Solution manual intermediate accounting 9e by nicolai ch09

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER PROPERTY, PLANT, AND EQUIPMENT: ACQUISITION AND DISPOSAL CONTENT ANALYSIS OF EXERCISES AND PROBLEMS Number Content Time Range (minutes) E9-1 Determination of Cost Analysis of numerous items to determine whether or not to include in property, plant, and equipment 5-10 E9-2 Property, Plant, and Equipment Analysis of various items for potential balance sheet inclusion 5-10 E9-3 Acquisition Costs Compute total acquisition costs of machine and prepare journal entry to record 5-10 E9-4 Acquisition Cost Journal entry to record acquisition Analysis of entry if price not available 5-15 E9-5 (AICPA adapted) Acquisition Cost Determination of cost and journal entry to record acquisition 5-15 E9-6 (AICPA adapted) Acquisition of Land and Building Computation of land and new building cost 10-15 E9-7 Lump Sum Purchase Cost assigned to land, buildings, and equipment 10-15 E9-8 Exchange of Assets No boot, similar productive assets Journal entries 10-15 E9-9 Exchange of Assets Boot, similar productive assets, loss Journal entries 10-15 E9-10 Exchange of Assets Boot, similar productive assets, gain Journal entries 10-15 E9-11 Exchange of Assets No boot, dissimilar productive assets Journal entries 10-15 E9-12 Exchange of Assets Boot, dissimilar productive assets Journal entries 10-15 E9-13 (AICPA adapted) Exchange of Assets No boot, similar productive assets Determination of amount to be shown in the accounting records 9-1 5-10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) E9-14 Self-Construction Determination of amount to be capitalized Evaluation under differing outside contractor's bids 10-15 E9-15 Donation Journal entry to record acquisition Financial statement disclosure Time differences for passage of title 10-20 E9-16 Interest During Construction Compilation of amount to be capitalized Financial statement disclosure 5-15 E9-17 Interest During Construction Compute amount of capitalized interest and interest revenue 5-15 E9-18 Expenditures Capital vs operating Classification of various items 5-10 E9-19 (Appendix) Oil and Gas Accounting Successful efforts, fullcost methods Determination of expense and balance sheet value 10-20 P9-1 Acquisition Costs Reclassification of erroneously recorded items Journal entries 20-30 P9-2 Costs Subsequent to Acquisition Adjusting entries to correct the books from improperly recorded costs Acquisition, legal fees, insurance, additions, repairs 45-60 P9-3 Cost Classification Journal entries to record various transactions Acquisition, parking lot, sale, lease, freight, installation, taxes 25-35 P9-4 (CMA adapted) Self-Construction Computation according to GAAP of amount to be capitalized Identification of any alternative procedures 30-45 P9-5 Acquisition Cost Acquisition, replacement, purchase Journal entries to record various transactions 20-30 P9-6 (AICPA adapted) Comprehensive: Analysis of Changes in Fixed Assets Preparation of schedules for changes in land, building, leasehold improvements, and machinery and equipment 25-35 P9-7 Assets Acquired by Exchange Various situations dealing with similar or dissimilar productive assets and boot Journal entries 40-60 P9-8 Assets Acquired by Exchange Various situations dealing with similar or dissimilar productive assets, boot, and changing fair value Journal entries 30-45 9-2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) P9-9 Interest During Construction Computation of amount to be capitalized and amount to be depreciated Straight-line Effects on financial statements 20-30 P9-10 Comprehensive: Interest Capitalization Computation of amounts of capitalized interest, interest expense, and interest revenue Journal entries to record construction costs, including interest 40-60 P9-11 Events Subsequent to Acquisition Replacement, repairs, demolition Journal entries to record various transactions 20-30 P9-12 (AICPA adapted) Comprehensive: Adjusting Entries Analysis of machinery and equipment account Schedules to show effect of additions and retirements on account balances Journal entries 40-60 P9-13 (AICPA adapted) Adjusting Entries Analysis of the building account Journal entries to adjust the account as necessary Supporting computations 40-60 P9-14 (Appendix) Oil and Gas Accounting Successful efforts, fullcost methods Financial statement disclosure 10-20 ANSWERS TO QUESTIONS Q9-1 For a company to include an asset in the category of property, plant, and equipment, the asset must: (1) be held for use in the normal course of business; (2) have an expected useful life of more than one year; and (3) be tangible property - that is, the asset must have physical substance Q9-2 Generally, a company capitalizes the expenditures that are necessary to obtain the benefits to be derived from the asset and includes them as a cost of property, plant, and equipment The expenditures include the costs incurred in the acquisition of an asset and in putting the asset into operating condition The company expenses the costs of maintaining the benefits at the levels originally expected Q9-3 A company classifies land held for investment on the balance sheet as an investment It does not include the land as property, plant, and equipment, since it is not being used in the