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8-1
in whole or in part.
CHAPTER 8
INVESTING ACTIVITIES
8.1 Capitalization versus Expensing Decision.
a. The effect in the first year would be an equal decrease in both the numerator
(adjusted net income) and the denominator (average total assets) of ROA.
Because net income is substantially smaller than average total assets, the
remain understated, and ROA would be overstated.
b. This error does not affect cash flows, but it does affect classification within the
8.2 Self-Constructed Assets. The company should capitalize the full costs of
construction, including direct labor, direct materials, and an allocation of overhead
8.3 Natural Resources. All costs are capitalized except for exploration costs associated
with dry wells, which may be capitalized if the firm chooses the full costing
approach or expensed if the firm chooses the successful efforts approach. Capitali-
fits criterion is not met.
8.4 Research and Development Costs. Standard setters require R&D costs to be
expensed because of the uncertainty in judging their future revenue-generating
potential. Although it is debatable whether capitalization better serves investors,
Chapter 8
Investing Activities
8-2
in whole or in part.
8.5 Capitalization of Software Development Costs. Adobe capitalizes software
development costs once a graphics software program reaches the technological
feasibility stage of development. However, Adobe indicates that the amount of
software cost capitalized is immaterial to the financial statements. The firm states:
incurred to develop the software
8.6 Testing for Goodwill Impairment. The tests for goodwill impairment are similar
under U.S. GAAP and IFRS. Goodwill is not considered a separable asset; there-
fore, goodwill impairment is assessed at the reporting unit (U.S. GAAP) or cash-
ing value.
U.S. GAAP tests for the impairment of amortizable intangibles first require a
comparison of undiscounted future cash flows from the asset to the book value of
the asset. If undiscounted future cash flows are higher, the asset is not impaired.
8.7 Earnings Management and Depreciation Measurement. Depreciation is a
process of allocating historical cost of depreciable assets to the periods of their use
in a rational and systematic manner. Three factors must be considered when mea-
Chapter 8
Investing Activities
8-3
in whole or in part.
timing of expense recognition. For example, incorrectly expensing a cost to manage
appears to be a means for managing earnings. For example, an airline that extends
the useful life of aircraft because of the implementation of more stringent mainten-
vation for the change.
8.8 Corporate Acquisitions and Goodwill. The acquirer records the intercorporate
exactly equals the fair value of the consideration given to acquire, no goodwill is
recorded. If the fair value of identifiable acquired assets (including intangibles other
than goodwill) exceeds the fair value of the consideration given to acquire (a bar-
gain purchase), the difference is recorded as a gain on acquisition and no goodwill
is recorded.
contracts and estimated liabilities on unsettled lawsuits. An acquiring company has
up to one year after the date of acquisition to revalue these acquisition reserves as
new information becomes available. After that, the acquisition reserve amounts
remain in the accounts and absorb expenditures (that would otherwise be recorded
Chapter 8
Investing Activities
8-4
in whole or in part.
8.10 Accounting for Available-for-Sale and Trading Marketable Equity Securities.
Firms report both available-for-sale and trading marketable equity securities at fair
value at the end of each reporting period. The reporting of any unrealized holding
gain or loss depends on the firm’s purpose for investing in securities. Firms that
on the expected holding period. Unrealized holding gains or losses on securities
available for sale are not included in net income each period; instead, they appear as
a component of other comprehensive income, labeled Unrealized Holding Gain or
Loss on Securities Available for Sale. The cumulative unrealized holding gain or
difference between the selling price and the acquisition cost of the security as a
realized gain or loss. At the time of sale, the firm must eliminate any amount in the
shareholders’ equity account, Accumulated Other Comprehensive Income, for the
unrealized holding gain or loss related to that security.
8.11 Equity Method for Minority, Active Investments.
b. The statement of cash flows for Ace Corporation will report a net reduction in
operating cash flow section under the indirect method, but dividends received in
securities.
