fa4e sm ch08

Chapter 8Reporting and Analyzing Long-Term Operating Assets

Learning Objectives – coverage by questionMini-

Exercises Exercises Problems Cases and Projects

LO1 – Describe and distinguish between tangible and intangible assets.

17 31

LO2 – Determine which costs to capitalize and report as assets and which costs to expense.

11,17 22

LO3 – Apply different depreciation methods to allocate the cost of assets over time.

12, 13,

16, 18, 1922 - 28, 32

LO4 – Determine the effects of asset sales and impairments on financial statements.

14, 1522, 24,

26, 3536, 38, 39 40, 42

LO5 – Describe the accounting and reporting for intangible assets.

17, 21 31, 34 37 42

LO6 – Analyze the effects of tangible and intangible assets on key performance measures.

20, 21 29, 30, 33 40 - 42

©Cambridge Business Publishers, 2014Solutions Manual, Chapter 8 8-1

DISCUSSION QUESTIONSQ8-1. Routine maintenance costs that are necessary to realize the full benefits of

ownership of the asset should be expensed. However, betterment or improvement costs should be capitalized if the outlay enhances the usefulness of the asset or extends the asset’s useful life beyond original expectations. As would be the case with any cost, an immaterial amount should be expensed as incurred.

Q8-2. Capitalizing interest costs as part of the cost of constructing an asset reduces interest expense, and increases net income during the construction period. In subsequent periods, the interest costs that were capitalized as part of the cost of the asset will increase the periodic depreciation expense and reduce net income.

Q8-3. As any asset is used up, its cost is removed from the balance sheet and transferred into the income statement as an expense. Capitalization of costs onto the balance sheet and subsequent removal as expense is the essence of accrual accounting. If the cost of a depreciable asset is recognized in full upon purchase, profit would be inaccurately measured: it would be too low in the year of purchase when the asset is expensed and too high in later years as revenues earned by the asset are not matched with a corresponding cost. The proper matching of costs (expenses) and revenues is essential for the proper recognition of profit.

Q8-4. The primary benefit of accelerated depreciation for tax reporting is that the higher depreciation deductions in early periods reduce taxable income and income taxes. Cash flow is, therefore, increased, and this additional cash can be invested to yield additional cash inflows (e.g., an "interest-free loan" that can be used to generate additional income). We would generally prefer to receive cash inflows sooner rather than later in order to maximize this investment potential.

Q8-5. When a change occurs in the estimate of an asset's useful life or its salvage value, the revision of depreciation expense is handled by depreciating the current undepreciated cost of the asset (original cost – accumulated depreciation) using the revised assumptions of remaining useful life and salvage value.

Present and future periods are affected by such revisions. Depreciation expense calculated and reported in past periods is not revised.

Q8-6. The gain or loss on the sale of a PPE asset is determined by the difference between the asset's book value and the sale proceeds. Sales proceeds in excess of book values create gains; sales proceeds less than book values cause losses. The relevant factors, then, are the depreciation rate and salvage values used to compute depreciation expense, accumulated depreciation and the net book value of the asset, as well as the selling price of the asset.

©Cambridge Business Publishers, 20148-2 Financial Accounting, 4th Edition

Q8-7. A PPE asset is considered to be impaired when the sum of the undiscounted expected cash flows to be derived from the asset is less than its current book value.

An impairment loss is calculated as the difference between the asset's book value and its current fair market value.

Q8-8. Research and development costs must be expensed under GAAP unless they have alternative future uses. Equipment relating to a specific research project with no alternative use would, therefore, be expensed rather than capitalized and subsequently depreciated.

Accounting standard-setters have justified this ‘expense as incurred’ treatment for R&D costs since the outputs from research and development activities are uncertain and there are, therefore, no expected cash flows against which to match any future depreciation expense.

Q8-9. The difficulty with amortizing intangible assets is estimating the useful life. For some intangibles, the useful life is limited and can be easily estimated. However, some intangibles have an indefinite life. This means that the useful life of the intangible is long and cannot be determined with any reasonable degree of accuracy. Under these circumstances, it is not appropriate to amortize the asset until the useful life can be determined.

Q8-10. Goodwill arises whenever a company acquires another company and the purchase price is greater than the fair value of the identifiable assets acquired. The amount of goodwill is the difference between the purchase price and the value assigned to the net assets of the acquired company. It is recorded as a long-term asset in the balance sheet.

