Solution Manual CH 08 FInancial Accounting Reporting and Analyzing Long-Term Assets

Chapter 8Reporting and Analyzing Long-Term Assets

QUESTIONS 1. The cost of a plant asset includes all normal, reasonable, and necessary costs of getting the

asset in place and ready for its intended use. 2. A plant asset is tangible; it is used in the production or sale of other assets or services; and

it has a useful life longer than one accounting period. 3. Land held for future expansion is classified as a long-term investment. It is not a plant asset

because it is not being used in the production or sale of other assets or services.4. Land is an asset with an unlimited life and, therefore, is not subject to depreciation. Land

improvements have limited lives and are subject to depreciation.5. The Modified Accelerated Cost Recovery System is not generally acceptable for financial

accounting purposes because it allocates depreciation over an arbitrary period that is usually much shorter than the predicted useful life of the asset.

6. The Accumulated Depreciation—Machinery account is a contra asset account with a credit balance that cannot be used to buy anything. The balance of the Accumulated Depreciation—Machinery account reflects that portion of the machinery's original cost that has been charged to depreciation expense. It also gives some indication of the asset’s age and how soon it will need to be replaced. Any funds available for buying machinery are shown on the balance sheet as liquid assets with debit balances.

7. The materiality principle justifies charging low-cost plant asset purchases to expense because such amounts are unlikely to impact the decisions of financial statement users.

8. Ordinary repairs are made to keep a plant asset in normal, good operating condition, and should be charged to expense of the current period. Extraordinary repairs are made to extend the life of a plant asset beyond the original estimated life; they are recorded as capital expenditures (and added to the asset account).

9. A company might sell or exchange an asset when it reaches the end of its useful life, or if it becomes inadequate or obsolete, or if the company has changed its business plans. An asset also can be damaged or destroyed by fire or some other accident that would require its disposal.

10. The process of allocating the cost of natural resources to expense over the periods when they are consumed is called depletion. The method to compute depletion is similar to units-of-production depreciation.

11. An intangible asset: (1) has no physical existence; (2) derives value from the unique legal and contractual rights held by its owner; and (3) is used in the company’s operations.

12. No, depletion expense should be calculated on the units that are extracted (similar to the units-of-production basis) and sold.

Solutions Manual, Chapter 8 ©McGraw-Hill Companies, Inc., 2005 412

13. Intangible assets are generally recorded at their cost and amortized over their predicted useful life. (However, some costs are not included, such as the research and development costs leading up to a patent.) The costs of intangible assets are generally allocated to amortization expense using the straight-line method over their useful lives. If the useful life of an intangible asset is indefinite, then it is not amortized—instead, it is annually tested for impairment.

14. A company has goodwill when its income return rate is greater than the income return rate normally earned in its industry. (Alternatively, goodwill is when the value of a company exceeds the value of its individual net assets [assets less liabilities].) Goodwill appears in the balance sheet when one company acquires another company or separate segment and pays a price that exceeds the combined values of all its net assets (assets less liabilities) excluding goodwill.

15. No; this type of goodwill would not be amortized. Instead, the FASB (SFAS 142) requires that goodwill be annually tested for impairment. If the book value of goodwill does not exceed its fair (market) value, goodwill is not impaired. However, if the book value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details of this two-step test are in advanced courses.)

16. The statement of cash flows is potentially impacted in three ways when accounting for long-term assets. If there are (1) additions or (2) disposals of long-term assets, these transactions (assuming they involve cash) are reported in the investing activities section of the statement of cash flows. Also, if the indirect method is used to prepare the statement of cash flows—see Chapter 12—then depreciation, depletion, and amortization of long-term assets are reported in the operating section of the statement of cash flows as adjustments to net income. (3) Cash payments for capital and revenue expenditures can also impact the statement of cash flows.

17. Total asset turnover is calculated by dividing net sales by average total assets. Financial statement users can use total asset turnover to evaluate the efficiency of a company in using its assets to generate sales.

18. Krispy Kreme titles its plant assets "Property and equipment, net." The book value of its property and equipment as of February 2, 2003, is $202,558,000 and as of February 3, 2002, is $112,577,000.

19. Tastykake’s plant assets are categorized as “Property, plant and equipment” and are reported at their gross values separately under “Land”, “Buildings and improvements,” and “Machinery and equipment.” The accumulated depreciation amount is deducted from the gross value of the long-term assets. The net value (book value) of the property, plant, and equipment on its 2002 balance sheet is $58,391,222.

20. The December 31, 2002, long-term assets of Harley-Davidson, Inc., are reported in its Note 2 as follows:

Under property, plant and equipment, at cost (in thousands):Land and land improvements....................... $ 20,674Buildings and improvements........................ 273,959Machinery and equipment............................ 1,448,312Construction-in-progress............................. 263,311Total property and equipment...................... 2,006,256Less accumulated depreciation................... 973,660Property and equipment, net........................ $1,032,596

©McGraw-Hill Companies, Inc., 2005 Financial Accounting, 3rd Edition413

QUICK STUDIESQuick Study 8-1 (10 minutes)

Recorded cost = $180,000 + $18,000 + $3,000 + $12,600 = $213,600

Note: The $2,250 repair charge is an expense because it is not a normal and reasonable expenditure necessary to get the asset in place and ready for its intended use.

Quick Study 8-2 (10 minutes)

1. The main difference between plant assets and current assets is that current assets are consumed or converted into cash within a short period of time while plant assets have a useful life of more than one accounting period.

2. The main difference between plant assets and inventory is that inventory is held for resale and plant assets are not.

3. The main difference between plant assets and long-term investments is that plant assets are used in the primary operation of the business and investments are not.


1. Straight-line:

($55,900 - $1,900) / 4 years = $13,500 depreciation per year

2. Units-of-production:

($55,900 - $1,900) / 120 concerts = $ 450 depreciation per concert x 40 concerts in 2005$18,000 depreciation in 2005


$55,900 Cost- 13,500 Accumulated depreciation (first year)

42,400 Book value at point of revision - 1,900 Salvage value

40,500 Remaining depreciable cost


÷ 2 Years of life remaining$20,250 Depreciation per year for years 2 and 3



Note: Double-declining-balance rate = (100% / 8 years) x 2 = 25%

First year:$930,000 x 25% = $232,500

Second year:($930,000 - $232,500) x 25% = $174,375

Third year:($930,000 - $232,500 - $174,375) x 25% = $130,781* (rounded)

* Total accumulated depreciation of $537,656 ($232,500 + $174,375 + $130,781) does not exceed the depreciable cost of $780,000 ($930,000 - $150,000).


1. (a) Capital expenditure(b) Revenue expenditure(c) Revenue expenditure(d) Capital expenditure

2. (a) Building.................................................................... 250,000Cash................................................................... 250,000

To record addition of a new wing.

(d) Equipment................................................................ 50,000Cash................................................................... 50,000

To record an extraordinary repair.


1. Machinery................................................................... 48,000Accumulated Depreciation–Machinery................... 20,400Loss on Exchange of Assets.................................... 2,000

Machinery.......................................................... 38,400Cash................................................................... 32,000

To record similar asset exchange.

2. Machinery................................................................... 42,000Accumulated Depreciation–Machinery................... 20,400

Machinery.......................................................... 38,400


Cash................................................................... 24,000 To record similar asset exchange.



