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10-1

CHAPTER 10

Plant Assets, Natural Resources,and Intangible Assets

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives QuestionsBrief

Exercises ExercisesA

ProblemsB

Problems

1. Describe how the cost principleapplies to plant assets.

1, 2, 3 1, 2 1, 2, 3 1A 1B

2. Explain the concept ofdepreciation.

4, 5 4

3. Compute periodic depreciationusing different methods.

6, 7, 22 3, 4, 5, 6 5, 6, 7 2A, 3A,4A, 5A

2B, 3B,4B, 5B

4. Describe the procedure forrevising periodic depreciation.

8 7 8 4A 4B

5. Distinguish between revenueand capital expenditures, andexplain the entries for each.

9, 24 8

6. Explain how to account forthe disposal of a plant asset.

10, 11 9, 10 9, 10 5A, 6A 5B, 6B

7. Compute periodic depletionof natural resources.

12, 13 11 11

8. Explain the basic issuesrelated to accounting forintangible assets.

14, 15, 16,17, 18, 19

12 12, 13 7A, 8A 7B, 8B

10-2

ASSIGNMENT CLASSIFICATION TABLE (Continued)

Study Objectives QuestionsBrief

Exercises ExercisesA

ProblemsB

Problems

9. Indicate how plant assets,natural resources, andintangible assets arereported.

20, 21, 23 13, 14 14 5A, 7A, 9A 5B, 7B, 9B

*10. Explain how to accountfor the exchange of plantassets.

25, 26 15, 16 15, 16

10-3

ASSIGNMENT CHARACTERISTICS TABLE

ProblemNumber Description

DifficultyLevel

TimeAllotted (min.)

1A Determine acquisition costs of land and building. Simple 20–30

2A Compute depreciation under different methods. Simple 30–40

3A Compute depreciation under different methods. Moderate 30–40

4A Calculate revisions to depreciation expense. Moderate 20–30

5A Journalize a series of equipment transactions related topurchase, sale, retirement, and depreciation.

Moderate 40–50

6A Record disposals. Simple 30–40

7A Prepare entries to record transactions related to acquisitionand amortization of intangibles; prepare the intangibleassets section.

Moderate 30–40

8A Prepare entries to correct errors made in recording andamortizing intangible assets.

Moderate 30–40

9A Calculate and comment on asset turnover ratio. Moderate 5–10

1B Determine acquisition costs of land and building. Simple 20–30

2B Compute depreciation under different methods. Simple 30–40

3B Compute depreciation under different methods. Moderate 30–40

4B Calculate revisions to depreciation expense. Moderate 20–30

5B Journalize a series of equipment transactions related topurchase, sale, retirement, and depreciation.

Moderate 40–50

6B Record disposals. Simple 30–40

7B Prepare entries to record transactions related to acquisitionand amortization of intangibles; prepare the intangibleassets section.

Moderate 30–40

8B Prepare entries to correct errors made in recording andamortizing intangible assets.

Moderate 30–40

9B Calculate and comment on asset turnover ratio. Moderate 5–10

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10-5

ANSWERS TO QUESTIONS

1. For plant assets, the cost principle means that cost consists of all expenditures necessary to acquirethe asset and make it ready for its intended use.

2. Examples of land improvements include driveways, parking lots, fences, and underground sprinklers.

3. (a) When only the land is to be used, all demolition and removal costs of the building less anyproceeds from salvaged materials are necessary expenditures to make the land ready for itsintended use.

(b) When both the land and building are to be used, necessary costs of the building includeremodeling expenditures and the cost of replacing or repairing the roofs, floors, wiring, andplumbing.

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

5. (a) Salvage value, also called residual value, is the expected value of the asset at the end of itsuseful life.

(b) Salvage value is used in determining depreciation in each of the methods except the declining-balance method.

6. (a) Useful life is expressed in years under the straight-line method and in units of activity underthe units-of-activity method.

(b) The pattern of periodic depreciation expense over useful life is constant under the straight-linemethod and variable under the units-of-activity method.

7. The effects of the three methods on annual depreciation expense are: Straight-line—constantamount; units of activity—varying amount; declining-balance—decreasing amounts.

8. A revision of depreciation is made in current and future years but not retroactively. The rationaleis that continual restatement of prior periods would adversely affect confidence in the financialstatements.

9. Revenue expenditures are ordinary repairs made to maintain the operating efficiency and productivelife of the asset. Capital expenditures are additions and improvements made to increase operatingefficiency, productive capacity, or useful life of the asset. Revenue expenditures are recognizedas expenses when incurred; capital expenditures are generally debited to the plant asset affected.

10. In a sale of plant assets, the book value of the asset is compared to the proceeds received from thesale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. Ifthe proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.

11. The plant asset and its accumulated depreciation should continue to be reported on the balancesheet without further depreciation adjustment until the asset is retired. Reporting the asset andrelated accumulated depreciation on the balance sheet informs the reader of the financial statementsthat the asset is still in use. However, once an asset is fully depreciated, even if it is still beingused, no additional depreciation should be taken. In no situation can the accumulated depreciation onthe plant asset exceed its cost.

10-6

Questions Chapter 10 (Continued)

12. Natural resources consist of underground deposits of oil, gas, and minerals, and standing timber.These long-lived productive assets have two distinguishing characteristics: they are physicallyextracted in operations, and they are replaceable only by an act of nature.

13. Depletion is the allocation of the cost of natural resources to expense in a rational and systematicmanner over the resource’s useful life. It is computed by multiplying the depletion cost per unit bythe number of units extracted and sold.

14. The terms depreciation, depletion, and amortization are all concerned with allocating the cost ofan asset to expense over the periods benefited. Depreciation refers to allocating the cost of aplant asset to expense, depletion to recognizing the cost of a natural resource as expense, andamortization to allocating the cost of an intangible asset to expense.

15. The intern is not correct. The cost of an intangible asset should be amortized over that asset’suseful life (the period of time when operations are benefited by use of the asset). In addition,some intangibles have indefinite lives and therefore are not amortized at all.

16. The favorable attributes which could result in goodwill include exceptional management, desirablelocation, good customer relations, skilled employees, high-quality products, and harmonious relationswith labor unions.

17. Goodwill is the value of many favorable attributes that are intertwined in the business enterprise.Goodwill can be identified only with the business as a whole and, unlike other assets, cannot besold separately. Goodwill can only be sold if the entire business is sold. And, if goodwill appearson the balance sheet, it means the company has purchased another company for more than thefair market value of its net assets.

18. Goodwill is recorded only when there is a transaction that involves the purchase of an entirebusiness. Goodwill is the excess of cost over the fair market value of the net assets (assets lessliabilities) acquired. The recognition of goodwill without an exchange transaction would lead tosubjective valuations which would reduce the reliability of financial statements.

