978-0078025549 Chapter 7 Solution Manual Part 1

Unlock access to all the studying documents.

View Full Document

Question 7-1 (LO 7-1)

WorldCom recorded assets on the balance sheet that should have been recorded as expenses

on the income statement. When WorldCom uses the telecommunication lines of another

Question 7-2 (LO 7-1)

The two major categories for long-term assets are (1) property, plant, and equipment and (2)

intangible assets. Property, plant, and equipment include land, land improvements, buildings,

7-3 (LO 7-1)

We initially record a long-term asset at its cost plus all expenditures necessary to get the asset

ready for use. Thus, the initial cost of a long-term asset might be more than just its purchase

Question 7-4 (LO 7-1)

Recording an expense incorrectly as an asset will overstate net income on the income

statement. If University Hero initially records an expense incorrectly as an asset, expenses are

understated or too small. Since expenses are subtracted from revenues in arriving at net income,

Question 7-5 (LO 7-1)

Costs Little King might incur to make the land ready for its intended use include the purchase

price plus closing costs such as fees for the attorney, real estate agent commissions, title, title

search, and recording. Little King also includes the cost of removing the old building as an

additional cost in making the land ready for its intended use. If any cash is received from selling

Question 7-6 (LO 7-1)

We don’t depreciate land because its service life never ends. Land improvements are

additional amounts spent to improve the land such as a parking lot, paving, temporary

Chapter 7

Long-Term AssetsREVIEW QUESTIONS

Question 7-7 (LO 7-1)

Costs we might incur to get equipment ready for use include sales tax, shipping, delivery,

Question 7-8 (LO 7-1)

We report natural resources on the balance sheet as part of property, plant, and equipment.

Question 7-9 (LO 7-2)

We value purchased intangible assets at their original cost plus all other costs, such as legal

and filing fees, necessary to get the asset ready for use. Reporting intangible assets developed

Question 7-10 (LO 7-2)

A patent is an exclusive right to manufacture a product or to use a process. A copyright is an

exclusive right of protection given to the creator of a published work, such as a song, film,

Question 7-11 (LO 7-2)

We record goodwill as an intangible asset on the balance sheet only when we purchase it as

part of the acquisition of another company. In this case, the acquiring company records goodwill

equal to the purchase price less the fair value of the net assets acquired. The fair value of the net

Question 7-12 (LO 7-3)

We capitalize a particular cost as an asset if it increases future benefits, whereas we expense a

Answers to Review Questions (continued)

Question 7-13 (LO 7-3)

We expense repairs and maintenance expenditures which maintain a given level of benefits,

in the period incurred. We capitalize as assets more extensive repairs that increase the future

benefits of the delivery truck, such as a new transmission or an engine overhaul. An addition

Question 7-14 (LO 7-3)

If a firm successfully defends an intangible right, it should capitalize the litigation costs and

amortize them over the remaining useful life of the related intangible. If the defense of an

Question 7-15 (LO 7-4)

The dictionary definition of depreciation is a decrease in value of an asset, whereas the

Question 7-16 (LO 7-4)

We must estimate the service life (also called useful life) of the asset as well as its residual

Question 7-17 (LO 7-4)

The service life tells how long the company expects to obtain benefits from the asset before

disposing of it. Under the straight-line method we determine service life in units of time. Under

Question 7-18 (LO 7-4)

Residual value, also referred to as salvage value, is the amount the company expects to

receive from selling the asset at the end of its service life. The allocation base is the asset’s cost

Question 7-19 (LO 7-4)

Straight-line creates an equal amount of depreciation each year. Double-declining-balance

Answers to Review Questions (continued)

Question 7-20 (LO 7-4)

Little King Sandwiches uses straight-line depreciation that creates an equal amount of

depreciation each year. In contrast, University Hero uses double-declining balance depreciation

that takes more depreciation in earlier years and less depreciation in later years. By taking more

Question 7-21 (LO 7-4)

University Hero depreciates over a shorter service life (20 years) and therefore will take more

depreciation expense per year. By taking more depreciation expense per year, University Hero

Question 7-22 (LO 7-4)

Most companies use the straight-line method for financial reporting and the Internal Revenue

Service’s prescribed accelerated method (called MACRS) for income tax purposes. Companies

choose straight-line for financial reporting for several reasons. Many probably believe they

Question 7-23 (LO 7-5)

No. Just as we don’t depreciate land because it has an unlimited life, we don’t amortize

intangible assets with unlimited useful lives such as goodwill and most trademarks. For most

other intangible assets that have a finite useful life, we allocate the asset’s cost less any estimated

Question 7-24 (LO 7-6)

Book value is the cost of the asset minus accumulated depreciation. We record a gain if we

Answers to Review Questions (continued)

Question 7-25 (LO 7-7)

Return on assets equals net income divided by average total assets. Return on assets indicates

the amount of net income generated for each dollar invested in assets. Profit margin equals net

Question 7-26 (LO 7-7)

Examples of high profit margin include companies that pursue a higher profit margin through

product differentiation and premium pricing. Apple and Saks Fifth Avenue are possible

*Question 7-27 (LO 7-8)

An asset impairment occurs when the future cash flows (future benefits) that we estimate a

long-term asset will generate, fall below its book value (cost minus accumulated depreciation).