1. Ore Mine..........................................................................1,500,000Cash.......................................................................... 1,500,000

To record cost of ore mine.

2. Depletion per unit = = $2.70 per ton

Depletion Expense—Ore Mine........................................243,000Accumulated Depletion—Ore Mine........................ 243,000

To record depletion of ore mine (90,000 x $2.70).


Intangible Assets: b) Trademark c) Leasehold f) Copyright g) Franchise

Natural Resources: a) Oil well d) Gold mine h) Timberland

Note: Building is reported under plant assets.


1.Jan. 4 Leasehold Improvements...............................................95,000

Cash.......................................................................... 95,000 To record leasehold improvements.

2.Dec. 31 Amortization Expense–Leasehold Improvements.............11,875

Accumulated Amortization—Leasehold Improvements......................................................... 11,875

To record amortization of leasehold over the remaining life of the lease.*

* Amortization = $95,000 / 8-year-lease-term = $11,875 per year.


Total asset turnover = = 0.80 times


$1,500,000 - $150,000500,000 tons

$13,557($14,968 + $18,810) / 2

($ millions)

Interpretation: The company’s turnover of 0.80 times is markedly lower than its competitors’ turnover of 2.0. This company must perform better if it is to be successful in the long run.


EXERCISES

Exercise 8-1 (15 minutes)

Invoice price of machine...........................$ 11,500Less discount (.02 x $11,500).................... (230 )Net purchase price..................................... 11,270Freight charges (transportation-in).......... 260Mounting and power connections............ 795Assembly.................................................... 375Materials used in adjusting....................... 30 Total cost to be recorded..........................$ 12,730


Cost of landPurchase price for land.............................$ 225,000Purchase price for old building................ 120,000Demolition costs for old building............. 34,500Landscaping............................................... 51,000 Total cost of land........................................$ 430,500

Cost of new building and land improvementsCost of new building..................................$1,354,500Cost of land improvements....................... 85,500 Total construction costs............................$1,440,000

Journal entryLand................................................................................. 430,500Land Improvements....................................................... 85,500Building........................................................................... 1,354,500 Cash.......................................................................... 1,870,500 To record costs of plant assets.



Purchase price................................................. $368,250Closing costs................................................... 19,600 Total cost of acquisition.................................. $387,850

Allocation of total costAppraised

ValuePercent of Total

Applying % to Cost

ApportionedCost

Land............................... $166,320 42% $387,850 x .42 $162,897Land improvements....... 55,440 14 $387,850 x .14 54,299Building......................... 174,240 44 $387,850 x .44 170,654 Totals............................. $396,000 100 % $387,850

Journal entryLand.......................................................................... 162,897Land Improvements................................................. 54,299Building.................................................................... 170,654

Cash................................................................... 387,850 To record costs of lump-sum purchase.


1. Straight-line depreciation: ($147,000 - $30,000) / 4 years = $29,250 per year

Year Annual Depreciation Year-End Book Value2004........ $ 29,250 $117,7502005........ 29,250 88,5002006........ 29,250 59,2502007........ 29,250 30,000Total....... $117,000

2. Double-declining-balance depreciation Depreciation rate: 100% / 4 years = 25% x 2 = 50%

YearBeginning-Year

Book ValueDepreciation

RateAnnual

DepreciationYear-End

Book Value2004....... $147,000 50% $ 73,500 $73,5002005....... 73,500 50 36,750 36,7502006....... 36,750 50 6,750* 30,0002007....... 30,000 -- -- 30,000Total....... $117,000


* Do not depreciate more than $6,750 in the third year since the salvage value is not subject to depreciation.



1. Straight-line ($42,300 - $6,000) / 10 years = $3,630

2. Units-of-production Depreciation per unit = ($42,300 - $6,000) / 363,000 units = $0.10 per unit

For 35,000 units in second year: Depreciation = 35,000 x $0.10 = $3,500

3. Double-declining-balanceDouble-declining-balance rate = (100% / 10 years) x 2 = 20% per yearFirst year’s depreciation = $42,300 x 20% = $8,460Book value at beginning of second year = $42,300 - $8,460 = $33,840Second year’s depreciation = $33,840 x 20% = $6,768


1. Straight-line depreciation for 2005 ($250,000 - $25,000) / 5 years = $45,000

2. Double-declining-balance depreciation for 2004 Rate = (100% / 5 years) x 2 = 40%

2004 depreciation ($250,000 x 40% x 9/12)...................... $ 75,000Book value at January 1, 2005 ($250,000 - $75,000)....... $175,000Depreciation for 2005 ($175,000 x 40%)........................... $ 70,000

Alternate calculation2004 depreciation ($250,000 x 40% x 9/12).................................. $ 75,0002005 depreciation $250,000 x 40% x 3/12............................................................... $ 25,000 ($250,000 - $75,000 - $25,000) x 40% x 9/12............................ 45,000 Total 2005 depreciation................................................................. $ 70,000


1. Original cost of machine......................................... $21,750Less two years' accumulated depreciation [($21,750 - $2,250) / 4 years] x 2 years................ (9,750 )Book value at end of second year.......................... $12,000

2. Book value at end of second year.......................... $12,000


Less revised salvage value..................................... (1,800 )Remaining depreciable cost................................... $10,200

Revised annual depreciation = $10,200 / 3 years = $3,400



1. Straight-line depreciationIncomebefore

DepreciationDepreciation

Expense*Net

Income

Year 1......... $ 85,500 $ 36,540 $ 48,960Year 2......... 85,500 36,540 48,960Year 3......... 85,500 36,540 48,960Year 4......... 85,500 36,540 48,960Year 5......... 85,500 36,540 48,960 Totals......... $427,500 $182,700 $244,800

*($235,200 - $52,500) / 5 years = $36,540

2. Double-declining-balance depreciationIncomebefore

DepreciationDepreciation

Expense*Net

Income

Year 1........ $ 85,500 $ 94,080 $ (8,580)Year 2......... 85,500 56,448 29,052Year 3......... 85,500 32,172 53,328Year 4......... 85,500 0 85,500Year 5......... 85,500 0 85,500 Totals......... $427,500 $182,700 $244,800

Supporting calculations for depreciation expense*Note: (100% / 5 years) x 2 = 40% depreciation rate

BeginningBook Value

AnnualDepreciation

(40% of Book Value)

AccumulatedDepreciation at the End of the

Year

Ending Book Value ($235,200 Cost Less

Accumulated Depreciation)

Year 1............... $235,200 $ 94,080 $ 94,080 $141,120 Year 2............... 141,120 56,448 150,528 84,672 Year 3............... 84,672 32,172** 182,700 52,500 Year 4............... 52,500 0 182,700 52,500 Year 5............... 52,500 0 182,700 52,500 Total.................. $182,700

**Must not use $33,869; instead take only enough depreciation in Year 3 to reduce book value to the $52,500 salvage value.



1. Annual depreciation = $561,000 / 20 years = $28,050 per year

Age of the building = Accumulated depreciation / Annual depreciation = $420,750 / $28,050 = 15 years

2. Entry to record the extraordinary repairsBuilding........................................................................... 67,200

Cash......................................................................... 67,200 To record extraordinary repairs.

