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Chapter 11

Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

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Solutions Manual, Vol.1, Chapter 11

© The McGraw-Hill Companies, Inc., 2013 11–1

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Intermediate Accounting, 7/e

QUESTIONS FOR REVIEW OF KEY TOPICS Question 11–1 The terms depreciation, depletion, and amortization all refer to the process of allocating the cost of property, plant, and equipment and finite-life intangible assets to periods of use. The only difference between the terms is that they refer to different types of these long-lived assets; depreciation for plant and equipment, depletion for natural resources, and amortization for intangibles.

Question 11–2 The term depreciation often is confused with a decline in value or worth of an asset. Depreciation is not measured as decline in value from one period to the next. Instead, it involves the distribution of the cost of an asset, less any anticipated residual value, over the asset's estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset.

Question 11–3 The process of cost allocation for plant and equipment and finite-life intangible assets requires that three factors be established at the time the asset is put into use. These factors are: 1. Service (useful) life—The estimated use that the company expects to receive from the asset. 2. Allocation base—The value of the usefulness that is expected to be consumed. 3. Allocation method—The pattern in which the usefulness is expected to be consumed.

Question 11–4 Physical life provides the upper bound for service life. Physical life will vary according to the purpose for which the asset is acquired and the environment in which it is operated. Service life may be less than physical life for several reasons. For example, the expected rate of technological changes may shorten service life. Management intent also may shorten the period of an asset’s usefulness below its physical life. For instance, a company may have a policy of using its delivery trucks for a three-year period before trading the trucks for new models.

Question 11–5 The total amount of depreciation to be recorded during an asset’s service life is called its depreciable base. This amount is the difference between the initial value of the asset at its acquisition (its cost) and its residual value. Residual or salvage value is the amount the company expects to receive for the asset at the end of its service life less any anticipated disposal costs.



Answers to Questions (continued) Question 11–6 Activity-based allocation methods estimate service life in terms of some measure of productivity. Periodic depreciation or depletion is then determined based on the actual productivity generated by the asset during the period. Time-based allocation methods estimate service life in years. Periodic depreciation or amortization is then determined based on the passage of time.

Question 11–7 The straight-line depreciation method allocates an equal amount of depreciable base to each year of an asset’s service life. Accelerated depreciation methods allocate higher portions of depreciable base to the early years of the asset’s life and lower amounts of depreciable base to later years. Total depreciation is the same by either approach.

Question 11–8 Theoretically, the use of activity-based depreciation methods would provide a better matching of revenues and expenses. Clearly, the productivity of a plant asset is more closely associated with the benefits provided by that asset than the mere passage of time. However, activity-based methods quite often are either infeasible or too costly to use. For example, buildings do not have an identifiable measure of productivity. For assets such as machinery, there may be an identifiable measure of productivity, such as machine-hours or units produced, but it is more costly to determine the amount each period than it is to simply measure the passage of time. For these reasons, most companies use time-based depreciation methods.

Question 11–9 Companies might use the straight-line method because they consider that the benefits derived from the majority of plant assets are realized approximately evenly over these assets’ useful lives. It also is the easiest method to understand and apply. The effect on net income also could explain why so many companies prefer the straight-line method to the accelerated methods. Straight line produces a higher net income in the early years of an asset’s life. Net income can affect bonuses paid to management or debt agreements with lenders. Income taxes are not a factor in determining the depreciation method because a company is not required to use the same depreciation method for both financial reporting and income tax purposes.

Question 11–10 The group approach to aggregation is applied to a collection of depreciable assets that share similar service lives and other attributes. For example, group depreciation could be used for fleets of vehicles or collections of machinery. The composite approach to aggregation is applied to dissimilar operating assets, such as all of the depreciable assets in one manufacturing plant. Individual assets in the composite may have diverse service lives. Both approaches are similar in that they involve applying a single straight-line rate based on the average service lives of the assets in the group or composite.



Answers to Questions (continued) Question 11–11 The allocation of the cost of a natural resource to periods of use is called depletion. The process otherwise is identical to depreciation. The activity-based units-of-production method is the predominant method used to calculate depletion, not the time-based straight-line method.

Question 11–12 The amortization of finite-life intangible assets is based on the same concepts as depreciation and depletion. The capitalized cost of an intangible asset that has a finite useful life must be allocated to the periods the company expects the asset to contribute to its revenue-generating activities. Intangibles, though, generally have no residual values, so the amortizable base is simply cost. Also, intangibles possess no physical life to provide an upper bound to service life. However, most intangibles have a legal or contractual life that limits useful life. Intangible assets that have indefinite useful lives, including goodwill, are not amortized.

Question 11–13 A company can calculate depreciation based on the actual number of days or months the asset was used during the year. A common simplifying convention is to record one-half of a full year’s expense in the years of acquisition and disposal. This is known as the half-year convention. The modified half-year convention records a full year’s expense when the asset is acquired in the first half of the year or sold in the second half. No expense is recorded when the asset is acquired in the second half of the year or sold in the first half.

Question 11–14 A change in the service life of plant and equipment and finite-life intangible assets is accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life.

Question 11–15 A change in depreciation method is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life using the new depreciation method, exactly as we would account for a change in estimate. One difference is that most changes in estimate do not require a company to justify the change. However, this change in estimate is a result of changing an accounting principle and therefore requires a clear justification as to why the new method is preferable. A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.



Answers to Questions (continued) Question 11–16 If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years’ financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary items, and earnings per share.

Question 11–17 Impairment of the value of property, plant, and equipment and intangible assets results when there has been a significant decline in value below carrying value (book value). For property, plant, and equipment and intangible assets with finite useful lives, GAAP requires an entity to recognize an impairment loss only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value. The loss recognized is the amount by which the book value exceeds the fair value of the asset or group of assets when the fair value is readily determinable. If fair value is not determinable, it must be estimated. One method of estimating fair value is to compute the present value of estimated future cash flows from the asset or group of assets. For intangible assets with indefinite useful lives other than goodwill, if book value exceeds fair value, an impairment loss is recognized for the differences. For goodwill, an impairment loss is indicated if the fair value of the reporting unit is less than its book value. A goodwill impairment loss is measured as the excess of book value of goodwill over its “implied” fair value. For property, plant, and equipment and intangible assets held for sale, if book value exceeds fair value, an impairment loss is recognized for the difference.

Question 11–18 Repairs and maintenance are expenditures made to maintain a given level of benefits provided by the asset and do not increase future benefits. Expenditures for these activities should be expensed in the period incurred. Additions involve adding a new major component to an existing asset. These expenditures usually are capitalized. Improvements are expenditures for the replacement of a major component of plant and equipment. The costs of improvements usually are capitalized. Rearrangements are expenditures to restructure plant and equipment without addition, replacement, or improvement. The objective is to create a new capability for the asset and not necessarily to extend useful life. The costs of material rearrangements should be capitalized if they clearly increase future benefits.



Answers to Questions (concluded) Question 11–19 IFRS allows a company to value property, plant, and equipment (PP&E) and intangible assets subsequent to initial valuation at (1) cost less accumulated depreciation/amortization or (2) fair value (revaluation). If a company chooses revaluation, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP prohibits revaluation.

Question 11–20 Under U.S. GAAP, an impairment loss for property, plant, and equipment and finite-life intangible assets is measured as the difference between book value and fair value. Under IFRS, an impairment loss is measured as the difference between book value and the recoverable amount. The recoverable amount is the higher of the asset’s value in use (present value of estimated future cash flows) and fair value less costs to sell.

Question 11–21 Under U.S. GAAP, the measurement of an impairment loss for goodwill is a two-step process. In step one we compare the fair value of the reporting unit with its book value. A loss is indicated if fair value is less than book value. In step two, we measure the impairment loss as the excess of book value over implied fair value. Under IFRS, the measurement of an impairment loss for goodwill is a one-step process that compares the recoverable amount of the cash-generating unit to book value. If the recoverable amount is less, reduce goodwill first, then other assets. The recoverable amount is the higher of fair value less costs to sell and value-in-use (present value of estimated future cash flows).

Question 11–22 Under IFRS, litigation costs to successfully defend an intangible right are expensed, except in rare situations when the expenditure increases future benefits.



BRIEF EXERCISES Brief Exercise 11–1 Depreciation is a process of cost allocation, not valuation. Koeplin should not record depreciation expense of $18,000 for year one of the machine’s life. Instead, it should distribute the cost of the asset, less any anticipated residual value, over the estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset, not the periodic decline in its value.



Brief Exercise 11–2 a. Straight-line: $30,000 – 2,000 = $7,000 per year 4 years b. Sum-of-the-years’ digits: Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10 2013 2014

$28,000 x 4/10 $28,000 x 3/10

= $11,200 = $ 8,400

c. Double-declining balance: Straight-line rate is 25% (1 ÷ 4 years) x 2

= 50% DDB rate

2013 2014

= $15,000 = $ 7,500

$30,000 x 50% ($30,000 – 15,000) x 50%

d. Units-of-production: $30,000 – 2,000 = $2.80 per unit depreciation rate 10,000 hours 2013 2014

2,200 hours x $2.80 = $6,160 3,000 hours x $2.80 = $8,400



Brief Exercise 11–3 a. Straight-line: $30,000 – 2,000 = $7,000 per year 4 years 2013 2014

$7,000 x 9/12 $7,000 x 12/12

= =

$5,250 $7,000

b. Sum-of-the-years’ digits: Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10 2013

$28,000 x 4/10 x 9/12

=

$8,400

2014

$28,000 x 4/10 x 3/12 + $28,000 x 3/10 x 9/12

= =

$2,800 6,300 $9,100

c. Double-declining balance: Straight-line rate is 25% (1 ÷ 4 years) x 2

= 50% DDB rate

2013

= $11,250

2014 or, 2014

$30,000 x 50% x 9/12 $30,000 x 50% x 3/12 + ($30,000 – 15,000) x 50% x 9/12

= $ 3,750 = 5,625 $ 9,375

($30,000 – 11,250) x 50%

= $ 9,375



Brief Exercise 11–4 Annual depreciation will equal the group rate multiplied by the depreciable base of the group: ($425,000 – 40,000) x 18% = $69,300 Since depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. Any actual gain or loss is implicitly included in the accumulated depreciation account. Journal entry (not required): Cash ................................................................................ Accumulated depreciation (difference) ............................ Equipment (account balance) .........................................

35,000 7,000 42,000

Brief Exercise 11–5 $8,250,000 Depletion per ton

=

= $2.75 per foot 3,000,000 cubic feet

Year 1 depletion Year 2 depletion


= $2.75 x 700,000 feet = $2.75 x 800,000 feet

= $1,925,000 = $2,200,000


Brief Exercise 11–6 Expenses for the year include: = Amortization of the patent † * Amortization of the developed technology = Total Goodwill is not amortized. amortized.

