Solutions manual intermediate accounting 18e by stice and stice ch11

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 11 QUESTIONS Depreciation refers to the cost allocation of tangible long-term assets, depletion refers to the cost allocation of natural resources, and amortization refers to the cost allocation of intangible assets All three terms have similar underlying principles governing their use productive output or service hours In theory, the use-factor methods provide a much better matching of costs against revenues than time-factor methods However, because use-factor methods require more extensive accounting records, they are not as common as the time-factor methods Four separate factors must be considered in determining the periodic depreciation charges that should be made for a company’s assets They are (1) asset cost, (2) residual or salvage value, (3) useful life, and (4) pattern of use These factors, when considered together, help determine which of the common methods is most appropriate for the circumstances With group depreciation, periodic depreciation expense is computed on a whole group of assets as if the group were one single asset The weighted-average life of the group is used to determine how much of the aggregate asset cost should be depreciated each year No gains or losses are recognized at the time of the retirement of individual assets; accumulated depreciation is reduced for the difference between the asset cost and the cash retirement proceeds Residual or salvage value is included in the formulas for all time-factor depreciation methods except for the declining-balance methods In practice, residual value is often ignored if it is the practice of a company to retain assets for most of their useful lives In the case of declining-balance methods, although residual value is not included in the formulas, it is considered when an asset is near the end of its useful life Generally, the book value should not be reduced below its expected residual value Some items of property, plant, and equipment are composed of identifiable subitems, or components, with substantially different useful lives or usage patterns The component approach to depreciation is to depreciate each component separately The component approach is allowed in the United States and is required under IAS 16 The amount of an asset retirement obligation is added to the cost of the associated asset Accordingly, the asset retirement obligation increases periodic depreciation In addition, the amount of the asset retirement obligation itself increases each year as the time until the obligation must be satisfied decreases However, this increase, which conceptually is exactly the same as interest expense, is not accounted for as interest expense Instead, it is called accretion expense Functional factors include inadequacy and obsolescence that reduce the usefulness of the asset Physical factors include wear and tear, deterioration and decay, and damage or destruction reducing the usefulness of the asset Time-factor methods of depreciation base cost allocation on time according to either straight-line or accelerated depreciation In theory, the pattern selected should be related to the pattern of benefits expected from the asset Because the pattern of benefits is very subjective, the selection of a specific time-factor method is usually an arbitrary decision Use-factor methods of depreciation base cost allocation on some measure that relates more directly to the use of the asset Most commonly, the allocation is based on When a useful-life estimate is changed, the remaining book value of the asset is depreciated over the revised remaining useful life In other words, the estimate impacts only the current and future periods No attempt is made to go back and “fix” the depreciation amount recognized in prior periods 425 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 426 10 When new estimates of recoverable natural resources are obtained, a new depletion cost per basic unit is computed from the beginning of the period in which the new estimate is made No adjustment is made to prior periods It is a change in estimate and therefore prospective in nature b If the fair value of the reporting unit exceeds the net book value of the assets and liabilities of the reporting unit, the goodwill is assumed to not be impaired and no impairment loss is recognized c If the fair value of the reporting unit is less than the net book value of the assets and liabilities of the reporting unit, a new fair value of goodwill is computed The goodwill value is the amount of fair value of a reporting unit that is left over after the values of all identifiable assets and liabilities of the reporting unit have been considered d If the implied amount of goodwill computed in (c) is less than the amount initially recorded, a goodwill impairment loss is recognized for the difference 11 A company should recognize an impairment loss when the undiscounted sum of expected future cash flows from the asset is less than the recorded book value of the asset The impairment loss is measured as the difference between the book value of the asset and the asset’s fair value Fair value can be estimated as the discounted sum of expected future cash flows 12 IAS 36 differs from U.S GAAP in that the discounted sum of future cash flows, rather than the undiscounted sum, is used to determine whether an impairment loss exists 13 If a non-U.S company chooses to revalue a long-term operating asset upward in accordance with IAS 16, the unrealized “gain” on the revaluation is recognized as a revaluation equity reserve This equity reserve increases the reported amount of equity but is not shown as a gain in the income statement 14 For accounting purposes, recorded intangible assets come in three varieties: a Intangible assets that are amortized The impairment test for these intangibles is the same as the 2-step test used for tangible long-term operating assets b Intangible assets that are not amortized The impairment test for these intangibles involves a simple 1-step comparison of the book value to the fair value c Goodwill, which is not amortized The goodwill impairment test is a 4-step process that first involves estimating the fair value of the entire reporting unit to which the goodwill is allocated 15 a Compute the fair value of each reporting unit to which goodwill has been assigned 16 Under IAS 36, the general structure of the impairment test for intangible assets is that the recorded amount of the intangible asset is compared to its “recoverable amount.” 17 a No depreciation is to be recognized b The asset is to be reported at the lower of its book value or its fair value (less the estimated cost to sell) 18 A gain or loss is recognized whenever an exchange of assets takes place unless the exchange does not affect the risk, timing, or amount of a company’s cash flows In those instances where the transaction lacks “commercial substance,” indicated gains are not recognized unless a small amount of cash is received Indicated losses are always recognized ‡ 19 Depreciation is an estimate, and the effort necessary to compute depreciation expense for the exact number of days an asset is owned usually exceeds any benefit derived For companies that acquire and dispose of many assets during a year, detailed tracking of daily depreciation is almost impossible A variety of simplifying assumptions are used, including rounding to the nearest whole month and the halfyear convention in which one-half of a year’s depreciation is taken on any asset acquired or disposed of during the year ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 427 ‡ in just a few classes and through the ignoring of salvage values Acceleration of tax depreciation deductions comes through shortened asset lives and use of accelerated depreciation methods like doubledeclining-balance 20 The original reasons for the development of the ACRS income tax depreciation method were simplification of the tax depreciation computations and acceleration of tax depreciation deductions to reduce income taxes and stimulate investment Simplification comes through the grouping of assets ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 428 PRACTICE EXERCISES PRACTICE 11–1 RECORDING DEPRECIATION EXPENSE Depreciation Expense Accumulated Depreciation PRACTICE 11–2 1,000 1,000 COMPUTING STRAIGHT-LINE DEPRECIATION ($108,000 – $20,000)/5 years = $17,600 annual depreciation expense Depreciation Expense Accumulated Depreciation 17,600 17,600 Book value: $108,000 – $17,600 = $90,400 PRACTICE 11–3 COMPUTING SUM-OF-THE-YEARS’-DIGITS DEPRECIATION and Year Computation ($115,000 – $20,000) × (5/15) ($115,000 – $20,000) × (4/15) ($115,000 – $20,000) × (3/15) ($115,000 – $20,000) × (2/15) ($115,000 – $20,000) × (1/15) PRACTICE 11–4 Depreciation Amount $31,667 25,333 19,000 12,667 6,333 Accumulated Depreciation $31,667 57,000 76,000 88,667 95,000 Book Value $83,333 58,000 39,000 26,333 20,000 COMPUTING DOUBLE-DECLINING-BALANCE DEPRECIATION and Double-declining-balance percentage: (100%/4 years) × = 50% Year Computation $100,000 × 0.50 $50,000 × 0.50 $25,000 × 0.50 $12,500 – $10,000 Depreciation Amount $50,000 25,000 12,500 2,500 Accumulated Depreciation $50,000 75,000 87,500 90,000 Book Value $50,000 25,000 12,500 10,000 The depreciation amount in the final year is the amount that reduces the machine’s book value to equal the estimated residual value To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 429 PRACTICE 11–5 COMPUTING SERVICE-HOURS DEPRECIATION and Rate per service hour: [($81,000 – $15,000)/20,000 hours] = $3.30 per hour Year Computation 9,000 hours × $3.30 per hour 5,000 hours × $3.30 per hour 4,000 hours × $3.30 per hour 2,000 hours × $3.30 per hour PRACTICE 11–6 Depreciation Amount $29,700 16,500 13,200 6,600 Accumulated Depreciation $29,700 46,200 59,400 66,000 Book Value $51,300 34,800 21,600 15,000 COMPUTING PRODUCTIVE-OUTPUT DEPRECIATION and Rate per unit: [($70,000 – $5,000)/13,000 units)] = $5 per unit Year Computation 3,000 units × $5 per unit 5,000 units × $5 per unit 2,000 units × $5 per unit 3,000 units × $5 per unit PRACTICE 11–7 Asset Asset Asset Asset Totals Depreciation Amount $15,000 25,000 10,000 15,000 Accumulated Depreciation $15,000 40,000 50,000 65,000 Book Value $55,000 30,000 20,000 5,000 COMPUTING GROUP DEPRECIATION Acquisition Cost $ 64,000 90,000 42,000 30,000 $226,000 Salvage Value $ 4,000 10,000 6,000 Useful Life years 10 Expense $10,000 8,000 4,000 6,000 $28,000 $28,000/$226,000 = 0.12389 This percentage is applied to the total original cost of all assets in the group in order to compute total annual depreciation expense To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 430 PRACTICE 11–8 GROUP DEPRECIATION: RECORDING ASSET SALES With group depreciation, gains and losses are typically not recognized on the sale of individual assets Cash Accumulated Depreciation Asset 22,000 20,000 42,000 Accumulated Depreciation is the plug figure in this entry We assume that the overall depreciation policy is accurate, so no gains or losses are recorded when disposing of group assets The group rate percentage is normally left the same unless there is persuasive evidence for the need of a change ($64,000 + $90,000 + $30,000 + $50,000) × 0.12389 = $28,990 PRACTICE 11–9 ASSET RETIREMENT OBLIGATION The present value of the asset retirement obligation is computed as follows: Business calculator keystrokes: FV = $250,000; I = 6%; N = 12 years → $124,242 The total cost of the landfill site is $649,242 = $525,000 + $124,242 Depreciation expense: $649,242/12 years = $54,104 Accretion expense: $124,242 × 0.06 = $7,455 PRACTICE 11–10 COMPUTING DEPLETION EXPENSE Depletion rate = (January cost – Residual value)/January tons ($100,000 – $20,000)/5,000 tons = $16.00 per ton 900 tons × $16.00 per ton = $14,400 depletion expense Depletion Expense Accumulated Depletion (or Mine) PRACTICE 11–11 CHANGE IN ESTIMATED LIFE Annual depreciation using the original estimates: ($40,000 – $4,000)/9 years = $4,000 annual depreciation expense Total accumulated depreciation after three years: $4,000 annual depreciation expense × years = $12,000 14,400 14,400 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 PRACTICE 11–11 431 (Concluded) Remaining useful life after three years: New estimate of years – years already elapsed = years remaining Annual depreciation using the revised estimates in the fourth year: [($40,000 – $12,000 accumulated depreciation) – $8,000]/4 years = $5,000 annual depreciation expense PRACTICE 11–12 CHANGE IN ESTIMATED UNITS OF PRODUCTION Depletion rate for Year = January cost/January tons $300,000/2,000 tons = $150.00 per ton 900 tons × $150.00 per ton = $135,000 depletion expense Depletion rate for Year = January cost/January tons ($300,000 – $135,000 + $120,000)/(600 tons + 700 tons) = $219.23 per ton 600 tons × $219.23 per ton = $131,538 PRACTICE 11–13 CHANGE IN DEPRECIATION METHOD Annual depreciation using the original estimates: ($80,000 – $8,000)/8 years = $9,000 annual depreciation expense Total accumulated depreciation after three years: $9,000 annual depreciation expense × years = $27,000 Book value at the end of three years: $80,000 – $27,000 = $53,000 Straight-line rate – 100%/5 = 20% Double the straight-line rate: 20% × = 40% Year depreciation expense: $53,000 × 40% = $21,200 PRACTICE 11–14 DETERMINING WHETHER A TANGIBLE ASSET IS IMPAIRED The equipment is not impaired The relevant comparison is the book value of the asset to the sum of the expected future cash flows Sum of future cash flows ($65,000 × 14 years) Book value ($1,500,000 – $600,000) $910,000 900,000 Because the sum of future cash inflows is more than the book value of the asset, no impairment has occurred In testing for impairment, the current value of the asset is not used Therefore, the equipment should continue to be reported in the company’s books at its net book value of $900,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 432 PRACTICE 11–15 RECORDING A TANGIBLE ASSET IMPAIRMENT The building is impaired The relevant comparison is the book value of the building to the sum of the expected future cash flows Sum of future cash flows ($40,000 × 30 years) Book value ($1,500,000 – $250,000) $1,200,000 1,250,000 Because the sum of future cash inflows is less than the book value of the asset, the building is impaired Accumulated Depreciation 250,000 Loss on Impairment ($1,250,000 – $600,000) 650,000 Building 900,000 PRACTICE 11–16 RECORDING UPWARD ASSET REVALUATIONS Building ($730,000 – $500,000) 230,000 Accumulated Depreciation 40,000 Revaluation Equity Reserve 270,000 PRACTICE 11–17 RECORDING AMORTIZATION EXPENSE Amortization Expense Accumulated Amortization 62,500 62,500 $250,000/4 years = $62,500 annual amortization expense (Note: Straight-line amortization is used unless there is compelling evidence for using another method.) PRACTICE 11–18 GOODWILL IMPAIRMENT Estimated fair value of the Manufacturing reporting unit: Present value of $700 per year for 10 years at 10% = $4,301 With a business calculator: Make sure to toggle so that the payments are assumed to occur at the end (END) of the period PMT = $700; N = 10; I = 10% → PV = $4,301 Net book value of the assets and liabilities of the Manufacturing reporting unit: Assets ($7,000 + $2,000) – Liabilities ($4,000) = $5,000 Because the estimated fair value of the reporting unit ($4,301) is less than the net book value of the reporting unit ($5,000), further computations are needed to determine the amount of a goodwill impairment loss, if any To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 PRACTICE 11–18 433 (Concluded) Implied fair value of goodwill as of December 31: Fair value of identifiable assets + Fair value of goodwill – Fair value of liabilities = Total fair value $8,000 + Fair value of goodwill – $4,000 = $4,301 Fair value of goodwill = $301 Journal entry necessary to recognize the goodwill impairment loss: Goodwill Impairment Loss Goodwill ($2,000 – $301) PRACTICE 11–19 1,699 1,699 EXCHANGE OF ASSETS Land 400,000 Accumulated Depreciation 340,000 Gain on Exchange ($400,000 – $360,000) 40,000 Building 700,000 Land 200,000 Accumulated Depreciation 340,000 Loss on Exchange ($360,000 – $200,000) 160,000 Building 700,000 PRACTICE 11–20 CLASSIFYING AN ASSET AS HELD FOR SALE Building—Held for Sale ($145,000 – $9,000) 136,000 Loss on Held-for-Sale Classification 14,000 Accumulated Depreciation—Building 225,000 Building 375,000 Building Held for Sale Gain on Recovery of Value—Held for Sale 14,000 14,000 Computation of gain: ($170,000 – $9,000) – $136,000 = $25,000; maximum gain that can be recognized is the amount of the initial loss recognized upon classification as held for sale = $14,000 PRACTICE 11–21 EXCHANGE OF ASSETS New Asset Accumulated Depreciation (old asset) Old Asset 150 850 1,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 434 PRACTICE 11–21 (Concluded) Cash New Asset Accumulated Depreciation (old asset) Gain on Exchange ($400 – $150 book value) Old Asset 300 100 850 Cash New Asset Accumulated Depreciation (old asset) Gain on Exchange Old Asset 80 120 850 250 1,000 50 1,000 Market value of old asset = $400 Indicated gain on exchange of old asset = $400 – $150 book value = $250 implied gain Recognized gain = [$80/($80 + $320)] × $250 = $50 Recorded asset value = $320 less deferred gain of $200 = $120 PRACTICE 11–22 ‡ DEPRECIATION FOR PARTIAL PERIODS Depreciation expense this year: ($100,000 – $15,000) × (5/15) × (9/12) = $21,250 Depreciation expense next year: ($100,000 – $15,000) × (4.25/15) = $24,083 Double-declining-balance percentage: (100%/5 years) × = 40% Depreciation expense this year: $100,000 × 0.40 × (9/12) = $30,000 Depreciation expense next year: ($100,000 – $30,000) × 0.40 = $28,000 PRACTICE 11–23 ‡ INCOME TAX DEPRECIATION According to the MACRS class-life definitions, ships are 10-year property, and 200% declining-balance depreciation, with a half-year convention, is used Double-declining-balance percentage: (1.00/10 years) × = 0.20, or 20% Depreciation deduction this year: $850,000 × 0.20 × (6/12) = $85,000 Depreciation deduction next year: ($850,000 – $85,000) × 0.20 = $153,000 ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 466 11–64 (Concluded) (b) Estimated fair value of the Abacus Manufacturing reporting unit: Business calculator keystrokes: PMT = $25,000; I = 6%; N = 22 years → $301,040 Net book value of the assets and liabilities of the Abacus Manufacturing reporting unit: Assets ($270,000 + $150,000) – Liabilities ($180,000) = $240,000 Because the estimated fair value of the reporting unit ($301,040) is greater than the net book value of the reporting unit ($240,000), the goodwill is presumed not to be impaired, and no further computations are needed In this case, it was not necessary to determine the fair values of the identifiable assets and liabilities (c) The journal entry to recognize amortization expense is as follows: 2013 Dec 31 Amortization Expense ($22,000/3 years) Accumulated Amortization 7,333 7,333 With intangible assets, the presumption is that in the absence of strong evidence to the contrary, the residual value is zero and the straight-line method should be used Impairment test: Book value: $22,000 – $7,333 = $14,667 Undiscounted future cash flows = $12,000 + $8,000 = $20,000 Because the undiscounted future cash flows are greater than the book value ($20,000 > $14,667), the asset is not impaired Accordingly, no additional journal entry is necessary (Note: It makes sense to recognize amortization expense first before doing the impairment test It is not correct to compare the book value as of the beginning of the year to the undiscounted cash flows remaining as of the end of the year Alternatively, think of this impairment test as being done in early 2014.) 11–65 (a) Gain on Exchange of Buildings and Equipment Buildings and Equipment To reverse entry made incorrectly on Lakeshore’s books 10,000 Buildings and Equipment (new) Accumulated Depreciation—Buildings and Equipment Buildings and Equipment (old) To record exchange of equipment No gain recognized 20,000 30,000 10,000 50,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 467 11–65 (Continued) (b) Gain on Exchange of Buildings and Equipment Cash Buildings and Equipment To reverse entry made incorrectly on Lakeshore’s books 30,000 Buildings and Equipment (new) Cash Accumulated Depreciation—Buildings and Equipment Buildings and Equipment (old) Gain on Exchange of Buildings and Equipment To record exchange of machine 8,750 5,000 60,000 Fair value of new asset Less: Gain deferred ($30,000 – $3,750) Valuation of new asset (c) (d) 5,000 25,000 70,000 3,750 $35,000 26,250 $ 8,750 Cost – Book value = Accumulated depreciation $70,000 – $10,000 = $60,000 Fair value – Book value = Indicated gain $40,000 – $10,000 = $30,000 $5,000 × $30,000 = $3,750 gain to be recognized $5,000 + $35,000 Buildings and Equipment Accumulated Depreciation—Buildings and Equipment Cash Loss on Exchange of Buildings and Equipment To reverse entry made incorrectly on Lakeshore’s books Buildings and Equipment (new) Accumulated Depreciation—Buildings and Equipment Cash Loss on Exchange of Buildings and Equipment ($40,000 – $30,000) Buildings and Equipment (old) To record exchange of building 118,000 110,000 6,000 2,000 24,000 110,000 6,000 10,000 150,000 No entry required Because the assets are dissimilar, the entire gain on the exchange is recognized and the entry made is correct To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 468 11–65 (Concluded) (e) Cash Intangible Assets To reverse incorrect entry Patent (new) Accumulated Amortization Loss on Exchange of Patents Patent (old) Cash To record exchange of patents 1,000 1,000 4,000 6,000 3,000 12,000 1,000 11–66 2013 Mar 15 Equipment (new) Accumulated Depreciation—Equipment Equipment (old) To record exchange of three small lathes for a large lathe No gain recognized because the transaction has no commercial substance June Land Common Stock Paid-ln Capital in Excess of Par To record purchase of land with common stock, market value, $75 per share 15,000 13,000 28,000 240,000 July 15 Cash 35,000 Equipment 120,000 Accumulated Depreciation—Machinery 38,000 Machinery Land Gain on Exchange of Assets To record acquisition of new earth-moving equipment in exchange for various assets Gain is recognized because the gain has commercial substance *Market value of land and molding machine less their book value equals gain: $155,000 – $122,000 = $33,000 3,200 236,800 50,000 110,000 33,000* To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 469 11–66 (Concluded) Aug 15 Patent Franchise Copyright Accumulated Depreciation—Machinery Machinery Gain on Exchange of Assets To record acquisition of patent, franchise, and copyright in exchange for milling machines 7,200* 7,200* 3,600* 9,000 17,000 10,000 *Market value of two milling machines: $18,000 Ratio of market values for acquired assets: Patent and franchise are equal Copyright is 50% of patent or franchise value Let x = patent; x also equals franchise, and 0.5x equals copyright x + x + 0.5x = $18,000 2.5x = $18,000 x = $7,200 cost assigned to patent and franchise 0.5x = $3,600 cost assigned to copyright Nov Machinery (new) Accumulated Depreciation—Machinery Machinery (old) Gain on Exchange of Assets To record exchange of packaging machines Indicated gain is recognized because the transaction is deemed to have commercial substance 