3. Cost of building Before repairs...................................................... $561,000 Add cost of repairs.............................................. 67,200 $628,200Less accumulated depreciation............................ 420,750 Revised book value of building............................. $207,450

4. Revised book value of building (part 3)............... $207,450New estimate of useful life (20 - 15 + 7)................ 12 yearsRevised annual depreciation................................. $17,287.5

Journal entryDepreciation Expense.................................................... 17,287.5 Accumulated Depreciation–Building........................ 17,287.5 To record depreciation.


1. Equipment...................................................................... 21,000Cash......................................................................... 21,000

To record betterment.

2. Repairs Expense........................................................... 5,250Cash......................................................................... 5,250

To record ordinary repairs.

3. Equipment..................................................................... 13,950Cash......................................................................... 13,950

To record extraordinary repairs.


Exercise 8-11 (15 minutes)1. Book value of the old tractor ($95,000 - $52,500)..........................$ 42,500

2. Loss on the exchangeBook value - Trade-in allowance ($42,500 - $28,000)..............$ 14,500

3. Debit to new Tractor accountCash paid + Trade-in allowance ($82,000 + $28,000)..............$110,000

Alternatively, answers can be taken from the following journal entry:Tractor (new)*................................................................................ 110,000Loss on Exchange of Assets....................................................... 14,500Accumulated Depreciation–Tractor............................................ 52,500

Tractor (old)........................................................................... 95,000Cash....................................................................................... 82,000

To record asset exchange. *($28,000+$82,000)

Exercise 8-12 (25 minutes)Note: Book value of Machine equals $42,000 - $22,625 = $19,375

1. Sold for $16,250 cashJan. 2 Cash...............................................................................16,250

Loss on Sale of Machinery..........................................3,125Accumulated Depreciation--Machinery......................22,625

Machinery................................................................. 42,000 To record cash sale of machine.

2. $20,000 trade-in allowance exceeds book value; but no gain is recognized on similar asset exchange ($625 gain is ‘buried’in the cost of the new machinery)

Jan. 2 Machinery*....................................................................57,875Accumulated Depreciation--Machinery......................22,625

Machinery................................................................. 42,000 Cash**....................................................................... 38,500 To record similar asset exchange. *[$58,500 - ($20,000-$19,375)] **($58,500- $20,000)

3. $15,000 trade-in allowance is less than book value (yielding a loss)Jan. 2 Machinery......................................................................58,500

Loss on Exchange of Machinery.................................4,375Accumulated Depreciation--Machinery......................22,625

Machinery................................................................. 42,000


Cash*......................................................................... 43,500 To record similar asset exchange. *($58,500-$15,000)


Exercise 8-13 (25 minutes)2008July 1 Depreciation Expense............................................. 6,625

Accumulated Depreciation--Machinery............ 6,625 To record one-half year depreciation.*

*Annual depreciation = $92,750 / 7 years = $13,250Depreciation for 6 months in 2008 = $13,250 x 6/12 = $6,625

1. Sold for $35,000 cash

July 1 Cash...............................................................................35,000Accumulated Depreciation—Machinery.....................59,625

Gain on Sale of Machinery....................................... 1,875 Machinery.................................................................. 92,750

To record disposal of machinery.*

*Total accumulated depreciation at date of disposal:Four years 2004-2007 (4 x $13,250)......... $53,000Partial year 2008 (6/12 x $13,250)............ 6,625Total accumulated depreciation.............. $59,625

2. Destroyed by fire with $30,000 cash insurance settlement

July 1 Cash...............................................................................30,000Loss from Fire............................................................... 3,125Accumulated Depreciation—Machinery.....................59,625

Machinery.................................................................. 92,750 To record disposal of machinery from fire.


Dec. 31 Depletion Expense—Mineral Deposit.........................398,310 Accumulated Depletion—Mineral Deposit............ 398,310 To record depletion [$3,633,750/1,425,000 tons= $2.55 per ton; 156,200 tons x $2.55 = $398,310].

Dec. 31 Depreciation Expense—Machinery ............................18,744 Accumulated Depreciation—Machinery................ 18,744 To record depreciation [$171,000/1,425,000 tons = $0.12 per ton; 156,200 tons x $0.12 = $18,744].



Jan. 1 Copyright.......................................................................236,700 Cash.......................................................................... 236,700 To record purchase of copyright.

Dec. 31 Amortization Expense—Copyright.............................19,725 Accumulated Amortization—Copyright................. 19,725 To record amortization of copyright [$236,700 / 12 years].

Exercise 8-16A (15 minutes)

Net assets (excluding goodwill).............................................. $437,000Normal rate of return in this industry..................................... x 10 %Normal net income on net assets........................................... 43,700Expected (typical) future net income..................................... 85,000 Expected net income above-normal....................................... $ 41,300

1. Value of goodwill = $41,300 x 10 = $413,000

2. Value of goodwill = $41,300 / 8% = $516,250

Note: These estimates of goodwill assume that Corey Alt’s departure does not impact the business’s goodwill.

Exercise 8-17 (15 minutes) 1. $323,866,000 for capital expenditures2. $175,778,000 for depreciation and amortization3. $1,017,992,000 used in investing activities


Total asset turnover for 2004 = = 2.96

Total asset turnover for 2005 = = 4.21

Analysis comments. Based on these calculations, Joy turned its assets over 1.25 (4.21 – 2.96) more times in 2005 than in 2004. This increase indicates that Joy became more efficient in using its assets. Moreover, Joy has improved its efficiency in using assets relative to its competitors who average 3.0. Together,


$4,862,000($1,586,000 + $1,700,000)/2

$7,542,000($1,700,000 + $1,882,000)/2

these results based on total asset turnover indicate that Joy has markedly improved its performance and is currently superior to its competitors.


PROBLEM SET AProblem 8-1A (50 minutes) Part 1

Appraised Value

Percent of Total

Apportioned Cost

Building.......................... $408,000 48% $378,000Land................................ 289,000 34 267,750Land improvements...... 42,500 5 39,375Vehicles.......................... 110,500 13 102,375 Total................................ $850,000 100 % $787,500

2005Jan. 1 Building...........................................................................378,000

Land.................................................................................267,750Land Improvements.......................................................39,375Vehicles...........................................................................102,375 Cash........................................................................... 787,500 To record asset purchases.

Part 2

Year 2005 straight-line depreciation on building

[($378,000 - $25,650) / 15 years] = $23,490

Part 3

Year 2005 double-declining-balance depreciation on land improvements (100% / 5 years) x 2 = 40% rate $39,375 x 40% = $ 15,750

Part 4

Accelerated depreciation does not lower the total amount of taxes paid over the asset's life. Instead, it defers or postpones taxes to the later years of an asset’s useful life. This is because accelerated methods charge a higher portion of asset costs against revenue in earlier years and a lower portion in later years. The result is to reduce taxable income more in earlier years but less in later years. [Note: From a present value perspective, there is a tax


savings from use of accelerated depreciation. The company gets to use the tax deferred amounts for investment purposes until they are due.]


