Proceeds from sale of machinery (see below)
Book value at time of sale ($104,000 – $12,000 – $12,000)
Sale price
Loss on sale of machinery
$80,000 – X =
X=
$ XX,XXX
12,000
(104,000)
$ XX,XXX
12,000
5,000
(205,000)
75,000
$ 80,000
X
$ 5,000
$ 5,000
$ 75,000
2. Castlewood would replace machinery if the replacement would result in additional
net income in the future. Any additional revenues generated as a result of a possible
increase in production capacity (that is, the ability to make and thus sell more product) and any costs that could be saved by automating the production process (for
example, lower wages) would increase net income. On the other hand, this increase
would be offset by the costs of acquiring and operating the new machinery.
LO 9,10,11
PROBLEM 8-11 AMORTIZATION OF INTANGIBLES AND EFFECTS ON
STATEMENT OF CASH FLOWS
1. 2007 amortization expense:
Accumulated amortization at 12/31/06
Plus 2007 amortization expense
Accumulated amortization at 12/31/07
$102,000 + X =
X=
$ 102,000
X
$ 119,000
$ 119,000
$ 17,000
8-22
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
2. Acquisition cost:
Cost of patent
Less accumulated amortization at 12/31/07
Carrying value at 12/31/07
X – $119,000 =
X=
Year acquired:
Accumulated amortization at 12/31/07
Divided by annual amortization
Years owned
It was acquired in 2001
Estimated useful life:
Cost of patent
Divided by estimated useful life
Annual amortization
$289,000/X =
X=
$
X
(119,000)
$ 170,000
$ 170,000
$ 289,000
$ 119,000
17,000
7 years
$ 289,000
X years
$ 17,000
$ 17,000
17 years
The acquisition cost of $289,000 would have been reported as an outflow in the investing activities section of the 2001 statement of cash flows.
3. Assuming the indirect method is used, the amortization expense relating to the patent would be added back to net income in the cash flows from operating activities
section of the statement of cash flows.
4. The proceeds from the sale of $200,000 would be reported as an inflow in the cash
flows from investing activities section of the statement of cash flows. In addition, the
gain on the sale of $30,000 ($200,000 – $170,000) would be subtracted from net income in the cash flows from operating activities section of the statement of cash
flows.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-23
ALTERNATE PROBLEMS
LO 3
PROBLEM 8-1A LUMP-SUM PURCHASE OF ASSETS AND SUBSEQUENT EVENTS
1. Relative fair values:
Piece 1
Piece 2
Piece 3
Total
(a)
(b)
(c)
$ 200,000
200,000
440,000
$ 840,000
$480,000
680,000
800,000
23.8%
23.8
52.4
100.0%
1
23.8%
$114,240
161,840
190,400
Piece
2
23.8%
$114,240
161,840
190,400
3
52.4%
$251,250
356,320
419,200
2. The purchase does not affect total assets; it affects only the composition of the assets. Cash is a current asset; equipment is a long-term asset.
LO 5
PROBLEM 8-2A DEPRECIATION AS A TAX SHIELD
If asset is not purchased:
Annual income tax is $62,000 × 30% = $18,600
If asset is purchased:
Income before tax
and depreciation
2007
2008
2009
2010
2011
$62,000
62,000
62,000
62,000
62,000
Depreciation
expense
$24,000*
14,400
8,640
5,184
7,776**
Income
before tax
$38,000
47,600
53,360
56,816
54,224
Tax
30%
$11,400
14,280
16,008
17,045
16,267
Total $75,000
*Straight-line rate = 1/5 or 20%; double-declining-balance rate = 2 × 20% = 40%,
2007 depreciation = 40% × $60,000 = $24,000.
**To bring accumulated depreciation to $60,000.
8-24
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
Total tax if not purchased:
$18,600 × 5 years =
Total tax if purchased =
Depreciation tax shield
$93,000
75,000
$18,000
The tax shield if Rummy uses the straight-line method is $60,000 × 30%, or $18,000.
Rummy would choose accelerated depreciation because the company would save
tax earlier.
