Fa4e Sm Ch08

Chapter 8 Reporting and Analyzing Long-Term Operating Assets Learning Objectives – coverage by question LO1 – Describe and distinguish between tangible and intangible assets. LO2 – Determine which costs to capitalize and report as assets and which costs to expense. LO3 – Apply different depreciation methods to allocate the cost of assets over time.

MiniExercises

Exercises

17

31

11,17

22

12, 13, 16, 18, 19

Problems

Cases and Projects

36, 38, 39

40, 42

37

42

22 - 28, 32

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

14, 15

LO5 – Describe the accounting and reporting for intangible assets.

17, 21

31, 34

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

20, 21

29, 30, 33

22, 24, 26, 35

40 - 42

©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 8

8-1

DISCUSSION QUESTIONS Q8-1.

Routine maintenance costs that are necessary to realize the full benefits of ownership of the asset should be expensed. However, betterment or improvement costs should be capitalized if the outlay enhances the usefulness of the asset or extends the asset‟s useful life beyond original expectations. As would be the case with any cost, an immaterial amount should be expensed as incurred.

Q8-2.

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

Q8-3.

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

Q8-4.

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

Q8-5.

When a change occurs in the estimate of an asset's useful life or its salvage value, the revision of depreciation expense is handled by depreciating the current undepreciated cost of the asset (original cost – accumulated depreciation) using the revised assumptions of remaining useful life and salvage value. Present and future periods are affected by such revisions. Depreciation expense calculated and reported in past periods is not revised.

Q8-6.

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

©Cambridge Business Publishers, 2014 8-2

Financial Accounting, 4th Edition

Q8-7.

A PPE asset is considered to be impaired when the sum of the undiscounted expected cash flows to be derived from the asset is less than its current book value. An impairment loss is calculated as the difference between the asset's book value and its current fair market value.

Q8-8.

Research and development costs must be expensed under GAAP unless they have alternative future uses. Equipment relating to a specific research project with no alternative use would, therefore, be expensed rather than capitalized and subsequently depreciated. Accounting standard-setters have justified this „expense as incurred‟ treatment for R&D costs since the outputs from research and development activities are uncertain and there are, therefore, no expected cash flows against which to match any future depreciation expense.

Q8-9.

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

Q8-10. Goodwill arises whenever a company acquires another company and the purchase price is greater than the fair value of the identifiable assets acquired. The amount of goodwill is the difference between the purchase price and the value assigned to the net assets of the acquired company. It is recorded as a long-term asset in the balance sheet. Since goodwill is assumed to have an indefinite life, it is not amortized. The only time that goodwill might affect the income statement is if it is determined that its value is impaired. In that case, an impairment loss is recorded in the income statement and the value of the goodwill asset on the balance sheet is reduced.


8-3

MINI EXERCISES M8-11. (10 minutes) a. b. c. d.

Expense Capitalize Capitalize (the new equipment enhances the assembly line) Expense – this is routine maintenance of the building, unless it extends the building‟s useful life e. Capitalize – the useful life is extended f. Capitalize – this is a purchased intangible asset

M8-12. (15 minutes) a. Straight-line: ($18,000 - $1,500)/ 5 years = $3,300 for both 2013 and 2014. b. Double-declining-balance: Twice straight-line rate = 2 x 1/5 = 40% 2013: $18,000 x 0.40 = $7,200 2014: ($18,000 - $7,200) x 0.40 = $4,320 Notice that, over the first two years, the company reports $6,600 of depreciation expense under the straight-line method and $11,520 of depreciation expense under the double-declining-balance method.

