Chapter 8: Long-Term Assets
Discussion Questions: Key Points
1. Capitalization means that an asset has been debited. The key criterion is whether the expenditure provides a future economic benefit. If so the expenditure should be capitalized. If the benefit is used up before the end of the accounting period, it is expensed.
2. The cost of demolishing the old building would be debited to the land account. This is a cost of making the land ready for use. The company did not purchase the building for any purpose other than to acquire that piece of land.
3. A lump-sum purchase is one in which two or more plant assets are acquired for one purchase price. Allocation of the lump-sum purchase price will take place according to the proportion each individual’s assets fair value represents of the entire groups.
4. Depreciation is the process of allocating the cost of an asset to the future periods in which the asset will help generate revenues for the business. It is used to help companies match the expenses of ownership of an asset with the revenues that the asset helps to produce.
5. Useful life and physical life are not necessarily the same, although they can be. A company may have a policy of disposing of assets well before their productive capacity is used up. Students may know of people who drive a car for three years and then trade it in for a new one. The useful life in this situation is three years because it is the best estimate of how long the car will be used. The physical life is much longer than that, however, as the car will most likely be sold in the used car market.
6. A company should select the depreciation method that most closely matches its expected use of the asset as doing so would help to provide more accurate and reliable financial statements.
a. Units-of-production matches best here, as the use of the machine will vary widely depending on how much it is needed during the year.
b. Double-declining balance makes the most sense in this situation, as the costs of maintenance will be higher in later years. Most of the value of the machine is associated with the early years of its physical life.
c. Straight-line matches the expected costs most closely with the revenues that the machine helps to generate.
7. An extraordinary repair is not expected to recur during the life of the asset and helps the asset to become more productive for the business. An ordinary repair would be done to return the asset to its functionality before the break-down. An extraordinary repair requires capitalization of the cost of the repair while an ordinary repair is expensed. Capitalized repairs would affect the income statement slowly over time.
8. Book value is the cost of the asset minus the accumulated depreciation to date associated with that asset. A gain or loss is the market value of the asset minus the book value of the asset.
9. A $500 gain would be recognized on the sale. (book value = $4,000; market value = $4,500 )
10. Depreciation, amortization, and depletion are all methods of allocating the cost of an asset to the accounting periods over which the asset helps a company recognize revenue. They all involve estimation of the useful lives of the assets involved and spreading the cost of the assets over the useful life (although impairment of goodwill, an intangible asset, is the exception to this rule).
a. Amortization
b. Depletion
Short Exercises
(5-10 min.) S 8-1
I 1. Franchises
P 2. Vehicles
P 3. Buildings
P 4. Furniture
I 5. Patents
I 6. Copyrights
I 7. Trademarks
P 8. Land improvements
(5-10 min.) S 8-2
A 1. Franchises
NA 2. Land
DR 3. Buildings
DR 4. Furniture
A 5. Patents
A 6. Copyrights
A 7. Trademarks
DR 8. Land improvements
DL 9. Gold ore deposits
(5-10 min.) S 8-3
L 1. Survey fees
LI 2. Fencing
LI 3. Lighting
L 4. Clearing land
LI 5. Parking lot
(5-10 min.) S 8-4
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Land / 60,000
Building / 48,000
Equipment / 12,000
Notes Payable / 120,000
Record purchase of land, a building, and equipment.
Computations:
Asset / MarketValue /
Percentage of Total Market Value
/ / / /Total Purchase Price
/ /Cost of Each Asset
Land / $ 80,000 / $80,000 / $160,000 / = / 50% / X / $120,000 / = / $ 60,000Building / 64,000 / $64,000 / $160,000 / = / 40% / X / $120,000 / = / 48,000
Equipment / 16,000 / $16,000 / $160,000 / = / 10% / X / $120,000 / = / 12,000
Total / $160,000 / 100% / $120,000
(5-10 min.) S 8-5
Req 1.
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Incorrect entry:
Airplane / 600,000
Cash / 600,000
Correct entry:
Repair Expense / 600,000
Cash / 600,000
Req 2.
Net income would be overstated by $600,000, because the $600,000 was not included as an expense.
(10-15 min.) S 8-6
· Depreciation is the process of allocating a plant asset’s cost to expense over its useful life. The primary purpose of depreciation is to match the period’s expenses against its revenues in order to measure net income.