Since goodwill is assumed to have an indefinite life, it is not amortized. The only time that goodwill might affect the income statement is if it is determined that its value is impaired. In that case, an impairment loss is recorded in the income statement and the value of the goodwill asset on the balance sheet is reduced.


MINI EXERCISESM8-11. (10 minutes)

a. Expenseb. Capitalizec. Capitalize (the new equipment enhances the assembly line)d. Expense – this is routine maintenance of the building, unless it extends the

building’s useful lifee. Capitalize – the useful life is extendedf. Capitalize – this is a purchased intangible asset

M8-12. (15 minutes)

a. Straight-line: ($18,000 - $1,500)/ 5 years = $3,300 for both 2013 and 2014.

b. Double-declining-balance: Twice straight-line rate = 2 x 1/5 = 40%2013: $18,000 x 0.40 = $7,200 2014: ($18,000 - $7,200) x 0.40 = $4,320

Notice that, over the first two years, the company reports $6,600 of depreciation expense under the straight-line method and $11,520 of depreciation expense under the double-declining-balance method.

M8-13. (15 minutes)

a. Straight-line: ($130,000 - $10,000)/ 6 years = $20,000 for both 2013 and 2014.

b. Double-declining-balance: Twice straight-line rate = 2 x 1/6 = 1/32013: $130,000 x 1/3 = $43,333 2014: ($130,000 - $43,333) x 1/3 = $28,889

c. Units of production: ($130,000 - $10,000) / 1,000,000 = $0.12 per unit2013: 180,000 units x $0.12 = $21,6002014: 140,000 units x $0.12 = $16,800


M8-14. (15 minutes)

Straight-line depreciation: $40,000/10 = $4,000; 8 years x $4,000 = $32,000.

a. Cash (+A) 3,500Accumulated depreciation (-XA, +A) 32,000Loss on sale of furniture and fixtures (+E, -SE) 4,500

Furniture and fixtures (-A) 40,000

b.

Balance Sheet Income Statement

Transaction Cash Asset +

Noncash Assets - Contra

Assets = Liabi-lities + Contrib.

Capital + Earned Capital Revenues - Expenses = Net

Income

Sold furniture and fixtures for cash.

+3,500Cash

-40,000Furniture

andFixtures

-

-32,000Accum.Deprec.

-4,500Retained Earnings -

+4,500Loss on Sale of

Furniture and

Fixtures

=

-4,500

M8-15. (15 minutes)

Twice the straight-line rate = 1/5 x 2 = 40%

Year 1: $75,000 x .4 = $30,000Year 2: ($75,000 - $30,000) x .4 = 18,000Year 3: ($75,000 - $30,000 - $18,000) x .4 = 10,800Total accumulated depreciation $58,800

a. Cash (+A) 25,000Accumulated depreciation (-XA, +A) 58,800

Machinery (-A) 75,000Gain on sale of machinery (+R, +SE) 8,800

b.

Balance Sheet Income Statement





Income

Sold machinery for cash.

+25,000Cash

-75,000Machinery -

-58,800Accum.Deprec.

+8,800Retained Earnings

+8,800Gain on Sale of

Machinery

- =+8,800


M8-16. (15 minutes)

a. Straight-line depreciation

2013: ($145,800 - $5,400)/3 = $46,800; (8/12) x $46,800 = $31,200

2014: $46,800

b. Double-declining-balance depreciationPreliminary computation: Twice straight-line rate = 2 x 100%/3 = 66⅔%($145,800 x 66⅔%) = $97,200

2013: (8/12) x $97,200 = $64,800

2014: ($145,800 - $64,800) x 66⅔% = $54,000

M8-17. (20 minutes)

a. Under U.S. GAAP, capitalization of development costs is not allowed and all R&D costs must be expensed. Under IFRS, development costs are capitalized if there is the intention, feasibility and resources to bring the asset to completion, there exists the ability to use or sell the asset to generate an economic benefit. Otherwise the costs must be expensed.

b. Yes, impairment should be tested for annually.