M8-13. (15 minutes) a. Straight-line: ($130,000 - $10,000)/ 6 years = $20,000 for both 2013 and 2014. b. Double-declining-balance: Twice straight-line rate = 2 x 1/6 = 1/3 2013: $130,000 x 1/3 = $43,333 2014: ($130,000 - $43,333) x 1/3 = $28,889 c. Units of production: ($130,000 - $10,000) / 1,000,000 = $0.12 per unit 2013: 180,000 units x $0.12 = $21,600 2014: 140,000 units x $0.12 = $16,800



M8-14. (15 minutes) Straight-line depreciation: $40,000/10 = $4,000; 8 years x $4,000 = $32,000. a. Cash (+A) .......................................................................................... 3,500 Accumulated depreciation (-XA, +A) ................................................. 32,000 Loss on sale of furniture and fixtures (+E, -SE) ................................. 4,500 Furniture and fixtures (-A) ................................................................40,000 b. Balance Sheet Transaction Sold furniture and fixtures for cash.

Cash Asset

Noncash + Assets

+3,500 Cash

-40,000 Furniture and Fixtures

-

-

Contra Assets

Liabi= lities

Income Statement Contrib. + + Capital

-32,000 Accum. Deprec.

Earned Capital

Revenues

- Expenses =

-4,500 Retained Earnings

-

+4,500 Loss on Sale of Furniture and Fixtures

Net Income -4,500

=

M8-15. (15 minutes) Twice the straight-line rate = 1/5 x 2 = 40% Year 1: $75,000 x .4 = Year 2: ($75,000 - $30,000) x .4 = Year 3: ($75,000 - $30,000 - $18,000) x .4 = Total accumulated depreciation

$30,000 18,000 10,800 $58,800

a. Cash (+A) ........................................................................................... 25,000 Accumulated depreciation (-XA, +A) .................................................. 58,800 Machinery (-A) .................................................................................. Gain on sale of machinery (+R, +SE) ...............................................

75,000 8,800

b.

Transaction Sold machinery for cash.

Cash Asset +25,000 Cash

Noncash + Assets -75,000 Machinery

-

-

Balance Sheet Contra Liabi= Assets lities -58,800 Accum. Deprec.

Income Statement Contrib. + + Capital

Earned Capital +8,800 Retained Earnings

Revenues +8,800 Gain on Sale of Machinery

- Expenses =

Net Income +8,800

-

=


8-5

M8-16. (15 minutes) a. Straight-line depreciation 2013: ($145,800 - $5,400)/3 = $46,800; (8/12) x $46,800 = $31,200 2014: $46,800 b. Double-declining-balance depreciation Preliminary computation: Twice straight-line rate = 2 x 100%/3 = 66⅔% ($145,800 x 66⅔%) = $97,200 2013: (8/12) x $97,200 = $64,800 2014: ($145,800 - $64,800) x 66⅔% = $54,000

M8-17. (20 minutes) a. Under U.S. GAAP, capitalization of development costs is not allowed and all R&D costs must be expensed. Under IFRS, development costs are capitalized if there is the intention, feasibility and resources to bring the asset to completion, there exists the ability to use or sell the asset to generate an economic benefit. Otherwise the costs must be expensed. b. Yes, impairment should be tested for annually.

M8-18. (20 minutes) a. Year 1 2 3 4

Book value $50,000 25,000 12,500 8,000

Depreciation rate 2 x ¼ = 0.5 2 x ¼ = 0.5

Depreciation expense $25,000 12,500 4,500 0*

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

b. Year 1 2 3 4 5

Book value $50,000 30,000 18,000 10,800 6,480

Depreciation rate 2 x 1/5 = 0.4 2 x 1/5 = 0.4 2 x 1/5 = 0.4 2 x 1/5 = 0.4

Depreciation expense $20,000 12,000 7,200 4,320 3,480*

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

continued next page ©Cambridge Business Publishers, 2014 8-6


M8-18. concluded c. Year 1 2 3 4 5 6 7 8 9 10

Book value $50,000 40,000 32,000 25,600 20,480 16,384 13,107 10,486 8,389 6,711

Depreciation rate 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2

Depreciation expense $10,000 8,000 6,400 5,120 4,096 3,277 2,621 2,097 1,678 5,711*

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

M8-19. (15 minutes) a. Year 2013 2014 2015

Barrels extracted 300,000 500,000 600,000

Depletion per barrel $32,000,000 / 4,000,000 = $8 $32,000,000 / 4,000,000 = $8 $32,000,000 / 4,000,000 = $8

Depletion $2,400,000 $4,000,000 $4,800,000

b. i.