· Lake is correct that depreciation can relate to the wear and tear of an asset. However, the depreciation of some assets is more affected by obsolescence than by physical wear and tear.
· Coe is wrong. Depreciation has nothing to do with a cash fund to replace an asset.
(10-15 min.) S 8-7
First-year depreciation:a. / Straight-line: ($45,000,000 – $5,000,000) / 5 years / = $ 8,000,000
b. / Units-of-production: [($45,000,000 – $5,000,000) /
3,000,000 miles] ´ 750,000 miles / = $ 10,000,000
c. / Double-declining-balance: (1/ 5 years) ´ 2 = 40%; 40% x $45,000,000 / = $18,000,000
Book value, under straight-line method:
Cost / $45,000,000
Less: Accumulated depreciation / (8,000,000)
Book value / $37,000,000
(10-15 min.) S 8-8
Second-year depreciation:
a. Straight-line: ($45,000,000 – $5,000,000) / 5 years = $8,000,000
b. Units-of-production: [($45,000,000 – $5,000,000) /3,000,000 miles] ´ 1,500,000 miles = $20,000,000
c. Double-declining-balance:
Year 1: 40% x $45,000,000= $18,000,000
Year 2: 40% x ($45,000,000 – $18,000,000) = $10,800,000
(5-10 min.) S 8-9
First-year depreciation (for a partial year):Straight-line: ($45,000,000 – $5,000,000) / 5 years ´ 9/12 = $6,000,000
(5-10 min.) S 8-10
DATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Depreciation Expense, Hot Dog Stand / 10,000
Accumulated Depreciation,
/ /Hot Dog Stand
/ / / 10,000Record depreciation on hot dog stand.
/ /Computations:
Straight-line for years 1-4: $40,000 / 8 years = $5,000 per year
$5,000 ´ 4 years = $20,000 for years 1- 4
Revised Straight-line: ($40,000 - $20,000)/2 years = $10,000 per year
(10-15 min.) S 8-11
CAP a. Purchase price
REV b. Ordinary recurring repairs
CAP c. Lubrication before machine is placed in service
REV d. Periodic lubrication
CAP e. Major overhaul
CAP f. Sales tax
CAP g. Transportation and insurance
CAP h. Installation
CAP i. Training of personnel
(5-10 min.) S 8-12
DATE / ACCOUNTS / POST
REF. / Dr. / Cr.
2010
Dec. / 31 / Cash / 28,000Accumulated Depreciation, Truck / 16,000
Truck / 41,000
Gain on Sale of Truck / 3,000
Record the sale of the truck.
Computations:
Sale price of assets $28,000
Book value:
Truck $41,000
Less: Accumulated depreciation (16,000)
25,000
Gain on sale $3,000
(15-20 min.) S 8-13
Purchase price paid for The Dandy Dime
/ $700,000Market value of The Dandy Dime’s assets / $800,000
Less: The Dandy Dime’s liabilities / (600,000)
Market value of The Dandy Dime’s net assets
/ 200,000Goodwill
/ $500,000Journal
DATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Assets / 800,000
Goodwill / 500,000
Liabilities
/ 600,000Cash / 700,000
Record purchase of The Dandy Dime.
(5-10 min.) S 8-14
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Apr / 1 / Patent / 500,000
Cash / 500,000
Record purchase of patent.
Dec / 31 / Amortization Expense / 75,000Patent / 75,000
Record amortization expense
Computations:
$500,000/5 = $100,000 x 9/12 = $75,000
(5-10 min.) S 8-15
Depletion expense per barrel of oil = $18,000,000/2,400,000 = $7.50
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
2011
Dec. / 31 / Depletion Expense, Oil and Gas (800,000 x $7.50) / 6,000,000
Accumulated Depletion, Oil
and Gas / 6,000,000
Record depletion.
(5-10 min.) S 8-16
<L1<ITEM<P>__H_ 1. A bond that management plans on owning until it is repaid. Management does not believe it will need to sell the bond to generate cash before the bond’s scheduled maturity date.</P</ITEM>
<ITEM<P>__N_ 2. Land that management is holding as an investment.</P</ITEM>
<ITEM<P>__T_ 3. Intel stock that company management plans on selling quickly, as soon as its price is 10% more than what the company paid at the time it purchased the stock.</P</ITEM>
<ITEM<P>__A_ 4. Ford Motor Company stock. Management does not actively manage this stock and intends to sell it only if they need to generate cash.</P</ITEM>
<ITEM<P>__A_ 5. A bond that management plans on owning until it is repaid. However, management believes it may have to sell the bond within the year in order to provide enough cash for operations.</P</ITEM>
<ITEM<P>__N_ 6. Inventory that management intends to sell within the year.
