Solution manual intermediate accounting 7th by nelson spiceland ch11

Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 11 Operational Assets: Utilization and Impairment QUESTIONS FOR REVIEW OF KEY TOPICS Question 11-1 The terms depreciation, depletion, and amortization all refer to the process of allocating the cost of an operational asset to periods of use The only difference between the terms is that they refer to different types of operational assets; depreciation for plant and equipment, depletion for natural resources, and amortization for intangibles Question 11-2 The term depreciation often is confused with a decline in value or worth of an asset Depreciation is not measured as decline in value from one period to the next Instead, it involves the distribution of the cost of an asset, less any anticipated residual value, over the asset's estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset Question 11-3 The process of cost allocation for operational assets requires that three factors be established at the time the asset is put into use These factors are: Service (useful) life — The estimated use that the company expects to receive from the asset Allocation base — The value of the usefulness that is expected to be consumed Allocation method — The pattern in which the usefulness is expected to be consumed Question 11-4 Physical life provides the upper bound for service life Physical life will vary according to the purpose for which the asset is acquired and the environment in which it is operated Service life may be less than physical life for several reasons For example, the expected rate of technological changes may shorten service life Management intent also may shorten the period of an asset’s usefulness below its physical life For instance, a company may have a policy of using its delivery trucks for a three-year period before trading the trucks for new models Question 11-5 The total amount of depreciation to be recorded during an asset’s service life is called its depreciable base This amount is the difference between the initial value of the asset at its acquisition (its cost) and its residual value Residual or salvage value is the amount the company expects to receive for the asset at the end of its service life less any anticipated disposal costs Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 11-6 Activity-based allocation methods estimate service life in terms of some measure of productivity Periodic depreciation or depletion is then determined based on the actual productivity generated by the asset during the period Time-based allocation methods estimate service life in years Periodic depreciation or amortization is then determined based on the passage of time Question 11-7 The straight-line depreciation method allocates an equal amount of depreciable base to each year of an asset’s service life Accelerated depreciation methods allocate higher portions of depreciable base to the early years of the asset’s life and lower amounts of depreciable base to later years Total depreciation is the same by either approach Question 11-8 Theoretically, the use of activity-based depreciation methods would provide a better matching of revenues and expenses Clearly, the productivity of a plant asset is more closely associated with the benefits provided by that asset than the mere passage of time However, activity-based methods quite often are either infeasible or too costly to use For example, buildings not have an identifiable measure of productivity For assets such as machinery, there may be an identifiable measure of productivity, such as machine hours or units produced, but it is more costly to determine the amount each period than it is to simply measure the passage of time For these reasons, most companies use time-based depreciation methods Question 11-9 Companies might use the straight-line method because they consider that the benefits derived from the majority of plant assets are realized approximately evenly over these assets’ useful lives It also is the easiest method to understand and apply The effect on net income also could explain why so many companies prefer the straight-line method to the accelerated methods Straight line produces a higher net income in the early years of an asset’s life Net income can affect bonuses paid to management, or debt agreements with lenders Income taxes are not a factor in determining the depreciation method because a company is not required to use the same depreciation method for both financial reporting and income tax purposes Question 11-10 The group approach to aggregation is applied to a collection of depreciable assets that share similar service lives and other attributes For example, group depreciation could be used for fleets of vehicles or collections of machinery The composite approach to aggregation is applied to dissimilar operating assets, such as all of the depreciable assets in one manufacturing plant Individual assets in the composite may have diverse service lives Both approaches are similar in that they involve applying a single straight-line rate based on the average service lives of the assets in the group or composite © The McGraw-Hill Companies, Inc., 2007 11-2 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 11-11 The allocation of the cost of a natural resource to periods of use is called depletion The process otherwise is identical to depreciation The activity-based units-of-production method is the predominant method used to calculate depletion, not the time-based straight-line