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Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition CHAPTER Reporting and Analyzing Long-Lived Assets ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems 1, 2, 1, 2, 1, 1A, 2A B Problems Describe how the cost principle applies to property, plant, and equipment Explain the concept of, 4, 5, and calculate, amortization 2, 3, 8, *12 3A, 4A, 5A 3B, 4B, 6A, *11A, 5B, 6B, *12A *11B, *12B Describe other account- 7, 8, 9, 10 ing issues related to amortization 3, 5A 5B Explain how to account for the disposal of property, plant, and equipment 11, 12, 13 6, 4A, 6A 4B, 6B Identify the basic issues 14, 15, 16 related to accounting for intangible assets 8, 6, 7, 7A, 8A 7B, 8B Indicate how long-lived assets are reported in the financial statements 9, 10, 11 6, 4A, 8A 4B, 8B Describe the methods 19, 20, 21 for evaluating the use of assets 12 10 9A, 10A 9B, 10B *13, *14 *11, *12 *11A, *12A *11B, *12B *8 Calculate amortization using the declining-balance method and the units-of-activity method (Appendix 9A) 17, 18 *22, *23 1B, 2B Solutions Manual 9-1 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 20-30 1A Analyze and record property transactions 2A Classify operating and capital expenditures Moderate 15-20 3A Calculate straight-line amortization and compare effects of different methods Moderate 40-50 4A Record property, plant, and equipment transactions; prepare partial balance sheet Moderate 30-40 5A Calculate amortization; discuss revision of estimate Moderate 10-15 6A Record acquisition, amortization, and disposal of equipment Simple 15-20 7A Correct errors in recording intangible asset transactions Moderate 30-40 8A Record intangible asset transactions; prepare partial balance sheet Moderate 30-40 9A Calculate and evaluate ratios Moderate 30-40 10A Evaluate ratios Moderate 20-30 *11A Calculate and compare amortization under straightline and declining-balance methods Moderate 30-40 *12A Calculate and compare amortization under straightline and units-of-activity methods Moderate 30-40 Simple 20-30 1B Analyze and record property transactions 2B Classify operating and capital expenditures Moderate 15-20 3B Calculate straight-line amortization and compare effects of different methods Moderate 40-50 4B Record property, plant, and equipment transactions; prepare partial balance sheet Moderate 30-40 5B Calculate amortization; discuss revision of estimate Moderate 10-15 Solutions Manual 9-2 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Problem Number Financial Accounting, Third Canadian Edition Description Difficulty Level Time Allotted (min.) Simple 15-20 6B Record acquisition, amortization, and disposal of equipment 7B Correct errors in recording intangible asset transactions Moderate 30-40 8B Record intangible asset transactions; prepare partial balance sheet Moderate 30-40 9B Calculate and evaluate ratios Moderate 30-40 10B Evaluate ratios Moderate 20-30 *11B Calculate and compare amortization under straightline and declining-balance methods Moderate 30-40 *12B Calculate and compare amortization under straightline and units-of-activity methods Moderate 30-40 Solutions Manual 9-3 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition ANSWERS TO QUESTIONS For long-lived assets, the cost principle requires that long-lived assets be recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use The matching principle requires that the cost of a long-lived asset be amortized to expense over the asset’s useful life RIM added $20 million in legal defence costs to its Patent account because the costs were considered necessary to prove the patent’s validity The costs were not recorded as an operating cost because they benefit future periods of RIM The main advantages of leasing are (1) reduced risk of obsolescence, (2) 100 percent financing, (3) income tax advantages, and (4) reduced recorded assets and liabilities You should explain to the president that amortization is a process of allocating the cost of a long-lived asset to expense over its service (useful) life in a rational and systematic manner Recognition of amortization is not intended to result in the accumulation of cash for replacement of the asset The effects of the three methods on annual amortization expense are: Straight-line results in a constant amount of amortization expense over the life of the asset Units-ofactivity results in varying amounts of amortization expense, which changes with the level of activity so it is difficult to predict the effects in any year Declining-balance results in decreasing amounts of amortization expense So the amortization expense is high in the early years and declines over time All three methods will charge the same total amount to amortization expense over the life of the assets, it is just the allocation of expense each period that varies The effects of the three methods on net earnings are: Straight-line results in a constant net earnings since amortization expense is the same each year Units-of-activity will result in a variable net earnings since amortization expense will change with the level of activity in each year Declining-balance results in lower net earnings in the early years since amortization expense is higher and higher net earnings in the later years since amortization expense declines over the life of the asset All three methods will result in the same total net earnings over the life of the assets, it is just the amount of expense and resultant net earnings that varies each period (The answer to Question is continued on the next page.) Solutions Manual 9-4 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition Questions (Continued) (Continued) The effects of the three methods on the book value are: Straight-line results in a declining book value at a constant rate each year since amortization expense and the amount added to the accumulated amortization account is the same Recall that book value is cost less accumulated amortization Units-of-activity will also result in a declining book value but at a variable amount since the amortization expense and amount added to the accumulated amortization account each year will also vary Declining-balance will also result in a declining book value but at an increasing amount in the early years and a decreasing amount in the later years since amortization expense and the amount added to the accumulated amortization account each year is higher in the early years All three methods will end up with the same book value at the end of the asset’s useful life, it is just the allocation of expense each period that varies Since Morgan uses the straight-line amortization method, its amortization expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method Petrunik’s amortization expense in the early years of an asset’s useful life will be higher as compared to the straight-line method Morgan’s net earnings will be higher than Petrunik’s in the first few years of the asset’s useful life These differences will impact the amortization expense, accumulated amortization and net earnings of the companies making comparison of their results and financial position difficult In reality, the choice of amortization method results in an artificial, timing difference only and should be ignored, if possible, in comparing financial positions Yes, income tax regulations require a company to use a different amortization method (the single-declining-balance method), regardless of which method is used in preparing financial statements Lucien Corporation’s motivation for using the straight-line method for financial reporting is to ensure that the amortization method selected provides the best matching of expense to revenue An impairment loss is a permanent decline in the market value of an asset This may happen when a machine has become obsolete, or the market for a product made by a machine has dried up or has become very competitive Unlike inventories, the application of the lower of cost and market rule does not apply automatically to property, plant, and equipment Because inventory is expected to be converted into cash within the year, it is important to value it annually at the lesser of its cost and market, or saleable value In contrast, property, plant, and equipment are used in operations over a longer term and are not available for resale The going concern assumption assumes that a company will recover at least the cost of its long-lived assets It is only when a permanent impairment occurs in the value of the asset that long-lived assets are written down to market 10 A revision of amortization is made in current and future years but not retroactively The rationale is that continual restatement of prior periods for what is merely a change in estimate would adversely affect the reader’s confidence in the financial statements Solutions Manual 9-5 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition Questions (Continued) 11 Amortization must be updated from the last time adjusting entries were recorded to the date of the sale because the amortization expense must be properly matched to the revenue earned in the period the asset was still in use Updating amortization also aids in determining the amount of the gain or loss on disposition 12 In a sale of long-lived assets, the net book value of the asset is compared to the proceeds received from the sale If the proceeds of the sale exceed the net book value of the asset, a gain on disposal occurs If the proceeds of the sale are less than the net book value of the asset sold, a loss on disposal occurs The calculation is the same for an asset that is retired except that there are no proceeds received Since no proceeds are received in a retirement, a gain will never occur 13 The machine and related accumulated amortization should continue to be reported on the balance sheet without further amortization or adjustment until the asset is retired Reporting the asset and related accumulated amortization on the balance sheet informs the reader of the financial statements that the company is still using the asset Once an asset is fully amortized, even if it is still being used, no additional amortization should be taken on this asset In no situation, can the accumulated amortization on the asset exceed the cost of the asset 14 Only intangible assets with limited lives such as patents and copyrights are amortized because their cost benefits a limited period of time Intangibles with unlimited lives such as trademarks are not amortized because their cost benefits an unlimited period of time, but their book value is assessed annually for impairment and a loss recognized if a decline in value has occurred 15 The student is not correct The cost of intangibles with limited lives should be amortized over the shorter of that asset's useful life (the period of time when operations are benefited by use of the asset) or its legal life 16 Goodwill is the value of many favourable attributes that are intertwined in the business enterprise Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately Goodwill can only be sold if the entire business is sold Solutions Manual 9-6 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition Questions (Continued) 17 (a) Long-lived assets are normally reported on the balance sheet under the headings “property, plant, and equipment” and “intangible assets.” The balances of the major classes of assets should be disclosed, as well as the accumulated amortization for amortizable assets, either on the balance sheet or in the notes to the financial statements (b) The statement of earnings reports amortization expense and any gain or loss on disposal of long-lived assets The statement of earnings also reports any impairment losses, when the market value of a long-lived asset permanently declines below its cost (c) The cash flow statement reports any cash paid to purchase long-lived assets and any cash received on their disposal in the investing activities section 18 The notes to financial statements should disclose the balance of the major classes of assets as well as the accumulated amortization for amortizable assets The amortization method(s) used must also be described and any impairment losses 19 (a) (b) Grocery stores usually have a high asset turnover and a low profit margin Car dealerships normally have a low asset turnover and a high profit margin 20 ($ in U.S millions) Return on assets: $247.5 =24.8% $997.6 Asset turnover: $995.6 =1.0 times 21 The return on $997.6 assets ratio measures the return being generated by each dollar invested in the business (net earnings ÷ average total assets) The return on assets can also be calculated by multiplying the profit margin by the asset turnover ratio The profit margin measures how effective the business is at generating earnings from its sales and the asset turnover measures how well the company can generate sales from a given level of assets Together, the two ratios can be combined to measure how effective a company is at generating earnings from a given level of assets (return on assets) Therefore if a company wants to improve its return on assets, it can so either by increasing the margin it generates from each dollar of sales (profit margin) or by increasing the volume of goods that is sells (asset turnover) Solutions Manual 9-7 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition *22 Straight-line and units-of-activity measures apply the amortization criteria to the original cost of the assets over a fixed period (in years or in units), which must be reduced by salvage value to get an accurate representation of the amortizable cost of the assets to the company Because the declining-balance method applies the amortization criteria, not to the original cost, but to a declining book value, the original cost is used instead of the amortizable cost Applying a fixed percentage rate to a declining balance will always result in an ending, residual amount Salvage value is considered in the declining-balance method in that the asset is never amortized below its salvage value, so in effect; this residual amount is adjusted to equal salvage value *23 The straight-line and declining-balance methods use annual amortization rates in their amortization calculations Therefore, the result must be adjusted for any period less than one year The units-of-activity method does not need to be adjusted for partial periods as this method multiplies the total production output by the actual production for the period This already reflects how much the asset was used during the period For example, if an asset was purchased July and produced 10,000 units for the period July through December, it already produces a result for that six month period (the company could not have produced units before it purchased the asset) and therefore does not need to be adjusted for the half year ownership period Solutions Manual 9-8 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures, except the fence, should be included in the cost of the land Therefore, the cost of the land is $56,000 ($50,000 + $2,500 + $3,500) The fence would be included in the cost of land improvements BRIEF EXERCISE 9-2 The cost of the truck is $28,400 (cash price $28,000 + painting and lettering $400) The expenditures for insurance and motor vehicle licence should be expensed, not added to the cost of the truck BRIEF EXERCISE 9-3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) O C C O C O O C C O BRIEF EXERCISE 9-4 The amortizable cost is $40,000 ($42,000 – $2,000) With a 4-year useful life, annual amortization is $10,000 ($40,000 ÷ 4) Under the straight-line method, amortization expense is the same each year, but must be prorated for the initial year Thus, amortization expense for 2005 is $6,667 ($10,000 X 8/12) and $10,000 for 2006 Solutions Manual 9-9 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BRIEF EXERCISE 9-5 Net book value ($90,000 - $54,000) Market value Impairment loss $36,000 30,000 $ 6,000 The journal entry to record the impairment loss, assuming the decline in value is permanent is: Loss on Impairment Accumulated Amortization (To record the impairment loss on machinery) 6,000 6,000 BRIEF EXERCISE 9-6 (a) (b) Amortization Expense (($72,000 - $2,000) ÷ 5) X 9/12) Accumulated Amortization—Office Equipment 10,500 Cash Accumulated Amortization—Office Equipment Gain on Disposal Office Equipment 21,000 52,500 10,500 1,500 72,000 Cost of office equipment Less: Accumulated amortization Book value at date of disposal Proceeds from sale Gain on disposal $72,000 52,500* 19,500 21,000 $ 1,500 * Amortization Jan 1, 2003 – Dec 31, 2005 ($72,000 - $2,000) ÷ X years Amortization Jan 1, 2006 – Sept 30, 2006 Accumulated amortization $42,000 10,500 $52,500 Solutions Manual 9-10 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-2 COMPARATIVE ANALYSIS PROBLEM ($ in millions) (a) Loblaw .Sobeys Profit margin Return on assets $845 =3.4% $25,220 $845 = 7.3% ($12,177+$11,110) ÷ $167.5 =5.2% ($3,274.7+$3,192.5) ÷ Asset turnover $25,220 =2.2 times ($12,177 + $11,110) ÷ (b) $167.5 = 1.5% $11,046.8 $11,046.8 =3.4 times ($3,274.7 + $3,192.5) ÷ Based on profit margin we can see that Loblaw is more profitable than Sobeys However, both retailers have profit margins above the industry average of 0.6%, which indicates that both Sobeys and Loblaw are more profitable than the average grocery retailer The return on assets ratio indicates that Sobeys is generating a slightly worse return than Loblaw based on the amount of assets invested in the business However, again, based on the industry average of 1.3% both companies are generating a better return on their assets than most other retailers in the industry The asset turnover measures how efficiently a company uses its assets to generate sales It shows the dollars of sales generated by each dollar invested in assets Sobeys’ asset turnover (3.4) was 54% higher than Loblaw’s (2.2) Therefore, it could be concluded that Sobeys was more efficient than Loblaw in utilizing assets to generate sales Loblaw is a little under the industry average of 2.5 times but this could be attributed to the rapid growth the company has been undergoing in the past several years Solutions Manual 9-68 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm (a) Financial Accounting, Third Canadian Edition BYP 9-3 RESEARCH CASE Intangible assets include brands, technology, contracts, artistic assets, customer lists and marketing-related assets Intangible asset value as a percent of overall asset value is approximately 75% of overall asset value for Canadian technology, financial, communications and non-cyclical consumer companies; approximately 50% for industrial, energy, base metal and consumer cyclical companies; approximately 25% for the utility sector (b) Company Royal Bank of Canada Canadian Tire Molson McCain Foods Sobeys Brand Value $4,418,000,000 1,358,000,000 1,081,000,000 1,009,000,000 834,000,000 Brand value as a percentage of market value 10.6% 26.0% 20.5% N/A 31.4% (c) The cost principle requires that property, plant, and equipment, goodwill and intangible assets be recorded at cost, their cash-equivalent prices on the date that they are acquired Brand value is the price that the brand would fetch in the open market today (d) Investors expect a return (income earned) on their investments The higher the asset values and value of their investments, the more income that will have to be earned to achieve the targeted return For example, in 2004 almost 50% of investors buying into a company expected a return of greater than 14% Venture capitalists (VCs) expect a higher rate of return In 2004, over 70% of VCs expected a return on investment greater than 14% Solutions Manual 9-69 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-4 INTERPRETING FINANCIAL STATEMENTS (a) The $110 million investment should be treated as a capital expenditure This will result in the creation of an asset that will have a long life and the cost will be matched with the revenue it generates through annual amortization charges (b) Maple Leaf could use the straight-line, declining-balance or the units-of-activity method to amortize the property, plant, and equipment associated with its Saskatchewan plant The straight-line method is simple to use and if the assets are used at a consistent level will match costs with revenue Declining-balance is appropriate in cases where the benefits are greater in the early years of an assets life The units-of-activity method would be the most appropriate in this case as the levels of production vary widely The units-of activity method will provide the best matching of costs with revenue (c) If the units-of-activity method is chosen and the plant moves to a double-shift operation and processes additional hogs, the amortization expense will increase substantially as the number of hogs processed increases Solutions Manual 9-70 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-5 INTERPRETING FINANCIAL STATEMENTS (a) Vivendi’s recording of impairment losses appears to be similar to accounting practices in Canada The company recorded an impairment loss for goodwill and other assets after assessing their market values (b) Impairment Loss – Goodwill Impairment Loss – Other intangible assets Goodwill Other intangible assets (c) €26 million €5 million €26 million €5 million This write-down will cause Vivendi’s intangible assets and shareholders’ equity (through retained earnings) to be lower Current earnings are also lower (which reduces retained earnings on the balance sheet) This should not impact future earnings unless further write-downs are required Solutions Manual 9-71 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-6 FINANCIAL ANALYSIS ON THE WEB Due to the frequency of change with regard to information available on the world wide web, the Accounting on the Web cases are updated as required Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our home page Solutions Manual 9-72 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm (a) Financial Accounting, Third Canadian Edition *BYP 9-7 COLLABORATIVE LEARNING ACTIVITY Ty Corporation—Straight-line method Annual amortization Building [($320,000 - $20,000) ÷ 30] Equipment [($110,000 - $10,000) ÷ 5] Total annual amortization $10,000 20,000 $30,000 Total accumulated amortization ($30,000 X 3) $90,000 Hamline Corporation – Double Declining-Balance Building: Calculation Year Book Value Beginning of Year 2004 2005 2006 $320,000 298,560 278,556 X Amortization Rate* End of Year = 6.7% 6.7% 6.7% Amortization Expense $21,440 20,004 18,663 Accumulated Amortization $ 21,440 41,444 60,107 Book Value $298,560 278,556 259,893 *Rate: 1/30 X = 6.7% Equipment: Calculation Year Book Value Beginning of Year 2004 2005 2006 $110,000 66,000 39,600 X Amortization Rate 40% 40% 40% End of Year = Amortization Expense $44,000 26,400 15,840 Accumulated Amortization $ 44,000 70,400 86,240 Book Value $66,000 39,600 23,760 *Rate: 1/5 X = 40% Total Accumulated Amortization = $60,107 + $86,240 = $146,347 Solutions Manual 9-73 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-7 (Continued) (b) Year Ty Corporation Net Earnings 2004 $ 84,000 2005 …… 88,400 2006 90,000 Total net earnings $262,400 (c) Hamline Corporation Net Earnings As Adjusted Calculations for Hamline Corporation $103,440 92,404 89,503 $68,000 + $65,4401 - $30,000 = $103,440 $76,000 + $46,4042 - $30,000 = $92,404 $85,000 + $34,5033 - $30,000 = $89,503 $285,347 $21,440 + $44,000 = $65,440 $20,004 + $26,400 = $46,404 $18,663 + $15,840 = $34,503 As shown above, when the two companies use the same amortization method, Hamline is more profitable than Ty Based on the above analysis, Ms Tucci should invest in Hamline Corporation because it is more profitable Solutions Manual 9-74 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-8 COMMUNICATION ACTIVITY Memorandum To: From: Date: Re: President, Accounting Standards Board President, Research Inc Today R&D Accounting Standards We would like to provide the following comments for your consideration as you review the current accounting standards for research and development costs Our company is in favour of capitalizing all research and development costs Some relatively small companies may spend less on R&D because they must expense these costs Requiring companies to expense R&D costs instead of allowing them to be capitalized leaves Canadian companies such as ours at a competitive disadvantage as compared to non-Canadian companies Canadian companies may be more reluctant to invest millions of dollars on research and development since the costs would negatively impact their financial statements in the short-run R&D is an important part of our base of knowledge assets Without capitalizing them, we are understating our balance sheet and future potential because we are not presenting to the users of financial statements the intrinsic value of our company, much of which is tied to successful research and development We believe expensing R&D costs to be an excessive application of the conservatism concept The conservatism concept dictates that when reasonable doubt exists, a company should choose the option that has the least favourable effect on earnings Expensing R&D costs is an example of applying the conservatism concept without regard for reality We hope these comments assist you in your revision of this standard We would be pleased to elaborate further on any of the above points at your convenience Solutions Manual 9-75 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-9 ETHICS CASE (a) The stakeholders in this situation are: Benny Benson, president of Imporia Container Ltd Yeoh Siew Poon, controller The shareholders of Imporia Container Ltd Potential investors in Imporia Container Ltd (b) Earnings before income taxes in the year of change will increase by implementing the president’s proposed changes because increasing the useful life will decrease the amortization expense Note to instructor: Students are not expected to, nor are able to, calculate the impact of this change However, the following calculations have been included in case you wish to expand upon this topic Old Estimates Asset cost Estimated salvage Amortizable cost Amortization per year ($2,800,000 ÷ 5) $3,000,000 200,000 2,800,000 $ 560,000 Revised Estimates Asset cost Estimated salvage Amortizable cost Amortization taken to date ($560,000 X 2) Remaining useful life in years Amortization per year (c) $3,000,000 200,000 2,800,000 1,120,000 1,680,000 years $ 336,000 Earnings management is a strategy used by the management of a company to deliberately manipulate the company's earnings so the figures match a pre-determined target The proposed change is an attempt at earnings management by the president because he is requesting the change in amortization entirely for the purpose of reducing net earnings Solutions Manual 9-76 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-9 (Continued) (d) The intentional misstatement of the life of an asset is unethical for whatever the reason and would represent an attempt at earnings management There is nothing per se unethical about changing the estimate either of the life of an asset or of an asset’s salvage value if the change is an attempt to better match cost and revenues and is a better allocation of the asset’s amortizable cost over the asset’s useful life In this case, it appears from the controller’s reaction that the revisions in the life are intended only to improve earnings which would be unethical The fact that the competition uses a longer life on its equipment is not necessarily relevant The competition’s maintenance and repair policies and activities may be different The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Imporia Container Ltd Solutions Manual 9-77 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition *BYP 9-10 SERIAL PROBLEM (a) Purchase price Painting Shelving Total cost of van (b) (1) Straight-line amortization Year 2006 2007 2008 2009 2010 2011 Amortizable Cost $30,000 30,000 30,000 30,000 30,000 30,000 $32,500 2,500 1,500 $36,500 Amortization Rate 20% * 4/12 20% 20% 20% 20% 20% * 8/12 Amortization Expense $ 2,000 6,000 6,000 6,000 6,000 4,000 $30,000 Accumulated Amortization $ 2,000 8,000 14,000 20,000 26,000 30,000 Net Book Value $36,500 34,500 28,500 22,500 16,500 10,500 6,500 (2) Double declining-balance amortization Year Net Book Value (beginning of year) 2006 2007 2008 2009 2010 2011 $36,500 31,633 18,980 11,388 6,833 6,500 Amortization Rate 40% * 4/12 40% 40% 40% 40% 40% Amortization Expense $ 4,867 12,653 7,592 4,555 3331 $30,000 Accumulated Amortization $ 4,867 17,520 25,112 29,667 30,000 30,000 Net Book Value $36,500 31,633 18,980 11,388 6,833 6,500 6,500 Note that amortization in 2010 is limited to the amount that will bring the residual value to $6,500 Consequently, no further amortization is deducted in 2011 Solutions Manual 9-78 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-10 (Continued) (b) (Continued) (3) Units-of-activity amortization Year Units-of-Activity Amortizable Cost per Unit (see below) 2006 2007 2008 2009 2010 2011 15,000 45,000 50,000 45,000 35,000 10,000 $0.15 0.15 0.15 0.15 0.15 0.15 Amortization Expense Accumulated Amortization $ 2,250 6,750 7,500 6,750 5,250 1,500 $30,000 $ 2,250 9,000 16,500 23,250 28,500 30,000 Net Book Value $36,500 34,250 27,500 20,000 13,250 8,000 6,500 Note: $30,000 ÷ 200,000 = $0.15 per km (c) Impact on Cookie Creation Ltd.'s balance sheet and statement of earnings in 2006: Cost of asset Accumulated amortization Net book value Amortization expense Straight-Line $36,500 Double Declining-Balance $36,500 2,000 $34,500 4,867 $31,633 2,250 $34,250 $2,000 $4,867 $2,250 Units-of-Activity $36,500 The double declining-balance method of amortization will result in the lowest amount of earnings reported, the lowest amount of retained earnings and the lowest net book value of the asset reported The straight line method of amortization will result in the greatest amount of earnings reported, the greatest amount of retained earnings and the greatest net book value of the asset reported (d) Over the van's five year useful life the total amortization will be $30,000 under each of Solutions Manual 9-79 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition the methods The impact will affect the timing of the amortization expense recognized each year only (e) The choice of amortization method will not affect the cash flow A reduction in cash flow occurs with the initial purchase of the van Amortization is the systematic allocation of asset costs over the asset's useful life Solutions Manual 9-80 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition BYP 9-10 (Continued) (f) The units of activity method may provide Natalie with a more accurate assessment of usage of the van in relation to the amount of revenue earned As long as Natalie is willing to track the number of kilometres driven over the course of the year, then this would be the method recommended (g) Advantages of leasing the van: • Reduced risk of obsolescence The lease term can provide for replacing the van before it physically wears out • 100% financing There is no need to borrow and come up with a down payment on the purchase of the van (Down payments are usually up to 20% of purchase price) • Income tax advantages In some cases the entire amount of the lease payment may be deductible for tax purposes • Off-balance sheet financing If the lease is classified as an operating lease then both the asset and liability are not recorded on the balance sheet • • • Disadvantages of leasing the van: Natalie wishes to take out the back seat and install some shelves in the van Under a lease agreement this may not be possible Some lease agreements require a monthly minimum payment based upon mileage If the mileage is exceeded then an additional charge is added onto the monthly minimum Some lease agreements can prove to be more expensive in terms of cost of financing than borrowing from a bank Solutions Manual 9-81 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition Legal Notice Copyright Copyright © 2006 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd Solutions Manual 9-82 Chapter Copyright © 2006 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition EXERCISE 9-9 (a) Account Financial Statement Section Accumulated amortization.. .Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description... distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition PROBLEM 9-3B (a) Cost: Cash price Delivery costs Installation