Chap 010

Chapter 10 Operational Assets: Acquisition and Disposition

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 379

Use the following to answer questions 38-42: 38-42. Listed below are ten terms followed by a list of phrases that describe or characterize five of

the terms. Match each phrase with the correct term placing the letter designating the best term in the space provided by the phrase.

Terms: a. Copyright b. Depletion c. Depreciation d. Donated assets e. Effective interest f. Goodwill g. Intangible assets h. Lump-sum purchase i. Patents j. Software development costs Phrases: 38. _____ Market rate times outstanding debt. 39. _____ Revenue recorded upon receipt from unrelated parties. 40. _____ Exclusive right to benefit from a creative work. 41. _____ Capitalized between points of technological feasibility and start of production. 42. _____ Price allocated in proportion to relative market values.

Answer: 38-E; 39-D; 40-A; 41-J; 42-H Multiple Choice Questions 43. Operational assets are: A) Created by the normal operation of the business and include accounts receivable. B) All assets except cash and cash equivalents. C) Current and long-term assets used in the production of either goods or services. D) Long-term revenue-producing assets.

Answer: D Learning Objective: 1 Level of Learning: 1

44. The acquisition costs of tangible operational assets do not include: A) The ordinary and necessary costs to bring the asset to its desired condition and location

for use. B) The net invoice price. C) Legal fees, delivery charges, installation, and any applicable sales tax. D) Maintenance costs during the first 30 days of use.



380 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition

45. Goodwill is: A) Amortized over the greater of its estimated life or forty years. B) Only recorded by the seller of a business. C) The excess of the fair market value of a business over the fair market value of all net

identifiable assets. D) Not subject to amortization for purposes of income taxes.

Answer: C Learning Objective: 1 Level of Learning: 1

46. Assets acquired in a lump-sum purchase are valued based on: A) Their assessed valuation. B) Their relative fair market values. C) The present value of their future cash flows. D) Their cost plus the difference between their cost and fair market values.

Answer: B Learning Objective: 2 Level of Learning: 1

47. Assets acquired under multi-year deferred payment contracts are: A) Valued at their fair value on the date of the final payment. B) Valued at the present value of the payments required by the contract. C) Valued at the sum of the payments required by the contract. D) None of the above.


48. Assets acquired by the issuance of equity securities are valued based on: A) Their fair market values. B) The fair market value of the equity securities. C) Whichever of A. or B. above is more reasonably determinable. D) Whichever of A. or B. above is smaller.


49. The basic principle used to value the asset acquired in a nonmonetary exchange is to value it at:

A) Fair value of the asset(s) given up. B) The book value of the asset given plus any cash or other monetary consideration received. C) Fair value or book value, whichever is smaller. D) Book value of the asset given.

Answer: A Learning Objective: 6 Level of Learning: 1

50. In nonmonetary exchanges, the asset received is not valued based on the fair value of the asset given up when:

A) When the fair value of the asset given is not determinable. B) When there is an exchange of similar assets with no cash received and a gain is indicated. C) When the exchange lacks commercial substance. D) All of the above are correct.




51. Interest is not capitalized for: A) Assets that are constructed as discrete projects. B) Assets constructed for sale or lease. C) Inventories routinely and repetitively produced in large quantities. D) Interest is capitalized for all of these items.


52. Average accumulated expenditures: A) Is an approximation of the average debt a firm would have outstanding if it financed all

construction through debt. B) May be computed as a simple average if all construction expenditures are made at the end

of the period. C) Are irrelevant if the company's total outstanding debt is less than total costs of

construction. D) All of the above are true statements.


53. Research and development (R&D) costs: A) Are always expensed in the period incurred. B) May be expensed or capitalized, at the option of the reporting entity. C) Must be capitalized and amortized. D) Generally pertain to activities that occur prior to the start of production.


54. Productive assets that are physically consumed in operations are: A) Equipment. B) Land. C) Land improvements. D) Natural resources.


55. An exclusive 20-year right to manufacture a product or use a product is a: A) Patent. B) Copyright. C) Trademark. D) Franchise.


56. The exclusive right to benefit from a creative work, such as a film, is a: A) Patent. B) Copyright. C) Trademark. D) Franchise.




57. The exclusive right to display a symbol of product identification is a: A) Patent. B) Copyright. C) Trademark. D) Franchise.


58. The capitalized cost of equipment excludes: A) Maintenance. B) Sales tax. C) Shipping. D) Installation.


59. Donated assets are recorded at: A) Zero (memo entry only). B) The donor's book value. C) The donee's stated value. D) Market value.


60. Until recently, the accounting treatment of nonmonetary asset exchanges depended on A) Whether the assets exchanged were similar or dissimilar. B) Whether a gain or loss was indicated in the exchange. C) Whether cash was given or received. D) All of the above factors.


61. If a company incurs disposition obligations as a result of acquiring an asset,: A) the company recognizes the obligation at fair value when the asset is acquired. B) the company recognizes the obligation at fair value when the asset is disposed. C) the company records the difference between the fair value of the asset and the obligation

when the asset is acquired. D) None of the above.


62. In a nonmonetary exchange of equipment, a gain is recognized if: A) The fair value of the equipment received exceeds the book value of the equipment

surrendered. B) The fair value of the equipment received exceeds the fair value of the equipment

surrendered. C) The fair value of the equipment surrendered exceeds the book value of the equipment

surrendered. D) None of the above is correct.




63. In accounting for oil and gas exploration costs, companies: A) May not use the full-cost method. B) May use the successful efforts method. C) May use the slippery slope method. D) All of the above are correct.


64. The fixed-asset turnover ratio provides: A) The rate of decline in asset lives. B) The rate of replacement of fixed assets. C) The amount of sales generated per dollar of fixed assets. D) The decline in book value of fixed assets compared to capital expenditures.


