spiceland sm ch11.pdf

7/25/2019 Spiceland SM ch11.pdf

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The McGraw-Hill Companies, Inc., 2007

Solutions Manual, Vol.1, Chapter 11 11-1

Question 11-1The 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 theyrefer to different types of operational assets; depreciation for plant and equipment, depletion fornatural resources, and amortization for intangibles.

Question 11-2

The term depreciation often is confused with a decline in value or worth of an assetDepreciation is not measured as decline in value from one period to the next. Instead, it involves thedistribution of the cost of an asset, less any anticipated residual value, over the asset's estimateduseful life in a systematic and rational manner that attempts to match revenues with the use of theasset.

Question 11-3The 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:1. Service (useful) life The estimated use that the company expects to receive from the asset.2. Allocation base The value of the usefulness that is expected to be consumed.

3. Allocation method The pattern in which the usefulness is expected to be consumed.

Question 11-4Physical 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 maybe less than physical life for several reasons. For example, the expected rate of technologicachanges may shorten service life. Management intent also may shorten the period of an assetsusefulness below its physical life. For instance, a company may have a policy of using its deliverytrucks 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 assets service life is called itsdepreciable base. This amount is the difference between the initial value of the asset at itsacquisition (its cost) and its residual value. Residual or salvage value is the amount the companyexpects to receive for the asset at the end of its service life less any anticipated disposal costs.

Chapter 11 Operational Assets: Utilization andImpairment

QUESTIONS FOR REVIEW OF KEY TOPICS
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11-2 Intermediate Accounting, 4/e

Answers to Questions (continued)

Question 11-6Activity-based allocation methods estimate service life in terms of some measure of

productivity. Periodic depreciation or depletion is then determined based on the actual productivitygenerated by the asset during the period. Time-based allocation methods estimate service life inyears. Periodic depreciation or amortization is then determined based on the passage of time.

Question 11-7The straight-line depreciation method allocates an equal amount of depreciable base to each

year of an assets service life. Accelerated depreciation methods allocate higher portions ofdepreciable base to the early years of the assets life and lower amounts of depreciable base to lateryears. Total depreciation is the same by either approach.

Question 11-8

Theoretically, the use of activity-based depreciation methods would provide a better matchingof revenues and expenses. Clearly, the productivity of a plant asset is more closely associated withthe benefits provided by that asset than the mere passage of time. However, activity-based methodsquite often are either infeasible or too costly to use. For example, buildings do not have anidentifiable measure of productivity. For assets such as machinery, there may be an identifiablemeasure of productivity, such as machine hours or units produced, but it is more costly to determinethe amount each period than it is to simply measure the passage of time. For these reasons, mostcompanies use time-based depreciation methods.

Question 11-9Companies 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. Italso is the easiest method to understand and apply. The effect on net income also could explain whyso many companies prefer the straight-line method to the accelerated methods. Straight lineproduces a higher net income in the early years of an assets life. Net income can affect bonusespaid to management, or debt agreements with lenders. Income taxes are not a factor in determiningthe depreciation method because a company is not required to use the same depreciation method forboth financial reporting and income tax purposes.

Question 11-10The 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 dissimilaroperating assets, such as all of the depreciable assets in one manufacturing plant. Individual assetsin the composite may have diverse service lives. Both approaches are similar in that they involveapplying a single straight-line rate based on the average service lives of the assets in the group orcomposite.


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Answers to Questions (continued)

Question 11-11The 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 thepredominant method used to calculate depletion, not the time-based straight-line method.

Question 11-12The 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 tothe 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. Alsointangibles possess no physical life to provide an upper bound to service life. However, mosintangibles have a legal or contractual life that limits useful life. Intangible assets that have indefiniteuseful lives, including goodwill, are not amortized.

Question 11-13A 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 yearsexpense in the years of acquisition and disposal. This is known as the half-year convention. Themodified half-year convention records a full years expense when the asset is acquired in the firsthalf of the year or sold in the second half. No expense is recorded when the asset is acquired in thesecond half of the year or sold in the first half.

Question 11-14A 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 ofthe asset (book value at date of change less estimated residual value) over the revised remainingservice life.

Question 11-15A 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 wouldaccount for a change in estimate. One difference is that most changes in estimate do not require acompany to justify the change. However, this change in estimate is a result of changing anaccounting 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 sharealong with clear justification for changing depreciation methods.


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Answers to Questions (concluded)

Question 11-16If 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 areretrospectively restated to reflect the correction. Any account balances that are incorrect as a resultof the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, thecorrection is reported as a prior period adjustment to the beginning balance in the statement ofshareholders equity. In addition, a disclosure note is needed to describe the nature of the error andthe impact of its correction on net income, income before extraordinary item, and earnings per share.

Question 11-17An 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 intangibleswith 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 assets book value.The loss recognized is the amount by which the book value exceeds the fair value of the asset orgroup of assets when the fair value is readily determinable. If fair value is not determinable, it mustbe estimated. One method of estimating fair value is to compute the present value of estimatedfuture cash flows from the asset or group of assets.

For intangible operational assets other than goodwill, if book value exceeds fair value, animpairment loss is recognized for the differences. For goodwill, an impairment loss is indicated ifthe fair value of the reporting unit is less than its book value. A goodwill impairment loss ismeasured 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 isrecognized for the difference.

Question 11-18Repairs and maintenance are expenditures made to maintaina given level of benefits provided

by the asset and do not increase future benefits. Expenditures for these activities should beexpensed in the period incurred.

Additions involve adding a new major component to an existing asset. These expendituresusually are capitalized.

Improvements are expenditures for the replacement of a major component of an operationalasset. 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 materialrearrangements should be capitalized if theyclearly increase future benefits.


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Brief Exercise 11-1

Depreciation is a process of cost allocation, not valuation. Koeplin should notrecord depreciation expense of $18,000 for year one of the machines life. Instead, ishould distribute the cost of the asset, less any anticipated residual value, over theestimated useful life in a systematic and rational manner that attempts to matchrevenues with the useof the asset, not the periodic decline in its value.

BRIEF EXERCISES


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Brief Exercise 11-2

a. Straight-line:

$30,000 - 2,000= $7,000per year

4 years

b. Sum-of-the-years digits:

Sum-of-the-digits is ([4 (4 + 1)] 2) = 10

2006 $28,000 x 4/10 = $11,200

2007 $28,000 x 3/10 = $ 8,400

c. Double-declining balance:

Straight-line rate is 25% (1 4 years) x 2 = 50% DDB rate

2006 $30,000 x 50% = $15,0002007 ($30,000 - 15,000) x 50% = $ 7,500

d. Units-of-production:

$30,000 - 2,000= $2.80 per unit depreciation rate

10,000 hours

2006 2,200 hours x $2.80 = $6,1602007 3,000 hours x $2.80 = $8,400


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Brief Exercise 11-3

a. Straight-line:

$30,000 - 2,000= $7,000per year

4 years

2006 $7,000 x 9/12 = $5,2502007 $7,000 x 12/12 = $7,000

b. Sum-of-the-years digits:


2006 $28,000 x 4/10 x 9/12 = $8,400

2007 $28,000 x 4/10 x 3/12 = $2,800+ $28,000 x 3/10 x 9/12 = 6,300

$9,100

c. Double-declining balance:


2006 $30,000 x 50% x 9/12 = $11,250

2007 $30,000 x 50% x 3/12 = $ 3,750+ ($30,000 15,000) x 50% x 9/12 = 5,625

$ 9,375or,2007 ($30,000 11,250) x 50% = $ 9,375


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Brief Exercise 11-4

Annual depreciation will equal the group rate multiplied by the depreciable baseof the group:

($425,000 40,000) x 18% = $69,300

Since depreciation records are not kept on an individual asset basis, dispositionsare recorded under the assumption that the book value of the disposed item exactlyequals any proceeds received and no gain or loss is recorded. Any actual gain or lossis implicitly included in the accumulated depreciation account.

Journal entry (not required):

Cash .............................................................................. 35,000Accumulated depreciation (difference) ........................... 7,000

Equipment(account balance)......................................... 42,000

Brief Exercise 11-5

$8,250,000Depletion per ton = = $2.75 per foot

3,000,000 cubic feet

2006 depletion = $2.75 x 700,000 feet = $1,925,0002007 depletion = $2.75 x 800,000 feet = $2,200,000


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Brief Exercise 11-6

Expenses for 2006 include:In-process R & D = $2,000,000Amortization of the patent = 400,000

Amortization of the developed technology* = 300,000Total $2,700,000

Goodwill is notamortized.

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 11-7Calculation of annual depreciation after the estimate change:

$9,000,000 Cost$320,000 Old annual depreciation ($8 million 25 years)x 2 years 640,000 Depreciation to date (2004-2005)

8,360,000 Undepreciated cost500,000 Revised residual value

7,860,000 Revised depreciable base18 Estimated remaining life- 18 years (20-2)

$ 436,667 2006 depreciation


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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 inthe depreciation method reflects a change in the (a) estimated future benefits from theasset, (b) the pattern of receiving those benefits, or (c) the companys knowledgeabout those benefits, and therefore the two events should be reported the same way.Accordingly, Robotics reports the change prospectively; previous financial statementsare not revised. Instead, the company simply employs the double-declining balancemethod from now on. The undepreciated cost remaining at the time of the changewould 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 anyfinancial statement line items and per share amounts affected for all periods reported.

Assets cost $9,000,000Accumulated depreciation to date* (640,000)Undepreciated cost, Jan. 1, 2006 $8,360,000

x 2/23 Double-declining balance depreciation for 2006 $ 726,957

*$8,000,000 25 = $320,000 x 2 years = $640,000

Remaining life is 23 years. Twice the straight-line rate is 2/23.


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Brief Exercise 11-9

If a material error is discovered in an accounting period subsequent to the periodin which the error is made, previous years financial statements that were incorrect asa result of the error are retrospectively restated to reflect the correction. Any accountbalances that are incorrect as a result of the error are corrected by journal entry. Ifretained earnings is one of the incorrect accounts, the correction is reported as a priorperiod adjustment to the beginning balance in the statement of shareholders equityIn addition, a disclosure note is needed to describe the nature of the error and theimpact of its correction on net income, income before extraordinary item, and earningsper share.

In this case, depreciation of $32,000 should have been $320,000 ($8,000,000

25 years). Therefore, 2004 income before tax is overstated by $288,000 ($320,000 32,000) and accumulated depreciation is understated by the same amount. Thefollowing journal entry is needed to record the error correction (ignoring income tax):

Retained earnings.......................................................... 288,000Accumulated depreciation ........................................ 288,000

Depreciation for 2006 would be $320,000.

Brief Exercise 11-10

Because the undiscounted sum of future cash flows of $28 million exceeds bookvalue of $26.5 million, there is no impairment loss.


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Because the undiscounted sum of future cash flows of $24 million is less thanbook value of $26.5 million, there is an impairment loss. The impairment loss is

calculated as follows:

Book value $26.5 millionFair value 21.0 millionImpairment loss $ 5.5 million


Recoverability: Because the book value of SCCs net assets of $42 millionexceeds fair value of $40 million, an impairment loss is indicated.

Determination of implied value of goodwill:Fair value of SCC $40 millionLess: Fair value of SCCs assets (excluding goodwill) 31 million

Implied goodwill $ 9 million

Measurement of impairment loss:

Book value of goodwill $15 millionLess: Implied value of goodwill 9 million

Impairment loss $ 6 million


Recoverability: Because the book value of SCCs net assets of $42 million is lessthan the fair value of $44 million, an impairment loss is notindicated.


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Annual maintenance on machinery, $5,400 - This is an example of normarepairs and maintenance. Future benefits are not increased; therefore theexpenditure should be expensed in the period incurred.

Remodeling of offices, $22,000 - This is an example of an improvement. Thecost of the remodeling should be capitalized and depreciated, either by (1)substitution, (2) direct capitalization of the cost, or (3) a reduction of accumulateddepreciation.

Rearrangement of the shipping and receiving area, $35,000 - This is an

example of a rearrangement. Because the rearrangement increased productivitythe cost should be capitalized and depreciated.

Addition of a security system, $25,000 - This is an example of an additionThe cost of the security system should be capitalized and depreciated.


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Exercise 11-11. Straight-line:

$33,000 - 3,000= $6,000 per year

5 years

2. Sum-of-the-years digits:

Year

Depreciable

Base X

Depreciation

Rate per Year = Depreciation2006 $30,000 5

15$10,000

2007 30,000 415

8,000

2008 30,000 315

6,000

2009 30,000 215

4,000

2010 30,000 115 2,000

Total $30,000

EXERCISES


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Exercise 11-1 (concluded)

3. Double-declining balance:

Straight-line rate of 20% (1 5 years) x 2 = 40% DDB rate.

Year

Book ValueBeginningof Year X

DepreciationRate per

Year = DepreciationBook ValueEnd of Year

2006 $33,000 40% $ 13,200 $19,8002007 19,800 40% 7,920 11,8802008 11,880 40% 4,752 7,1282009 7,128 40% 2,851 4,277

2010 4,277 * 1,277 * 3,000Total $30,000

* Amount necessary to reduce book value to residual value

4. Units-of-production:

$33,000 - 3,000= $.30 per mile depreciation rate

100,000 miles

Year

ActualMilesDriven X

DepreciationRate per

Mile = Depreciation

Book ValueEnd ofYear

2006 22,000 $.30 $6,600 $26,4002007 24,000 .30 7,200 19,2002008 15,000 .30 4,500 14,7002009 20,000 .30 6,000 8,700

2010 21,000 * 5,700 * 3,000Totals 102,000 $30,000

* Amount necessary to reduce book value to residual value


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$115,000 - 5,000= $11,000per year

10 years



2006 $110,000 x 10/55 = $20,0002007 $110,000 x 9/55 = $18,000



2006 $115,000 x 20% = $23,0002007 ($115,000 - 23,000) x 20% = $18,400

4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 10 years) x 1.5 = 15% rate

2006 $115,000 x 15% = $17,2502007 ($115,000 - 17,250) x 15% = $14,663


$115,000 - 5,000= $.50 per unit depreciation rate

220,000 units

2006 30,000 units x $.50 = $15,0002007 25,000 units x $.50 = $12,500


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$115,000 - 5,000

= $11,000per year10 years

2006 $11,000 x 3/12 = $ 2,7502007 $11,000 x 12/12 = $11,000


Sum-of-the-digits is {[10 (10 + 1)]/2} = 55

2006 $110,000 x 10/55 x 3/12 = $ 5,000

2007 $110,000 x 10/55 x 9/12 = $15,000+ $110,000 x 9/55 x 3/12 = 4,500

$19,500



2006 $115,000 x 20% x 3/12 = $5,750

2007 $115,000 x 20% x 9/12 = $17,250+ ($115,000 - 23,000) x 20% x 3/12 = 4,600

$21,850or,2007 ($115,000 - 5,750) x 20% = $21,850

4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 10 years) x 1.5 = 15% rate

2006 $115,000 x 15% x 3/12 = $ 4,313

2007 $115,000 x 15% x 9/12 = $12,937+ ($115,000 - 17,250) x 15% x 3/12 = 3,666

$16,603Or,


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2007 ($115,000 - 4,313) x 15% = $16,603


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$115,000 - 5,000= $.50 per unit depreciation rate

220,000 units

2006 10,000 units x $.50 = $ 5,0002007 25,000 units x $.50 = $12,500

Exercise 11-4Building depreciation:

$5,000,000 - 200,000= $160,000 per year

30 years

Building addition depreciation:

Remaining useful life from June 30, 2006 is 27.5 years.

$1,650,000= $60,000 per year

27.5 years

2006 $60,000 x 6/12 = $30,000

2007 $60,000 x 12/12 = $60,000


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Exercise 11-5Asset A:Straight-line rate is 20% (1 5 years) x 2 = 40% DDB rate

$24,000= $60,000 = Book value at the beginning of year 2

.40

Cost - (Cost x 40%) = $60,000.60Cost = $60,000Cost = $100,000

Asset B:Sum-of-the-digits is 36 {[8 (8 + 1)]2}

($40,000 - residual) x 7/36 = $7,000$280,000 - 7residual = $252,0007residual = $28,000

Residual = $4,000

Asset C:$65,000 - 5,000

= $6,000Life

Life = 10 years

Asset D:$230,000 - $10,000 = $220,000 depreciable base$220,000 10 years = $22,000 per year

Method used is straight-line.

Asset E:Straight-line rate is 12.5% (1 8 years) x 1.5 = 18.75% rate

Year 1 $200,000 x 18.75% = $37,500

Year 2 ($200,000 - 37,500) x 18.75% = $30,469


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Exercise 11-61. b2. b3. b

4. a

Exercise 11-7

Requirement 1

Asset CostResidual

ValueDepreciable

BaseEstimatedLife(yrs.)

Depreciationper Year

(straight line)Stoves $15,000 $3,000 $12,000 6 $2,000

Refrigerators 10,000 1,000 9,000 5 1,800Dishwashers 8,000 500 7,500 4 1,875

Totals $33,000 $4,500 $28,500 $5,675

$5,675Group depreciation rate = = 17.2% (rounded)

$33,000

Group life = $28,500

= 5.02 years (rounded)$5,675

Requirement 2To record the purchase of new refrigerators.

Refrigerators ................................................................. 2,700Cash .......................................................................... 2,700

To record the sale of old refrigerators.

Cash .............................................................................. 200Accumulated depreciation (difference) ............................ 1,300

Refrigerators ............................................................. 1,500


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Exercise 11-8

Requirement 1Cost of the equipment:

Purchase price $154,000Freight charges 2,000Installation charges 4,000

$160,000

Straight-line rate of 12.5% (1 8 years) x 2 = 25% DDB rate.

Year

Book ValueBeginning

of Year X

Depreciation

Rate per Year = Depreciation

Book Value

End of Year2006 $160,000 25% $ 40,000 $120,0002007 120,000 25% 30,000 90,0002008 90,000 25% 22,500 67,5002009 67,500 25% 16,875 50,6252010 50,625 * 5,000 45,6252011 45,625 * 5,000 40,6252012 40,625 * 5,000 35,6252013 35,625 * 5,000 30,625

Total $129,375

* Switch to straight-line in 2010:

Straight-line depreciation:

$50,625 - 30,625= $5,000 per year

4 years

Requirement 2For plant and equipment used in the manufacture of a product, depreciation is a

product cost and is included in the cost of inventory. Eventually, when the product issold, depreciation will be included in cost of goods sold.


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Exercise 11-9

Requirement 1$4,500,000

Depletion per ton = = $5.00 per ton900,000 tons

2006 depletion = $5.00 x 240,000 tons = $1,200,000

Requirement 2Depletion is part of product cost and is included in the cost of the inventory of

coal, just as the depreciation on manufacturing equipment is included in inventorycost. The depletion is then included in cost of goods sold in the income statement

when the coal is sold.


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Exercise 11-10

Requirement 1Cost of copper mine:

Mining site $1,000,000Development costs 600,000Restoration costs 303,939

$1,903,939

$300,000 x 25% = $ 75,000400,000 x 40% = 160,000600,000 x 35% = 210,000

$445,000 x .68301* = $303,939

*Present value of $1, n= 4, i = 10%

Depletion:$1,903,939

Depletion per pound = = $.1904 per pound10,000,000 pounds

2006 depletion = $.1904 x 1,600,000 pounds = $304,6402007 depletion = $.1904 x 3,000,000 pounds = $571,200

Depreciation:

$120,000 - 20,000Depreciation per pound = = $.01 per pound

10,000,000 pounds

2006 depreciation = $.01 x 1,600,000 pounds = $16,0002007 depreciation = $.01 x 3,000,000 pounds = $30,000

Requirement 2Depletion of natural resources and depreciation of assets used in the extraction ofnatural resources are part of product cost and are included in the cost of the inventoryof copper, just as the depreciation on manufacturing equipment is included ininventory cost. The depletion and depreciation are then included in cost of goods soldin the income statement when the copper is sold.


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Exercise 11-11

Requirement 1a. To record the purchase of a patent.

January 1, 2004Patent ............................................................................ 700,000

Cash .......................................................................... 700,000

To record amortization on the patent.

December 31, 2004 and 2005Amortization expense ($700,000 10 years) ..................... 70,000

Patent ........................................................................ 70,000

b. To record the purchase of a franchise.

2006

Franchise....................................................................... 500,000Cash .......................................................................... 500,000

c. To record research and development expenses.

2006Research and development expense .............................. 380,000

Cash .......................................................................... 380,000


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Year-end adjusting entries

Patent: To record amortization on the patent.

December 31, 2006Amortization expense (determined below) ........................ 112,000

Patent ........................................................................ 112,000

Calculation of annual amortization after the estimate change:($ in thousands)

$700 Cost$70 Old annual amortization ($700 10 years)

x 2 years 140 Amortization to date (2004-2005)560 Unamortized cost (balance in the patent account)

5 Estimated remaining life$112 New annual amortization

Franchise: To record amortization of franchise.

December 31, 2006Amortization expense($500,000 10 years)...................... 50,000

Franchise................................................................... 50,000

Requirement 2

Intangible assets:

Patent $448,000 [1]Franchise 450,000 [2]

Total intangibles $898,000

[1] $560,000 - 112,000


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[2] $500,000 - 50,000

Exercise 11-12To record the purchase of a patent.

January 2, 2006Patent ............................................................................ 500,000

Cash .......................................................................... 500,000

To record amortization of a patent for the year 2006.

Amortization expense ($500,000 8 years) ....................... 62,500Patent ........................................................................ 62,500

To record amortization of the patent for the year 2007.

Amortization expense ($500,000 8 years) ....................... 62,500Patent ........................................................................ 62,500

To record costs of successfully defending a patent infringement suit.

January, 2008Patent ............................................................................ 45,000

Cash .......................................................................... 45,000


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To record amortization of patent for the year 2008.

Amortization expense (determined below) ........................ 70,000Patent ........................................................................ 70,000

Calculation of revised annual amortization:($ in thousands)

$500 Cost$62.5 Old annual amortization ($500 8 years)

x 2 years 125 Amortization to date (2006-2007)

375 Unamortized cost (balance in the patent account)45 Add

420 New unamortized cost 6 Estimated remaining life(8 years 2 years)$ 70 New annual amortization

Exercise 11-13

($ in millions)Amortization expense (determined below) ........................ 2.5

Patent ........................................................................ 2.5

Calculation of annual amortization after the estimate change:$ in millions)

$9 Cost$1 Old annual amortization ($9 9 years)

x 4 years 4 Amortization to date (2002-2005)

5 Unamortized cost (balance in the patent account) 2 Estimated remaining life(6 years 4 years)$2.5 New annual amortization


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Exercise 11-14

Requirement 1

Depreciation expense(determined below) ......................... 3,088Accumulated depreciation - computer ....................... 3,088

Calculation of annual depreciation after the estimate change:

$40,000 Cost$7,200 Old annual depreciation ($36,000 5 years)

x 2 years 14,400 Depreciation to date (2004-2005)25,600 Undepreciated cost

900 Revised residual value24,700 Revised depreciable base 8 Estimated remaining life(10 years - 2 years)

$ 3,088 New annual depreciation

Requirement 2

Depreciation expense(determined below) ......................... 3,889Accumulated depreciation - computer ....................... 3,889


$40,000 CostOld depreciation:

$12,000 2004 -($36,000 x 5/15)9,600 2005 - ($36,000 x 4/15)

21,600 Depreciation to date (2004-2005)18,400 Undepreciated cost

900 Revised residual value17,500 Revised depreciable basex 8/36 Estimated remaining life- 8 years

$ 3,889 2006 depreciation


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Exercise 11-15SYD depreciation

[10+9+8 x ($1.5 - .3) million] = $589,09155

$1,500,000 Cost

589,091 Depreciation to date, SYD (2003 - 2005)910,909 Undepreciated cost as of 1/1/06300,000 Less residual value610,909 Depreciable base 7 yrs. Remaining life (10 years - 3 years)


Adjusting entry (2006 depreciation):

Depreciation expense (calculated above)........................... 87,273Accumulated depreciation ......................................... 87,273


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Exercise 11-16

Requirement 1In general, we report voluntary changes in accounting principles retrospectively

However, a change in depreciation method is considered a change in accountingestimate resulting from a change in accounting principle. In other words, a change inthe depreciation method reflects a change in the (a) estimated future benefits from theasset, (b) the pattern of receiving those benefits, or (c) the companys knowledgeabout those benefits, and therefore the two events should be reported the same way.Accordingly, Clinton reports the change prospectively; previous financial statementsare not revised. Instead, the company simply employs the straight-line method fromnow on. The undepreciated cost remaining at the time of the change would bedepreciated straight-line over the remaining useful life. A disclosure note should

justify that the change is preferable and describe the effect of the change on anyfinancial statement line items and per share amounts affected for all periods reported.

Requirement 2

Assets cost $2,560,000Accumulated depreciation to date (given) (1,650,000)Undepreciated cost, Jan. 1, 2006 $ 910,000Estimated residual value (160,000)To be depreciated over remaining 3 years $ 750,000

3 yearsAnnual straight-line depreciation 2006-8 $ 250,000

Adjusting entry:

Depreciation expense (calculated above)............ 250,000Accumulated depreciation ............................. 250,000


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Exercise 11-17

Requirement 1Analysis:

Correct Incorrect(Should Have Been Recorded) (As Recorded)

2003 Machine 350,000 Expense 350,000Cash 350,000 Cash 350,000

2003 Expense 70,000 Depreciation entry omittedAccum. deprec. 70,000

2004 Expense 70,000 Depreciation entry omitted

Accum. deprec. 70,000

2005 Expense 70,000 Depreciation entry omittedAccum. deprec. 70,000

During the three-year period, depreciation expense was understated by$210,000, but other expenses were overstated by $350,000, so net incomeduring the period was understated by $140,000, which means retainedearnings is currently understatedby that amount.

During the three-year period, accumulated depreciation was understated, andcontinues to be understated by $210,000.

To correct incorrect accountsMachine ........................................................... 350,000

Accumulated depreciation ($70,000 x 3 years) .. 210,000Retained earnings ($350,000 210,000) ............ 140,000

Requirement 2

Correcting entry:

Assuming that the machine had been disposed of, no correcting entry would berequired because, after five years, the accounts would show appropriatebalances.


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Exercise 11-18

Requirement 1Book value $6.5 million

Fair value 3.5 millionImpairment loss 3.0 million

Requirement 2Because the undiscounted sum of future cash flows of $6.8 million exceeds book

value of $6.5 million, there is no impairment loss.

Exercise 11-19

Requirement 1Determination of implied goodwill:Fair value of Centerpoint, Inc. $220 millionFair value of Centerpoints net assets (excluding goodwill) 200 millionImplied value of goodwill $ 20 million

Measurement of impairment loss:Book value of goodwill $50 millionImplied value of goodwill 20 million

Impairment loss $30million

Requirement 2Because the fair value of the reporting unit, $270 million, exceeds book value

$250 million, there is no impairment loss.


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Exercise 11-201. To record the replacement of the heating system.

Accumulated depreciation - building............................. 250,000Cash .......................................................................... 250,000

2. To record the addition to the building.

Building ........................................................................ 750,000Cash .......................................................................... 750,000

3. To expense annual maintenance costs.

Maintenance expense .................................................... 14,000Cash .......................................................................... 14,000

4. To capitalize rearrangement costs.

Machinery ..................................................................... 50,000Cash .......................................................................... 50,000


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Exercise 11-21

Requirement 1

Cash .............................................................................. 17,000Accumulated depreciation - lathe (determined below) ....... 56,250Loss on sale (difference).................................................. 6,750

Lathe(balance) ............................................................ 80,000

Accumulated depreciation:

$80,000 - 5,000Annual depreciation = = $15,0005 years

2002 $15,000 x 1/2 = $ 7,5002003 15,0002004 15,0002005 15,0002006 $15,000 x 1/4 = 3,750

Total $56,250


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Requirement 2

Cash .............................................................................. 17,000Accumulated depreciation - lathe (determined below) ....... 67,500

Gain on sale(difference) .............................................. 4,500Lathe(balance) ............................................................ 80,000

Accumulated depreciation:

Sum-of-the-digits is ([5 (5 + 1)]/2) = 15

2002 $75,000 x 5/15 x 6/12 = $12,500

2003 $75,000 x 5/15 x 6/12 = $12,500+ $75,000 x 4/15 x 6/12 = 10,000 22,500

2004 $75,000 x 4/15 x 6/12 = $10,000+ $75,000 x 3/15 x 6/12 = 7,500 17,500

2005 $75,000 x 3/15 x 6/12 = $ 7,500+ $75,000 x 2/15 x 6/12 = 5,000 12,500

2006 $75,000 x 2/15 x 3/12 = 2,500Total $67,500

Exercise 11-221. d2. b3. b

4. a


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Exercise 11-23

List A List B

g 1. Depreciation a. Cost allocation for natural resource.d 2. Service life b. Accounted for prospectively.f 3. Depreciable base c. When there has been a significant

decline in value.e 4. Activity-based method d. The amount of use expected from an operationa

asset.m 5. Time-based method e. Estimates service life in units of output.h 6. Double-declining balance f. Cost less residual value.j 7. Group method g. Cost allocation for plant and equipment.k 8. Composite method h. Does not subtract residual value from cost.a 9. Depletion i. Accounted for the same way as a change in

estimate.l 10. Amortization j. Aggregates assets that are similar.b 11. Change in useful life k. Aggregates assets that are physically unified.i 12. Change in depreciation method l. Cost allocation for an intangible asset.c 13. Write-down of asset m. Estimates service life in years.


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Exercise 11-24

1. d. Because 50% of the original estimate of quality ore was recovered during theyears 1997 through 2004, recorded depletion of $250,000 [50% x ($600,000 -

$100,000 salvage value)]. In 2005, the earlier depletion of $250,000 isdeducted from the $600,000 cost along with the $100,000 salvage value. Theremaining depletable cost of $250,000 will be allocated over the 250,000 tonsbelieved to remain in the mine. The $1 per ton depletion is then multipliedtimes the tons mined each year..

2. a. The cost should be amortized over the remaining legal life or useful life,whichever is shorter. In addition to the initial costs of obtaining a patent, legalfees incurred in the successful defense of a patent should be capitalized as part

of the cost, whether it was internally developed or purchased from an inventor.The legal fees capitalized then should be amortized over the remaining usefullife of the patent.

3. a. Given that the company paid $6,000,000 for net assets acquired with a fairvalue of $5,496,000, goodwill was $504,000. Under SFAS 142, Goodwill andOther Intangible Assets, purchased goodwill is not amortized but is testedannually for impairment.


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Exercise 11-25

Requirement 1

To record the acquisition of small tools.

2004Small tools ................................................................... 8,000

Cash .......................................................................... 8,000

To record additional small tool acquisitions.

2006Small tools .................................................................... 2,500

Cash .......................................................................... 2,500

To record the sale/depreciation of small tools.

2006Cash ............................................................................. 250Depreciation expense(difference).................................... 1,750

Small tools ................................................................ 2,000


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Requirement 2To record the acquisition of small tools.

2004Small tools ................................................................... 8,000

Cash .......................................................................... 8,000

To record the replacement/depreciation of small tools.

2006Depreciation expense ................................................... 2,500

Cash .......................................................................... 2,500

To record the sale of small tools.

2006Cash ............................................................................. 250

Depreciation expense ................................................ 250


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Problem 11-1

Requirement 1

Determine useful life:$200,000 depreciable base

= 20-year useful life$10,000 annual depreciation

Determine age of assets:$40,000 accumulated depreciation

= 4 years old$10,000 annual depreciation

Double-declining balance in 4th year of life:Year 1 (2003) $200,000 x 10% = $20,000Year 2 (2004) 180,000 x 10% = 18,000Year 3 (2005) 162,000 x 10% = 16,200Year 4 (2006) 145,800 x 10% = 14,580

Requirement 2

Depreciation expense (below) ..................... 20,000Accumulated depreciation .................... 20,000

$200,000 Cost30,000 Depreciation to date, SL 3 years (2003-2005)

$170,000 Undepreciated cost as of 1/1/06

Seventeen-year remaining life, or 1/17 x 2 = 2/17 = x $170,000 = $20,000

A disclosure note reports the effect of the change on net income and earningsper share along with clear justification for changing depreciation methods.

PROBLEMS


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Problem 11-2

Requirement 1Cord Company

ANALYSIS OF CHANGES IN PLANT ASSETSFor the Year Ending December 31, 2006

Balance Balance12/31/05 Increase Decrease 12/31/06

Land $ 175,000 $ 312,500 [1] $ -- $ 487,500Land improvements -- 192,000 -- 192,000Buildings 1,500,000 937,500 [1] -- 2,437,500Machinery and equipment 1,125,000 385,000 [2] 17,000 1,493,000Automobiles and trucks 172,000 12,500 24,000 160,500

Leasehold improvements 216,000 -- -- 216,000$3,188,000 $1,839,500 $41,000 $4,986,500

Explanations of Amounts:

[1] Plant facility acquired from King 1/6/06 allocation to Land and Building:Fair value 25,000 shares of Cord common

stock at $50 market price $1,250,000

Allocation in proportion to appraised values at date of exchange:

% ofAmount Total

Land $187,500 25Building 562,500 75

$750,000 100

Land $1,250,000 x 25% = $ 312,500Building $1,250,000 x 75% = 937,500

$1,250,000

[2] Machinery and equipment purchased 7/1/06:Invoice cost $325,000Delivery cost 10,000Installation cost 50,000

Total acquisition cost $385,000


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Problem 11-2 (continued)

Requirement 2Cord Company

DEPRECIATION AND AMORTIZATION EXPENSE

For the Year Ended December 31, 2006Land Improvements:

Cost $192,000Straight-line rate (1 12 years) x 8 1/3%Annual depreciation 16,000Depreciation on land improvements for 2006:(3/25 to 12/31/06) x 3/4 $ 12,000

Buildings:Book value, 1/1/06($1,500,000 - 328,900) $1,171,100

Building acquired 1/6/06 937,500Total amount subject to depreciation 2,108,600150% declining balance rate:

(1 25 years = 4% x 1.5) x 6% 126,516

Machinery and equipment:Balance, 1/1/06 $1,125,000Straight-line rate(1 10 years) x 10% 112,500

Purchased on 7/1/06 385,000

Depreciation for one-half year x 5% 19,250Depreciation on machinery and equipment for 2006 131,750

Automobiles and trucks:Book value, 1/1/06 ($172,000 - 100,325) $71,675

Deduct 1/1/06 book value of truck soldon 9/30 ($9,100 + 2,650) (11,750)

Amount subject to depreciation 59,925150% declining balance rate:(1 5 years = 20% x 1.5) x 30% 17,978

Automobile purchased 8/30/06 12,500Depreciation for 2006 (30% x 4/12) x 10% 1,250

Truck sold on 9/30/06 - depreciation (given) 2,650Depreciation on automobiles and trucks 21,878


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Problem 11-2 (concluded)

Leasehold improvements:Book value, 1/1/06 ($216,000 - 108,000) $108,000

Amortization period(1/1/06 to 12/31/10) 5 yearsAmortization of leasehold improvements for 2006 21,600Total depreciation and amortization expense for 2006 $313,744

Problem 11-3

Pell CorporationDEPRECIATION EXPENSE

For the Year Ended December 31, 2006

Land improvements:Cost $ 180,000Straight-line rate (1 15 years) x 6 2/3% $ 12,000

Building:Book value 12/31/05 ($1,500,000 - 350,000) $1,150,000150% declining balance rate:

(1 20 years = 5% x 1.5) x 7.5% 86,250

Machinery and Equipment:Balance, 12/31/05 $1,158,000Deduct machine sold (58,000) $1,100,000Straight-line rate(1 10 years) x 10% 110,000

Purchased 1/2/06 287,000Depreciation x 10% 28,700

Machine sold 3/31/06 58,000Depreciation for three months x 2.5% 1,450

Total depreciation on machinery and equipment 140,150

Automobiles:Book value on 12/31/05 ($150,000 - 112,000) $38,000150% declining balance rate:

(1 3 years = 33.333% x 1.5) x 50% 19,000Total depreciation expense for 2006 $257,400


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Problem 11-41. Depreciation for 2004 and 2005.

December 31, 2004Depreciation expense ($48,000 8 years x 9/12)................. 4,500

Accumulated depreciation - equipment ..................... 4,500

December 31, 2005Depreciation expense ($48,000 8 years) ......................... 6,000


2. The year 2006 expenditure.

January 4, 2006Repair and maintenance expense................................... 2,000Equipment..................................................................... 10,350

Cash .......................................................................... 12,350

3. Depreciation for the year 2006.

December 31, 2006Depreciation expense (determined below) ......................... 5,800



$ 48,000 Cost10,500 Depreciation to date ($4,500 + $6,000)37,500 Undepreciated cost10,350 Asset addition47,850 New depreciable base

8 1/4 Estimated remaining life(10 years - 1 3/4 years)


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Problem 11-5(1) $65,000

Allocation in proportion to appraised values at date of exchange:

% ofAmount Total

Land $72,000 8Building 828,000 92

$900,000 100

Land $812,500 x 8% = $ 65,000Building $812,500 x 92% = 747,500

$812,500(2) $747,500

(3) 50 years $747,500 - 47,500

$14,000 annual depreciation

(4) $ 14,000 Same as prior year, since method used is straight-line.

(5) $ 85,400 3,000 shares x $25 per share = $75,000Plus demolition of old building 10,400

$85,400

(6) None No depreciation before use.(7) $ 16,000 Fair market value.

(8) $ 2,400 $16,000 x 15% (1.5 x Straight-line rate of 10%).

(9) $ 2,040 ($16,000 - 2,400) x 15%.

(10) $ 99,000 Total cost of $110,000 - $11,000 in normal repairs.

(11) $ 17,000 ($99,000 - 5,500) x 10/55.

(12) $ 5,100 ($99,000 - 5,500) x 9/55 x 4/12.

(13) $ 30,840 PVAD = $4,000 (7.71008 *)* Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)

(14) $ 2,056 $30,840


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15 years

Problem 11-6

Requirement 1

Building:

$500,000= $20,000 per year x 9/12 = $15,000

25 years

Machinery:

$240,000 - (10% x $240,000)

= $27,000 per year x 9/12 = $20,2508 years

Equipment:

Sum-of-the-digits is ([6 (6 + 1)]2) = 21

($160,000 - 13,000) x 6/21 = $42,000 x 9/12 = $31,500

Requirement 2

(1)

June 29, 2007Depreciation expense (determined below) ......................... 5,625

Accumulated depreciation - machinery ..................... 5,625

$100,000 - (10% x $100,000)

= $11,250 x 6/12 = $5,6258 years


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(2)

June 29, 2007Cash .............................................................................. 80,000Accumulated depreciation - machinery (below) .............. 14,063Loss on sale of machinery(difference)............................. 5,937

Machinery ................................................................. 100,000

Accumulated depreciation on machinery sold:

2006 depreciation = $11,250 x 9/12 = $ 8,438

2007 depreciation = $11,250 x 6/12 5,625Total $14,063

Requirement 3Building:

$500,000= $20,000

25 years

Machinery:

$140,000 - (10% x $140,000)= $15,750

8 years

Equipment:

($160,000 - 13,000) x 6/21 = $42,000 x 3/12 = $10,500

+ ($160,000 - 13,000) x 5/21 = $35,000 x 9/12 = 26,250$36,750


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Problem 11-7

Requirement 1Cost of mineral mine:

Purchase price $1,600,000Development costs 600,000

$2,200,000

Depletion:

$2,200,000 - 100,000Depletion per ton = = $5.25 per ton

400,000 tons

2006 depletion = $5.25 x 50,000 tons = $262,500

2007 depletion:Revised depletion rate = ($2,200,000 - 262,500) - 100,000

= $4.20487,500 - 50,000 tons

2007 depletion = $4.20 x 80,000 tons = $336,000

Depreciation:

Structures:$150,000

Depreciation per ton = = $.375 per ton400,000 tons

2006 depreciation = $.375 x 50,000 tons = $18,750

2007 depreciation:Revised depreciation rate = $150,000 - 18,750

= $.30487,500 - 50,000 tons



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Equipment:$80,000 - 4,000

Depreciation per ton = = $.19 per ton400,000 tons


2007 depreciation:Revised depreciation rate = ($80,000 - 9,500) - 4,000

= $.152487,500 - 50,000 tons


Requirement 2Mineral mine:Cost $ 2,200,000Less accumulated depletion:

2006 depletion $262,5002007 depletion 336,000 598,500

Book value, 12/31/07 $1,601,500

Structures:Cost $ 150,000Less accumulated depreciation:

2006 depreciation $18,7502007 depreciation 24,000 42,750

Book value, 12/31/07 $107,250

Equipment:Cost $ 80,000Less accumulated depreciation:

2006 depreciation $ 9,5002007 depreciation 12,160 21,660

Book value, 12/31/07 $58,340


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Requirement 3Depletion of natural resources and depreciation of assets used in the extraction of

natural resources are part of product cost and are included in the cost of the inventoryof the mineral, just as the depreciation on manufacturing equipment is included ininventory cost. The depletion and depreciation are then included in cost of goods soldin the income statement when the mineral is sold.

In 2006, since all of the ore was sold, all of 2006s depletion and depreciation isincluded in cost of goods sold. In 2007, since not all of the extracted ore was sold, aportion of both 2007s depletion and depreciation remains in inventory.


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Problem 11-8

Requirement 1

Calculation of goodwill:

Purchase price $2,000,000Less: Fair market value of net identifiable assets 1,700,000

$ 300,000

The cost of goodwill is not amortized.

To record amortization of patent.

Amortization ($80,000 8 years x 6/12) .............................. 5,000

Patent ........................................................................ 5,000

To record amortization of franchise.

Amortization expense ($200,000 10 years x3

/12)............. 5,000Franchise................................................................... 5,000


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Requirement 2Intangible assets:

Goodwill $300,000 [1]Patent 75,000 [2]Franchise 195,000 [3]

Total intangibles $570,000

[1] $300,000[2] $ 80,000 - 5,000[3] $200,000 - 5,000


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Problem 11-9

Requirement 1Machine 101:

$70,000 - 7,000= $6,300 per year x 3 years = $ 18,900

10 years

Machine 102:

$80,000 - 8,000= $9,000 per year x 1.5 years = 13,500

8 years

Machine 103:

$30,000 - 3,000= $3,000 per year x 4/12 = 1,000

9 years

Accumulated depreciation, 12/31/05 $33,400

Requirement 2To record depreciation on machine 102 through date of sale.

March 31, 2006Depreciation expense ($9,000 per year x 3/12).................... 2,250


To record sale of equipment.

March 31, 2006Cash .............................................................................. 52,500Accumulated depreciation ($13,500 + 2,250).................... 15,750Loss on sale of equipment (determined below).................. 11,750

Equipment................................................................. 80,000


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Loss on sale of machine 102:Proceeds $52,500Less book value on 3/31/06:

Cost $80,000Less accumulated depreciation:Depreciation through 12/31/05 $13,500Depreciation from 1/1/06 to

3/31/06 ($9,000 x 3/12) 2,250 15,750 64,250Loss on sale $11,750

Requirement 3Building:

Useful life of the building:

$200,000= $40,000 in depreciation per year

5 years(2001-2005)

$840,000 - 40,000= 20-year useful life

$40,000

To record depreciation on the building.

Depreciation expense[($840,000 - 40,000) 20 years] ........ 40,000Accumulated depreciation - building......................... 40,000


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To record depreciation on the equipment.

Depreciation expense (determined below) ......................... 15,775Accumulated depreciation - equipment ..................... 15,775

Equipment:Machine 103(determined above) $ 3,000Machine 101:

Cost $70,000Less: Accumulated depreciation 18,900Book value, 12/31/05 51,100Revised remaining life(7 years - 3 years) 4 years 12,775

$15,775


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Problem 11-10a. This is a change in estimate.

No entry is needed to record the change.

2006 adjusting entry:Depreciation expense (determined below) ........................ 37,500

Accumulated depreciation ........................................ 37,500


$1,000,000 Cost$25,000 Old depreciation ($1,000,000 40 years)x 3 yrs (75,000) Depreciation to date (2003-2005)

925,000 Undepreciated cost(700,000) New estimated salvage value225,000 New depreciable base

6 yrs. Estimated remaining life(6 years: 2006-2011)$ 37,500 New annual depreciation

A disclosure note should describe the effect of a change in estimate on incomebefore extraordinary items, net income, and related per-share amounts for the currentperiod.


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b. This is a change in accounting principle that is accounted for as a change inestimate.

Depreciation expense (below) ..................... 21,000Accumulated depreciation ............ 21,000

SYD2002 depreciation $ 60,000 ($330,000 x 10/55)

2003 depreciation 54,000 ($330,000 x 9/55)

2004 depreciation 48,000 ($330,000 x 8/55)

2005 depreciation 42,000 ($330,000 x 7/55)

Accumulated depreciation $204,000

$330,000 Cost204,000 Depreciation to date, SYD (above)126,000 Undepreciated cost as of 1/1/06

0 Less residual value126,000 Depreciable base 6 yrs. Remaining life (10 years - 4 years)


A disclosure note reports the effect of the change on net income and earningsper share along with clear justification for changing depreciation methods.

c. This is a change in accounting principle accounted for as a change in estimate.

Because the change will be effective only for assets placed in service after thedate of change, depreciation schedules do not require revision because the changedoes not affect assets depreciated in prior periods. A disclosure note still is requiredto provide justification for the change and to report the effect of the change on currentyears income.


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Problem 11-11

Requirement 1

Analysis:Correct Incorrect

(Should Have Been Recorded) (As Recorded)

2004 Equipment 1,900,000 Equipment 2,000,000Expense 100,000 Cash 2,000,000

Cash 2,000,000

2004 Expense 475,000 [1] Expense 500,000[2]Accum. deprec. 475,000 Accum. deprec. 500,000

2005 Expense 356,250 [3] Expense 375,000[4]Accum. deprec. 356,250 Accum. deprec. 375,000

[1]$1,900,000 x 25% (2 times the straight-line rate of 12.5%)[2]$2,000,000 x 25%[3]($1,900,000 - 475,000) x 25%[4]($2,000,000 - 500,000 ) x 25%

During the two-year period, depreciation expense was overstatedby $43,750,but other expenses were understatedby $100,000, so net income during theperiod was overstatedby $56,250, which means retained earnings is currentlyoverstatedby that amount.

During the two-year period, accumulated depreciation was overstated, andcontinues to be overstated by $43,750.

To correct incorrect accountsRetained earnings................................................ 56,250Accumulated depreciation ................................................... 43,750

Equipment....................................................... 100,000


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Requirement 2This is a change in accounting principle accounted for as a change in estimate.

No entry is needed to record the change.

2006 adjusting entry:

Depreciation expense (determined below).................. 178,125Accumulated depreciation ..................................... 178,125

A change in depreciation method is considered a change in accounting estimateresulting from a change in accounting principle. Accordingly, the Collins Corporationreports the change prospectively; previous financial statements are not revised.Instead, the company simply employs the straight-line method from now on. Theundepreciated cost remaining at the time of the change is depreciated straight-lineover the remaining useful life.

Assets cost (after correction) $1,900,000Accumulated depreciation to date ($475,000 + 356,250) (831,250)Undepreciated cost, Jan. 1, 2006 1,068,750Estimated residual value (0)

To be depreciated over remaining 6 years 1,068,750 6 yearsAnnual straight-line depreciation 2006-2011 $ 178,125


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Problem 11-12

Requirement 1Plant and equipment:Depreciation to date:

$150 million 10 years = $15 million per year x 3 years = $45 million

Book value: $150 million $45 million = $105 million

Patent:Amortization to date:

$40 million 5 years = $8 million per year x 3 years = $24 million

Book value: $40 million $24 million = $16 million

Requirement 2Tangible operational assets and finite life intangibles are tested for impairment

only when events or changes in circumstances indicate book value may not berecoverable.

Requirement 3Goodwill 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 reportingunit is below its book value.

Requirement 4Plant and equipment:An impairment loss is indicated because the book value of the assets, $105

million, is greater than the $80 undiscounted sum of future cash flows. The amount ofthe impairment loss is determined as follows:

Book value $105 millionFair value (60) millionImpairment loss 45 million

Patent:There is no impairment loss because the undiscounted sum of future cash flows,

$20 million, exceeds book value of $16 million.


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Goodwill:An impairment loss is indicated because the book value of the assets of the

reporting unit, $470 million, is greater than the $450 million fair value of the reportingunit. The amount of the impairment loss is determined as follows:

Determination of implied goodwill:Fair value of Ellison Technology $450 millionFair value of Ellisons net assets (excluding goodwill) (390) millionImplied value of goodwill $ 60 million

Measurement of impairment loss:Book value of goodwill $100 millionImplied value of goodwill (60) millionImpairment loss $40million


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Analysis Case 11-1The terms depreciation, depletion, and amortization all refer to the same process

of allocating the cost of an operational asset to the periods benefited by their use.However, each term is applied to a different type of operational asset; depreciation isused for plant and equipment, depletion for natural resources, and amortization forintangibles.

There are differences in determining the factors necessary to calculatedepreciation, depletion, and amortization but the concepts involved are the same. Theservice life of plant and equipment and natural resources is limited to physical lifewhile the service life of intangible assets is limited to the assets legal or contractuallife, or 40 years, whichever is shorter.

The majority of companies use straight-line depreciation and straight-lineamortization. Natural resources usually are depleted using the units-of-productionmethod.

CASES


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Communication Case 11-2Suggested Grading Concepts and Grading Scheme:

Content (70%)______ 50 Explains the concept of depreciation as a process of

cost allocation, not valuation._____ Rational match versus market fluctuations._____ Numerical example.

______ 10 Purpose of the balance sheet is to provide information aboutfinancial position, not to directly measure company value.

______ 10 Purpose of the income statement is to provide cash flowinformation, not to directly measure the changein company

value.____

______ 70 points

Writing (30%)______ 6 Terminology and tone appropriate to the audience of

a company president.

______ 12 Organization permits ease of understanding.

_____ Introduction that states purpose._____ Paragraphs that separate main points.

______ 12 English_____ Sentences grammatically clear and well organized,

concise._____ Word selection._____ Spelling._____ Grammar and punctuation.

____

______ 30 points


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Judgment Case 11-3

Requirement 1Portland should have selected the straight-line depreciation method when

approximately the same amount of an assets service potential is used up each period.If the reasons for the decline in service potential are unclear, then the selection of thestraight-line method could be influenced by the ease of recordkeeping, its use forsimilar assets, and its use by others in the industry.

Requirement 2a. By associating depreciation with a group of machines instead of each

individual machine, Portlands bookkeeping process is greatly simplified. Also, sinceactual machine lives vary from the average depreciable life, unrecognized net losses

on early dispositions are expected to be offset by continuing depreciation on machinesusable beyond the average depreciable life. Periodic income does not fluctuate as aresult of recognizing gains and losses on machine dispositions.

b. Portland should divide the depreciable base of each machine by its estimatedlife to obtain its annual depreciation. The sum of the individual annual depreciationamounts should then be divided by the sum of the individual capitalized costs toobtain the annual composite depreciation rate.


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Judgment Case 11-4

Requirement 1a. 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 purchaseprice, delivery, installation, testing, and setup.

b. The objective of depreciation accounting is to allocate the depreciable base ofan asset over its estimated useful life in a systematic and rational manner. Thisprocess matches the depreciable base of the asset with revenues generated from itsuse. Depreciable base is the capitalized cost less its estimated residual value.

Requirement 2The 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 matchedagainst the larger revenues generated in the earlier years. An accelerated depreciationmethod also would be appropriate when benefits derived from the asset areapproximately equal over the assets life, but repair and maintenance costs increasesignificantly in later years. The early years record higher depreciation expense andlower repairs and maintenance expense, while the later years have lower depreciationand higher repairs and maintenance.

Judgment Case 11-5There 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 criticalconsideration.

Information is material if it can have an effect on a decision made by users. Oneconsequence of materiality is that GAAP need be followed only if an item is material.The threshold for materiality will depend principally on the relativedollar amount ofthe transaction.

In this case, is the $70,000 material? Net-of-tax income would be $49,000 higherif the expenditures were capitalized instead of expensed [$70,000 x (1-.30)]. Thisrepresents 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 theexpenditures were capitalized. This represents an increase of less than one-half of onepercent. Would these differences have an effect on decision-makers? There is nosingle answer to this question. The FASB has been reluctant to establish anyquantitative materiality guidelines. The threshold for materiality has been left tosubjective judgment of the company preparing the financial statement and its auditors.


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Communication Case 11-6There 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. Theprocess of developing and synthesizing the arguments will likely be more beneficial

than any single solution. Each student should benefit from participating in theprocess, interacting first with his or her partner, then with the class as a whole. It isimportant that each student actively participate in the process. Domination by one ortwo individuals should be discouraged.

A significant benefit of this case is that it is forcing students to consider thesubjective nature of materiality when applying GAAP.


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Integrating Case 11-7

Requirement 1

a. ($ in millions)Inventory(understatement of 2007 beginning inventory) ........ 10

Retained earnings (understatement of 2006 income)......... 10

Note: The 2005 error requires no adjustment because it has self-corrected by 2007.

b.Retained earnings (2005-2006 patent amortization).............. 6

Patent [($18 million 6 years) x 2] ................................. 6

2007 adjusting entry:Patent amortization expense ($18 million 6 years) ......... 3Patent ...................................................................... 3

c.2007 adjusting entry:Depreciation expense(below) ........................................ 4

Accumulated depreciation ....................................... 4

($ in millions)

SYD2005 depreciation $10 ($30 x 5/15)

2006 depreciation 8 ($30 x 4/15)

Accumulated depreciation $18

$30 Cost18 Depreciation to date, SYD (above)12 Undepreciated cost as of 1/1/070 Less residual value

12 Depreciable base 3 yrs. Remaining life (5 years - 2 years)

$ 4 New annual depreciation


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Case 11-7 (concluded)

Requirement 2Shareholders Net

Assets Liabilities Equity Income Expenses2005 $640 $330 $310 $210 $1502005 inventory (12) (12) (12) 12Patent amortization (3) (3) (3) 3Depreciation no adjustments to prior years

____ ____ ____ ____ ____$625 $330 $295 $195 $165

2006 $820 $400 $420 $230 $175

2005 inventory 12 (12)2006 inventory 10 10 10 (10)Patent amortization (6) (6) (3) 3Depreciation no adjustments to prior years

____ ____ ____ ____ ____

$824 $400 $424 $249 $156


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Judgment Case 11-8

Requirement 1A 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 principlethat is accounted for as a change in estimate. Both the sum-of-the-years digitsmethod and the straight-line method are generally accepted. A change in accountingprinciple results from the adoption of a generally accepted accounting principledifferent from the generally accepted principle used previously for reporting purposes.

Requirement 2A 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 withcertainty. Estimates are an inherent part of the accounting process. Therefore,accounting and reporting for certain financial statement elements requires the exerciseof judgment, subject to revision based on experience.

Trueblood Accounting Case 11-9A solution and extensive discussion materials accompany each case in the

Deloitte & Touche Trueblood Case Study Series.


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Research Case 11-10

Requirement 1SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived

Assets, and SFAS No. 142, Goodwill and Other Intangible Assets, are the tworelevant accounts standards.

Requirement 2Tangible operational assets and finite life intangibles are tested for impairment

only when events or changes in circumstances indicate book value may not berecoverable.

Intangible assets with indefinite useful lives, including goodwill, should be testedfor 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 3Tangible 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 isrequired only when the undiscounted sum of estimated future cash flows from an assetis less than the assets book value. The measurement of impairment lossstep 2isthe difference between the assets 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 thangoodwill is a one-step process. We compare the fair value of the asset with its bookvalue. If book value exceeds fair value, an impairment loss is recognized for thedifference.

Goodwill:Determining whether to record an impairment loss and actually recording the loss

is a two-step process. Step 1 - A goodwill impairment loss is indicated when the fairvalue of the reportingunit is less than its book value. Step 2 - A goodwill impairmentloss is measured as the excess of the book value of the goodwill over its implied fairvalue. The implied fair value of goodwill is calculated in the same way that goodwillis determined in a business combination. That is, its a residual amount measured bysubtracting the fair value of all identifiable net assets from the purchase price usingthe units previously determined fair value as the purchase price.


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Requirement 4Operational 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 5An 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 isrecognized for any write-down to fair value less cost to sell.

14Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, Statement of Financial AccountingStandardsNo. 144 (Norwalk, Conn.: FASB, 2001), par. 30.


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Ethics Case 11-11

Requirement 12006 expense using CEO's approach:

$42,000,000 Cost$4,200,000 Old annual depreciation ($42,000,000 10 years)

x 2 years 8,400,000 Depreciation to date (2004-2005)33,600,000 Book value

3 Estimated remaining life(2006-2008)$11,200,000 New annual depreciation

2006 income would include only depreciation expense of $11,200,000.

2006 expense using Heather's approach:

$42,000,000 Cost$4,200,000 Old annual depreciation ($42,000,000 10 years)

x 2 years 8,400,000 Depreciation to date (2004-2005)33,600,000 Book value12,900,000 Write-down20,700,000 New depreciable base

3 Estimated remaining life(2006-2008)$ 6,900,000 New annual depreciation

2006 income would include depreciation expense of $6,900,000 and an asset write-down 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).


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Requirement 2Discussion should include these elements.

Facts:SFAS 144 provides guidance for recording impairment losses on partial write-

downs of operational assets remaining in use. Assets should be written down if therehas been a significant impairment of value such as in decreased product demand andfull recovery of book value through use or resale is not expected. Although thedecision and computation to record an impairment loss often is very subjective anddifficult to measure, Heather is able to estimate an equipment impairment of$12,900,000, presumably using the best information available. The simple revision inservice 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 effortto reflect a favorable net income?

Who is affected?

spiceland sm ch11.pdf

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