19. Research and development costs present several accounting problems. It is sometimes difficultto assign the costs to specific projects, and there are uncertainties in identifying the extent andtiming of future benefits. As a result, the FASB requires that research and development costs berecorded as an expense when incurred.

20. McDonald’s asset turnover ratio is computed as follows:

assets total Average

sales Net=

$20.5billion$28.9 billion

= .71 times

10-7

Questions Chapter 10 (Continued)

21. Since Resco uses the straight-line depreciation method, its depreciation expense will be lower inthe early years of an asset’s useful life as compared to using an accelerated method. Yapan’sdepreciation expense in the early years of an asset’s useful life will be higher as compared tothe straight-line method. Resco’s net income will be higher than Yapan’s in the first few years ofthe asset’s useful life. And, the reverse will be true late in an asset’s useful life.

22. Yes, the tax regulations of the IRS allow a company to use a different depreciation method on thetax return than is used in preparing financial statements. Lopez Corporation uses an accelerateddepreciation method for tax purposes to minimize its income taxes and thereby the cash outflowfor taxes.

23. By selecting a longer estimated useful life, May Corp. is spreading the plant asset’s cost over alonger period of time. The depreciation expense reported in each period is lower and net income ishigher. Won’s choice of a shorter estimated useful life will result in higher depreciation expensereported in each period and lower net income.

24. Expensing these costs will make current period income lower but future period income higher becausethere will be no additional depreciation expense in future periods. If the costs are ordinary repairs,they should be expensed.

25. When assets are exchanged, the gain or loss on disposal is computed as the difference betweenthe book value and the fair market value of the asset given up at the time of exchange.

26. Yes, Tatum should recognize a gain equal to the difference between the fair market value of theold machine and its book value. If the fair market value of the old machine is less than its bookvalue, Tatum should recognize a loss equal to the difference between the two amounts.

10-8

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 10-1

All of the expenditures should be included in the cost of the land. Therefore,the cost of the land is $81,000, or ($70,000 + $3,000 + $2,500 + $2,000 + $3,500).

BRIEF EXERCISE 10-2

The cost of the truck is $31,900 (cash price $30,000 + sales tax $1,500 + paintingand lettering $400). The expenditures for insurance and motor vehicle licenseshould not be added to the cost of the truck.

BRIEF EXERCISE 10-3

Depreciable cost of $36,000, or ($42,000 – $6,000). With a four-year useful life,annual depreciation is $9,000, or ($36,000 ÷ 4). Under the straight-line method,depreciation is the same each year. Thus, depreciation is $9,000 for both thefirst and second years.

BRIEF EXERCISE 10-4

It is likely that management requested this accounting treatment to boostreported net income. Land is not depreciated; thus, by reporting land at$120,000 above its actual value the company increased yearly income by

$6,000, $120,00020 years

or the reduction in depreciation expense. This practice is

not ethical because management is knowingly misstating asset values.

BRIEF EXERCISE 10-5

The declining balance rate is 50%, or (25% X 2) and this rate is applied to bookvalue at the beginning of the year. The computations are:

Book Value X Rate = Depreciation

Year 1Year 2

$42,000($42,000 – $21,000)

50%50%

$21,000$10,500

10-9

BRIEF EXERCISE 10-6

The depreciation cost per unit is 22 cents per mile computed as follows:

Depreciable cost ($33,500 – $500) ÷ 150,000 = $.22Year 1 30,000 miles X $.22 = $6,600Year 2 20,000 miles X $.22 = $4,400

BRIEF EXERCISE 10-7

Book value, 1/1/08......................................................................................... $20,000Less: Salvage value .................................................................................... 2,000Depreciable cost............................................................................................ $18,000Remaining useful life ................................................................................... 4 yearsRevised annual depreciation ($18,000 ÷ 4)........................................... $ 4,500

BRIEF EXERCISE 10-8

1. Repair Expense .................................................................... 45Cash ................................................................................ 45

2. Delivery Truck....................................................................... 400Cash ................................................................................ 400

BRIEF EXERCISE 10-9

(a) Accumulated Depreciation—Delivery Equipment.......................................................................... 41,000

Delivery Equipment .................................................... 41,000

(b) Accumulated Depreciation—Delivery Equipment.......................................................................... 39,000Loss on Disposal.................................................................. 2,000

Delivery Equipment .................................................... 41,000

10-10

BRIEF EXERCISE 10-9 (Continued)

Cost of delivery equipment $41,000 Less accumulated depreciation 39,000 Book value at date of disposal 2,000 Proceeds from sale 0 Loss on disposal $ 2,000

BRIEF EXERCISE 10-10

(a) Depreciation Expense—Office Equipment.................. 5,250Accumulated Depreciation—Office Equipment ................................................................ 5,250

(b) Cash ......................................................................................... 20,000Accumulated Depreciation—Office Equipment......... 47,250Loss on Disposal................................................................. 4,750

Office Equipment ........................................................ 72,000

Cost of office equipment $72,000 Less accumulated depreciation 47,250* Book value at date of disposal 24,750 Proceeds from sale 20,000 Loss on disposal $ 4,750

*$42,000 + $5,250


(a) Depletion cost per unit = $7,000,000 ÷ 35,000,000 = $.20 depletion cost per ton$.20 X 6,000,000 = $1,200,000

Depletion Expense .............................................. 1,200,000Accumulated Depletion ............................ 1,200,000

(b) Ore mine ................................................................ $7,000,000Less: Accumulated depletion........................ 1,200,000 $5,800,000

10-11


(a) Amortization Expense—Patent ($120,000 ÷ 10) .......... 12,000Patents............................................................................. 12,000

(b) Intangible AssetsPatents............................................................................. $108,000


SPAIN COMPANYBalance Sheet (partial)

December 31, 2008 Property, plant, and equipment

Coal mine.................................................. $ 500,000Less: Accumulated depletion ........... 108,000 $392,000Buildings................................................... 1,100,000Less: Accumulated depreciation..... 650,000 450,000

Total property, plant, and equipment ................................... $842,000

Intangible assetsGoodwill .................................................... 410,000


$51.2 ÷ $32.2 + $35.0

2

= 1.52 times


Delivery Equipment (new) ......................................................... 24,000Accumulated Depreciation—Delivery Equipment............. 30,000Loss on Disposal ......................................................................... 12,000

Delivery Equipment (old) .................................................. 61,000Cash......................................................................................... 5,000

10-12

BRIEF EXERCISE 10-15 (Continued)

Fair market value of old delivery equipment $19,000Cash 5,000Cost of delivery equipment $24,000

Fair market value of old delivery equipment $19,000Book value of old delivery equipment ($61,000 – $30,000) 31,000Loss on disposal $12,000


Delivery Equipment (new).......................................................... 43,000Accumulated Depreciation—Delivery Equipment ............. 30,000

Gain on Disposal ................................................................. 7,000Delivery Equipment (old) .................................................. 61,000Cash ......................................................................................... 5,000

Fair market value of old delivery equipment $38,000Cash 5,000Cost of new delivery equipment $43,000

Fair market value of old delivery equipment $38,000Book value of old delivery equipment ($61,000 – $30,000) 31,000Gain on disposal $ 7,000

10-13

SOLUTIONS TO EXERCISES

EXERCISE 10-1

(a) Under the cost principle, the acquisition cost for a plant asset includesall expenditures necessary to acquire the asset and make it ready for itsintended use. For example, the cost of factory machinery includes thepurchase price, freight costs paid by the purchaser, insurance costsduring transit, and installation costs.