normal course of business in a productive capacity Q9-4 The book value of an asset is the recorded acquisition cost less the accumulated depreciation recorded to date Q9-5 At the date of acquisition, the acquisition cost is equal to the market value At the end of the life of the asset, the book value should equal the residual value (a market value) During the life of the asset, there is no defined relationship between the book value and market value because depreciation is a process of cost allocation, not of market valuation 9-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q9-6 In a lump-sum purchase, the company allocates the total purchase price to the individual assets on the basis of their relative fair values This allocation is necessary because some of the assets may have different economic lives, may not be depreciable, or may be depreciated by different methods Q9-7 When a company exchanges securities for an asset, the acquisition cost of that asset is either the fair value of the securities given up or the fair value of the asset acquired The company makes the choice on the basis of the market that is more reliable If neither of these amounts is known, it may use an appraisal of the asset, or, as a final solution, the company's board of directors may place a value on the transaction Q9-8 The distinction between similar and dissimilar productive assets is that similar productive assets are of the same general type and perform the same basic function and are used in the same line of business This distinction is made because, in the exchange of similar productive assets, the earning process is not considered completed, and thus the accounting for the transaction is different than when dissimilar productive assets are exchanged Q9-9 When similar productive assets are exchanged, the company recognizes a gain to the extent that it receives "boot" along with the asset The company recognizes a loss in accordance with the conservatism principle of accounting When dissimilar productive assets are exchanged, the earning process is considered completed and the company recognizes both gains and losses Q9-10 The term "boot" refers to monetary consideration either paid or received For the special rules to apply, the boot must be less than 25% of the fair value of the transaction Q9-11 The general principle underlying accounting for dissimilar productive assets is that the earning process has been completed and thus gains or losses are recognized On the other hand, in accounting for similar productive assets the earning process has not been completed The company is in the same relative position, so gains on the exchange is deferred (except to the extent that boot is received) Losses are recognized in accordance with the conservatism principle Q9-12 According to the provisions of FASB Statement No 34, a company capitalizes interest on the acquisition of an asset if the asset requires a period of time to get it ready for its intended use - a criterion that is met for the self-construction of an asset Specifically, the company does not capitalize interest for the following types of assets: Inventories that are routinely manufactured or otherwise produced on a repetitive basis Assets that are in use or ready for their intended use Assets that are not being used in the earning activities of the company and are not undergoing the activities necessary to get them ready for use Since imputed interest is not capitalized, the company must have borrowed funds to finance the self-construction of the asset In contrast, interest on a note payable (that is not associated with the construction of an asset) is expensed as incurred 9-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q9-13 A company bases the amount of interest capitalized for a self-constructed asset on the actual amounts borrowed and the cost of those borrowings The amount is intended to be that portion of the interest cost incurred during the asset's construction period that theoretically could have been avoided The company determines the amount that it capitalizes by applying an interest rate to the average amount of the expenditures on the self-constructed asset during the capitalization period Q9-14 Since activities that are necessary to get the asset ready for its intended use are in progress, the asset qualifies for interest capitalization The company capitalizes interest to the building account unless it makes specific expenditures that are normally added to the land account, as discussed at the beginning of this chapter Q9-15 Three alternative treatments of fixed overhead costs are (1) to allocate a portion of the total fixed overhead to the cost of the asset being constructed, (2) to include only the incremental fixed overhead that is attributable to construction in the cost of the self-constructed asset, or (3) to include no fixed overhead in the cost of the selfconstructed asset Proponents of the allocation of total overhead argue that construction should be treated the same as any other production process that receives a portion of overhead costs This method is appropriate when the company is operating at full capacity and regular production is reduced by the selfconstruction Arguments in favor of including only the incremental increase are that normal production