Oil reserve (+A) ......................................................... 32,000,000 Cash (-A) ..............................................................

ii. Oil inventory (+A) ...................................................... Oil reserve (-A) ......................................................

32,000,000

2,400,000 2,400,000

c. + i. Balance

Oil Reserve (A) 32,000,000 2,400,000 29,600,000

+ ii.

Oil Inventory (A) 2,400,000

Balance

2,400,000

-

ii.


8-7

M8-20. (15 minutes) a. PPE turnover rates for 2007 Texas Instruments

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

Intel Corp.

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

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

M8-21. (15 minutes) a. $4,801,914 / $38,851,259 = 12.4%. Abbott‟s R&D expenditure level could be compared to the R&D expenditure level for its competitors to gain a sense of the appropriateness of its R&D expenditures. The median value of R&D intensity for pharmaceutical companies is 19.6% in Exhibit 5.13 in Chapter 5. Abbott is one of the larger, more established firms in this industry and may have an R&D program that is more stable and less intensive than the median. b. R&D costs must be expensed when incurred unless they are expenditures for depreciable assets that have alternative future uses (in which case the depreciation is expensed as recognized). As a result, the balance sheet does not reflect the costs incurred for long-term R&D assets. In addition, operating expenses are increased, thus reducing retained earnings. ($000) Transaction R&D expenditures

Balance Sheet Cash Asset -4,801,914 Cash

Noncash + = Assets =

Liabilities

Contrib. + + Capital

Income Statement Earned Capital -4,801,914 Retained Earnings

Revenues -

-

Expenses +4,801,914 R&D Expense

=

=

Net Income -4,801,914



EXERCISES E8-22. (15 minutes) a. Machine (+A) ..................................................................................... 89,500 Cash (-A) ($85,000 + $2,000 + $2,500) ............................................ 89,500 b. ($89,500 - $7,000) / 5 = $16,500 per year. Depreciation expense (+E, -SE) ........................................................ 16,500 Accumulated depreciation (+XA, -A) ................................................. 16,500 c. Cash (+A) ........................................................................................... 12,000 Accumulated depreciation (-XA, +A) ($16,500 x 4) ............................ 66,000 Loss on sale of machine (+E, -SE) .................................................... 11,500 Machine (-A) .....................................................................................

89,500

E8-23. (20 minutes) a. Straight line: ($80,000 - $5,000)/5 years = $15,000 per year b. Double declining balance: Twice straight-line rate = 2 x 100%/5 = 40% Year 1 2 3 4 5 Total

Book Value x Rate $80,000 x 0.40 = ($80,000 - $32,000) x 0.40 = ($80,000 - $51,200) x 0.40 = ($80,000 - $62,720) x 0.40 =

Depreciation Expense $32,000 19,200 11,520 6,912 5,368 (plug) $75,000


8-9

E8-24. (25 minutes) a. 1. Cumulative depreciation expense to date of sale: [($800,000-$80,000)/10 years] x 6 years = $432,000 2. Net book value of the plane at date of sale: $800,000 - $432,000 = $368,000 b. 1. $ 0 Cash (+A) ......................................................................................... 368,000 Accumulated depreciation (-XA, +A) ................................................ 432,000 Plane (-A) .........................................................................................

800,000

2. Loss on sale of: $195,000 - $368,000 = $173,000 Cash (+A) ......................................................................................... 195,000 Accumulated depreciation (-XA, +A) ................................................. 432,000 Loss on sale of plane (+E, -SE) ........................................................ 173,000 Plane (-A) .........................................................................................