65. The cost of self-constructed fixed assets should: A) Include indirect costs allocated just as they are for production. B) Include only incremental indirect costs. C) Include only specifically identifiable indirect costs. D) Not include indirect costs.


66. Interest may be capitalized: A) On routinely manufactured goods as well as self-constructed assets. B) On self-constructed assets from the date an entity formally adopts a plan to build a

discrete project. C) Whether or not there is specific borrowing for the construction. D) Whether or not there are actual interest costs.


67. Research and development costs for projects other than software development should be: A) Expensed in the period incurred. B) Expensed in the period they are determined to be unsuccessful. C) Deferred pending determination of success. D) Expensed if unsuccessful, capitalized if successful.


68. Research and development expense for a given period includes: A) The full cost of a newly acquired operational asset that has an alternative future use. B) Depreciation on a research and development facility. C) Research and development conducted on a contract basis for another entity. D) Patent filing and legal costs.




69. Software development costs are capitalized if they are incurred: A) Prior to point at which technological feasibility has been established. B) After commercial production has begun. C) After technological feasibility has been established but prior to the product availability

date. D) None of the above is correct.


70. Amortization of capitalized computer software costs is: A) Either the percentage-of-revenue method or the straight-line method at the company's

option. B) The greater of the percentage-of-revenue method or the straight-line method. C) The lesser of the percentage-of-revenue method or the straight-line method. D) Based on neither the percentage-of-revenue nor the straight-line method.


71. When selling operational assets for cash: A) The seller recognizes a gain or loss for the difference between the cash received and the

fair value of the asset sold. B) The seller recognizes a gain or loss for the difference between the cash received and the

book value of the asset sold. C) The seller recognizes losses, but not gains. D) None of the above.


72. Interest is eligible to be capitalized as part of an asset's cost, rather than being expensed immediately when:

A) The interest is incurred during the construction period of the asset. B) The asset is a discrete construction project for sale or lease. C) The asset is self-constructed, rather than acquired. D) All of the above are correct.


73. In computing capitalized interest, average accumulated expenditures A) Are the simple arithmetic mean of all construction expenditures. B) Are determined by time-weighting individual expenditures made during the asset

construction period. C) Are multiplied by the company's most recent financing rates. D) All of the above are correct.




74. Asset retirement obligations: A) Increase the balance in the related asset account. B) Is measured at fair value in the balance sheet. C) Are liabilities associated with disposition of an operational asset. D) All of the above are correct.


75. Asset retirement obligations are recognized: A) When the related asset is retired or sold. B) In the period they are incurred. C) Gradually over the useful life of the related asset. D) When the related asset is acquired.


76. Which of the following does not pertain to accounting for asset retirement obligations? A) They accrete (increase over time) at the company's cost of capital. B) They must be recognized, according to SFAS 143. C) Statement of Financial Accounting Concepts No. 7 is used to adjust cash flow obligations

for uncertainty. D) All of the above pertain to accounting for asset retirement obligations.

Answer: A Learning Objective: 1 Level of Learning: 2 Rationale: Actually, the obligations accrete at the credit-adjusted risk free rate. Use the following to answer questions 77-78: Montana Mining Co. (MMC) paid $200 million for the right to explore and extract rare metals from land owned by the state of Montana. To obtain the rights, MMC agreed to restore the land to a suitable condition for other uses after its exploration and extraction activities. MMC incurred exploration and development costs of $60 million on the project. MMC has a credit-adjusted risk free interest rate is 7%. It estimates the possible cash flows for restoring the land, three years after completion of its extraction activities, as follows:

Cash Outflow Probability $10 million 60% $30 million 40%

77. The asset retirement obligation (rounded) that should be recognized by MMC upon

completion of the extraction activities is: A) $8.2 million B) $14.7 million C) $18 million D) $30 million

Answer: B Learning Objective: 1 Level of Learning: 3 Rationale: The present value of the expected cash flows, that is, 0.81630 x [(.60 x $10 million)

+ (.40 x $30 million)], which is $14,693,400 or $14.7 million (rounded).



78. The asset retirement obligation (rounded) that should be recognized by MMC one year after

completion of the extraction activities is: A) $0 B) $14.7 million C) $15.7 million D) $19.3 million

Answer: C Learning Objective: 1 Level of Learning: 3 Rationale: $14.7 million x 1.07 = $15.7 million (rounded). Use the following to answer questions 79-81: On June 1, 2005, the Crocus Company began construction of a new manufacturing plant. The plant was completed on October 31, 2006. Expenditures on the project were as follows (in $ millions):

July 1, 2005 54 October 1, 2005 22 February 1, 2006 30 April 1, 2006 21 September 1, 2006 20 October 1, 2006 6

On July 1, 2005, Crocus obtained a $60 million construction loan with a 6% interest rate. The loan was outstanding through the end of October, 2006. The company's other interest-bearing debt was a long-term note for $100 million with an interest rate of 8%. This note was outstanding during all of 2005 and 2006. The company's fiscal year-end is December 31. 79. What is the amount of interest that Crocus should capitalize in 2005, using the specific interest

method? A) $1.90 million B) $1.95 million C) $2.96 million D) None of the above is correct.

Answer: B Learning Objective: 7 Level of Learning: 3 Rationale: Average expenditures for 2005: ($54 million x 6/6) + $22 million x 3/6) = $65 million. The

interest is $65 million x .06 x 6/12 = $1.95 million. 80. In computing the capitalized interest for 2006, Crocus' average accumulated expenditures

total: A) $46.30 million B) $103.54 million C) $122.30 million D) $124.25 million

Answer: D Learning Objective: 7 Level of Learning: 3 Rationale: The correct answer is: [from 2005 ($77.95 million x 10/10) + ($30 million x

9/10) + ($21 million x 7/10) + ($20 million x 2/10) + ($6 million x 1/10) = $124.25 million.