costs should include the same amount of overhead whether construction is going on or not, the normal overhead would be incurred anyway, and that the cost of an asset and the decision to construct it should be based on additional and incremental costs incurred This method is appropriate when the company is in an excess capacity situation The argument in favor of including no fixed overhead is that the fixed overhead does not change as a result of the construction Therefore, to include some overhead would result in less overhead being expensed in the current period, and an increase in income Q9-16 Under generally accepted accounting principles, a company may not recognize profit on the self-construction of an asset The revenue recognition principle allows recognition of profit on asset use and disposal, not on the acquisition or construction of an asset If construction costs are materially greater than the fair value of the asset, then the convention of conservatism requires the company to write-down the capitalized costs and recognize a loss Q9-17 The distinction between a capital expenditure and an operating expenditure is whether the costs have increased the future economic benefits of the asset above those that were originally expected The future economic benefits can be increased by extending the life of the asset, improving productivity, producing the same product at a lower cost, or increasing the quality of the product For example, if a machine receives a major overhaul that increases the benefits to be realized from the asset, the costs are capitalized Conversely, ordinary repairs are of a maintenance type that not increase the total benefits to be realized, and, therefore, are expensed As another example, the cost of adding a new wing to an existing hospital is capitalized since it increases the total benefits of the hospital, whereas repairing the elevators does not increase the economic benefit of the hospital and so is expensed 9-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q9-18 An addition is a new asset that is being "added" or utilized in conjunction with an old asset In contrast, an improvement/ replacement involves the substitution of a new part or asset for an old one In accounting for an addition, a company capitalizes the costs of the addition, and takes out of the old asset account any portion of the old asset that is demolished or removed A company capitalizes improvement and replacement costs using the substitution method when it knows the book value of the asset being replaced, by replacing the old book value with the cost of the new asset If it does not know the old book value, then it still capitalizes the cost of the new asset, but with either a debit to the Accumulated Depreciation account of the old asset or a debit to the old Asset account Q9-19 The costs of ordinary repairs and maintenance are expenses incurred routinely to keep the asset in operating condition Since these costs not increase the future benefits of the asset, a company expenses them as they are incurred For interim financial reporting, the use of an Allowance account is appropriate in order to even out the expenses However, this account is closed at the end of the year Extraordinary repairs are those that cannot be foreseen and not occur in the usual course of operations, such as emergency repairs to a machine that breaks down during production Usually, a company expenses these costs, but care should be taken to note whether these repairs increase the future benefits of the asset If they do, then the company capitalizes the costs Q9-20 Leasehold improvements are improvements made to leased property that, upon termination of the lease, will revert back to the lessor A company capitalizes the cost of these improvements and subsequently amortizes them over the economic life of the improvements or the lease term, whichever is shorter Q9-21 An Allowance for Repairs account appears only on balance sheets of interim financial statements if a company incurs repair costs unevenly At year-end, this account is closed; thus, it does not appear on a year-end balance sheet Q9-22 A company accounts for the disposal of an asset by removing both the asset and accumulated depreciation to date from the ledger, recording the receipt of cash, if any, and also recording any gain or loss It reports this gain or loss in ordinary income (in the category of Other Items) on the income statement unless it meets the criteria for an extraordinary item Q9-23 Under the successful-efforts method of accounting for oil and gas properties, a company capitalizes only those costs incurred in drilling for successful wells while it expenses the costs of unsuccessful wells In contrast, under the full-costing method a company capitalizes all costs of drilling wells, whether the drilling was successful or not 9-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C9-1 (AICPA adapted solution) The expenditures that are capitalized when equipment is acquired for cash include the invoice price of the equipment (net of discounts) plus all incidental outlays relating to its purchase or preparation for use, such as insurance during transit, freight, duties, ownership search, ownership registration, installation, and breaking-in costs Any available discounts, whether taken