Problem 8-2A (45 minutes)Part 1

LandBuilding

2Building

3

LandImprove-ments 1

LandImprovements

2Purchase price*........ $1,792,000 $616,000 $392,000Demolition................ 422,600Land grading............ 167,200New building............ $2,019,000New improvements.. _________ _______ _________ _______ $158,000Totals....................... $2,381,800 $616,000 $2,019,000 $392,000 $158,000

*Allocation of purchase priceAppraised

ValuePercentof Total

ApportionedCost**

Land........................................... $1,865,600 64% $1,792,000Building 2.................................. 641,300 22 616,000Land Improvements 1.............. 408,100 14 392,000 Totals......................................... $2,915,000 100 % $2,800,000

**Multiply the percentages in column 3 by the $2,800,000 purchase price.

Part 22005Jan. 1 Land....................................................................... 2,381,800

Building 2.............................................................. 616,000Building 3.............................................................. 2,019,000Land Improvements 1.......................................... 392,000Land Improvements 2.......................................... 158,000 Cash................................................................ 5,566,800 To record costs of plant assets.

Part 32005Dec. 31 Depreciation Expense—Building 2...............................26,800

Accumulated Depreciation—Building 2................. 26,800 To record depreciation. [($616,000 - $80,000)/20]

31 Depreciation Expense—Building 3...............................65,156 Accumulated Depreciation—Building 3................. 65,156 To record depreciation. [($2,019,000 - $390,100)/25]

31 Depreciation Expense—Land Improv. 1......................28,000 Accum. Depreciation—Land Improv. 1.................. 28,000 To record depreciation [$392,000/14 = $28,000].

31 Depreciation Expense—Land Improv. 2......................7,900 Accum. Depreciation—Land Improv. 2.................. 7,900


To record depreciation [$158,000/20].


Problem 8-3A (50 minutes)

2004Jan. 1 Equipment .................................................................273,140

Cash..................................................................... 273,140 To record loader costs ($255,440 +$15,200 +$2,500).

Jan. 3 Equipment.....................................................................3,660 Cash......................................................................... 3,660 To record betterment of loader.

Dec. 31 Depreciation Expense—Equipment............................60,238*

Accumulated Depreciation—Equipment.............. 60,238 To record depreciation.

*2004 depreciation after January 3rd betterment Total original cost..................................................................... $273,140 Plus cost of betterment............................................................ 3,660 Revised cost of equipment...................................................... 276,800 Less revised salvage ($34,740 + $1,110)................................ 35,850 Cost to be depreciated............................................................. 240,950 Annual depreciation ($240,950 / 4 years) (rounded).............. $ 60,238*

2005Jan. 1 Equipment.....................................................................4,500

Cash......................................................................... 4,500 To record extraordinary repair on loader.

Feb. 17 Repairs Expense—Equipment.................................... 920 Cash......................................................................... 920 To record ordinary repair on loader.

Dec. 31 Depreciation Expense—Equipment............................37,042* Accumulated Depreciation—Equipment.............. 37,042 To record depreciation.

*2005 depreciation after January 1st extraordinary repair Total cost ($276,800 + $4,500)............................................................................$281,300 Less accumulated depreciation ........................................................................ 60,238 Book value...........................................................................................................221,062 Less salvage........................................................................................................ 35,850 Remaining cost to be depreciated.....................................................................$185,212 Revised remaining useful life (Original 4 years - 1yr. + 2yrs.).............................. 5.0 yrs. Revised annual depreciation ($185,212 / 5 yrs) (rounded)..............................$ 37,042


Problem 8-4A (40 minutes)2004

Jan. 1 Trucks............................................................................20,580 Cash......................................................................... 20,580 To record cost of truck ($19,415 + $1,165).

Dec. 31 Depreciation Expense—Trucks.................................. 3,516 Accumulated Depreciation—Trucks.................... 3,516 To record depreciation [($20,580 - $3,000)/5].

2005Dec. 31 Depreciation Expense—Trucks..................................4,521*

Accumulated Depreciation—Trucks.................... 4,521 To record depreciation.

*2005 depreciation Total cost.............................................................................................................$ 20,580 Less accumulated depreciation (from 2004).................................................... 3,516 Book value...........................................................................................................17,064 Less revised salvage value................................................................................ 3,500 Remaining cost to be depreciated.....................................................................$ 13,564 Revised useful life...............................................................................................4.00 yrs. Less one year used in 2004................................................................................ 1.00 yrs. Revised remaining useful life............................................................................ 3.00 yrs. Total depreciation for 2005 ($13,564/3)(rounded)............................................$ 4,521

2006Dec. 31 Depreciation Expense—Trucks.................................. 4,521

Accumulated Depreciation—Trucks.................... 4,521 To record annual depreciation.

Dec. 31 Cash............................................................................... 6,200Accumulated Depreciation—Trucks..........................12,558**

Loss on Disposal of Trucks........................................ 1,822***

Trucks...................................................................... 20,580 To record sale of truck.

**Accumulated depreciation on truck at 12/31/20062004...................................................................................$ 3,5162005................................................................................... 4,5212006................................................................................... 4,521 Total.................................................................................. $12,558

***Book value of truck at 12/31/2006Total cost..........................................................................$20,580Less accumulated depreciation..................................... (12,558 )Book value .......................................................................$ 8,022Loss ($6,200 cash received - $8,022 book value).........$ 1,822


Problem 8-5A (45 minutes)

Part 1Cost of machine...............................................................$210,000Less estimated salvage value......................................... 20,000 Total depreciable cost.....................................................$190,000

Year Straight-Linea Units-of-ProductionbDouble-Declining-

Balancec

1...................... $ 47,500 $ 48,560 $105,0002...................... 47,500 48,960 52,5003...................... 47,500 47,840 26,2504...................... 47,500 44,640 6,250

Totals ......... $190,000 $190,000 $190,000 aStraight- line: Cost per year = $190,000/4 years = $47,500 per year bUnits-of-production: Cost per unit = $190,000/475,000 units = $0.40 per unit

Year Units Unit Cost Depreciation1................. 121,400 $0.40 $ 48,5602................. 122,400 0.40 48,9603................. 119,600 0.40 47,8404................. 118,200 0.40 44,640 *Total.......... $190,000 * Take only enough depreciation in Year 4 to reduce book

value to the asset’s $20,000 salvage value.

cDouble-declining-balance: (100%/4) x 2 = 50% depreciation rate

Year

BeginningBook Value

AnnualDepreciation

(50% ofBook Value)

AccumulatedDepreciationat the End of

the Year

Ending Book Value ($210,000 Cost Less

AccumulatedDepreciation)

1......... $210,000 $105,000 $105,000 $105,0002......... 105,000 52,500 157,500 52,5003......... 52,500 26,250 183,750 26,2504......... 26,250 6,250 * 190,000 20,000Total... $190,000

*Take only enough depreciation in Year 4 to reduce book value tothe asset’s $20,000 salvage value.


Problem 8-5A (Concluded)Part 2a.Jan. 2 Machinery................................................................. 167,000

Cash.................................................................... 167,000 To record machinery purchase.

Jan. 3 Machinery................................................................. 3,420 Cash.................................................................... 3,420 To record machinery costs.

Jan. 3 Machinery................................................................. 1,080 Cash.................................................................... 1,080 To record machinery costs.

b. First yearDec. 31 Depreciation Expense—Machinery............................26,150

Accumulated Depreciation—Machinery.............. 26,150 To record depreciation [($171,500 - $14,600)/6].