M8-18. (20 minutes)

a.Year Book value Depreciation rate Depreciation expense

1 $50,000 2 x ¼ = 0.5 $25,0002 25,000 2 x ¼ = 0.5 12,5003 12,500 4,5004 8,000 0*

*No depreciation is recorded in Year 4 because the asset is depreciated to its residual value of $8,000.

b.Year Book value Depreciation rate Depreciation expense

1 $50,000 2 x 1/5 = 0.4 $20,0002 30,000 2 x 1/5 = 0.4 12,0003 18,000 2 x 1/5 = 0.4 7,2004 10,800 2 x 1/5 = 0.4 4,3205 6,480 3,480*

*$3,480 of depreciation is required in Year 5 to depreciate the asset to its residual value of $3,000.

continued next page


M8-18. concluded

c.Year Book value Depreciation rate Depreciation expense

1 $50,000 2 x 1/10 = 0.2 $10,0002 40,000 2 x 1/10 = 0.2 8,0003 32,000 2 x 1/10 = 0.2 6,4004 25,600 2 x 1/10 = 0.2 5,1205 20,480 2 x 1/10 = 0.2 4,0966 16,384 2 x 1/10 = 0.2 3,2777 13,107 2 x 1/10 = 0.2 2,6218 10,486 2 x 1/10 = 0.2 2,0979 8,389 2 x 1/10 = 0.2 1,67810 6,711 5,711*

* $5,711 of depreciation is required in Year 10 to depreciate the remaining value of the asset. Alternatively, DeFond could switch to straight-line depreciation in Year 7, recording $3,027 of depreciation in Years 7 through 10.

M8-19. (15 minutes)

a.Year Barrels extracted Depletion per barrel Depletion2013 300,000 $32,000,000 / 4,000,000 = $8 $2,400,0002014 500,000 $32,000,000 / 4,000,000 = $8 $4,000,0002015 600,000 $32,000,000 / 4,000,000 = $8 $4,800,000

b.i. Oil reserve (+A) 32,000,000

Cash (-A) 32,000,000

ii. Oil inventory (+A) 2,400,000Oil reserve (-A) 2,400,000

c.+ Oil Reserve (A) - + Oil Inventory (A) -

i. 32,000,000 ii. 2,400,0002,400,000 ii.

Balance 29,600,000 Balance 2,400,000


M8-20. (15 minutes)

a. PPE turnover rates for 2007

Texas Instruments $13,735 / [($4,428 + $3,680) / 2] = 3.39

Intel Corp. $53,999 / [($23,627 + $17,899) / 2] = 2.60

Texas Instruments turns its PPE more quickly than does Intel.

b. PPE turnover rates increase with increases in sales volume relative to the dollar amount of PPE on the balance sheet. The PPE turnover rate is often a very difficult turnover rate to change, and typically requires creative thinking. Many companies are outsourcing the manufacturing process in whole or in part to others in the supply chain. This is beneficial so long as the savings realized by the reduction of manufacturing assets more than offset the higher cost of the goods as these are now purchased rather than manufactured. Another approach is to utilize long-term operating assets in partnership with another firm, say in a joint venture.

M8-21. (15 minutes)

a. $4,801,914 / $38,851,259 = 12.4%.

Abbott’s R&D expenditure level could be compared to the R&D expenditure level for its competitors to gain a sense of the appropriateness of its R&D expenditures. The median value of R&D intensity for pharmaceutical companies is 19.6% in Exhibit 5.13 in Chapter 5. Abbott is one of the larger, more established firms in this industry and may have an R&D program that is more stable and less intensive than the median.

b. R&D costs must be expensed when incurred unless they are expenditures for depreciable assets that have alternative future uses (in which case the depreciation is expensed as recognized). As a result, the balance sheet does not reflect the costs incurred for long-term R&D assets. In addition, operating expenses are increased, thus reducing retained earnings.

($000) Balance Sheet Income Statement

Transaction Cash Asset + Noncash



Income

R&D expenditures

-4,801,914Cash = -4,801,914

Retained Earnings

- +4,801,914R&D

Expense

= -4,801,914


EXERCISESE8-22. (15 minutes)

a. Machine (+A) 89,500Cash (-A) ($85,000 + $2,000 + $2,500) 89,500

b. ($89,500 - $7,000) / 5 = $16,500 per year.

