Ch07 SM 9e

Financial Accounting 8e

Chapter 7

Plant Assets & Intangibles

Short Exercises

(5 min.) S 7-1

1.Property and Equipment, at Cost

Millions

Aircraft$ 2,392

Package handling and ground support

equipment12,229

Computer and electronic equipment.28,159

Vehicles.581

Facilities and other. 1,432

Total cost..44,793

Less: Accumulated depreciation. (14,900)

Net property and equipment$29,893

2.Cost

=$44,793 million

Book value=$29,893 million

Book value is less than cost because accumulated depreciation is subtracted from cost to compute book value.

(5 min) S 7-2

Land ($210,000 .30*)..63,000

Building ($210,000 .10)..21,000

Equipment ($210,000 .60).126,000

Note Payable..210,000

*Supporting computations:

Current

Market

ValuePercent of Total

Land.$ 66,000$66,000 / $220,000= 30.0%

Building... 22,000$22,000 / $220,000= 10.0%

Equipment.. 132,000$132,000 / $220,000= 60.0%

Total.$220,000100.0%

(5 min.) S 7-3

Income Statement

RevenuesCORRECT

ExpensesUNDERSTATED

Net income OVERSTATED

(10 min.) S 7-41.First-year depreciation:

Straight-line ($44,400,000 $5,400,000) / 5 years$ 7,800,000

Units-of-production [($44,400,000 $5,400,000) /

6,500,000 miles] 725,000 miles..$ 4,350,000

Double-declining-balance ($44,400,000 40%)...

$17,760,000

Second-year depreciation:

Straight-line ($44,400,000 $5,400,000) / 5 years$ 7,800,000

Units-of-production [($44,400,000 $5,400,000) /

6,500,000 miles] 1,225,000 miles...$ 7,350,000

Double-declining-balance [($44,400,000 $17,760,000) 40%].$10,656,000

2.Book value:

Straight-

LineUnits-of-

ProductionDouble-

Declining-

Balance

Cost$44,400,000$44,400,000$44,400,000

Less: Accumulated

Depreciation (7,800,000) (4,350,000) (17,760,000)

Book value, Year 1..$36,600,000$40,050,000$26,640,000

(10 min.) S 7-51.Double-declining-balance (DDB) depreciation offers the tax advantage for the first year of an assets use. Because DDBs first-year depreciation is greater than first-year depreciation under other methods, net income is lower. Lower net income results in lower taxes and more cash that the taxpayer can invest to earn a return.

2.

DDB depreciation..$17,760,000

Straight-line depreciation... (7,800,000)

Excess depreciation tax deduction.$ 9,960,000

Income tax rate.. .36

Income tax savings for first year..$ 3,585,600

(5-10 min.) S 7-6First-year depreciation (for a partial year):

a.Straight-line (41,000,000 5,200,000) / 5 years

3/121,790,000

b.Units-of-production (41,000,000 5,200,000) /

5,200,000 miles 390,000 miles) or

2,683,200 if depletion per unit is rounded2,685,000

c.Double-declining-balance (41,000,000 2/5

3/12)..4,100,000

SL depreciation produces the highest net income (lowest depreciation). DDB depreciation produces the lowest net income (highest depreciation).

(10 min.) S 7-7Depreciation Expense Concession Stand......15,000

Accumulated Depreciation Concession Stand15,000

Depreciation for years 1-5:

$90,000 / 10 years=$ 9,000 per year

$ 9,000 5 years=$45,000 for years 1-5Assets remaining

depreciable(New) Estimated=(New) Annual

book valueuseful life remainingdepreciation

$90,000 $45,0003 years=$15,000 per year

$45,000

(5-10 min.) S 7-81.($67,850,000 $2,950,000) / 11 years 5 = $29,500,000

2.

2017

Jan. 1Cash...........8,000,000

Accumulated Depreciation...29,500,000

Loss on Sale of Airplane...30,350,000

Airplane.67,850,000

(5-10 min.) S 7-91.Units-of-production depreciation method is similar to the method used to calculate depletion.

Billions

2.Oil Inventory ($18* .8).14.4

Oil Reserves...14.4

*$18 = $234 / 13

Billions

3.Cost of Oil Sold ($18 .2)3.6

Oil Inventory..3.6

(5-10 min.) S 7-10Req. 1

Cost of goodwill purchased:

MillionsPurchase price paid for Seacoast Snacks, Inc.

$8.2

Market value of Seacoast Snacks net assets:

Market value of Seacoast Snacks assets

$12.0

Less: Seacoast Snacks liabilities (10.0)

Market value of Seacoast Snacks net assets 2.0

Cost of goodwill$6.2

Req. 2

In future years PTL, Inc. will determine whether its goodwill has been impaired. If the goodwills value has not been impaired, there is nothing to record. But if goodwills value has been impaired, PTL, Inc. will record a loss and write down the book value of the goodwill. (5 min.) S 7-11

(Dollar amounts in millions)Return on assets=Net incomeAverage total assets

15%=$18$120

(5 min.) S 7-12

2012 Return on assets=Net incomeAverage total assets

17.7%=$42,500$240,000

2013 Return on assets=Net incomeAverage total assets

18.0%=$45,000$250,000

(5 min.) S 7-13Southeast Satellite Systems, Inc.

Statement of Cash Flows

For the Year Ended December 31, 2012

Cash flows from investing activities:Millions

Purchase of other companies.$(15.0)

Capital expenditures.........(8.0)

Proceeds from sale of North American operations...... 13.0

Net cash (used for) investing activities.......$(10.0)

(5 min.) S 7-14

AssetBook

ValueEstimated Future Cash FlowsFair

ValueImpaired?

(Y or N)Amount of Loss

a. Equipment$160,000$120,000$100,000Y$60,000

b. Trademark$320,000$420,000$380,000N--

c. Land$56,000$30,000$28,000Y$28,000

d. Factory building$3 million$3 million$2 millionN--

Exercises

(5-10 min.) E 7-15A

Land:$330,000 + $2,500 + $5,500 + $5,000 = $343,000

Land improvements:$51,000 + $11,000 + $2,000 = $64,000

Building:$54,000 + $750,000 = $804,000

(10-15 min.) E 7-16AAllocation of cost to individual machines:

MachineAppraised

ValuePercentage of Total

Appraised (Market) ValueTotal

CostCost of

Each Machine

1$ 63,000$63,000 / $210,000=.30$204,000 .30=$ 61,200

2 107,100 107,100 / 210,000=.51 204,000 .51=104,040

3 39,900 39,900 / 210,000= .19 204,000 .19= 38,760

Totals$210,0001.00$204,000

Sale price of machine No. 1.$63,000

Cost. 61,200

Gain on sale of machine$ 1,800

(5-10 min.) E 7-17A(a) Sales tax

(b) Transportation and insurance(c) Purchase price(d) InstallationCapital Expenditure

Capital Expenditure

Capital Expenditure

Capital Expenditure

(e) Training of personnel(f) Reinforcement to platform(g) Income taxCapital Expenditure

