Chapter 9: Reporting And Analysing Long-Lived Assets

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

CHAPTER 9

Reporting and Analysing Long-Lived Assets

ASSIGNMENT CLASSIFICATION CLASSIFICATION TABLE

Study Objectives / Questions / Brief
Exercises / Exercises / A
Problems / B
Problems /
1. Describe how the cost principle applies to property, plant and equipment. / 1, 2, 3, 4, 5 / 1, 2 / 1, 2, 7 / 1A, 2A, / 1B, 2B
2. Explain the concept of amortization. / 6
3. Calculate periodic amortization using the straight-line method, and contrast its expense pattern with those of other methods. / 7, 8, 9, 10 / 3 / 3, *11, *12 / 3A, *11A, *12A / 3B, 11B, *12B
4. Describe the procedure for revising periodic amortization. / 11, 12 / 4, 5 / 4, 5 / 4A, 5A / 4B, 5B
5. Explain how to account for the disposal of property, plant and equipment. / 13, 14 / 6, 7 / 6 / 3A, 4A, 6A, *12A / 3B, 6B, *12B
6. Identify the basic issues related to reporting intangible assets. / 15, 16, 17 / 8 / 7, 8 / 2A, 7A, 8A / 2B, 7B, 8B
7. Indicate how long-lived assets are reported on the balance sheet. / 18, 19 / 9, 10 / 9 / 3A, 8A / 3B, 8B
8. Describe the methods for evaluating the use of assets. / 20, 21, 22 / 11 / 10 / 9A, 10A / 9B, 10B
*9. Calculate periodic amortization using the declining-balance method and the units-of-activity method. / *23 / *12, *13 / *11, *12 / *11A, *12A / *11B, *12B

ASSIGNMENT CHARACTERISTICS TABLE

Problem
Number / Description / Difficulty
Level / Time
Allotted (min.) /
1A / Determine acquisition cost. / Simple / 20-30
2A / Classify expenditures. / Moderate / 15-20
3A / Record property, plant and equipment transactions; prepare partial balance sheet. / Moderate / 40-50
4A / Revise amortization; calculate gain or loss on disposal. / Moderate / 30-40
5A / Classify operating and capital expenditures. / Moderate / 10-15
6A / Record disposal of equipment. / Simple / 15-20
7A / Correct errors in recording and amortizing intangible assets. / Moderate / 30-40
8A / Record intangible asset transactions; prepare intangible assets section. / Moderate / 30-40
9A / Calculate and evaluate ratios. / Moderate / 30-40
10A / Evaluate ratios. / Moderate / 20-30
*11A / Calculate amortization under straight-line and declining balance methods. / Moderate / 30-40
*12A / Calculate amortization under straight-line and units-of- activity methods; calculate total expense over life of asset. / Moderate / 30-40
1B / Determine acquisition cost. / Simple / 20-30
2B / Classify expenditures. / Moderate / 15-20
3B / Record property, plant and equipment transactions; prepare partial balance sheet. / Moderate / 40-50
4B / Revise amortization. / Moderate / 30-40
5B / Classify operating and capital expenditures. / Moderate / 10-15
6B / Record disposal of equipment. / Simple / 15-20
7B / Correct errors in recording and amortizing intangible assets. / Moderate / 30-40
8B / Record intangible asset transactions; prepare intangible assets section. / Moderate / 30-40
9B / Calculate and evaluate ratios. / Moderate / 30-40
10B / Evaluate ratios. / Moderate / 20-30
*11B / Calculate amortization under straight-line and declining balance methods. / Moderate / 30-40
*12B / Calculate amortization under straight-line and declining balance methods; calculate total expense over life of asset. / Moderate / 30-40

ANSWERS TO QUESTIONS

[Tashia, I would unbold the numbers 1, 2, and 3 – Zoë, I don’t know how to fix this - Tashia]

1. For long-lived assets, the cost principle states that long-lived assets are recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use. The matching principle requires that the cost of a long-lived asset be amortized to expense over the asset’s useful life.

2. The cost principle has persisted because it provides information that is objective and verifiable. Market values are subjective. It is a situation where reliability takes precedence over relevance.

3. (a) In a cash transaction, cost is equal to the cash paid.

(b) In a noncash transaction, cost is equal to the cash equivalent price paid, which is the fair market value of the asset given up, if determinable. If not, the fair market value of the asset received is used.

4. An impairment loss is recognized when the value of a long-lived asset is written down to market value. The impairment loss is only recognized when there has been a permanent decline in value, which is assessed using specific recoverability tests. Once an impairment loss has been recognized the book value of the asset is not subsequently adjusted for any recovery in value.

5. The primary advantages of leasing are (1) reduced risk of obsolescence, (2) low down

paymentpayment, (3) shared tax advantages, and (4) reduced recorded assets and liabilities, and (5) asset financing that might not otherwise be available.

6. You should explain to the president that amortization is a process of allocating the cost of a long-lived asset to expense over its service (useful) life in a rational and systematic manner. Recognition of amortization is not intended to result in the accumulation of cash for replacement of the asset.

7. (a) Useful life is expressed in years under the straight-line and declining-balance methods

and in units of activity under the units-of-activity method.

(b) The pattern of periodic amortization expense over useful life is constant under the straight-line method, and accelerated in the early years of declining-balance method and variable under the units-of-activity method.