Chapter 8
Investing Activities
8-5
in whole or in part.
Determining whether an investing firm should consolidate the VIE is at the
heart of Interpretation No. 46R. An investing firm consolidates the VIE if it absorbs
the majority of the entity’s expected losses if they occur, receives a majority of the
entity’s expected residual returns if they occur, or both. The consolidating firm is
consolidates the variable interest entity.
8.13 Choice of a Functional Currency. The following discussion applies the five criteria
Cash Flows of Foreign Entity. No information is provided about cash flows,
which implies that Qing’s policy is to allow all of its foreign subsidiaries to retain
currency.
Cost Factors. All material contracts are denominated in the peso, also indicating
the peso as the functional currency.
Financing. Financing for manufacturing plants is denominated in U.S. dollars, with
Relations between Parent and Foreign Unit. Senior management of the subsidi-
currency, this is not an uncommon arrangement for multinational corporations.
in choosing a functional currency.
Chapter 8
Investing Activities
8-6
in whole or in part.
8.14 Foreign Currency as Functional Currency. The text provides a description of the
exchange rates used when the foreign currency is the functional currency. The logic
in other countries.
8.15 Analyzing Disclosures Regarding Fixed Assets.
a. NewMarket Monsanto Olin
Corporation Company Corporation
Average depreciable assets at cost:
0.5($752 + $777) .............................. $765
b.
Accumulated depreciation, Year-end ... $ 611 $ 2,517 $ 1,348
c. Depreciation—straight-line method ..... $ 27 $ 328 $ 72
Difference between straight-line and
accelerated depreciation:
d. Net income as reported ......................... $ 33 $ 267 $ 55
Add back depreciation expense on
straight-line method (net of taxes):
Subtract depreciation expense for tax
reporting (net of taxes):
Chapter 8
Investing Activities
8-7
in whole or in part.
e. NewMarket Monsanto Olin
Corporation Company Corporation
Reported property, plant, and
equipment (net):
Restatement to accelerated depreciation:
g. Note that the depreciable assets for NewMarket Corporation and Olin Corpora-
NewMarket and Olin having a higher proportion of long-live manufacturing
tion of new depreciable assets.
8.16 Asset Impairments.
a. U.S. GAAP Treatment: Because total undiscounted future cash flows of
$1,000,000. Although the firm uses undiscounted future cash flows to decide
whether an impairment charge is necessary, fair value is used to measure the
actual impairment charge.
Chapter 8
Investing Activities
8-8
in whole or in part.
The company would report the impairment loss in income from continuing op-
b. Compare the carrying amount of the unit to the unit’s fair value:
8.17 Upward Revaluations under IFRS.
a. Fair value increases above original acquisition cost in 2013, causing a €10,000
upward revaluation of the land and an increase in other comprehensive income
its value in 2016, and this partial reversal of the prior year’s unrealized loss re-
ported in income is reported in 2016 income as an unrealized gain.
Chapter 8
Investing Activities
8-9
in whole or in part.
8.18 Application of Statement No. 115 for Investments in Marketable Equity
Securities.
a. (1) The change in the market value of Suntrust’s investment in Coke’s com-
mon stock has no effect on the bank’s 2006 net income. Under Statement
(2) As described above, the 2006 unrealized holding “gain” of $379,204,000
comprehensive income.
Solution a, but its components would differ.
8.19 Effect of an Acquisition on the Date of Acquisition Balance Sheet.
Allocation (Fair value/book value differences):
Chapter 8
Investing Activities
8-10
in whole or in part.
Excess ........................................................................ $ 187 million
Allocated to:
Fixed assets ...................................................... $50 million
Worksheet (January 1, 2014) Company Company tions dated
Balance Sheet
Cash........................................................... $ 25 $ 15 $ 40
Accounts receivable .................................. 60 40 100
Accounts payable and accruals ................. $ (60) $ (40) $(25) $(125)
Long-term debt.......................................... (120) (60) (180)