$400,000 300,000 $700,000

In-process research and development is not

†

Amortization of the patent: ($4,000,000  5) x 6/12

=

$400,000

*Amortization of the developed technology: ($3,000,000  5) x 6/12 = $300,000

Brief Exercise 11–7 Calculation of annual depreciation after the estimate change: $9,000,000 $320,000 x 2 years

640,000 8,360,000 500,000 7,860,000  18 $ 436,667

Cost Previous annual depreciation ($8 million ÷ 25 years) Depreciation to date (2011–2012) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life – 18 years (20 – 2) 2013 depreciation



Brief Exercise 11–8 In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Robotics reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the double-declining-balance method from now on. The undepreciated cost remaining at the time of the change would be depreciated DDB over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported. Asset’s cost Accumulated depreciation to date* Undepreciated cost, Jan. 1, 2013 Double-declining balance depreciation for 2013

$9,000,000 (640,000) $8,360,000 x 2/23 † $ 726,957

*$8,000,000 ÷ 25 = $320,000 x 2 years = $640,000 †

Remaining life is 23 years. Twice the straight-line rate is 2/23.



Brief Exercise 11–9 If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years’ financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary items, and earnings per share. In this case, depreciation of $32,000 should have been $320,000 ($8,000,000  25 years). Therefore, 2011 income before tax is overstated by $288,000 ($320,000 – 32,000) and accumulated depreciation is understated by the same amount. The following journal entry is needed in 2013 to record the error correction (ignoring income tax): Retained earnings ............................................................ 288,000 288,000 Accumulated depreciation .......................................... Depreciation for 2013 would be $320,000.

Brief Exercise 11–10 Because the undiscounted sum of future cash flows of $28 million exceeds book value of $26.5 million, there is no impairment loss.

Brief Exercise 11–11 Because the undiscounted sum of future cash flows of $24 million is less than book value of $26.5 million, there is an impairment loss. The impairment loss is calculated as follows: Book value Fair value Impairment loss © The McGraw-Hill Companies, Inc., 2013 11–14

$26.5 million 21.0 million $ 5.5 million Intermediate Accounting, 7/e

Brief Exercise 11–12 Under IFRS, the impairment loss is the difference between book value and the recoverable amount. The recoverable amount is $22 million, the higher of the valuein-use of $22 million (present value of estimated future cash flows) and the $21 million fair value less costs to sell. Book value Recoverable amount Impairment loss

$26.5 million 22.0 million $ 4.5 million

Brief Exercise 11–13 Recoverability: Because the book value of SCC’s net assets of $42 million exceeds the fair value of $40 million, an impairment loss is indicated. Determination of implied value of goodwill: Fair value of SCC Less: Fair value of SCC’s assets (excluding goodwill) Implied goodwill

$40 million 31 million $ 9 million

Measurement of impairment loss: Book value of goodwill Less: Implied value of goodwill Impairment loss


Brief Exercise 11–14 Recoverability: Because the book value of SCC’s net assets of $42 million is less than the fair value of $44 million, an impairment loss is not indicated.



Brief Exercise 11–15 Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $41 million, the higher of the $41 million value-in-use (present value of estimated future cash flows) and the $40 million fair value less costs to sell. Book value Recoverable amount Impairment loss


Brief Exercise 11–16 Annual maintenance on machinery, $5,400—This is an example of normal repairs and maintenance. Future benefits are not increased; therefore, the expenditure should be expensed in the period incurred. Remodeling of offices, $22,000—This is an example of an improvement. The cost of the remodeling should be capitalized and depreciated, either by (1) substitution, (2) direct capitalization of the cost, or (3) a reduction of accumulated depreciation. Rearrangement of the shipping and receiving area, $35,000—This is an example of a rearrangement. Because the rearrangement increased productivity, the cost should be capitalized and depreciated. Addition of a security system, $25,000—This is an example of an addition. The cost of the security system should be capitalized and depreciated.



EXERCISES Exercise 11–1 1. Straight-line: $33,000 – 3,000 = $6,000 per year 5 years 2. Sum-of-the-years’ digits:

Year 2013

Depreciable Base $30,000

2014

30,000

2015

30,000

2016

30,000

2017

30,000 Total


Depreciation X Rate per Year = 5 15 4 15 3 15 2 15 1 15

Depreciation $10,000 8,000 6,000 4,000 2,000 $30,000


Exercise 11–1 (concluded) 3. Double-declining balance: Straight-line rate of 20% (1 ÷ 5 years) x 2 = 40% DDB rate.

Year 2013 2014 2015 2016 2017 Total

Book Value Beginning of Year X $33,000 19,800 11,880 7,128 4,277

Depreciation Rate per Year = 40% 40% 40% 40% *

Depreciation $ 13,200 7,920 4,752 2,851 1,277 * $30,000

Book Value End of Year $19,800 11,880 7,128 4,277 3,000

* Amount necessary to reduce book value to residual value

4. Units-of-production: $33,000 – 3,000 = $.30 per mile depreciation rate 100,000 miles

Year 2013 2014 2015 2016 2017 Totals

Actual Miles Driven X 22,000 24,000 15,000 20,000 21,000 102,000

Depreciation Rate per Mile = $.30 .30 .30 .30 *

Depreciation $6,600 7,200 4,500 6,000 5,700 * $30,000

Book Value End of Year $26,400 19,200 14,700 8,700 3,000

* Amount necessary to reduce book value to residual value



Exercise 11–2 1. Straight-line: $115,000 – 5,000 = $11,000 per year 10 years 2. Sum-of-the-years’ digits: Sum-of-the-digits is ([10 (10 + 1)] ÷ 2) = 55 2013 2014

$110,000 x 10/55 $110,000 x 9/55

= $20,000 = $18,000

3. Double-declining balance: Straight-line rate is 10% (1 ÷ 10 years) x 2

= 20% DDB rate

2013 2014

= $23,000 = $18,400

$115,000 x 20% ($115,000 – 23,000) x 20%

4. One hundred fifty percent declining balance: Straight-line rate is 10% (1 ÷ 10 years) x 1.5

= 15% rate

2013 2014

= $17,250 = $14,663

$115,000 x 15% ($115,000 – 17,250) x 15%

5. Units-of-production: $115,000 – 5,000 = $.50 per unit depreciation rate 220,000 units 2013 2014

30,000 units x $.50 = $15,000 25,000 units x $.50 = $12,500



Exercise 11–3 1. Straight-line: $115,000 – 5,000 = $11,000 per year 10 years 2013 2014

$11,000 x 3/12 $11,000 x 12/12

= =

$ 2,750 $11,000

2. Sum-of-the-years’ digits: Sum-of-the-digits is {[10 (10 + 1)]/2} = 55 2013

$110,000 x 10/55 x 3/12

= $ 5,000

2014

$110,000 x 10/55 x 9/12 + $110,000 x 9/55 x 3/12

= $15,000 = 4,500 $19,500

3. Double-declining balance: Straight-line rate is 10% (1 ÷ 10 years) x 2

= 20% DDB rate

2013

=

$5,750

= =

$17,250 4,600 $21,850

=

$21,850

2014 or, 2014

$115,000 x 20% x 3/12 $115,000 x 20% x 9/12 + ($115,000 – 23,000) x 20% x 3/12 ($115,000 – 5,750) x 20%

4. One hundred fifty percent declining balance: Straight-line rate is 10% (1 ÷ 10 years) x 1.5

= 15% rate

2013

=

$ 4,313

= =

$12,937 3,666 $16,603

=

$16,603

2014 Or, 2014

$115,000 x 15% x 3/12 $115,000 x 15% x 9/12 + ($115,000 – 17,250) x 15% x 3/12 ($115,000 – 4,313) x 15%



Exercise 11–3 (concluded) 5. Units-of-production: $115,000 – 5,000 = $.50 per unit depreciation rate 220,000 units 2013 2014

10,000 units x $.50 = 25,000 units x $.50 =

$ 5,000 $12,500

Exercise 11–4 Building depreciation: $5,000,000 – 200,000 = $160,000 per year 30 years Building addition depreciation: Remaining useful life from June 30, 2013, is 27.5 years. $1,650,000 = $60,000 per year 27.5 years 2013 $60,000 x 6/12 = $30,000 2014 $60,000 x 12/12 = $60,000



Exercise 11–5 Asset A: Straight-line rate is 20% (1 ÷ 5 years) x 2 = 40% DDB rate $24,000 = $60,000 = Book value at the beginning of year 2 .40 Cost – (Cost x 40%) = $60,000 .60Cost = $60,000 Cost = $100,000 Asset B: Sum-of-the-years’ digits is 36 {[8 (8 + 1)]÷2} ($40,000 – residual) x 7/36 = $7,000 $280,000 – 7residual -------------------------- = $7,000 36 $280,000 – 7residual = $252,000 7residual =

$28,000

Residual =

$4,000

Asset C: $65,000 – 5,000 = $6,000 Life Life = 10 years Asset D: $230,000 – 10,000 = $220,000 depreciable base $220,000 ÷ 10 years = $22,000 per year Method used is straight line. Asset E: Straight-line rate is 12.5% (1 ÷ 8 years) x 1.5 = 18.75% rate Year 1 $200,000 x 18.75% = $37,500 Year 2 ($200,000 – 37,500) x 18.75% = © The McGraw-Hill Companies, Inc., 2013 11–22

$30,469 Intermediate Accounting, 7/e

Exercise 11–6 Requirement 1 1. Straight-line: $260,000 – 20,000 = $40,000 per year 6 years 2013 2014

$40,000 x 8/12 $40,000 x 12/12

= $26,667 = $40,000

2. Sum-of-the-years’ digits: Sum-of-the-years’ digits is ([6 (6 + 1)] ÷ 2) = 21 2013

$240,000 x 6/21 x 8/12 = $45,714

2014

$240,000 x 6/21 x 4/12 = $22,857 + $240,000 x 5/21 x 8/12 = 38,095 $60,952

3. Double-declining balance: 1/6 (the straight-line rate) x 2

= 1/3 DDB rate

2013

= $57,778

2014 or, 2014

$260,000 x 1/3 x 8/12 $260,000 x 1/3 x 4/12 + ($260,000 – 86,667) x 1/3 x 8/12

= $28,889 = 38,518 $67,407

($260,000 – 57,778) x 1/3

= $67,407



Exercise 11–7 Requirement 1 U.S. GAAP: 2013: 2014:

$120,000  8 = $15,000 x 6/12 = $120,000  8 = $15,000

$7,500

Requirement 2 IFRS: 2013:

Machine: $100,000  8 = $12,500 x 6/12 = $6,250 Drill: $ 20,000  4 = $5,000 x 6/12 Total

2014:

=

2,500 $8,750

Machine: $100,000  8 = $12,500 Drill: $ 20,000  4 = 5,000 Total $17,500



Exercise 11–8 Requirement 1 Depreciation for 2013: $240,000  6 = $40,000 x 9/12 = $30,000 Requirement 2 Before After Revaluation Revaluation Equipment $240 x 220/210 = $251 Accumulated depreciation 30 x 220/210 = 31 Book value $ 210 x 220/210 = $ 220

($ in thousands)

Equipment ($251,000 – 240,000) Accumulated depreciation ($31,000 – 30,000) Revaluation surplus–OCI ($220,000 – 210,000)

11,000 1,000 10,000

Requirement 3 Depreciation for 2014: $220,000  5.25 years = $41,905 Requirement 4 Before After Revaluation Revaluation Equipment $240 x 195/210 = $223 Accumulated depreciation 30 x 195/210 = 28 Book value $ 210 x 195/210 = $195

($ in thousands)

Revaluation expense* ($195,000 – 210,000) Accumulated depreciation ($28,000 – 30,000) Equipment ($223,000 – 240,000)

15,000 2,000 17,000

*If a revaluation surplus account relating to the same asset had existed, that account would have been debited up to the amount of its balance before debiting revaluation expense. Solutions Manual, Vol.1, Chapter 11


Exercise 11–9 Requirement 1

Asset Stoves Refrigerators Dishwashers Totals

Cost $15,000 10,000 8,000 $33,000

Residual Depreciable Value Base $3,000 $12,000 1,000 9,000 500 7,500 $4,500 $28,500

Depreciation per Year (straight line) $2,000 1,800 1,875 $5,675

Estimated Life(yrs.) 6 5 4

$5,675 Group depreciation rate =

= 17.2% (rounded) $33,000

Group life

=

$28,500 = 5.02 years (rounded) $5,675

Requirement 2 To record the purchase of new refrigerators. Refrigerators.................................................................... Cash .............................................................................

2,700 2,700

To record the sale of old refrigerators. Cash ................................................................................. Accumulated depreciation (difference) ............................. Refrigerators................................................................


200 1,300 1,500


Exercise 11–10 Requirement 1 Cost of the equipment: Purchase price Freight charges Installation charges

$154,000 2,000 4,000 $160,000

Straight-line rate of 12.5% (1 ÷ 8 years) x 2 = 25% DDB rate.

Year 2013 2014 2015 2016 2017 2018 2019 2020 Total

Book Value Beginning Depreciation of Year X Rate per Year = $160,000 25% 120,000 25% 90,000 25% 67,500 25% 50,625 * 45,625 * 40,625 * 35,625 *

Depreciation $ 40,000 30,000 22,500 16,875 5,000 5,000 5,000 5,000 $129,375

Book Value End of Year $120,000 90,000 67,500 50,625 45,625 40,625 35,625 30,625

* Switch to straight-line in 2017: Straight-line depreciation: $50,625 – 30,625 = $5,000 per year 4 years Requirement 2 For plant and equipment used in the manufacture of a product, depreciation is a product cost and is included in the cost of inventory. Eventually, when the product is sold, depreciation will be included in cost of goods sold.



Exercise 11–11 Requirement 1 $4,500,000 Depletion per ton

=

= $5.00 per ton 900,000 tons

2013 depletion

= $5.00 x 240,000 tons

= $1,200,000

Requirement 2 Depletion is part of product cost and is included in the cost of the inventory of coal, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion is then included in cost of goods sold in the income statement when the coal is sold.

Exercise 11–12 Timber tract: $3,200,000 – 600,000 = $.52 per board foot 5,000,000 board feet 500,000 x $.52 = $260,000 depletion Logging roads: $240,000  5,000,000 board feet = $.048 per board foot 500,000 x $.048 = $24,000 depreciation



Exercise 11–13 Requirement 1 Cost of copper mine: Mining site $1,000,000 Development costs 600,000 Restoration costs 303,939 † $1,903,939 †

$300,000 x 25% = 400,000 x 40% = 600,000 x 35% =

$ 75,000 160,000 210,000 $445,000 x .68301* = $303,939

*Present value of $1, n = 4, i = 10% (Table 2)

Depletion: $1,903,939 Depletion per pound =

= $.1904 per pound 10,000,000 pounds

2013 depletion 2014 depletion

= $.1904 x 1,600,000 pounds = $304,640 = $.1904 x 3,000,000 pounds = $571,200

Depreciation: $120,000 – 20,000 Depreciation per pound =

= $.01 per pound 10,000,000 pounds

2013 depreciation 2014 depreciation

= $.01 x 1,600,000 pounds = $.01 x 3,000,000 pounds

= =

$16,000 $30,000

Requirement 2 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and are included in the cost of the inventory of copper, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the copper is sold.



Exercise 11–14 Requirement 1 a. To record the purchase of a patent. January 1, 2011 Patent ............................................................................... 700,000 Cash ............................................................................. 700,000 To record amortization on the patent. December 31, 2011 and 2012 Amortization expense ($700,000 ÷ 10 years) ...................... Patent ...........................................................................

70,000 70,000

b. To record the purchase of a franchise. 2013 Franchise ......................................................................... 500,000 Cash ............................................................................. 500,000 c. To record research and development expenses. 2013 Research and development expense................................ 380,000 Cash ............................................................................. 380,000



Exercise 11–14 (concluded) Year-end adjusting entries Patent: To record amortization on the patent after change in useful life. December 31, 2013 Amortization expense (determined below) ......................... 112,000 Patent .......................................................................... 112,000 Calculation of annual amortization after the estimate change: ($ in thousands)

$700 $70 x 2 years

140 560 ÷ 5 $112

Cost Previous annual amortization ($700 ÷ 10 years) Amortization to date (2011–2012) Unamortized cost (balance in the patent account) Estimated remaining life New annual amortization

Franchise: To record amortization of franchise. December 31, 2013 Amortization expense ($500,000 ÷ 10 years) ...................... Franchise .....................................................................

50,000 50,000

Requirement 2 Intangible assets: Patent Franchise Total intangibles

$448,000 [1] 450,000 [2] $898,000

[1] $560,000 – 112,000 [2] $500,000 – 50,000 Solutions Manual, Vol.1, Chapter 11


Exercise 11–15 To record the purchase of a patent. January 2, 2013 Patent ............................................................................... 500,000 Cash ............................................................................. 500,000 To record amortization of a patent for the year 2013. Amortization expense ($500,000 ÷ 8 years) ........................ Patent ...........................................................................

62,500 62,500

To record amortization of the patent for the year 2014. Amortization expense ($500,000 ÷ 8 years) ........................ Patent ...........................................................................

62,500 62,500

To record costs of successfully defending a patent infringement suit. January, 2015 Patent ............................................................................... Cash .............................................................................


45,000 45,000


Exercise 11–15 (concluded) To record amortization of patent for the year 2015. Amortization expense (determined below) ......................... Patent ..........................................................................

70,000 70,000

Calculation of revised annual amortization: ($ in thousands)

$500 $62.5 x 2 years

125 375 45 420 ÷ 6 $ 70

Cost Previous annual amortization ($500 ÷ 8 years) Amortization to date (2013–2014) Unamortized cost (balance in the patent account) Add New unamortized cost Estimated remaining life (8 years – 2 years) New annual amortization

Exercise 11–16 ($ in millions)

Amortization expense (determined below) ......................... Patent ..........................................................................

2.5 2.5

Calculation of annual amortization after the estimate change: $ in millions)

$9 $1 x 4 years

4 5 ÷ 2 $2.5


Cost Previous annual amortization ($9 ÷ 9 years) Amortization to date (2009–2012) Unamortized cost (balance in the patent account) Estimated remaining life (6 years – 4 years) New annual amortization


Exercise 11–17 Requirement 1 2013 amortization: $1,200,000 ÷ 10 = $120,000 x 6/12 = $60,000 Requirement 2 Franchise ($1,180,000 – [$1,200,000 – 60,000]) Revaluation surplus–OCI

40,000 40,000

Requirement 3 2014 amortization: $1,180,000 ÷ 9.5 = $124,211



Exercise 11–18 Requirement 1 Depreciation expense (determined below) .......................... Accumulated depreciation—computer .......................

3,088 3,088

Calculation of annual depreciation after the estimate change: $40,000 $7,200 x 2 years

14,400 25,600 900 24,700 ÷ 8 $ 3,088

Cost Previous annual depreciation ($36,000 ÷ 5 years) Depreciation to date (2011–2012) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life (10 years – 2 years) New annual depreciation

Requirement 2 Depreciation expense (determined below) .......................... Accumulated depreciation—computer .......................

3,889 3,889

Calculation of annual depreciation after the estimate change: $40,000 $12,000 9,600 21,600 18,400 900 17,500 x 8/36 $ 3,889


Cost Previous depreciation: 2011 – ($36,000 x 5/15) 2012 – ($36,000 x 4/15) Depreciation to date (2011–2012) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life – 8 years 2013 depreciation © The McGraw-Hill Companies, Inc., 2013 11–35

Exercise 11–19 SYD depreciation [10 + 9 + 8 x ($1.5 – .3) million] = $589,091 55 $1,500,000 589,091 910,909 300,000 610,909 ÷ 7 yrs. $ 87,273

Cost Depreciation to date, SYD (2010–2012) Undepreciated cost as of 1/1/13 Less residual value Depreciable base Remaining life (10 years – 3 years) New annual depreciation

Adjusting entry (2013 depreciation): Depreciation expense (calculated above) ............................ Accumulated depreciation...........................................


87,273 87,273


Exercise 11–20 Requirement 1 In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Clinton reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change would be depreciated straight line over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported. Requirement 2 Asset’s cost Accumulated depreciation to date (given) Undepreciated cost, Jan. 1, 2013 Estimated residual value To be depreciated over remaining 3 years Annual straight-line depreciation 2013–2015

$2,560,000 (1,801,000) $ 759,000 (160,000) $ 599,000 ÷ 3 years $ 199,667 (rounded)

Adjusting entry: Depreciation expense (calculated above) ............ Accumulated depreciation ..........................