60,000 52,000 72,000 40,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 470 11–67 Hedlund Corporation Depreciation and Amortization Expense For the Year Ended December 31, 2013 Building: Book value 1/1/2013 ($1,200,000 – $263,100) $ 936,900 150% declining-balance rate [(100%/25) × 1.5] × 6% Total depreciation on building $ 56,214 Machinery and equipment: Balance, 1/1/2013 $900,000 Deduct: Machine destroyed by fire 23,000 $ 877,000 × 10% $ 87,700 Depreciation Machine destroyed by fire, 4/1/2013 $ 23,000 Depreciation from 1/1 to 4/1/2013 (0.10 × 3/12) × 2.5% 575 Purchased 7/1/2013 $ 310,000 Depreciation from 7/1 to 12/31/2013 (0.10 × 6/12) × 5% 15,500 Total depreciation on machinery and equipment $103,775 Automotive equipment: Depreciation on $115,000 balance, 1/1/2013 $ 18,000 Deduct depreciation on car traded in, 1/2/2013 (SYD 3rd year 2/10 × $18,000) 3,600 $ 14,400 Car purchased, 1/2/2013 $ 24,000 Depreciation SYD 1st year × 4/10 9,600 Total depreciation on automotive equipment $ 24,000 Leasehold improvements: Cost, 5/1/2013 $ 168,000 Amortization period (5/1/2013 to 12/31/2019) ÷80 mos Amortization per month $ 2,100 Amortization for 2013 (5/1 to 12/31/2013) × mos Total amortization on leasehold improvements $ 16,800 Total depreciation and amortization expense for 2013 $200,789 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 471 11–67 (Continued) Hedlund Corporation Accumulated Depreciation and Amortization December 31, 2013 Accumulated depreciation—buildings at 12/31/2013: Balance, 1/1/2013 Depreciation for 2013 Balance, 12/31/2013 Accumulated depreciation—machinery and equipment at 12/31/2013: Balance, 1/1/2013 Depreciation for 2013 Deduct: Machine destroyed by fire (5 × 10% × $23,000) Balance, 12/31/2013 Accumulated depreciation—automotive equipment at 12/31/2013: Balance, 1/1/2013 Depreciation for 2013 $263,100 56,214 $319,314 $250,000 103,775 $353,775 11,500 $342,275 Deduct: Car traded in ($18,000 – $5,400) Balance, 12/31/2013 $ 84,600 24,000 $108,600 12,600 $ 96,000 Accumulated amortization—leasehold improvements at 12/31/2013: Amortization for 2013 Balance, 12/31/2013 Total accumulated depreciation and amortization at 12/31/2013 $ 16,800 $ 16,800 $774,389 Hedlund Corporation Gain or Loss from Disposal of Assets For the Year Ended December 31, 2013 Gain on machine destroyed by fire: Insurance recovery Book value of machine destroyed [$23,000 – (5 × 0.10 × $23,000)] Loss on car traded in on new car purchase: Book value of car traded in Trade-in allowed ($24,000 – $20,000) Net gain on asset disposals for 2013 $15,500 11,500 $ 5,400 4,000 $ 4,000 (1,400) $ 2,600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 472 11–67 (Concluded) Hedlund Corporation Noncurrent Operating Assets Section of Balance Sheet December 31, 2013 Land Buildings Machinery and equipment Automotive equipment Leasehold improvements Totals Cost $ 150,000 1,200,000 1,187,000* 121,000† 168,000 $2,826,000 Accumulated Depreciation and Amortization $319,314 342,275 96,000 16,800 $774,389 Explanations of Amounts *Machinery and equipment at 12/31/2013: Balance, 1/1/2013 Purchased, 7/1/2013 ($280,000 + $5,000 + $25,000) Deduct: Machine destroyed by fire 4/1/2013 Balance, 12/31/2013 Book Value $ 150,000 880,686 844,725 25,000 151,200 $2,051,611 $ 900,000 310,000 $1,210,000 23,000 $1,187,000 † Automotive equipment at 12/31/2013: Balance, 1/1/2013 Car purchased, 1/2/2013 Deduct: Car traded in Balance, 12/31/2013 $ 115,000 24,000 $ 139,000 18,000 $ 121,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 473 11–68 Oteron Company Depreciation and Amortization Expense For the Year Ended December 31, 2013 Land improvements: Cost Straight-line rate (15 years) Annual depreciation Depreciation on land improvements for 2013 (4/6 to 12/31/2013, or months) Buildings: Carrying amount, 1/1/2013 ($1,500,000 – $320,500) Building acquired 1/6/2013 Total amount subject to depreciation 150% declining-balance rate [(100%/30) × 1.5] Depreciation on buildings for 2013 Machinery and equipment: Balance, 1/1/2013 Straight line (12 years) Purchased 7/1/2013 Depreciation for 2013 (12 years) $ 210,000 ữ 15 $ 14,000 ì 9/12 $ 1,179,500 600,000 $ 1,779,500 ì 5% $ 88,975 $ 825,000 ữ 12 $ 315,000 ữ 12 $ 26,250 ì 6/12 Depreciation on machinery and equipment for 2013 Automobiles and trucks: Carrying amount, 1/1/2013 ($146,000 – $94,600) Deduct: Carrying amount, 1/1/2013 on truck sold 9/30/2013 ($10,841 + $2,502) Amount subject to depreciation 150% declining-balance rate [(1.00/6) × 1.5] Automobile purchased 8/30/2013 Depreciation for 2013 (0.25 × 4/12) Truck sold 9/30/2013—depreciation for 2013 (1/1 to 9/30/2013) Depreciation on automobiles and trucks for 2013 Leasehold improvements: Carrying amount, 1/1/2013 ($205,000 – $102,500) Amortization period (1/1/2013 to 12/31/2017) Amortization of leasehold improvements for 2013 Total depreciation and amortization expense for 2013 *Limited to total 8-year useful life of leasehold improvement $ 10,500 $ 68,750 13,125 $ 81,875 $ 51,400 $ × $ × 13,343 38,057 25% 18,000 8.33% $ 9,514 1,500 2,502 $ 13,516 $ 102,500 ÷ years* $ 20,500 $ 215,366 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 474 11–69 The correct answer is b The total cost of the mineral mine will include the $2,820,000 spent to acquire the mine and the $360,000 in development costs for a total of $3,180,000 This will be reduced by the estimated recoverable value of the property of $300,000 for a net cost of $2,880,000 Since 1,200,000 tons are expected to be extracted, depletion will be $2,880,000/1,200,000, or $2.40 per ton The depletion on 60,000 tons extracted in 2013 will be 60,000 × $2.40, or $144,000 The correct answer is b Under double-declining-balance depreciation over a 5-year life, depreciation on the $50,000 machine would have been 40% or $20,000 in the first year, and 40% of the remaining $30,000 or $12,000 in the