Fifth yearDec. 31 Depreciation Expense—Machinery............................26,150

Accumulated Depreciation—Machinery.............. 26,150 To record year’s depreciation.

c. Accumulated depreciation at the date of disposal Five years' depreciation (5 x $26,150).........................$130,750

Book value at the date of disposal Original total cost..........................................................$171,500 Accumulated depreciation........................................... (130,750 ) Book value.....................................................................$ 40,750

(i) Sold for $13,500 cash Dec. 31 Cash...............................................................................13,500

Loss on Sale of Machinery..........................................27,250Accumulated Depreciation—Machinery....................130,750 Machinery................................................................. 171,500

(ii) Sold for $45,000 cash Dec. 31 Cash...............................................................................45,000

Accumulated Depreciation—Machinery....................130,750 Machinery................................................................. 171,500 Gain on Sale of Machinery..................................... 4,250

(iii) Destroyed in fire and collected $24,000 cash from insurance company Dec. 31 Cash...............................................................................24,000


Accumulated Depreciation—Machinery....................130,750Loss from Fire..............................................................16,750 Machinery................................................................. 171,500


Problem 8-6A (40 minutes) Part 12005 (a)June 25 Leasehold......................................................................185,000

Cash......................................................................... 185,000 To record payment for sublease.

(b)July 1 Prepaid Rent.................................................................70,000

Cash......................................................................... 70,000 To record prepaid annual lease rental.

(c)July 5 Leasehold Improvements............................................129,840

Cash......................................................................... 129,840 To record costs of leasehold improvements.

(d)Dec. 31 Rent Expense................................................................9,250

Accumulated Amortization—Leasehold.............. 9,250 To record leasehold amortization ($185,000/10 x 6/12).

(e)Dec. 31 Amortization Expense—Leasehold Improvements............6,492

Accumulated Amortization—Leasehold Improvements............................................................. 6,492 To record leasehold improvement amortization ($129,840/10 years remaining on lease x 6/12).

(f)Dec. 31 Rent Expense................................................................35,000

Prepaid Rent........................................................... 35,000 To record one-half year lease rental ($70,000 x 6/12).


Problem 8-6A (Concluded)

Part 2 (a)

July 23 Mineral Deposit.............................................................4,836,000 Cash......................................................................... 4,836,000 To record purchase of mineral deposit.

(b)July 25 Machinery......................................................................390,000

Cash......................................................................... 390,000 To record costs of machinery.

(c)Dec. 31 Depletion Expense—Mineral Deposit.........................248,000

Accum. Depletion—Mineral Deposit.................... 248,000 To record depletion [$4,836,000/ 7,800,000 tons = $0.62 per ton. 400,000 tons x $0.62 = $248,000].

(d)Dec. 31 Depreciation Expense—Machinery............................20,000

Accum. Depreciation—Machinery........................ 20,000 To record depreciation [$390,000/ 7,800,000 tons = $0.05 per ton. 400,000 tons x $0.05 = $20,000].

Analysis Component:Similarities—Amortization, depletion, and depreciation are similar in that they are all methods of allocating costs of long-term assets to the periods that benefit from their use. Differences—They are different in that they apply to different types of long-term assets: amortization applies to intangible assets with (definite) useful lives; depletion applies to natural resources; and depreciation applies to plant assets. Also, amortization is typically computed using the straight-line method, whereas the units-of-production method is usually used in depletion.


Problem 8-7AA (30 minutes) Part 1

Equity......................................................................................................... $395,930Normal return in the industry................................................................... x 20% Normal net income.................................................................................... $ 79,186

Expected net income for this company................................................... $100,000Normal net income (from above)............................................................. 79,186 Above-normal net income........................................................................ $ 20,814

Rent Center’s proposalGoodwill ($20,814 / 15%).................................................................. $138,760

Part 2

Potential Buyer’s proposalGoodwill ($20,814 x 5)....................................................................... $104,070

Part 3

Net assets without goodwill (equals equity).................................... $395,930Cost of goodwill acquired by buyer (from part 1)........................... 138,760 Purchase price (buyer’s investment)................................................. $534,690

Part 4

Net income divided by buyer’s Investment ($100,225 / $534,690).................................................. 18.7%

Goodwill is measured as the excess of the cost of an acquired entity over the value of the acquired net assets. Goodwill is recorded as an asset and it is not amortized. Instead, the FASB (SFAS 142) requires that goodwill be annually tested for impairment. If the book value of goodwill does not exceed its fair value, goodwill is not impaired. However, if the book value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details of this test are in advanced courses.)


PROBLEM SET BProblem 8-1B (50 minutes) Part 1

Appraised Value

Percent of Total

Apportioned Cost

Building........................... $ 784,800 45% $ 724,500Land................................. 540,640 31 499,100Land improvements....... 226,720 13 209,300Trucks............................. 191,840 11 177,100 Total................................. $1,744,000 100 % $1,610,000

2005Jan. 1 Buildings.........................................................................724,500

Land.................................................................................499,100Land Improvements.......................................................209,300Trucks..............................................................................177,100 Cash........................................................................... 1,610,000 To record asset purchases.

Part 2 Year 2005 straight-line depreciation on building

[($724,500 - $100,500) / 12 years] = $52,000

Part 3 Year 2005 double-declining-balance depreciation on land improvements

(100% / 10 years) x 2 = 20% rate$209,300 x 20% = $41,860

Part 4Accelerated depreciation does not increase the total amount of taxes paid over the asset’s life. Instead, it defers or postpones taxes to the later years of an asset’s useful life. This is because accelerated methods charge a higher portion of asset costs against revenue in earlier years and a lower portion in later years. The result is to reduce taxable income more in earlier years and less in later years. [Note: From a present value perspective, there is a tax savings from use of accelerated depreciation. The company gets to use the tax deferred amounts for investment purposes until they are due.]


Problem 8-2B (45 minutes) Part 1

LandBuilding

BBuilding

C

LandImprove-ments B

LandImprove-ments C

Purchase price*......... $ 769,500 $459,000 $121,500Demolition.................. 117,000Land grading.............. 172,500New building.............. $1,356,000New improvements. . . ________ _______ _________ _______ $101,250 Totals..........................$1,059,000 $459,000 $1,356,000 $121,500 $101,250

Allocation ofpurchase price

AppraisedValue

Percentof Total

ApportionedCost

Land........................................... $ 792,585 57% $ 769,500Building B................................. 472,770 34 459,000Land Improvements B.............. 125,145 9 121,500 Totals......................................... $1,390,500 100% $1,350,000

Part 22005Jan. 1 Land......................................................................... 1,059,000

Building B................................................................ 459,000Building C................................................................ 1,356,000Land Improvements B............................................ 121,500Land Improvements C............................................ 101,250 Cash................................................................... 3,096,750 To record cost of plant assets.

Part 3 2005Dec. 31 Depreciation Expense—Building B........................................

....................................................................................................

....................................................................................................

24,600

Accumulated Depreciation—Building B.......................... 24,600 To record depreciation [($459,000 - $90,000)/15].

31 Depreciation Expense—Building C...........................53,025 Accumulated Depreciation—Building C.............. 53,025 To record depreciation [($1,356,000 - $295,500)/20].

31 Depreciation Expense--Land Improvements B.......................................................................................................................................................................................

20,250


Accum. Depreciation--Land Improvements B........ 20,250 To record depreciation [$121,500/6].

31 Depreciation Expense--Land Improvements C.......................................................................................................................................................................................

10,125

Accum. Depreciation--Land Improvements C........ 10,125 To record depreciation [$101,250/10].


Problem 8-3B (50 minutes)2004

Jan. 1 Equipment.....................................................................26,900 Cash......................................................................... 26,900 To record costs of van ($24,950 + $1,950).

