SOLUTIONS TO UPDATE EXERCISES
UPDATE EXERCISE 10-1 (20-25 minutes)
(a) Exchange has commercial substance
Depreciation Expense 700
Accumulated Depreciation-Melter (Old) 700
Cost of old melter11,200
Less: Salvage value 700
Depreciation cost10,500
Depreciation per year ($10,500/5) 2,100
Depreciation for 4 months (2,100 x 1/3) 700
Melter (New)15,200
Accumulated Depreciation-Melter (Old) 7,000
Gain on Disposal of Old Melter 1,000
Melter (Old) 11,200
Cash 10,000
Computation of gain on old melter
Cost of old melter$11,200
Accumulated depreciation-melter (old)
($6,300 + $700) 7,000
Book value of old melter 4,200
Fair value of old melter 5,200
Gain on disposal of old melter$ 1,000
Computation of basis of new melter
Cash paid$10,000
Fair value of old melter 5,200
Cost of new melter$15,200
b. Exchange lacks commercial substance
Depreciation Expense / 700Accumulated Depreciation—Melter (Old) / 700
($11,200 – $700 = $10,500;
$2,100 X 4/12 = $700)
Melter (New) / 14,200
Accumulated Depreciation—Melter (Old) / 7,000
Melter (Old) / 11,200
Cash / 10,000
Cost of old melter$11,200
Accumulated depreciation (7,000)($6,300 + $700)
Book value$ 4,200
UPDATE EXERCISE 10-1 (Continued)
**Cash paid / $10,000Book value of old melter / 4,200
Cost of new melter / $14,200
UPDATE EXERCISE 10-2 (15-20 minutes)
(a) Exchange lacks commercial substance
Carlos Arruza Company
Equipment (New)12,000*
Accumulated Depreciation-Equipment (Old)19,000
Equipment (Old) 28,000
Cash 3,000
* Cost of new equipment:
Cash paid$ 3,000
Book value of old equipment 9,000
Cost of new equipment$12,000
Tony LoBianco Company
Cash 3,000
Equipment (New)15,000*
Accumulated Depreciation-Equipment (New)10,000
Equipment (Old) 28,000
* Cost of new equipment:
Book value of equipment
($28,000-$10,000)$18,000
Less: Cash received 3,000
Cost of new equipment$15,000
UPDATE EXERCISE 10-2 (Continued)
(b) Exchange has commercial substance
Carlos Arruza Company
Equipment (New)15,500*
Accumulated Depreciation-Equipment (Old)19,000
Equipment (Old) 28,000
Cash 3,000
Gain on Disposal of Equipment 3,500**
* Cost of new equipment:
Cash paid$ 3,000
Fair value of old equipment 12,500
Cost of new equipment$15,500
** Computation of gain on disposal of equipment:
Fair value of old equipment$12,500
Book value of old equipment
($28,000-$19,000) 9,000
Gain on disposal of equipment$ 3,500
Tony LoBianco Company
Cash 3,000
Equipment (New)12,500*
Accumulated Depreciation-Equipment (Old)10,000
Loss on Disposal of Equipment 2,500**
Equipment (Old) 28,000
* Cost of new equipment:
Fair value of equipment$15,500
Less: Cash received 3,000
Cost of new equipment$12,500
** Computation of loss on disposal of equipment:
Book value of old equipment
($28,000-$10,000)$18,000
Fair value of equipment (Old) 15,500
Loss on disposal of equipment$ 2,500
UPDATE EXERCISE 10-3 (10-15 minutes)
Busytown Corporation
Machine (New)...... 425*
Accumulated Depreciation-Machine (Old)...... 140
Loss on Disposal of Machine...... 65**
Machine (Old)...... 290
Cash...... 340
* Computation of basis of new machine:
Cash paid$340
Fair value of old machine 85
$425
** Computation of loss:
Book value of old machine ($290 - $140)$150
Fair value of old machine (85)
Loss on exchange$ 65
Dick Tracy Business Machine Company
Cash...... 340
Inventory (Old)...... 85
Cost of Goods Sold...... 270
Sales...... 425
Inventory (New)...... 270
UPDATE EXERCISE 10-4 (15-20 minutes)
a.Equipment (New)56,900*
Accumulated Depreciation-Equipment (Old)20,000
Equipment (old) 62,000
Cash 9,100
Gain on Disposal of Equipment 5,800**
* Cost of equipment:
Cash paid for equipment$ 8,000
Cash paid for freight and installation 1,100
Fair value of old equipment 47,800
Cost of equipment$56,900
UPDATE EXERCISE 10-4 (Continued)
** Computation of gain on disposal of equipment:
Fair value of old equipment$47,800
Book value of old equipment 42,000
Gain on disposal of equipment$ 5,800
b.Fair Values Not Determinable
Equipment (New)51,100*
Accumulated Depreciation-Equipment (Old)20,000
Equipment (Old) 62,000
Cash 9,100
* Computation of cost of new equipment:
Cash paid for equipment$ 8,000
Cash paid for freight and installation 1,100
Book value of old equipment 42,000
Cost of new equipment$51,100
UPDATE PROBLEM 10-11. / Susquehanna Corporation
Cash / 23,000
Machine (New) / 69,000
Accumulated Depreciation- Machine (Old) / 50,000
Loss on Disposal of Machine / 18,000*
Machine (Old) / 160,000
*Computation of loss: Book value / $110,000
Fair value / (92,000)
Loss / $ 18,000
Choctaw Company
Machine (New) / 92,000
Accumulated Depreciation- Machine (Old) / 45,000
Loss on Disposal of Machine / 6,000 / *
Cash / 23,000
Machine (Old) / 120,000
*Computation of loss: Book value / $ 75,000
Fair value / (69,000)
Loss / $ 6,000
2. / Susquehanna Corporation
Machine (New) / 110,000
Accumulated Depreciation-Machine (old) / 50,000
Machine (old) / 160,000
Powhatan Company
Machine (New) 76,000
Accumulated Depreciation-Machine (Old)71,000
Machine (Old)147,000
UPDATE Problem 10-1 (Continued)
3.Susquehanna Corporation
Machine (New)100,000
Accumulated Depreciation-Machine (Old)50,000
Loss on Disposal of Machine18,000
Machine (Old)160,000
Cash8,000
Shawnee Company
Machine (New) 92,000
Accumulated Depreciation-Machine (Old) 75,000
Cash8,000
Machine (Old) 160,000
Gain on Exchange of Machinery 15,000*
* Book value of old $ 160,000
( 75,000)
85,000
Fair value of asset received
($92,000 + 8,000) 100,000
Gain $ 15,000
UPDATE PROBLEM 10-2(a)Exchange has commercial substance:
Arna Inc.’s Books
Asset B / 75,000Accumulated Depreciation—Asset A / 45,000
Asset A / 96,000
Gain on Disposal of Plant Assets
($60,000 – [$96,000 – $45,000]) / 9,000
Cash / 15,000
Bontemps Inc.’s Books
Cash / 15,000Asset A / 60,000
Accumulated Depreciation—Asset B / 52,000
Asset B / 110,000
Gain on Disposal of Plant Assets
($75,000 – [$110,000 – $52,000]) / 17,000
(b)Exchange lacks commercial substance:
Arna Inc.’s Books
Asset B ($75,000 – $9,000) / 66,000*Accumulated Depreciation—Asset A / 45,000
Asset A / 96,000
Cash / 15,000
* Cost of asset:
Book value – Asset A / $ 51,000
Cash paid / 15,000
Cost - Asset B / $ 66,000
UPDATE PROBLEM 10-2 (Continued)
Bontemps Inc.’s Books
Cash15,000
Asset A 43,000*
Accumulated Depreciation—Asset B52,000
Asset B110,000
*Fair value of asset$60,000Book value of$58,000
acquiredOR Asset B