199,667 199,667


Exercise 11–21 Requirement 1 Analysis: Correct (Should Have Been Recorded) 2010 Machine Cash

350,000 350,000

Incorrect (As Recorded) Expense Cash

350,000 350,000

2010 Expense 70,000 Accum. deprec. 70,000

Depreciation entry omitted





During the three-year period, depreciation expense was understated by $210,000, but other expenses were overstated by $350,000, so net income during the period was understated by $140,000, which means retained earnings is currently understated by that amount. During the three-year period, accumulated depreciation was understated, and continues to be understated by $210,000. To correct incorrect accounts Machine .............................................................. Accumulated depreciation ($70,000 x 3 years) ... Retained earnings ($350,000 – 210,000) .............

350,000 210,000 140,000

Requirement 2 Correcting entry: Assuming that the machine had been disposed of, no correcting entry would be required because, after five years, the accounts would show appropriate balances.



Exercise 11–22 Requirement 1 Book value Fair value Impairment loss

$6.5 million 3.5 million $3.0 million

Requirement 2 Because the undiscounted sum of future cash flows of $6.8 million exceeds book value of $6.5 million, there is no impairment loss.



Exercise 11–23 Requirement 1 IFRS requires an impairment loss to be recognized when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. In this case, value-in-use and fair value less costs to sell are the same, $3.5 million. Because book value ($6.5 million) exceeds this amount, a loss is indicated. The loss is the difference between book value and the recoverable amount, which also is the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. Therefore, the amount of impairment loss is the same as under U.S. GAAP, $3 million. Book value Recoverable amount Impairment loss


Requirement 2 An impairment loss also is indicated because book value ($6.5 million) exceeds fair value less costs to sell/value-in-use ($5 million). The amount of impairment loss is $1.5 million. Book value Recoverable amount Impairment loss


Under U.S. GAAP, because the undiscounted sum of future cash flows of $6.8 million exceeds book value of $6.5 million, there is no impairment loss.



Exercise 11–24 Requirement 1 IFRS requires an impairment loss to be recognized when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. In this case, value-in-use of £150 million is higher. Because book value (£220 million) exceeds this amount, a loss is indicated. The loss is the difference between book value and the recoverable amount, which also is the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. The amount of impairment loss is £70 million. Book value Recoverable amount Impairment loss

£220 million 150 million £ 70 million

Requirement 2 U.S. GAAP requires an impairment loss to be recognized when an asset’s book value exceeds the undiscounted sum of estimated future cash flows. In this case, a loss is indicated because the book value of £220 million exceeds the undiscounted sum of estimated future cash flows of £210 million. The loss is the difference between book value and fair value, or $75 million in this case. Book value Fair value Impairment loss


£220 million 145 million £ 75 million


Exercise 11–25 Requirement 1 An impairment loss is indicated because the estimated undiscounted sum of future cash flows of $15 million is less than the book value of $18.3 million. The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows: Book value Estimated fair value Impairment loss

$18,300,000 11,000,000 $ 7,300,000

Requirement 2 The loss would appear in the income statement along with other operating expenses. Requirement 3 Loss on impairment ............................................ Accumulated depreciation .................................. Plant assets ......................................................

7,300,000 14,200,000 21,500,000

Requirement 4 An impairment loss is indicated because the estimated undiscounted sum of future cash flows of $12 million is less than the book value of $18.3 million. The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows: Book value Estimated fair value Impairment loss

$18,300,000 11,000,000 $ 7,300,000

Requirement 5 Because the estimated undiscounted sum of future cash flows of $19 million exceeds the book value of $18.3 million, no impairment loss is indicated. © The McGraw-Hill Companies, Inc., 2013 11–42


Exercise 11–26 Requirement 1 Determination of implied goodwill: Fair value of Centerpoint, Inc. Fair value of Centerpoint’s net assets (excluding goodwill) Implied value of goodwill Measurement of impairment loss: Book value of goodwill Implied value of goodwill Impairment loss

$220 million 200 million $ 20 million $50 million 20 million $30 million

Requirement 2 Because the fair value of the reporting unit, $270 million, exceeds book value, $250 million, there is no impairment loss.

Exercise 11–27 Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $225 million, the higher of the $225 million value-in-use (present value of estimated future cash flows) and the $220 million fair value less costs to sell. Book value Recoverable amount Impairment loss




Exercise 11–28 Requirement 1 Calculation of goodwill: Consideration exchanged Less fair value of net assets: Assets Less: Liabilities assumed Goodwill

$420 million $512 million (150) million

(362) million $ 58 million

Requirement 2 Because the book value of the net assets ($410 million) exceeds fair value ($400 million), an impairment loss is indicated. Determination of implied goodwill: Fair value of Harman, Inc. Fair value of Harman’s net assets (excluding goodwill) Implied value of goodwill


Measurement of impairment loss: Book value of goodwill (determined in requirement 1) Implied value of goodwill Impairment loss

$ 58 million 30 million $ 28 million

Requirement 3 Entry to record the impairment loss: ($ in millions)

Loss on impairment of goodwill ........................ Goodwill .........................................................


28 28


Exercise 11–29 Requirement 1 The Codification topic number that provides guidance on accounting for the impairment of long-lived assets is FASB ASC 360: “Property, Plant, and Equipment.” Requirement 2 The specific citation that discusses the disclosures required in the notes to the financial statements for the impairment of long-lived assets classified as held and used is FASB ASC 360–10–50–2: “Property, Plant, and Equipment–Overall–Disclosure– Impairment or Disposal of Long-Lived Assets.” Requirement 3 All of the following information shall be disclosed in the notes to financial statements that include the period in which an impairment loss is recognized: a. A description of the impaired long-lived asset (asset group) and the facts and circumstances leading to the impairment b. If not separately presented on the face of the statement, the amount of the impairment loss and the caption in the income statement or the statement of activities that includes that loss c. The method or methods for determining fair value (whether based on a quoted market price, prices for similar assets, or another valuation technique) d. If applicable, the segment in which the impaired long-lived asset (asset group) is reported under Topic 280.



Exercise 11–30 The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Depreciation involves a systematic and rational allocation of cost rather than a process of valuation: FASB ASC 360–10–35–4: “Property, Plant, and Equipment–Overall– Subsequent Measurement–Depreciation.” The cost of a productive facility is one of the costs of the services it renders during its useful economic life. Generally accepted accounting principles (GAAP) require that this cost be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility. This procedure is known as depreciation accounting, a system of accounting that aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation. 2. The calculation of an impairment loss for property, plant, and equipment: FASB ASC 360–10–35–17: “Property, Plant, and Equipment–Overall– Subsequent Measurement.” An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). That assessment shall be based on the carrying amount of the asset (asset group) at the date it is tested for recoverability, whether in use or under development. An impairment loss shall be measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value.



Exercise 11–30 (concluded) 3. Accounting for a change in depreciation method: FASB ASC 250–10–45–18: “Accounting Changes and Error Correction–Overall–Other Presentation Matters.” Distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is effected by a change in accounting principle. One example of this type of change is a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets (hereinafter referred to as depreciation method). The new depreciation method is adopted in partial or complete recognition of a change in the estimated future benefits inherent in the asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate. Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this subtopic. 4. Goodwill should not be amortized: FASB ASC 350–20–35–1: “Intangibles-Goodwill and Other–Goodwill– Subsequent Measurement.” Goodwill shall not be amortized. Instead, goodwill shall be tested for impairment at a level of reporting referred to as a reporting unit.



Exercise 11–31 1. To record the replacement of the heating system. Accumulated depreciation—building ............................. 250,000 Cash ............................................................................. 250,000 2. To record the addition to the building. Building ........................................................................... 750,000 Cash ............................................................................. 750,000 3. To expense annual maintenance costs. Maintenance expense ...................................................... Cash .............................................................................

14,000 14,000

4. To capitalize rearrangement costs. Machinery ....................................................................... Cash .............................................................................


50,000 50,000


Exercise 11–32 Requirement 1 2011 amortization: $6,000,000  10 = $600,000 x 3/12 = $150,000 2012 amortization: $6,000,000  10 = $600,000 Requirement 2 Patent Cash

500,000 500,000

Requirement 3 Calculation of revised annual amortization: $6,000,000 750,000 5,250,000 500,000 5,750,000 ÷ 8 3/4 $ 657,143

Cost Amortization to date (above) Unamortized cost (balance in the patent account) Add New unamortized cost Estimated remaining life (10 years – 1 1/4 years) New annual amortization

Requirement 4 Requirement 2: Litigation expense Cash

500,000 500,000

Requirement 3: 2013 amortization: $6,000,000  10 = $600,000



Exercise 11–33 Requirement 1 Cash ................................................................................. Accumulated depreciation—lathe (determined below)....... Loss on sale (difference) .................................................... Lathe (balance) ..............................................................

17,000 56,250 6,750 80,000

Accumulated depreciation: Annual depreciation = 2009 2010 2011 2012 2013 Total

$80,000 – 5,000 = $15,000 5 years

$15,000 x 1/2 =

$15,000 x 1/4 =


$ 7,500 15,000 15,000 15,000 3,750 $56,250


Exercise 11–33 (concluded) Requirement 2 Cash ................................................................................ Accumulated depreciation—lathe (determined below) ...... Gain on sale (difference) ............................................... Lathe (balance) .............................................................

17,000 67,500 4,500 80,000

Accumulated depreciation: Sum-of-the-digits is ([5 (5 + 1)]/2) = 15 2009

$75,000 x 5/15 x 6/12 =

2010 +

$75,000 x 5/15 x 6/12 = $75,000 x 4/15 x 6/12 =

$12,500 10,000

22,500

+

$75,000 x 4/15 x 6/12 = $75,000 x 3/15 x 6/12 =

$10,000 7,500

17,500

+

$75,000 x 3/15 x 6/12 = $75,000 x 2/15 x 6/12 =

$ 7,500 5,000

12,500

2011 2012 2013

$75,000 x 2/15 x 3/12 = Total


$12,500

2,500 $67,500


Exercise 11–34 List A

List B

g 1. Depreciation d 2. Service life f 3. Depreciable base e 4. m h j k a

5. 6. 7. 8. 9.

l 10. b 11. i 12. c 13.

a. Cost allocation for natural resource. b. Accounted for prospectively. c. When there has been a significant decline in value. Activity-based method d. The amount of use expected from plant and equipment and finite-life intangible assets. Time-based method e. Estimates service life in units of output. Double-declining balance f. Cost less residual value. Group method g. Cost allocation for plant and equipment. Composite method h. Does not subtract residual value from cost. Depletion i. Accounted for the same way as a change in estimate. Amortization j. Aggregates assets that are similar. Change in useful life k. Aggregates assets that are physically unified. Change in depreciation l. Cost allocation for an intangible asset. method Write-down of asset m. Estimates service life in years.