Jan. 3 Equipment..................................................................... 1,550 Cash......................................................................... 1,550 To record betterment of van.

Dec. 31 Depreciation Expense—Equipment............................4,970*

Accumulated Depreciation—Equipment.............. 4,970 To record depreciation.

*2004 depreciation after January 3rd bettermentTotal original cost......................................................................$26,900Plus cost of betterment............................................................. 1,550 Revised cost of equipment.......................................................28,450Less revised salvage ($3,400 + $200)).................................... 3,600 Cost to be depreciated..............................................................$24,850Annual depreciation ($24,850 / 5 years)..................................$ 4,970

2005Jan. 1 Equipment..................................................................... 1,970

Cash......................................................................... 1,970 To record extraordinary repair on van.

May 10 Repairs Expense—Equipment.................................... 600 Cash......................................................................... 600 To record ordinary repair on van.

Dec. 31 Depreciation Expense—Equipment............................ 3,642* Accum. Depreciation—Equipment....................... 3,642 To record depreciation.

*2005 depreciation after 1/1 extraordinary repairTotal cost ($28,450 + $1,970)..............................................................................$30,420Less accumulated depreciation......................................................................... 4,970 Book value...........................................................................................................25,450Less salvage........................................................................................................ 3,600 Remaining cost to be depreciated.....................................................................$21,850Revised remaining useful life (Original 5 years - 1yr. + 2yrs.).....................................6.0 yrs.Revised annual depreciation ($21,850 / 6 yrs) (rounded)................................$ 3,642


Problem 8-4B (40 minutes)2004Jan. 1 Machinery......................................................................113,000

Cash......................................................................... 113,000 To record costs of machinery ($106,600 +$6,400).

Dec. 31 Depreciation Expense—Machinery............................17,200 Accumulated Depreciation—Machinery.............. 17,200 To record depreciation [($113,000-9,800)/6].

2005Dec. 31 Depreciation Expense—Machinery............................27,583*

Accum. Depreciation—Machinery........................ 27,583 To record depreciation.

*2005 depreciation:Total cost.....................................................................................$113,000Less accumulated depreciation (from 2004)............................ 17,200 Book value...................................................................................95,800Less revised salvage value........................................................ 13,050 Remaining cost to be depreciated............................................ $ 82,750Revised useful life.......................................................................4.0 yrs.Less 1 year in 2004..................................................................... 1.0 yrs. Revised remaining useful life.................................................... 3.0 yrs.

Total depreciation for 2005 ($82,750/ 3 yrs) [rounded].............$ 27,583

2006Dec. 31 Depreciation Expense—Machinery............................27,583

Accumulated Depreciation—Machinery.............. 27,583 To record depreciation.

Dec. 31 Cash............................................................................... 25,240Accumulated Depreciation—Machinery....................72,366**Loss on Disposal of Machinery..................................15,394***

Machinery................................................................ 113,000 To record sale of machine.

**Accumulated depreciation on machine at 12/31/2006:2004................................................................................... $ 17,2002005................................................................................... 27,5832006................................................................................... 27,583 Total.................................................................................. $ 72,366

***Book value of machine at 12/31/2006:Total cost.......................................................................... $113,000


Less accumulated depreciation..................................... (72,366 )Book value ....................................................................... $ 40,634Loss ($25,240 cash received - $40,634 book value)..... $ 15,394


Problem 8-5B (45 minutes) Part 1

Cost of machine...........................................................$312,000Less estimated salvage value..................................... 28,000 Total depreciable cost.................................................$284,000

Year Straight-Linea Units-of-ProductionbDouble-Declining-

Balancec

1.................... $ 56,800 $ 61,400 $124,8002.................... 56,800 57,600 74,8803.................... 56,800 56,750 44,9284.................... 56,800 58,150 26,9575.................... 56,800 50,100 12,435 Totals........... $284,000 $284,000 $284,000

aStraight- line: Cost per year = $284,000/5 years = $56,800 per year

bUnits-of-production: Cost per unit = $284,000/1,136,000 units = $0.25 per unit

Year Units Unit Cost Depreciation1............... 245,600 $0.25 $ 61,4002............... 230,400 0.25 57,6003............... 227,000 0.25 56,7504............... 232,600 0.25 58,1505............... 211,200 0.25 50,100 * Total........ $284,000

* Take only enough depreciation in Year 5 to reduce book value to the asset’s $28,000 salvage value.

cDouble-declining-balance (amounts rounded to the nearest dollar): (100%/5) x 2 = 40% depreciation rate

YearBeginning

Book Value

AnnualDepreciation

(40% ofBook Value)

AccumulatedDepreciationat the End of

the Year

Ending Book Value ($312,000 Cost less

AccumulatedDepreciation)

1............ $312,000 $124,800 $124,800 $187,2002............ 187,200 74,880 199,680 112,3203............ 112,320 44,928 244,608 67,3924............ 67,392 26,957 271,565 40,4355............ 40,435 12,435 ** 284,000 28,000Total...... $284,000


** Take only enough depreciation in Year 5 to reduce book value to the asset’s $28,000 salvage value.


Problem 8-5B (Concluded)Part 2a.Jan. 1 Machinery.................................................................. 130,000

Cash..................................................................... 130,000 To record machinery costs.

Jan. 2 Machinery.................................................................. 3,390 Cash..................................................................... 3,390 To record machinery costs.

Jan. 2 Machinery.................................................................. 4,800 Cash..................................................................... 4,800 To record machinery costs.

b. First yearDec. 31 Depreciation Expense—Machinery............................17,170

Accumulated Depreciation—Machinery.............. 17,170 To record depreciation [($138,190-$18,000)/7 = $17,170].

Sixth yearDec. 31 Depreciation Expense—Machinery............................17,170

Accumulated Depreciation—Machinery.............. 17,170 To record the sixth year’s depreciation.

c. Accumulated depreciation at the date of disposal First six years' depreciation (6 x $17,170).....................$103,020

Book value at the date of disposal Original total cost............................................................$138,190 Accumulated depreciation.............................................. (103,020 ) Total..................................................................................$ 35,170

(i) Sold for $30,000 cash Dec. 31 Cash...............................................................................30,000

Loss on Sale of Machinery..........................................5,170Accumulated Depreciation—Machinery....................103,020 Machinery................................................................ 138,190

(ii) Sold for $50,000 cash Dec. 31 Cash...............................................................................50,000

Accumulated Depreciation—Machinery....................103,020 Machinery................................................................ 138,190 Gain on Sale of Machinery.................................... 14,830

(iii) Destroyed in fire and collected $20,000 cash from insurance Dec. 31 Cash...............................................................................20,000


Loss from Fire..............................................................15,170Accumulated Depreciation—Machinery....................103,020 Machinery................................................................ 138,190


Problem 8-6B (40 minutes)

Part 1

2007 (a)Jan. 1 Leasehold......................................................................30,000

Cash......................................................................... 30,000 To record payment for sublease.

(b)Jan. 1 Prepaid Rent.................................................................26,400

Cash......................................................................... 26,400 To record prepaid annual lease rental.

(c)Jan. 3 Leasehold Improvements............................................18,000

Cash......................................................................... 18,000 To record costs of leasehold improvements.

(d)Dec. 31 Rent Expense................................................................6,000

Accumulated Amortization—Leasehold.............. 6,000 To record leasehold amortization ($30,000/5).