LO 5
1. Year
1
2
3
4
5
6
PROBLEM 8-3A BOOK VERSUS TAX DEPRECIATION
Straight-Line
$ 4,700*
4,700
4,700
4,700
4,700
4,700
$28,200
–
MACRS
$ 5,650
9,025
5,400
3,250
3,250
1,625
$28,200
=
Difference
$ (950)
(4,325)
(700)
1,450
1,450
3,075
$
0
*$28,200/6 years = $4,700 per year
2. The president is correct that a total of $28,200 will be deducted as depreciation under either method over the six-year life. However, the memo should note that all other things being equal, Payton should prefer MACRS for taxes, since it results in lower taxes during the early years in the life of the truck. Money received earlier is
preferable to money received later.
LO 11
PROBLEM 8-4A AMORTIZATION AND CASH FLOW
1. 2007 income = $500,000 – $62,500 – $50,000 = $387,500.
2. Cash on hand, December 31, 2007 = $500,000 – $62,500 = $437,500.
3. Cash increased from revenue and decreased by cash expenses. The amount is different than income for 2007 because amortization, like depreciation, is an expense
but not a cash outflow. The cost of long-term assets like a copyright is a cash outflow when it is purchased.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 11
8-25
PROBLEM 8-5A RECONSTRUCT NET BOOK VALUES USING STATEMENT OF
CASH FLOWS
1. Book value of land at time of sale:
Book value
Sales proceeds
Loss (gain) on sale
$
X – $187,000 =
X=
$ 17,000
$ 204,000
Book value of trademark at time of sale:
Book value
Sales proceeds
Loss (gain) on sale
X – $121,000 =
X=
X
187,000
$ 17,000
$
X
121,000
$ (7,000)
$ (7,000)
$ 114,000
2. Net book value of property, plant, and equipment at December 31, 2006:
Net book value at 12/31/06
Plus purchases during 2007
Less book value of land sold during 2007
Less 2007 depreciation
Net book value at 12/31/07
$
X
277,000
(204,000)
(205,000)
$1,555,000
X + $277,000 – $204,000 – $205,000 =
X=
$1,555,000
$1,687,000
3. Net book value of intangibles at December 31, 2006:
Net book value at 12/31/06
Plus payment of legal fees during 2007
Less book value of trademark sold during 2007
Less 2007 amortization
Net book value at 12/31/07
$
X
6,000
(114,000)
(3,000)
$ 34,000
X + $6,000 – $114,000 – $3,000 =
X=
$ 34,000
$ 145,000
8-26
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
ALTERNATE MULTI-CONCEPT PROBLEMS
LO 1,5,8,9,10
PROBLEM 8-6A COST OF ASSETS, SUBSEQUENT BOOK VALUES, AND
BALANCE SHEET PRESENTATION
Depreciation or amortization and book values
a. Depreciation should be calculated as follows:
Original cost
Add: cab/oven
Total cost
Less: Residual value
Depreciable amount
$ 16,000
10,900
$ 26,900
300
$ 26,600
Depreciation expense $26,600/5 years
Book value:
Total cost
Accumulated depreciation
Book value
$ 5,320
$ 26,900
5,320
$ 21,580
b. Depreciation:
$2,700 × 66 2/3%* = $1,800
*Straight-line rate = 100%/3 = 33 1/3%, double-declining-balance rate = 66 2/3%.
Book value:
$2,700 – $1,800 = $900
c. Depreciation:
($8,000 – 1,000)/8 × 3/12 = $219
Book value at time of sale:
Accumulated depreciation = ($8,000 – $1,000) × 5/8 = $4,375
Book value = $8,000 – $4,375 = $3,625
Book value
Sale price
Loss on sale
d. Amortization:
$14,000/4 years = $3,500
$3,500 × 6/12 = $1,750
Book value:
$14,000 – $1,750 = $12,250
$3,625
1,500
$2,125
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 2,5
8-27
PROBLEM 8-7A COST OF ASSETS AND EFFECT ON DEPRECIATION
1. The proper cost to record for the acquisition is $190,000 ($168,000 + $16,500 +
$4,400 + $1,100). All costs, except the operating costs for the first year, should be
capitalized as part of the cost of the equipment. The operating costs of $26,400
should be expensed.