Depreciation expense (+E, -SE) 16,500Accumulated depreciation (+XA, -A) 16,500

c. Cash (+A) 12,000Accumulated depreciation (-XA, +A) ($16,500 x 4) 66,000Loss on sale of machine (+E, -SE) 11,500

Machine (-A) 89,500

E8-23. (20 minutes)

a. Straight line:($80,000 - $5,000)/5 years = $15,000 per year

b. Double declining balance: Twice straight-line rate = 2 x 100%/5 = 40%

Year Book Value x Rate Depreciation Expense1 $80,000 x 0.40 = $32,0002 ($80,000 - $32,000) x 0.40 = 19,2003 ($80,000 - $51,200) x 0.40 = 11,5204 ($80,000 - $62,720) x 0.40 = 6,912

5 5,368 (plug)Total $75,000


E8-24. (25 minutes)

a. 1. Cumulative depreciation expense to date of sale:[($800,000-$80,000)/10 years] x 6 years = $432,000

2. Net book value of the plane at date of sale:$800,000 - $432,000 = $368,000

b. 1. $ 0

Cash (+A) 368,000Accumulated depreciation (-XA, +A) 432,000

Plane (-A) 800,000

2. Loss on sale of: $195,000 - $368,000 = $173,000

Cash (+A) 195,000Accumulated depreciation (-XA, +A) 432,000Loss on sale of plane (+E, -SE) 173,000

Plane (-A) 800,000

3. Gain on sale of: $600,000 - $368,000 = $232,000

Cash (+A) 600,000Accumulated depreciation (-XA, +A) 432,000

Gain on sale of plane (+R, +SE) 232,000Plane (-A) 800,000

E8-25. (15 minutes)

a. Straight-line: 2013 and 2014 ($218,700 - $23,400)/6 years = $32,550

b. Double-declining-balance: twice straight-line rate = 100% x 2/6 = 33⅓%2013 $218,700 x 33⅓% = $72,9002014 ($218,700 - $ 72,900) x 33⅓% = $48,600

E8-26. (15 minutes)

a. Depreciation expense to date of sale is [($27,200 - $2,000)/6] x 3 = $12,600. The net book value of the van is, therefore, $27,200 - $12,600 = $14,600.

b. 1. 02. $400 gain ($15,000 - $14,600)3. $2,600 loss ($12,000 - $14,600)


E8-27. (20 minutes)

a. Straight line: ($110,000 - $15,000) / 6 = $15,833 each year.

b. Double-declining-balance: rate = 2 x 1/6 = 1/3.

2013: $110,000 x 1/3 = $36,6672014: ($110,000 – $36,667) x 1/3 = $24,4442015: ($110,000 – $36,667 – $24,444) x 1/3 = $16,296

c. Straight line: ($110,000 – $15,833x2 – $10,000) / 5 = $13,667 in 2015 and each subsequent year.

Double-declining balance: rate = 2 x 1/5 = 40%.($110,000 – $36,667 – $24,444) x 40% = $19,556 in 2015

E8-28. (20 minutes)

a. Straight-line: $6,000,000 / 30 = $200,000 per year each year.

b. Double-declining balance: rate = 2 x 1/30 = 1/15.

2013: $6,000,000 x 1/15 = $400,0002014: ($6,000,000 – $400,000) x 1/15 = $373,333

c. The revised depreciation rate = 2 x 1/23 = 8.7%

2015: ($6,000,000 – $400,000 – $373,333) x 8.7% = $454,493

E8-29. (10 minutes)

Percent depreciated = Accumulated depreciation / Asset cost = $5,156 million / ($9,508 - $121 - $649) million = 59%

Note: We eliminate land and construction in progress from the computation because these assets are not depreciated.

Assuming that assets are replaced evenly as they are used up, we would expect assets to be 50% depreciated, on average. Deere’s 59% is higher than this level. Our concern is that it will require higher capital expenditures in the near future to replace aging assets.


E8-30. (25 minute)

a. Receivable turnover rate Inventory turnover rate PPE turnover rate

2010$26,662

= 7.77$13,831

= 4.77$26,662

= 3.73$3,615+$3,250 $3,115+$2,639 $7,279+$7,000

2 2 2

2011$29,611

= 7.92$15,693

= 4.78$29,611

= 3.96$3,867+$3,615 $3,416+$3,155 $7,666+$7,279

2 2 2

b. 3M’s Receivable and PPE turnover ratios have improved significantly while its inventory turnover rates improved marginally. 3M’s revenues increased significantly in 2011, and that increase is likely to account for the increase in PPET. However, PPE turns can also be improved by off-loading manufacturing to other companies in the supply chain and acquiring long-term operating assets in partnership with other companies, for example, in a joint venture. The Receivable turnover improvement could be due to monitoring more closely the quality of customers to which credit is granted, implementing better collection procedures, and offering discounts as an incentive for early payment. Inventory turnover rates can be improved by weeding out slowly moving product lines, by reducing the depth and breadth of products carried, and by implementing just-in-time deliveries.