Exercise 11–35 Requirement 1 To record the acquisition of small tools. 2011 Small tools ..................................................................... Cash ............................................................................

8,000 8,000

To record additional small tool acquisitions. 2013 Small tools ...................................................................... Cash ............................................................................

2,500 2,500

To record the sale/depreciation of small tools. 2013 Cash ............................................................................... Depreciation expense (difference) .................................... Small tools ..................................................................


250 1,750 2,000


Exercise 11–35 (concluded) Requirement 2 To record the acquisition of small tools. 2011 Small tools ...................................................................... Cash .............................................................................

8,000 8,000

To record the replacement/depreciation of small tools. 2013 Depreciation expense ..................................................... Cash .............................................................................

2,500 2,500

To record the sale of small tools. 2013 Cash ................................................................................ Depreciation expense ..................................................


250 250


CPA / CMA REVIEW QUESTIONS CPA Exam Questions 1. a. Double-declining-balance depreciation rate = 2 x 1/8 = ¼ or 25% First year depreciation will be $7,500 x 0.25 = $1,875 Second year depreciation will be ($7,500 – 1,875) x 0.25 = $1,406 2. b. The depreciation method used must be straight line because year 1 depreciation is $7,400 (($40,000 – 3,000) / 5 = $7,400). Year 2 depreciation would also be $7,400. 3. b. $20,000/5,000,000 gallons = $0.004/gallon ($0.004/gallon) x (250,000 gallons) = $1,000 4. d. Goodwill is an indefinite life intangible asset and is therefore not amortized. 5. c. $50,000  10 years = $5,000 per year in amortization. $50,000 – 5,000 = $45,000. The 3% franchise fee is a period expense and is not capitalized. 6. c. First two years = ($60,000 – 0)  10 = $6,000 per year Year 2013

= [$60,000 – (2 x $6,000) – 3,000] 3 = $15,000

7. d. The book value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2013 was [($22,000,000 – 4,000,000) / 12] x 7 = $10,500,000 so book value is ($22,000,000 – 10,500,000) = $11,500,000. Because the $11,500,000 book value is more than expected future cash flows of [(5 x $1,500,000) + 1,000,000] = $8,500,000, the stamping machine is impaired. 8. d. $147,000. All of the expenditures are capitalized.



CPA Exam Questions (concluded) 9. c. $12,000. $80,000  10 years = 20,000  5 years =

$ 8,000 4,000

Total depreciation =

$12,000

10. a. When as asset is revalued, the entire class of property, plant, and equipment to which the asset belongs must be revalued. 11. b. A decrease in income. If book value is higher than fair value, the difference is reported as an expense in the income statement. 12. b. An active market must exist for an intangible asset to be revalued. 13. c. $70 million. Book value of $400 million – 330 million recoverable amount (higher of fair value less costs to sell and present value of future cash flows). 14. d. $45 million. Book value of $500 million – 455 million recoverable amount (higher of fair value less costs to sell and present value of future cash flows).



CMA Exam Questions 1. d. Because 50% of the original estimate of quality ore was recovered during the years 2004 through 2011, recorded depletion of $250,000 [50% x ($600,000 – 100,000 salvage value)]. In 2012, the earlier depletion of $250,000 is deducted from the $600,000 cost along with the $100,000 salvage value. The remaining depletable cost of $250,000 will be allocated over the 250,000 tons believed to remain in the mine. The $1 per ton depletion is then multiplied times the tons mined each year. 2. a. Given that the company paid $6,000,000 for net assets acquired with a fair value of $5,496,000, goodwill was $504,000. According to GAAP, acquired goodwill is not amortized but is qualitatively assessed and/or tested annually for impairment. 3. a. The cost should be amortized over the remaining legal life or useful life, whichever is shorter. In addition to the initial costs of obtaining a patent, legal fees incurred in the successful defense of a patent should be capitalized as part of the cost, whether it was internally developed or purchased from an inventor. The legal fees capitalized then should be amortized over the remaining useful life of the patent.



PROBLEMS Problem 11–1 Requirement 1 Determine useful life: $200,000 depreciable base = 20-year useful life $10,000 annual depreciation Determine age of assets: $40,000 accumulated depreciation = 4 years old $10,000 annual depreciation Double-declining balance in 4th year of life: Year 1 (2010) $200,000 x 10% = $20,000 Year 2 (2011) 180,000 x 10% = 18,000 Year 3 (2012) 162,000 x 10% = 16,200 Year 4 (2013) 145,800 x 10% = 14,580 Requirement 2 Depreciation expense (below) ...................... Accumulated depreciation .................... $200,000 30,000 $170,000

20,000 20,000

Cost Depreciation to date, SL 3 years (2010–2012) Undepreciated cost as of 1/1/13

Seventeen-year remaining life, or 1/17 x 2 = 2/17 = x $170,000 = $20,000 A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.



Problem 11–2 Requirement 1 CORD COMPANY Analysis of Changes in Plant Assets For the Year Ending December 31, 2013

Land Land improvements Buildings Machinery and equipment Automobiles and trucks Leasehold improvements

Balance 12/31/12 $ 175,000 -1,500,000 1,125,000 172,000 216,000 $3,188,000

Increase 312,500 [1] 192,000 937,500 [1] 385,000 [2] 12,500 -$1,839,500

$

Decrease $ ---17,000 24,000 -$41,000

Balance 12/31/13 $ 487,500 192,000 2,437,500 1,493,000 160,500 216,000 $4,986,500

Explanations of Amounts: [1]

Plant facility acquired from King 1/6/13—allocation to Land and Building: Fair value—25,000 shares of Cord common stock at $50 per share fair value $1,250,000 Allocation in proportion to appraised values at date of exchange: % of Amount Total Land $187,500 25 Building 562,500 75 $750,000 100 Land $1,250,000 x 25% = Building $1,250,000 x 75% =

[2]

$ 312,500 937,500 $1,250,000

Machinery and equipment purchased 7/1/13: Invoice cost $325,000 Delivery cost 10,000 Installation cost 50,000 Total acquisition cost $385,000



Problem 11–2 (continued) Requirement 2 CORD COMPANY Depreciation and Amortization Expense For the Year Ended December 31, 2013 Land Improvements: Cost Straight-line rate (1 ÷ 12 years) Annual depreciation Depreciation on land improvements for 2013: (3/25 to 12/31/13)

Buildings: Book value, 1/1/13 ($1,500,000 – 328,900) Building acquired 1/6/13 Total amount subject to depreciation 150% declining balance rate: (1 ÷ 25 years = 4% x 1.5)

Machinery and equipment: Balance, 1/1/13 Straight-line rate (1 ÷ 10 years)

$192,000 x 8 1/3% 16,000 x 3/4

$ 12,000

$1,171,100 937,500 2,108,600 x 6%

$ 126,516

$1,125,000 x 10%

112,500

Purchased on 7/1/13 385,000 Depreciation for one-half year x 5% Depreciation on machinery and equipment for 2013

19,250 $ 131,750

Automobiles and trucks: Book value, 1/1/13 ($172,000 – 100,325) Deduct 1/1/13 book value of truck sold on 9/30 ($9,100 + 2,650) Amount subject to depreciation 150% declining balance rate: (1 ÷ 5 years = 20% x 1.5)

Automobile purchased 8/30/13 Depreciation for 2013 (30% x 4/12) Truck sold on 9/30/13 – depreciation (given) Depreciation on automobiles and trucks


$71,675 (11,750) 59,925 x 30% 12,500 x 10%

17,978 1,250 2,650 $ 21,878


Problem 11–2 (concluded) Leasehold improvements: $108,000 Book value, 1/1/13 ($216,000 – 108,000) ÷ 5 years Amortization period (1/1/13 to 12/31/17) Amortization of leasehold improvements for 2013 Total depreciation and amortization expense for 2013

$ 21,600 $313,744

Problem 11–3 PELL CORPORATION Depreciation Expense For the Year Ended December 31, 2013 Land improvements: Cost Straight-line rate (1 ÷ 15 years)

$ 180,000 x 6 2/3%

Building: Book value 12/31/12 ($1,500,000 – 350,000) 150% declining balance rate:

$1,150,000 x 7.5%

$ 86,250

$1,158,000 (58,000) $1,100,000 x 10%

110,000

287,000 x 10%

28,700

(1 ÷ 20 years = 5% x 1.5)

Machinery and Equipment: Balance, 12/31/12 Deduct machine sold Straight-line rate (1 ÷ 10 years) Purchased 1/2/13 Depreciation

Machine sold 3/31/13 Depreciation for three months Total depreciation on machinery and equipment Automobiles: Book value on 12/31/12 ($150,000 – 112,000) 150% declining balance rate: (1 ÷ 3 years = 33.333% x 1.5)

Total depreciation expense for 2013 Solutions Manual, Vol.1, Chapter 11

$ 12,000

58,000 x 2.5%

1,450 $140,150

$38,000 x 50%

$ 19,000 $257,400


Problem 11–4 1. Depreciation for 2011 and 2012. December 31, 2011 Depreciation expense ($48,000 ÷ 8 years x 9/12) ................. Accumulated depreciation—equipment......................

4,500

December 31, 2012 Depreciation expense ($48,000 ÷ 8 years) .......................... Accumulated depreciation—equipment......................

6,000

4,500

6,000

2. The year 2013 expenditure. January 4, 2013 Repair and maintenance expense .................................... Equipment ....................................................................... Cash .............................................................................

2,000 10,350 12,350

3. Depreciation for the year 2013. December 31, 2013 Depreciation expense (determined below) .......................... Accumulated depreciation—equipment......................

5,800 5,800

Calculation of annual depreciation after the estimate change: $ 48,000 10,500 37,500 10,350 47,850 ÷ 8 1/4 $ 5,800

Cost Depreciation to date ($4,500 + 6,000) Undepreciated cost Asset addition New depreciable base Estimated remaining life (10 years – 1 3/4 years) New annual depreciation



Problem 11–5 (1)

$65,000 Allocation in proportion to appraised values at date of exchange: % of Amount Total Land $72,000 8 Building 828,000 92 $900,000 100 Land $812,500 x 8% = Building $812,500 x 92% =

$ 65,000 747,500 $812,500

(2) $747,500 [From (1)] (3)

50 years

$747,500 – 47,500 $14,000 annual depreciation

(4)

$ 14,000

Same as prior year, since method used is straight line.

(5)

$ 85,400

3,000 shares x $25 per share = Plus demolition of old building

(6)

None

(7)

$ 16,000

Fair value.

(8)

$ 2,400

$16,000 x 15% (1.5 x Straight-line rate of 10%).

(9)

$ 2,040

($16,000 – 2,400) x 15%.