(b) 1. Land2. Factory Machinery3. Delivery Equipment4. Land Improvements5. Delivery Equipment6. Factory Machinery7. Prepaid Insurance8. License Expense

EXERCISE 10-2

1. Factory Machinery2. Truck3. Factory Machinery4. Land5. Prepaid Insurance6. Land Improvements7. Land Improvements8. Land9. Building

10-14

EXERCISE 10-3

(a) Cost of landCash paid........................................................................................ $80,000Net cost of removing warehouse ........................................... 6,900 ($8,600 – $1,700)Attorney’s fee................................................................................ 1,100Real estate broker’s fee............................................................. 5,000

Total......................................................................................... $93,000

(b) The architect’s fee ($7,800) should be debited to the Building account.The cost of the driveways and parking lot ($14,000) should be debitedto Land Improvements.

EXERCISE 10-4

1. False. Depreciation is a process of cost allocation, not asset valuation.2. True.3. False. The book value of a plant asset may be quite different from its

market value.4. False. Depreciation applies to three classes of plant assets: land improve-

ments, buildings, and equipment.5. False. Depreciation does not apply to land because its usefulness and

revenue-producing ability generally remain intact over time.6. True.7. False. Recognizing depreciation on an asset does not result in an ac-

cumulation of cash for replacement of the asset.8. True.9. False. Depreciation expense is reported on the income statement, and

accumulated depreciation is reported as a deduction from plant assets onthe balance sheet.

10. False. Three factors affect the computation of depreciation: cost, usefullife, and salvage value (also called residual value).

10-15

EXERCISE 10-5

(a) Depreciation cost per unit is $1.60 per mile [($168,000 – $8,000) ÷ 100,000].

(b) Computation End of Year

YearUnits ofActivity X

DepreciationCost /Unit =

AnnualDepreciation

ExpenseAccumulatedDepreciation

BookValue

2008200920102011

26,00032,00025,00017,000

$1.60 1.60 1.60 1.60

$41,600 51,200 40,000 27,200

$ 41,600 92,800 132,800 160,000

$126,400 75,200 35,200 8,000

EXERCISE 10-6

(a) Straight-line method:

$120,000 – $12,0005

= $21,600 per year.

2008 depreciation = $21,600 X 3/12 = $5,400.

(b) Units-of-activity method:

$120,000 – $12,00010,000

= $10.80 per hour.

2008 depreciation = 1,700 hours X $10.80 = $18,360.

(c) Declining-balance method:

2008 depreciation = $120,000 X 40% X 3/12 = $12,000.Book value January 1, 2009 = $120,000 – $12,000 = $108,000.2009 depreciation = $108,000 X 40% = $43,200.

10-16

EXERCISE 10-7

(a) (1) 2008: ($30,000 – $2,000)/8 = $3,5002009: ($30,000 – $2,000)/8 = $3,500

(2) ($30,000 – $2,000)/100,000 = $0.28 per mile2008: 15,000 X $0.28 = $4,2002009: 12,000 X $0.28 = $3,360

(3) 2008: $30,000 X 25% = $7,5002009: ($30,000 – $7,500) X 25% = $5,625

(b) (1) Depreciation Expense .................................................. 3,500Accumulated Depreciation—Delivery Truck........ 3,500

(2) Delivery Truck................................................................. $30,000Less: Accumulated Depreciation ............................. (3,500)

$26,500

EXERCISE 10-8

(a) Type of Asset Building Warehouse

Book value, 1/1/08Less: Salvage valueDepreciable cost

Revised useful life in years

Revised annual depreciation

$686,000 37,000$649,000

44

$ 14,750

$75,000 3,600$71,400

15

$ 4,760

(b) Dec. 31 Depreciation Expense—Building............... 14,750Accumulated Depreciation— Building................................................. 14,750

10-17

EXERCISE 10-9

Jan. 1 Accumulated Depreciation—Machinery........ 62,000Machinery ....................................................... 62,000

June 30 Depreciation Expense ......................................... 4,000Accumulated Depreciation— Computer ($40,000 X 1/5 X 6/12)......... 4,000

30 Cash........................................................................... 14,000Accumulated Depreciation—Computer......... 28,000 ($40,000 X 3/5 = $24,000; $24,000 + $4,000)

Gain on Disposal .......................................... 2,000 [$14,000 – ($40,000 – $28,000)]Computer ........................................................ 40,000

Dec. 31 Depreciation Expense ......................................... 6,000Accumulated Depreciation—Truck ........ 6,000 [($39,000 – $3,000) X 1/6]

31 Loss on Disposal .................................................. 9,000Accumulated Depreciation—Truck ................. 30,000 [($39,000 – $3,000) X 5/6]

Delivery Truck ............................................... 39,000

EXERCISE 10-10

(a) Cash...................................................................................... 28,000Accumulated Depreciation—Equipment .................. 27,000 [($50,000 – $5,000) X 3/5]

Equipment................................................................. 50,000Gain on Disposal .................................................... 5,000

(b) Depreciation Expense..................................................... 3,000 [($50,000 – $5,000) X 1/5 X 4/12]

Accumulated Depreciation—Equipment........ 3,000

Cash...................................................................................... 28,000Accumulated Depreciation—Equipment .................. 30,000 ($27,000 + $3,000)

Equipment................................................................ 50,000Gain on Disposal ................................................... 8,000

10-18

EXERCISE 10-10 (Continued)

(c) Cash......................................................................................... 11,000Accumulated Depreciation—Equipment ..................... 27,000Loss on Disposal................................................................. 12,000

Equipment ..................................................................... 50,000

(d) Depreciation Expense........................................................ 6,750 [($50,000 – $5,000) X 1/5 X 9/12]

Accumulated Depreciation—Equipment............. 6,750

Cash......................................................................................... 11,000Accumulated Depreciation—Equipment ..................... 33,750 ($27,000 + $6,750)Loss on Disposal................................................................. 5,250

Equipment ..................................................................... 50,000

EXERCISE 10-11

(a) Dec. 31 Depletion Expense.......................................... 90,000Accumulated Depletion........................ 90,000 (100,000 X $.90)

Cost (a) $720,000Units estimated (b) 800,000 tonsDepletion cost per unit [(a) ÷ (b)] $0.90

(b) The costs pertaining to the unsold units are reported in current assets aspart of inventory (20,000 X $.90 = $18,000).