E8-31. (10 minutes)

a. Fair Value (capitalized)

Usefullife

b Amortization expense for 2013

Patent $200,000 3 years $66,667Trademark $500,000 IndefiniteNoncompetition agreement $300,000 5 years 60,000

$126,667


E8-32. (15 minutes)

a. Cost of resource property: $7,200,000 + $420,000 + $50,000 + $800,000 = $8,470,000

Residual value: $1,200,000Depletion base: $8,470,000 – $1,200,000 = $7,270,000Depletion rate: $7,270,000 / 500,000 tons = $14.54 per ton

2013: 60,000 x $14.54 = $872,4002014: 85,000 x $14.54 = $1,235,900

b. 2013: Inventory (+A) 872,400

Resource property (-A) 872,400

2014: Inventory (+A) 1,235,900Resource property (-A) 1,235,900

E8-33. (15 minutes)

a. Percent depreciated – 2011: $11,320 / $12,266 = 92.3%2010: $10,925 / $11,804 = 92.6%

b. PPET: $96,504 / [(946 + 879)/2] = 105.8 times

c. Adams’ assets are almost completely depreciated. This results in an extremely high percent depreciated ratio and also a very high PPE turnover ratio (PPET). Adding inventories and receivables to get all the firm’s net operating asset turnover (NOAT) is more reasonable devisor. Adams outsources most of its manufacturing and, recognizing concerns that these numbers might produce, reports in its 10K that its current facilities (PPE assets) are adequate for the foreseeable future. Thus, although the ratios might suggest otherwise, the company does not anticipate large capital expenditures in the near future. Indeed this has been the case for the last several years as well.

E8-34. (15 minutes)

a. The list illustrates the wide range in expenditures for R&D (as a percent of sales) across firms. Note the large amount spent by pharmaceutical companies Pfizer (13.51%) and Merck (17.62%), compared to the amount spent by Lenovo (1.53%). The companies in the list are paired by industry. It is interesting to see how similar some firms in the same industry are. For example, Callaway Golf and Adams Golf and Head N.V. spend almost the same percentage of sales on R&D despite the fact that Callaway is several times larger than Adams.

continued next page©Cambridge Business Publishers, 2014

Solutions Manual, Chapter 8 8-13

E8-34. concluded

b. Beside industry affiliation, the differences in R&D expenditures as a percent of sales is due to differences in markets, product mix, and other strategic considerations. As suppliers of technology (hardware and software), Intel and Microsoft depend very heavily on their intellectual property. As a result, their expenditures on research and development are among the highest of established firms. Apple has established itself as an innovator in technology and design and has spent billions of dollars developing unique products such as the iPad®. Apple’s research intensity for 2011 has been reduced by the tremendous increase in the company’s sales revenue. From 2009 to 2011, Apple’s revenues increased by 152%, while R&D increased by 82%.

E8-35. (20 minutes)

a. Yes, the equipment is impaired at July 1, 2013 because its book value is not recoverable through future cash flows. Specifically, on July 1, 2013, its book value is $145,000 ($225,000 initial cost less $80,000 accumulated depreciation*) and the estimated future (undiscounted) cash flows are only $125,000.

*4 years of [($225,000-$25,000)/10 years].

b. The impairment loss in a is computed as the equipment's book value minus its current fair value: $145,000 $90,000 = $55,000

Impairment loss (+E, -SE) 55,000Equipment* (-A) 55,000

*Accumulated depreciation is sometimes credited for the loss.

c. Assuming that the salvage value remains the same after the impairment (this is not likely given the decline in market value of the asset), the annual depreciation expense would be ($90,000 - $25,000) / 6 = $10,833 per year.

Depreciation expense (+E, -SE) 10,833Accumulated depreciation (+XA, -A) 10,833

d.

($000) Balance Sheet Income Statement





Income

b.Impairment charge.

