Financial Accounting: Assets

Financial Accounting: Assets

Question 1 (30 marks)

Computer question

You should work through Computer illustration 10-1 in the Lesson Notes before attempting this question.

Vaught Company purchased a special machine at a cost of €91,000. It was estimated that the machine would have a residual value of €7,000 at the end of its service life. Statistics relating to the machine over its service life were as follows:

Estimated service life:

Years5

Output, units6,000

Actual operations:

Units of

Yearoutput

11,400

21,300

31,000

41,100

51,200

Required

Prepare three depreciation schedules to calculate the depreciation of the asset over its service life under the straight-line, productive output, and double declining balance methods.

This question consists of four parts. Parts A, B, and C are independent of each other, except that they share common data. Part D is an extension of part C.

The following three partially completed worksheets in the file FA2LXQ1 have been provided that will assist you in computing depreciation using the straight-line, productive output, and double declining balance methods:

• LXQ1A
• LXQ1B
• LXQ1C

Note:

The worksheets developed in this question round all amounts to the nearest dollar. You may notice that some columns of numbers do not seem to add up to the sums at the foot of the columns. However, the sums are actually correct if you display the columns to two decimal places.

Procedure

Part a (10 marks)

Using the worksheet LXQ1A, finish the partially completed worksheet for the straightline method. Use the following steps to complete the worksheet:

1.Open the file FA2LXQ1 in your FA2\DATA directory. Click the sheet tab for LXQ1A.

2.Examine the formulas in this worksheet. Notice that column B (Depreciation Expense) and column D (Closing Carrying Amount) are both blank, with the exception of cell D15. Also notice that cells D8 and D9 are blank.

3.In cells D8 and D9, enter the appropriate formulas.

4.Enter the appropriate formulas for cells B16 to B25 and cells D16 to D25. In order for your worksheet to be general enough to compute depreciation schedules for different assets, you should not enter numbers into these cells. Use absolute cell references whenever necessary to enable copying of the formulas to other cells. A good test for a properly constructed worksheet is to change the Cost of Asset in cellD5 to see if the depreciation schedule is changed automatically.

Hint:

The cell formulas for depreciation expense in column B should check if the closing book value of the previous period is greater than the asset’s residual value. If it is, a depreciation amount still applies for the current period. Otherwise, the depreciation amount should be zero for this period because the asset value has been fully depreciated.

5.After you have completed the worksheet, save a copy and print it. Do not submit the printouts.

6.Report the following:

• dollar amount to be depreciated (2 marks)
• annual depreciation amount (2 marks)
• the year the asset’s closing carrying amount equals its residual value (2 marks)
• the formulas in cells D8, D9, B16, and D16 (4 marks)

Part b (10 marks)

Using the worksheet LXQ1B, finish the partially completed worksheet for the productive output method. Use the following steps:

1.Click the LXQ1B sheet tab.

2.Examine the worksheet. Note that the formula in cell C15 is built in such a way that depreciation expense would not be taken beyond the asset’s residual value.

3.Enter the appropriate data into cells D5, D6, and D7, and cells B15 to B24 inclusive. You also need to copy the formulas in cells C15 and D15 to the rest of their respective columns, as appropriate.

4.Enter the appropriate formulas in cells E15 to E24 and cells F15 to F24.

5.Save and print the worksheet.

6.Report the following:

• cost of asset (2 marks)
• total productive units (2 marks)
• depreciation rate per unit (2 marks)
• the formulas in cells C19, D19, E19, and F19 (4 marks)

Part c (10 marks)

Using the worksheet LXQ1C, finish the partially completed worksheet for the double declining balance method. Use the following steps:

1.Click the LXQ1C sheet tab.

2.Examine the worksheet by moving the cell pointer around. Observe that the worksheet calculates a depreciation schedule for a non-current asset over a maximum 10year service life using the double declining balance method.

3.Enter the appropriate data in cells D5 and D6.

4.Enter the appropriate formulas in columns E and F.

5.Save and print the worksheet.