EXERCISE 10-12

Dec. 31 Amortization Expense—Patent ....................... 12,000Patents ($90,000 X 1/5 X 8/12)................. 12,000

Note: No entry is made to amortize goodwill because it has an indefinite life.

10-19

EXERCISE 10-13

1/2/08 Patents .................................................................... 560,000Cash ................................................................ 560,000

4/1/08 Goodwill.................................................................. 360,000Cash ................................................................ 360,000 (Part of the entry to record purchase of another company)

7/1/08 Franchise................................................................ 440,000Cash ................................................................ 440,000

9/1/08 Research and Development Expense........... 185,000Cash ................................................................ 185,000

12/31/08 Amortization Expense—Patent ....................... 80,000 ($560,000 ÷ 7)Amortization Expense—Franchise ................ 22,000 [($440,000 ÷ 10) X 1/2]

Patents....................................................... 80,000Franchise .................................................. 22,000

Ending balances, 12/31/08:Patent = $480,000 ($560,000 – $80,000).Goodwill = $360,000Franchise = $418,000 ($440,000 – $22,000).R&D expense = $185,000

EXERCISE 10-14

Asset turnover ratio = $4,900,000$1,400,000

= 3.5 times

10-20

*EXERCISE 10-15

(a) Trucks (new).......................................................................... 53,000Accumulated Depreciation—Trucks (old) ................... 22,000Loss on Disposal................................................................. 6,000

Trucks (old)................................................................... 64,000Cash ................................................................................ 17,000

Cost of old trucks $64,000 Less: Accumulated depreciation 22,000 Book value 42,000 Fair market value of old trucks 36,000 Loss on disposal $ 6,000

Fair market value of old trucks $36,000 Cash paid 17,000 Cost of new trucks $53,000

(b) Machine (new)....................................................................... 12,000Accumulated Depreciation—Machine (old) ................ 4,000

Gain on Disposal ........................................................ 1,000Machine (old)................................................................ 12,000Cash ................................................................................ 3,000

Cost of old machine $12,000 Less: Accumulated depreciation 4,000 Book value 8,000 Fair market value of old machine 9,000 Gain on disposal $ 1,000

Fair market value of old machine $ 9,000 Cash paid 3,000 Cost of new machine $12,000

10-21

*EXERCISE 10-16

(a) Delivery Truck (new) .......................................................... 4,000Loss on Disposal................................................................. 3,000Accumulated Depreciation—Delivery Truck (old)......................................................................... 15,000

Delivery Truck (old) ................................................... 22,000

Cost of old truck $22,000 Less: Accumulated depreciation 15,000 Book value 7,000 Fair market value of old truck 4,000 Loss on disposal $ 3,000

(b) Delivery Truck (new) .......................................................... 4,000Accumulated Depreciation—Delivery Trucks (old)....................................................................... 8,000

Delivery Truck (old) ................................................... 10,000Gain on Disposal ........................................................ 2,000

Cost of old truck $10,000 Less: Accumulated depreciation 8,000 Book value 2,000 Fair market value of old truck 4,000 Gain on Disposal $ 2,000

Cost of new delivery truck* $ 4,000

*Fair value of old truck

10-22

SOLUTIONS TO PROBLEMS

PROBLEM 10-1A

Item Land Building Other Accounts

1 2 3 4 5 6 7 8 910

($ 4,000)

( 145,000)

( 2,000)

( 15,000) (3,500)

($162,500)

$700,000

35,000 10,000

$745,000

$ 5,000 Property Taxes Expense

14,000 Land Improvements

10-23

PROBLEM 10-2A

(a)Year Computation

Cumulative12/31

BUS 1200620072008

$ 90,000 X 20% = $18,000$ 90,000 X 20% = $18,000$ 90,000 X 20% = $18,000

$ 18,000 36,000 54,000

BUS 2200620072008

$120,000 X 50% = $60,000$ 60,000 X 50% = $30,000$ 30,000 X 50% = $15,000

$ 60,000 90,000 105,000

BUS 320072008

24,000 miles X $.60* = $14,40034,000 miles X $.60* = $20,400

$ 14,400 34,800

*$72,000 ÷ 120,000 miles = $.60 per mile.

(b) Year Computation Expense

BUS 2(1)

(2)

2006

2007

$120,000 X 50% X 9/12 = $45,000

$75,000 X 50% = $37,500

$45,000

$37,500

10-24

PROBLEM 10-3A

(a) (1) Purchase price.............................................................................. $ 38,000Sales tax ......................................................................................... 1,700Shipping costs.............................................................................. 150Insurance during shipping ....................................................... 80Installation and testing .............................................................. 70

Total cost of machinery.................................................... $ 40,000

Machinery...................................................................... 40,000Cash ....................................................................... 40,000

(2) Recorded cost............................................................................... $ 40,000Less: Salvage value................................................................... 5,000Depreciable cost .......................................................................... $ 35,000Years of useful life....................................................................... ÷ 5

Annual depreciation........................................................... $ 7,000

Depreciation Expense............................................... 7,000Accumulated Depreciation ............................. 7,000

(b) (1) Recorded cost............................................................................... 160,000Less: Salvage value................................................................... 10,000Depreciable cost .......................................................................... $150,000Years of useful life....................................................................... ÷ 4


(2) Book Valueat Beginning

of YearDDBRate

Annual DepreciationExpense

AccumulatedDepreciation

$160,000 80,000 40,000 20,000

*50%**50%**50%**50%*

$80,000 40,000 20,000

** 10,000

$ 80,000 120,000 140,000 150,000

**100% ÷ 4-year useful life = 25% X 2 = 50%.

10-25

PROBLEM 10-3A (Continued)

(3) Depreciation cost per unit = ($160,000 – $10,000)/125,000 units = $1.20per unit.

Annual Depreciation Expense

2008: $1.20 X 45,000 = $54,0002009: 1.20 X 35,000 = 42,0002010: 1.20 X 25,000 = 30,0002011: 1.20 X 20,000 = 24,000

(c) The declining-balance method reports the highest amount of depreciationexpense the first year while the straight-line method reports the lowest.In the fourth year, the straight-line method reports the highest amount ofdepreciation expense while the declining-balance method reports thelowest.

These facts occur because the declining-balance method is an acceler-ated depreciation method in which the largest amount of depreciationis recognized in the early years of the asset’s life. If the straight-linemethod is used, the same amount of depreciation expense is recognizedeach year. Therefore, in the early years less depreciation expense will berecognized under this method than under the declining-balance methodwhile more will be recognized in the later years.

The amount of depreciation expense recognized using the units-of-activitymethod is dependent on production, so this method could recognize moreor less depreciation expense than the other two methods in any yeardepending on output.

No matter which of the three methods is used, the same total amountof depreciation expense will be recognized over the four-year period.