Capital Expenditure

Immediate Expense

(h) Major overhaul(i) Ordinary recurring repairsCapital Expenditure

Immediate Expense

(j) Lubrication before machine is placed in serviceCapital Expenditure

(k) Periodic lubricationImmediate Expense

(15 min.) E 7-18AJournal

ACCOUNT TITLESDEBITCREDIT

1.a.Land

483,000

Cash

483,000

b.Building

($1,300 + $15,300 + $685,000 + $28,220)

729,820

Note Payable

685,000

Cash ($1,300 + $15,300 + $28,220)

44,820

c.Depreciation Expense

5,626

Accumulated Depreciation

($729,820 $336,000) / 35 6/12

5,626

2.BALANCE SHEET

Plant assets:

Land...$483,000

Building.$729,820

Less Accumulated depreciation. (5,626)

Building, net.724,194

3.INCOME STATEMENT

Expense:

Depreciation expense...$ 5,626

(15-20 min.) E 7-19AReq. 1Year Straight-LineUnits-of-ProductionDouble-Declining-

Balance

2012 $ 4,025$ 6,210 $ 9,300

2013 4,025 5,520 4,650

2014 4,025 1,610 2,150

2015 4,025 2,760 -0-

$16,100$16,100$16,100

_____

Computations:

Straight-line: ($18,600 $2,500) 4 = $4,025 per year.

Units-of-production: ($18,600 $2,500) 35,000 miles = $.46 per mile;

201213,500$.46=$ 6,210

201312,000 .46= 5,520

2014 3,500 .46= 1,610

2015 6,000 .46= 2,760

Double-declining-balance Twice the straight-line rate: 1/4 2 = 50%

2012$18,600 .50= $9,300

2013($18,600 $9,300) .50= $4,650

2014($9,300 $4,650) =

$4,650 $2,500 (residual value) = $2,150

Req. 2

The units-of production method tracks the wear and tear on the van most closely.

Req. 3

For income tax purposes, the double-declining-balance method is best because it provides the most depreciation and, thus, the largest tax deductions in the early life of the asset. The company can invest the tax savings to earn a return on the investment.

(15 min.) E 7-20AINCOME STATEMENT

Expenses:

Depreciation expense Building

[($53,000 + $103,000 + $66,000) $56,000] / 20

$ 8,300

Depreciation expense Furniture and Fixtures

($59,000 2/5)

23,600

Supplies expense

($9,600 $1,200)

8,400

BALANCE SHEET

Current assets:

Supplies

$ 1,200

Plant assets:

Building ($53,000 + $103,000 + $66,000)$222,000

Less: Accumulated depreciation. (8,300)$213,700

Furniture and fixtures..... 59,000

Less: Accumulated depreciation. (23,600)35,400

STATEMENT OF CASH FLOWS

Cash flows from investing activities:

Purchase of buildings ($53,000* + $66,000)

$(119,000)

Purchase of furniture and fixtures

(59,000)

_____

*Does not include the $103,000 note payable because Sunshine Bakery paid no cash on the note.

(10-15 min.) E 7-21AJournal

DATEACCOUNT TITLESDEBITCREDIT

Year20Depreciation Expense ($355,000 40).

8,875

Accumulated Depreciation Building..8,875

Year21Depreciation Expense.. 16,840*

Accumulated Depreciation Building..16,840

_____

*Computations:

Depreciable cost: $445,000 $90,000 = $355,000

Depreciation through year 20: = $8,875 20 = $177,500

Assets remaining depreciable book value:

$445,000 $177,500 $14,900 (new residual value) = $252,600

New annual depreciation:

$252,600 15 (revised life remaining) = $16,840

(15-20 min.) E 7-22AJournal


2013Depreciation for 9 months:

Sept.30Depreciation Expense

1,566a


Fixtures

1,566

Sale of fixtures:

30Cash..

2,600


Store Fixtures ($3,480 + $1,566)..5,046

Loss on Sale of Fixtures..1,054b

Fixtures..8,700

_____

a2012 depreciation: $8,700 2/5 = $3,480

2013 depreciation: ($8,700 $3,480) 2/5 9/12 = $1,566bLoss on sale of fixtures:

Sale price of old fixtures.$ 2,600

Book value of old fixtures:

Cost..$8,700

Less: Accumulated depreciation ($3,480 + $1,566)....(5,046)( 3,654)

Loss on sale...$(1,054)

(10-15 min.) E 7-23A

Cost of old truck..$360,000

Less: Accumulated depreciation:

($360,000 $50,000) 75 + 85 + 135 + 39(103,540)a

1,000

_______

Book value of old truck..$256,460

_____

aAlternate solution setup for accumulated depreciation:

($360,000 $50,000)=$.31 per mile

1,000,000 miles

75,000 + 85,000 + 135,000 + 39,000 = 334,000 miles driven

Accumulated depreciation=334,000 miles $.31

=$103,540

Calculation of gain or loss:

Purchase price of Freightliner truck $210,000

Cash paid for Freightliner truck (20,000) Trade-in value of Mack truck 190,000

Book value of Mack truck (256,460) Net loss on disposal of Mack truck $ (66,460)

Journal


2015Truck Freightliner 210,000

Accumulated Depreciation Mack

Truck

103,540

Loss on Disposal of Mack Truck 66,460

Truck Mack 360,000

Cash

20,000

(10-15 min.) E 7-24A

Journal


(a)Purchase of mineral assets:

Mineral Asset.425,000

Cash425,000

(b)Payment of fees and other costs:

Mineral Asset ($110 + $2,000)2,110

Cash2,110

Mineral Asset..55,390

Cash.55,390

(c)Depletion for the first year

Mineral Asset Inventory..67,550*

Mineral Asset67,550

(d)Sale of ore

Cost of Mineral Asset Sold.....57,900

Mineral Asset Inventory.57,900

_____

*$425,000 + $110 + $2,000 + $55,390 = $482,500$482,500 250,000 tons = $1.93 per ton

35,000 tons $1.93 = $67,55030,000 tons x $1.93 = $57,900(10-15 min.) E 7-25AJournal


Req.1

(a)Purchase of patent:

Patents

1,500,000

Cash

1,500,000

(b)Amortization for each year:

Amortization Expense Patents

($1,500,000 15)

100,000

Patents

100,000

Req. 2

Impairment of patent in year 10:

Impairment Loss on Patents

500,000**

Patents

500,000

Yes, the asset is impaired because its net book value ($500,000*) is greater than the estimated future cash flows ($400,000)._____

*Asset remaining book value: $1,500,000 ($100,000 10) = $500,000

**Impairment loss: $500,000 [$500,000 (book value) - $0 (fair value)](5-10 min.) E 7-26AReq. 1


Millions

Purchase price paid for HarborSide.com

$20

Market value of HarborSides net assets:

Market value of HarborSides assets ($15 + $21).$36

Less: HarborSides liabilities

(28)

Market value of HarborSides net assets

8

Cost of goodwill

$ 12

Req. 2

Journal


Current Assets

15

Long-Term Assets

21

Goodwill

12

Liabilities

28

Cash

20

Req. 3

Caltron will determine whether its goodwill has been impaired in value. If the goodwills value has not been impaired, there is nothing to record. But if goodwills value has been impaired, Caltron will record a loss and write down the book value of the goodwill.