-55,000Equip-ment

--55,000

Retained Earnings

-+55,000

Impairment Loss

=-55,000

c. Depreciation expense. - +10,833

Accum.Deprec.

-10,833Retained Earnings

- +10,833Deprec. Expense

= -10,833


PROBLEMSP8-36. (20 minutes)

In order to determine the entries for the sale of property, plant and equipment, we need to “fill in the blanks” for the PPE and accumulated depreciation accounts. Once we record the purchases and the depreciation expense, we can determine the cost and accumulated depreciation for the assets sold.

(i) Property, plant and equipment (+A) 5,559,183Cash (-A) 5,559,183

(ii) Depreciation expense (+E, -SE) 3,174,956Accumulated depreciation (+XA, -A) 3,174,956

(iii) Cash (+A) 96,916

Accumulated depreciation (-XA, +A) 906,373Property, plant and equipment (-A) ……………………...... 923,806Gain on sale of property and equipment (+R, +SE)……… 79,483

+ Property, Plant and Equipment (A) - - Accumulated Depreciation (XA) +Balance 80,132,394 57,852,770 Balance(i) 5,559,183 3,174,956 (ii)

923,805 (iii) (iii) 906,373Balance 84,767,771 60,121,353 Balance

P8-37. (20 minutes)

a. $649 million / $6,615 million = 9.8%

b. R&D costs are expensed in the income statement except for the portion relating to depreciable assets that have alternate uses. Expensing (rather than capitalizing and depreciating) reduces assets, and the additional expense reduces profit and equity (via the reduction in retained earnings). In addition, expensing R&D as incurred means that potentially valuable intangible assets are omitted from the balance sheet.

c. Agilent has reduced its R&D spending as a percent of revenues in recent years and, as a result, increased its earnings. (Agilent had a loss from operations in 2003.) This has turned operating losses into an operating profit for the company. However, Agilent is dependent upon technology in order to maintain its market position, and R&D is critical to its very existence. Agilent has divested itself of some high-intensity R&D businesses over the eight years from 2003 to 2011, and its spending on R&D has remained pretty constant in absolute terms from 2005 to the present. The decrease in intensity is due to increased revenues, not decreases in R&D spending. In addition, a company can maintain its investment in intellectual capital and reduce expenses by outsourcing the activity to other countries where the intellectual resources are less expensive.


P8-38. (20 minutes)

($ millions)a.

i. Depreciation expense (+E, -SE) 2,060Accumulated depreciation (+XA, -A) 2,060

ii. Property and equipment (+A) 2,129Cash (-A) 2,129

iii. Cash (+A) 69

Accumulated depreciation (-XA, +A) (see T-account) 990Property and equipment (-A) (see T-account) 1,059

iv. Repair and maintenance expense (+E, -SE) 726Cash (-A) 726

v. Impairment and writedown charges (+E, -SE) 34Property and equipment (-A) 34

+ Property and Equipment (A) - - Accumulated Depreciation (XA) +Balance 35,765 10,485 Balance(ii) 2,129 2,060 (i)

1,059 (iii) (iii) 99034 (v)

(b) 247Balance 37,048 11,555 Balance

b. The problem provides information directly to make entries (i), (ii), (iv) and (v) in part a. For part (iii), we can infer the accumulated depreciation on disposed property and equipment as being the amount ($990) that makes that account balance. Since no gain or loss was reported on these disposals, the credit to property and equipment in part (iii) is the amount that balances the disposal transaction ($1,059).

However, this leaves the property and equipment T-account unbalanced. A likely reason is that Target acquires some property and equipment without an expenditure of cash. (Chapter 10 will cover capital lease transactions, which play a role in Target’s operations.) Based on the information in the problem, we would estimate that $247 million of property and equipment was acquired through such transactions, because that amount balances the property and equipment T-account.


P8-39. (20 minutes)

The process used in this question is to fill in the entries for property and equipment and for accumulated depreciation in parts a, b and c, and then to use the “plug” figures in the T-accounts to determine the values in part d.