second year, for a total of $32,000 The remaining $18,000 would be depreciated straight-line over the remaining three years at the rate of $6,000 per year As a result, after the first three years, accumulated depreciation would have been $32,000 + $6,000, or $38,000 ‡ 11–70 For each depreciation method, the total amount of tax reduction over the 5-year life of the equipment is $170,000 ($425,000 × 0.40) Different depreciation methods change the timing of the recognition of the depreciation but not affect the total amount of depreciation 2013 2014 2015 2016 2017 2018 Total PV Factor Table ll i = 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 Straight Line Depr Tax Present Savings Value $ 17,000* $ 15,455 34,000 28,098 34,000 25,544 34,000 23,222 34,000 21,111 17,000 9,597 $170,000 $123,027 COMPUTATIONS: * $170,000/5 = $34,000 × 1/2 year = $17,000 ** $170,000 × 0.40 = $68,000 × 1/2 year = $34,000 † $136,000 × 0.40 = $54,400 $81,600 × 0.40 = $32,640 $48,960 × 0.40 = $19,584 ‡ Relates to Expanded Material 200% Declining Balance Depr Tax Present Savings Value $ 34,000** $ 30,909 54,400† 44,956 32,640 24,522 19,584 13,376 19,584 12,160 9,792 5,528 $ 170,000 $ 131,451 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 11–70.‡ 475 (Concluded) Tax accounting and financial accounting are used for different purposes In the Thor Power Tool case (1979), the Supreme Court stated: The primary goal of financial accounting is to provide useful information to management, shareholders, creditors, and others properly interested; the major responsibility of the accountant is to protect these parties from being misled In addition, Congress frequently uses the tax code to encourage or discourage certain behaviors Accelerated depreciation is allowed for tax purposes because Congress wishes to increase the present value of the depreciation deductions and thus encourage investment This is one case in which a firm can easily justify using different accounting methods for taxes and for financial accounting ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 476 CASES Discussion Case 11–71 Both of these arguments demonstrate common misunderstandings as to the nature of depreciation Depreciation is a cost allocation procedure, not a valuation technique Thus, even though the assets of Guzman Co may be understated due to inflation, current GAAP does not recognize changing prices in the basic financial statements If valuation data are found to be more useful to users than cost allocation depreciation, there would be justification for using techniques other than cost allocation Even though Liebnitz spends considerable money for repairs, the basic asset still has a limited life, and the original cost must be allocated against revenue This case provides a vehicle for class discussion as to the exact nature of depreciation under current GAAP Because there are other possible ways to look at depreciation, students should be made aware of various approaches Discussion Case 11–72 The FASB has concluded that an entity should recognize an impairment loss only when the undiscounted sum of estimated future cash flows from an asset is less than the carrying amount of the asset and that the impairment loss should be measured based on the present value of estimated future cash flows from the asset In this case, the carrying value of the building at January 1, 2013, is $3,750,000 ($5,000,000/40 years = $125,000 depreciation per year, or $1,250,000 for the 10-year period 2003– 2012.) If it is assumed the building can be rented for $240,000 over the entire 30-year remaining life of the building, the undiscounted sum of the estimated future cash flows of $7,200,000 ($240,000 × 30) suggests that no impairment write-down is necessary If it is assumed that the building can be rented for only 10 years, the undiscounted future cash flows sum to only $2,400,000, and an impairment write-down is necessary The amount of the write-down would be based on the present value of the expected future cash flows of $1,474,696 (PMT = $240,000, N = 10, I = 10%) The difference of approximately $2.275 million is an estimate of the impairment loss There are several uncertainties in the case that add complexities to Julie’s assignment Because the building is leased for only 10 years, there is no assurance that the entire 30-year period should be used in the computation of the impairment Julie should review the renewal clause in the lease for any unusual provisions Because there is the possibility that Ferris Bueller may use the building again for operating purposes at the end of the 10-year period, the question of permanent impairment is more uncertain Perhaps the building’s value would exceed the rental value if it were again used as a manufacturing facility The other possibility is that the building could be sold at the end of the 10-year period Market values for real estate should also be reviewed to determine any impairment computation This case provides a basis for a good class discussion on how uncertainties in the area of long-lived operating assets make resolution of issues such as impairment very complex For Julie Ramos to make a specific recommendation, she must make certain assumptions about the future If Ferris Bueller does not want to write the asset down, it could refute the assumptions and thus provide justification for retaining the $3,750,000 book value Students should be encouraged to explore the ramifications of this complex area To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 477 Discussion Case 11–73 (a) Arguments for straight-line: Easy to apply Same depreciation charge each year Most commonly used method Easily understood by users Arguments against straight-line: Usually different from that used on tax returns, thus requiring interperiod tax allocation May not follow pattern of use of asset (b) Arguments for productive-output: Is directly related to use of asset Produces better matching of costs against revenues than other methods Arguments against productive-output: Requires estimate of number of units asset will produce, which is more difficult to estimate than number of years More difficult to apply than some others because numerator changes each year Requires accurate records of number of units produced If asset is used to produce different kinds of items, requires weighting different items in some fashion to arrive at depreciation percentage Because this machine performs only one function, this is not a serious objection for this case (c) Arguments for sum-of-the-years’-digits: Produces a declining pattern of depreciation that is consistent with the pattern of use for many assets Compared with other declining patterns, allocates full cost without need to change methods Permits applying a predetermined percentage against original cost—easier to apply than doubledeclining-balance Arguments against sum-of-the-years’-digits: Not as commonly used as double-declining-balance More complex to apply than straight-line Misunderstood by users Discussion Case 11–74 This case is designed to let students explore the amortization question without relying on the FASB to provide the answers Resourceful students may learn that FASB ASC Subtopic 926-20 (Entertainment— Films—Other Assets—Film Costs) requires that the costs to produce a motion picture should be capitalized and amortized The amortization method mandated is not based on an estimate of useful life but is based on an estimate of total expected gross revenues from the film Film production cost amortization in any given year is accomplished by amortizing the total production cost in the same ratio that current gross revenue bears to anticipated total gross revenue For example, assume that a film cost $40 million to produce and that total expected gross revenues are $100 million During the first year after its production, the film generates total gross revenue of $25 million Because the film generated 25% ($25 million/$100 million) of total expected gross revenue during the year, 25% of the production cost of the film, or $10 million, should be shown as amortization expense for the year To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 478 Discussion Case 11–74 (Concluded) Conceptually, this method is very similar to the productive-output method described in the text, and students should note that this method is superior to the straight-line method because revenue is usually received in an uneven pattern The estimated total gross revenue can be thought of as the estimate of total productive output for the film Forecasting motion picture gross revenues is certainly a subjective process, but it is probably no more subjective than estimating the economic useful life of a patent or trademark— and certainly no more subjective than estimating the economic life of that same motion picture Because of the inherent uncertainty involved, any film cost allocation mechanism will involve a substantial amount of subjectivity; however, management does not have complete latitude in making the total gross revenue estimates Just as with useful-life estimates, the choice is somewhat constrained by the degree with which the firm’s auditors are comfortable with the estimate Discussion Case 11–75 The first year of a new management is a unique opportunity for making asset write-offs and restructuring charges because the negative impact on earnings will be blamed on the previous management Managements are typically replaced because of dissatisfaction with their performance Accordingly, restructuring and reevaluations of the assets are expected In calculating these charges, the new management has no incentive to understate their magnitude When faced with a difficult decision of whether or not to write off an asset, new management would always have an incentive to write it off in the first year when old management will be blamed rather than waiting until subsequent years when the new management will be held responsible for poor earnings Discussion Case 11–76 An increase in estimated useful life would decrease depreciation expense for the year, increase net income, and increase the book value of the asset (above what it would have been without the change in useful life) The effects on net income can be quite significant The most theoretically correct reason for increasing the estimated useful life of an asset is that new technology has made it possible to prolong the life of the asset, or new engineering studies reveal that the previous estimate understated the life of the asset For example, on July 1, 1986, Delta Air Lines changed the depreciation period for its flight equipment from 10 years to 15 years This change had the effect of decreasing Delta’s depreciation expense for the year ended June 30, 1987, by $130 million and increasing Delta’s net income for the year by $69 million—a 35% increase In practice, a reason often given for increasing an estimated useful life is that the change will bring the firm’s accounting practices more in line with other firms in the industry For example, in 1987 General Motors increased the estimated service lives of its plant, equipment, and special tools, bringing GM’s estimates more in line with Chrysler and Ford The increases reduced depreciation expense for 1987 by $1.2 billion, resulting in an increase in operating income of 93% Clearly, these useful-life changes can have an enormous impact on earnings Accordingly, it is natural to suspect that at least some of these changes are motivated by management’s desire to improve reported earnings To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 479 Case 11–77 The following information was extracted from Note Summary of Significant Accounting Policies to Disney’s 2009 financial statements: Parks, resorts and other property are carried at historical cost Depreciation is computed on the straight-line method over estimated lives as follows: Attractions Buildings and improvements Leasehold improvements Land improvements Furniture, fixtures and equipment 25–40 years 20–40 years life of lease or asset life if less 20–40 years 3–25 years Film and television production, participation and residual costs are expensed based on the ratio of the current period’s revenues to estimated remaining total revenues (Ultimate Revenues) from all sources on an individual production basis Ultimate Revenues for film productions include revenues that will be earned within ten years from the date of the initial theatrical release For television network series, we include revenues that will be earned within ten years from delivery of the first episode, or if still in production, five years from delivery of the most recent episode, if later In order to find out Disney’s total depreciation and amortization expense for 2009, one has to look at the statement of cash flows Depreciation and amortization total $1,631 million The following comes from Note on Film and Television Costs: Based on management’s total gross revenue estimates as of October 3, 2009, approximately 84% of unamortized film and television costs for released productions (excluding amounts allocated to acquired film and television libraries) are expected to be amortized during the next three years The Company expects to amortize, based on current estimates, approximately $1.5 billion in capitalized film and television production costs during fiscal 2010 The reason for the difference is that since the Pixar acquisition, Disney has disposed of some of its other assets that had goodwill associated with them When Disney sells assets that have goodwill allocated to them, that goodwill is removed from Disney’s books, and this is why goodwill is only $21.683 billion in 2009 Case 11–78 Depreciable cost for 1998 was as follows: Flight equipment held all of 1998 Acquired during year [($11,180 – $9,619) × 1/2] Total depreciable cost for 1998 $ 9,619.00 780.50 $10,399.50 Estimated depreciation expense for 1998: [$10,399.5 – $10,399.5(0.05)] ÷ 20 years = $494 [$10,399.5 – $10,399.5(0.05)] ÷ 25 years = $395 The assumption of no disposals during 1998 is not reasonable The change in accumulated depreciation during the year is $385 ($3,895 – $3,510) Because this is significantly less than the estimated depreciation expense for the year ($494), it appears that there have been some disposals To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 480 Case 11–79 To: FASB Members From: New Research Staff Member Subject: Depreciation—One Method Only Recently, a recommendation was received from a financial analysts group urging the FASB to address the area of depreciation accounting with the objective of designating just one method as acceptable Below are reasons for and against adding such a project to the FASB’s agenda For: • • Current GAAP allows companies many choices of depreciation method This diversity impairs the comparability of financial statements Choice of depreciation method gives managers one more way to manipulate the reported financial statement numbers Against: • All assets are not used in the same way Some are used uniformly throughout their useful lives; others are used more heavily in early years GAAP should have the flexibility to allow for this difference in circumstances • FASB resources are limited Depreciation accounting is an area that has been settled and quiet for years The Board should work on more pressing matters • Over 90% of large firms use straight-line depreciation Why worry about the small number who not? Case 11–80 There are two extreme possible courses of action: Do nothing to the depreciation numbers Present the financial statements, as they are, to the employee committee Some risk is inherent in this strategy because if the employee committee discovers the questionable depreciation calculations, the atmosphere in the negotiations will turn nasty very quickly In addition, doing nothing when you know that the numbers are deceiving is an unethical approach Insist that your partner revise the financial statements using more realistic depreciation calculations Refuse to cooperate with any attempt to deceive the employee committee Of course, this approach runs the risk of angering your partner and long-time friend, perhaps harming your entire business relationship The dilemma here is that two important relationships of trust must be maintained—your relationship with the employees and your relationship with your partner Neither of the two courses of action described above preserves both of those relationships A possible alternative is to redirect the focus of the negotiations from the reported financial numbers back to the real issue—what is a fair wage for your employees It seems that, in this case, the most relevant information is comparative wage data for employees in other firms in the area who similar work In addition, you and your partner must consider what costs there are in potentially losing a number of your existing employees Focusing on these issues, rather than arguing about financial statement assumptions, would probably be more fruitful for both sides of the negotiation Case 11–81 Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice ... Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 427 ‡ in just a few classes and through the ignoring of salvage values Acceleration... computations and acceleration of tax depreciation deductions to reduce income taxes and stimulate investment Simplification comes through the grouping of assets ‡ Relates to Expanded Material... To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 429 PRACTICE 11–5 COMPUTING SERVICE-HOURS DEPRECIATION and Rate per service hour: [($81,000