(5-10 min.) E 7-27AReq. 1Profit margin for the year ended January 31, 2011:

Net earnings $ 2,010

= 4.12%

Net sales

$48,815Req. 2

Asset turnover for the year ended January 31, 2011:

Net sales

$48,815 = 1.45

Average total assets $33,699

Req. 3Return on assets for the year ended January 31, 2011:Net earnings

$ 2,010 = 5.96% or (4.12% x 1.45 = 5.97%)*

Average total assets $33,699

_____

*difference due to rounding

(10 min.) E 7-28A

a.Sale of building

(or disposal of building).$ 680,000

b.Insurance proceeds from fire

(or disposal of building). 190,000

c.Renovation of store

(or capital expenditures) (130,000)

d.Purchase of store fixtures


(5-10 min.) E 7-29B

Land:$160,000 + $150,000 + $5,000 + $2,000 + $3,000 =$320,000

Land improvements:$46,000 + $16,000 + $7,000 = $69,000

Building:$58,000 + $700,000 = $758,000 (10-15 min.) E 7-30BReq. 1Allocation of cost to individual machines:

MachineAppraised

ValuePercentage of Total

Appraised (Market) ValueTotal

CostCost of

Each Machine

1$ 50,000$ 50,000 / $200,000=.25$192,000 .25=$ 48,000

2 96,000 96,000 / 200,000=.48 192,000 .48=92,160

3 54,000 54,000 / 200,000=.27 192,000 .27= 51,840

Totals$200,0001.00$192,000

Req. 2Sale price of machine no. 3..$54,000

Cost. (51,840)

Gain on sale of machine$ 2,160

(5-10 min.) E 7-31B(a) Sales tax

(b) Transportation and insurance(c) Purchase price(d) InstallationCapital Expenditure

Capital Expenditure

Capital Expenditure

Capital Expenditure

(e) Training of personnel(f) Reinforcement to platform(g) Income taxCapital Expenditure

Capital Expenditure

Immediate Expense

(h) Major overhaul(i) Ordinary recurring repairsCapital Expenditure

Immediate Expense

(j) Lubrication before machine is placed in serviceCapital Expenditure

(k) Periodic lubricationImmediate Expense

(15 min.) E 7-32BReq. 1Journal


a.Land485,000

Cash.....485,000

b.Building

($1,700 + $15,700 + $705,000 + $30,040).......752,440

Note Payable..705,000

Cash ($1,700 + $15,700 + $30,040)

47,440

c.Depreciation Expense3,928


($752,440 $340,000) / 35 4/12...

3,928

Req. 2BALANCE SHEET

Plant assets:

Land

$485,000

Building.$752,440

Less: Accumulated depreciation

(3,928)

Building, net

748,512

Req. 3

INCOME STATEMENT

Expense:

Depreciation expense

$ 3,928

(15-20 min.) E 7-33BReq. 1Year Straight-LineUnits-of-ProductionDouble-Declining-

Balance

2012$ 4,525$ 4,800 $11,000

2013 4,525 5,120 5,500

2014 4,525 2,900 1,600

2015 4,525 5,280 -0-

$18,100$18,100$18,100

_____

Computations:

Straight-line: ($22,000 $3,900) 4 = $4,525 per year.

Units-of-production: ($22,000 $3,900) 113,125 miles = $.16 per mile;

201230,000$.16=$ 4,800

201332,000 .16= 5,120

201418,125 .16= 2,900

201533,000 .16= 5,280

Double-declining-balance Twice the straight-line rate: 1/4 2 = 50%

2012$22,000 .50= $11,000

2013($22,000 $11,000) .50= $5,500

2014($11,000 - $5,500) $3,900 =

$5,500 $3,900 (residual value)

= $1,600

Req. 2

The units-of production method tracks the wear and tear on the van most closely.

Req. 3For income tax purposes, the double-declining-balance method is best because it provides the most depreciation and, thus, the largest tax deductions in the early life of the asset. The company can invest the tax savings to earn a return on the investment.

(15 min.) E 7-34BINCOME STATEMENT

Expenses:

Depreciation expense Building

[($158,000 + $65,000) $50,000] / 20$ 8,650

Depreciation expense Furniture and Fixtures

($51,000 2/5)20,400

Supplies expense

($9,000 $1,300)7,700

BALANCE SHEET

Current assets:

Supplies$ 1,300

Plant assets:

Building ($158,000 + $65,000).$223,000

Less: Accumulated depreciation (8,650)$214,350

Furniture and fixtures... 51,000

Less: Accumulated depreciation (20,400)30,600

STATEMENT OF CASH FLOWS


Purchase of buildings ($54,000* + $65,000).$(119,000)

Purchase of furniture and fixtures.(51,000)

_____

*Does not include the $104,000 note payable because Early Bird Caf paid no cash on the note.

(10-15 min.) E 7-35BJournal

DATEACCOUNT TITLES DEBITCREDIT

Year20Depreciation Expense ($357,000 40)

8,925

Accumulated Depreciation Building

8,925

Year21Depreciation Expense

17,080*

Accumulated Depreciation Building

17,080

_____

*Computations:

Depreciable cost: $450,000 $93,000 = $357,000

Depreciation through year 20: $357,000 40 = $8,925 20 = $178,500

Assets remaining depreciable book value:

$450,000 $178,500 $15,300 = $256,200

New annual depreciation: $256,200 15 (revised life remaining)

= $17,080



2013Depreciation for 10 months:

Oct.31Depreciation Expense1,640a


Fixtures..1,640

Sale of fixtures:

31Cash2,200


Store Fixtures ($3,280 + $1,640)..4,920

Loss on Sale of Fixtures.1,080b

Fixtures..8,200

_____

a2012 depreciation: $8,200 2/5 = $3,280

2013 depreciation: ($8,200 $3,280) 2/5 10/12 = $1,640bLoss on sale of fixtures:

Sale price of old fixtures $2,200

Book value of old fixtures:

Cost$8,200

Less: Accumulated depreciation(4,920) (3,280)

Loss on sale.. $(1,080)

(10-15 min.) E 7-37B

Cost of old truck$430,000

Less: Accumulated depreciation:

($430,000 $20,000) 81+ 111 + 141 + 41(153,340)a

1,000

_______

Book value of old truck$276,660

_____

aAlternate solution setup for accumulated depreciation:

($430,000 $20,000)=$.41 per mile

1,000,000 miles

81,000 + 111,000 + 141,000 + 41,000 = 374,000 miles driven

Accumulated depreciation=374,000 miles $.41

=$153,340

Calculation of gain or loss:

Purchase price of Freightliner truck.. $250,000

Cash paid for Freightliner truck.. (24,000) Trade-in value of Mack truck... 226,000

Book value of Mack truck. (276,660) Net loss on disposal of Mack truck... $ (50,660)Journal


2015Truck Freightliner 250,000

Accumulated Depreciation Mack

Truck

153,340

Loss on Disposal of Mack Truck50,660

Truck Mack 430,000

Cash

24,000

(10-15 min.) E 7-38B

Journal

DATEACCOUNT TITLES AND EXPLANATIONDEBITCREDIT

(a)Purchase of mineral assets:


Cash428,000

(b)Payment of fees and other costs:

Mineral Asset ($130 + $2,300)2,430

Cash2,430


Cash66,820

(c)Depletion for the year

Mineral Asset Inventory..76,500*

Mineral Asset76,500

(d)Sales of ore

Cost of Mineral Asset Sold.61,200**

Mineral Asset Inventory.61,200

_____

*$428,000 + $2,430 + $66,820 = $497,250

$497,250 325,000 tons = $1.53 per ton

50,000 tons $1.53 = $76,500

**40,000 tons x $1.53 = $61,200



Req.1

(a)Purchase of patent:

Patents

1,200,000

Cash

1,200,000

(b)Amortization for each year:

Amortization Expense Patents

($1,200,000 12)

100,000

Patents

100,000

Req.2Impairment loss:

Impairment Loss on Patents

400,000

Patents

400,000

The asset is impaired because the net book value ($400,000) is greater than the estimated future cash flows ($350,000). The amount of the impairment loss is $400,000 (net book value minus fair value of $-0-).(5-10 min.) E 7-40BReq. 1


Millions

Purchase price paid for Northeast.com.$19

Market value of Northeasts net assets:

Market value of Northeasts assets ($11 + $25)..$36

Less: Northeasts liabilities.. (22)

Market value of Northeasts net assets. 14

Cost of goodwill$5

Req. 2

Journal


Current Assets..11

Long-Term Assets....25

Goodwill..5

Liabilities22

Cash.19

Req. 3

Doltron will determine whether its goodwill has been impaired in value. If the goodwills value has not been impaired, there is nothing to record. But if goodwills value has been impaired, Doltron will record a loss and write down the book value of the goodwill.

(5-10 min.) E 7-41B Req. 1Profit margin for the year ended January 31, 2011:

Net earnings $ 1,116 = 1.36%

Net sales

$82,189

Req. 2

Asset turnover for the year ended January 31, 2011:

Net sales

$82,189 = 3.5Average total assets $23,505Req. 3Return on assets for the year ended January 31, 2011:Net earnings

$ 1,116= 4.75% or (1.36% x 3.5 = 4.76%) *

Average total assets $23,505_____

*difference due to rounding

(10 min.) E 7-42B

a.Sale of building

(or disposal of building).$ 620,000

b.Insurance proceeds from fire

(or disposal of building). 100,000

c.Renovation of store


d.Purchase of store fixtures


Quiz

Q7-43d

Q7-44a

Q7-45d[$480,000 / ($480,000 + $270,000) ($3,000,000 +

$1,000,000)] 15 = $170,667

Q7-46c

Q7-47dDDB [($34,000 2/5) = $13,600; ($34,000 $13,600 2/5)]

UOP ($34,000 $4,000) /100,000 hrs. = $.30 25,000 hrs.)

Q7-48c

($26,000 $2,000) / 6 3 = $12,000;

($26,000 $12,000) / 7 = $2,000

Q7-49d

Q7-50a

Q7-51b

Q7-52SL depreciation = $1,050 [($9,200 $800) / 8

Book value = $7,100 [$9,200 ($1,050 x 2)]

Q7-53c

$800 gain = $7,900 (sale price) $7,100 (book value)

Q7-54c($832,000 $68,800) (54,000 / 240,000) = $171,720

Q7-55a$66 ($72 $23) = $17

Q7-56c$1,000,000 $820,000

Q7-57b$45,000 / $500,000

Problems

(20-30 min.) P 7-58A

Req. 1

ITEMLANDLAND

IMPROVEMENTSSALES

BUILDINGGARAGE

BUILDINGFURNITURE

(a)$280,000$ 70,000

(b)8,300

(c)$ 31,400

(d)300

(e)5,900

(f)1,500

(g)$ 500

(h)19,200

(i)516,000

(j)41,000

(k)9,600

(l)6,900*

(m)52,500

(n)7,800

(o)4,50038,2502,250

(p) $79,800

(q) 1,200

Totals$294,500$104,600$583,550$113,250 $81,000

Computations:

(a)

Land:

$320,000 / $400,000 $350,000 = $280,000

Garage building:

$ 80,000 / $400,000 $350,000 = $70,000

(o)

Land improvements:$ 45,000 .10 = $4,500

Sales building:

$ 45,000 .85 = $38,250

Garage building:

$ 45,000 .05 = $2,250

_____

*Some accountants would debit this cost to the Land account.

(continued) P 7-58AReq. 2

Journal

DATEACCOUNT TITLES DEBITCREDIT

Dec.31Depreciation Expense Land

Improvements ($104,600 / 20 9/12)... 3,923*


Land Improvements3,923

31Depreciation Expense Sales Building

($583,550 / 50 9/12)... 8,753


Sales Building..8,753

31Depreciation Expense Garage

Building ($113,250 / 50 9/12).. 1,699


Garage Building..1,699

31Depreciation Expense Furniture

($81,000 / 12 9/12)..... 5,063


Furniture5,063

____

*$3,664 ($97,700 / 20 9/12) if $6,900 (l in Req. 1) is debited to Land.


This problem shows how to determine the cost of a plant asset. It also demonstrates the computation of depreciation for a variety of plant assets. Because virtually all businesses use plant assets, a manager needs to understand how those assets costs and depreciation amounts are determined. Depreciation affects net income. Managers need to understand the meaning, components, and computation of net income, because often their performance is measured by how much net income the business earns. This problem covers all these concepts with specific examples.

Student responses will vary.

(15 min.) P 7-59A

Req. 1

Journal

ACCOUNT TITLES DEBIT CREDIT

Equipment...108,000

Cash.108,000

Depreciation Expense Buildings.30,700

Accumulated Depreciation Buildings30,700*

Depreciation Expense Equipment...40,000

Accumulated Depreciation Equipment..40,000**

*($701,000 $87,000) / 20

**[($409,000 $263,000) 2/10 + ($108,000 2/10 6/12)]

Req. 2

BALANCE SHEET

Property, plant, and equipment:

Land$147,000

Buildings $ 701,000

Less: Accumulated Depreciation

($348,000 + $30,700)(378,700)322,300

Equipment ($409,000 + $108,000)$ 517,000


($263,000 + $40,000).................(303,000)

214,000

Total property, plant, and equipment..$683,300

(25-35 min.) P 7-60A

Journal

DATEACCOUNT TITLES DEBIT CREDIT

Jan. 4Equipment (new)

178,000


Equipment 61,000

Equipment (old)...134,000

Cash ($178,000 $77,000).