800,000

3. Gain on sale of: $600,000 - $368,000 = $232,000 Cash (+A) ......................................................................................... 600,000 Accumulated depreciation (-XA, +A) ................................................. 432,000 Gain on sale of plane (+R, +SE) ...................................................... Plane (-A) .........................................................................................

232,000 800,000

E8-25. (15 minutes) a. Straight-line: 2013 and 2014 ($218,700 - $23,400)/6 years = $32,550 b. Double-declining-balance: twice straight-line rate = 100% x 2/6 = 33⅓% 2013 $218,700 x 33⅓% = $72,900 2014 ($218,700 - $ 72,900) x 33⅓% = $48,600

E8-26. (15 minutes) a. Depreciation expense to date of sale is [($27,200 - $2,000)/6] x 3 = $12,600. The net book value of the van is, therefore, $27,200 - $12,600 = $14,600. b. 1. 0 2. $400 gain ($15,000 - $14,600) 3. $2,600 loss ($12,000 - $14,600)



E8-27. (20 minutes) a. Straight line: ($110,000 - $15,000) / 6 = $15,833 each year. b. Double-declining-balance: rate = 2 x 1/6 = 1/3. 2013: $110,000 x 1/3 = $36,667 2014: ($110,000 – $36,667) x 1/3 = $24,444 2015: ($110,000 – $36,667 – $24,444) x 1/3 =

$16,296

c. Straight line: ($110,000 – $15,833x2 – $10,000) / 5 = $13,667 in 2015 and each subsequent year. Double-declining balance: rate = 2 x 1/5 = 40%. ($110,000 – $36,667 – $24,444) x 40% = $19,556 in 2015

E8-28. (20 minutes) a. Straight-line: $6,000,000 / 30 = $200,000 per year each year. b. Double-declining balance: rate = 2 x 1/30 = 1/15. 2013: $6,000,000 x 1/15 = $400,000 2014: ($6,000,000 – $400,000) x 1/15 = $373,333 c. The revised depreciation rate = 2 x 1/23 = 8.7% 2015: ($6,000,000 – $400,000 – $373,333) x 8.7% = $454,493

E8-29. (10 minutes) Percent depreciated = Accumulated depreciation / Asset cost = $5,156 million / ($9,508 - $121 - $649) million = 59% Note: We eliminate land and construction in progress from the computation because these assets are not depreciated. Assuming that assets are replaced evenly as they are used up, we would expect assets to be 50% depreciated, on average. Deere‟s 59% is higher than this level. Our concern is that it will require higher capital expenditures in the near future to replace aging assets.


8-11

E8-30. (25 minute) a. 2010

2011

Receivable turnover rate $26,662 = 7.77 $3,615+$3,250 2 $29,611 $3,867+$3,615 2

= 7.92

Inventory turnover rate $13,831 = 4.77 $3,115+$2,639 2

PPE turnover rate $26,662 = 3.73 $7,279+$7,000 2

$15,693 $3,416+$3,155 2

$29,611 $7,666+$7,279 2

= 4.78

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

E8-31. (10 minutes) a.

Fair Value (capitalized)

Useful life

b

Amortization expense for 2013

Patent

$200,000

3 years

$66,667

Trademark Noncompetition agreement

$500,000 $300,000

Indefinite 5 years

60,000 $126,667



= 3.96

E8-32. (15 minutes) a. Cost of resource property: $7,200,000 + $420,000 + $50,000 + $800,000 = $8,470,000 Residual value: $1,200,000 Depletion base: $8,470,000 – $1,200,000 = $7,270,000 Depletion rate: $7,270,000 / 500,000 tons = $14.54 per ton 2013: 60,000 x $14.54 = $872,400 2014: 85,000 x $14.54 = $1,235,900 b. 2013: Inventory (+A) ................................................................................... 872,400 Resource property (-A) ..................................................................... 872,400 2014: Inventory (+A) ................................................................................... 1,235,900 Resource property (-A) ..................................................................... 1,235,900