10-26

PROBLEM 10-4A

YearDepreciation


2006200720082009201020112012

(b)$13,500(a)

13,500 (b)10,800(b)

10,800 10,800

12,800(c)

12,800

$13,500 27,000 37,800 48,600 59,400 72,200 85,000

(a) $90,000 – $9,0006 years

= $13,500

(b) Book value – Salvage valueRemaining useful llife

= $63,000 – $9,000

5 years = $10,800

(c) $30,600 – $5,0002 years

= $12,800

10-27

PROBLEM 10-5A

(a) Apr. 1 Land .......................................................... 2,130,000Cash ................................................. 2,130,000

May 1 Depreciation Expense......................... 26,000Accumulated Depreciation— Equipment ................................. 26,000 ($780,000 X 1/10 X 4/12)

1 Cash .......................................................... 450,000Accumulated Depreciation— Equipment .......................................... 338,000

Equipment...................................... 780,000Gain on Disposal ......................... 8,000

Cost $780,000Accum. depreciation— equipment 338,000 [($780,000 X 1/10 X 4) +

$26,000]Book value 442,000Cash proceeds 450,000Gain on disposal $ 8,000

June 1 Cash .......................................................... 1,500,000Land ................................................. 400,000Gain on Disposal ......................... 1,100,000

July 1 Equipment............................................... 2,000,000Cash ................................................. 2,000,000

Dec. 31 Depreciation Expense......................... 50,000Accumulated Depreciation— Equipment ................................. 50,000 ($500,000 X 1/10)

31 Accumulated Depreciation— Equipment .......................................... 500,000

Equipment...................................... 500,000

10-28


Cost $500,000Accum. depreciation— equipment 500,000 ($500,000 X 1/10 X 10) Book value $ 0

(b) Dec. 31 Depreciation Expense ........................ 570,000Accumulated Depreciation— Buildings ................................... 570,000 ($28,500,000 X 1/50)

31 Depreciation Expense ........................ 4,772,000Accumulated Depreciation— Equipment................................. 4,772,000

($46,720,000* X 1/10) $4,672,000[($2,000,000 X 1/10) X 6/12] 100,000

$4,772,000

*($48,000,000 – $780,000 – $500,000)

(c) JIMENEZ COMPANYPartial Balance Sheet

December 31, 2009 Plant Assets*

Land .............................................................. $ 5,730,000Buildings ..................................................... $28,500,000Less: Accumulated depreciation—

buildings .................................... 12,670,000 15,830,000Equipment................................................... 48,720,000Less: Accumulated depreciation—

equipment.................................. 9,010,000 39,710,000Total plant assets ............................ $61,270,000

*See T-accounts which follow.

10-29


LandBal. 4,000,000 Apr. 1 2,130,000

June 1 400,000

Bal. 5,730,000

BuildingsBal. 28,500,000 Bal. 28,500,000

Accumulated Depreciation—BuildingsBal. 12,100,000Dec. 31 adj. 570,000Bal. 12,670,000

EquipmentBal. 48,000,000 July 1 2,000,000

May 1 780,000Dec. 31 500,000

Bal. 48,720,000

Accumulated Depreciation—EquipmentMay 1 338,000 Dec. 31 500,000

Bal. 5,000,000May 1 26,000Dec. 31 50,000Dec. 31 adj. 4,772,000Bal. 9,010,000

10-30

PROBLEM 10-6A

(a) Accumulated Depreciation—Office Furniture............................................................................. 50,000Loss on Disposal................................................................. 25,000

Office Furniture ........................................................... 75,000

(b) Cash ......................................................................................... 21,000Accumulated Depreciation—Office Furniture............................................................................. 50,000Loss on Disposal ................................................................. 4,000

Office Furniture ........................................................... 75,000

(c) Cash ......................................................................................... 31,000Accumulated Depreciation—Office Furniture............................................................................. 50,000

Gain on Disposal ........................................................ 6,000Office Furniture ........................................................... 75,000

10-31

PROBLEM 10-7A

(a) Jan. 2 Patents ............................................................ 45,000Cash ........................................................ 45,000

Jan.– Research and DevelopmentJune Expense...................................................... 140,000

Cash ........................................................ 140,000

Sept. 1 Advertising Expense .................................. 50,000Cash ........................................................ 50,000

Oct. 1 Franchise........................................................ 100,000Cash ........................................................ 100,000

(b) Dec. 31 Amortization Expense—Patents............. 12,000Patents ................................................... 12,000 [($70,000 X 1/10) + ($45,000 X 1/9)]

31 Amortization Expense—Franchise ........ 5,300Franchise............................................... 5,300 [($48,000 X 1/10) + ($100,000 X 1/50 X 3/12)]

(c) Intangible AssetsPatents ($115,000 cost – $19,000 amortization) (1) ................ $ 96,000Franchise ($148,000 cost – $24,500 amortization) (2)............ 123,500

Total intangible assets ............................................................ $219,500

(1) Cost ($70,000 + $45,000); amortization ($7,000 + $12,000).(2) Cost ($48,000 + $100,000); amortization ($19,200 + $5,300).

10-32

PROBLEM 10-8A

1. Research and Development Expense....................... 136,000Patents ....................................................................... 136,000

Patents ................................................................................ 6,800Amortization Expense—Patents........................ 6,800 [$9,800 – ($60,000 X 1/20)]

2. Goodwill.............................................................................. 920Amortization Expense—Goodwill ..................... 920

Note: Goodwill should not be amortized because it has an indefinite life unlikePatents.

10-33

PROBLEM 10-9A

(a) Lebo Ritter

Asset turnover ratio $1,200,000$2,500,000

= .48 times$1,080,000$2,000,000

= .54 times

(b) Based on the asset turnover ratio, Ritter is more effective in using assetsto generate sales. Its asset turnover ratio is almost 13% higher than Lebo’sratio.

10-34

PROBLEM 10-1B

Item Land Building Other Accounts

1 2 3 4 5 6 7 8 910

($ 2,000)

125,000

( 24,000)( (2,500)($148,500)

$600,000 22,000

10,000

$632,000

$ 3,000 Property Taxes Expense



10-35

PROBLEM 10-2B

(a)Year Computation

Cumulative12/31

MACHINE 12005200620072008

$ 80,000 X 10% = $8,000$ 80,000 X 10% = $8,000$ 80,000 X 10% = $8,000$ 80,000 X 10% = $8,000

$ 8,000 16,000 24,000 32,000

MACHINE 2200620072008

$100,000 X 25% = $25,000$ 75,000 X 25% = $18,750$ 56,250 X 25% = $14,063

$25,000 43,750 57,813

MACHINE 32008 1,000 X ($72,000 ÷ 24,000) = $3,000 $ 3,000

(b) Year Depreciation Computation Expense

MACHINE 2(1)

(2)