6.Report the following:

• Annual rate of depreciation (2 marks)
• Balance in accumulated depreciation at the end of years 1, 2, 3, and 4 (4 marks)
• The formulas (if any) in cells E14, F14, E15, and F15 (4 marks)

Question 2 (25 marks)

Multiple choice (1 mark each)

a.What is a primary theoretical objection to the straight-line method of depreciation?

1)It ignores variation in the rate of asset use among periods.

2)It tends to result in a constant rate of return on a diminishing investment base.

3)It gives a lower periodic expense than the accelerated methods over the life of the asset.

4)It recognizes the declining productivity of the asset.

b.As generally used in accounting, which of the following best describes accumulated depreciation?

1)An expense on the income statement

2)The amount of the cost of property, plant, or equipment written off as expense since the asset acquisition date

3)Funds (or cash) set aside to replace the property, plant, or equipment being depreciated

4)Earnings retained in the business that will be used to purchase replacement property, plant, or equipment when the related asset becomes fully depreciated

c.Which depreciation method gives recognition to a pattern of decreasing economic benefit with the passage of time?

1)Straight-line method

2)Productive output method

3)Declining balance method

4)Increasing charge method

d.Which depreciation method is particularly appropriate where (a) obsolescence is not the primary factor, (b) actual use can be accounted for, and (c) the service life in units of use can be estimated reliably?

1)Sum-of-the-years’-digits method

2)Declining balance method

3)Productive output method

4)Straight-line method

e.When a machine with a five-year estimated useful life is sold during the second year of its life, how would the use of the sum of the years digits method of depreciation, instead of the straight-line method, affect the gain or loss on the sale?

GainLoss

1)IncreaseDecrease

2)IncreaseIncrease

3)DecreaseIncrease

4)No effectNo effect

f.A “secret reserve” occurs if a company’s real financial position is better than what is presented in its financial statements. Which of the following would create a secret reserve?

1)When a betterment is recorded as an expense

2)When inadequate depreciation is recorded

3)When liabilities are understated

4)When shareholders’ equity is overstated

g.Lamina Co. recently sold some equipment with a net book value of €150,000 for €100,000. What is one of the ways this transaction will be reported on the cash flow statement?

1)As a €100,000 cash outflow in the investing activities section

2)As a €150,000 cash outflow in the investing activities section

3)As a €50,000 addition to net profit in the operating activities section

4)As a €50,000 reduction of net profit in the operating activities section

h.How are assets depreciated under the half-year approach to fractional-year depreciation?

1)Assets are depreciated for a half-year in the year of purchase and no depreciation is recorded in the year of disposal.

2)Assets are depreciated for a half-year in the year of disposal and no depreciation is recorded in the year of purchase.

3)Assets are depreciated for a half-year in the year of purchase and depreciated for a half-year in the year of disposal.

4)No depreciation is recorded in either the year of purchase or the year of disposal.

i.Under the required treatment, at what value must non-current assets be reflected at on the financial statements?

1)Fair value

2)Value in use

3)Historic cost less accumulated depreciation

4)Lower of carrying amount and fair value less selling cost

(2 marks each)

j.Burkina acquired a tract of land containing an extractable natural resource. Burkina is required by the purchase contract to restore the land to a condition suitable for recreational use after extraction of the natural resource. Geological surveys estimated that the recoverable reserves will be 1,500,000 tons, and that the land will have a value of €600,000 after restoration. Relevant cost information:

Land purchase cost...... €6,000,000

Restoration cost, estimated...... 900,000

Cost of geological surveys completed...... 300,000

Burkina will maintain no inventory of extracted material because it will be extracted only as sold. What should be the depletion rate per ton (exclusive of current extraction costs) of the resource as it is sold?

1)€3.80

2)€4.00

3)€4.40

4)€4.80

k.On January 1, 20X4, Decca spent €12,000 successfully defending one of its patent infringement suits. The related patent was originally recorded at €68,000 on January1, 1999, at which time it had a legal life of 17 years. Since that date, Decca has depreciated the patent using the straight-line method of depreciation. How much should be recorded for patent depreciation expense for the year ended December31, 20X4?

1)€4,000

2)€5,000

3)€12,000

4)€12,800

l.Lacroix Co. recently sold some equipment with a net book value of €150,000 for €100,000. What impact did this transaction have on shareholders’ equity and the current ratio?

Shareholders’ equityCurrent ratio

1)IncreaseIncrease

2)IncreaseDecrease

3)DecreaseDecrease

4)DecreaseIncrease

m.Electra Co. has recently discovered that the net recoverable amount of ore likely to be extracted from its mine has a value of €1,500,000. This is €500,000 less than the net book value of the natural resource and €1,000,000 less than the estimated net recoverable amount of one year ago. As a result, the remaining life of the mine has been reduced from four years to three years. How should the change in value be accounted for?

1)Debit to retained earnings for €500,000

2)Debit to retained earnings for €1,000,000

3)Debit to loss for €500,000

4)The €500,000 loss should be charged to income over the three-year remaining useful life of the mine.

n.Corporations A and B purchased identical equipment having an estimated service life of 10 years. Corporation A uses straight-line depreciation and B uses the double declining balance method. Assuming that the companies are identical in all other respects, which of the following statements is true?

1)Corporation B will record more depreciation on this asset over the entire 10years than A.

2)At the end of the third year, the net book value of the asset will be lower for A than for B.

3)Net profit will be lower for A in the ninth year than for B.

4)Depreciation expense will be higher the first year for A than for B.

o.PZE Inc. purchased a machine on January 1, 20X5, for €400,000. PZE estimated the machine would have no salvage value and is depreciating it, using the straight-line method, over its estimated useful life of eight years. At December 31, 20X8, after recording the annual depreciation expense, PZE determines that the machine has suffered an impairment loss. The machine’s recoverable amount was determined to be €120,000. What is the amount of depreciation expense that will be recorded on the machine in 20X9?

1)€50,000

2)€80,000

3)€30,000

4)€70,000

p.RJ purchased a tooling machine for €30,000. The machine was being depreciated using the straight-line method over an estimated useful life of 20 years, with no residual value. At the beginning of the eleventh year, after the machine had been in use for 10years, the company paid €9,000 for a major overhaul of the machine. As a result of this improvement, the company estimated that the useful life of the machine would be extended an additional five years. What should be the depreciation expense recorded for the above machine in the eleventh year?

1)€1,000

2)€1,333

3)€1,500

4)€1,600

q.At the end of the year, Wayne Company sold a building, receiving as consideration a €400,000 noninterest-bearing note due in three years. The building cost €380,000 and the accumulated depreciation was €160,000 at the date of sale. The prevailing rate of interest for a note of this type was 12%. What gain or loss should Wayne report on its income statement in the year of the sale?

1)€20,000 gain

2)€64,720 gain

3)€180,000 gain

4)€220,000 loss

Question 3 (18 marks)

Argyles’ Bistro is a very successful restaurant located in the theatre district of a large urban centre. The company is five years old and is owned and operated by Arthur and Anita Argyle. The restaurant has been so successful that the Argyles’ have not had to use any bank financing. To date the company has been financed by the owners’ personal investment, accumulated profits, and supplier credit.

Argyles’ serves gourmet fare and is able to charge a premium price for its food and wine. In the last six months the restaurant has been written up in a favourable manner in several publications including a high end travel magazine and the city’s most popular newspaper. Arthur feels that their concept can be successfully translated to a second location in the city’s business district and should provide access to a whole new market of diners. Although the business has been very successful and has generated significant cash flows, the couple’s accountant feels that bank financing will be required to support their expansion plans. Both Anita and Arthur feel the time is right, given their current popularity and positive press exposure, and plan to open a second restaurant within the next month.

Argyles’ Bistro has a January 31 year end which corresponds to its slow season. This is also the time of year when Arthur and Anita do strategic planning. Earlier this year during their strategic planning session, Arthur and Anita decided to refurbish the kitchen cooking and refrigeration units. The units were purchased at a cost of €80,000 in the firstweek in February. The equipment was not, however, fully installed and operational until the first week of May because of modifications which had to be made to the kitchen layout and wiring at a cost of €18,000. Arthur feels that the cost of the equipment should include €2,500 in interest, which they would have had to incur from February until May if they had chosen to finance the purchase with a bank loan instead of paying cash.