81. What is the amount of interest that Crocus should capitalize in 2006, using the specific interest

method (rounded to the nearest thousand dollars)? A) $7,248,000 (rounded) B) $7,283,000 (rounded) C) $8,740,000 (rounded) D) None of the above is correct.

Answer: B Learning Objective: 7 Level of Learning: 3 Rationale: Of the average accumulated expenditures ($124.25 million from question 80), $60

million was financed at 6% for 10 months in 2006, and the remainder of $64.25 million was financed at 8% for that period. The total interest cost was $7,283,000 (rounded).

82. Grab Manufacturing Co. purchased a ten-ton draw press at a cost of $180,000 with terms of

5/15 n/45. Payment was made within the discount period. Shipping costs were $4,600, which included $200 for insurance in transit. Installation costs totaled $12,000, which included $4,000 for taking out a section of a wall and rebuilding it because the press was too large for the doorway. The capitalized cost of the ten-ton draw press is:

A) $171,000. B) $183,600. C) $187,600. D) $185,760.

Answer: C Learning Objective: 1 Level of Learning: 3 Rationale:

Purchase price ($180,000 x 95%) $171,000 Shipping Costs 4,600 Installation costs 12,000 Total cost of equipment $187,600

83. Holiday Laboratories purchased a high speed industrial centrifuge at a cost of $420,000.

Shipping costs totaled $15,000. Foundation work to house the centrifuge cost $8,000. An additional water line had to be run to the equipment at a cost of $3,000. Labor and testing costs totaled $6,000. Materials used up in testing cost $3,000. The capitalized cost is:

A) $455,000. B) $446,000. C) $437,000. D) $435,000.

Answer: A Learning Objective: 1 Level of Learning: 3 Rationale:

Purchase price $420,000 Shipping Costs 15,000 Foundation work 8,000 Water line 3,000 Labor and testing 6,000 Materials used in testing 3,000 Total cost of equipment $455,000



84. Vijay Inc. purchased a 3-acre tract of land for a building site for $320,000. On the land was a

building with an appraised value of $120,000. The company demolished the old building at a cost of $12,000, but was able to sell scrap from the building for $1,500. The cost of title insurance was $900 and attorney fees for reviewing the contract was $500. Property taxes paid were $3,000, of which $250 covered the period subsequent to the purchase date. The capitalized cost of the land is:

A) $336,400. B) $336,150. C) $334,650. D) $201,150.


Purchase price $320,000 Demolition costs 12,000 Scrap sold (1,500 ) Title insurance 900 Legal fees 500 Property taxes ($3,000 250) 2,750 Total cost of land $334,650

85. Juliana Corporation purchased all of the outstanding stock of Caldwell Inc., paying

$2,700,000 cash. Juliana assumed all of the liabilities. Book values and fair values of acquired assets and liabilities were:

Book value Fair Value Current assets (net) $420,000 $450,000 Property, plant, & equip. (net) 1,600,000 2,250,000 Liabilities 500,000 600,000

Juliana would record goodwill of: A) $1,180,000. B) $600,000. C) $880,000. D) $100,000.

Answer: B Learning Objective: 1 Level of Learning: 3 Rationale:

Purchase price $2,700,000 Less: Fair value of net assets Assets ($450,000 + 2,250,000) $2,700,000 Less: Liabilities assumed (600,000 ) (2,100,000 ) Goodwill $ 600,000



86. Lake Incorporated purchased all of the outstanding stock of Huron Company paying $950,000

cash. Lake assumed all of the liabilities. Book values and fair values of acquired assets and liabilities were:

Book Value Fair Value Current assets (net) $130,000 $125,000 Property, plant, equip. (net) 600,000 750,000 Liabilities 150,000 175,000

Lake would record goodwill of: A) $ 0. B) $ 75,000. C) $445,000. D) $250,000

Answer: D Learning Objective: 1 Level of Learning: 3 Rationale:

Purchase price $950,000 Less: Fair value of net assets Assets ($125,000 + 750,000) $875,000 Less: Liabilities assumed 175,000 (700,000 ) Goodwill $ 250,000

87. Alamos Co. exchanged land and $18,000 cash for equipment. The book value and the fair

value of the land were $82,000 and $90,000, respectively. Which of the following choices would be correct?

Alamos would record equipment at and record a gain/(loss) of: A) $ 82,000; $ 8,000 B) $108,000; $ 8,000 C) $ 82,000; $(8,000) D) $108,000; $(8,000)


Equipment (FV of land + $18,000) 108,000 Cash 18,000 Land (book value) 82,000 Gain ($90,000 82,000) 8,000



88. Bloomington Inc. exchanged land for equipment and $3,000 in cash. The book value and the

fair value of the land were $104,000 and $90,000, respectively. Which of the following choices would be correct?

Bloomington would record equipment at and record a gain/(loss) of: A) $ 87,000; $ 3,000 B) $104,000; $ (5,000) C) $ 87,000; $(14,000) D) None of the above is correct.


Equipment (FV of land - $3,000) 87,000 Cash 3,000 Loss ($104,000 90,000) 14,000 Land (book value) 104,000

89. P. Chang & Co. exchanged land and $9,000 cash for equipment. The book value and the fair

value of the land were $106,000 and $90,000, respectively. Which of the following choices would be correct?

Chang would record equipment at and record a gain/(loss) of: A) $ 99,000; $(16,000) B) $ 90,000; $(25,000) C) $108,000; $ 16,000 D) $106,000; $( 9,000)


Equipment (FV of land + $9,000) 99,000 Loss ($106,000 90,000) 16,000 Cash 9,000 Land (book value) 106,000

90. Horton Stores exchanged land for equipment and received $5,000 in cash. The book value and

the fair value of the land were $100,000 and $90,000, respectively. Which of the following choices would be correct?