method Question 11-12 The amortization of intangible assets is based on the same concepts as depreciation and depletion The capitalized cost of an intangible asset that has a finite useful life must be allocated to the periods the company expects the asset to contribute to its revenue generating activities Intangibles, though, generally have no residual values, so the amortizable base is simply cost Also, intangibles possess no physical life to provide an upper bound to service life However, most intangibles have a legal or contractual life that limits useful life Intangible assets that have indefinite useful lives, including goodwill, are not amortized Question 11-13 A company can calculate depreciation based on the actual number of days or months the asset was used during the year A common simplifying convention is to record one-half of a full year’s expense in the years of acquisition and disposal This is known as the half-year convention The modified half-year convention records a full year’s expense when the asset is acquired in the first half of the year or sold in the second half No expense is recorded when the asset is acquired in the second half of the year or sold in the first half Question 11-14 A change in the service life of an operational asset is accounted for as a change in an estimate The change is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life Question 11-15 A change in depreciation method is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life using the new depreciation method, exactly as we would account for a change in estimate One difference is that most changes in estimate not require a company to justify the change However, this change in estimate is a result of changing an accounting principle and therefore requires a clear justification as to why the new method is preferable A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (concluded) Question 11-16 If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years’ financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction Any account balances that are incorrect as a result of the error are corrected by journal entry If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary item, and earnings per share Question 11-17 An impairment in the value of an operational asset results when there has been a significant decline in value below carrying value (book value) For tangible operational assets and intangibles with finite useful lives, GAAP require an entity to recognize an impairment loss only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value The loss recognized is the amount by which the book value exceeds the fair value of the asset or group of assets when the fair value is readily determinable If fair value is not determinable, it must be estimated One method of estimating fair value is to compute the present value of estimated future cash flows from the asset or group of assets For intangible operational assets other than goodwill, if book value exceeds fair value, an impairment loss is recognized for the differences For goodwill, an impairment loss is indicated if the fair value of the reporting unit is less than its book value A goodwill impairment loss is measured as the excess of book value of goodwill over its “implied” fair value For operational assets held for sale, if book value exceeds fair value, an impairment loss is recognized for the difference Question 11-18 Repairs and maintenance are expenditures made to maintain a given level of benefits provided by the asset and not increase future benefits Expenditures for these activities should be expensed in the period incurred Additions involve adding a new major component to an existing asset These expenditures usually are capitalized Improvements are expenditures for the replacement of a major component of an operational asset The costs of improvements usually are capitalized Rearrangements are expenditures to restructure an operational asset without addition, replacement, or improvement The objective is to create a new capability for the asset and not necessarily to extend useful life The costs of material rearrangements should be capitalized if they clearly increase future benefits © The McGraw-Hill Companies, Inc., 2007 11-4 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief Exercise 11-1 Depreciation is a process of cost allocation, not valuation Koeplin should not record depreciation expense of $18,000 for year one of the machine’s life Instead, it should distribute the cost of the asset, less any anticipated residual value, over the estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset, not the periodic decline in its value Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-2 a Straight-line: $30,000 - 2,000 = $7,000 per year years b Sum-of-the-years’ digits: Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10 2006 2007 $28,000 x 4/10 $28,000 x 3/10 = $11,200 = $ 8,400 c Double-declining balance: Straight-line rate is 25% (1 ÷ years) x = 50% DDB rate 2006 2007 = $15,000 = $ 7,500 $30,000 x 50% ($30,000 - 15,000) x 50% d Units-of-production: $30,000 - 2,000 = $2.80 per unit depreciation rate 10,000 hours 2006 2007 2,200 hours x $2.80 = $6,160 3,000 hours x $2.80 = $8,400 © The McGraw-Hill Companies, Inc., 2007 11-6 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-3 a Straight-line: $30,000 - 2,000 = $7,000 per year years 2006 2007 $7,000 x 9/12 $7,000 x 12/12 = = $5,250 $7,000 b Sum-of-the-years’ digits: Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10 2006 $28,000 x 