(e)Dec. 31 Amortization Expense—Leasehold Improvements.........3,600

Accumulated Amortization—Leasehold Improvements............................................................ 3,600 To record leasehold improvement amortization ($18,000/5 years remaining on lease).

(f)Dec. 31 Rent Expense................................................................26,400

Prepaid Rent........................................................... 26,400 To record annual lease rental.


Problem 8-6B (Concluded)

Part 2

Feb. 19 Mineral Deposit.............................................................4,450,000 Cash......................................................................... 4,450,000 To record purchase of mineral deposit.

Mar. 21 Machinery......................................................................200,000 Cash......................................................................... 200,000 To record costs of machinery.

Dec. 31 Depletion Expense—Mineral Deposit.........................313,280 Accum. Depletion—Mineral Deposit.................... 313,280 To record depletion [$4,450,000/ 5,000,000 tons = $0.89 per ton. 352,000 tons x $0.89 = $313,280].

Dec. 31 Depreciation Expense—Machinery............................14,080 Accum. Depreciation—Machinery........................ 14,080 To record depreciation [$200,000/ 5,000,000 tons = $0.04 per ton. 352,000 tons x $0.04 = $14,080].

Analysis Component:Similarities—Amortization, depletion, and depreciation are similar in that they are all methods of allocating costs of long-term assets to the periods that benefit from their use. Differences—They are different in that they apply to different types of long-term assets: amortization applies to intangible assets (with definite useful lives); depletion applies to natural resources; and depreciation applies to plant assets. Also, amortization is typically computed using the straight-line method, whereas the units-of-production method is usually used in depletion.


Problem 8-7BA (30 minutes) Part 1

Equity......................................................................................................... $667,375Normal return in the industry (given)...................................................... x 32% Normal net income (rounded).................................................................. $213,560

Expected net income for this company................................................... $230,000Normal net income.................................................................................... 213,560 Above-normal net income........................................................................ $ 16,440

Pack’s proposalGoodwill ($16,440 / 10%).................................................................. $164,400

Part 2

Buyer’s proposalGoodwill ($16,440 x 8)....................................................................... $131,520

Part 3

Net assets without goodwill............................................................. $667,375Cost of goodwill acquired by buyer (from part 1)........................... 164,400 Purchase price (buyer’s investment)................................................. $831,775

Part 4

Net income divided by buyer’s investment ($200,175 / $831,775)................................................... 24.1%

Goodwill is measured as the excess of the cost of an acquired entity over the value of the acquired net assets. Goodwill is recorded as an asset and it is not amortized. Instead, the FASB (SFAS 142) requires that goodwill be annually tested for impairment. If the book value of goodwill does not exceed its fair value, goodwill is not impaired. However, if the book value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details of this test are in advanced courses.)


Serial Problem

Serial Problem, Success Systems (45 minutes)

1. For the three months ended March 31, 2005, depreciation expense was $400 for office equipment and $1,250 for the computer equipment. Annualizing these three months results in the following amounts for depreciation expense:

Depreciation Expense—Office Equipment ($400 x 4)......................$1,600 Depreciation Expense—Computer Equipment ($1,250 x 4)............$5,000

2. December 31,

2004December 31,

2005Office Equipment........................................ $8,000 $8,000Accumulated Depreciation–Office

Equipment.............................................. 400 2,000 Office Equipment (book value)................. $7,600 $6,000

December 31, 2004

December 31, 2005

Computer Equipment................................. $20,000 $20,000Accumulated Depreciation–

Computer Equipment........................... 1,250 6,250 Computer Equipment (book value)........... $18,750 $13,750

3. Note: Total asset turnover = Net sales / Average total assets

The 3-month total asset turnover for Success Systems at March 31, 2005

$43,853 / [($129,909 + $93,248)/2] = 0.39 times

An estimate of its annual total asset turnover is 1.56 (0.39 x 4 quarters). This value for the total asset turnover is lower than usual for companies competing in this industry (2.5). However, Success Systems is in its first year of operations, and its turnover will improve if it can generate increased sales throughout the year while maintaining a similar asset level.


Reporting in Action – BTN 8-1

1. The percent of original cost remaining to be depreciated is computed by taking the ratio of the book value of property, plant, and equipment to their original cost reported in Krispy Kreme’s Note 5 ($ thousands):As of 02/02/03: $202,558 / $252,770 = 80.1%As of 02/03/02: $112,577 / $156,484 = 71.9%

2. Its "Summary of Significant Accounting Policies" (Note 2) reports that intangible assets and goodwill have been evaluated as having indefinite lives and, as a result, are not subject to amortization provisions. For the fiscal year ended February 3, 2002, the Company recorded an expense of $100,000 to amortize intangible assets related to an acquisition completed prior to June 30, 2001. The company believes that no impairment of intangible assets exists as of February 2, 2003. (Instructor note: SFAS 142 has changed the accounting for goodwill—it is no longer amortized. Instead, an annual impairment test is applied to goodwill. Moreover, intangible assets that are identified with an indefinite life are no longer amortized, but are subject to an impairment test.)

3. According to Note 5, the change in total property, plant and equipment before accumulated depreciation for the year ended February 3, 2003, is an increase of $96,286 ($252,770 - $156,484). In comparison, according to the statement of cash flows, $83,196 is used for the purchase of property, plant and equipment, and $701 is received from the disposal of property, plant and equipment. This gives a net cash outflow of $82,495 (all $s in thousands).

One possible explanation for the difference in these amounts is that Krispy Kreme acquired plant assets for something other than cash—for example, it acquired certain plant assets for a promise (note agreement) to pay later. Another possible explanation is that Krispy Kreme disposed of some of its plant assets at a loss during the year.

4. Total asset turnover for year ended ($ thousands):

2/02/03: = 1.48 times

2/03/02: = 1.85 times

5. Solution depends on the financial statement data obtained.


$394,354($255,376 + $171,493)/2

$491,549($410,487 + $255,376)/2

Comparative Analysis — BTN 8-2

Note: Total asset turnover = Net sales / Average total assets

1. Total asset turnover for Krispy Kreme ($ thousands)

Current Year: $491,549 / [($410,487 + $255,376)/2] = 1.48 times

One Year Prior: $394,354 / [($255,376 + $171,493)/2] = 1.85 times

Total asset turnover for Tastykake ($ thousands)



2. Each dollar of Krispy Kreme’s assets produces $1.48 in net sales for the current year and $1.85 in net sales for the prior year. Each dollar of Tastykake’s assets produces $1.39 in net sales for the current year and $1.46 in net sales for the prior year. Consequently, we see that Krispy Kreme employs its assets more efficiently than does Tastykake. However, both companies have experienced a decline in asset efficiency for the current year.


Ethics Challenge — BTN 8-3

1. When managers acquire new assets a number of decisions relative to depreciation must be made. Specifically, the asset must be assigned a useful life, a salvage value, and a method of depreciation.

2. When assets are placed in use on a day other than the first day of the month an assumption is often made that the assets are placed in use on the first day of the month nearest to the date of the purchase. For example, for assets purchased on the 1st through 15th days of the month, the first day of the month is assumed to be the purchase date. For assets purchased on the 16th through month-end, the first day of the next month is assumed to be the purchase date.