E8-33. (15 minutes) a. Percent depreciated – 2011: $11,320 / $12,266 = 92.3% 2010: $10,925 / $11,804 = 92.6% b. PPET: $96,504 / [(946 + 879)/2] = 105.8 times c. Adams‟ assets are almost completely depreciated. This results in an extremely high percent depreciated ratio and also a very high PPE turnover ratio (PPET). Adding inventories and receivables to get all the firm‟s net operating asset turnover (NOAT) is more reasonable devisor. Adams outsources most of its manufacturing and, recognizing concerns that these numbers might produce, reports in its 10K that its current facilities (PPE assets) are adequate for the foreseeable future. Thus, although the ratios might suggest otherwise, the company does not anticipate large capital expenditures in the near future. Indeed this has been the case for the last several years as well.

E8-34. (15 minutes) a. The list illustrates the wide range in expenditures for R&D (as a percent of sales) across firms. Note the large amount spent by pharmaceutical companies Pfizer (13.51%) and Merck (17.62%), compared to the amount spent by Lenovo (1.53%). The companies in the list are paired by industry. It is interesting to see how similar some firms in the same industry are. For example, Callaway Golf and Adams Golf and Head N.V. spend almost the same percentage of sales on R&D despite the fact that Callaway is several times larger than Adams. continued next page ©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 8

8-13

E8-34. concluded b. Beside industry affiliation, the differences in R&D expenditures as a percent of sales is due to differences in markets, product mix, and other strategic considerations. As suppliers of technology (hardware and software), Intel and Microsoft depend very heavily on their intellectual property. As a result, their expenditures on research and development are among the highest of established firms. Apple has established itself as an innovator in technology and design and has spent billions of dollars developing unique products such as the iPad®. Apple‟s research intensity for 2011 has been reduced by the tremendous increase in the company‟s sales revenue. From 2009 to 2011, Apple‟s revenues increased by 152%, while R&D increased by 82%.

E8-35. (20 minutes) a. Yes, the equipment is impaired at July 1, 2013 because its book value is not recoverable through future cash flows. Specifically, on July 1, 2013, its book value is $145,000 ($225,000 initial cost less $80,000 accumulated depreciation*) and the estimated future (undiscounted) cash flows are only $125,000. *4 years of [($225,000-$25,000)/10 years]. b. The impairment loss in a is computed as the equipment's book value minus its current fair value: $145,000  $90,000 = $55,000 Impairment loss (+E, -SE) .................................................................. 55,000 Equipment* (-A) ................................................................................

55,000

*Accumulated depreciation is sometimes credited for the loss. c. Assuming that the salvage value remains the same after the impairment (this is not likely given the decline in market value of the asset), the annual depreciation expense would be ($90,000 - $25,000) / 6 = $10,833 per year. Depreciation expense (+E, -SE) ....................................................... 10,833 Accumulated depreciation (+XA, -A) ................................................ 10,833 d. ($000)

Income Statement

Balance Sheet

Transaction b. Impairment charge.

c. Depreciation expense.

Cash Asset

Noncash + Assets -55,000 Equipment

-

Contra Assets

Contrib. + + Capital

Earned Capital -55,000 Retained Earnings

-

-

=

Liabilities

+10,833 Accum. Deprec.

-10,833 Retained Earnings

Revenues

-

Expenses

=

-

+55,000 Impairment Loss

=

-

+10,833 Deprec. Expense

=

Net Income -55,000

-10,833



PROBLEMS P8-36. (20 minutes) In order to determine the entries for the sale of property, plant and equipment, we need to “fill in the blanks” for the PPE and accumulated depreciation accounts. Once we record the purchases and the depreciation expense, we can determine the cost and accumulated depreciation for the assets sold. (i)

(ii)

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

5,559,183

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

3,174,956

(iii) Cash (+A) ......................................................................................... 96,916 Accumulated depreciation (-XA, +A) ................................................ 906,373 Property, plant and equipment (-A) ……………………...... Gain on sale of property and equipment (+R, +SE)……… + Property, Plant and Equipment (A) Balance 80,132,394 (i) 5,559,183 923,805 Balance 84,767,771