4/10 x 9/12 = $8,400 2007 $28,000 x 4/10 x 3/12 + $28,000 x 3/10 x 9/12 = = $2,800 6,300 $9,100 c Double-declining balance: Straight-line rate is 25% (1 ÷ years) x = 50% DDB rate 2006 = $11,250 2007 or, 2007 $30,000 x 50% x 9/12 $30,000 x 50% x 3/12 + ($30,000 – 15,000) x 50% x 9/12 = $ 3,750 = 5,625 $ 9,375 ($30,000 – 11,250) x 50% = $ 9,375 Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-4 Annual depreciation will equal the group rate multiplied by the depreciable base of the group: ($425,000 – 40,000) x 18% = $69,300 Since depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded Any actual gain or loss is implicitly included in the accumulated depreciation account Journal entry (not required): Cash Accumulated depreciation (difference) Equipment (account balance) 35,000 7,000 42,000 Brief Exercise 11-5 $8,250,000 Depletion per ton = = $2.75 per foot 3,000,000 cubic feet 2006 depletion 2007 depletion = $2.75 x 700,000 feet = $2.75 x 800,000 feet © The McGraw-Hill Companies, Inc., 2007 11-8 = $1,925,000 = $2,200,000 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-6 Expenses for 2006 include: In-process R & D = † Amortization of the patent = * Amortization of the developed technology = Total $2,000,000 400,000 300,000 $2,700,000 Goodwill is not amortized † Amortization of the patent: ($4,000,000 ÷ 5) x 6/12 = $400,000 *Amortization of the developed technology: ($3,000,000 ÷ 5) x 6/12 = $300,000 Brief Exercise 11-7 Calculation of annual depreciation after the estimate change: $9,000,000 $320,000 x years 640,000 8,360,000 500,000 7,860,000 ÷ 18 $ 436,667 Solutions Manual, Vol.1, Chapter 11 Cost Old annual depreciation ($8 million ÷ 25 years) Depreciation to date (2004-2005) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life - 18 years (20-2) 2006 depreciation © The McGraw-Hill Companies, Inc., 2007 11-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-8 In general, we report voluntary changes in accounting principles retrospectively However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way Accordingly, Robotics reports the change prospectively; previous financial statements are not revised Instead, the company simply employs the double-declining balance method from now on The undepreciated cost remaining at the time of the change would be depreciated DDB over the remaining useful life A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported Asset’s cost Accumulated depreciation to date* Undepreciated cost, Jan 1, 2006 Double-declining balance depreciation for 2006 $9,000,000 (640,000) $8,360,000 x 2/23 † $ 726,957 *$8,000,000 ÷ 25 = $320,000 x years = $640,000 † Remaining life is 23 years Twice the straight-line rate is 2/23 © The McGraw-Hill Companies, Inc., 2007 11-10 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 11-3 Requirement Portland should have selected the straight-line depreciation method when approximately the same amount of an asset’s service potential is used up each period If the reasons for the decline in service potential are unclear, then the selection of the straight-line method could be influenced by the ease of recordkeeping, its use for similar assets, and its use by others in the industry Requirement a By associating depreciation with a group of machines instead of each individual machine, Portland’s bookkeeping process is greatly simplified Also, since actual machine lives vary from the average depreciable life, unrecognized net losses on early dispositions are expected to be offset by continuing depreciation on machines usable beyond the average depreciable life Periodic income does not fluctuate as a result of recognizing gains and losses on machine dispositions b Portland should divide the depreciable base of each machine by its estimated life to obtain its annual depreciation The sum of the individual annual depreciation amounts should then be divided by the sum of the individual capitalized costs to obtain the annual composite depreciation rate Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-65 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 11-4 Requirement a The capitalized cost for the computer includes all costs reasonable and necessary to prepare it for its intended use Examples of such costs are the purchase price, delivery, installation, testing, and setup b The objective of depreciation accounting is to allocate the depreciable base of an asset over its estimated useful life in a systematic and rational manner This process matches the depreciable base of the asset with revenues generated from its use Depreciable base is the capitalized cost less its estimated residual value Requirement The rationale for using accelerated depreciation methods is based on the assumption that an asset is more productive in the earlier years of its estimated useful life Therefore, larger depreciation charges in the earlier years would be matched against the larger revenues generated in the earlier years An accelerated depreciation method also would be appropriate when benefits derived from the asset are approximately equal over the asset’s life, but repair and maintenance costs increase significantly in later years The early years record higher depreciation expense and lower repairs and maintenance expense, while the later years have lower depreciation and higher repairs and maintenance Judgment Case 11-5 There is no necessarily correct answer to the question The support made for the answer given is more important than the answer itself Materiality is the critical consideration Information is material