CHAPTER 9
LONG-LIVED ASSETS
BRIEF EXERCISES
BE9–1
a. The new method, straight-line depreciation, will increase net income in the early years and
reduce income in the later years versus using an accelerated method. An accelerated method
of depreciation increases the depreciation charges in the early years of the life of an asset and
reduces the depreciation charges in the later years.
b. Allegheny may have decided that it wanted depreciation charges to be spread evenly over the
life of an asset so that the impact on net income in any one reporting period was less. It may
also feel that it will make its financial statements easier to compare with its competitors.
During periods of high fixed asset investment Allegheny’s results may look unfavorable versus
other companies that use a straight-line method instead of an accelerated method.
c. In the annual report one could look through the first footnote. This footnote typically highlights
all of the significant accounting policies and methods used by the company to prepare the
financial statements.
EXERCISES
E9–1
a. Lowery, Inc., should capitalize all costs associated with getting the equipment in a serviceable
condition and location. These costs would be the actual purchase price of $920,000, the
transportation cost of $62,000, and the insurance cost of $10,000. Therefore, the total cost of
the equipment is $992,000.
b. The depreciation base equals the dollar amount of a fixed asset's cost that the company does
not expect to recover over the asset's useful life, but instead expects to consume over the
asset's useful life. Since the plant equipment's total cost is $992,000 and since Lowery, Inc.,
expects to sell the equipment for $50,000 at the end of its useful life, Lowery, Inc., does not
expect to recover $942,000 of the asset's cost. Therefore, the depreciation base equals
$942,000. The depreciation base always equals the capitalized cost of a fixed asset less its
estimated salvage value.
c. The amount that will be depreciated over the life of the plant equipment is its depreciation
base. The depreciation base equals the amount of the equipment's future benefits that the
company will consume. The outflow of future benefits are expenses, in this case depreciation
expense. Therefore, the total amount that Lowery, Inc., will depreciate over the equipment's
useful life is $942,000.
1
E9–3
a. All costs that are necessary and reasonable to get an asset ready for its intended use should
be capitalized as part of the cost of that asset. In the case of property, plant, and equipment,
"ready for its intended use" means that the asset is in a serviceable condition and location.
Item
Tract of land
Demolition of warehouse
Scrap from warehouse
Construction of building
Driveway and parking lot
Permanent landscaping
Total
Land
Land
Improvements
Building
$90,000
10,000
(7,000)
$140,000
$32,000
4,000
$ 97,000
$32,000
$140,000
b. Land:
Since land is assumed to have an indefinite life, it is never depreciated.
Land Improvements:
Depreciation Expense—Land Improvements (E, –SE) ...................
Accumulated Depreciation—Land Improvements (–A) ..............
Depreciated land improvements.
1,600
1,600
Building:
Depreciation Expense—Building (E, –SE) ......................................
Accumulated Depreciation—Building (–A) .................................
Depreciated building.
7,000
7,000
E9–4
a.
b.
c.
d.
e.
f.
g.
h.
i.
Maintenance
Maintenance
Maintenance
Betterment
Maintenance
Maintenance
Betterment
Maintenance
Betterment
Note: The classification of these expenditures can be quite subjective. Some accountants might
very well classify some of these expenditures differently. For example, one might argue
that the cost of the muffler in (h) is actually a betterment expenditure if the reduced noise
allows workers to work more efficiently, thereby increasing the productive capacity of the
machine.
E9–14
a. Cash (+A) .......................................................................................
Accumulated Depreciation—Office Equipment (+A) .......................
Office Equipment (–A) ...............................................................
Gain on Sale of Fixed Assets (Ga, +SE) ...................................
Sold office equipment.
235,000
300,000
b. Cash (+A) .........................................................................................
Accumulated Depreciation—Office Equipment (+A) .......................
Loss on Sale of Fixed Assets (Lo, –SE) ..........................................
Office Equipment (–A) ...............................................................
Sold office equipment.
185,000
300,000
15,000
500,000
35,000
500,000
E9–19
a. Swift Corporation should capitalize these costs. Assets are defined as items that are expected
to provide future economic benefits to the entity. Organization costs are costs incurred by an
entity prior to starting operations. Such costs include legal fees to incorporate and accountant's
fees to set up an accounting system. Without incurring these costs, most companies could not
be in business. Consequently, organization costs allow a company to be in business, thereby
helping it to generate future benefits. Since these costs help in generating future benefits, they
should most definitely be capitalized.
b. Theoretically, organization costs should be amortized over their useful life. In the extreme,
organization costs provide a benefit over the entire life of a company. Since under the going
concern assumption accountants assume that entities will exist indefinitely, it would seem that
organization costs should be amortized over an indefinite period. Since this position is not
practical, the accounting profession has decided that organization costs should be amortized
over a period not to exceed forty years.
Assuming that Swift Corporation amortizes its organization costs over the maximum period of
forty years, the appropriate adjusting journal entry for a single year would be as follows:
Amortization Expense (E, –SE) .......................................................
Organization Costs (–A) ............................................................