By selecting the first day of the following month, Choi is getting a one-time deferral of some partial months of depreciation. She is still employing a systematic and rational method of allocating costs if she consistently chooses the first day of the following month. However, since she appears to be using this method only with respect to current year additions, it appears that she is using accounting rules to reduce depreciation expense this year. Also, her practice is not in keeping with general business practices as described above. The facts of the situation seem to suggest an ethical violation rather than a legitimate depreciation decision rule.

3. By always assuming the first day of the following month as the date of purchase, less depreciation is (initially) accrued for the assets employed. This means depreciation expense will be less than if assets were considered employed on the first of the month closest to the date of purchase. With reduced depreciation charges, net income will be higher for this current year. Therefore, this practice will result in a higher profit margin for her company for this year.

Communicating in Practice — BTN 8-4

The solution to this activity will vary based on the industry and the companies chosen for analysis. Many instructors find it useful to report the results from the teams to the class for purposes of classroom discussion and analysis.


Taking It to the Net — BTN 8-5

1. Adaptec is a technology company that specializes in data storage solutions. Adaptec’s products include software and hardware products that are designed to move, manage, and protect critical data and digital content.

2. The company maintains a patent award program that encourages its engineers to document patentable inventions so that Adaptec can continue to apply for patents both in the U.S. and in foreign countries.

The company, at times, purchases technology licenses from other companies rather than develop all needed patents internally.

3. Adaptec’s statement of operations (income statement) for 2002 shows patent settlement revenue of $9.3 million. This likely relates to monies recovered from other parties who have been ruled (by judges or juries) to have infringed on Adaptec’s patents. In 2001, negative revenues are shown for patent settlement fees. The negative revenues could be due to an appeal of the original 2000 court decision with Adaptec having to return part of the 2000 settlement fee.

Teamwork in Action — BTN 8-6

1. Annual depreciation for each year of the asset’s useful life:

Year Straight-line Double-Declining-Balance Units-of-Production2004 ($44,000-2,000)/4

= $10,500(100%/4) x 2 = 50% is declining-balance rate.BV x rate = $44,000 x 50%

= $22,000

($44,000-$2,000)/60,000 miles = $.70 per mile.12,000 miles x $.70 = $ 8,400

2005 $10,500 $22,000 x 50%= $11,000 18,000 miles x $.70 = $12,600

2006 $10,500 $11,000 x 50% = $5,500 21,000 miles x $.70 = $14,700

2007 $10,500 $5,500 (depreciate to salvage) = $3,500

9,000* miles x $.70 = $ 6,300

* Depreciation is based on the estimated capacity of 60,000 miles. Even though the van is driven 10,000 miles in the last year, depreciation can only be taken for the remaining 9,000 miles of estimated capacity. This will record depreciation to the estimated salvage value.


Teamwork in Action (Continued)

2. Depreciation is recorded in an adjusting entry at the end of each period. The entry is:

Depreciation Expense................................... xxxx*Accumulated Depreciation.............. xxxx*

*Amount varies by method and year (see part 1).

3. Each expert’s presentation of the comparison of methods will be slightly different. The experts should make the following points: The straight-line method reduces net income by the same amount each year. The declining-balance method reduces net income the largest in 2004 (first year of use) and by a lesser amount in each subsequent year. The impact of the units-of-production method varies year to year according to the amount of estimated capacity consumed (miles driven).

4. Book value at the end of each year = Cost - Accumulated depreciation = $44,000 – (amount varies by method—see part 1 for annual amounts)

Year Straight-lineDouble-Declining-

Balance Units of Production2004......... $33,500 $22,000 $35,6002005.........

..........

..........

23,000 11,000 23,000

2006......... 12,500 5,500 8,3002007......... 2,000 2,000 2,000

For reporting purposes, each expert will have different results. But each should show:

Plant Assets:Transport Van................................................ $44,000Less: Accumulated Depreciation................. XXXX*

XXXX*

* Amounts vary by the method and the year selected for illustration. Experts should explain the amounts shown.


Business Week Activity — BTN 8-7

1. In accounting terms, if a company pays $1 billion for another company that has tangible assets, such as plant and equipment, valued at $600 million, then the amount of goodwill is calculated to be $400 million. Therefore, goodwill represents the purchase price of a company that exceeds the value of the identifiable net assets.

2. Formerly, goodwill was required to be amortized deducting a portion of it from net income every year for up to 40 years.

3. The FASB has recently adopted a new standard in accounting for goodwill—these are reflected in SFAS 141 and 142. Specifically, as before, goodwill is measured as the excess of the cost of an acquired entity over the value of the acquired net assets. However, in contrast to the prior standard, goodwill is recorded as an asset and it is not amortized. Instead, SFAS 142 requires that goodwill be annually tested for impairment. If the book value of goodwill does not exceed its fair value, goodwill is not impaired. However, if the book value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details of this test are in advanced courses.)

4. It is a good idea to become familiar with the accounting for goodwill because goodwill write-downs are widely anticipated by numerous companies in the coming years. Many of the 1990’s mega-mergers have not lived up to expectations and, therefore, the acquirers often overpaid. This generated goodwill that must be tested for impairment (and likely written off against earnings).


Entrepreneurial Decision — BTN 8-8

Part 1

(a) Under current conditions, the total asset turnover is 3. This is computed as net sales of $3,000,000 divided by its average total assets of $1,000,000.* This means the company turns its assets over 3 times per year or, stated differently, each $1 of assets produces $3.00 of net sales per year.

* Total asset turnover = (b) Under this proposal, its asset turnover would increase to 3.67. This is

computed by taking its net sales of $5,500,000 ($3,000,000 + $2,500,000) and dividing by its average total assets of $1,500,000 ($1,000,000 + $500,000). This means the company would now turn its assets over 3.67 times per year or, stated differently, each $1 of assets would now produce $3.67 of net sales per year.

Part 2

Cordova’s proposal would yield an improved total asset turnover of 3.67 vis-à-vis the current total asset turnover of 3. However, we need to recognize that this proposal depends on our confidence in both maintaining current sales, meeting future sales expectations, and not losing or alienating current and/or future customers due to the expanded operations. Assuming all of our estimates are reasonable, we need to focus on any potential customer concern and the impact on other dimensions of analysis that such a proposal can bring about.*

*We must remember that total asset turnover is only one dimension of a complete analysis of this proposal. For example, we would want to explore the impact of this proposal on net income and other activities.

Hitting the Road — BTN 8-9

No formal solution exists for this activity. It is usually interesting for the class to exchange their discoveries via class discussion. This is particularly the case with respect to patents, copyrights, and trademarks.


Net salesAverage total assets

Global Decision — BTN 8-10

Note: Total asset turnover = Net sales / Average total assets

1. Total asset turnover for Grupo Bimbo (millions of pesos):



2. Grupo Bimbo and Krispy Kreme were the most efficient in producing net sales from total assets employed ($1.49 and $1.48 respectively). Specifically, each peso of Grupo Bimbo’s assets produces 1.49 pesos in net sales for the current year and 1.43 pesos in net sales for the prior year. In comparison, each dollar of Krispy Kreme’s assets produces $1.48 in net sales for the current year and $1.85 in net sales for the prior year, whereas each dollar of Tastykake’s assets produces $1.39 in net sales for the current year and $1.46 in net sales for the prior year.


Documents

Solution Manual CH 08 FInancial Accounting Reporting and Analyzing Long-Term Assets