2. Depreciation reported in year 1 is $21,640 ($216,400/10). Depreciation that should
have been reported is $19,000 [($168,000 + $16,500 + $4,400 + $1,100)/10]. Operating costs are not included in the cost of the asset.
3. Key reported income of $55,000 – $21,640, or $33,360. The correct amount of income should be as follows:
Income before equipment cost
Depreciation
Operating expenses
Net income
$ 55,000
(19,000)
(26,400)
$ 9,600
4. Key should not include operating costs in the value of the asset recorded on the balance sheet. The effect of this error is to overstate assets on the balance sheet.
LO 7,8
PROBLEM 8-8A CAPITAL EXPENDITURES, DEPRECIATION, AND DISPOSAL
1. 2006 Depreciation = [($612,000 – $12,000)/25 years)] = $24,000
2007 Depreciation = [($612,000 + $87,600 – $30,000 – $24,000)/24)] = $26,900
2. The cost of the fire equipment increased the value of an asset that will last for more
than one year. The cost would have been expensed if it was maintenance. Wagner
would prefer to expense the cost of the fire equipment for taxes in order to take advantage of the tax shield immediately. However, Wagner would prefer to capitalize
the cost for accounting purposes in order to better match revenue with the costs incurred to generate that revenue.
3. Loss at sale = $612,000 + $87,600 – $24,000 – $26,900 – $360,000 = $288,700
Loss on sale if fire equipment is expensed = $612,000 – $24,000 – $24,000 –
$360,000 = $204,000
8-28
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 6,10
PROBLEM 8-9A AMORTIZATION OF INTANGIBLE, REVISION OF RATE
1. The $350,000 of cost that represents research and development should be treated
as an expense in the year of acquisition, 2002. The $23,800 of costs that represents
the patent should be treated as an intangible asset and amortized over the 20-year
time period.
2. Maciel should record amortization expense of $23,800/20 years, or $1,190 per year.
3. The book value of the patent after 5 years of amortization is:
$23,800 – (5 × $1,190) = $17,850. Since the patent is worthless, the amount of
$17,850 should be recorded as a loss.
LO 8,11
PROBLEM 8-10A PURCHASE AND DISPOSAL OF OPERATING ASSET AND
EFFECTS ON STATEMENT OF CASH FLOWS
1. Partial statements of cash flows for 2007:
Cash flows from operating activities:
Net income
Plus depreciation expense
Cash flows from investing activities:
Purchase of delivery truck
Partial statements of cash flows for 2008:
Cash flows from operating activities:
Net income
Plus depreciation expense
Loss on sale
Cash flows from investing activities:
Purchase of delivery truck
Proceeds from sale of machinery (see below)
$XX,XXX
8,000
(45,000)
$XX,XXX
8,000
12,000
(80,000)
17,000
Book value at time of sale ($45,000 – $8,000 – $8,000)
Sale price
Loss on sale of machinery
$ 29,000
X
$ 12,000
$29,000 – X =
X=
$ 12,000
$ 17,000
2. Mansfield would replace the medium-sized delivery truck with a larger truck if the replacement would result in additional net income in the future. Any additional revenues generated as a result of Mansfield’s ability to deliver and sell more product
would increase net income. On the other hand, this increase would be offset by the
costs of acquiring and operating the new delivery truck.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
LO 9,10,11
8-29
PROBLEM 8-11A AMORTIZATION OF INTANGIBLES AND EFFECTS ON
STATEMENT OF CASH FLOWS
1. 2007 amortization expense:
Accumulated amortization at 12/31/06
Plus 2007 amortization expense
Accumulated amortization at 12/31/07
$1,510,000 + X =
X=
2. Acquisition cost:
Cost of patent
Less accumulated amortization at 12/31/07
Carrying value at 12/31/07
X – $1,661,000 =
X=
Year acquired:
Accumulated amortization at 12/31/07
Divided by annual amortization
Years owned
It was acquired in 1997
Estimated useful life:
Cost of patent
Divided by estimated useful life
Annual amortization
$3,018,000/X =
X=
$ 1,510,000
X
$ 1,661,000
$ 1,661,000
$ 151,000
$
X
(1,661,000)
$ 1,357,000
$ 1,357,000
$ 3,018,000
$ 1,661,000
151,000
11 years
$ 3,018,000
X years
$ 151,000
$
151,000
20 years
The acquisition cost of $3,018,000 would have been reported as an outflow in the
Investing Activities section of the 1997 statement of cash flows.
