Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CHAPTER REPORTING AND ANALYZING LONG-LIVED ASSETS LEARNING OBJECTIVES Determine the cost of property, plant, and equipment Explain and calculate depreciation Account for the derecognition of property, plant, and equipment Identify the basic accounting issues for intangible assets and goodwill Illustrate how long-lived assets are reported in the financial statements Describe the methods for evaluating the use of assets SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT Questions 1 C C 11 AP 16 C 21 C C K 12 C 17 C 22 AN C AP 13 2,4 C 18 C 23 AN AN C 14 C 19 C 24 AN C 10 C 15 C 20 C 1 AP AP AP 13 AP 17 AN AP AP 10 AP 14 K K AP 11 AP 15 AP AP AP 12 4,5 AP 16 AN 13 AN Brief Exercises Exercises 1 AP AP AN 10 4,5 AP 1,2 AP 2,3 AN 2,4 AP 11 AP AP 2,3 AN AP 12 AN Problems: Set A and B 1 AP AN 2,3 AN 10 4,5 AP 1,2 AP 2,3 AP 2,3,5 AP 11 4,6 AN 1,2 AN 2,3 AP C 12 AN 1,2,3 AP Accounting Cycle Review 1,2,3,4,5 AP Cases 2,4,5 AN 1,2,4,6 E 2,6 S 2,6 AN 2,6 E AN Solutions Manual 9-1 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legend: The following abbreviations will appear throughout the solutions manual file LO Learning objective BT Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Difficulty: Time: AACSB CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006 Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech Diversity Diversity Reflective Thinking Reflec Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation Solutions Manual 9-2 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ANSWERS TO QUESTIONS (a) Accounting standards require property, plant, and equipment to be recorded initially at cost, which consists of the purchase price, less any discounts or rebates and any other expenditures necessary to acquire the asset and make it ready for its intended use at its intended location of use (b) Operating expenditures are expensed in the period they are incurred They help maintain an asset but not add additional value, useful life, or economic benefits Capital expenditures are included as part of the cost of the new equipment They are incurred to make an asset ready for use or to enhance its productivity or extend its life (c) An asset retirement cost is an estimate of the cost of an obligation to dismantle, remove, or restore a long-lived asset when it is retired These costs are included in the cost of property, plant, and equipment and depreciated over the life of the asset LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Land improvements are structural additions made to the land such as parking lots and fences as they are depreciable assets Clearing and grading the land are not land improvements but are part of the land cost as they are required to get the land ready for its intended use They would therefore be capitalized (recorded) in the Land account LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting An operating lease allows the lessee to account for the leasing transaction as a rental and so the lease payments are recorded to Rent Expense, an income statement account As a result, neither the asset nor the liability related to the asset is recorded on the company’s books For a finance lease, both the asset and the liability related to the leased asset are recorded on the company’s books even though the asset is not legally owned by the party leasing the asset Solutions Manual 9-3 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Q (continued) The asset account involved would be Equipment under Finance Leases, for example, and the related liability account would be Finance Lease Liability LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting (1) Depreciation Expense (2) Net Income (3) Accumulated Depreciation (4) Carrying Amount (a) Early years Straight-line Same each year Constant charge (depreciation expense) to income Increases at a constant amount each year Declines at a constant amount each year Units-ofproduction Varies with number of units produced Impact on income will vary with the number of units produced Increases at a Declines at a variable amount variable amount based on number of units produced Diminishingbalance Decreases each year Increasing income each year because depreciation expense is lower each year Increases at a diminishing amount each year Declines at a higher amount in the early years All three result in the same total depreciation expense All three result in the same total impact on net income All three result in the same total accumulated depreciation All three result in the same ending carrying amount (b) Total life Straight-line, units-ofproduction, diminishingbalance LO BT: AN Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 9-4 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition If the residual value was deducted for the diminishing balance method, the carrying value would never reach the residual value Applying a fixed percentage rate to a diminishing balance will always result in an undepreciated balance because a portion of the depreciable amount will always remain at the end of the period Residual value is considered in the diminishing-balance method by ensuring that the asset is never depreciated below its residual value In this way, we always make sure that the undepreciated balance (carrying amount) is adjusted to equal residual value at the end of the asset’s useful life Residual value is subtracted from the cost when using the other methods because the resulting depreciable cost is needed to determine the annual depreciation expense LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting The straight-line and diminishing-balance methods use annual depreciation rates in their depreciation calculations Therefore, the result must be adjusted for any period less than one year The units-of-production method does not need to be adjusted for partial periods as this method multiplies the depreciable amount per unit by the actual units produced in the period This reflects how much the asset was used during the period For example, if an asset was purchased July and produced 10,000 units for the period July through December, it can only produce units for that sixmonth period (the company could not have produced units before it purchased the asset) and therefore no adjustment for the half-year ownership period is needed LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting (a) A company should choose the depreciation method it believes will best reflect the pattern over which the asset’s future economic benefits are expected to be consumed The depreciation method must be revised if the expected pattern of consumption of the future economic benefits has changed Solutions Manual 9-5 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Q7 (continued) (b) Private companies using ASPE would not be allowed to use the revaluation model and therefore must use the cost model Publicly traded companies, which must follow IFRS, can choose to use the cost model or the revaluation model Factors to consider when choosing the revaluation model over the cost model are whether fair values are more relevant than cost (such as in the real estate industry), whether reliable measures of fair value can be obtained, and whether the benefits from the revaluation model exceed the additional costs involved in determining the value of the assets each year LO BT: K Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting (a) Companies need to calculate an impairment loss when an asset becomes obsolete or when a competitive market causes a decline in sales of products produced by that asset The impairment loss is the amount by which the carrying amount of the asset exceeds its recoverable amount The loss is recorded with a debit to Impairment Loss and a credit to the Accumulated Depreciation account of the asset or the asset itself if a contra account is not used (b) Some companies attempt to record asset impairments in fiscal years where the company is experiencing poor results and the additional charge for the impairment will not be noticed or will be received in a better light by the financial statement users Once the carrying amounts of the assets are reduced from the recording of the impairment loss, subsequent depreciation is correspondingly reduced Since management’s judgement is involved in arriving at the amount of impairment loss, the timing of the recording of the loss may be the result of management’s objective to manipulate current and future years’ financial results This approach becomes problematic to the financial statement users who are looking to compare results over several fiscal years to properly identify and assess financial trends LO BT: AP Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 9-6 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition When recording depreciation every year, cash is not involved in the transaction The purpose of recording depreciation is to allocate the cost of the long-lived asset over the accounting periods the asset is used to assist in producing revenue and earning income Although cash is paid when the asset is purchased, when recording depreciation, no cash is set aside for the purpose of replacing the asset at the end of the useful life That is why the financial statements must disclose the cost and the accumulated depreciation of the long-lived assets in order for the reader to predict the future cash flows that will be involved when a retirement and replacement of the asset takes place LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 10 Depreciation must be updated for the period that has elapsed since depreciation was last recorded to the date of the sale because the depreciation expense must properly reflect the total period over which the asset’s economic benefits are used Updating depreciation also aids in determining the correct amount of the gain or loss on disposition LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 11 In a disposal of property, plant, and equipment, the carrying amount of the asset is compared to the proceeds received from the disposal If the proceeds of the disposal exceed the carrying amount of the asset, a gain on disposal occurs If the proceeds of the sale are less than the carrying amount of the asset sold, a loss on disposal occurs The calculation is the same for an asset that is retired if proceeds, such as a residual value, are received Often there are no proceeds received when an asset is retired If no proceeds are received, a gain will never occur LO BT: AP Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 9-7 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 12 Financial Accounting, Seventh Canadian Edition The machine and related accumulated depreciation should continue to be reported on the statement of financial position without further depreciation or adjustment until the asset is retired Reporting the asset and related accumulated depreciation on the statement of financial position informs the reader of the financial statements that the company is still using the asset Once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset In no situation can the accumulated depreciation on