2006

2007

$100,000 X 25% X 9/12 = $18,750

$81,250 X 25% = $20,313

$18,750

$20,313

10-36

PROBLEM 10-3B

(a) (1) Purchase price.............................................................................. $ 46,500Sales tax ......................................................................................... 2,200Shipping costs.............................................................................. 175Insurance during shipping ....................................................... 75Installation and testing .............................................................. 50

Total cost of machinery.................................................... $ 49,000

Machinery...................................................................... 49,000Cash ....................................................................... 49,000

(2) Recorded cost............................................................................... $ 49,000Less: Salvage value................................................................... 5,000Depreciable cost .......................................................................... $ 44,000Years of useful life....................................................................... ÷ 4


Depreciation Expense............................................... 11,000Accumulated Depreciation ............................. 11,000

(b) (1) Recorded cost............................................................................... $120,000Less: Salvage value................................................................... 8,000Depreciable cost .......................................................................... $112,000Years of useful life ...................................................................... ÷ 4


(2)

Year

Book Value atBeginning of

Year DDB Rate

AnnualDepreciation


2008200920102011

$120,000 60,000 30,000 15,000

*50%**50%**50%**50%*

$60,000 30,000 15,000

7,000**

$ 60,000 90,000105,000

112,000

*100% ÷ 4-year useful life = 25% X 2 = 50%.**[($120,000 – $8,000) – $105,000] = $7,000.

10-37

PROBLEM 10-3B (Continued)

(3) Depreciation cost per unit = ($120,000 – $8,000)/25,000 units =$4.48 per unit.

Annual Depreciation Expense

2008: $4.48 X 6,500 = $29,1202009: 4.48 X 7,500 = 33,6002010: 4.48 X 6,000 = 26,8802011: 4.48 X 5,000 = 22,400

(c) The straight-line method reports the lowest amount of depreciationexpense the first year while the declining-balance method reports thehighest. In the fourth year, the declining-balance method reports thelowest amount of depreciation expense while the straight-line methodreports the highest.

These facts occur because the declining-balance method is an accelerateddepreciation method in which the largest amount of depreciation isrecognized in the early years of the asset’s life. If the straight-line methodis used, the same amount of depreciation expense is recognized eachyear. Therefore, in the early years less depreciation expense will berecognized under this method than under the declining-balance methodwhile more will be recognized in the later years.

The amount of depreciation expense recognized using the units-of-activitymethod is dependent on production, so this method could recognize moreor less depreciation expense than the other two methods in any yeardepending on output.

No matter which of the three methods is used, the same total amountof depreciation expense will be recognized over the four-year period.

10-38

PROBLEM 10-4B

YearDepreciation


2006200720082009201020112012

$12,000(a)

12,000 9,600(b)

9,600 9,600 11,600(c)

11,600

$12,000 24,000 33,600 43,200 52,800 64,400 76,000

(a) $80,000 – $8,0006 years

= $12,000

(b) Book value – Salvage valueRemaining useful llife

= $56,000 – $8,000

5 years = $9,600

(c) $27,200 – $4,0002 years

= $11,600

10-39

PROBLEM 10-5B

(a) Apr. 1 Land .......................................................... 2,200,000Cash ................................................. 2,200,000

May 1 Depreciation Expense......................... 20,000Accumulated Depreciation— Equipment ................................. 20,000 ($600,000 X 1/10 X 4/12)

1 Cash .......................................................... 360,000Accumulated Depreciation— Equipment .......................................... 260,000

Equipment...................................... 600,000Gain on Disposal ......................... 20,000

Cost $600,000Accum. depreciation— equipment 260,000 [($600,000 X 1/10 X 4) + $20,000] Book value 340,000Cash proceeds 360,000Gain on disposal $ 20,000

June 1 Cash .......................................................... 1,800,000Land ................................................. 600,000Gain on Disposal ......................... 1,200,000

July 1 Equipment............................................... 1,800,000Cash ................................................. 1,800,000

Dec. 31 Depreciation Expense......................... 50,000Accumulated Depreciation— Equipment ................................. 50,000 ($500,000 X 1/10)

31 Accumulated Depreciation— Equipment .......................................... 500,000

Equipment...................................... 500,000

10-40


Cost $500,000Accum. depreciation— equipment 500,000 ($500,000 X 1/10 X 10) Book value $ 0

(b) Dec. 31 Depreciation Expense ........................ 530,000Accumulated Depreciation— Buildings ................................... 530,000 ($26,500,000 X 1/50)

31 Depreciation Expense ........................ 3,980,000Accumulated Depreciation— Equipment................................. 3,980,000

($38,900,000* X 1/10) $3,890,000[($1,800,000 X 1/10) X 6/12] 90,000

$3,980,000

*($40,000,000 – $600,000 – $500,000)

(c) YOCKEY COMPANYPartial Balance Sheet

December 31, 2009 Plant Assets*

Land .............................................................. $ 4,600,000Buildings ..................................................... $26,500,000Less: Accumulated depreciation—

buildings .................................... 12,630,000 13,870,000Equipment................................................... 40,700,000Less: Accumulated depreciation—

equipment.................................. 8,290,000 32,410,000Total plant assets ............................ $50,880,000

*See T-accounts which follow.

10-41


LandBal. 3,000,000 Apr. 1 2,200,000

June 1 600,000

Bal. 4,600,000

BuildingsBal. 26,500,000 Bal. 26,500,000

Accumulated Depreciation—BuildingsBal. 12,100,000Dec. 31 adj. 530,000Bal. 12,630,000

EquipmentBal. 40,000,000 July 1 1,800,000

May 1 600,000Dec. 31 500,000

Bal. 40,700,000

Accumulated Depreciation—EquipmentMay 1 260,000 Dec. 31 500,000

Bal. 5,000,000May 1 20,000Dec. 31 50,000Dec. 31 adj. 3,980,000Bal. 8,290,000

10-42

PROBLEM 10-6B

(a) Accumulated Depreciation—Delivery Equipment ......................................................................... 24,000Loss on Disposal................................................................. 26,000

Delivery Equipment.................................................... 50,000

(b) Cash ......................................................................................... 31,000Accumulated Depreciation—Delivery Equipment ......................................................................... 24,000

Gain on Disposal ........................................................ 5,000Delivery Equipment.................................................... 50,000

(c) Cash ......................................................................................... 18,000Accumulated Depreciation—Delivery Equipment ......................................................................... 24,000Loss on Disposal................................................................. 8,000

Delivery Equipment.................................................... 50,000

10-43

PROBLEM 10-7B

(a) Jan. 2 Patents ............................................................ 27,000Cash ........................................................ 27,000

Jan.– Research and DevelopmentJune Expense...................................................... 140,000

Cash ........................................................ 140,000

Sept. 1 Advertising Expense .................................. 75,000Cash ........................................................ 75,000

Oct. 1 Copyright........................................................ 120,000Cash ........................................................ 120,000

(b) Dec. 31 Amortization Expense—Patents............. 9,000Patents ................................................... 9,000 [($60,000 X 1/10) + ($27,000 X 1/9)]

31 Amortization Expense—Copyright ........ 4,200Copyright............................................... 4,200 [($36,000 X 1/10) + ($120,000 X 1/50 X 3/12)]

(c) Intangible AssetsPatents ($87,000 cost – $15,000 amortization) (1)................... $ 72,000Copyright ($156,000 cost – $18,600 amortization) (2)............ 137,400

Total intangible assets ............................................................ $209,400

(1) Cost ($60,000 + $27,000); amortization ($6,000 + $9,000).(2) Cost ($36,000 + $120,000); amortization ($14,400 + $4,200).