$75,000 10,400 $85,400

No depreciation before use.

(10) $ 99,000

Total cost of $110,000 – 11,000 in normal repairs.

(11) $ 17,000

($99,000 – 5,500) x 10/55.

(12) $ 5,100

($99,000 – 5,500) x 9/55 x 4/12.

(13) $ 30,840

PVAD = $4,000 (7.71008 * ) * Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)

(14) $ 2,056

$30,840 15 years



Problem 11–6 Requirement 1 Building: $500,000 = $20,000 per year x 9/12 = $15,000 25 years Machinery: $240,000 – (10% x $240,000) = $27,000 per year x 9/12 = $20,250 8 years Equipment: Sum-of-the-digits is ([6 (6 + 1)]÷2) = 21 ($160,000 – 13,000) x 6/21 = $42,000 x 9/12 = $31,500 Requirement 2 (1) June 29, 2014 Depreciation expense (determined below) .......................... Accumulated depreciation—machinery......................

5,625 5,625

$100,000 – (10% x $100,000) = $11,250 x 6/12 = $5,625 8 years



Problem 11–6 (concluded) (2) June 29, 2014 Cash ................................................................................ Accumulated depreciation—machinery (below) ............. Loss on sale of machinery (difference) ............................. Machinery ...................................................................

80,000 14,063 5,937 100,000

Accumulated depreciation on machinery sold: 2013 depreciation = $11,250 x 9/12 = 2014 depreciation = $11,250 x 6/12 Total

$ 8,438 5,625 $14,063

Requirement 3 Building: $500,000 = $20,000 25 years Machinery: $140,000 – (10% x $140,000) = $15,750 8 years Equipment: +

($160,000 – 13,000) x 6/21 = $42,000 x 3/12 = ($160,000 – 13,000) x 5/21 = $35,000 x 9/12 =


$10,500 26,250 $36,750


Problem 11–7 Requirement 1 Cost of mineral mine: Purchase price Development costs

$1,600,000 600,000 $2,200,000

Depletion: $2,200,000 – 100,000 Depletion per ton =

= $5.25 per ton 400,000 tons

2013 depletion

= $5.25 x 50,000 tons = $262,500

2014 depletion: Revised depletion rate =

($2,200,000 – 262,500) – 100,000 = $4.20 487,500 – 50,000 tons

2014 depletion

= $4.20 x 80,000 tons = $336,000

Depreciation: Structures: $150,000 Depreciation per ton =

= $.375 per ton 400,000 tons

2013 depreciation

= $.375 x 50,000 tons = $18,750

2014 depreciation: Revised depreciation rate =

$150,000 – 18,750 = $.30 per ton 487,500 – 50,000 tons

2014 depreciation = $.30 x 80,000 tons = $24,000 © The McGraw-Hill Companies, Inc., 2013 11–66


Problem 11–7 (continued) Equipment: $80,000 – 4,000 Depreciation per ton =

= $.19 per ton 400,000 tons

2013 depreciation

= $.19 x 50,000 tons = $9,500

2014 depreciation: Revised depreciation rate =

($80,000 – 9,500) – 4,000 = $.152 per ton 487,500 – 50,000 tons

2014 depreciation = $.152 x 80,000 tons = $12,160 Requirement 2 Mineral mine: Cost Less accumulated depletion: 2013 depletion 2014 depletion Book value, 12/31/14 Structures: Cost Less accumulated depreciation: 2013 depreciation 2014 depreciation Book value, 12/31/14 Equipment: Cost Less accumulated depreciation: 2013 depreciation 2014 depreciation Book value, 12/31/14


$ 2,200,000 $262,500 336,000

598,500 $1,601,500 $ 150,000

$18,750 24,000

42,750 $107,250 $ 80,000

$ 9,500 12,160

21,660 $58,340


Problem 11–7 (concluded) Requirement 3 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold. In 2013, since all of the ore was sold, all of 2013’s depletion and depreciation is included in cost of goods sold. In 2014, since not all of the extracted ore was sold, a portion of both 2014’s depletion and depreciation remains in inventory.



Problem 11–8 Requirement 1 Calculation of goodwill: Consideration exchanged Less: Fair value of net identifiable assets Goodwill acquired

$2,000,000 1,700,000 $ 300,000

The cost of goodwill is not amortized. To record amortization of patent. Amortization ($80,000 ÷ 8 years x 6/12) .............................. Patent ..........................................................................

5,000 5,000

To record amortization of franchise. Amortization expense ($200,000 ÷ 10 years x 3/12) ............. Franchise .....................................................................


5,000 5,000


Problem 11–8 (concluded) Requirement 2 Intangible assets: Goodwill Patent Franchise Total intangibles

$300,000 [1] 75,000 [2] 195,000 [3] $570,000

[1] $300,000 [2] $ 80,000 – 5,000 [3] $200,000 – 5,000



Problem 11–9 Requirement 1 Machine 101: $70,000 – 7,000 = $6,300 per year x 3 years =

$ 18,900

= $9,000 per year x 1.5 years =

13,500

10 years Machine 102: $80,000 – 8,000 8 years Machine 103: $30,000 – 3,000 = $3,000 per year x 4/12

=

1,000

9 years Accumulated depreciation, 12/31/12

$33,400

Requirement 2 To record depreciation on machine 102 through date of sale. March 31, 2013 Depreciation expense ($9,000 per year x 3/12) .................... Accumulated depreciation—equipment .....................

2,250 2,250

To record sale of equipment. March 31, 2013 Cash ................................................................................ Accumulated depreciation ($13,500 + 2,250) .................... Loss on sale of equipment (determined below) .................. Equipment ...................................................................


52,500 15,750 11,750 80,000


Problem 11–9 (continued) Loss on sale of machine 102: Proceeds Less book value on 3/31/13: Cost Less accumulated depreciation: Depreciation through 12/31/12 Depreciation from 1/1/13 to 3/31/13 ($9,000 x 3/12) Loss on sale

$52,500 $80,000 $13,500 2,250

15,750

64,250 $11,750

Requirement 3 Building: Useful life of the building: $200,000 = $40,000 in depreciation per year 5 years (2008–2012)

$840,000 – $40,000 = 20-year useful life $40,000 To record depreciation on the building. Depreciation expense [($840,000 – 40,000) ÷ 20 years] ........ Accumulated depreciation—building .........................


40,000 40,000


Problem 11–9 (concluded) To record depreciation on the equipment. Depreciation expense (determined below) ......................... Accumulated depreciation—equipment ..................... Equipment: Machine 103 (determined above) Machine 101: Cost Less: Accumulated depreciation Book value, 12/31/12 Revised remaining life (7 years – 3 years)


15,775 15,775

$ 3,000 $70,000 18,900 51,100 ÷ 4 years

12,775 $15,775


Problem 11–10 a. This is a change in estimate.

No entry is needed to record the change. 2013 adjusting entry: Depreciation expense (determined below) ......................... 370,000 Accumulated depreciation .......................................... 370,000

Calculation of annual depreciation after the estimate change: $10,000,000

Cost $250,000 Previous depreciation ($10,000,000 ÷ 40 years) x 3 yrs (750,000) Depreciation to date (2010–2012) 9,250,000 Undepreciated cost ÷ 25 yrs. Estimated remaining life (25 years: 2013–2037) $ 370,000 New annual depreciation A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.



Problem 11–10 (concluded) b. This is a change in accounting principle that is accounted for as a change in estimate. Depreciation expense (below) ...................... 21,000 Accumulated depreciation ............ 21,000 SYD 2009 depreciation 2010 depreciation 2011 depreciation 2012 depreciation

$ 60,000 54,000 48,000 42,000 Accumulated depreciation $204,000 $330,000 204,000 126,000 0 126,000 ÷ 6 yrs. $ 21,000

($330,000 x 10/55) ($330,000 x 9/55) ($330,000 x 8/55) ($330,000 x 7/55)

Cost Depreciation to date, SYD (above) Undepreciated cost as of 1/1/13 Less residual value Depreciable base Remaining life (10 years – 4 years) New annual depreciation

A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods. c. This is a change in accounting principle accounted for as a change in estimate. Because the change will be effective only for assets placed in service after the date of change, depreciation schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure note still is required to provide justification for the change and to report the effect of the change on current year’s income.



Problem 11–11 Requirement 1 Analysis: Correct (Should Have Been Recorded)

Incorrect (As Recorded)

2011 Equipment 1,900,000 Expense 100,000 Cash 2,000,000

Equipment 2,000,000 Cash 2,000,000

2011 Expense 475,000 [1] Accum. deprec. 475,000

Expense 500,000 [2] Accum. deprec. 500,000

2012 Expense 356,250 [3] Accum. deprec. 356,250

Expense 375,000 [4] Accum. deprec. 375,000

[1] $1,900,000 x 25% (2 times the straight-line rate of 12.5%) [2] $2,000,000 x 25% [3] ($1,900,000 – 475,000) x 25% [4] ($2,000,000 – 500,000 ) x 25% During the two-year period, depreciation expense was overstated by $43,750, but other expenses were understated by $100,000, so net income during the period was overstated by $56,250, which means retained earnings is currently overstated by that amount. During the two-year period, accumulated depreciation was overstated, and continues to be overstated by $43,750. To correct incorrect accounts Retained earnings ................................................. Accumulated depreciation ................................................. Equipment ........................................................