or not, should be deducted from the capitalizable cost of the equipment a When the market value of the equipment is not determinable by reference to a similar cash purchase, the capitalizable cost of equipment purchased with bonds having an established market price is the market value of the bonds b When the market value of the equipment is not determinable by reference to a similar cash purchase, and the common stock used in the exchange does not have an established market price, the capitalizable cost of equipment is the equipment's estimated fair value if that is more clearly evident that the fair value of the common stock Independent appraisals may be used to determine the fair values of the assets involved c When the market value of equipment acquired is not determinable by reference to a similar cash purchase, the capitalizable cost of equipment purchased by exchanging similar equipment having a determinable market value is the lower of the recorded amount of the equipment relinquished or the market value of the equipment exchanged The factors that determine whether expenditures relating to property, plant, and equipment already in use are capitalized are as follows: Expenditures are relatively large in amount They are nonrecurring in nature They extend the useful life of the property, plant, and equipment They increase the usefulness of the property, plant, and equipment The net book value at the date of the sale (cost of the property, plant, and equipment less the accumulated depreciation) is removed from the accounts The excess of cash from the sale over the net book value removed is accounted for as a gain on the sale, while the excess of net book value removed over cash from the sale is accounted for as a loss on the sale C9-2 (AICPA adapted solution) Expenditures are capitalized when they benefit future periods The cost to acquire the land is capitalized and classified as land, a nondepreciable asset Since tearing down the small factory is readying the land for its intended use, its cost is part of the cost of the land and is capitalized and classified as land As a result, this cost is not depreciated as it would be if it was classified with the capitalizable cost of the building 9-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C9-2 (continued) (continued) Since the rock blasting and removal is required for the specific purpose of erecting the building, its cost is part of the cost of the building and is capitalized and classified with the capitalizable cost of the building This cost is depreciated over the estimated useful life of the building The road is a land improvement, and its cost is capitalized and classified separately as a land improvement This cost is depreciated over its estimated useful life The added four stories is an addition, and its cost is capitalized and classified with the capitalizable cost of the building This cost is depreciated over the remaining life of the original office building because that life is shorter than the estimated useful life of the addition The gain is recognized on the sale of the land and building because income is realized whenever the earning process is complete and the sale takes place The book value at the date of the sale is composed of the capitalized cost of the land, the land improvement, and the building, as determined above, less the accumulated depreciation on the land improvement and the building The excess of the proceeds received from the sale over the net book value at the date of sale is accounted for as part of income from continuing operations in the income statement C9-3 (AICPA adapted solution) The capitalizable cost includes all costs relating to purchase or preparation for use Such cost may include delivery and installation The capitalizable cost represents the cash equivalent price and accordingly would not include interest charges Normal maintenance performed on the new machine should not be capitalized as part of the machine's cost It should be expensed as incurred if the machine is not used in the manufacturing process or should be inventoried as part of factory overhead if the machine is used in the manufacturing process Normal maintenance does not enhance the service potential of the machine The wing added to the manufacturing building should be capitalized The addition should be depreciated over its estimated useful life or the remaining useful life of the building of which it is an integral part, whichever is shorter The addition should be included in the property, plant, and equipment section of the balance sheet The leasehold improvements made to the office space should be capitalized The leasehold improvements should be depreciated (amortized) over their estimated useful lives or the term of the lease, whichever is shorter The unamortized portion of the leasehold improvements could be included as a separate caption in the property, plant, and equipment section or the intangible assets section of the balance sheet The amortized portion of the leasehold improvements would be shown as an expense in the income statement 9-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C9-4 (AICPA adapted solution) The following costs, if applicable, should be capitalized as a cost of land: (a) Negotiated purchase price (b) Brokers' commission (c) Legal fees (d) Title fee (e) Recording fee (f) Escrow fees (g) Surveying fees (h) Existing unpaid taxes, interest, or liens assumed by the buyer (i) Clearing, grading, landscaping, and subdividing (j) Cost of removing old building (less salvage) (k) Special assessments such as lighting or sewers if they are permanent in nature A plant asset acquired on a deferred-payment plan should be recorded at an equivalent cash price excluding interest If interest is not stated in the sales contract, an imputed interest should be determined The asset should then be recorded at its present value, which is computed by discounting the payments at the stated or imputed interest rate The interest portion (stated or imputed) of the contract price should be charged to interest expense over the life of the contract In general, plant assets should be recorded at the fair value of the consideration given or the fair value of the asset received, whichever is more clearly evident This general theoretical preference is somewhat constrained by the requirements of APB Opinion No 29 Specifically when exchanging an old machine and paying cash for a new machine, the new machine should be recorded at the amount of monetary consideration (cash) paid plus the undepreciated cost of the nonmonetary asset (old machine) surrendered if there is no indicated loss An indicated loss should be recognized; this would reduce the recorded amount of the new machine No indicated gain, however, should be recognized by the party paying monetary consideration C9-5 (AICPA adapted solution) Capital expenditures benefit future periods Revenue (operating) expenditures benefit the current period only a The purchase price of the land should be capitalized The land should be shown as a noncurrent asset on the balance sheet at its original cost and it is not subject to depreciation 9-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C9-5 (continued) (continued) b The cost of constructing the factory should be capitalized and depreciated over the expected life of the factory The depreciation should be added to cost of inventory, via factory overhead, as goods are produced, and is expensed as cost of sales as goods are sold The factory expenditures, net of accumulated depreciation, should be shown as a noncurrent asset on the balance sheet Inventory should be reported as a current asset on the balance sheet, and cost of sales should be reported as an expense on the income statement c The cost of grading and paving the parking lot should be capitalized and depreciated over the expected life of either the factory or parking lot, whichever is shorter The depreciation should be added to cost of inventory, via factory overhead, as goods are produced, and is expensed as cost of sales as goods are sold The land improvement expenditures, net of accumulated depreciation, should be shown as a noncurrent asset on the balance sheet Inventory should be reported as a current asset on the balance sheet, and cost of sales should be reported as an expense on the income statement d The cost of maintaining the factory once production has begun is a "revenue type" expenditure However, since it is a factory cost, it should be added to cost of inventory, via factory overhead, as goods are produced, and is expensed as cost of sales as goods are sold Inventory should be reported as a current asset on the balance sheet, and cost of sales should be reported as an expense on the income statement a It is clear that considerable value attaches to the television rights A conservative approach to the valuation is to compute the present value of the cash flows expected under the currently existing television contract However, since it can be expected that a new television contract will be signed to replace the existing contract, probably at different rates, it could be argued that a longer time period should be considered Certainly a buyer would be including a longer time period in the estimation of the future cash flows expected if the franchise is purchased b The value assigned to the television rights is considered depreciable because the service provided by the franchise (that is, playing the games) is partially used up each season The depreciation is over the period used in determining the value of the television rights The argument against depreciating the value of the television rights would be that the televising of football games can be expected to continue indefinitely in the future, and, therefore, the value does not decline c The purchase price assignable to player contracts is the present value of the benefits generated by the player less the salaries payable under current contracts This is a subjective valuation that would be very difficult to determine in practice d The value assigned to the player contracts is depreciated over the estimated playing career or the contract period, whichever is shorter C9-6 9-10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-7 (continued) (continued) Other Company Cash Machine (new) Machine (old) aGain 5,000 15,000a 20,000 = (BV of asset surrendered = FV of asset surrendered) Cost = BV of asset surrendered + Gain - Boot received = $20,000 + - $5,000 Note: Bremer Company's journal entry is consistent with alternative in Exhibit 9-2 The Other Company's journal entry