101,000

Gain on Trade-in of Equipment

4,000

[$77,000 - ($134,000 - $61,000)]

June29Depreciation Expense Building. 5,375


Building..5,375

[($650,000 $220,000) / 40 6/12]

29Cash

110,000

Note Receivable

394,625


Building ($140,000 + $5,375)

145,375

Building

650,000

Oct.30Land* 144,000

Building**

216,000

Cash

360,000

*[$160,800 / ($160,800 + $241,200) $360,000]

**[$241,200 / ($160,800 + $241,200) $360,000]

(continued) P 7-60A

Journal


Dec. 31Depreciation Expense

Equipment ($178,000 2/8)

44,500


Equipment

44,500

31Depreciation Expense Buildings

630


Buildings

630

[$216,000 (30% $216,000)] / 40 2/12

(30-40 min.) P 7-61A

Req. 1

Straight-Line Depreciation Schedule

Depreciation for the Year

DATEASSET

COSTDEPRECIATION

RATE (DEPRECIABLE

COST =DEPRECIATION

EXPENSEACCUMULATED

DEPRECIATIONASSET BOOK

VALUE

1-07-2012$277,000$277,000

12-31-20121/5$252,000$50,400$ 50,400 226,600

12-31-20131/5 252,000 50,400 100,800 176,200

12-31-20141/5 252,000 50,400 151,200 125,800

12-31-20151/5 252,000 50,400 201,600 75,400

12-31-20161/5 252,000 50,400 252,000 25,000

Asset cost: $240,000 + $1,400 + $6,500 + $29,100 = $277,000

Depreciation for each year: ($277,000 $25,000) / 5 years = $50,400 (continued) P 7-61A

Req. 1

Units-of-Production Depreciation Schedule


DATEASSET

COSTDEPRECIATION

PER DOCUMENT (NUMBER OF

DOCUMENTS =DEPRECIATION

EXPENSEACCUMULATED


VALUE

1-07-2012$277,000$277,000

12-31-2012$1.12 50,000$56,000$ 56,000 221,000

12-31-2013 1.12 47,500 53,200 109,200 167,800

12-31-2014 1.12 45,000 50,400 159,600 117,400

12-31-2015 1.12 42,500 47,600 207,200 69,800

12-31-2016 1.12 40,000 44,800 252,000 25,000

Total documents225,000

Depreciation per document: ($277,000 $25,000) / 225,000 documents = $1.12 per document(continued) P 7-61A

Req. 1

Double-Declining-Balance Depreciation Schedule


DATEASSET

COST DDB RATE (ASSET BOOK

VALUE =DEPRECIATION

EXPENSEACCUMULATED


VALUE

1-07-2012 $277,000$277,000

12-31-2012.40*$277,000$110,800$ 110,800 166,200

12-31-2013.40 166,200 66,480 177,280 99,720

12-31-2014.40 99,720 39,888 217,168 59,832

12-31-2015.40 59,832 23,933 241,101 35,899

12-31-2016 35,899 10,899** 252,000 25,000

* DDB rate: (1/5 years 2) = 2/5 = .40

** Depreciation for 2016: $35,899 - $25,000 = $10,899(continued) P 7-61A

Req. 2

The depreciation method that maximizes reported income in the first year of the computers life is the straight-line method, which produces the lowest depreciation for that year ($50,400). The method that maximizes cash flow by minimizing income tax payments in the first year is the double-declining-balance method (or MACRS depreciation when used for tax purposes) which produces the highest depreciation amount for that year ($110,800).

Req. 3 DEPRECIATION METHOD THAT IN THE EARLY YEARS

MAXIMIZES

REPORTED

INCOMEMINIMIZES

INCOME TAX

PAYMENTS

Net income for first year:SLDDB

Cash provided by operations

before income tax$158,000$158,000

Depreciation expense 50,400 110,800

Income before income tax 107,600 47,200

Income tax expense (32%) 34,432 15,104

$ 73,168$ 32,096

Net income advantage of SL over DDB $41,072

Cash flow analysis for first year:

Cash provided by operations before

income tax$158,000$158,000

Income tax expense 34,432 15,104


(cash flow)$123,568$142,896

Cash flow advantage of DDB over SL

$19,328

(20-25 min.) P 7-62A

Req. 1

Millions

Cost of plant assets... $4,831

Less: Accumulated depreciation (2,124)

Book value, net $2,707

Req. 2

Evidences of the purchase of plant assets and goodwill:

1.Property, plant, and equipment increased on the balance sheet.2.Goodwill increased on the balance sheet.3.Statement of cash flows reports Additions to property, plant, and equipment.

Req. 3Property, Plant, and EquipmentAccumulated Depreciation

2/28/11 Bal.4,197Cost ofAccum. depr. 2/28/11 Bal.1,729

Purchased assets sold of assets soldDepr. during

during 2012713 in 201279 in 201265 2012460

2/29/12 Bal.4,8312/29/12 Bal.2,124

Goodwill

2/28/11 Bal.512

Purchased

during 2012 43*

2/29/12 Bal.555

_____

*Determined by deduction, since there was no loss on goodwill.

Req. 4

Feb.29Loss on Impairment ($555 - $450)105

Goodwill105

(20-30 min.) P 7-63A

Req. 1

Journal


Iron Ore..2,400,000

Cash..2,400,000

Iron Ore..63,000

Cash..63,000

Iron Ore..73,000

Cash..73,000

Iron Ore....................34,100

Note Payable...34,100

Iron Ore Inventory...428,350*

Iron Ore 428,350

Accounts Receivable (25,000 $33)..825,000

Sales Revenue825,000

Cost of Iron Ore Sold (25,000 x $13.18).329,500

Iron Ore Inventory.329,500

Operating Expenses...246,000

Cash..246,000

Income Tax Expense (see Req. 2)..69,860

Income Tax Payable.69,860

*$2,400,000 + $63,000 +$73,000 + $34,100 = $2,570,100; $2,570,100 / 195,000 = $13.18 x 32,500


Mid Atlantic Energy Company

Income Statement Iron Ore Operations

Year 1

Sales revenue.$825,000

Cost of iron ore sold....$329,500

Other operating expenses.. 246,000 575,500

Income before tax............249,500

Income tax expense (28%).. 69,860

Net income..$ 179,640

The iron ore operations were profitable. Net income of $179,640 on sales of $825,000 is quite high (21.8% of sales).Req. 3

Iron ore inventory ($428,350 - $329,500)..$ 98,850

Iron ore ($2,570,100 - $428,350)..$2,141,750

(30-40 min.) P 7-64AReq. 1

To determine the gain or loss on the sale of a plant asset, compare the cash received to the assets book value, as follows:

Billions

Cash received from sale of asset.$ 0.8

Book value of asset sold:

Cost.$ 1.6

Less: Accumulated depreciation. (1.0) ( 0.6 )

Gain (Loss) on sale..$ 0.2

Req. 2

Balance sheet at December 31, 2012:

Property, plant, and equipment ($4.9 + $1.3 $1.6)$ 4.6

Less: Accumulated depreciation ($2.6 + $1.8 $1.0). (3.4)

Property, plant, and equipment, net (book value)...$ 1.2

Req. 3

Statement of cash flows for 2012:

Cash flows from operating activities:

Net income ($26.6 $21.7)..$ 4.9

Reconciliation of net income to

net cash provided by operations:

Depreciation 1.8


Purchases of property, plant, and equipment (1.3)

Sales of property, plant, and equipment 0.8

(20-30 min.) P 7-65AReq. 1

Jan. 29, 2011

Jan. 30, 2010

Net income$ 2,920 $ 2,488

Net revenue $67,390 $65,357

= Profit margin = 4.33%= 3.81%

Req. 2

Jan. 29, 2011

Jan. 30, 2010

Sales (net revenue)$67,390 $65,357

Average total assets $44,119 $44,320

= Asset turnover = 1.53 = 1.47

Req. 3

Jan. 29, 2011

Jan. 30, 2010

Net income$ 2,920 $ 2,488


= Return on assets6.62%5.61%

Req. 4

All of the following contributed to the increase in ROA during the most recent year: Sales increased, increasing net income, profit margin, and asset turnover. Expenses decreased, increasing net income and profit margin.