Impairment is a two-step process. Step 1: Test for Impairment – the long-term asset is impaired if

*Question 7-28 (LO 7-8)

A big bath is when a company records all losses in one year to make a bad current year even

worse. By recording additional expenses in the current year, management is able to report higher

BRIEF Exercises

Brief Exercise 7-1 (LO 7-1)

Purchase price of land (and warehouse to be removed) $490,000

Broker’s commission 29,000

Brief Exercise 7-2 (LO 7-1)

Purchase price $30,000

Freight 2,000

Installation 4,000

Testing 1,500

The $600 property tax is a recurring cost that benefits the company in the

Brief Exercise 7-3 (LO 7-2)

(in millions)

Purchase price $19.0

Less:

Fair value of assets acquired 14.3

Less: fair value of liabilities assumed (2.5)

Brief Exercise 7-4 (LO 7-2)

Technician salaries for R&D $540,000

Depreciation on R&D facilities and equipment 145,000

The $27,000 in patent filing and related legal costs are recorded to the patent

intangible asset account.

Brief Exercise 7-5 (LO 7-3)

(1) Expense in the period incurred.

(2) Capitalize and depreciate over the useful life of the asset.

(3) Capitalize and depreciate over the useful life of the asset.

(4) Capitalize and depreciate over the useful life of the asset.

Brief Exercise 7-6 (LO 7-4)

The company controller’s approach to measuring depreciation is based on the

dictionary definition of depreciation – decrease in value of an asset.

Depreciation in accounting is different. Depreciation in accounting is the process

Brief Exercise 7-7 (LO 7-4)

Year

Brief Exercise 7-8 (LO 7-4)

1. Straight-line

2. Double-decli

ning-balance

3. Activity-based

Depreciation

expense =$30,000 – $3,000 =$1.35 per hour

x 3,100 hours = $4,185

20,000 hours

Depreciation

expense =$30,000 – $3,000 = $6,750

4 years

Depreciation

expense

= $30,000 x 2/4 = $15,000

Brief Exercise 7-9 (LO 7-5)

The $5 million

trademark and

the $6 million

Brief Exercise 7-10 (LO 7-6)

Sale amount $16,000

Less:

Cost of the ice cream equipment 90,000

Less: Accumulated depreciation (71,000)

Brief Exercise 7-11 (LO 7-6)

Debit Credit

Equipment (Delivery Truck) 31,000

Accumulated Depreciation 33,000

Brief Exercise 7-12 (LO 7-6)

Debit Credit

Equipment 22,000

Accumulated Depreciation 4,400

Loss 1,600

Amortization

Brief Exercise 7-13 (LO 7-7)

Net income = 20%

Net income

= 20%$885,000

*Brief Exercise 7-14 (LO 7-8)

Step 1: Test for Impairment

The long-term asset is not impaired since future cash flows ($38 million) are

Step 2: If Impaired, Record Loss

Since the asset does not meet the first test for impairment, no impairment loss

is recorded.

*Brief Exercise 7-15 (LO 7-8)

Step 1: Test for Impairment

The long-term asset is impaired since future cash flows ($32 million) are less

Step 2: If Impaired, Record Loss

The impairment loss is $3.5 million, calculated as the amount by which book

Exercises

Exercise 7-1 (LO 7-1)

Purchase price of land (and building to be removed) $1,000,000

Title insurance 3,000

Back property taxes 9,000

Cost of removing the building 50,000

For property taxes, $5,000 relates only to the current period and we expense it in

the current period. All of the other costs, including the $9,000 in back property

Exercise 7-2 (LO 7-1)

Purchase price $75,000

Sales tax 6,000

Shipping 1,000

With the exception of the $700 annual insurance, each of the expenditures

described is necessary to bring the machine to its condition and location for use.

Debit Credit

Equipment 84,000

Prepaid Insurance 700

Exercise 7-3 (LO 7-1)

Estimated

Fair Value

Allocation

Percentage

Amount of

Basket Purchase

Recorded

Amount

Land $ 175,000 $175,000/$700,000 = 25% X $600,000 $150,000

Building 455,000 $455,000/$700,000 = 65% X $600,000 390,000