Horton would record equipment at and record a gain/(loss) of: A) $90,000; $ 5,000 B) $85,000; $(10,000) C) $95,000; $ 0 D) $90,000; $(10,000)


Equipment (FV of land $5,000) 85,000 Cash 5,000 Loss ($100,000 90,000) 10,000 Land (book value) 100,000



Use the following to answer questions 91-92: Below are data relative to an exchange of similar assets by Grand Forks Corp. Old Equipment Cash Book Value Fair Value Paid Case A $50,000 $60,000 $15,000 Case B $40,000 $35,000 $ 8,000 91. In Case A, Grand Forks would record the new equipment at: A) $65,000. B) $75,000. C) $50,000. D) $60,000.


Equipment ($60,000 + 15,000) 75,000 Cash 15,000 Equipment-old (book value) 50,000 Gain 10,000

92. In Case B, Grand Forks would record a gain/(loss) of: A) $ 5,000 B) $ 3,000 C) $(5,000) D) $(3,000)


Equipment ($35,000 + 8,000) 43,000 Loss ($40,000 35,000) 5,000 Cash 8,000 Equipment-old (book value) 40,000

Use the following to answer questions 93-94: Below are listed data relative to an exchange of equipment by Pensacola Inc. Old Equipment Cash Book Value Fair Value Received Case A $75,000 $80,000 $12,000 Case B $60,000 $56,000 $10,000



93. In Case A, Pensacola would record the new equipment at: A) $68,000. B) $63,750. C) $67,250. D) $80,000.


Equipment- new ($80,000 12,000) 68,000 Cash 12,000 Equipment-old (book value) 75,000 Gain 5,000

94. In Case B, Pensacola would record a gain/(loss) of: A) $ 4,000. B) $ (4,000). C) $ (10,000). D) None of the above is correct.


Equipment new ($56,000 10,000) 46,000 Cash 10,000 Loss 4,000 Equipment-old (book value) 60,000

Use the following to answer questions 95-98: On January 1, 2006, Kendall Inc. began construction of an automated cattle feeder system. The system was finished and ready for use on September 30, 2007. Expenditures on the project were as follows: January 1, 2006 $200,000 September 1, 2006 $300,000 December 31, 2006 $300,000 March 31, 2007 $300,000 September 30, 2007 $200,000 Kendall borrowed $750,000 on a construction loan at 12% interest on January 1, 2006. These loans were outstanding throughout the construction period. The company had $4,500,000 in 9% bonds outstanding in 2006 and 2007.



95. Average accumulated expenditures for 2006 was: A) $300,000. B) $350,000. C) $500,000. D) $400,000.


January 1, 2006 $200,000 x 12/12 = $200,000September 1, 2006 300,000 x 4/12 = 100,000December 31, 2006 300,000 x 0/12 = 0 $800,000 $300,000

96. Interest capitalized for 2006 was: A) $48,000. B) $42,000. C) $60,000. D) $36,000.

Answer: D Learning Objective: 7 Level of Learning: 3 Rationale: $300,000 (determined above) x 12% = $36,000 97. Average accumulated expenditures for 2007 by the end of the construction period was: A) $1,300,000. B) $1,236,000. C) $1,200,000. D) $1,036,000.

Answer: D Learning Objective: 7 Level of Learning: 3 Rationale:

Accumulated expenditures at 12/31/06 (determined above) $ 836,000 x 9/9 = $836,000 March 31, 2007 300,000 x 6/9 = 200,000 September 30, 2007 200,000 x 0/9 = 0 $1,336,000 $1,036,000

98. Interest capitalized for 2007 was: A) $104,625. B) $86,805 C) $97,875. D) $67,500.


Total $1,036,000 (determined above) = Specific borrowing 750,000 x 12% x 9/12 = $67,500 Excess 286,000 x 9% x 9/12 = 19,305 Capitalized interest $86,805



Use the following to answer questions 99-102: On January 1, 2006, Dreamworld Co. began construction of a new warehouse. The building was finished and ready for use on September 30, 2007. Expenditures on the project were as follows: January 1, 2006 $300,000 September 1, 2006 $450,000 December 31, 2006 $450,000 March 31, 2007 $450,000 September 30, 2007 $300,000 Dreamworld had $5,000,000 in 12% bonds outstanding through both years. 99. Dreamworld's average accumulated expenditures for 2006 was: A) $300,000. B) $450,000. C) $525,000. D) $600,000.


January 1, 2006 $300,000 x 12/12 = $300,000 September 1, 2006 450,000 x 4/12 = 150,000 December 31, 2006 450,000 x 0/12 = 0 $1,200,000 $450,000

100. Dreamworld's capitalized interest in 2006 was: A) $72,000. B) $63,000. C) $54,000. D) $36,000.

Answer: C Learning Objective: 7 Level of Learning: 3 Rationale: $450,000 (determined above) x 12% = $54,000 101. The average accumulated expenditures for 2007 by the end of the construction period was: A) $1,950,000. B) $1,554,000. C) $1,254,000. D) $975,000.


Accumulated expenditures at 12/31/06 (determined above) $ 1,254,000 x 9/9 = $1,254,000 March 31, 2007 450,000 x 6/9 = 300,000 September 30, 2007 300,000 x 0/9 = 0 $2,004,000 $1,554,000



102. What was the final cost of Dreamworld's warehouse? A) $2,154,480. B) $2,143,860. C) $1,950,000. D) $1,254,000.


Accumulated expenditures at 9/31/07 before 2207 interest(determined above) $ 2,004,000 2007 interest capitalized $1,554,000 x 12% x 9/12 139,860 Total capitalized cost $2,143,860

103. On July 1, 2006, Larkin Co. purchased a $400,000 tract of land that is intended to be the site

of a new office complex. Larkin incurred additional costs and realized salvage proceeds during 2006 as follows:

Demolition of existing building on site $75,000 Legal and other fees to close escrow 12,000 Proceeds from sale of demolition scrap 10,000

What would be the balance in the land account as of December 31, 2006? A) $400,000. B) $475,000. C) $477,000. D) $487,000.