Assets decreased, increasing the asset turnover.

(20-30 min.) P 7-66B

Req. 1

ITEMLANDLAND

IMPROVEMENTSSALES

BUILDINGGARAGEFURNITURE

(a)$297,000 $ 63,000

(b)8,000

(c) $ 31,300

(d)600

(e)5,200

(f)1,700

(g)$ 200

(h)19,400

(i)512,000

(j) 41,500

(k)9,700

(l)6,100*

(m)52,300

(n)7,200

(o)4,20034,860 2,940

(p) $79,000

(q) 1,400

Totals$310,800$102,800$576,160 $107,440 $80,400

Computations:

(a)

Land: $330,000 / $400,000 $360,000 = $297,000

Garage: $70,000 / $400,000 $360,000 = $63,000

(o)

Land improvements: $42,000 .10 = $4,200

Sales building: $42,000 .83 = $34,860

Garage: $42,000 .07 = $2,940

_____

*Some accountants would debit this cost to the Land account.

(continued) P 7-66BReq. 2

Journal


Dec.31Depreciation Expense Land

Improvements ($102,800 / 25 6/12)... 2,056*


Land Improvements2,056

31Depreciation Expense Sales

Building ($576,160 / 40 6/12).. 7,202


Sales Building

7,202

31Depreciation Expense Garage

($107,440 / 40 6/12) 1,343


Garage1,343

31Depreciation Expense Furniture

($80,400 / 10 6/12)..4,020


Furniture.4,020

_____

*$1,934 ($96,700 / 25 6/12) if $6,100 (l in Req. 1) is debited to Land.


This problem shows how to determine the cost of a plant asset. It also demonstrates the computation of depreciation for a variety of plant assets. Because virtually all businesses use plant assets, a manager needs to understand how those assets costs and depreciation are determined. Depreciation affects net income. Managers need to understand the meaning, components, and computation of net income because often their performance is measured by how much net income the business earns. This problem covers all these concepts with specific examples.


(15 min.) P7-67BReq. 1

Journal


Equipment...100,000

Cash.100,000

Depreciation Expense Buildings.30,850*

Accumulated Depreciation Buildings30,850

Depreciation Expense Equipment38,800**

Accumulated Depreciation Equipment..38,800

*($702,000 $85,000) / 20 = $30,850]

**[($408,000 $264,000) 2/10] + ($100,000 2/10 6/12) = $38,800]

Req. 2

BALANCE SHEET

Property, plant, and equipment:

Land

$ 143,000

Buildings

$702,000


($344,000 + $30,850)

(374,850)327,150

Equipment ($408,000 + $100,000)

$508,000


($264,000 + $38,800)

(302,800)

205,200

Total property, plant, and equipment

$675,350

(25-35 min.) P 7-68BJournal


Jan. 3Equipment (new)

178,000


Equipment

68,000

Equipment (old)..131,000

Cash...

105,000

Gain on Trade-in of Equipment...10,000

June30Depreciation Expense Building

[($640,000 $240,000) / 40 x 6/12]

5,000


Building

5,000

June30Cash

120,000

Note Receivable

415,000


Building ($100,000 + $5,000)

105,000

Building

640,000

Oct. 31Land ($70,200 / $351,000 $320,000)..64,000

Building ($280,800 / $351,000 $320,000)256,000

Cash

320,000

Dec.31Depreciation Expense

Equipment ($178,000 2/4)

89,000


Equipment

89,000

Dec. 31Depreciation Expense Building

[($256,000 - $25,600) / 40 X 2/12]

960


Building

960

(30-40 min.) P 7-69BReq. 1

Straight-Line Depreciation Schedule


DATEASSET

COSTDEPRECIATION

RATE DEPRECIABLE

COST =DEPRECIATION

EXPENSEACCUMULATED


VALUE

1-04-2012$279,500$279,500

12-31-20121/5$255,000$51,000$ 51,000 228,500

12-31-20131/5 255,000 51,000 102,000 177,500

12-31-20141/5 255,000 51,000 153,000 126,500

12-31-20151/5 255,000 51,000 204,000 75,500

12-31-20161/5 255,000 51,000 255,000 24,500

Asset cost: $235,000 + $1,100 + $6,200 + $37,200 = $279,500Depreciation for each year: ($279,500 $24,500) / 5 years = $51,000


Units-of-Production Depreciation Schedule


DATEASSET

COSTDEPRECIATION

DOCUMENT NUMBER OF

DOCUMENTSDEPRECIATION

EXPENSEACCUMULATED


VALUE

1-04-2012$279,500$279,500

12-31-2012 $1.70 35,000$59,500$ 59,500 220,000

12-31-20131.70 32,500 55,250 114,750 164,750

12-31-20141.70 30,000 51,000 165,750 113,750

12-31-20151.70 27,500 46,750 212,500 67,000

12-31-20161.70 25,000 42,500 255,000 24,500

Total documents150,000

Depreciation per document: ($279,500 $24,500) / 150,000 documents = $1.70


Double-Declining-Balance Depreciation Schedule


DATEASSET

COST DDB RATE ASSET BOOK

VALUE =DEPRECIATION

EXPENSEACCUMULATED


VALUE

1-04-2012$279,500$279,500

12-31-2012 .40* $279,500$111,800$111,800 167,700

12-31-2013 .40 167,700 67,080 178,880 100,620

12-31-2014 .40 100,620 40,248 219,128 60,372

12-31-2015 .40 60,372 24,149 243,277 36,223

12-31-2016 36,223 11,723** 255,000 24,500

*DDB rate = (1/5 years 2) = 2/5 = .40

**Depreciation for 2016: $36,223 $24,500 = $11,723

(continued) P 7-69B

Req. 2The depreciation method that maximizes reported income in the first year of the computers life is the straight-line method. Straight-line produces the lowest depreciation for that year ($51,000).

The method that maximizes cash flow by minimizing income tax payments in the first year is the double-declining-balance method (or MACRS depreciation when used for tax purposes), which produces the highest depreciation amount for that year ($111,800).

Req. 3

DEPRECIATION METHOD THAT IN THE EARLY YEARS

MAXIMIZES

REPORTED

INCOMEMINIMIZES

INCOME TAX

PAYMENTS

Net income for first year:SLDDB

Cash provided by operations before income tax$154,000

$154,000

Depreciation expense 51,000 111,800

Income before income tax 103,000 42,200

Income tax expense (40%) 41,200 16,880

Net income$ 61,800$ 25,320

Net income advantage of SL over DDB

$ 36,480

Cash flow analysis for first year:

Cash provided by operations before

income tax$154,000$154,000

Income tax expense 41,200 16,880


(called cash flow)$ 112,800$ 137,120

Cash flow advantage of DDB over SL$24,320

(20-25 min.) P 7-70B

Req. 1

Millions

Cost of plant assets..$ 4,838

Less: Accumulated depreciation.. (2,124)

Book value of plant assets.$ 2,714

Req. 2

Evidences of the purchase of plant assets and goodwill:1.Property, plant, and equipment increased on the balance sheet.2.Goodwill increased on the balance sheet.3.Statement of cash flows reports Additions to property, plant and equipment.