Amortized organization costs.
1,125
1,125
c. As mentioned in part (b), organization costs theoretically provide benefits over the entire life of
the company. Under the going concern assumption, the company is assumed to exist
indefinitely. If the company is assumed to exist indefinitely and if organization costs provide
benefits over the entire life of the company, then these costs should provide an indefinite
benefit. Consequently, organization costs should provide a benefit for an indefinite period of
time, which implies that they should be reported as an asset (i.e., future benefit) indefinitely.
But if organization costs are amortized, the asset will at some point in time have a zero
balance, and the cost of the asset cannot be matched against the benefits the asset will help
generate in the future. This situation contradicts the matching principle and the concept of an
asset.
d. A patent gives a company the exclusive right to use or market a particular product or process,
thereby providing the company with an expected future benefit. Consequently, the costs
incurred to acquire a patent should be capitalized as an asset and amortized over the patent's
useful life. If Swift were to immediately expense the $65,000, the company would be implying
that it did not expect to receive any benefits from the patent in the future. If this were the case,
one would have to question why Swift purchased the patent in the first place.
e. Research and development costs may or may not provide a company with future benefits. The
company will not know whether or not a particular R & D expenditure will provide a future
benefit until some time in the future. Due to the uncertainty of projecting the usefulness of a
given R & D expenditure, the FASB, in Statement of Financial Accounting Standards No. 2,
"Accounting for Research and Development Costs," requires companies to expense R & D
costs in the year in which they are incurred.
f. Engaging in research and development activities can lead companies to develop new products
or processes that will provide them with future benefits. In such cases, the R & D costs should,
theoretically, be capitalized. The R & D costs would then be allocated to those periods in which the
costs help generate a benefit. From a practical standpoint, however, this matching of costs with the
associated benefits is not readily possible. For example, consider a company that spends
$10,000,000 trying to develop a more efficient manufacturing process. The company's attempts
end in failure, but the company acquires some new technology from its R & D activities that permit
it to develop a revolutionary new product ten years later. In this case, it is clear that the
$10,000,000 eventually provided a future benefit. But this information is available only with
hindsight. At the time the $10,000,000 was expended, all the company knew was that the R & D
project was a failure. So, while capitalizing R & D costs and then amortizing the costs over their
useful lives is theoretically superior to immediately expensing the R & D costs, immediately
expensing R & D costs is extremely practical and lessens a manager's ability to manipulate the
financial statements.
PROBLEMS
P9–10
(a)
S-L Depreciation
(10-year life)
Tax Payments:
Revenues
$ 250,000
Depreciation expense
(40,000)a
Other expenses
(140,000)
Net income before taxes
$ 70,000
Income taxes
(22,400)
Net income
$ 47,600
_______________
a $40,000 = ($400,000 – 0) ÷ 10 years
b $80,000 = ($400,000  20%)
c $80,000 = ($400,000 – 0) ÷ 5 years
Bonus Payment:
Net income
Bonus percentage
Bonus amount
$
$
47,600
8%
3,808
(b)
DDB
Depreciation
(c)
S-L Depreciation
(5-year life)
$ 250,000
(80,000)b
(140,000)
$ 30,000
(9,600)
$ 20,400
$ 250,000
(80,000)c
(140,000)
$ 30,000
(9,600)
$ 20,400
$
$
20,400
8%
1,632
$
$
20,400
8%
1,632
Dividend Payment
Net income
Dividend percentage
Dividend amount
$
$
47,600
75%
35,700
$
$
20,400
75%
15,300
$
$
20,400
75%
15,300
P9–13
a. Most assets are reported on the balance sheet at historical cost or at historical cost less
accumulated depreciation. The historical cost of a particular asset is constant over time.
However, the fair market value of that same asset fluctuates over time. Consequently, the fair
market value of assets can be less than, equal to, or greater than the historical cost of the
assets at any point in time.
b. Diversified would pay more for Specialists due to goodwill (i.e., synergy). Specialists' assets
considered as a package are worth more than the sum of their individual values. Goodwill
arises because certain "assets" are not included on a company's balance sheet. Items that
cannot be given a value (i.e., cannot be quantified) are omitted from a balance sheet.
Examples include customer loyalty and the company's name recognition.
c. Assets (+A) .......................................................................................
Goodwill (+A) ....................................................................................
Liabilities (+L) .............................................................................
Cash (–A) ...................................................................................
Purchased Specialists, Inc.
1,350,000
700,000
250,000
1,800,000
d. Until recently under GAAP, goodwill was capitalized at the time of acquisition and then
amortized over a maximum of 40 years. The school of thought holding the opposite viewpoint
espouses that goodwill should be expensed at the time of acquisition. They maintain that since
goodwill is a plug number on the books of the acquired company and its amortization period is
totally arbitrary, it need not be put on the balance sheet.
Further, goodwill should be
periodically tested to see if it has been “impaired” (i.e., if the fair value of the assets acquired
has dropped).
a. Based on the balance sheet changes, the company recorded $506 million of goodwill in 2006.