3. Assuming that the indirect method is used, the amortization expense relating to the
patent would be added back to net income in the Cash Flows from Operating Activities section of the statement of cash flows.
4. The proceeds from the sale of $1,700,000 would be reported as an inflow in the
Cash Flows from Investing Activities section of the statement of cash flows. In addition, the gain on the sale of $343,000 ($1,700,000 – $1,357,000) would be deducted
from net income in the Cash Flows from Operating Activities section of the statement
of cash flows.
8-30
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
CASES
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1,9
CASE 8-1 LIFE TIME FITNESS
1. A note to the statements indicates the company has land, buildings, leasehold improvements, construction in progress, and equipment. The equipment account is
broken into various types of equipment.
2. The company uses the straight-line method of depreciation.
3. The estimated useful life varies from 3 to 5 years for some types of equipment to 40
years for some buildings.
4. The property and equipment has accumulated depreciation of $102,341,000 at December 31, 2004, and book value of $503,690,000 at that date.
5. The statement of cash flows indicates purchases of $156,674,000 and cash received
from sales of property and equipment of $2,139,000.
LO 11
CASE 8-2 LIFE TIME FITNESS’S STATEMENT OF CASH FLOWS
1. The statement of cash flows indicates purchases of property and equipment of
$156,674,000.
2. The statement of cash flows indicates sales of property and equipment of
$2,139,000.
3. Depreciation and amortization is indicated in the cash flows statement as
$29,665,000. Depreciation is not a cash flow. It is listed in the operating activities
category of the cash flows statement when using the indirect method because it is
necessary to eliminate the items that did not involve cash.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-31
MAKING FINANCIAL DECISIONS
LO 1,5
CASE 8-3 COMPARING COMPANIES
ACCELERATED COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007
Sales
Cost of goods sold
Gross profit
Administrative costs
Depreciation expense
Operating expenses
Income before tax
Tax expense (40%)
Net income
$720,000
360,000
$360,000
$ 96,000
144,000
240,000
$120,000
48,000
$ 72,000
Since the balance of the Accumulated Depreciation account for Straight Company is
$240,000 and the depreciation expense is $120,000 per year, the assets must be two
years old. The amount of depreciation expense for Accelerated Company on the
double-declining-balance method is as follows:
2003: $600,000 × 40% = $240,000.
2004: $600,000 – $240,000 = $360,000 × 40% = $144,000.
The analyst should consider the difference in the cash flows of the two companies. Accelerated Company has a lower net income but actually has a higher cash inflow. This
occurs because the depreciation expense results in a tax savings. It is not entirely accurate to say that depreciation is a “noncash” expense because it results in a real cash
savings in the form of lower income tax.
LO 5
CASE 8-4 DEPREICATION ALTERNATIVES
For accounting purposes, the company should use straight-line depreciation because it
will better match the cost using the asset with the equal production levels. For taxes, the
company should also use the straight-line method because the increasing tax rates will
yield a higher cash savings from the tax shield. Depreciation is not a cash outflow, but
the tax savings results in a cash inflow because of reduced tax liability.
8-32
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
ETHICAL DECISION MAKING
LO 3
CASE 8-5 VALUING ASSETS
Students should be asked to determine the impact of using the first appraisal versus the
second appraisal. Both appraisals result in a total increase in assets of $20,000
($220,000 – $200,000), but they differ in the amount allocated to the land account. Students should see that a second opinion may have been necessary to accurately appraise the property, but, on the other hand, the appraisal may have been requested to
maximize the amount allocated to the depreciable asset, the building.