if it can have an effect on a decision made by users One consequence of materiality is that GAAP need be followed only if an item is material The threshold for materiality will depend principally on the relative dollar amount of the transaction In this case, is the $70,000 material? Net-of-tax income would be $49,000 higher if the expenditures were capitalized instead of expensed [$70,000 x (1-.30)] This represents a 4.45% increase in income ($49,000 ÷ $1,100,000) The effect on the balance sheet is small Shareholders' equity would be higher by $49,000 if the expenditures were capitalized This represents an increase of less than one-half of one percent Would these differences have an effect on decision-makers? There is no single answer to this question The FASB has been reluctant to establish any quantitative materiality guidelines The threshold for materiality has been left to subjective judgment of the company preparing the financial statement and its auditors © The McGraw-Hill Companies, Inc., 2007 11-66 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Communication Case 11-6 There is no right or wrong answer to this case Both views, expense and capitalize, can be defended once consideration is given to the materiality issue The process of developing and synthesizing the arguments will likely be more beneficial than any single solution Each student should benefit from participating in the process, interacting first with his or her partner, then with the class as a whole It is important that each student actively participate in the process Domination by one or two individuals should be discouraged A significant benefit of this case is that it is forcing students to consider the subjective nature of materiality when applying GAAP Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-67 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Integrating Case 11-7 Requirement a Inventory (understatement of 2007 beginning inventory) Retained earnings (understatement of 2006 income) ($ in millions) 10 10 Note: The 2005 error requires no adjustment because it has self-corrected by 2007 b Retained earnings (2005-2006 patent amortization) Patent [($18 million ÷ years) x 2] 2007 adjusting entry: Patent amortization expense ($18 million ÷ years) Patent c 2007 adjusting entry: Depreciation expense (below) Accumulated depreciation 4 ($ in millions) SYD 2005 depreciation 2006 depreciation Accumulated depreciation $30 18 12 12 ÷ yrs $ $10 ($30 x 5/15) ($30 x 4/15) $18 Cost Depreciation to date, SYD (above) Undepreciated cost as of 1/1/07 Less residual value Depreciable base Remaining life (5 years - years) New annual depreciation © The McGraw-Hill Companies, Inc., 2007 11-68 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 11-7 (concluded) Requirement Assets 2005 2005 inventory Patent amortization Depreciation 2006 2005 inventory 2006 inventory Patent amortization Depreciation $640 (12) (3) $330 $310 (12) (3) $210 (12) (3) Expenses $150 12 no adjustments to prior years $625 $330 $295 $195 $165 $820 $400 $420 $230 12 10 (3) $175 (12) (10) 10 (6) 10 (6) no adjustments to prior years $824 Solutions Manual, Vol.1, Chapter 11 Shareholders’ Net Liabilities Equity Income $400 $424 $249 $156 © The McGraw-Hill Companies, Inc., 2007 11-69 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 11-8 Requirement A change from the sum-of-the-years’ digits method of depreciation to the straight-line method for previously recorded assets is a change in accounting principle that is accounted for as a change in estimate Both the sum-of-the-years’ digits method and the straight-line method are generally accepted A change in accounting principle results from the adoption of a generally accepted accounting principle different from the generally accepted principle used previously for reporting purposes Requirement A change in the expected service life of an asset arising because of more experience with the asset is a change in accounting estimate A change in accounting estimate occurs because future events and their effects cannot be perceived with certainty Estimates are an inherent part of the accounting process Therefore, accounting and reporting for certain financial statement elements requires the exercise of judgment, subject to revision based on experience Trueblood Accounting Case 11-9 A solution and extensive discussion materials accompany each case in the Deloitte & Touche Trueblood Case Study Series © The McGraw-Hill Companies, Inc., 2007 11-70 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 11-10 Requirement SFAS No 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” and SFAS No 142, “Goodwill and Other Intangible Assets,” are the two relevant accounts standards Requirement Tangible operational assets and finite life intangibles are tested for impairment only when events or changes in circumstances indicate book value may not be recoverable Intangible assets with indefinite useful lives, including goodwill, should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value Requirement Tangible operational assets and finite life intangibles: Determining whether to record an impairment loss and actually recording the loss is a two-step process The first step is a recoverability test - an impairment loss is required only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value The measurement of impairment loss—step 2—is the difference between the asset’s book value and its fair value Intangible operational assets with indefinite useful lives (other than goodwill): The measurement