Purchase price $400,000 Demolition costs 75,000 Legal fees 12,000 Sale of scrap (10,000 ) Total cost of land $477,000

104. In the current year Tool Corp. purchased Patent X for $42,000 and Patent Y for $38,000.

Additional acquisition costs for X and Y were $7,000 and $5,000, respectively. Tool also paid litigation costs for patent infringement on X and Y of $40,000 and $30,000, respectively. The X litigation was unsuccessful. The Y litigation was successful. What amount should Tool capitalize for patents?

A) $ 73,000. B) $162,000. C) $ 43,000. D) $ 92,000.

Answer: A Learning Objective: 8 Level of Learning: 3 Rationale: Since the defense of Patent X was unsuccessful, the patent will not provide future benefits for

the company. Only the costs associated with Patent Y should be capitalized: $38,000 + 5,000 + 30,000 = $73,000



105. Liddy Corp. began constructing a new warehouse for its operations during the current year. In

the year Liddy incurred interest of $30,000 on a working capital loan, and interest on a construction loan for the warehouse of $60,000. Interest computed on the average accumulated expenditures for the warehouse construction was $50,000. What amount of interest should Liddy expense for the year?

A) $ 30,000. B) $ 40,000. C) $ 90,000. D) $140,000.


Total interest cost incurred ($30,000 + 60,000) $90,000 Interest capitalized (50,000 ) Interest expense $40,000

106. During 2006, the Longhorn Oil Company incurred $5,000,000 in exploration costs for each of

20 oil wells drilled in 2006 in west Texas. Of the 20 wells drilled, 14 were dry holes. Longhorn uses the successful efforts method of accounting. Assuming that none of the oil found is depleted in 2006, what oil exploration expense would Longhorn charge for this activity in its 2006 income statement?

A) $ 0 B) $30 million C) $70 million D) $100 million

Answer: C Learning Objective: 1 Level of Learning: 3 Rationale: Expense the dry holes -- $100 million x (14/20) = $70 million 107. During 2006, Prospect Oil Corporation incurred $4,000,000 in exploration costs for each of 15

oil wells drilled in 2006. Of the 15 wells drilled, 10 were dry holes. Prospect uses the successful efforts method of accounting. Assuming that Prospect depletes 30% of the oil discovered in 2006, what amount of these exploration costs would remain on its 12/31/06 balance sheet?

A) $6 million B) $14 million C) $20 million D) $42 million

Answer: B Learning Objective: 1 Level of Learning: 3 Rationale: Capitalize the wells that are not dry holes: 5 x $4 million = $20 million. Of this,

30% is depleted in 2006 and the rest remains on the balance sheet. Therefore, 70% of $20 million remains = $14 million.



Problems 108. On July 1, 2006, Jekel & Hyde Inc. purchased land and incurred other costs relative to the

construction of a new warehouse. A summary of economic activities is listed below:

Purchase price $185,000 Title insurance $1,500 Legal fees to purchase land $1,000 Cost of razing old building on lot 8,500 Proceeds from sale of salvageable materials (1,200) Property taxes, January 1, 2006 - June 30, 2006 3,000 Cost of grading and filling building site 9,000 Cost of building construction 620,000 Interest on construction loan 12,000 Cost of constructing driveway 8,000 Cost of parking lot and fencing 12,000

Required:

Indicate the accounts that would be affected by the above transactions and the resulting balance in each account. Apply the interest on the construction loan to the cost of the building only.

Answer: Land: Purchase price $185,000 Title insurance 1,500 Legal fees 1,000 Cost of razing old building $8,500 Proceeds from sale of salvaged materials (1,200) 7,300 Property tax prior to 6/30 3,000 Cost of grading and filling building site 9,000 Total $206,800 Building: Cost of building construction $620,000 Interest on construction loan 12,000 Total $632,000 Land improvements: Driveway $ 8,000 Parking lot and fencing 12,000 Total $20,000 Learning Objective: 1 Level of Learning: 3



109. Mad Hatter Enterprises purchased new equipment for $365,000, FOB shipping point. Other

costs connected with the purchase were as follows:

State sales tax 29,200 Freight costs 5,600 Insurance while in transit 800 Insurance after equipment placed in service 1,200 Installation costs 2,000 Testing, including $300 of spoilage 700

Required:

Determine the capitalized cost of the equipment.

Answer: Purchase price $365,000 Sales tax 29,200 Freight 5,600 Insurance-shipping 800 Installation 2,000 Testing 700 Total cost of equipment $403,300 Learning Objective: 1 Level of Learning: 3

110. During the current year, Brewer Company purchased all of the outstanding common stock of Miller Inc. paying $12,000,000 cash. The book values and fair values of Miller's assets and liabilities acquired are listed below:

Book Value Fair Value Accounts receivable $1,800,000 $ 1,625,000 Inventories 2,700,000 4,000,000 Property, plant, and equipment 9,000,000 11,625,000 Accounts payable 3,000,000 3,000,000 Bonds payable 4,500,000 4,125,000

Required:

Prepare the journal entry to record the acquisition by Brewer Company.

Answer: Accounts receivable 1,625,000 Inventory 4,000,000 Property, plant, and equipment 11,625,000 Goodwill 1,875,000 Accounts payable 3,000,000 Bonds payable 4,125,000 Cash 12,000,000 Learning Objective: 1 Level of Learning: 3



111. On August 15, 2006, Willis Inc. purchased all of the outstanding common stock of Bork Inc. paying $7,400,000 cash. The book values and fair values of Willis' assets and liabilities are listed below:

Book Value Fair Value Accounts receivable $1,080,000 $ 975,000Inventories 1,620,000 2,400,000Property, plant, and equipment 5,400,000 6,975,000Accounts payable 1,800,000 1,800,000Bonds payable 2,700,000 2,475,000

Required:

Prepare the journal entry to record the acquisition by Willis Inc.