Less gain deferredLess cash received 15,000
($17,000) 17,000 $43,000
Basis of Asset A$43,000
UPDATE PROBLEM 10-3(a) / Garrison Books
(1) / Crane / 190,000
Accumulated Depreciation—Equipment / 60,000
Loss on Disposal of Crane / 8,000
Crane / 140,000
Cash / 118,000
Keillor Books
(2) / Cash / 118,000
Equipment Inventory / 72,000
Sales / 190,000
Cost of Goods Sold / 165,000
Equipment Inventory / 165,000
(b) Garrison Books
Crane198,000*
Accumulated Depreciation—Equipment60,000
Crane140,000
Cash118,000
* Book value of old ($80,000) + cash paid ($118,000)
(c) / Garrison Books(1) / Equipment / 190,000
Accumulated Depreciation—Equipment / 60,000
Equipment / 140,000
Cash / 92,000
Gain on Disposal of Plant Assets / 18,000
($98,000 – $80,000)
Keillor Books
(2) / Cash / 92,000
Equipment Inventory / 98,000
Sales / 190,000
Cost of Goods Sold / 165,000
Equipment Inventory / 165,000
(d)Garrison Books
Equipment183,000*
Accumulated Depreciation—Equipment60,000
Cash103,000
Equipment140,000
* Book value of old ($80,000) + Cash paid ($103,000)
UPDATE EXERCISE 22-1 (10-15 minutes)
(a)The net income to be reported in 2005, using the retroactive approach, would be computed as follows:
Income before income taxes$700,000
Income taxes (35% X $700,000) 245,000
Net income$455,000
(b)Construction in Process...... 190,000
Deferred Tax Liability...... 66,500
Retained Earnings...... 123,500*
*($190,000 X 65% = $123,500)
UPDATE EXERCISE 22-2 (10-15 minutes)
(a)Inventory...... 14,000*
Retained earnings...... 14,000
*($19,000 + $23,000 + $25,000) – ($15,000 + $18,000 + $20,000)
(b) Net Income (FIFO)2002$19,000
2003 23,000
2004 25,000
(c)Inventory...... 24,000*
Retained Earnings...... 24,000
*($19,000 + $23,000 + $25,000) – ($12,000 + $14,000 + $17,000)
UPDATE EXERCISE 22-3 (30-35 minutes)
(a)Depreciation to date on equipment
Sum-of-the-years’-digits depreciation
2002 (5/15 X $510,000)$170,000
2003 (4/15 X $510,000)136,000
2004 (3/15 X $510,000) 102,000
$408,000
Cost of equipment$525,000
Depreciation to date 408,000
Book value (December 31, 2004)$117,000
Book value – salvage value = Depreciable cost
$117,000 - $15,000 = $102,000
Depreciation for 2005: $102,000 / 2 = $51,000
Depreciation Expense51,000
Accumulated Depreciation-Equipment 51,000
(b)Depreciation to date on building
$693,000 / 30 years = $23,100 per year
$23,100 x 3 = $69,300 depreciation to date
Cost of building$693,000
Depreciation to date 69,300
Book value (December 31, 2004)$623,700
Depreciation for 2005: $623,700 / (40-3) = $16,856.76
Depreciation Expense 16,856.76
Accumulated Depreciation-Buildings 16,856.76
UPDATE EXERCISE 22-4 (25-35 minutes)
(a) Change in Asset Depreciation
Cost of depreciable assets$100,000
Depreciation in 2004 40,000
Book value at December 31, 2004$ 60,000
Depreciation for 2005 using straight-line depreciation
$60,000 / 3 = $20,000
DENISE HABBE INC.
Comparative Income Statements
For the Years 2005 and 2004
2005$ 340,000 / 2004
$ 270,000
Sales
Cost of sales / 176,000* / 166,000**
Gross profit / 164,000 / 104,000
Expenses / 78,000*** / 50,000
Net income / $ 86,000 / $ 54,000
***$200,000 – $24,000
***$142,000 + $24,000
***$88,000 – ($30,000 – $20,000)
DENISE HABBE INC.
