CHAPTER REVIEW
Plant Assets
1. (L.O. 1) Plant assets are resources that have a physical substance (a definite size and shape), are used in the operations of a business and are not intended for sale to customers. They are also called property, plant, and equipment; plant and equipment; or fixed assets.
Cost of Plant Assets
2. Plant assets are recorded at cost in accordance with the historical cost principle. Cost consists of all expenditures necessary to (1) acquire the asset, and (2) make it ready for its intended use.
3. The cost of land includes the cash purchase price, closing costs such as title and attorney’s fees, real estate broker’s commission, and accrued property taxes and other liens on the land assumed by the purchaser. All necessary costs incurred in making land ready for its intended use are debited to the Land Account.
4. Land improvements are structural additions made to land, such as driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of land improvements includes all expenditures needed to make the improvements ready for their intended use.
5. The cost of buildings includes all necessary costs related to the purchase or construction of a building:
a. When a building is purchased, such costs include the purchase price, closing costs, and real estate broker’s commission.
b. Costs to make the building ready for its intended use include expenditures for remodeling and replacing or repairing the roof, floors, wiring, and plumbing.
c. When a new building is constructed, cost consists of the contract price plus payments for architects’ fees, building permits, interest payments during construction, and excavation costs.
6. The cost of equipment consists of the cash purchase price, sales taxes, freight charges, and
insurance paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing, and testing the unit. Recurring costs such as licenses and insurance are
expensed as incurred.
Depreciation
7. (L.O. 2) Depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner.
a. The cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the expense recognition principle.
b. During an asset’s life, its usefulness may decline because of wear and tear or obsolescence.
c. Recognition of depreciation does not result in the accumulation of cash for the replacement of the asset.
8. Three factors that affect the computation of depreciation are (1) cost, (2) useful life, and (3) salvage value.
9. Three methods of recognizing depreciation are (a) straight-line, (b) units-of-activity, and (c) declining-balance.
a. Each method is acceptable under generally accepted accounting principles.
b. Management selects the method it believes to be appropriate.
c. Once a method is chosen, it should be applied consistently.
Straight-Line Method
10. Under the straight-line method depreciation is the same for each year of the asset’s useful life.
a. The formula for computing annual depreciation expense is:
Depreciable Cost ÷ Useful Life (in years) = Depreciation Expense
b. To illustrate the computation, assume that the Benson Company purchased a delivery truck for $11,000 on January 1 with an estimated salvage value of $1,000 at the end of its four-year service life. Annual depreciation is $2,500 [($11,000 – $1,000 ÷ 4)].
c. The straight-line method predominates in practice.
d. This method is simple to apply and it matches expenses and revenues appropriately when the use of the asset is reasonably uniform throughout the service life.
Units-of-Activity Method
11. Under the units-of-activity method, service life is expressed in terms of the total units of production or expected use from the asset, rather than time.
a. The formulas for computing depreciation expense are:
(1) Depreciable Cost ÷ Total Units of Activity = Depreciable Cost per Unit
(2) Depreciable Cost per Unit X Units of Activity During the Year = Depreciation Expense
b. To illustrate the computation, assume that Benson Company expects to drive the truck purchased in (10b) above for 100,000 miles and that 30,000 miles are driven in the first year. Depreciation for the first year is $3,000.
(1) $10,000 ÷ 100,000 = $.10 per mile.
(2) $.10 X 30,000 = $3,000.
c. In using this method, it is often difficult to make a reasonable estimate of total activity.
d. When the productivity of an asset varies significantly from one period to another, this method results in the best matching of expenses with revenues.
Declining-Balance Method
12. The declining-balance method produces a decreasing annual depreciation expense over the useful life of the asset.
a. The formula for computing depreciation expense is:
Book Value at Beginning of Year X Declining-Balance Rate = Depreciation Expense
b. To illustrate the computation, assume that Benson Company uses a declining-balance rate that is double the straight-line rate of 25%. Depreciation in the first year is $5,500 ($11,000 X 50%).
c. Under this method, the depreciation rate remains constant from year to year, but the book value to which the rate is applied declines each year.
d. This method is compatible with the expense recognition principle because the higher depreciation in early years is matched with the higher benefits received in these years.
13. Taxpayers must use on their tax returns either the straight-line method or a special accelerated depreciation method called the Modified Accelerated Cost Recovery System (MACRS).
Revising Periodic Depreciation
14. If wear and tear or obsolescence indicate that annual depreciation is inadequate or
excessive, a change in the periodic amount should be made.
a. When a change is made, (1) there is no correction of previously recorded depreciation
expense, and (2) depreciation expense for current and future years is revised.
b. To determine the new annual depreciation expense, the depreciable cost at the time of the revision is divided by the remaining useful life.
Expenditures During Useful Life
15. Ordinary repairs are expenditures to maintain the operating efficiency and expected productive life of the plant asset. They are debited to Maintenance and Repairs Expense as incurred and are often referred to as revenue expenditures.
16. Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset. These expenditures are usually material in amount and occur infrequently during the period of ownership.
17. Capital expenditures increase the company’s investment in productive facilities. These expenditures include additions and improvements.
Plant Asset Disposals
18. (L.O. 3) Plant assets may be disposed of by (a) retirement, (b) sale, or (c) exchange.
19. At the time of disposal, it is necessary to determine the book value of the plant asset.
a. If the disposal occurs during the year, depreciation for the fraction of the year to the date of disposal must be recorded.
b. The book value is then eliminated by debiting the Accumulated Depreciation account for the total depreciation to the date of disposal and crediting the asset account for the cost of the asset.