Answer: Accounts receivable 975,000 Inventory 2,400,000 Property, plant, and equipment 6,975,000 Goodwill 1,325,000 Accounts payable 1,800,000 Bonds payable 2,475,000 Cash 7,400,000 Learning Objective: 1 Level of Learning: 3

112. Watson Company purchased assets of Holmes Ltd. at auction for $1,300,000. An independent appraisal of the market value of the assets acquired is listed below:

Land $214,500Building 357,500Equipment 572,000Inventories 286,000

Required:

Prepare the journal entry to record the purchase of the assets.

Answer: Appraised Allocated Values Percent Costs Land $ 214,500 15% $ 195,000Building 357,500 25 325,000Equipment 572,000 40 520,000Inventory 286,000 20 260,000 $1,430,000 100% $1,300,000 Land 195,000 Building 325,000 Equipment 520,000 Inventory 260,000 Cash 1,300,000 Learning Objective: 2 Level of Learning: 3



113. Eli Company purchased assets of Whitney Inc. at auction for $1,560,000. An independent

appraisal of the market value of the assets acquired is listed below:

Land $171,600 Building 514,800 Equipment 600,600 Inventories 429,000

Required:

Prepare the journal entry to record the purchase of the assets.

Answer: Appraised Allocated Values Percent Costs Land $171,600 10% $156,000 Building 514,800 30 468,000 Equipment 600,600 35 546,000 Inventory 429,000 25 390,000 $1,716,000 100% $1,560,000 Land 156,000 Building 468,000 Equipment 546,000 Inventory 390,000 Cash 1,560,000 Learning Objective: 2 Level of Learning: 3

114. Beacon Inc. received a gift of land and building in the Twin Pines Park as an inducement to relocate. The land and buildings have fair market values of $45,000 and $455,000.

Required: Prepare journal entries to record the above transactions.

Answer: Land 45,000 Buildings 455,000 Revenue-donation of assets 500,000

Learning Objective: 4 Level of Learning: 3



115. Cool Globe Inc. entered into two transactions, as follows:

(a.) They purchased equipment paying $20,000 down and signed a noninterest-bearing note requiring the balance to be paid in four annual installments of $20,000 on the anniversary date of the contract. Based on Bright Light's 12% borrowing rate for such transactions, the implicit interest cost is $19,253.

(b.) They purchased a tract of land in exchange for $10,000 cash down payment and a noninterest-bearing note requiring five $10,000 annual payments, with the first annual payment in one year. The fair market value of the land is $46,000.

Required:

Prepare the journal entries for these transactions.

Answer: (a.) Equipment 80,747 Discount on notes payable 19,253 Notes payable 80,000 Cash 20,000 (b.) Land 46,000 Discount on notes payable 14,000 Cash 10,000 Notes payable 50,000


116. Wendell Corporation exchanged an old truck and $25,500 cash for a new truck. The old truck had a book value of $6,000 and a market value of $7,700.

Required:

Prepare the journal entry to record the exchange.

Answer: Truck (new) 33,200 Gain 1,700 Cash 25,500 Truck (old), net 6,000


117. Kerry, Inc. exchanged land for a front-end loader and cash of $8,000. The land had a book value of $55,000 and a market value of $60,000.

Required:


Answer: Equipment 68,000 Gain 5,000 Cash 8,000 Land 55,000




118. Peanut Corporation exchanged land for a front-end loader and cash of $6,500. The land had a

book value of $45,000 and a market value of $34,000. Required:


Answer: Equipment 40,500 Loss 11,000 Cash 6,500 Land 45,000


119. Ford Inc. exchanged land and $7,500 cash for material handling equipment. The land had a book value of $75,000 and a market value of $105,000.

Required:




120. Walker Corporation exchanged land and $4,500 cash for material handling equipment. The land had a book value of $45,000 and a market value of $58,000.

Required:






121. Cheney Company sold a 20-ton mechanical draw press for $60,000. The old draw press cost

$77,000 and had a net book value of $55,000. Required:

Prepare the journal entry to record the disposition.

Answer: Cash 60,000 Accumulated depreciation 22,000 Equipment 77,000 Gain on disposal of equipment 5,000


122. McLean Mfg. Company sold a three-speed lathe for $24,000 cash. The lathe cost $66,200 and had a net book value of $23,200.

Required:

Prepare the journal entry to record the sale.

Answer: Cash 24,000 Accumulated depreciation 43,000 Equipment 66,200 Gain 800


123. Champion Industries exchanged a dust-scrubbing piece of equipment for another version of the same type of equipment and received $12,000 cash. The old dust scrubber cost $76,200 and had a net book value of $54,500. The new dust scrubber had a fair market value of $58,500.

Required:


Answer: Equipment - new 58,500 Cash 12,000 Accumulated depreciation 21,700 Equipment - old 76,200 Gain 16,000 Learning Objective: 6 Level of Learning: 3



124. Agasse Industries took out a $1,500,000, 8% construction loan on January 1, 2006, to build a

new production facility. Construction started on April 1. Agasse made payments to the general contractor of $400,000 on June 30, $900,000 on August 31, and $500,000 on December 31.

Required:

Compute the amount of interest that Agasse would capitalize in 2006.

Answer: Expenditures 6/30 $400,000 x 6/12= $200,000 8/31 900,000 x 4/12= 300,000 Average accumulated expenditures for 2006 $500,000 Interest capitalized in 2006 = $500,000 x 8% = $40,000


125. Montgomery Industries spent $600,000 in 2005 on a construction project to build a library. Montgomery also capitalized $30,000 of interest on the project in 2005. Montgomery financed 100% of the construction with a 10% construction loan. The project was completed on September 30, 2006. Additional expenditures in 2006 were as follows:

Feb. 28 90,000 Apr. 30 180,000 Jul. 1 36,000 Sept. 30 64,000

Required:

Determine the completed cost of the library. Show well labeled supporting computations.