is consistent with alternative in Exhibit 9-2 Exchange of similar productive assets Bremer Company Equipment: Car (new) Accumulated Depreciation: Equipment Cash Equipment: Car (old) Gain aTotal Boot $800 ($1,800) $212 (FV BV ) Boot Fair value ($800 $6,000) (rounded) of asset received = BV of asset surrendered + Gain - Boot = $5,000 + $212 - $800 Other Company Equipment: Car (new) Cash Equipment: Car (old) aGain 7,000 212a gain = FV of asset surrendered - BV of asset surrendered = $6,800 - $5,000 = $1,800 Gain recognized bCost 4,412b 2,000 800 6,800a 800 6,000 = (BV of asset surrendered = FV of asset surrendered) Cost = BV of asset surrendered + Boot paid = $6,000 + $800 Note: Bremer Company's journal entry is consistent with alternative in Exhibit 9-2 The Other Company's journal entry is consistent with alternative in Exhibit 9-2 9-38 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-8 Exchange of similar productive assets Machine (new) Accumulated Depreciation: Machine Machine (old) Cash aGain 29,000a 15,000 40,000 4,000 is not recognized (since no boot is received) Cost = BV of asset surrendered + Boot paid = $25,000 + $4,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 Exchange of similar productive assets Machine (new) Accumulated Depreciation: Machine Loss Machine (old) Cash 34,000b 7,000 3,000a aLoss = FV of asset surrendered - BV of asset surrendered = $30,000 - $33,000 bCost = FV of asset surrendered + Boot paid = $30,000 + $4,000 40,000 4,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 Exchange of similar productive assets Machine (new) 16,875b Accumulated Depreciation: Machine 25,000 Cash 5,000 Machine (old) Gain aTotal gain = (FV of asset surrendered - BV of asset surrendered) = ($32,000 - $20,000) = $12,000 Gain recognized 45,000 1,875a Boot $5,000 (FV BV ) ($12,000) Boot Fair value $5,000 $27,000 of asset received = $1,875 bCost = BV of asset surrendered + Gain - Boot = $20,000 + $1,875 - $5,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 9-39 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-8 (continued) Exchange of similar productive assets Machine (new) Accumulated Depreciation: Machine Loss Cash Machine (old) 27,000b 9,000 4,000a 5,000 45,000 aLoss = FV of asset surrendered - BV of asset surrendered = $32,000 - $36,000 bCost = FV of asset surrendered - Boot received = $32,000 - $5,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 Exchange of similar productive assets Machine (new) Accumulated Depreciation: Machine Machine (old) aGain 80,000a 70,000 150,000 is not recognized (since no boot is received) Cost = BV of asset surrendered = $80,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 Exchange of similar productive assets Machine (new) Accumulated Depreciation: Machine Loss Machine (old) 90,000b 56,000 4,000a 150,000 aLoss = FV of asset surrendered - BV of asset surrendered = $90,000 - $94,000 bCost = FV of asset surrendered = $90,000 Note: This journal entry is consistent with alternative in Exhibit 9-2 Exchange of dissimilar productive assets: all gains or losses recognized Building Gain Land 200,000 70,000 130,000 9-40 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-8 (continued) Exchange of dissimilar productive assets: all gains or losses recognized Building Gain Cash Land 200,000 40,000 30,000 130,000 Exchange of dissimilar productive assets: all gains or losses recognized Building Cash Gain Land 200,000 20,000 90,000 130,000 P9-9 Average costs = [(Beginning cumulative costs + Ending cumulative costs) ¸ 2] Average costs, 2004 $1,000,000 [($0 + $2,000,000) ¸ 2] Average costs, 2005 $4,000,000 [($2,000,000 + $120,000) + ($2,120,000 + $3,760,000) ¸ 2] Average costs, 2006 $8,500,000 [($2,120,000 + $3,760,000 + $458,000) + ($6,338,000 + $4,324,000) ¸ 2] Capitalized interest, 2004 = $1,000,000 x 12% = $120,000 Capitalized interest, 2005 = ($3,000,000 x 12%) + ($1,000,000 x 9.8%a) = $360,000 + $98,000 = $458,000 Capitalized interest, 2006 = [($3,000,000x12%) + ($5,500,000x9.8%)] x 1/2b = ($360,000 + $539,000) x ½ = $449,500 a ( $ 6,000,000 $14,000,000 x 14%) ( x 8%) $20,000,000 $20,000,000 bSince the project is completed on June 30, 2006, interest for half a year is capitalized 9-41 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-9 (continued) Total costs = Expenditures + Capitalized interest = ($2,000,000 + $3,760,000 + $4,324,000) + ($120,000 + $458,000 + $449,500) = $11,111,500 Straight-line depreciation = Cost - Estimated residual value Estimated service life = $11,111,500 20 $0 = $555,575 in 2007 The interest capitalization has the following effects on the financial statements: Income Statement: 2004: Interest expense decreased by $120,000 Net income increased by $120,000 2005: Interest expense decreased by $458,000 Net income increased by $458,000 2006: Interest expense decreased by $449,500 Net income increased by $449,500 Balance Sheet: December 31, 2004: Asset (construction in process) increased by $120,000 Retained earnings increased by $120,000 December 31, 2005: Asset (construction in process) increased by $458,000 for a total of $578,000 Retained earnings increased by $458,000, for a total of $578,000 December 31, 2006: Asset (construction in process) increased by $449,500 for a total of $1,027,500 Retained earnings increased by $449,500, for a total of $1,027,500 9-42 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-9 (continued) Cash Flow Statement: If the company is producing the asset for its own use, the cash paid for the interest that is capitalized is included in cash outflows for investing activities instead of cash flows from operating activities There would be no affect if the company was producing the asset for sale to others P9-10 Supporting computations: Construction costs, (excluding capitalized interest) 2004: $ 6,000,000 2005: $11,460,000 2006: $ 1,800,000 Average costs = [(Beginning cumulative costs + Ending cumulative costs) ¸ 2] Average costs, 2004 = $ 3,000,000 [($0 + $6,000,000) ¸ 2] 2005 = $12,000,000 [($6,000,000 + $270,000) + ($6,270,000 + $11,460,000) ¸ 2] 2006 = $20,000,000 [($6,270,000,000 + $11,460,000 + $1,370,000) + ($19,100,000 + $1,800,000) ¸ 2] Capitalized interest, 2004 = $3,000,000 x 12% x 9/12a = $270,000 2005 = ($10,000,000 x 12%) + ($2,000,000 x 8.5%)b = $1,370,000 2006 = [($10,000,000x12%) + ($10,000,000x8.5%)] x 3/12c = $512,500 Interest revenue, 2004 = ($10,000,000 - $3,000,000) x 11% = $770,000 9-43 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-10 (continued) Interest expense, 2004 = ($20,000,000 x 10%) + ($60,000,000 x 8%) + ($10,000,000 x 12%) - $270,000 = $2,000,000 + $4,800,000 + $1,200,000 - $270,000 = $7,730,000 2005 = $2,000,000 + $4,800,000 + $1,200,000 - $1,370,000 = $6,630,000 2006 = $2,000,000 + $4,800,000 + $1,200,000 - $512,500 = $7,487,500 aSince activities were suspended for months, interest is only capitalized for months a $20,000,000 x 10% $80,000,000 $60,000,000 x 8% $80,000,000 cSince the project is completed on March 31, 2006, interest for three months is capitalized Journal entries, 2004: Construction in Progress Cash 6,000,000 6,000,000 Cash [($10M - $3M) x 0.11] Interest Revenue 770,000 770,000 Interest Expense Construction in Progress Cash [($10Mx0.12)+($20Mx0.10)+($60Mx0.08)] Journal entries, 2005: Construction in Progress Cash 7,730,000 270,000 8,000,000 11,460,000 11,460,000 Interest Expense Construction in Progress Cash 6,630,000 1,370,000 8,000,000 9-44 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-10 (continued) (continued) Journal entries, 2006: Construction in Progress Cash 1,800,000 1,800,000 Interest Expense Construction in Progress Cash 7,487,500 512,500 8,000,000 Power Plant Construction in Progress 21,412,500* 21,412,500 *$6,000,000 + $270,000 + $11,460,000 + $1,370,000 + $1,800,000 + $512,500 If the month suspension was due to an environmental dispute, activities would still be in progress according to FASB Statement No 34 Therefore interest for a full year would be capitalized in 2004 ($3,000,000 x 12% = $360,000) and therefore the journal entry to record the interest payment would be: Interest Expense Construction in Progress Cash 7,640,000 360,000 8,000,000 P9-11 2004 Jan 10 24 Feb Accumulated Depreciation: Machinery Cash (Accounts Payable, etc.) Replacement of motor 800 Cash Accumulated Depreciation: Machinery Loss on Sale of Machinery Machinery Sale of machine 600 9,000 400 Loss on Demolition of Building Materials Inventory Accumulated Depreciation: Building Building Cash (Accounts Payable, etc.) Demolition of old building 9-45 800 10,000 1,500 700 25,000 25,000 2,200 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-11 (continued) Feb 14 Mar 10 19 27 Repair Expense Cash (Accounts Payable, etc.) Repairs to machine 700 Repair Expense Cash (Accounts Payable, etc.) Repairs due to accident 2,000 Machinery Cash (Accounts Payable, etc.) Replacement of motor 900 Office Fixtures Office Expenses Cash (Accounts Payable, etc.) Office rearrangement 700 500 700 2,000 900 1,200 P9-12 (AICPA adapted solution) Adjusting journal entries, December 31, 2004 (1) Buildings Machinery and Equipment To correct the recording of the cost of constructing the small storage building (2) (3) Due from Officers Machinery and Equipment To correct the recording of the cost of the power lawnmower purchased for the personal use of the president Accumulated Depreciation: Machinery and Equipment Gain or Loss on Retirement of Machinery and Equipment Machinery and Equipment To record retirement of damaged fork lift truck battery; the asset has been depreciated for years at $60 per year 9-46 2,000 2,000 600 600 180 420 600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-12 (continued) (continued) (4) (5) (6) (7) (8) Prepaid Equipment Rental Expense Equipment Rental Expense Gain or Loss on Retirement of Machinery and Equipment Machinery and Equipment To remove equipment rental expense and prepayment from Machinery and Equipment account 180 180 Machinery and Equipment Accumulated Depreciation: Machinery and Equipment Gain or Loss on Retirement of Machinery and Equipment Machinery and Equipment To record retirement of Rockwood saw and gain on sale 150 40 320 1,500 150 1,500 Machinery and Equipment Held for Sale Accumulated Depreciation: Machinery and Equipment Gain or Loss on Retirement of Machinery and Equipment Machinery and Equipment To record retirement of casting machine and write-down to its market value 1,800 Machinery and Equipment Interest Expense Notes Payable To record full cost of baking oven purchased on installment payment plan and interest charges paid in December 6,964 36 Accumulated