Statement of Retained Earnings
For the Years 2005 and 2004
Retained earnings (January 1) / 2005$101,000 / 2004
$ 72,000
Net income / 86,000 / 54,000
Dividends / (30,000) / (25,000)
Retained earnings (December 31) / $157,000 / $101,000
UPDATE EXERCISE 22-4 (Continued)
Note to instructor:
1.2004 cost of sales increased $24,000; 2005 cost of sales decreased $24,000.
2.2004 expenses remained unchanged.
3.2005 expenses decreased $10,000 ($30,000 – $20,000).
4.Additional disclosures would be a footnote describing accounting change.
5.Another acceptable presentation for the retained earnings state-ment for 2005 is:
Retained earnings (January 1), unadjusted$125,000
Prior period adjustment—inventory error (24,000)
Retained earnings adjusted 101,000
Net income 86,000
Dividends (30,000)
Retained earnings$157,000
UPDATE EXERCISE 22-5 (5-10 minutes)
1.a.6.a.
2.b.7.b.
3.a.8.a.
4.b.9.b.
5.b.10.b.
SOLUTIONS TO PROBLEMS
UPDATE PROBLEM 22-1(a)1.Cost of equipment $65,000
Less: Salvage value 5,000
Depreciable cost $60,000
Depreciation to 2004
2001 ($60,000 / 10)$ 6,000
2002 ($60,000 / 10) 6,000
2003 ($60,000 / 10) 6,000
$18,000
Depreciation in 2004
Cost of equipment$65,000
Less: Depreciation to 2004 18,000
Book value (January 1, 2004) 47,000
Less: Salvage value 3,000
Depreciable cost$44,000
Depreciation in 2004
$44,000 / 4 = $11,000
Depreciation Expense...... 11,000
Accumulated Depreciation-Equipment.. 11,000
2.Cost of building$300,000
Less: Depreciation to 2004
2002 60,000
2003 48,000
Book value (January 1, 2004)$192,000
Less: Salvage value 30,000
Depreciable cost$162,000
Depreciation in 2004
($162,000 / 8) = $20,250
Depreciation Expense...... 20,250
Accumulated Depreciation-Building.... 20,250
3.Accumulated Depreciation—Machine...... 1,500
Retained Earnings...... 1,500
( [2002: $10,000* – $9,000** X 1/2 year]
+ [2003: $10,000* – $9,000**] )
*$80,000 ÷ 8 **($80,000 – $8,000) ÷ 8
(b)BRUEGGEN COMPANY
Comparative Income Statements
For the Years 2004 and 2003
20042003
Income before depreciation$300,000$310,000
Depreciation expense* 40,250 63,000
Net income$259,750$247,000
*Deprecation Expense20042003
Equipment$ 11,000$ 6,000
Building 20,250 48,000
Machine 9,000 9,000
$ 40,250$ 63,000
UPDATE PROBLEM 22-2(a)1.Bad debt expense for 2002 should not have been reduced by $12,000. A change in the experience rate is considered a change in estimate, which should be handled prospectively.
2.A change from LIFO to FIFO is considered a change in accounting principle, which must be handled retrospectively.
3.a.The inventory error in 2004 is a prior period adjustment and the 2004 and 2005 statements should be restated.
b.The lawsuit settlement is correctly treated.
(b)LARRY KINGSTON INC.