Answer: Expenditures Accumulated expenditures 12/31/2005 $630,000 x 9/9 = $

630,000 2/28/2006 90,000 x 7/9 = 70,000 4/30/2006 180,000 x 5/9 = 100,000 7/1/2006 36,000 x 3/9 = 12,000 9/30/2006 64,000 x 0/9 = 0 Average accumulated expenditures for 2006 $812,000 Interest capitalized in 2006 ($812,000 x 10% x 9/12) 60,900 Completed cost of the library $1,060,900




126. During the current year, Peterson Data Corporation purchased all of the outstanding common

stock of Junior Jackson Inc. (JJI), paying $36 million in cash. Peterson recorded the assets acquired as follows:

Accounts receivable $2,500,000Inventory 9,000,000Property, plant, and equipment 25,500,000Goodwill 6,000,000

The book value of JJI's assets and owners' equity before the acquisition were $22 million and

$18 million, respectively. Required: Compute the fair value of JJI's liabilities that Peterson incurred in the acquisition.

Answer: Fair value of assets Fair value of liabilities = Cash paid Therefore, Fair value of liabilities = Fair value of assets Cash paid = $43 million 36 million = $7 million. Learning Objective: 7 Level of Learning: 3

127. During the current year, Compton Crate Corporation purchased all of the outstanding common stock of Little Lacy Ltd. (LLL), paying $60 million in cash. Compton recorded the assets acquired as follows:

Accounts receivable $5,500,000Inventory 18,000,000Property, plant, and equipment 45,500,000Goodwill 22,000,000

The book value of LLL's assets and owners' equity before the acquisition were $50 million

and $30 million, respectively. Required: Compute the fair value of LLL's liabilities that Compton incurred in the

acquisition.

Answer: Fair value of assets Fair value of liabilities = Cash paid Therefore, Fair value of liabilities = Fair value of assets Cash paid = $91 million 60 million = $31 million. Learning Objective: 7 Level of Learning: 3



Use the following to answer questions 128-129: In its 2004 annual report to shareholders, Boston Beer Co. disclosed the following footnote: E. Property, Plant and Equipment

Property, plant and equipment for the years ended December 25, 2004 and December 27, 2003 consisted of the following (in thousands): 2004 2003 Kegs $ 25,427 $ 23,404 Plant and 20,359 19,185 machinery Office equipment 6,791 5,937 and furniture Leasehold 3,861 3,604 improvements Land 350 350 Building 1,420 1,420 $ 58,208 $ 53,900 Less accumulated 40,996 36,841 depreciation _______ _______ $ 17,212 $ 17,059 The Company recorded depreciation expense related to these assets of $4.4 million and $4.7 million for the years ended December 25, 2004 and December 27, 2003, respectively. Also, Boston Beer reported the following information in the annual report (in thousands): Years ended 12/25/04 12/27/03 Cash flows for investing activities: Purchases of property, (4,559 ) (1,729 ) plant and equipment (PPE) Proceeds on disposal of 4 32 fixed assets (PPE) Required:



128. Use a T- account to show the balances and changes during 2004 in Boston Beer's: Property,

Plant and Equipment account and its Accumulated depreciationProperty, Plant & equipment account.

Answer: Property Plant & Equipment Acc.Deprec.-- Property Plant & Equipment

Beg. Balance 53,900 36,841 Beg. Balance Purchases 4,559 Disposals 251 Acc. Deprec. 4,400 Depreciation Exp. On disposals 245

End. Balance 58,208 40,996 End. Balance Learning Objective: 1 Level of Learning: 3

129. Show the journal entry to record Boston Beer's disposal of the PPE during 2004.

Answer: Cash 4 Acc. Deprec. 245 Loss on disposal 2 PPE 251 Learning Objective: 1 Level of Learning: 3

Use the following to answer questions 130-131: In its 2004 annual report to shareholders, Plank Breweries disclosed the following footnote: 4. Fixed Assets

Fixed assets consist of the following (in $ thousands): December 31,

2004 2003 Brewery and retail $ 14,465 $ 14,246 equipment Furniture and fixtures 918 772 Leasehold improvements 13,808 13,563 Construction in 584 165 progress Assets held for sale 4

29,775 28,750 Less accumulated (9,555 ) (7,625 ) depreciation __________ __________ $ 20,220 $ 21,125 Total depreciation expense was approximately $2.121 million and $2.179 million for the years ended December 31, 2004 and 2003, respectively.



Also, Plank Breweries reported the following information in its annual report (in $ thousands): Years Ended December 31, 2004 2003 Acquisition of fixed assets 1,279 808 Proceeds from sale of fixed assets 15 157 Required: 130. Use a T- account to show the balances and changes during 2004 in Plank Breweries: Fixed assets account and Accumulated depreciationfixed assets account (in $ thousands).

Answer: Fixed assets Acc.Deprec.-- Fixed assets

Beg. Balance 28,750 7,625 Beg. Balance Purchases 1,279 Disposals 254 Acc. Deprec. 2,121 Depreciation Exp. on disposals 191

End. Balance 29,775 9,555 End. Balance Learning Objective: 1 Level of Learning: 3

131. Show the journal entry to record Plank's disposal of the fixed assets during 2004.

Answer: Cash 15 Acc. Deprec. 191 Loss on disposal 47 Fixed assets 253 Learning Objective: 1 Level of Learning: 3



132. In its 2004 annual report to shareholders, Custard Cup Inc. disclosed the following footnote: Note 4 Property, Plant and Equipment

Property, plant and equipment (PPE) at December 31, 2004, and December 31, 2003, consisted of the following:

2001 2000 (In millions) Machinery and equipment $244 $237 Buildings and 90 89 improvements Office furniture and 6 6 fixtures _______ _______ 340 332 Less: Accumulated 183 165 depreciation and amortization _______ _______ 157 167 Land 15 15 Construction in progress 24 6 $196 $188

Depreciation expense for property, plant and equipment was $26 million in 2004. Required: Compute the Accumulated depreciation on PPE disposed of by Custard Cup during

2004.