(5-10 min.) S 8-17
2 / BS / $1,000
3 / IS / $20
4 / BS, SE / $110, $20
5 / BS, IS / $110, $20
6 / IS / $75
Short Exercises
(10-15 min.) E 8-18A
Req 1
Cost of land: $80,000 + $120,000 + $2,100 + $2,500 + $10,400 = $215,000
Cost of building: $800,000
Cost of land improvements: $51,000 + $15,000 + $6,000 = $72,000
Req 2
Bozeman will depreciate the building and the land improvements.
(10-15 min.) E 8-19A
Req. 1
Cost of building in 2011:Construction cost / $900,000
Architect fees and building permits / 72,000
Total / $972,000
Req. 2
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
2011 / Building / 900,000
Cash / 900,000
Incurred construction cost.
Building / 72,000
Cash / 72,000
Paid architect fees and building permit fees.
(10-15 min.) E 8-20A
JournalDATE / ACCOUNTS / POST
REF. / Dr. / Cr.
Tanning Bed 1 / 2,500
Tanning Bed 2 / 4,170
Tanning Bed 3 / 3,330
Cash / 5,000
Notes Payable / 5,000
Record purchase of 3 tanning beds.
Computations:
Tanning Bed / Appraised Value / Percentage of Total Appraised Value / Total Purchase Price / Cost of Each Bed /1 / $ 3,000 / $3,000 / $12,000 / = / .250 / ´ $10,000 / = / $ 2,500 /
2 / 5,000 / $5,000 / $12,000 / = / .417 / x $10,000 / = / 4,170
3 / 4,000 / $4,000 / $12,000 / = / .333 / x $10,000 / = / 3,330
Totals / $12,000 / 1.000 / $10,000
(15-20 min.) E 8-21A
Reqs. 1 and 2
Year / Cost - / Accumulateddepreciation = / Equipment, net* / Net income
1 / $500,000 / $100,000 / $400,000 U / $ 400,000U**
2 / $500,000 / $200,000 / $300,000 U / $ 100,000 O
3 / $500,000 / $300,000 / $200,000 U / $ 100,000 O
4 / $500,000 / $400,000 / $100,000 U / $ 100,000 O
5 / $500,000 / $500,000 / Correct / $ 100,000 O
U = Understated O = Overstated
Computations:
Straight-line: ($500,000)/ 5 years = $100,000 per year.
*Equipment, net represents the net amount that should have appeared on the balance sheet for each year. Since no asset amount was recorded for this purchase, this represents the amount of the understatement.
**$500,000 expense recorded - $100,000 depreciation expense that should have been recorded = $400,000 understatement of net income.
(15-20 min.) E 8-22A
Req 1
DEPRECIATION EXPENSE PER YEAR /Year / Straight-Line / Units-of-Production / Double-Declining-Balance
2010 / $ 6,000 / $ 2,400 / $ 15,000
2011 / 6,000 / 7,200 / 7,500
2012 / 6,000 / 9,600 / 750
2013 / 6,000 / 4,800 / 750
$24,000 / $24,000 / $24,000
Computations:
Straight-line: ($30,000 – $6,000)/ 4 years = $6,000 per year.
Units-of-production: ($30,000 – $6,000)/ 1,000 operations = $24 per operation
Year 1: 100 operations ´ $24 = $2,400
Year 2: 300 operations ´ $24 = $7,200
Year 3: 400 operations ´ $24 = $9,600
Year 4: 200 operations ´ $24 = $4,800
Double-declining-balance: (1/4 years) ´ 2 = 50%
Year 1: 50% x $30,000 = $15,000
Year 2: 50% x ($30,000 – $15,000) = $7,500
Years 3 and 4: ($30,000 – $15,000 – $7,500) = $7,500 – $6,000 residual value = $1,500/ 2 years = $750.
Req 2
The units-of-production method tracks the wear and tear on the equipment 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. This conserves cash in the early years.