(d) The intangible assets of the company consist of two patents and twocopyrights. One patent with a total cost of $87,000 is being amortizedin two segments ($60,000 over 10 years and $27,000 over 9 years); theother patent was obtained at no recordable cost. A copyright with a costof $36,000 is being amortized over 10 years; the other copyright with acost of $120,000 is being amortized over 50 years.

10-44

PROBLEM 10-8B

1. Research and Development Expense........................... 95,000Patents ........................................................................... 95,000

Patents .................................................................................... 4,750Amortization Expense—Patents............................ 4,750 [$6,750 – ($40,000 X 1/20)]

2. Goodwill.................................................................................. 800Amortization Expense—Goodwill ......................... 800

Note: Goodwill should not be amortized because it has an indefinite life unlikePatents.

10-45

PROBLEM 10-9B

(a) Gavin Corp. Keady Corp.

Asset turnover ratio $1,300,000$2,000,000

= .65 times$1,140,000$1,500,000

= .76 times

(b) Based on the asset turnover ratio, Keady Corp. is more effective in usingassets to generate sales. Its asset turnover ratio is 17% higher thanGavins’s asset turnover ratio.

10-46

CHAPTER 10 COMPREHENSIVE PROBLEM SOLUTION

(a) 1. Equipment....................................................................... 13,800Cash ............................................................................ 13,800

2. Depreciation Expense—Equipment ....................... 450Accumulated Depreciation—Equipment......... 450

Cash.................................................................................. 3,500Accumulated Depreciation—Equipment .............. 2,250

Equipment................................................................. 5,000Gain on Disposal .................................................... 750

3. Accounts Receivable .................................................. 9,000Sales............................................................................ 9,000

Cost of Goods Sold ..................................................... 6,300Merchandise Inventory ......................................... 6,300

4. Bad Debts Expense ..................................................... 3,500Allowance for Doubtful Accounts..................... 3,500

5. Interest Receivable ...................................................... 600Interest Revenue..................................................... 600

6. Insurance Expense ...................................................... 2,400Prepaid Insurance .................................................. 2,400

7. Depreciation Expense—Building ............................ 4,000Accumulated Depreciation—Building ............. 4,000

8. Depreciation Expense—Equipment ....................... 9,900Accumulated Depreciation—Equipment......... 9,900

9. Depreciation Expense—Equipment ....................... 1,600Accumulated Depreciation—Equipment......... 1,600

10-47

COMPREHENSIVE PROBLEM (Continued)

10. Amortization Expense—Patents .............................. 900Patent .......................................................................... 900

11. Salaries Expense........................................................... 2,200Salaries Payable ...................................................... 2,200

12. Unearned Rent ............................................................... 2,000Rent Revenue ........................................................... 2,000

13. Interest Expense............................................................ 4,140Interest Payable ....................................................... 4,140

10-48


(b) WINTERSCHID COMPANYTrial Balance

December 31, 2008 Debits Credits

Cash...............................................................................Accounts Receivable ...............................................Notes Receivable.......................................................Interest Receivable ...................................................Merchandise Inventory............................................Prepaid Insurance .....................................................Land...............................................................................Building ........................................................................Equipment....................................................................Patent ............................................................................Allowance for Doubtful Accounts........................Accumulated Depreciation—Building................Accumulated Depreciation—Equipment ...........Accounts Payable .....................................................Salaries Payable ........................................................Unearned Rent............................................................Notes Payable (short-term) ....................................Interest Payable .........................................................Notes Payable (long-term)......................................Winterschid, Capital .................................................Winterschid, Drawing...............................................Sales ..............................................................................Interest Revenue........................................................Rent Revenue .............................................................Gain on Disposal .......................................................Bad Debts Expense ..................................................Cost of Goods Sold ..................................................Depreciation Expense—Building.........................Depreciation Expense—Equipment ....................Insurance Expense ...................................................Interest Expense........................................................Other Operating Expenses.....................................Amortization Expense–Patents ............................Salaries Expense.......................................................Total ...............................................................................

$ 17,70045,80010,000

60029,9001,200

20,000150,000

68,8008,100

12,000

3,500636,300

4,00011,9502,4004,140

61,800900

112,200$1,201,290

$ 4,00054,00033,70027,3002,2004,000

11,0004,140

35,000113,600

909,000600

2,000750

$1,201,290

10-49


(c) WINTERSCHID COMPANYIncome Statement

For the Year Ended December 31, 2008

Sales...............................................................................Cost of Goods Sold...................................................Gross Profit..................................................................Operating Expenses Salaries Expense.................................................. Other Operating Expenses................................ Depr. Expense—Equipment ............................. Depr. Expenses—Building................................ Bad Debts Expense ............................................. Insurance Expense.............................................. Amortization Expense—Patents .....................Total Operating Expense.........................................Income From Operations.........................................Other Revenues and Gains Rent Revenue ........................................................ Gain on Disposal.................................................. Interest Revenue ..................................................

Other Expenses and LossesInterest Expense...................................................

Net Income ...................................................................

$112,20061,80011,9504,0003,5002,400

900

2,000750

6003,350

4,140

$909,000 636,300272,700

196,75075,950

(790)$ 75,160

WINTERSCHID COMPANYOwner’s Equity Statement

For the Year Ended December 31, 2008

Winterschid, Capital, 1/1/08...........................................................Add: Net Income................................................................................

Less: Drawings..................................................................................Winterschid, Capital, 12/31/08 ......................................................

$113,600 75,160188,760

12,000$176,760

10-50


(d) WINTERSCHID COMPANYBalance Sheet

December 31, 2008

Current Assets Cash ................................................................... Accounts Receivable.................................... Allowance for Doubtful Accounts............ Notes Receivable........................................... Interest Receivable ....................................... Merchandise Inventory ................................ Prepaid Insurance ......................................... Total Current Assets.............................Property, Plant, and Equipment Land ................................................................... Building............................................................. Less Accum. Depr......................................... Equipment........................................................ Less Accum. Depr......................................... Total Plant Assets..................................Intangible Assets Patent.................................................................Total Assets ..........................................................

Current Liabilities Notes Payable (short-term) ........................ Accounts Payable.......................................... Interest Payable ............................................. Unearned Rent................................................ Salaries Payable............................................. Total Current Liabilities .......................Long-term Liabilities Notes Payable (long-term)..........................Total Liabilities.....................................................Owner’s Equity Winterschid, Capital .....................................Total Liabilities and Owner’s Equity .....................

