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P10-16. Making asset age and intercompany comparisons (LO 10-3)
Requirement 1:
ROA for Gardenia Co. (000s omitted):
Jan. 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31
2017 2017 2018 2019 2020 2021
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copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 10-1
Requirement 2:
ROA for Lantana Co. (000s omitted):
Jan. 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31
2017 2017 2018 2019 2020 2021
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be
copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 10-2
2017
2018 2019
2020 2021
Beginning of the
(Beginning of year
x 10%)
1 Assets are, on average, 5 years old, with a 10-year life = ½ depreciated.
Therefore, $20,000,000 net asset base x 2 = $40,000,000 gross asset base.
Requirement 3:
Gardenia’s rapidly increasing ROA gives the appearance of significant
year-to-year improvement. But this is illusory because the ROA increase is
caused primarily by the increasing average age of its asset base. This factor
Lantana’s much smaller upward drift in ROA is attributable to the stable
average asset age that results from its continual replacement of 10% of its
P10-17. Accounting for asset retirement obligations (LO 10-6)
Requirement 1:
GAAP requires companies to recognize an asset retirement obligation (ARO)
when a reasonable estimate of its fair value can be made. These legal
obligations arise when a company builds or buys an asset that requires
mandatory expenditures at the end of the asset’s useful life to protect public
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-3
welfare or improve safety. For example, dismantling an offshore oil platform
requires expenditures to protect and restore the marine environment.
Coyote Co. can estimate the fair value of this obligation as the present value
of the estimated future cash outflows.
Amortization table:
(a) (b) (c)
Year
Present Value
ARO
At 1/1
Accretion
Expense
Present Value
ARO
At 12/31
*rounding error of $31
Requirement 2:
The costs associated with the decommissioning of the power plant will be
shown on the income statement as both:
Increased depreciation expense each period as a result of recording and
DR Accretion expense $931,380
CR Asset retirement obligation $931,380
The $15,000,000 total decontamination cost is shown as part of the expense
of operating the power plant and is matched with the revenue generated by
the plant over its productive life. Prior to the issuance of pre-Codification
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-4
SFAS No. 143, companies would often ignore these costs until they were
incurred at the end of the asset’s life, thereby overstating operating income.
P10-18. Accounting for assets held for sale (LO 10-6)
Requirement 1:
Carrying value at 12/31/17:
When assets are held for sale, they are reported at the lower of carrying value
or fair value less costs to sell. The fair value less costs to sell of the railroad
assets is:
Since management has committed to a plan, has identified a potential buyer,
and is anticipating a sale within the year, the railroad assets should be
*(This is $6,500,000 - $5,227,000)
Requirement 2:
Prescott Co.
Partial Income Statement
For the Year Ending December 31, 2017
Discontinued operations (see Note xx)
Loss from operations of
discontinued railroad component
(Including $1,273,000 impairment
loss) (1 ,748,000)+
Net income $6 ,127,000
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-5
*(This is net income of $7,400,000 plus the loss of $475,000 added back on the
railroad component)
+(This is the loss on the railroad component of $475,000 plus the impairment loss of
$1,273,000)
Prescott’s income statement for the year ended December 31, 2017 should
report discontinued operations for the railroad component after income from
continuing operations and before extraordinary items.
Requirement 3:
Operating margin ROA
With DCO treatment
*(This is $20,000,000 – $1,800,000)
+(This is $94,500,000 – $6,500,000)
If the disposal does not qualify as a discontinued operation, Prescott Co.
would continue to report the results for the railroad component as part of
ongoing operations year-to-year.
Requirement 4:
During 2018 the assets held for sale will not be depreciated. The assets will
continue to be valued at the lower of carrying value or fair value less costs to
sell. Any losses previously recorded may be recovered—but not in excess of
the cumulative loss previously recognized (FASB ASC 360-10-35-40).
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-6
P10-19.Evaluating approaches to long-lived asset valuation (LO 10-1)
Requirement 1:
Expected benefit approaches focus on the estimated value of long-term
assets in an output market, that is, a market where the assets could be sold.
This approach assigns a value to an asset based on the expected future cash
flows the asset is capable of generating. One valuation measure under this
Another valuation measure under this approach is what the asset would bring
if it were sold in the marketplace. In this case, the Boeing 777 would be
valued at its net realizable value. Problems that arise in implementing the
Economic sacrifice approaches focus on an asset’s cost in an input market—
a market where the asset could be acquired. The most obvious example of
Historical cost is the dominant approach underlying current GAAP. A second
example of an economic sacrifice approach is current replacement cost. This
Requirement 2:
From the perspective of a financial analyst, the answer to the question is yes.
Since the primary input into financial analysis is information about a firm,
analysts would like to have these other valuations in addition to historical
cost. After all, if they feel that any of the additional valuations are not as
reliable as historical cost in a given setting, they can always choose to ignore
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-7
them. But having these data would make trend analyses, cross-sectional
Requirement 3:
The primary benefit is a more relevant valuation of the company’s assets,
and, thus, a more relevant valuation of the entire company (i.e., its common
stock). The primary cost, which most managers would probably argue
P10-20. Weakness of the Straight-line Depreciation Method (LO 10-1, LO 10-7)
Requirement 1:
a. Annual depreciation expense = (Cost – salvage) ÷ life
$3,962 = ($15,849 − $0) ÷ 4
End
of Depreciation Accumulated Book
Year Expense Depreciation Value
b. If the company were to record straight-line depreciation, its four years’
income statements would appear as follows:
1 2 3 4
Revenue
$
5,000
$
5,000
$
5,000
$
5,000
Depreciation expense
3,96
2
3,96
2
3,96
2
3,96
3
Net income (A) $ $ $ $
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-8
1,038 1,038 1,038 1,037
$
$
$
$
26.2%
Requirement 2:
a.
Under the present value method of depreciation, annual depreciation expense
is the difference between the present value of future cash flows at the
beginning of year and end of year.
Beginning
of year PV
Annual of Future
Depreciatio
n
Accumulate
d
Year cash flow cash flows expense Depreciation
Book
Value
b.
1 2 3 4
Revenue
$
5,000
$
5,000
$
5,000
$
5,000
Depreciation expense
3,41
5
3,75
6
4,13
3
4,54
5
Net income (A)
$
1,585
$
1,244
$
867
$
455
Initial investment (B) $ $ $ $
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-9
Requirement 3:
Clearly, the rising annual return on investment under straight-line is an illusion,
created by the use of an arbitrary method of depreciation. In this example, with
straight-line depreciation, a constant numerator (Net income) is divided by a
declining denominator (Initial investment) to produce a rising annual return on
On the other hand, the present value method yields an annual return on
investment of 10% in the income statement so long as the actual cash flows
coincide with the anticipated cash flows. If the actual cash flows were to
exceed, or fall short of, the anticipated cash flows, the annual return on
investment would be correspondingly higher or lower. The use of this method
enables a reader of the income statement to determine whether, and to what
Requirement 4:
The “present value method” is not an acceptable method in U.S. financial
speculative. So while this approach certainly seems to fit the general
depreciation criteria of a method that is both “systematic and rational,” it falls
short when it comes to verifiability and objectivity. It may, however, be used by
companies for internal reporting purposes, especially when one seeks to
evaluate the performance of divisions and subsidiaries.
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 10-10