Retirement of Plant Assets
20. In accounting for a disposal by retirement,
a. if the asset is fully depreciated, the entry is a debit to Accumulated Depreciation and a credit to the plant asset account.
b. if the asset is retired before it is fully depreciated and no scrap or salvage value is received,
a loss on disposal of plant assets occurs.
c. the loss on disposal of plant assets is reported in the Other expenses and losses section of the income statement.
Sale of Plant Assets
21. In a disposal by sale, the book value of the asset is compared with the proceeds received from the sale.
a. If the proceeds of the sale exceed the book value, a gain on disposal of plant assets occurs which is reported in the Other revenues and gains section of the income statement.
b. If the proceeds of the sale are less than the book value of the asset, a loss on disposal of plant assets occurs which is reported in the Other expenses and losses section of the income statement.
Natural Resources
22. (L.O. 4) Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. These assets are frequently called wasting assets.
Acquisition Cost
23. The acquisition cost of a natural resource is the price needed to acquire the resource and prepare it for its intended use.
Depletion
24. Depletion is the systematic write-off of the cost of natural resources. The units-of-activity method is generally used to compute depletion because periodic depletion is generally a function of the units extracted during the year. The formulas for computing depletion expense are:
a. Total Cost minus Salvage Value ÷ Total Estimated Units = Depletion Cost per Unit.
b. Depletion Cost per Unit X Number of Units Extracted and Sold = Depletion Expense.
25. To record depletion expense, Depletion Expense is debited and a contra asset account, Accumulated Depletion, is credited.
a. Depletion expense is reported as a cost of producing the product.
b. Accumulated Depletion is deducted from the cost of the natural resource in the balance sheet.
Intangible Assets
26. Intangible assets are rights, privileges, and competitive advantages that result from the ownership of assets that do not possess physical substance. Intangibles may arise from government grants, acquisition of another business, and private monopolistic arrangements.
27. In general, accounting for intangible assets parallels the accounting for plant assets. Intangible assets are (a) recorded at cost, (b) cost is written off over useful life in a rational and systematic manner, assuming the useful life is limited, and (c) at disposal, book value is eliminated and gain or loss, if any, is recorded. If the life of the intangible is indefinite, the cost of the intangible should not be allocated.
28. Differences between the accounting for intangible assets and the accounting for plant assets
include:
a. The systematic write-off of an intangible asset is referred to as amortization.
b. To record amortization, Amortization Expense is debited and the specific intangible asset is credited.
c. Amortization is typically computed on a straight-line basis.
Patents
29. A patent is an exclusive right issued by the U.S. Patent Office that enables the recipient to manufacture, sell, or otherwise control his or her invention for a period of twenty years from the date of grant.
a. The initial cost of a patent is the cash or cash equivalent price paid when the patent is
acquired.
b. When legal costs are incurred in successfully defending the patent, they are added to the Patents account and amortized over the remaining useful life of the patent.
c. The cost of the patent should be amortized over its legal life (20 years) or useful life, whichever is shorter.
Copyrights
30. Copyrights are granted by the federal government, giving the owner the exclusive right to reproduce and sell an artistic or published work. Copyrights extend for the life of the creator plus 70 years.
Trademark or Trade name
31. A trademark or trade name is a word, phrase, jingle, or symbol that distinguishes or identifies
a particular enterprise or product.
Franchise
32. A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products, to perform specific services, or to use certain trademarks or trade names, usually within a designated geographic area. Another type of franchise, commonly
referred to as a license or permit, is entered into between a governmental body and a business enterprise and permits the enterprise to use public property in performing its services.
Goodwill
33. Goodwill is the value of all favorable attributes that relate to a business enterprise such as exceptional management, skilled employees, high-quality products, fair pricing policies, and harmonious relations with labor unions.
a. Goodwill can be identified only with the business as a whole.
b. Goodwill is recorded only when there is an exchange transaction that involves the purchase of an entire business.
c. When an entire business is purchased, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.
34. Goodwill is not amortized because it is considered to have an indefinite life.
Research and Development
35. Research and development costs are costs that are spent on developing new products and processes. Such costs are usually recorded as an expense when incurred.
Financial Statement Presentation
36. (L.O. 5) In the balance sheet, plant assets and natural resources are usually combined under Property, Plant, and Equipment and intangibles are shown separately under Intangible Assets.
a. There should be disclosure of the balances in the major classes of assets and accumulated depreciation of major classes of assets or in total.
b. Depreciation and amortization methods used should be described and the amount of depreciation and amortization expense for the period disclosed.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. The cost of equipment consists of the cash purchase price plus certain related costs such as sales taxes and freight charges.
True False
2. Cost to construct a plant includes the contract price, architect’s fees, building fees, excavation costs but not interest costs incurred to finance the project.
True False
3. The book value of an asset equals its cost less accumulated depreciation.
True False
4. Under the declining-balance method of depreciation, an asset may not be depreciated below its estimated salvage value.
True False
5. Ordinary repairs are expenditures to increase the operating efficiency, productive capacity, or expected useful life of a plant asset.
True False
6. The useful life of a copyright is generally shorter than its legal life.
True False
7. Unlike other assets that can be sold individually in the marketplace, goodwill can be identified only with the business as a whole.
True False
8. The process of allocating the cost of natural resources to expense is called amortization.
True False
*9. Gains on exchanges of plant assets are recorded in the period the exchange occurs.
True False
*10. When plant assets are exchanged, the cost of the new equipment is always equal to the fair value of the new equipment plus the cash paid.