Answer: Acc.Deprec.-- Property Plant & Equipment (in millions)

165 Beg. Balance Acc. Deprec. 26 Depreciation Exp. On disposals 8

183 End. Balance

Learning Objective: 1 Level of Learning: 3 Essay

Instructions: The following answers point out the key phrases that should appear in students' answers. They are not intended to be examples of complete student responses. It might be helpful to provide detailed instructions to students on how brief or in-depth you want their answers to be. 133. How are donated assets recorded?

Answer: Debit the asset account for FMV based on available market price data or appraisal. Credit a revenue from donation account. Learning Objective: 4 Level of Learning: 2



134. How are assets valued when they are acquired by issuing stock?

Answer: Record the asset at FMV of the asset or the security, whichever is more clearly evident. Learning Objective: 2 Level of Learning: 2

135. Why are software development costs treated differently than other types of R&D?

Answer: The problem with attempting to capitalize R&D in most situations is the determination of a future benefit. With software development, a point of technological feasibility can be determined and a reasonable future benefit estimated. Learning Objective: 8 Level of Learning: 2

136. Explain the appropriate accounting method used to account for lump sum purchases of a group of operational assets?

Answer: Such purchases require that the lump sum price be allocated among the assets acquired so that each may be accounted for individually in subsequent periods. To do so, the relative values of the assets acquired form a pro rated allocation of the lump sum cost. The rationale is that there is an implicit discount for the lump sum purchase that is divided among the individual items as a proportion of their own values. Learning Objective: 3 Level of Learning: 2

137. What disclosures are required relative to interest costs incurred during the year?

Answer: Disclose the total amount of interest costs incurred and the amount of interest capitalized. Interest expense is reported in the income statement. Learning Objective: 7 Level of Learning: 2

138. When is interest capitalized? Briefly describe how the amount to be capitalized is computed.

Answer: Interest is capitalized during the construction period for self-constructed assets and for assets constructed as discrete projects for sale or lease, but not for items that are routinely manufactured. The amount of interest capitalized is equal to the average accumulated expenditures multiplied by the appropriate interest rates, not to exceed the actual interest cost incurred. Learning Objective: 7 Level of Learning: 2

139. Briefly explain how R & D is reported in financial statements.

Answer: Most R & D costs are expensed in the periods incurred, and GAAP requires that total R&D expense incurred must be disclosed in a note or as a separate line item. R&D performed for others would be recorded as inventory and eventually would be included in cost of goods sold. Learning Objective: 8 Level of Learning: 2



140. Kellogg Company and its subsidiaries are engaged in the manufacture and marketing of ready-

to-eat cereal and convenience foods. In its annual report to shareholders, Kellogg disclosed the following:

DISPOSITIONS Last year, the Company sold certain assets and liabilities of the Lender's Bagels business to

Aurora Foods Inc. for $275 million in cash. As a result of this transaction, the Company recorded a pretax charge of $178.9 million ($119.3 million after tax or $.29 per share). This charge included approximately $57 million for disposal of other assets associated with the Lender's business, which were not purchased by Aurora. Disposal of these other assets was completed during the current year. The original reserve of $57 million exceeded actual losses from asset sales and related disposal costs by approximately $9 million. This amount was recorded as a credit to other income (expense), net during the current year.

Required:

Explain how the Kellogg transactions described could be interpreted as an example of earnings management.

Answer: The disposal of assets required Kellogg to anticipate (and create an allowance for) a loss on the disposition. Last year, Kellogg's recorded loss was greater than ultimately required. As a result, they reversed the loss by increasing income in the current year. This is an example of a cookie jar reserve, much like that described for allowances for uncollectible accounts in Chapter 7. Learning Objective: 1 Level of Learning: 3

141. Why would an oil company argue to use the full-cost method of accounting for oil and gas exploration costs?

Answer: Under the full-cost method, oil and gas exploration costs are capitalized, whether or not the specific well explored is successful in finding reserves. The basis for this is that the exploration program is the unit of investment, a portfolio of exploration efforts, and the success of the program, not individual wells is the relevant basis for developing assets (reserves). The full-cost method tends to be favored by smaller companies, whose smaller numbers of explorations naturally give it less diversification that a large company can generate by its exploration program. These companies argue that they are disadvantaged in the capital market by having to use the same accounting as the larger, more diversified companies. Learning Objective: 1 Level of Learning: 3



142. Peoplesoft recorded capitalized software amortization, included in Cost of license fees in the

accompanying consolidated statements of operations, of $36.8 million in 2003, $14.4 million in 2002 and $6.5 million in 2001.

Peoplesoft accounts for the development cost of software intended for sale in accordance with

Statement of Financial Accounting Standards No. 86, Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, (SFAS 86). SFAS 86 requires product development costs to be charged to expense as incurred until technological feasibility is attained. Technological feasibility is attained when the Company s software has completed system testing and has been determined viable for its intended use. The time between the attainment of technological feasibility and completion of software development has been short with immaterial amounts of development costs incurred during this period. Accordingly, the Company did not capitalize material amounts of development costs in 2003 or 2002, other than product development costs acquired through business combinations or purchased from third parties. The Company capitalizes software acquired through technology purchases and business combinations if the related software under development has reached technological feasibility or if there are alternative future uses for the software.

Required:

Describe how software companies like Peoplesoft treat software development costs differently from the typical GAAP treatment of research and development costs in other industries. Why is this the case?

Answer: SFAS 86 calls for software developers to capitalize costs associated with developing products after technological feasibility is established. This is an exception to the general rule in GAAP that research and development expenditures be expensed when incurred. This is due in part to the political clout of the software industry and to the unique nature of the software business in which the product's future earnings potential passes the critical juncture of technological feasibility. Learning Objective: 8 Level of Learning: 3

Documents

Chap 010