($ thousands)a. Depreciation expense (+E, -SE) 144,630

Accumulated depreciation (+XA, -A) 144,630

b. Property and equipment (+A) 61,906

Cash (-A) 61,906

c. Loss on impairment of property and equipment (+E) 5,453Property and equipment (-A) 5,453

d. Cash (+A) 11,433

Accumulated depreciation (-XA, +A) (see T-account) 90,694Property and equipment (-A) (see T-account) 100,988Gain on sale of property and equipment (+R,+SE) 1,139

+ Property and Equipment (A) - - Accumulated Depreciation (XA) +Balance 1,902,584 1,073,557 Balance(b) 61,906 144,630 (a)

5,453 (c)100,988 (d) (d) 90,694

Balance 1,858,049 1,127,493 Balance


CASES and PROJECTSC8-40. (90 min)

a. PPE Turnover: $14,880.2/[($2,127.7 + $3,345.9)/2] = 4.6

The firm does not appear to be as capital intensive as others in the industry based on a higher than average PPE turnover ratio than its closest competitors.

b. Accumulated depreciation / Depreciable asset cost

$4,146.2/ ($7,492.1 - $61.2*- $521.9*) =0.60 or 60%*Note: We eliminate land from the computation because land is never depreciated. We eliminate construction in progress because these represent assets that the company is building. These assets are not yet in service and are consequently not yet depreciable. This elimination is also used in part c.

If plant assets are replaced at a constant rate, we would expect those assets to be about 50% “used up,” on average. A substantially higher percentage “used up” indicates that the assets are closer to the end of their useful lives and will require replacement (and usually higher maintenance costs near the end of their useful lives). Such a situation would negatively impact future cash flows.

c. Average depreciation assets = [($7,492.1 – 61.2 – 521.9) + ($6,949.7 – 58.0 – 469.0)] / 2 = $6,665.85

Average depreciaiable assets/ Depreciation expense = $6,665.85 / $462 per year = 14.4 years.

d. Depreciation expense (+E, -SE) 462.0PPE accumulated depreciation (+XA, -A) 462.0

PPE (+A) 648.8Cash (-A) 648.8

Impairment loss (+E, -SE) 1.7PPE (-A) 1.7


C8-41. (40 minutes)

Reducing operating assets is an important means of increasing performance measures including the return on net operating assets. Most companies focus first on reducing receivables and inventories. This is the so-called low-hanging fruit that can lead to quick results. Some possible actions include those listed. Students will think of additional possibilities.

a. Reducing receivables through:

1. Better underwriting of credit quality2. Better controls to identify delinquencies, automated over-due notices, and better

collection procedures3. Increased attention to accuracy in invoicing4. Offering early payment incentives

b. Reducing inventories and inventory costs through essentially eliminating nonproductive activities including inspection, moving activities, waiting setup time:

1. Use of less costly components (of equal quality) and production with lower wage rates

2. Elimination of product features not valued by customers3. Outsourcing to reduce product cost4. Just-in-time deliveries of raw materials5. Elimination of manufacturing bottlenecks to reduce work-in-process inventories6. Producing to order rather than to estimated demand to reduce finished goods

inventories7. Eliminating defects

c. Reducing PPE assets is much more difficult. The benefits, however, can be substantial. Some suggestions are the following:

1. Sale of unused and unnecessary assets2. Acquisition of production and administrative assets in partnership with other

companies for greater throughput3. Acquisition of finished or semi-finished goods (sub-components) from suppliers

to reduce manufacturing assets

d. Reducing unnecessary intangible assets that are reported on the balance sheet is the most difficult.

1. Sale of assets no longer relevant to company plans2. License intangibles to other companies


C8-42. (30 minutes)

a. Take-Two (TTWO) spent $159,859 in 2011 and in 2012 $196,683 on software development. TTWO’s amortization and write-downs were $143,811 in 2011 and $150,700 in 2012. Using EA’s method, the money spent on additions would be expensed, and the amortization and write-downs would disappear. The result is that if TTWO’s used EA’s approach, 2011 expenses would increase by $16,048 ($159,859 – 143,811). Net income would decrease by $10,431 [$16,048 X (1-0.35)] in 2011. In 2012, TTWO’s expenses would increase by $45,983 ($196,683 - $150,700) if TTWO used the same method as EA. Net income would decrease by $29,889 [$45,983 X (1-0.35)].

b. A variety of answers are possible here. Amortization (including write- downs) as a percentage of “amortizable cost” (average of beginning and ending balances) declined from 55% in 2011 to 51% in 2012. The decrease indicates a possible decrease in the rate of amortization. However, because write- downs are included in the denominator, the increase could be partly due to higher write-downs in 2011.


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