6-1
ANSWERS TO QUESTIONS – CHAPTER 6
1. Long-term operational assets are those assets that are used by a business to generate
2. Tangible assets are those assets that have a physical existence. Some examples include
3. Specifically identifiable intangible assets are those assets that are purchased for a specific
value or have a known value. Examples include patents, leases, and copyrights. Intangible
4. Depreciation is the systematic allocation of the cost of property, plant and equipment to the
5. Natural resources are assets that are produced by nature. Some examples include oil,
6. Land is not a depreciable asset because land has an infinite life. Land is not destroyed by its
7. Amortization is the systematic allocation of the cost of intangible assets over their estimated
8. The historical cost concept requires that long-term operational assets be recorded at the
amount paid for them. This is the amount that will be shown on the balance sheet as long as
9. The cost of a building includes the amount paid for the building plus any amounts that are
10. A basket purchase of assets is the purchase of a group of assets for a single purchase price.
6-2
relative fair market value method. The fair market value of each asset is determined and
then its ratio to the total fair market value of all assets is applied to the total purchase price.
11. The life cycle of a long-term operational asset simply describes the process of acquiring,
12. Straight-line depreciation. This method allocates an equal amount of depreciation to each
period over the useful life of the asset. Example: Asset cost of $4,000 with a 4-year life and
no salvage value would produce a depreciation expense of $1,000 per year. This method is
appropriate when the usefulness of an asset is consistent over the asset‘s life.
called double–declining balance because the method applies twice the straight-line rate to the
book value of the asset.
Example: Asset cost of $4,000 with an estimated useful life of 4 years would produce an
expense of $2,000 in the first year [$4,000 x (2 x .25)]. The amount of depreciation expense
13. Recognition of depreciation expense reduces total assets; while the asset account
14. The recognition of depreciation expense does not affect cash flows. Depreciation
15. Total assets will be lower at the end of the first year of the asset’s life if MalMax chooses the
double-declining balance method of computing depreciation rather than straight-line. This
16. When the total cost of an asset is expensed in the year acquired, total expense will be
6-3
17. Salvage value is the estimated value of a plant asset at the end of its useful life to the
business.
18. Accumulated depreciation is a contra asset account. As the cost of a plant asset is expensed,
a contra asset account is credited, rather than a direct reduction of the related asset account.
19. Book value of an asset is its historical cost less any accumulated depreciation.
20. Recording the depreciation recognized in the contra asset account allows the total cost of the
asset and the total amount expensed to be shown in the accounts and on the balance sheet.
21. Book value is computed as the cost of the equipment less the accumulated depreciation of
that equipment, $5,000 − $3,000 = $2,000. This does not represent the fair market value of
22. The method of depreciation chosen for a particular piece of equipment should represent
as closely as possible the pattern of its usage of that piece of equipment. For instance,
23. When an asset is purchased and put into service, an estimate is made of the expected
useful life of the asset. However, as the asset is used, it may become apparent that the
estimate was incorrect or circumstances may have changed (e.g., the asset is used more
24. When an expenditure improves the quality of an asset, this improvement is accounted for as
if a new asset is purchased; the equipment account is debited. The improvement is
6-4
25. When a long-term operational asset is sold for a gain, total assets and equity increase by the
amount of the gain. The gain is the amount the asset is sold for over the book value of the
26. Depletion is the process of systematically allocating the cost of natural resources to expense
based on estimated production of the asset. The most common method used to calculate
27. Some of the most common intangible assets include patents, copyrights, and goodwill.
Amortization is generally based on the legal life of the asset, the useful life of the asset, or, in
28. Most countries have developed accounting principles that they apply to financial
statements. While there are many similarities, some significant differences do exist. For
29. The estimated useful life and salvage of an asset is determined based on the judgment and
estimation of the accountant or management. Because the length of time of actual use and
the actual value at disposal is not known, these amounts are based on the best judgment of
SOLUTIONS TO EXERCISES – CHAPTER 6
EXERCISE 6-1
Note: There are many possibilities for answers to this question. The answers given are only a
few examples of long-term operational assets that these companies may own. Also note that even
6-5
though the companies have very different business activities, they may have some of the same
kinds of long-term operational assets.