8. The effects of the three methods on annual amortization expense are: Straight-line—constant amount–-expense is constant and effect on net earnings is smooth. Units-of-activity—varying amounts–-the expense increases with an increase in the level of activity and net earnings decrease. Declining-balance—decreasing amounts–-the expense declines over time and net earnings increase. In the early years of an asset’s life, declining-balance and units-of-activity generally lead to higher amortization and lower net earnings than the straight-line method. Over the total life of the asset, total amortization will be the same regardless of the amortization method chosen.

Questions (Continued)

9. Since Morgan uses the straight-line amortization method, its amortization expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method. Fairchild’s amortization expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Morgan’s net earnings will be higher than Fairchild’s in the first few years of the asset’s useful life. These differences will impact the amortization expense, accumulated amortization and net earnings of the companies making comparison of their results and financial position difficult. In reality, the choice of amortization method results in an artificial, timing difference only and should be ignored, if possible, in comparing financial positions.

10. Yes, income tax regulations allow a company to use a different amortization method on the tax return than is used in preparing financial statements. Tax regulations require the taxpayer to use the single-declining-balance method, regardless of which method is used in preparing financial statements. Lucille Corporation’s motivation for using the straight line method for financial reporting is to ensure that the amortization method selected provides the best matching of revenue to expense.

11. Operating expenditures are ordinary repairs made to maintain the operating efficiency and expected productive life of the asset. Capital expenditures are additions and improvements made to increase efficiency, productivity, or expected useful life of the asset. Operating expenditures are recognized as expenses when incurred; capital expenditures are generally debited to the asset account affected.

12. A revision of amortization is made in current and future years but not retroactively. The rationale is that continual restatement of prior periods for what is merely a change in estimate would adversely affect the reader’s confidence in the financial statements.

13. In a sale of long-lived assets, the book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the book value of the asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the asset sold, a loss on disposal occurs.

14. The machine and related accumulated amortization should continue to be reported on the balance sheet without further amortization or adjustment until the asset is retired. Reporting the asset and related accumulated amortization on the balance sheet informs the reader of the financial statements that the company is still using the asset. Once an asset is fully amortized, even if it is still being used, no additional amortization should be taken on this asset. In no situation can the amortization on the asset exceed the cost of the asset.

15. The student is not correct. Only intangible assets with limited lives such as patents and copyrights are amortized. Intangibles with unlimited lives such as trademarks are not amortized but their book value is assessed annually for impairment and a loss recognized if a decline in value has occurred.

Questions (Continued)

16. Goodwill is the value of many favourable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold.

17. Research and development costs present several accounting problems. It is sometimes difficult to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, the CICA requires that research costs are always recorded as an expense and development costs are usually recorded as an expense. If future benefits are identifiable for development costs, then these development costs can be capitalized.

18. Long-lived assets should be reported on the balance sheet at cost less accumulated amortization. The statement of earnings includes amortization expense and any gain or loss on disposal of long-lived assets. The cash flow statement will include any cash paid to purchase long-lived assets and any cash received on their disposal.

19. The notes to financial statements should disclose the balance of the major classes of assets and the amortization method(s) and rates used.

20. (a) Grocery stores usually have a high asset turnover and a low profit margin.

(b) Car dealerships normally have a low asset turnover and a high profit margin.

21. ($ in U.S. millions)

Solutions Manual 9-1 Chapter 9

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

Return on assets:

Asset turnover:

Solutions Manual 9-1 Chapter 9

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

22. The return on assets ratio measures the return being generated by each dollar invested in the business (net earnings ÷ average total assets). The return on assets can also be calculated by multiplying the profit margin by the asset turnover ratio. The profit margin measures how effective the business is at generating earnings from its sales and the asset turnover measures how well the company can generate sales from a given level of assets. Together, the two ratios can be combined to measure how effective a company is at generating earnings from a given level of assets (return on assets). Therefore if a company wants to improve its return on assets, it can do so by either by increasing the margin it generates from each dollar of sales (profit margin) or by increasing the volume of goods that is sells (asset turnover).

Questions (Continued)

*23. Straight-line and units-of-activity measures apply the amortization criteria to the original cost of the assets over a fixed period (in years or in units), which must be reduced by salvage value to get an accurate representation of the amortizable cost of the assets to the company. Because the declining-balance method applies the amortization criteria, not to the original cost, but to a declining book value, the original cost is used instead of the amortizable cost. Applying a fixed percentage rate to a declining balance will always result in an ending, residual amount. Salvage value is considered in the declining-balance method in that the asset is never amortized below its salvage value, so in effect, this residual amount is adjusted to equal salvage value.

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 9-1

All of the expenditures should be included in the cost of the land. Therefore, the cost of the land is $56,000 ($50,000 + $2,500 + $3,500).

BRIEF EXERCISE 9-2

The cost of the truck is $18,400 (cash price $18,000 + painting and lettering $400). The expenditures for insurance and motor vehicle licence should be expensed, not added to the cost of the truck.

BRIEF EXERCISE 9-3

Amortizable cost of $40,000 ($42,000 –$2,000). With a 4-year useful life, annual amortization is $10,000 ($40,000 ÷ 4). Under the straight-line method, amortization is the same each year. Thus, amortization is $10,000 for both the first and second years.