$ 45,800 4,000

150,000 54,000 68,800 33,700

$17,700

41,80010,000

60029,900

1,200

20,000

96,000

35,100

$11,00027,3004,1404,000

2,200

$101,200

151,100

8,100$260,400

48,640

35,00083,640

176,760$260,400

10-51

BYP 10-1 FINANCIAL REPORTING PROBLEM

(a) Property, plant, and equipment is reported net, book value, on theDecember 31, 2005, balance sheet at $8,681,000,000. The cost of theproperty, plant, and equipment is $17,145,000,000 as shown in Note 4.

(b) Depreciation expense is calculated using the straight-line method overan asset’s estimated useful live. (see Note 4).

(c) Depreciation expense was:

2005: $1,103,000,000.2004: $1,062,000,000.2003: $1,020,000,000.

Amortization expense was:

2005: $150,000,000.2004: $147,000,000.2003: $145,000,000.

(d) PepsiCo’s capital spending was:

2005: $1,736,000,000.2004: $1,387,000,000.

(e) PepsiCo reports amortizable intangible assets, net of $530,000,000 andnonamortizable intangible assets, net of $5,174,000,000. In Note 4, thecompany indicates that intangible assets consist primarily of brandsand goodwill.

10-52

BYP 10-2 COMPARATIVE ANALYSIS PROBLEM

(a) PepsiCo Coca-Cola

Assetturnoverratio $32,562 ÷

$27,987 + $31,727

2 = 1.09 times $23,104 ÷

$31,441+ $29,427

2 = .76 times

(b) The asset turnover ratio measures how efficiently a company uses itsassets to generate sales. It shows the dollars of sales generated by eachdollar invested in assets. PepsiCo’s asset turnover ratio (1.09) was 43%higher than Coca-Cola’s (.76). Therefore, it can be concluded that PepsiCowas more efficient during 2005 in utilizing assets to generate sales.

10-53

BYP 10-3 EXPLORING THE WEB

Answers will vary depending on the company selected.

10-54

BYP 10-4 DECISION MAKING ACROSS THE ORGANIZATION

(a) Reimer Company—Straight-line method

Annual DepreciationBuilding [($320,000 – $20,000) ÷ 40]...................................... $ 7,500Equipment [($110,000 – $10,000) ÷ 10] ................................. 10,000Total annual depreciation ......................................................... $17,500

Total accumulated depreciation ($17,500 X 3)............................ $52,500

Lingo Company—Double-declining-balance method

Year Asset ComputationAnnual

DepreciationAccumulatedDepreciation

2006

2007

2008

BuildingEquipmentBuildingEquipmentBuildingEquipment

$320,000 X 5%$110,000 X 20%$304,000 X 5%$ 88,000 X 20%$288,800 X 5%$ 70,400 X 20%

$16,000 22,000 15,200 17,600 14,440 14,080

$38,000

32,800

28,520$99,320

(b)

Year

ReimerCompany

Net Income

LingoCompany

Net IncomeAs Adjusted Computations for Lingo Company

200620072008

$ 84,000 88,400 90,000

$ 88,500 91,300 96,020

$68,000 + $38,000 – $17,500 = $88,500$76,000 + $32,800 – $17,500 = $91,300$85,000 + $28,520 – $17,500 = $96,020

Total net income $262,400 $275,820

(c) As shown above, when the two companies use the same depreciationmethod, Lingo Company is more profitable than Reimer Company. Whenthe two companies are using different depreciation methods, LingoCompany has more cash than Reimer Company for two reasons:

10-55

BYP 10-4 (Continued)

(1) its earnings are generating more cash than the earnings of ReimerCompany, and (2) depreciation expense has no effect on cash. Cashgenerated by operations can be arrived at by adding depreciation expenseto net income. If this is done, it can be seen that Lingo Company’s opera-tions generate more cash ($229,000 + $99,320 = $328,320) than ReimerCompany’s ($262,400 + $52,500 = $314,900). Based on the above analysis,Mrs. Vogts should buy Lingo Company. It not only is in a better financialposition than Reimer Company, but it is also more profitable.

10-56

BYP 10-5 COMMUNICATION ACTIVITY

To: Instructor

From: Student

Re: American Exploration Company footnote

American Exploration Company accounts for its oil and gas activities using thesuccessful efforts approach. Under this method, only the costs of successfulexploration are included in the cost of the natural resource, and the costsof unsuccessful explorations are expensed.

Depletion is determined using the units-of-activity method. Under this method,a depletion cost per unit is computed based on the total number of unitsexpected to be extracted. Depletion expense for the year is determined bymultiplying the units extracted and sold by the depletion cost per unit.

10-57

BYP 10-6 ETHICS CASE

(a) The stakeholders in this situation are:

� Dennis Harwood, president of Buster Container Company.� Shelly McGlone, controller.� The stockholders of Buster Container Company.� Potential investors in Buster Container Company.

(b) The intentional misstatement of the life of an asset or the amount of thesalvage value is unethical for whatever the reason. There is nothing per seunethical about changing the estimate either of the life of an asset or ofan asset’s salvage value if the change is an attempt to better match costand revenues and is a better allocation of the asset’s depreciable costover the asset’s useful life. In this case, it appears from the controller’sreaction that the revisions in the life are intended only to improveearnings and, therefore, are unethical.

The fact that the competition uses a longer life on its equipment is notnecessarily relevant. The competition’s maintenance and repair policiesand activities may be different. The competition may use its equipmentfewer hours a year (e.g., one shift rather than two shifts daily) than BusterContainer Company.

(c) Income before income taxes in the year of change is increased $140,000by implementing the president’s proposed changes.

Old EstimatesAsset costEstimated salvageDepreciable costDepreciation per year (1/8)

$3,100,000 300,000 2,800,000$ 350,000

Revised EstimatesAsset costEstimated salvageDepreciable costDepreciation taken to date ($350,000 X 2)

Remaining life in yearsDepreciation per year

$3,100,000 300,000 2,800,000 700,000 2,100,000

10 years$ 210,000

10-58

BYP 10-7 ALL ABOUT YOU ACTIVITY

(a) 1 c 2 b 3 a 4 d 5 c

(b) For the most part, the value of a brand is not reported on a company’sbalance sheet. Most companies are required to expense all costs relatedto the maintenance of a brand name. Also any research and developmentthat went into the development of the related product is generallyexpensed. The only way significant costs related to the value of thebrand are reported on balance sheet is when a company purchasesanother company that has a significant tradename (brand). In that case,given an objective transaction, companies are able to assign value tothe brand and report it on the balance sheet. A conservative approachis used in this area because the value of the brand can be extremelydifficult to determine. It should be noted that international rules permitcompanies to report brand values on their balance sheets.

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