Comparative Income Statements
For the Years 2002 through 2005
2002 / 2003$125,000*** / 2004
$204,000 / 2005
$271,000
Income before extraordinary item / $143,000
Extraordinary gain / 40,000
Net income* / $143,000 / $165,000 / $204,000 / $271,000
*Computations:
2002$140,000 / 2003
$160,000 / 2004
$205,000 / 2005
$260,000**
Net income (unadjusted)
1.Bad debt expense adjustment / (12,000)
2.Inventory adjustment / 15,000 / 5,000 / 10,000
3.Inventory over-
statement / (11,000) / 11,000
4.Tax settlement
$143,000 / $165,000 / $204,000 / $271,000
**Reflects FIFO inventory for 2005
***$160,000 – $40,000 + $5,000 = $125,000
UPDATE PROBLEM 22-31.Retained Earnings...... 4,000
Sales Commissions Payable...... 2,500
Sales Commissions Expense...... 1,500
2.Cost of Sales ($21,000 + $6,700)...... 27,700
Retained Earnings...... 21,000
Inventory...... 6,700
Income Overstated (Understated)2003 / 2004
$16,000 / 2005
$21,000
Beginning inventory
Ending inventory / $(16,000) / (21,000) / 6,700
$(16,000) / $ (5,000) / $27,700
3.Accumulated Depreciation—Equipment...... 4,800
Depreciation Expense...... 4,800*
*Equipment cost$100,000
Depreciation before 2005 (36,000)
Book value$ 64,000
$64,000 / 8 = $ 8,000
Depreciation recorded 12,800
Difference$ 4,800
4.Construction in Process...... 55,000
Income Taxes Payable...... 22,000
Retained Earnings...... 33,000
UPDATE PROBLEM 22-4(a)PLATO CORPORATION
Projected Income Statement
For the Year Ended December 31, 2004
______
Sales$29,000,000
Cost of Goods Sold$14,000,000
Depreciation a 1,600,000
Operating Expenses 6,400,000 22,000,000
Income before Income Taxes$ 7,000,000
Unrealized Holding Gain b 2,000,000
Income before Taxes and Bonus$ 9,000,000
President’s Bonus 1,000,000
Income before Income Taxes$ 8,000,000
Provision for Income Taxes
Current$ 3,000,000
Deferred c 1,000,000 4,000,000
Net Income$ 4,000,000
Conditions met:
1.Net income before taxes and bonus > $8,000,000.
2.Payable for income taxes does not exceed $3,000,000.
aDepreciation for the current year includes $600,000 for the old equipment and $2,000,000 for the robotic equipment. If the robotic equipment is changed to straight-line, its depreciation is only $1,000,000 and the total is $1,600,000.
bBy urging the Board of Directors to change the classification of Securities A and D to Trading securities, income is increased by a $2,000,000 recognition of a holding gain.
cThe unrealized holding gain is not currently taxable.
(b)Students’ answers will vary.
There is nothing unethical about changing the first-year election of depreciation back to the straight-line method provided that it meets with the approval of appropriate corporate decision makers. Considering the immediate needs for cash of $1,000,000 for the
UPDATE PROBLEM 22-4 (Continued)
president’s bonus and $3,000,000 for income taxes, there may be a need to sell some of the marketable securities. Therefore, the transfer of $3,000,000 of available-for-sale securities to trading securities may also be appropriate.
It is naive to believe that corporate officers do no planning for year-end (or interim) financial statements. The slippery slope arises with manipulation of financial statements. The security reclassification for the selected securities clearly manipulates the income to the benefit of the president. While legal and within GAAP guidelines, the ethics of this situation are borderline. Any auditor would automatically bring this transaction to the attention of the board of directors.
Some stakeholders and their interests are:
Stakeholder / InterestsPresident / Personal gain of $1,000,000 bonus.
CFO / Placed in ethical dilemma between the interests of the president and the corporation.
Board of Directors / May be subject to the manipulations of the CEO for his personal gain.
Stockholders / Increased income from higher (paper) income may increase demand for dividends. Lower income from bonus may decrease cash available for dividends.
Employees / President takes 25% of net income for himself. For example, this could have been used to provide other benefits to all employees, such as a bonus or pension plan.
Creditors / The increased income represents a 33% infla-tion of the true net income of the corporation. This may lead to unreliable decisions of creditworthiness.
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