Req. 3

Property, Plant, and EquipmentAccumulated Depreciation

2/28/11 Bal.4,192Cost ofAccum. depr. 2/28/11Bal.1,729

Purchased assets sold of assets soldDepr. during

during 2012723 in 201277 in 201266 2012461

2/29/12 Bal.4,8382/29/12 Bal.2,124

Goodwill

2/28/11 Bal.510

Purchased

during 2012 47*

2/29/12 Bal.557

_____

*Determined by deduction, since there was no loss on goodwill.

Req. 4

Feb. 29Loss on Impairment

107

Goodwill ($557 - $450)

107

(20-30 min.) P 7-71B

Req. 1

Journal


Iron Ore .....2,800,000

Cash..2,800,000

Iron Ore .67,000

Cash..67,000

Iron Ore .....76,500

Cash..76,500

Iron Ore .....38,550

Note Payable...38,550

Iron Ore Inventory...478,515*

Iron Ore 478,515

Accounts Receivable (25,000 $37)..925,000

Sales Revenue925,000

Cost of Iron Ore Sold (25,000 x $13.87).346,750

Iron Ore Inventory..346,750

Operating Expenses...254,000

Cash..254,000

Income Tax Expense (see Req. 2)..113,488

Income Tax Payable..113,488

*$2,800,000 + $67,000 + $76,500 +$38,550 = $2,982,050; $2,982,050 / 215,000 = $13.87 x 34,500


Central Energy Company

Income Statement Iron Ore Mine Project

Year 1

Sales revenue..$925,000

Cost of iron ore sold..$346,750

Operating expenses... 254,000 600,750

Income before tax...324,250

Income tax expense (35%) 113,488

Net income$ 210,762

The Iron Ore Mine project was very profitable. Net income of $210,762 on sales of $925,000 (23%) is outstanding.

Req. 3

Iron ore inventory ($478,515 - $346,750)..$ 131,765

Iron ore ($2,982,050 - $478,515)..$ 2,503,535

(30-40 min.) P 7-72BReq. 1

To determine the gain or loss on the sale of a plant asset, compare the cash received to the assets book value, as follows:

Billions

Cash received from sale of asset.$ 0.6

Book value of asset sold:

Cost

$0.9

Less: Accumulated depreciation

(0.8)( 0.1)

Gain (Loss) on sale

$0.5

Req. 2

Balance sheet at December 31, 2012:

Property, plant, and equipment ($4.8 + $2.0 $0.9)

$ 5.9

Less: Accumulated depreciation ($2.8 + $1.3 $0.8)

(3.3)

Property, plant, and equipment, net (book value)

$ 2.6

Req. 3

Statement of cash flows for 2012:

Cash flows from operating activities:

Net income ($26.2 $22.0) $4.2

Reconciliation of net income to

net cash provided by operations:

Depreciation1.3


Purchases of property, plant, and equipment.. $(2.0)

Sales of property, plant, and equipment. 0.6

(20-30 min.) P 7-73B

Req. 1

Jan. 31, 2011

Jan. 31, 2010

Net income $ 1,114$ 991

Net revenue $18,391 $17,178

= Profit margin = 6.06%= 5.77%

Req. 2

Jan. 31, 2011

Jan. 31, 2010Sales$18,391 $17,178


= Asset turnover = 1.38 = 1.40

Req. 3

Jan. 31, 2011

Jan. 31, 2010

Net income $ 1,114$ 991


= Return on assets = 8.34% = 8.08%

Req. 4

The following contributed to the increase in ROA during the most recent year.

Sales increased, increasing net income and profit margin. Assets increased, decreasing the asset turnover.

Challenge Exercises and Problem (10-15 min.) E 7-74

Req. 1

(in millions)Current Assets..5,288

Assets of Discontinued Operations.2,264

Property and Equipment 6,579

Goodwill..8,946

Intangible Assets..679

Other Assets..31

Liabilities...12,038

Cash and Common Stock.11,749

Req. 2

Loss from Impairment.5,382

Goodwill....5,382

(15-20 min.) E 7-75Millions

Net income under straight-line depreciation.$64

Difference in depreciation for 2013 (year 2 of 8):

Straight line depreciation, as reported...$30

DDB depreciation for year 2 (see below) 45

Increase in depreciation expense.... 15

Decrease in net income...(15)

Net income Kerusi can expect for 2013

if the company uses DDB depreciation..$49

DDB depreciation by year:Millions

Year

1 $240 2/8.. $60

2($240 $60) 2/8............. 45

(15-25 min.) E 7-76

Year

1234

Millions of Euros ()

1.Total current assetsNo effect

2.Equipment, net15.0 U*10.0 U**5.0 UCorrect

3.Net income15.0 U*5.0 O 5.0 O5.0 O

_____

U = Understated

O = Overstated

*Cost (20.0 million) Depreciation expense (5 million)

= 15 million

**Cost (20.0 million) Two years depreciation (10.0 million)

= 10.0 million

(20-30 min.) P 7-77

Req.1

Property and Equipment

Bal 5/31/2008 (BS)29,305

Capital expenditures (SCF)2,459 202Impairment (note)

2,302Original cost of plant and equipment sold (plug)

Bal.5/31/2009 (BS)29,260


Acc. Depr. on assets sold1,784 (plug)15,827Bal. 5/31/2008 (BS)

1,800Depr. exp.(note)

15,843Bal 5/31/2009 (BS)

Req. 2Journal



2,459

Cash

2,459

Depreciation Expense

1,800


1,800

Loss on Impairment of Assets

202


202

Cash (SCF)

79


1,784

Loss on Sale of Assets

439


2,302

Decision Cases

(30-45 min.) Decision Case 1

Req. 1

La Petite France Bakery and Burgers Ahoy!

Income Statements

For the Year Ended December 31

ACCOUNT TITLELa Petite France

(FIFO and SL)Burgers Ahoy!

(LIFO and DDB)

Sales revenue$350,000 $350,000

Cost of goods sold.. 128,000* 149,000*

Gross margin.......222,000 201,000

Operating expenses.......$50,000$50,000

Depreciation expense

La Petite (SL):

[($150,000 $20,000) / 10]. 13,000

Burgers (DDB):

($150,000 1/10 2)... 30,000

Total expenses.. 63,000 80,000

Income before tax.......159,000 121,000

Income tax expense (40%). 63,600 48,400

Net income.$ 95,400 $ 72,600

(continued) Decision Case 1

Req. 1

*Cost of goods sold: Units Cost

La Petite (FIFO):10,000$4=$ 40,000

5,000 5=25,000

7,000 6=42,000

3,000 7= 21,000

25,000$128,000

Burgers (LIFO):10,000$7=$ 70,000

7,000 6=42,000

5,000 5=25,000

3,000 4= 12,000

25,000$149,000

(continued) Decision Case 1

Req. 2

INVESTMENT NEWSLETTER

TO:

Our Clients

FROM:

Student Name

RE:

Selecting the stock of La Petite France Bakery or Burgers Ahoy! as a long-term investment

In picking a stock we suggest you consider the following factors:

La Petite France and Burgers Ahoy! are basically identical companies. The two companies started operations at the same time and engaged in essentially the same transactions. Their main difference lies in the accounting methods that they use.