Students should be asked about the nature of the appraisal process. Is it possible for
two appraisers to have different estimates of the fair market value? Should the accountant always accept the first appraisal? When is it acceptable to seek another opinion?
Are Terry and Tammy unethical simply because they sought a separate opinion? The
instructor may wish to draw a parallel to “opinion-shopping” on the part of clients who
seek an opinion of auditors or public accountants.
It appears that the concept of neutrality has been violated in this case. It is not wrong
for Terry and Tammy to seek a second appraisal if their motive was to develop an accurate, unbiased measure of the land and building. However, if their motive was to minimize the amount allocated to the land account, their actions must be questioned.
LO 5
CASE 8-6 DEPRECIATION ESTIMATES
Both methods will result in the total cost of the asset being recorded on the income
statement over the life of the asset. However, depreciating the asset is much more preferable because it matches the cost evenly over the asset’s life. You should try to convince the manager that it is not correct to depreciate the asset over a longer life and
then record a large loss in the third year. If the manager is not convinced, you may have
to consider whether the matter should be discussed with his superior and/or the company’s auditors.
REAL WORLD PRACTICE 8.1
Depreciation and amortization is indicated in the cash flows statement as $29,665,000.
The notes indicate the company uses the straight-line method.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-33
SOLUTION TO INTEGRATIVE PROBLEM
Part 2
1.
PEK COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007
Sales
Cost of goods sold
Gross profit
Depreciation on plant equipment
Depreciation on buildings
Interest expense
Other expenses
Income before taxes
Income tax expense (30% rate)
Net income
$1,250,000
636,500
$ 613,500
$85,400*
12,000
55,400**
83,800
236,600
$ 376,900
113,070
$ 263,830
*$58,400 + ($270,000/10 years).
**$33,800 + ($270,000 × 8%).
PEK COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities
(includes depreciation expense)
Net cash provided by operating activities
Cash flows from financing activities:
Dividends
Net increase in cash
*$83,200 + $27,000 additional depreciation.
Supplemental Schedule of Noncash Investing and Financing Activities:
Acquisition of equipment in exchange for a note of $270,000.
$263,830
110,200*
$374,030
(35,000)
$339,030
8-34
2.
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
PEK COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007
Sales
Cost of goods sold
Gross profit
Depreciation on plant equipment
Depreciation on buildings
Interest expense
Other expenses
Income before taxes
Income tax expense (30% rate)
Net income
$1,250,000
636,500
$ 613,500
$107,491*
12,000
55,400
83,800
258,691
$ 354,809
106,443
$ 248,366
*$58,400 + $49,091.
PEK COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities
(includes depreciation expense)
Net cash provided by operating activities
Cash flows from financing activities:
Dividends
Net increase in cash
*$83,200 + $49,091 additional depreciation.
Supplemental Schedule of Noncash Investing and Financing Activities:
Acquisition of equipment in exchange for a note of $270,000.
$ 248,366
132,291*
$ 380,657
(35,000)
$ 345,657
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES
8-35
3. a. LIFO cost of goods sold:
40,000($3.25) =
$130,000
60,000($3.10) =
186,000
75,000($3.00) =
225,000
40,000($2.50) =
100,000
30,000($2.20) =
66,000
5,000($2.10) =
10,500
Total LIFO cost of goods sold
Total FIFO cost of goods sold
Increase in cost of goods sold
$717,500
636,500
$ 81,000
b. Additional cost of goods sold
Times the tax rate
Decrease in income tax expense
$ 81,000
30%
$ 24,300
c. Additional cost of goods sold
Decrease in income taxes
Decrease in net income
$ 81,000
24,300
$ 56,700
4. a. Sales on account
Times estimated uncollectibles
Increase in other expenses
$800,000
3%
$ 24,000
b. Increase in other expenses
Times the tax rate
Decrease in income tax expense
$ 24,000
30%
$ 7,200
c. Increase in other expenses
Decrease in income taxes
Decrease in net income
$ 24,000
7,200
$ 16,800