(a) Freds:
Buildings, Office Equipment, Cash Registers, Shelving, Land, etc.
(d) Harley-Davidson Co.:
Buildings, Land, Office Equipment, Manufacturing Equipment, etc.EXERCISE 6-2
Event
Long-Term Operational Asset
a.
No
b.
Yes
c.
Yes (If the company is in a business that uses or sells timber)
d.
Yes (As long as it is not held for investment purposes)
e.
Yes
f.
Yes
g.
No
h.
Yes
i.
Yes
j.
No
k.
No
l.
Yes
EXERCISE 6-3
No.
Tangible (T), Intangible (I)
a.
18-Wheel Truck
T
b.
Timber
T
c.
Log Loader
T
d.
Dental Chair
T
6-6
e.
Goodwill
I
f.
Computer Software
I
g.
Retail Store Building
T
h.
Shelving for Inventory
T
i.
Trademark
I
j.
Gas Well
T
k.
Drilling Rig
T
l.
FCC License for TV Station
I
EXERCISE 6-4
Costs that are to be capitalized:
List Price $160,000
Less: Discount (8,000)*
*$160,000 x 5% = $8,000
The operator salary and increase in insurance are operating expenses.
EXERCISE 6-5
b. % of* Purchase Allocated
Total Appraised Value App. Val. Price Cost
c. No, the historical cost concept requires that assets be recorded at the amount paid for them.
d.
Balance Sheet
Income Statement
Statemt. of
Assets
=
Liab.
+
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flows
Cash
+
Land
+
Bldg.
=
+
(800,000)
+
240,000
+
560,000
=
NA
+
NA
NA
−
NA
=
NA
(800,000) IA
6-7
EXERCISE 6-6
a.
Asset
Appraised Value
Percent of Appraised Value
Land
$200,000
25%
Building
480,000
60%
Equipment
120,000
15%
Total
$800,000
100%
Asset
% of App. Value
Purchase Price
Allocated Cost
Land
25%
x
$600,000
=
$150,000
Building
60%
x
600,000
=
360,000
Equipment
15%
x
600,000
=
90,000
Total
$600,000
b.
Assets
=
Equity
Rev.
−
Exp.
=
Net. Inc.
Cash Flow
Cash
+
Land
+
Building
+
Equip.
=
(600,000)
+
150,000
+
360,000
+
90,000
=
NA
NA
−
NA
=
NA
(600,000) IA
6-8
EXERCISE 6-7
a.
Balance Sheet
Income Statement
Statemt. of
Assets
=
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flows
Event
Cash
+
Equip.
−
A. Depr.
=
Com.
Stock
+
Ret.
Earn.
1.
20,000
NA
NA
20,000
NA
NA
NA
NA
20,000 FA
2.
(20,000)
20,000
NA
NA
NA
NA
NA
NA
(20,000) IA
3.
36,000
NA
NA
NA
36,000
36,000
NA
36,000
36,000 OA
4.
(21,000)
NA
NA
NA
(21,000)
NA
21,000
(21,000)
(21,000) OA
5.
(6,000)
NA
NA
NA
(6,000)
NA
6,000
(6,000)
(6,000) OA
6.
NA
NA
3,0001
NA
(3,000)
NA
3,000
3,000)
NA
Bal.
9,000
+
20,000
−
3,000
=
20,000
+
6,000
36,000
30,000
6,000
9,000 NC
1(Cost − Salvage value) ÷ useful life = Depreciation expense per year
$20,000 − $5,000 = $15,000; $15,000 ÷ 5 = $3,000 per year
b. $3,000
d. No; depreciation expense is a non-cash activity.