of an impairment loss for indefinite life intangibles other than goodwill is a one-step process We compare the fair value of the asset with its book value If book value exceeds fair value, an impairment loss is recognized for the difference Goodwill: Determining whether to record an impairment loss and actually recording the loss is a two-step process Step - A goodwill impairment loss is indicated when the fair value of the reporting unit is less than its book value Step - A goodwill impairment loss is measured as the excess of the book value of the goodwill over its “implied” fair value The implied fair value of goodwill is calculated in the same way that goodwill is determined in a business combination That is, it’s a residual amount measured by subtracting the fair value of all identifiable net assets from the purchase price using the unit’s previously determined fair value as the purchase price Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-71 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 11-10 (concluded) Requirement Operational assets to be sold should be classified as held for sale in the period in which all of the following criteria are met: a Management commits to a plan to sell b The asset or asset group is available for immediate sale in its present condition c An active program to locate a buyer and other actions required to complete the plan to sell the asset or asset group have been initiated d The sale is probable e The asset or asset group is being actively marketed for sale at a price that is reasonable in relation to its current fair value f Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.14 Requirement An operational asset or group of assets classified as held for sale is measured at the lower of its book value or fair value less cost to sell An impairment loss is recognized for any write-down to fair value less cost to sell 14 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” Statement of Financial Accounting Standards No 144 (Norwalk, Conn.: FASB, 2001), par 30 © The McGraw-Hill Companies, Inc., 2007 11-72 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Ethics Case 11-11 Requirement 2006 expense using CEO's approach: $42,000,000 $4,200,000 x years 8,400,000 33,600,000 ÷ $11,200,000 Cost Old annual depreciation ($42,000,000 ÷ 10 years) Depreciation to date (2004-2005) Book value Estimated remaining life (2006-2008) New annual depreciation 2006 income would include only depreciation expense of $11,200,000 2006 expense using Heather's approach: $42,000,000 $4,200,000 x years 8,400,000 33,600,000 12,900,000 20,700,000 ÷ $ 6,900,000 Cost Old annual depreciation ($42,000,000 ÷ 10 years) Depreciation to date (2004-2005) Book value Write-down New depreciable base Estimated remaining life (2006-2008) New annual depreciation 2006 income would include depreciation expense of $6,900,000 and an asset writedown of $12,900,000 for a total income reduction of $19,800,000 Using Heather's approach, 2006's before tax income would be lower by $8,600,000 ($19,800,000 - 11,200,000) Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-73 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 11-11 (concluded) Requirement Discussion should include these elements Facts: SFAS 144 provides guidance for recording impairment losses on partial writedowns of operational assets remaining in use Assets should be written down if there has been a significant impairment of value such as in decreased product demand and full recovery of book value through use or resale is not expected Although the decision and computation to record an impairment loss often is very subjective and difficult to measure, Heather is able to estimate an equipment impairment of $12,900,000, presumably using the best information available The simple revision in service life approach is clearly an effort to enhance net income on the part of the CEO Ethical Dilemma: Is Heather's obligation to challenge the questionable application of revision in service life more important than her obligation to her boss and to the company's effort to reflect a favorable net income? Who is affected? Heather CEO and other managers Other employees Shareholders Potential shareholders Creditors Company auditors © The McGraw-Hill Companies, Inc., 2007 11-74 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 11-12 Requirement By changing its depreciation method, a company can shift reported income between periods For example, a shift from an accelerated method to the straight-line method increases income in the year of the change However, in some future period or periods, income will be lower than it would have been if the change had not been made This is not an effective way to manage earnings because the effect on income of switching from one method to another must be disclosed Requirement A company can manage earnings by changing the estimated useful lives of depreciable assets For example, reducing useful lives causes a decrease in income in one or more years including the year of the change, and increases income in some future years This is not an effective way to manage earnings because the effect on income of changing useful lives, if material, must be disclosed Requirement One possible approach to answering this question is to assume a company overstates its impairment loss For example, assume that the book value of depreciable assets is $20 million The fair value of these assets is estimated to be $13 million, indicating an impairment loss of $7 million If these assets are written down to $8 million, the company has effectively shifted $5 million in pre-tax income from the current period to future periods By writing down the assets to $8 million instead of $13 million, future depreciation is $5 million less than it would have been with a more appropriate write-down Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-75 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 11-13 Transaction Disposition Transaction is correctly recorded as repairs and maintenance expense Transaction is correctly recorded as repairs and maintenance expense Transaction is incorrectly recorded The amount should be capitalized as part of the cost of the plant Transaction is incorrectly recorded The amount should be capitalized either as part of the cost of the plant or as a reduction in the accumulated depreciation of the plant Transaction is correctly recorded as repairs and maintenance expense Transaction is correctly recorded as repairs and maintenance expense Transaction is incorrectly recorded The amount should be capitalized as equipment Transaction is correctly recorded as repairs and maintenance expense © The McGraw-Hill Companies, Inc., 2007 11-76 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Real World Case 11-14 Requirement ($ in millions) Plant, rental machines and other property (Cost): Balance, beginning of 2004 Add: Acquisitions during 2004 Less: Balance end of 2004 Dispositions during 2004 $36,153 5,368 (36,385) $ 5,136 Plant, rental machines and other property (Accumulated depreciation): Balance, beginning of 2004 Add: Depreciation for 2004 Less: Balance end of 2004 Accumulated depreciation of 2004 dispositions $21,464 3,959 (21,210) $ 4,213 Gain (loss) on 2004 dispositions: Cost of dispositions Less: Accumulated depreciation of dispositions Book value of dispositions Proceeds from dispositions Less: Book value of dispositions Gain on 2004 dispositions $ 5,136 (4,213) $ 923 $1,311 (923) $ 388 Requirement 2004 depreciable assets: Plant, rental machines and other property Less: Land and land improvements Cost of depreciable assets $36,385 (840) $35,545 The disclosure note indicates that IBM uses the straight-line depreciation method $35,545 ÷ $3,959 (2004 depreciation) = 8.98 years The approximate average service life of IBM's depreciable assets is years Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-77 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Real World Case 11-15 Requirement The following was taken from the company’s 2003 financial statements Your results could differ if the company changes any of its policies in years after 2003 a The company's depreciation and depletion policies, disclosed in Note Summary of Significant Account Policies, are as follows: Depreciation and depletion of all capitalized costs of proved oil and gas producing properties, except mineral interests, are expensed using the unit-ofproduction method by individual field as the proved developed reserves are produced Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual field as the related proved reserves are produced Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed Depreciation and depletion expenses for coal assets are determined using the unit-of-production method as the proved reserves are produced The capitalized costs of all other plant and equipment are depreciated or amortized over their estimated useful lives In general, the declining-balance method is used to depreciate plant and equipment in the United States; the straight-line method generally is used to depreciate international plant and equipment and to amortize all capitalized leased assets b Expenditures for maintenance, repairs and minor renewals to maintain facilities in operating condition are generally expensed as incurred Major replacements and renewals are capitalized Environmental expenditures that relate to ongoing operations or to conditions caused by past operations are expensed Expenditures that create future benefits or contribute to future revenue generation are capitalized Maintenance and repair costs incurred, which are not significant improvements, are expensed Environmental expenditures are expensed or capitalized as appropriate, depending upon their future economic benefit © The McGraw-Hill Companies, Inc., 2007 11-78 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 11-16 Requirement The statement of cash flows reports depreciation and amortization of $1,375 million Requirement FedEx uses the straight-line depreciation method for financial reporting Service life ranges are as follows: Wide-body aircraft and related equipment 15 to 22 years Narrow-body and feeder aircraft and related equipment to 15 years Package handling and ground support equipment and vehicles to 30 years Computer and electronic equipment to 10 years Other to 40 years Substantially all property and equipment have no residual values For income tax purposes, depreciation is generally computed using accelerated methods Though not specifically indicated, presumably this is the Modified Accelerated Cost Recovery System (MACRS) Solutions Manual, Vol.1, Chapter 11 © The McGraw-Hill Companies, Inc., 2007 11-79 ... 2007 11-10 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 11-9 If a material error is discovered in an accounting. .. 87,273 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Exercise 11-16 Requirement In general, we report voluntary changes in accounting. .. increase future benefits © The McGraw-Hill Companies, Inc., 2007 11-4 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief