Chapter 8: Operating Assets: Property, Plant and Equipment, and Intangibles
230. Refer to the information for Hu Corporation.
Required:
Calculate the following ratios for Hu for 2017.
A. Average life of property, plant, and equipment
B. Average age of property, plant, and equipment
C. What information do these ratios provide to investors and creditors?
ANSWER:
A.
Average Life = Property, Plant, and Equipment/Depreciation Expense
$1,737/$344 = 5.0 years
B.
Average Age = Accumulated Depreciation/Depreciation Expense
$696/$344 = 2.0 years
C.
The average life of the property plant and equipment tells us that the assets have a
total expected life of about 5.0 years. The average age of the property, plant, and
equipment tells us that the assets are about two years old. In comparing these two
ratios, one can see that these assets are about 40% through their useful life.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-12 – LO: 08-12
KEYWORDS:
Bloom’s: Analyzing
231. Refer to the information for Hu Corporation.
Required:
(1) Determine the book value of Hu’s property, plant and equipment at December 31, 2017 and 2016.
(2) What types of transaction(s) could have caused the change in book value of property, plant, and equipment during
2017?
ANSWER:
(1)
Book value at December 31, 2017
$12,684
Book value at December 31, 2016
$1,041
(2) The transactions that could cause the change in the book value of property, plant, and
equipment in 2017 would be mainly due to investments,acquisitions, depreciation and
disposals. By making a review of the statement of cash flows, the type of investments made
by Hu during 2017 could be better determined.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-071 – LO: 08-07
KEYWORDS:
Bloom’s: Analyzing
the decline in the asset’s usefulness. Some assets decline in usefulness more rapidly than
others, which causes management to select the best method for each asset.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Applying
232. Refer to the information for Hu Corporation.
Required:
(1) Which items on Hu’s balance sheet could be considered intangible assets? Explain the nature of each of these.
(2) Explain why it is important that Hu disclose the amounts expended on research and development each year.
ANSWER:
(1) Hu’s intangible assets are: music catalogues, copyrights, cable television and sports
franchises, brands, trademarks, and goodwill. Music catalogues are rights to play certain
music created by particular artists. Contracts give Hu the right to perform a particular act or
other right. Copyrights represent the right to use a published work. Cable television
franchises give Hu the right to use particular cable television rights. Goodwill is the amount
paid in excess of the fair market value of a company or business acquired.
(2) Amounts expended for research and development costs are not capitalized and reported as
assets because of the uncertainty of future benefits and the association of the benefits with
specific time periods. Since research and development costs are not reported on the balance
sheet, the company must justify its costs. Research and development costs appear on the
income statement. Investors need to be aware of these potential assets when analyzing
companies.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-09 – LO: 08-09
KEYWORDS:
Bloom’s: Applying
233. Refer to the information for Hu Corporation.
Required:
(1) Explain the impact on net income and cash flows of Hu using straight-line depreciation for financial reporting and
accelerated depreciation methods for income tax purposes.
(2) In the notes to the financial statements, Hu indicates that it uses different depreciation methods for different types of
plant and equipment assets. Explain why Hu might follow this policy.
ANSWER:
(1) Accelerated depreciation allows a company to save income taxes because depreciation is
considered a tax shield, i.e., more expense lowers taxes paid. Straight-line depreciation
creates the smallest expense in the early years of life, which causes net income to be higher.
A company prefers to use straight-line depreciation for financial reporting purposes, and an
accelerated depreciation method for tax purposes. The reduction in income taxes provides
additional cash flows since the amount paid for taxes will be less than if straight-line were
used. Depreciation itself does not use cash. The use of different methods for financial
reporting purposes as compared to tax purposes creates a deferred income tax liability on the
balance sheet.
(2) Depreciation is a cost allocation process whose purpose is to allocate the original
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
234. Music Company’s only asset as of January 1, 2016, was a copyright. During 2016, only the following three
transactions occurred:
Royalties earned from copyright use, $510,000 in cash
Cash paid for advertising and salaries, $62,500
Amortization, $50,000
Required:
1. What amount of income will Music report in 2016?
2. What is the amount of cash on hand at December 31, 2016?
3. Explain how the cash balance increased from zero at the beginning of the year to its year-end balance. Why does the
increase in cash not equal the income?
ANSWER:
1. 2016 income = $510,000 – $62,500 – $50,000 = $397,500
2. Cash on hand, December 31, 2016 = $510,000 – $62,500 = $447,500
3. Cash increased from revenue and decreased by cash expenses. The amount is different than
income for 2016 because amortization, like depreciation, is an expense but not a cash
outflow. The cost of long-term assets like a copyright is a cash out-flow when it is purchased.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-11 – LO: 08-11
KEYWORDS:
Bloom’s: Analyzing
Original cost, January 1, 2014
Less: Accumulated depreciation (2 years at $900 per year)
Book value, January 1, 2016
Plus: Major overhaul
Less: Residual value
Remaining depreciable amount.
Depreciation = Remaining Depreciable Amount/Remaining Life
Depreciation per Year = $12,200/10 years = $1,220
DIFFICULTY:
LEARNING OBJECTIVES:
FACC.PONO.13.08-07 – LO: 08-07
235. Gallery Manufacturing purchased, for cash, three large pieces of equipment. Based on recent sales of similar
equipment, the fair market values are as follows:
Piece 1 $250,000
Piece 2 $350,000
Piece 3 $450,000
Required:
1. What value is assigned to each piece of equipment if the equipment was purchased for (a) $510,000, (b) $710,000, and
(c) $810,000?
2. How does the purchase of the equipment affect total assets?
ANSWER:
1. Relative fair values:
$ 250,000
23.8%
350,000
33.3
450,000
42.9
$1,050,000
100.0%
Piece
1
2
3
23.8%
33.3%
42.9%
(a)
$510,000*
$121,380
$170,000
$218,790
(b)
710,000*
168,980
236,667
304,590
(c)
810,000*
192,780
270,000
347,490
* Rounding of percentages results in values that are not equal to the total purchase price.
2. The purchase does not affect total assets; it affects only the composition of the assets.
Cash is a current asset; equipment is a long-term asset.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-04 – LO: 08-04
KEYWORDS:
Bloom’s: Analyzing
LEARNING OBJECTIVES:
FACC.PONO.13.08-12 – LO: 08-12
KEYWORDS:
Bloom’s: Analyzing
237. Burgess Company purchased an asset on January 1, 2014, for $10,000. The asset was expected to have a ten-year life
and a $1,000 salvage value. The company uses the straight-line method of depreciation. On January 1, 2016, the company
determines that the asset will last only five more years. Calculate the amount of depreciation for 2016.
ANSWER:
Depreciation for 2014 and 2015:
($10,000 – $1,000)/10 years =
$900 per year × 2 yrs =
$ 1,800
Depreciation for 2016:
Remaining depreciable amount
$8,200 – $1,000 =
$ 7,200*
Divided by remaining life
÷ 5 years
Depreciation
$1,440
*Acquisition Cost, Jan. 1, 2014
$10,000
Less: Accum. Deprec. (2 yrs × $900)
1,800
Book Value Jan. 1, 2016
$ 8,200
Less Residual Value
1,000
Remaining depreciable amount
$ 7,200
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-06 – LO: 08-06
KEYWORDS:
Bloom’s: Analyzing
238. At December 31, 2016, Ashland Company has the following amounts on its financial statements:
Property, plant, and equipment
$10,000
Accumulated depreciation
5,000
Total assets at January 1, 2016
30,000
Total assets at December 31, 2016
40,000
Net sales
62,000
Depreciation expense
1,000
Based on this information, calculate the following ratios:
(1) Average life of the assets
(2) Average age of the assets
(3) Asset turnover
ANSWER:
(1) Average Life of the Assets = Property, Plant, and Equipment/Depreciation Expense =
$10,000/$1,000 = 10 years
(2) Average Age of the Assets = Accumulated Depreciation/Depreciation Expense =
$5,000/$1,000 = 5 years
(3) Asset Turnover = Sales/Average Total Assets
Average Total Assets = ($30,000 + $40,000)/2 = $35,000
Asset Turnover = $62,000/$35,000 = 1.77
DIFFICULTY:
Moderate
243. You have just received an email from the new staff person, Jennifer Lark. She has just started working in the Fixed
Assets Department of your company. She would like to know under what circumstances should she capitalize interest as
part of the cost of an asset. In a brief memo, explain the issues to Ms. Lark.
ANSWER:
INTERNAL MEMORANDUM
TO: Ms. Jennifer Lark, Fixed Asset Department
FROM: (student name)
DATE: xxx
Generally, interest on borrowed money should be treated as an expense of the period. If our
company buys an asset and borrows money to finance the purchase, the interest on the
borrowed money is not considered part of the asset’s cost. Therefore, interest is treated as a
period cost and should appear on the income statement as interest expense in the period
incurred. There is one exception to this general guideline. If our company constructs an asset
over a period of time and borrows money to finance the construction, the interest incurred
during the construction period is not treated as interest expense. Instead, the interest is
included as part of the acquisition cost of the asset.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-04 – LO: 08-04
KEYWORDS:
Bloom’s: Applying
244. What is the relationship between the depreciation method chosen and income taxes paid in the early years? Explain.
ANSWER:
The depreciation method chosen for tax purposes should be the method that creates the
largest depreciation expense and thus the least taxable income. In turn, this would mean less
taxes would be paid.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Understanding
245. Marrow Company has a large portion of its plant assets concentrated in an area where technology is changing
rapidly. Marrow wants to minimize taxable income and maximize net income reported to stockholders. Recommend a
course of action for Marrow. Support your recommendation.
ANSWER:
When technology is changing rapidly, more cost should be allocated during the early years of
life when the plant asset is more productive. This is achieved by using an accelerated
depreciation method like MACRS or double-declining-balance. These methods create a
larger expense in the early years of life and reduce the income for the period, which reduces
the amount of taxes paid. A company should select the method for financial reporting that
maximizes net income such as straight-line, and the method that creates the lowest taxes for
tax reporting such as MACRS.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Applying
246. River Company wants to minimize the amount of time and effort its bookkeepers spend on calculating depreciation.
Since River has not been profitable, taxes are not an issue, but maximizing the profit and minimizing reported losses are
major concerns. Recommend a course of action for River. Support your recommendation.
ANSWER:
River should use the straight-line method to minimize the time spent in calculating
depreciation. This method also creates the smallest expense in the early years of a plant
asset’s life and reports the largest amount of net income to please stockholders.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Applying
247. What is the relationship between the book value of a plant asset, the market value of the plant asset, and the salvage
value of a plant asset? Explain.
ANSWER:
The book value of a plant asset is the asset’s original cost less accumulated depreciation. The
amount of accumulated depreciation depends on the depreciation method chosen. The market
value of a plant asset is the amount for which the asset can be sold for on the market. Book
value does not follow the market value. The residual value of a plant asset is an estimate of
the amount for which the asset can be sold at the end of its useful life.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Understanding
248. Why do many companies use one method to calculate depreciation for the income statement developed for
stockholders and another method for income tax purposes?
ANSWER:
Companies may use one method of depreciation for financial reporting and another method
for tax purposes because the objectives are different. The accountant’s purpose in recording
depreciation for financial reporting purposes is to allocate the original cost of the asset to the
periods benefited in a manner that matches the decline in usefulness of the asset. The
accountant’s purpose in recording depreciation for tax purposes is to minimize the amount of
income tax that must be paid.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
KEYWORDS:
Bloom’s: Understanding
249. Explain by what processes the costs of operating assets are allocated to expense.
ANSWER:
There are two categories of operating assets that require different allocation procedures.
Tangible plant assets are allocated using one of several different depreciation methods, while
intangible assets are allocated to accounting periods using straight-line amortization.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-05 – LO: 08-05
FACC.PONO.13.08-10 – LO: 08-10
KEYWORDS:
Bloom’s: Understanding
250. Distinguish between capital and revenue expenditures.
ANSWER:
Capital expenditures are added to the acquisition cost of a plant asset because they either
extend the useful life or make the asset more productive. Revenue expenditures are reported
on the income statement as expenses.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.08-07 – LO: 08-07
KEYWORDS:
Bloom’s: Understanding
251. What impact does materiality have on the determination of how a cost related to a plant asset is reported on the
financial statements?
ANSWER:
When an expenditure is incurred, a determination must be made as to whether the cost is a
capital or revenue expenditure. Capital expenditures are reported as assets, whereas revenue
expenditures are reported as expenses. If the dollar amount of the expenditure is small, the
cost of accounting for the item as a capital expenditure (and subsequent depreciation) may
outweigh the benefits. A company may create a company policy that treats expenditures
below a certain amount as expenses.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-07 – LO: 08-07
KEYWORDS:
Bloom’s: Understanding
252. How are research and development costs reported in the financial statements? Why is this treatment required?
ANSWER:
Research and development costs should be expensed immediately in the period incurred
because of the uncertainty of predicting whether any future benefits will result and in
determining which accounting period the benefits will impact.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-09 – LO: 08-09
KEYWORDS:
Bloom’s: Understanding
253. How does goodwill arise? How is it accounted for and reported on the financial statements?
ANSWER:
Goodwill arises when a company purchases a business and the amount of the purchase price
paid exceeds the market value of the individual net assets at the time of purchase. It is
reported as an intangible asset on the balance sheet at historical cost. Periodically, goodwill is
assessed for impairment. It has an indefinite life and should not be amortized.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-09 – LO: 08-09
FACC.PONO.13.08-10 – LO: 08-10
KEYWORDS:
Bloom’s: Understanding
254. Mega Industries has an intangible asset is being amortized over a ten-year time period. However, a competitor has
just introduced a new product that will have a serious negative impact on the asset’s value. Should the company continue
to amortize the intangible asset over the ten-year life? Explain.
ANSWER:
If an intangible becomes worthless, the asset should be written off as an expense in the period
when the decline in value occurs. If the intangible continues to have value but will provide
benefit over a period shorter than was originally estimated, the event should be treated as a
change in estimate. The portion of the intangible that is unamortized should be amortized
over the remaining life of the asset.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-10 – LO: 08-10
KEYWORDS:
Bloom’s: Applying
255. Relative to plant assets, how can a company report a net loss for a period, and yet still have positive cash flows from
operating activities?
ANSWER:
A company can report a net loss for the period and still have a positive cash flow from
operating activities because of the noncash expense items that may be reported on the income
statement. Two of these items, depreciation and amortization, are added back to net income
because they did not involve a cash outflow, but still reduced the amount of net income
reported.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-11 – LO: 08-11
KEYWORDS:
Bloom’s: Understanding
256. A statement of cash flows reports property, plant, and equipment transactions.
A.
What are the effects of acquisitions of plant assets on the statement of cash flows?
B.
In which section of the statement of cash flows are cash flows from sales of plant assets reported?
C.
How is depreciation reported on the statement of cash flows? Why?
ANSWER:
A.
Additions are reported as investing activities. The cash paid to acquire these assets is
reported as a deduction in the investing activities category.
B.
Investing Activities category
C.
Depreciation is not an actual cash flow, but it is an expense on the income statement
that does not require the use of cash. When a statement of cash flows is prepared using
the indirect method, depreciation expense will be added back in the operating
activities category since this expense was subtracted in arriving at net income, but it
did not require the use of cash.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.08-11 – LO: 08-11
KEYWORDS:
Bloom’s: Understanding
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
257. Explain the meaning or significance of the following ratios:
A.
Average life of property, plant, and equipment
B.
Average age of property, plant, and equipment
ANSWER:
A.
The average life indicates how many years of useful life the company expects
from the asset.
B.
The average age indicates how old the plant assets are.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.08-12 – LO: 08-12
KEYWORDS:
Bloom’s: Understanding