-

(iii)

-

(iii)

923,806 79,483

Accumulated Depreciation (XA) + 57,852,770 Balance 3,174,956 (ii) 906,373 60,121,353 Balance

P8-37. (20 minutes) a. $649 million / $6,615 million = 9.8% b. R&D costs are expensed in the income statement except for the portion relating to depreciable assets that have alternate uses. Expensing (rather than capitalizing and depreciating) reduces assets, and the additional expense reduces profit and equity (via the reduction in retained earnings). In addition, expensing R&D as incurred means that potentially valuable intangible assets are omitted from the balance sheet. c. Agilent has reduced its R&D spending as a percent of revenues in recent years and, as a result, increased its earnings. (Agilent had a loss from operations in 2003.) This has turned operating losses into an operating profit for the company. However, Agilent is dependent upon technology in order to maintain its market position, and R&D is critical to its very existence. Agilent has divested itself of some high-intensity R&D businesses over the eight years from 2003 to 2011, and its spending on R&D has remained pretty constant in absolute terms from 2005 to the present. The decrease in intensity is due to increased revenues, not decreases in R&D spending. In addition, a company can maintain its investment in intellectual capital and reduce expenses by outsourcing the activity to other countries where the intellectual resources are less expensive. ©Cambridge Business Publishers, 2014 Solutions Manual, Chapter 8

8-15

P8-38. (20 minutes) ($ millions) a. i. Depreciation expense (+E, -SE) ...................................................... 2,060 Accumulated depreciation (+XA, -A) .................................................2,060 ii.

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

iii. Cash (+A) .........................................................................................

69

Accumulated depreciation (-XA, +A) (see T-account) ...................... 990 Property and equipment (-A) (see T-account) ...................................1,059 iv. Repair and maintenance expense (+E, -SE) .................................... 726 Cash (-A) .......................................................................................... 726 v.

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

+ Property and Equipment (A) Balance 35,765 (ii) 2,129 1,059 34 (b) 247 Balance 37,048

-

-

(iii) (v)

(iii)

34 34 Accumulated Depreciation (XA) + 10,485 Balance 2,060 (i) 990

11,555

Balance

b. The problem provides information directly to make entries (i), (ii), (iv) and (v) in part a. For part (iii), we can infer the accumulated depreciation on disposed property and equipment as being the amount ($990) that makes that account balance. Since no gain or loss was reported on these disposals, the credit to property and equipment in part (iii) is the amount that balances the disposal transaction ($1,059). However, this leaves the property and equipment T-account unbalanced. A likely reason is that Target acquires some property and equipment without an expenditure of cash. (Chapter 10 will cover capital lease transactions, which play a role in Target‟s operations.) Based on the information in the problem, we would estimate that $247 million of property and equipment was acquired through such transactions, because that amount balances the property and equipment T-account.



P8-39. (20 minutes) The process used in this question is to fill in the entries for property and equipment and for accumulated depreciation in parts a, b and c, and then to use the “plug” figures in the T-accounts to determine the values in part d. ($ thousands) a. Depreciation expense (+E, -SE) ....................................................... 144,630 Accumulated depreciation (+XA, -A) ................................................

144,630

b. Property and equipment (+A) ............................................................ 61,906 Cash (-A) .......................................................................................... c. Loss on impairment of property and equipment (+E) ........................5,453 Property and equipment (-A) ............................................................