the asset exceed the cost of the asset LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 13 Tangible and intangible assets have similar characteristics, in that they are purchased for use in the operations and not for resale, have usefulness beyond one fiscal year, and are depreciated or amortized, with the exception of land and indefinite life intangible assets Tangible and intangible assets are also similar in that their cost includes all of the necessary outlays that are made to get the asset ready for its intended use They differ in their physical substance in that intangible assets have no physical substance LO 2,4 BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 14 Since finite intangible assets have limited usefulness to the business, each period of benefit should be charged with the allocation of the amortizable cost of the intangible asset used to generate revenue Indefinite life intangible assets cannot have a systematic allocation of their amortizable cost allocated against revenues as the period of benefit is indeterminable Rather, these assets are tested for impairment more frequently to ensure that their recoverable amount continues to exceed their carrying amount LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 9-8 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 15 Financial Accounting, Seventh Canadian Edition (a) The accountant’s argument is not valid The cost of intangible assets with finite lives should be amortized over the shorter of that asset's useful life (the period of time when operations are benefited by use of the asset) or its legal life In many instances, reasonable estimates must be arrived at in order to record the necessary transactions and adjusting entries at the end of an accounting period Having an alternative to the estimate that is more certain does not make the information more relevant (b) If useful life is shorter than legal life, amortizing the asset over its legal life would be inappropriate because the amortization each year would be too low and the asset would have a carrying amount shown on the statement of financial position after its useful life had passed LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 16 Goodwill and intangible assets have similar characteristics, in that they are recorded at cost, purchased for use in the operations of the business and not for resale, have usefulness beyond one fiscal year, and have no physical substance They differ in that goodwill does not exist on its own, is unidentifiable and cannot be separated from a business entity and so it cannot be sold; nor is it based on contractual or legal rights Goodwill is not amortized as it has an indefinite life and is only derecognized if the business as a whole is resold Goodwill can also be reduced from impairment LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 17 The legal fees should be added to the cost of the patent and amortized over the patent’s remaining useful life as they prove the patent’s validity and add to, or ensure the continuation of, the future economic benefits to be generated by the patent LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 9-9 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 18 Financial Accounting, Seventh Canadian Edition Goodwill is the value of many favourable attributes that are intertwined in the business enterprise Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately Goodwill can only be sold if the entire business is sold LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 19 (a) Long-lived assets are normally reported on the statement of financial position under the headings “property, plant, and equipment”, “intangible assets”, and “goodwill.” The balances of the major classes of assets should be disclosed, as well as the accumulated depreciation and accumulated amortization, either on the statement of financial position or in the notes to the financial statements (b) The income statement reports, in the operating expenses section, depreciation expense, amortization expense, any gain or loss on disposal of property, plant, and equipment, and any impairment losses (c) The statement of cash flows reports, in the investing activities section, any cash paid to purchase long-lived assets and any cash received on their disposal LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 20 The notes to the financial statements should disclose the balance of the major classes of assets as well as the accumulated depreciation and amortization for depreciable and amortizable assets if this information has not been reported directly in the financial statements The depreciation and amortization method(s) used and the useful lives or rates should also be described Under IFRS, companies must disclose if they are using the cost or revaluation model for each class of long-lived assets and include a reconciliation of the carrying amount at the beginning and end of period for each class of long-lived assets If the revaluation model is used, disclosure of any increases and decreases from revaluation, as well as other information, is required Information relating to any impairment recorded must also be disclosed Solutions Manual 9-10 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR9-1 (CONTINUED) (d) (2) CLEAR IMAGES LTD Statement of Changes in Equity Month Ended August 31, 2018 Balance, August Net income Balance, August 31 Common Shares $300,000 0000 000 $300,000 Retained Earnings $1,531,331 32,959 $1,564,290 Total Equity $1,831,331 32,959 $1,864,290 Solutions Manual 9-101 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR9-1 (CONTINUED) (d) (3) CLEAR IMAGES LTD Statement of Financial Position August 31, 2018 Assets Current assets Cash Accounts receivable Less: Allowance for doubtful accounts Interest receivable Notes receivable Inventory Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Intangible assets Patents Less: Accumulated amortization Total assets $ 390,770 $2,723,878 320,000 150,000 40,625 24,000 400 2,403,878 667 100,000 195,000 3,090,315 109,375 23,600 $3,223,290 Liabilities and Shareholders’ Equity Liabilities Accounts payable Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity $1,009,000 350,000 $1,359,000 300,000 1,564,290 1,864,290 $3,223,290 LO 1,2,3,4,5 BT: AP Difficulty: M Time: 90 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 9-102 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-1 (a) (b) Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE The North West Company Inc uses a straight-line method of depreciating its property and equipment Instead of using the term depreciation, North West uses the term amortization ($ in thousands) (1) Cost January 31, 2016 Land Buildings Leasehold improvements Fixtures and equipment Computer equipment January 31, 2015 Land Buildings Leasehold improvements Fixtures and equipment Computer equipment $ 16,935 417,182 64,055 294,922 77,142 $870,236 $ 16,041 377,061 51,845 265,706 73,151 $783,804 (2) Accumulated Depreciation (3) Impairment Losses (4) Carrying Amount $232,202 34,811 207,004 67,413 $541,430 $ 16,935 184,980 29,244 87,918 9,729 $328,806 $209,584 30,296 186,617 62,074 $488,571 $ 16,041 167,477 21,549 79,089 11,077 $295,233 (c) Net change in accumulated amortization Amortization recorded in 2016 Difference from disposals and effect of movements in foreign exchange (d) North West has a balance of Goodwill at January 31, 2016 of $37,260,000 (e) At January 31, 2016, North West report intangibles including: Software, Cost-U-Less banner, and Other for a total carrying amount of $32,610,000 There were no impairment losses recorded for intangibles for the year ended January 31, 2016, nor were any fully depreciated intangibles written off during the year $52,859 40,216 $12,643 LO 2,4,5 BT: AN Difficulty: M Time: 15 AACSB: Analytic and Communication CPA: cpa-t001 CM: Reporting Solutions Manual 9-103 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-2 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE Rosewood follows IFRS, which allows companies to reverse impairment losses This means it would record the following entry and adjust the carrying amount of the buildings from $5,000,000 to $5,800,000: Resort Property Impairment Loss 800,000 800,000 (b) Blaze Mountain Resort follows ASPE, which does not allow companies to reverse impairment losses Therefore, no adjustment is required for Blaze Mountain (c) Before considering any adjustments for impairment loss reversals, a preliminary calculation of profit margin and return on assets is as follows: Profit Margin Asset Turnover Return on Assets Rosewood (without impairment reversal) $180,000 ÷ $2,250,000 = 8.0% $2,250,000 ÷ $9,000,000 = 0.3 times $180,000 ÷ $9,000,000 = 2.0% Blaze Mountain (without impairment reversal) $200,000 ÷ $2,500,000 = 8.0% $2,500,000 ÷ $10,000,000 = 0.3 times $200,000 ÷ $10,000,000 = 2.0% Solutions Manual 9-104 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT9-2 (CONTINUED) (c) (continued) If we take into consideration the adjustment Rosewood made above to reverse the impairment loss, income would now increase by $800,000 to $980,000 while average assets would increase by $400,000 ($800,000 ÷ 2) We are dividing this last term by two because the denominator pertains to average assets, not assets at the end of the year The adjusted ratios for Rosewood are as follows: Rosewood (with impairment reversal) Profit Margin Asset Turnover Return on Assets (d) $980,000 ÷ $2,250,000 = 43.6% $2,250,000 ÷ $9,400,000 = 0.2 times $980,000 ÷ $9,400,000 = 10.4% Blaze Mountain (without impairment reversal) $200,000 ÷ $2,500,000 = 8.0% $2,500,000 ÷ $10,000,000 = 0.3 times $200,000 ÷ $10,000,000 = 2.0% When looking at the profit margin and return on assets, it appears that Rosewood is performing better However, that preliminary analysis does not account for the fact that the companies are using different accounting standards One needs to be cautious when comparing companies that follow different standards Different accounting policies can make direct comparability difficult Generally, if you are comparing financial statements of companies that not follow the same standards, you would make adjustments so that the financial statements are comparable Solutions Manual 9-105 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT9-2 (CONTINUED) (e) Examples of additional information that would help assess the nature and performance of long-lived assets would include: • Specific ratios adjusted to remove accounting standard differences • The hotel star rating of the resorts to help assess the quality and popularity of the resorts (this will help you assess future cash flows and potential impairment) • Budgets and forecasts along with details on room occupancy rates would also help assess future cash flows • The condition and age of the buildings • Whether significant renovations or other large expenses are expected in the near future LO 2,6 BT: AN Difficulty: C Time: 40 AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 9-106 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-3 Financial Accounting, Seventh Canadian Edition PROFESSIONAL JUDGEMENT CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) Land – no depreciation is recorded on this asset because its useful life is infinite and the cost cannot be allocated over the useful life Buildings – as usage of buildings is uniform over their useful life, the straight-line method would be appropriate in this case Drilling rigs – since the use of these rigs is seasonal in nature, it would make sense to use the units-of-production method for these assets so that depreciation would be higher during periods when the rigs are being used the most and lower in periods when the rigs are not used as much Furniture – as usage of these assets is uniform over their useful life, the straight-line method would be the most appropriate method (b) Intangible assets with definite lives should be amortized Amortization is typically recorded using the straight-line method and is recorded over the lesser of the intangible’s legal life and useful life In this case, a patent has a 20-year legal life but the useful life of the patent is likely to be five years given the length of the royalty contract with the drill bit manufacturer (c) Since the company is planning to have its shares trade on a public stock exchange sometime over the next years, it may be better to prepare its financial statements under IFRS now rather than converting from ASPE to IFRS when the company goes public (d) When a bank lends money to a company, the bank wants security or collateral for its loan The best collateral includes assets that can retain their value over time and are not easily moved If the company defaulted on its loan payments, the bank could seize these assets Therefore, the bank would want to use land and buildings for collateral The bank would be least likely to use an intangible asset because it is difficult to determine its value and this value could fall rapidly over time Furniture is unlikely to serve as collateral because it can be moved and would be hard for the bank to seize such an asset In addition, furniture has little resale value Solutions Manual 9-107 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT9-3 (CONTINUED) (e) The asset turnover ratio is calculated by dividing sales revenue by average total assets Next year, the numerator is not expected to change If the company is not planning to purchase any new rigs or other assets, because these assets are depreciated each year, their carrying amounts will fall and consequently, the denominator of this ratio will decline Therefore, the asset turnover ratio will rise Normally an increase in this ratio would lead one to conclude that the company is generating more revenues with its assets, but in this case the increase simply means that the company has decided not to replace some of its aging assets LO 1,2,4,6 BT: E Difficulty: C Time: 20 AACSB: Analytic and Communication CPA: cpa-t001, cpa-e003 CM: Reporting and Comm Solutions Manual 9-108 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-4 Financial Accounting, Seventh Canadian Edition ETHICS CASE (a) The stakeholders in this situation are: Benny Benson, president of Imporia Container Ltd Yeoh Siew Hoon, controller The shareholders and creditors of Imporia Container Ltd Potential investors and creditors in Imporia Container Ltd (b) Income before income tax in 2018 (the year of change) will increase by implementing the president’s proposed changes because increasing the useful life and residual value will decrease the depreciation expense The change will not affect net income for 2017 (c) The proposed changes in useful life and residual value will increase the profit margin because the depreciation expense has been reduced, causing the increased profit The proposed change will also cause an increase in the average assets without changing net sales An increase in average assets decreases the asset turnover (d) The intentional misstatement of the life and residual value of an asset is unethical and would represent an attempt at income manipulation There is nothing unethical about changing the estimate of either the life of an asset or its residual value if the change is an attempt to better reflect the pattern of consumption of economic benefits In this case, it is clear that the revisions in the life and residual value are intended only to improve income, which would be unethical LO 2,6 BT: E Difficulty: M Time: 15 AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics Solutions Manual 9-109 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-5 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE In order to solve, one must work backward to calculate income before interest, taxes, and depreciation (EBITDA) For Luxor: Net income Income taxes ($175,000 / 78 x 22) Income before income taxes ($175,000 / 78) Add: Interest expense ($2,800,000 x 4%) $112,000 Depreciation expense ($1,700,000 ÷ 20) 85,000 Income before interest, taxes, and depreciation For Cale: Income before interest, taxes, and depreciation Less: Interest expense ($350,000 x 4%) $14,000 Depreciation expense ($100,000 ÷ 5) 20,000 Rent expense ($17,000 x 12) 204,000 Income before income taxes Income tax expense ($183,359 x 22%) Net Income (b) Total assets Luxor Dec 31, 2018 Less: Land Buildings net of accumulated depreciation ($1,700,000 – $85,000) Remaining assets Dec 31, 2018: $175,000 49,359 224,359 197,000 $ 421,359 $421,359 238,000 183,359 40,339 $143,020 $3,025,000 $800,000 1,615,000 Assets for Cale Equal to remaining assets of Luxor Add: Leasehold improvements net of accumulated Depreciation ($100,000 - $ 20,000) Total assets Cale Dec 31, 2018: 2,415,000 $ 610,000 $610,000 80,000 $690,000 Solutions Manual 9-110 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT9-5 (CONTINUED) (c) Asset turnover Luxor $3,000,000 = 1.0 times $3,025,000 Cale $3,000,000 = 4.3 times $690,000 Despite the fact that the assets used by these two businesses are essentially the same, the turnover ratio is dramatically different because the land and building is owned by Luxor and leased by Cale This example demonstrates how financial information may be misinterpreted by financial statement users This example also demonstrates the need for change in the accounting standards, to those proposed for implementation in 2019, for public companies (d) Profit margin Luxor $175,000 = 5.8% $3,000,000 Cale $143,020 = 4.8% $3,000,000 Luxor manages to outpace Cale by a full percentage point on profit margin because, although it incurred additional interest expense, its depreciation expense was far lower than Cale’s combined interest and rent expense (e) Return on assets Luxor $175,000 = 5.8% $3,025,000 Cale $143,020 = 20.7% $690,000 Because the lease of the premises by Cale is treated as an operating lease, large amounts for land and building are not included on the statement of financial position as assets Consequently, Cale has a much better return on asset ratio than Luxor Solutions Manual 9-111 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT9-5 (CONTINUED) (f) Because the lease of the premises by Cale is treated as an operating lease, large amounts for land and building are not included on the statement of financial position as assets In addition, although there is a commitment to pay $17,000 per month for the next years, no liability appears on the statement of financial position Therefore, it is more difficult for readers of the financial statements to assess Cale’s financial position and profitability (g) The revaluation method under IFRS affects the amount reported for property, plant, and equipment on the statement of financial position Cale has treated the lease as an operating lease and so the assets are not capitalized and therefore not available for revaluation Cale’s ratios would not change In the case of Luxor, the revaluation model could affect the ratios For example, if land is revalued at a higher amount, the return on assets and asset turnover ratios would reduce and become worse, but the profit margin would remain unchanged as gains on revalued assets are recorded in other comprehensive income, not net income (h) Because the accounting recommendations concerning leases has been adopted effective 2019, Cale would need to capitalize the building on its statement of financial position This would increase total assets and cause the asset turnover ratio to reduce and therefore become worse LO 2,6 BT: S Difficulty: C Time: 45 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 9-112 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-6 Financial Accounting, Seventh Canadian Edition STUDENT VIEW CASE (a) Option 1: $760.54 × 36 months = $27,379.44 total costs incurred $27,379.44 – $25,000 = $2,379.44 costs of financing (b) Option (lease): $608.43 × 36 months = $21,903.48 total costs incurred (c) Option (purchase): $21,903.48 (from (b) above) + $7,500 = $29,403.48 total costs incurred You would own the three-year old truck after having purchased it for $7,500 (d) Option of leasing the truck with no purchase at the end of its useful life appears, at least initially, to be the least expensive alternative However, at the end of three years, you not own a truck Option 1, purchasing the truck rather than leasing it, would appear to be a reasonable choice as you own the truck that you can continue to use for a number of years without making any additional loan payments beyond the three-year loan period LO BT: AN Difficulty: M Time: 15 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 9-113 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT9-7 (a) Financial Accounting, Seventh Canadian Edition SERIAL CASE The following costs should be capitalized: Purchase new server Purchase equipment Furniture Shipping (furniture) Total costs to be capitalized $25,000 4,500 2,500 500 $32,500 The additional yearly software usage license for the new employees, the additional insurance, and painting the office should be expensed (b) Jan 2 Depreciation Expense Accumulated Depreciation—Equipment ($15,000 ÷ × 6/12 = $1,500) 1,500 Accumulated Depreciation—Equipment Loss on Disposal Equipment 12,000 3,000 1,500 15,000 Accumulated depreciation—equipment: [($15,000 ÷ 5) × 3.5] + $1,500 = $12,000 The equipment has been in use for four years so on the date of disposal its accumulated depreciation is $12,000 (4 years at $3,000 per year) (c) Jan Equipment Furniture Office Expense Prepaid Insurance Repair and Maintenance Expense Cash 29,500 3,000 2,000 1,000 2,850 38,350 LO 1,2,3 BT: AP Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 9-114 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legal Notice Copyright © 2017 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXVII VI F2) Solutions Manual 9-115 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... and Decision- Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting. .. 18 Financial Accounting, Seventh Canadian Edition Goodwill is the value of many favourable attributes that are intertwined in the business enterprise Goodwill can be identified only with the business. .. from revaluation, as well as other information, is required Information relating to any impairment recorded must also be disclosed Solutions Manual 9-10 Chapter Copyright © 2017 John Wiley &