Required

(3 marks for overview; 12 marks for analysis and recommendations; 3 marks for writing skills)

As the Argyles’ accountant, what advice would you give with respect to the cost of the equipment as well as the accounting policy(s) to be adopted to depreciate the equipment.

Question 4 (8 marks)

Q. Enterprises purchased a delivery vehicle for €32,000 on the first day of the fiscal year. The vehicle is expected to have a useful life of five years and residual value of €2,000.

Required

a.(3 marks)

Calculate depreciation expense for the first year assuming the company uses

i.the straight-line method

ii.the declining balance method at 1.5 times the straight-line rate

iii.sum-of-the-year’s-digits method

b.(3 marks)

What assumption does each of the methods in make about the economic benefit derived from an asset?

c.(2 mark)

Which method would you recommend that Q. Enterprises uses? (You must explain the reason for your recommendation to receive marks.)

Question 5 (19 marks)

On February 2, 20X5, Petry Enterprises paid €76,000 cash for a piece of equipment to be used in its blast furnace facility. The equipment has an estimated useful life of sevenyears and an estimated residual value of €6,000. The company’s policy is to record a full year of depreciation in the year of purchase and no depreciation in the year of disposal. The equipment is expected to provide 33,600 hours of service over its useful life with estimated service hours of 4,200 in 20X5, 4,300 in 20X6, and 4,600 in 20X7. The company’s accountant has looked at several methods of depreciation that could be used for the equipment and has prepared the following schedule for the three most likely alternatives:

Alternative 1Alternative 2Alternative 3

Estimated depreciation expense — 20X5€179,500€8,750€10,000

After consideration of the alternatives, the company chose to use the straight-line method of depreciation. In 20X6 an accident occurred which caused damage to the equipment. The equipment was repaired in 20X6, at a cost of €5,000, but it was determined in early 20X7 that an impairment loss may have occurred. An analysis performed in early 20X7 concluded that the equipment had a value in use of €40,000, a net selling price of €36,000 and a remaining useful life of two years with no residual value.

a.(3 marks)

Identify the depreciation method being used in each of alternatives 1, 2, and 3.

b.(3 marks)

Prepare the journal entries to record depreciation expense and the €5,000 expenditure in 20X6.

c.(7 marks)

Prepare the journal entries to record the impairment loss and depreciation expense for 20X7.

d.(6 marks)

Assuming Petry Enterprises uses the indirect method of presenting cash flows from operating activities, prepare the cash flow statement disclosures with respect to the equipment for the years 20X5, 20X6, and 20X7.

Suggested solutions

Question 1 (30 marks)

Computer solution

Notes:

Students’ solutions may vary from those provided here. Deviations from the “suggested” solution do not mean that students have made errors. There is more than one way to formulate the depreciation models; assess the logic used by students and award full marks if the approach adopted by the student is “correct.”

Part a: Straight-line method (10 marks)

The amount to be depreciated is €84,000. (2 marks)

The annual depreciation amount is €16,800. (2 marks)

The asset’s closing carrying amount equals its residual value in year5. (2 marks)

CellFormula (4 marks)

D8=D5–D6

D9=D8/D7

B16@IF(D15>$D$6,$D$9,0)

D16=$D$15–C16

Part b: Productive output method (10 marks)

The cost of the asset is €91,000. (2 marks)

The total number of productive units is 6,000. (2 marks)

The depreciation rate per unit is €14. (2 marks)

CellFormula (4 marks)

C19@IF(B19*$D$8>(F18–$D$6),F18–$D$6,B19*$D$8)

D19=C19

E19=E18+D19

F19=$F$14–E19

Part c: Double-declining-balance method (10 marks)

The annual rate of depreciation is 40.00%. (2 marks)

Balance accumulated depreciation for the following: (4 marks)

Year 1 = 36,400

Year 2 = 58,240

Year 3 = 71,344

Year 4 = 79,206

CellFormula (4 marks)

E14none

F14=D5

E15=E14+D15

F15=$F$14–E15

Question 2 (25 marks)

Multiple choice(1 mark each)

a.1)

Theoretically, the depreciation method should reflect the pattern of benefits; the straightline method ignores variations in the pattern of benefits.