Depreciation: Machinery and Equipment Depreciation Expense: Machinery and Equipment To correct recording of depreciation: Recorded by company $2,800 Correct depreciation (2,560) (see schedule C) Correction $ 240 9-47 2,500 700 5,000 7,000 240 240 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-12 (continued) Schedules THE DEWOSKIN COMPANY Machinery and Equipment Acquisitions December 31, 2004 (Schedule A) Burnham grinder Air compressor Electric spot welder Baking oven Total $ 1,200 2,500 4,500 10,000 $18,200 Machinery and Equipment (Schedule B) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Balance 12/31/03 $ 5,900 400 – – 3,900 – 5,300 – 4,200 – 5,700 – $25,400 2004 Retirements $1,500 (5) – – – – – 5,000 (6) – 600 (3) – – – $7,100 2004 Additions – – – – – – – – – – – $18,200 $18,200 9-48 Balance 12/31/04 $ 4,400 400 – – 3,900 – 300 – 3,600 – 5,700 18,200 $36,500 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-12 (continued) (continued) Accumulated Depreciation (Schedule C) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Balance 12/31/03 $ 5,900 380 – – 2,535 – 2,385 – 1,050 – 285 – $12,535 2004 Retirements $1,500 (5) – – – – – 2,500 (6) – 180 (3) – – – $4,180 2004 Additions – $ 20 – – 390 – 280 – 390 – 570 910 $2,560 Balance 12/31/04 $ 4,400 400 – – 2,925 – 165 – 1,260 – 855 910 $10,915 P9-13 (AICPA adapted solution) Depreciation Expense: Building Accumulated Depreciation: Building To record one-half year's depreciation on old boiler ($10,000 x 4% x 1/2) 200.00 200.00 Building Gain or Loss on Disposition of Fixed Assets To correct the recording of insurance recovery 2,000.00 Purchase Discountd Fuel Expensea Fuel Inventorya Accumulated Depreciation: Buildingb Gain or Loss on Disposition of Fixed Assetsc Building To correct the recording of the purchase of the new boiler and the trade-in of the old 274.40 741.60 82.40 6,200.00 2,320.00 9-49 2,000.00 9,618.40 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-13 (continued) (continued) aComputation of fuel expense Fuel oil included in invoice price of new boiler (1,000 gallons at $0.80) Sales tax at 3% Fuel cost Less: Fuel inventory ($824 x $800.00 24.00 $824.00 100 ) 1000 Fuel expense bComputation (82.40) $741.60 of accumulated depreciation on building: $10,000 x 4% x 15½ years = $6,200.00 cComputation of gain or loss on disposition of fixed assets: Cost of old boiler Accumulated depreciation Book value at time of explosion Less trade-in allowance (fair market value) Tentative loss on disposition dComputation $10,000.00 (6,200.00) $ 3,800.00 (1,480.00) $ 2,320.00 of cash discount on purchase of boiler: Invoice price Less: Fuel oil included in invoice price Trade-in allowance $16,000.00 $ 800.00 1,480.00 Purchases discount at 2% (2,280.00) $13,720.00 $ 9-50 274.40 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-13 (continued) Building Repair Expense To correct the recording of the cost of installation of the boiler 1,000.00 1,000.00 Depreciation Expense: Buildinge Accumulated Depreciation: Building To correct recorded depreciation expense on the building and the new boiler eCost of building Less cost of old boiler (depreciation recorded in entry no 1) Cost subject to full year of depreciation Depreciation at 4% Cost of new boiler 22.19 22.19 $100,000.00 (10,000.00) $ 90,000.00 $ 3,600.00 $ 16,381.60 Depreciation on new boiler ($16,381.60 9ẵ x ẵ) (New boiler is depreciated over remaining life of the buildings) 862.19 Total adjusted depreciation Depreciation recorded Depreciation adjustment required $ 4,462.19 (4,440.00) $ 22.19 Cost of new boiler: Invoice price Less: Fuel oil Remainder $16,000.00 (800.00) $15,200.00 Add: Sales tax Installation Total Less: Cash discount Cost of new boiler $ 9-51 456.00 1,000.00 1,456.00 $16,656.00 (274.40) $16,381.60 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P9-14 a Successful-efforts method: The cost of dry wells (50% x $6 million) is expensed in 2004 The cost of successful wells (50% x $6 million) is capitalized in 2004 and expensed over the life of the wells On the income statement for 2005, cost depletion expense is reported at $300,000 (10% x $3 million) On the 2005 ending balance sheet, the asset is reported at a net value of $2,700,000 (the $3,000,000 cost less the $300,000 depletion) b Full-cost method: The total cost of $6 million is capitalized in 2004 On the income statement for 2005, cost depletion expense is reported at $600,000 (10% x $6 million) On the 2005 ending balance sheet, the asset is reported at a net value of $5,400,000 (the $6 million cost less the $600,000 depletion) Small oil companies generally prefer the full-cost method because it results in higher asset values on the balance sheet and delaying the recognition of expenses in the income statement 9-52 ... value, except by coincidence The issue of reducing income taxes is also not relevant to financial reporting C9-10 (AICPA adapted solution) The valuation of assets that are acquired by a corporation... principle underlying accounting for dissimilar productive assets is that the earning process has been completed and thus gains or losses are recognized On the other hand, in accounting for similar... successful or not 9-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C9-1 (AICPA adapted solution) The expenditures that are capitalized