1.La Petite Frances income statement reports a net income of $95,400 compared to $72,600 for Burgers Ahoy!. On the surface La Petite France appears to be more profitable. This difference is illusory, however, because La Petite uses the FIFO method to account for inventories and the straight-line method to account for depreciation of its plant assets. If prices continue to rise, use of these methods result in the highest possible reported income. However, this may not result in a higher price for La Petite Frances stock.

2.Burgers Ahoy! reports a lower net income than La Petite France, but Burgers has more cash to invest in promising projects because Burgers pays less in income taxes. Burgers uses the LIFO method for inventories and the double-declining-balance method for depreciation. These methods result in lower net incomes. More (continued) Decision Case 1

importantly, LIFO and DDB result in the lowest amount of income tax and thereby save money that Burgers can invest in new projects.

3.Over the long run we favor Burgers Ahoy! because Burgers will have more cash to invest. That should result in higher real profits even if those profits dont show up on the income statement immediately.


(20-30 min.) Decision Case 21.A dishonest manager might debit the cost of an expense to a plant asset account in order to overstate reported asset and income amounts. Remember the WorldCom case discussed in the chapter.

2.A dishonest manager might debit an expense account for the cost of a plant asset for two reasons: (1) To obtain a quicker tax deduction for the expense than for depreciation expense over the life of the asset, and (2) To understate reported asset and income amounts.

3.We support the recording and reporting of intangible assets at cost, less accumulated amortization, in accordance with GAAP because the business paid a price for intangibles like any other asset. The argument for recording intangibles at $1 or $0 is consistent with the perspective of a lender, who might reason that, in the liquidation of a business, most of its intangibles are worthless. However, accounting serves other users besides lenders. Also, someone who evaluates a company and believes its intangibles are worthless can simply subtract the intangibles cost from total assets and from total owners equity to compute revised totals for analytical purposes. But the reverse is not true. If intangibles were not reported on the balance sheet, a user of the statements who believes the intangibles have value could not add the unknown amount to compute revised total assets and total owner equity.


Ethical Issue

Req. 1

The ethical issue in this case is What is the proper amount of the purchase price to allocate to the land and the proper amount to allocate to the building? The taxpayer wants to allocate as much of the purchase price as possible to the building because tax laws allow a deduction from taxable income for depreciation expense on plant assets other than land. The greater the allocation to the building, the greater the depreciation deduction, and therefore the lower the tax payments because there is no tax deduction on the land. The cost of the land is not depreciated.

Req. 2 and Req. 3

The stakeholders in this situation include United Jersey Bank, their management, their shareholders, the Internal Revenue Service, and taxpayers in general. The immediate economic consequences of the decision are positive for United Jersey Bank as well as their management. However, those consequences, as well as legal consequences, could ultimately turn negative for them if an IRS audit finds them to be unlawfully evading taxes. United Jersey Banks allocation was unethical. The nations taxpayers you and I are robbed of fair and equitable treatment by this dishonest tactic.

Req. 4

United Jersey Bank should change the allocation of their purchase price to 60% building and 40% land. In the long run, for fair and equitable treatment for all taxpayers, as well as the best economic and legal outcome, there is nothing like the truth.

Focus on Financials: Amazon.com, Inc.

(30-40 min.)

Req. 1

Fixed assets include furniture and fixtures, heavy equipment, technology, infrastructure, internal-use software and website development.

Req. 2

Note 1 states that the depreciation method used for the financial statements is the straight-line method. Note 1 does not state the method used for income-tax purposes, but Amazon.com most likely uses the Modified Accelerated Cost Recovery System (MACRS).

This method is preferable for income-tax purposes because it provides the most depreciation expense as quickly as possible. This decreases immediate tax payments and saves cash for use in the business.

Req. 3

Millions

Depreciation and amortization expense $ 552

Accumulated depreciation and amortization.. $ 842

Accumulated depreciation and amortization exceeds depreciation and amortization expense because the expense is for only the current year. Accumulated depreciation and amortization is the sum of the depreciation and amortization amounts for all years the company has used its property and equipment.

Req. 4

During 2010, Amazon.com, Inc. paid $979 million to purchase fixed assets, including internal-use software and website development. These expenditures increased significantly from $373 million in 2009. This is good news. The company increased its investment in these types of assets by about 162% in 2010, indicating that they were expanding their operations.

Req. 5

Amazon.com, Inc. reports goodwill of $1,349 million on its 2010 balance sheet, and acquired intangible assets, included within Other Assets on the balance sheet, of $745 million. As explained in Notes 1 and 4 to the Consolidated Financial Statements, the company does not amortize goodwill and other indefinite-lived assets. It evaluates the remaining useful lives of assets that are not being amortized to determine whether circumstances continue to support an indefinite life. Amazon.com, Inc. performs an annual impairment test for goodwill and writes goodwill off when its value is impaired.

Amazon.com, Inc. amortizes the cost of the other intangibles over their estimated useful lives.

Focus on Analysis: RadioShack, Corp.

(20-30 min.)

Req. 1

RadioShack Corporation paid $80.1 million for capital expenditures during fiscal 2010. This information is found in the investing activities section of the cash flows statement.

Req. 2

Property and equipment are recorded at cost less accumulated depreciation and amortization. Major additions and betterments that substantially extend the useful life of an asset are capitalized and depreciated. Expenditures for normal maintenance and repairs are charged directly to expense as incurred.

Req. 3Depreciation and amortization are calculated using the straight-line method over the following useful lives: 10-40 years for buildings; 2-15 years for furniture, fixtures, equipment and software; leasehold improvements are amortized over the shorter of the terms of the underlying leases, including certain renewal periods, or the estimated useful lives of the improvements.

Req. 4Gross property, plant and equipment (from Note 3) at the end of fiscal 2010 was $1,094.4 million. It was $1,081.7 million at the end of fiscal 2009. Accumulated depreciation and amortization (from Note 3) was $820.1 million at the end of fiscal 2010 and $799.4 million at the end of (continued) RadioShack, Corp.

fiscal 2009. Accordingly, the book value of property, plant, and equipment (net assets) was $274.3 million at the end of fiscal 2010 and $282.3 million at the end of fiscal 2009. Gross PPE increased slightly during 2010 but net PPE still declined slightly during 2010. This change indicates that the major cause for the change in property, plant, and equipment was an additional year depreciation recorded because the assets were used an additional year.Req. 520102009

Net income$ 206.1$ 205.0

Average total assets(2,175.4 +$2,429.3) / 2$2,429.3 + $2,254.0 / 2

= Return on assets=8.95%== 8.75%

Radio Shacks performance was slightly better in 2010 than in 2009. Return on Assets is slightly higher in 2010 than in 2009.

Group Projects


2 Financial Accounting 8/e Solutions Manual

1 Chapter 7 Plant Assets & Intangibles

Ch07 SM 9e

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Transcript of Ch07 SM 9e