6-9
EXERCISE 6-
Year 2 ($110,000 − $44,000) x (2 x .20) = $26,400
a.
Balance Sheet
Income Statement
Statemt. of
Assets
=
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flows
Event
2014
Cash
+
Equip.
−
A. Depr.
=
Com.
Stock
+
Ret.
Earn.
Issue
stock
120,000
NA
NA
120,000
NA
NA
NA
NA
120,000 FA
Pur.
Equip.
(110,000)
110,000
NA
NA
NA
NA
NA
NA
(110,000) IA
Rev.
85,000
NA
NA
NA
85,000
85,000
NA
85,000
85,000 OA
Depr.
Exp.
NA
NA
44,000
NA
(44,000)
NA
44,000
(44,000)
NA
Bal.
95,000
+
110,000
−
44,000
=
120,000
+
41,000
85,000
44,000
41,000
95,000 NC
Balance Sheet
Income Statement
Statemt. of
Assets
=
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flows
Event
2015
Cash
+
Equip.
−
A. Depr.
=
Com.
Stock
+
Ret.
Earn.
Bal.
95,000
110,000
44,000
120,000
41,000
Rev.
72,000
NA
NA
NA
72,000
72,000
NA
72,000
72,000 OA
Depr.
Exp.
NA
NA
26,400
NA
(26,400)
NA
26,400
(26,400)
NA
Bal.
167,000
+
110,000
−
70,400
=
120,000
+
86,600
72,000
−
26,400
=
45,600
72,000 NC
6-10
EXERCISE 6-8 (cont.)
Posey Company
Financial Statements
2014
2015
Income Statements for the Year Ended December 31
Service Revenue
$85,000
$72,000
Depreciation Expense
(44,000)
(26,400)
Net Income
$41,000
$45,600
Balance Sheets as of December 31
Assets
Cash
$ 95,000
$167,000
Equipment
110,000
110,000
Accumulated Depreciation
(44,000)
(70,400)
Total Assets
$161,000
$206,600
Stockholders’ Equity
Common Stock
$120,000
$120,000
Retained Earnings
41,000
86,600
Total Stockholders’ Equity
$161,000
$206,600
Statements of Cash Flows for the Year Ended December 31
Cash Flows From Operating Activities:
Inflow from Customers
$85,000
$ 72,000
Cash Flows From Investing Activities:
Outflow to Purchase Equipment
(110,000)
-0-
Cash Flows From Financing Activities:
Inflow from Stock Issue
120,000
-0-
Net Change in Cash
95,000
72,000
Plus: Beginning Cash Balance
-0-
95,000
Ending Cash Balance
$95,000
$167,000
6-11
EXERCISE 6-9
a.
1. Straight-Line Calculation:
2. Double-Declining Balance Calculation:
(Cost − Accumulated Depreciation) x (2 x Straight-Line Rate)
Straight-Line Rate = 1 5 = .20
Year 1 ($75,000 − $0) x (2 x .20) = $30,000
*Since the total depreciable cost is $60,000 ($75,000 − $15,000), the depreciation is
limited in Year 4 ($60,000 − $58,800).
b.
Metal Manufacturing
Statements Model
Balance Sheet
Income Statement
Stmt. of
Assets
=
Equity
Rev
−
Exp.
=
Net Inc.
Cash Flows
Cash
+
Book Value of Drill
Press
=
Ret. Ear.
(75,000)
+
75,000
=
NA
NA
−
NA
=
NA
(75,000) IA
Straight-Line Depreciation
NA
+
(12,000)
=
(12,000)
NA
−
12,000
=
(12,000)
NA
DDB Depreciation
NA
+
(30,000)
=
(30,000)
NA
−
30,000
=
(30,000)
NA
EXERCISE 6-10 Double-Declining Balance
(Cost − Accum. Depr.) x (2 x SL Rate) = Depr. Exp. Per Year
SL Rate = 1 5 = .20