61,906

5,453

d. Cash (+A) ......................................................................................... 11,433 Accumulated depreciation (-XA, +A) (see T-account) ....................... 90,694 Property and equipment (-A) (see T-account) .................................. Gain on sale of property and equipment (+R,+SE) + Property and Equipment (A) Balance 1,902,584 (b) 61,906 5,453 100,988 Balance 1,858,049

-

-

(c) (d)

(d)

100,988 1,139

Accumulated Depreciation (XA) + 1,073,557 Balance 144,630 (a) 90,694 1,127,493

Balance


8-17

CASES and PROJECTS C8-40. (90 min) a. PPE Turnover: $14,880.2/[($2,127.7 + $3,345.9)/2] = 4.6 The firm does not appear to be as capital intensive as others in the industry based on a higher than average PPE turnover ratio than its closest competitors. b. Accumulated depreciation / Depreciable asset cost $4,146.2/ ($7,492.1 - $61.2*- $521.9*) =0.60 or 60%

*Note: We eliminate land from the computation because land is never depreciated. We eliminate construction in progress because these represent assets that the company is building. These assets are not yet in service and are consequently not yet depreciable. This elimination is also used in part c.

If plant assets are replaced at a constant rate, we would expect those assets to be about 50% “used up,” on average. A substantially higher percentage “used up” indicates that the assets are closer to the end of their useful lives and will require replacement (and usually higher maintenance costs near the end of their useful lives). Such a situation would negatively impact future cash flows. c. Average depreciation assets = [($7,492.1 – 61.2 – 521.9) + ($6,949.7 – 58.0 – 469.0)] / 2 = $6,665.85 Average depreciaiable assets/ Depreciation expense = $6,665.85 / $462 per year = 14.4 years. d. Depreciation expense (+E, -SE) ....................................................... 462.0 PPE accumulated depreciation (+XA, -A) .........................................

462.0

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

648.8

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

1.7



C8-41. (40 minutes) Reducing operating assets is an important means of increasing performance measures including the return on net operating assets. Most companies focus first on reducing receivables and inventories. This is the so-called low-hanging fruit that can lead to quick results. Some possible actions include those listed. Students will think of additional possibilities. a. Reducing receivables through: 1. Better underwriting of credit quality 2. Better controls to identify delinquencies, automated over-due notices, and better collection procedures 3. Increased attention to accuracy in invoicing 4. Offering early payment incentives b. Reducing inventories and inventory costs through essentially eliminating nonproductive activities including inspection, moving activities, waiting setup time: 1. Use of less costly components (of equal quality) and production with lower wage rates 2. Elimination of product features not valued by customers 3. Outsourcing to reduce product cost 4. Just-in-time deliveries of raw materials 5. Elimination of manufacturing bottlenecks to reduce work-in-process inventories 6. Producing to order rather than to estimated demand to reduce finished goods inventories 7. Eliminating defects c. Reducing PPE assets is much more difficult. The benefits, however, can be substantial. Some suggestions are the following: 1. Sale of unused and unnecessary assets 2. Acquisition of production and administrative assets in partnership with other companies for greater throughput 3. Acquisition of finished or semi-finished goods (sub-components) from suppliers to reduce manufacturing assets d. Reducing unnecessary intangible assets that are reported on the balance sheet is the most difficult. 1. Sale of assets no longer relevant to company plans 2. License intangibles to other companies


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C8-42. (30 minutes) a. Take-Two (TTWO) spent $159,859 in 2011 and in 2012 $196,683 on software development. TTWO‟s amortization and write-downs were $143,811 in 2011 and $150,700 in 2012. Using EA‟s method, the money spent on additions would be expensed, and the amortization and write-downs would disappear. The result is that if TTWO‟s used EA‟s approach, 2011 expenses would increase by $16,048 ($159,859 – 143,811). Net income would decrease by $10,431 [$16,048 X (1-0.35)] in 2011. In 2012, TTWO‟s expenses would increase by $45,983 ($196,683 $150,700) if TTWO used the same method as EA. Net income would decrease by $29,889 [$45,983 X (1-0.35)]. b. A variety of answers are possible here. Amortization (including write- downs) as a percentage of “amortizable cost” (average of beginning and ending balances) declined from 55% in 2011 to 51% in 2012. The decrease indicates a possible decrease in the rate of amortization. However, because write- downs are included in the denominator, the increase could be partly due to higher write-downs in 2011.



Fa4e Sm Ch08

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