56,250 43,750 100,000


Problem 11–11 (concluded) Requirement 2 This is a change in accounting principle accounted for as a change in estimate. No entry is needed to record the change. 2013 adjusting entry: Depreciation expense (determined below) .................. 178,125 Accumulated depreciation ...................................... 178,125

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. Accordingly, the Collins Corporation reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change is depreciated straight line over the remaining useful life. Asset’s cost (after correction) Accumulated depreciation to date ($475,000 + 356,250) Undepreciated cost, Jan. 1, 2013 Estimated residual value To be depreciated over remaining 6 years Annual straight-line depreciation 2013–2018


$1,900,000 (831,250) 1,068,750 (0) 1,068,750 ÷ 6 $ 178,125

years


Problem 11–12 Requirement 1 Plant and equipment: Depreciation to date: $150 million  10 years = $15 million per year x 3 years = $45 million Book value: $150 million – 45 million = $105 million Patent: Amortization to date: $40 million  5 years = $8 million per year x 3 years = $24 million Book value: $40 million – 24 million = $16 million Requirement 2 Property, plant, and equipment and finite-life intangible assets are tested for impairment only when events or changes in circumstances indicate book value may not be recoverable. Requirement 3 Goodwill should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value. A company has the option of avoiding annual testing by making qualitative evaluations of the likelihood of goodwill impairment to determine if step one is necessary. Requirement 4 Plant and equipment: An impairment loss is indicated because the book value of the assets, $105 million, is greater than the $80 undiscounted sum of future cash flows. The amount of the impairment loss is determined as follows: Book value Fair value Impairment loss

$105 million (60) million 45 million

Patent: There is no impairment loss because the undiscounted sum of future cash flows, $20 million, exceeds book value of $16 million. © The McGraw-Hill Companies, Inc., 2013 11–78


Problem 11–12 (concluded) Goodwill: An impairment loss is indicated because the book value of the assets of the reporting unit, $470 million, is greater than the $450 million fair value of the reporting unit. The amount of the impairment loss is determined as follows: Determination of implied goodwill: Fair value of Ellison Technology Fair value of Ellison’s net assets (excluding goodwill) Implied value of goodwill

$450 million (390) million $ 60 million

Measurement of impairment loss: Book value of goodwill Implied value of goodwill Impairment loss

$100 million (60) million $ 40 million



Problem 11–13 Requirement 1 Hecala’s cost of the mineral mine is $13,721,871, determined as follows: Mining site $10,000,000 Development costs 3,200,000 Restoration costs 521,871 $13,721,871 †

$600,000 x 30% = 700,000 x 30% = 800,000 x 40% =

†

$180,000 210,000 320,000 $710,000 x .73503* = $521,871

*Present value of $1, n = 4, i = 8%

Requirement 2 Depletion: $13,721,871  800,000 tons = $17.1523 per ton 120,000 tons x $17.1523 = $2,058,276 Depreciation of machinery: $140,000 – 10,000 = $.1625 per ton 800,000 tons 120,000 tons x $.1625 = $19,500 Depreciation of structures: $68,000  800,000 tons = $.085 per ton 120,000 tons x $.085 = $10,200



Problem 11–13 (continued) Requirement 3 2013 accretion expense: $521,871 x .08 x 8/12 = $27,833 Requirement 4 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and therefore are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold. Requirement 5 A change in the service life of plant and equipment and finite-life intangible assets is accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating/depleting the remaining depreciable/depletable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life (tons of ore in this case). 2014 Depletion: Original cost Less: 2013 depletion Remaining depletable cost  Revised estimate of tons remaining (1,000,000 – 120,000) Depletion rate x Tons extracted 2014 depletion


$13,721,871 (2,058,276) $11,663,595 880,000 tons $13.2541 per ton 150,000 tons $1,988,115


Problem 11–13 (concluded) 2014 Depreciation of machinery: Original cost Less: 2013 depreciation Less: residual value Remaining depreciable cost  Revised estimate of tons remaining (1,000,000 – 120,000) Depreciation rate x Tons extracted 2014 depreciation

$140,000 (19,500) $120,500 (10,000) $110,500 880,000 tons $.1256 per ton 150,000 tons $18,840

2014 Depreciation of structures: Original cost Less: 2013 depreciation Remaining depreciable cost  Revised estimate of tons remaining (1,000,000 – 120,000) Depreciation rate x Tons extracted 2014 depreciation


$68,000 (10,200) $57,800 880,000 tons $.0657 per ton 150,000 tons $9,855


CASES Analysis Case 11–1 The terms depreciation, depletion, and amortization all refer to the same process of allocating the cost of property and equipment and finite-life intangible assets to the periods benefited by their use. However, each term is applied to a different type of long-lived asset; depreciation is used for plant and equipment, depletion for natural resources, and amortization for intangibles. There are differences in determining the factors necessary to calculate depreciation, depletion, and amortization but the concepts involved are the same. The service life of plant and equipment and natural resources is limited to physical life, while the service life of intangible assets is limited to the asset’s legal or contractual life, or 40 years, whichever is shorter. The majority of companies use straight-line depreciation and straight-line amortization. Natural resources usually are depleted using the units-of-production method.



Communication Case 11–2 Suggested Grading Concepts and Grading Scheme: Content (70%) ______ 50 Explains the concept of depreciation as a process of cost allocation, not valuation. ____ Rational match versus market fluctuations. ____ Numerical example. ______

10 Purpose of the balance sheet is to provide information about financial position, not to directly measure company value.

______

10 Purpose of the income statement is to provide cash flow information, not to directly measure the change in company value. ____ ______ 70 points Writing (30%) ______ 6 Terminology and tone appropriate to the audience of a company president. ______

12 Organization permits ease of understanding. ____ Introduction that states purpose. ____ Paragraphs that separate main points.

______

12 English ____ Sentences grammatically clear and well organized, concise. ____ Word selection. ____ Spelling. ____ Grammar and punctuation. ____ ______ 30 points



Judgment Case 11–3 Requirement 1 Portland should have selected the straight-line depreciation method when approximately the same amount of an asset’s service potential is used up each period. If the reasons for the decline in service potential are unclear, then the selection of the straight-line method could be influenced by the ease of recordkeeping, its use for similar assets, and its use by others in the industry. Requirement 2 a. By associating depreciation with a group of machines instead of each individual machine, Portland’s bookkeeping process is greatly simplified. Also, since actual machine lives vary from the average depreciable life, unrecognized net losses on early dispositions are expected to be offset by continuing depreciation on machines usable beyond the average depreciable life. Periodic income does not fluctuate as a result of recognizing gains and losses on machine dispositions. b. Portland should divide the depreciable base of each machine by its estimated life to obtain its annual depreciation. The sum of the individual annual depreciation amounts should then be divided by the sum of the individual capitalized costs to obtain the annual composite depreciation rate.



Judgment Case 11–4 Requirement 1 a. The capitalized cost for the computer includes all costs reasonable and necessary to prepare it for its intended use. Examples of such costs are the purchase price, delivery, installation, testing, and setup. b. The objective of depreciation accounting is to allocate the depreciable base of an asset over its estimated useful life in a systematic and rational manner. This process matches the depreciable base of the asset with revenues generated from its use. Depreciable base is the capitalized cost less its estimated residual value. Requirement 2 The rationale for using accelerated depreciation methods is based on the assumption that an asset is more productive in the earlier years of its estimated useful life. Therefore, larger depreciation charges in the earlier years would be matched against the larger revenues generated in the earlier years. An accelerated depreciation method also would be appropriate when benefits derived from the asset are approximately equal over the asset’s life, but repair and maintenance costs increase significantly in later years. The early years record higher depreciation expense and lower repairs and maintenance expense, while the later years have lower depreciation and higher repairs and maintenance.

Judgment Case 11–5 There is no necessarily correct answer to the question. The support made for the answer given is more important than the answer itself. Materiality is the critical consideration. Information is material if it can have an effect on a decision made by users. One consequence of materiality is that GAAP needs to be followed only if an item is material. The threshold for materiality will depend principally on the relative dollar amount of the transaction. In this case, is the $70,000 material? Net-of-tax income would be $49,000 higher if the expenditures were capitalized instead of expensed [$70,000 x (1 – .30)]. This represents a 4.45% increase in income ($49,000 ÷ $1,100,000). The effect on the balance sheet is small. Shareholders' equity would be higher by $49,000 if the expenditures were capitalized. This represents an increase of less than one-half of one percent. Would these differences have an effect on decision makers? There is no single answer to this question. The FASB has been reluctant to establish any quantitative materiality guidelines. The threshold for materiality has been left to subjective judgment of the company preparing the financial statement and its auditors. © The McGraw-Hill Companies, Inc., 2013 11–86


Communication Case 11–6 There is no right or wrong answer to this case. Both views, expense and capitalize, can be defended once consideration is given to the materiality issue. The process of developing and synthesizing the arguments will likely be more beneficial than any single solution. Each student should benefit from participating in the process, interacting first with his or her partner, then with the class as a whole. It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. A significant benefit of this case is that it is forcing students to consider the subjective nature of materiality when applying GAAP.



Integrating Case 11–7 Requirement 1 a. Inventory (understatement of 2014 beginning inventory) ......... Retained earnings (understatement of 2013 income) .........

($ in millions)

10 10

Note: The 2012 error requires no adjustment because it has self-corrected by 2014.

b. Retained earnings (2012–2013 patent amortization) ............. Patent [($18 million ÷ 6 years) x 2]...................................

6

2014 adjusting entry: Patent amortization expense ($18 million ÷ 6 years) ......... Patent .........................................................................

3

c. 2014 adjusting entry: Depreciation expense (below) .......................................... Accumulated depreciation .........................................

6

3

4 4

($ in millions)

SYD 2012 depreciation 2013 depreciation Accumulated depreciation

$30 18 12 0 12 ÷ 3 yrs. $ 4

$10 ($30 x 5/15) 8 ($30 x 4/15) $18

Cost Depreciation to date, SYD (above) Undepreciated cost as of 1/1/14 Less residual value Depreciable base Remaining life (5 years – 2 years) New annual depreciation



Case 11–7 (concluded) Requirement 2 Assets 2012 2012 inventory Patent amortization Depreciation

2013 2012 inventory 2013 inventory Patent amortization Depreciation

$310 (12) (3)

$210 (12) (3)

Expenses

$640 (12) (3)

$330

____ $625

____ $330

$150 12 3

____ $295

____ $195

____ $165

$820

$400

$420

$230 12 10 (3)

$175 (12) (10) 3

no adjustments to prior years

10 (6)

10 (6)

no adjustments to prior years

____ $824


Shareholders’ Net Liabilities Equity Income

____

____

____

____

$400

$424

$249

$156


Judgment Case 11–8 Requirement 1 A change from the sum-of-the-years’-digits method of depreciation to the straight-line method for previously recorded assets is a change in accounting principle that is accounted for as a change in estimate. Both the sum-of-the-years’-digits method and the straight-line method are generally accepted. A change in accounting principle results from the adoption of a generally accepted accounting principle different from the generally accepted principle used previously for reporting purposes. Requirement 2 A change in the expected service life of an asset arising because of more experience with the asset is a change in accounting estimate. A change in accounting estimate occurs because future events and their effects cannot be perceived with certainty. Estimates are an inherent part of the accounting process. Therefore, accounting and reporting for certain financial statement elements requires the exercise of judgment, subject to revision based on experience.



Research Case 11–9 Requirement 1 The reference locations for the impairment of property, plant, and equipment and intangible assets include: FASB ASC 360–10: “Property, Plant and Equipment– Overall,” and FASB ASC 350–20: “Intangibles–Goodwill and Other–Goodwill.” Requirement 2 Property, plant, and equipment and finite-life intangible assets are tested for impairment only when events or changes in circumstances indicate book value may not be recoverable. Intangible assets with indefinite useful lives, including goodwill, should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value. Goodwill, however, may first be qualitatively assessed to determine the likelihood that fair value is less than book value before conducting step one of the goodwill impairment test. Requirement 3 Property, plant, and equipment and finite-life intangible assets: Determining whether to record an impairment loss and actually recording the loss is a two-step process. The first step is a recoverability test—an impairment loss is required only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value. The measurement of impairment loss—step two— is the difference between the asset’s book value and its fair value. Intangible assets with indefinite useful lives (other than goodwill): The measurement of an impairment loss for indefinite-life intangible assets other than goodwill is a one-step process. We compare the fair value of the asset with its book value. If book value exceeds fair value, an impairment loss is recognized for the difference. Goodwill: Determining whether to record an impairment loss and actually recording the loss is a two-step process. Step 1: A goodwill impairment loss is indicated when the fair value of the reporting unit is less than its book value. Step 2: A goodwill impairment loss is measured as the excess of the book value of the goodwill over its “implied” fair value. The implied fair value of goodwill is calculated in the same way that goodwill is determined in a business combination. That is, it’s a residual amount measured by subtracting the fair value of all identifiable net assets from the consideration exchanged using the unit’s previously determined fair value as the consideration exchanged. Solutions Manual, Vol.1, Chapter 11


Case 11–9 (concluded) Requirement 4 Property, plant, and equipment and intangible assets to be sold should be classified as held-for-sale in the period in which all of the following criteria are met: a. Management, having the authority to approve the action, commits to a plan to sell the asset. b. The asset or asset group is available for immediate sale in its present condition. c. An active program to locate a buyer and other actions required to complete the plan to sell the asset or asset group have been initiated. d. The sale is probable. e. The asset or asset group is being actively marketed for sale at a price that is reasonable in relation to its current fair value. f. Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. The specific reference for these criteria is FASB ASC 360–10–45–9. Requirement 5 Property, plant, and equipment and intangible assets or groups of these assets classified as held-for-sale is measured at the lower of its (a) book value or (b) fair value less cost to sell. An impairment loss is recognized for any write-down to fair value less cost to sell.



Ethics Case 11–10 Requirement 1 2013 expense using CEO's approach: $42,000,000 $4,200,000 x 2 years

8,400,000 33,600,000 ÷ 3 $11,200,000

Cost Previous annual depreciation ($42,000,000 ÷ 10 years) Depreciation to date (2011–2012) Book value Estimated remaining life (2013–2015) New annual depreciation

2013 income would include only depreciation expense of $11,200,000. 2013 expense using Heather's approach: $42,000,000 $4,200,000 x 2 years

8,400,000 33,600,000 12,900,000 20,700,000 ÷ 3 $ 6,900,000

Cost Previous annual depreciation ($42,000,000 ÷ 10 years) Depreciation to date (2011–2012) Book value Write-down New depreciable base Estimated remaining life (2013–2015) New annual depreciation

2013 income would include depreciation expense of $6,900,000 and an asset writedown of $12,900,000 for a total income reduction of $19,800,000. Using Heather's approach, 2013's before tax income would be lower by $8,600,000 ($19,800,000 – 11,200,000).



Case 11–10 (concluded) Requirement 2 Discussion should include these elements. Facts: GAAP provides guidance for recording impairment losses on partial write-downs of property, plant, and equipment and intangible assets remaining in use. Assets should be written down if there has been a significant impairment of value such as in decreased product demand and full recovery of book value through use or resale is not expected. Although the decision and computation to record an impairment loss often is very subjective and difficult to measure, Heather is able to estimate an equipment impairment of $12,900,000, presumably using the best information available. The simple revision in service life approach is clearly an effort to enhance net income on the part of the CEO. Ethical Dilemma: Is Heather's obligation to challenge the questionable application of revision in service life more important than her obligation to her boss and to the company's effort to reflect a favorable net income? Who is affected? Heather CEO and other managers Other employees Shareholders Potential shareholders Creditors Company auditors



Judgment Case 11–11 Requirement 1 By changing its depreciation method, a company can shift reported income between periods. For example, a shift from an accelerated method to the straight-line method increases income in the year of the change. However, in some future period or periods, income will be lower than it would have been if the change had not been made. This is not an effective way to manage earnings because the effect on income of switching from one method to another must be disclosed. Requirement 2 A company can manage earnings by changing the estimated useful lives of depreciable assets. For example, reducing useful lives causes a decrease in income in one or more years including the year of the change, and increases income in some future years. This is not an effective way to manage earnings because the effect on income of changing useful lives, if material, must be disclosed. Requirement 3 One possible approach to answering this question is to assume a company overstates its impairment loss. For example, assume that the book value of depreciable assets is $20 million. The fair value of these assets is estimated to be $13 million, indicating an impairment loss of $7 million. If these assets are written down to $8 million, the company has effectively shifted $5 million in pre-tax income from the current period to future periods. By writing down the assets to $8 million instead of $13 million, future depreciation is $5 million less than it would have been with a more appropriate write-down.



Judgment Case 11–12 Transaction

Disposition

1.

Transaction is correctly recorded as repairs and maintenance expense.

2.


3.

Transaction is incorrectly recorded. The amount should be capitalized as part of the cost of the plant.

4.

Transaction is incorrectly recorded. The amount should be capitalized either as part of the cost of the plant or as a reduction in the accumulated depreciation of the plant.

5.


6.


7.

Transaction is incorrectly recorded. The amount should be capitalized as equipment.

8.




Real World Case 11–13 Requirement 1 ($ in millions)

Property, plant and equipment (Cost): Balance, beginning of 2010 Add: Acquisitions during 2010 Less: Balance end of 2010 Dispositions during 2010

$24,221 2,586 (24,906) $ 1,901

Property, plant, and equipment (Accumulated depreciation): Balance, beginning of 2010 Add: Depreciation for 2010 Less: Balance end of 2010 Accumulated depreciation of 2010 dispositions

$ 11,835 2,220 (12,367) $ 1,688

Gain (loss) on 2010 dispositions: Cost of dispositions Less: Accumulated depreciation of dispositions Book value of dispositions Proceeds from dispositions Less: Book value of dispositions Gain on 2010 dispositions

$1,901 (1,688) $ 213 $1,469 (213) $1,256

Requirement 2 2010 depreciable assets: Property, plant, and equipment Less: Land Cost of depreciable assets

$24,906 (682) $24,224

Assuming that Caterpillar uses the straight-line depreciation method, $24,224 ÷ $2,220 (2010 depreciation) = 10.91 years. The approximate average service life of Caterpillar's depreciable assets is 11 years.



Real World Case 11–14 Requirement 3 The following was taken from the company’s 2010 financial statements. Your results could differ if the company changes any of its policies in years after 2010. a. The company's depreciation and depletion policies, disclosed in Note 1. Summary of Significant Account Policies, are as follows: Depreciation and depletion of all capitalized costs of proved crude oil and natural gas producing properties, except mineral interests, are expensed using the unit-of-production method generally by individual field as the proved developed reserves are produced. Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual field as the related proved reserves are produced. Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed. Depreciation and depletion expenses for mining assets are determined using the unit-of-production method as the proven reserves are produced. The capitalized costs of all other plant and equipment are depreciated or amortized over their estimated useful lives. In general, the declining-balance method is used to depreciate plant and equipment in the United States; the straight-line method generally is used to depreciate international plant and equipment and to amortize all capitalized leased assets. b. Expenditures for maintenance (including those for planned major maintenance projects), repairs, and minor renewals to maintain facilities in operating condition are generally expensed as incurred. Major replacements and renewals are capitalized.



IFRS Case 11–15 Requirement 2 GlaxoSmithKline values its property, plant, and equipment at cost less provision for depreciation and impairment. IFRS also allows the valuation of these assets at fair value (revaluation). If revaluation is chosen, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP does not allow the revaluation option. Property, plant, and equipment must be valued at cost less accumulated depreciation and impairment. Requirement 3 For goodwill, impairments of goodwill are not reversed. U.S. GAAP also does not allow for reversals of goodwill impairment. Impairment losses on other noncurrent assets are only reversed if there has been a change in estimates used to determine recoverable amounts and only to the extent that the revised recoverable amounts do not exceed the carrying values that would have existed, net of depreciation or amoritzation, had no impairments been recognized. U.S. GAAP does not allow reversals of impairment losses.



Analysis Case 11–16 Requirement 1 The statement of cash flows reports depreciation and amortization of $970 million. Requirement 2 Dell uses the straight-line depreciation method over the estimated economic lives of the assets, which range from 10 to 30 years for buildings and two to five years for all other assets.



Air France–KLM Case Requirement 1 (€ in millions)

March 31, 2011

Before Revaluation

Flight equipment Accumulated depreciation Book value

€18,486 7,446 €11,040

After Revaluation x 12,000/11,040 = x 12,000/11,040 = x 12,000/11,040 =

€20,093 8,093 €12,000

The entry to revalue the flight equipment and the accumulated depreciation accounts (and thus the book value) is: Flight equipment (€20,093 – 18,486) Accumulated depreciation (€8,093 – 7,446) Revaluation surplus—OCI (€12,000 – 11,040)

1,607 647 960

Requirement 2 Under U.S. GAAP, property, plant, and equipment is valued at cost less accumulated depreciation. U.S. GAAP prohibits revaluation. Requirement 3 IFRS requires that each component of an item of property, plant, and equipment must be depreciated separately if its cost is significant in relation to the total cost of the item. AF uses this approach with its flight equipment. Note 3.13.2 states, “Any major airframes and engines (excluding parts with limited useful lives) are treated as a separate asset component with the cost capitalized and depreciated over the period between the date of acquisition and the next major overhaul.” In the United States, component depreciation is allowed but is not often used in practice.



Air France-KLM Case (concluded) Requirement 4 Per Note 3.14, fixed assets are tested for when there is an indication of impairment. This approach is similar to U.S. GAAP. However, under IFRS, assets must be assessed for indicators of impairment at the end of each reporting period. Requirement 5 In Note 3.14, AF states that the company deems the recoverable value of the asset to be the higher of market value less cost of disposal and its value in use. The later is determined according to the discounted future cash flow method. While not stated, AF then compares the recoverable amount to book value. If book value is higher, an impairment loss is recognized for the difference. Under U.S. GAAP, the measurement of an impairment loss is a two-step process. Step one, recoverability, requires an impairment loss to be recognized only when an asset’s book value exceeds the undiscounted sum of the asset’s estimated future cash flows. If a loss is required, step two measures the loss as the difference between book value and fair value of the asset. Requirement 6 (€ in millions)

Revaluation expense Other intangible assets (€373 – 360)


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11sol_7e_final.pdf

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