303
CHAPTER 11
Investing Activities
THINKING BEYOND THE QUESTION
How do we account for investing activities?
Investing is necessary for a company to grow. Good investments provide
resources that a company can use to produce and sell additional prod-
QUESTIONS
Q11-1 The primary types of assets Archer would include in its accounting sys-
tem are:
a. Current assets: those assets management expects to convert to
cash or consume during the next fiscal year.
i. Cash and short-term marketable securities: highly liquid re-
b. Long-term assets: those assets that management does not expect to
convert to cash or consume during the next fiscal year.
i. Property, plant, and equipment: physical assets used by the
304 Chapter 11
Q11-2 The gross amount of property, plant, and equipment is the original cost
paid to acquire those assets. The net amount of property, plant, and
Q11-3 Student responses will vary. Some students will note that interest is the
cost of renting money. It is a period cost that is traceable to a given peri-
od and should be expensed on the income statement during that period.
Q11-4 This statement is not true. Sometimes the units–of-production method will
lead to faster depreciation than straight-line and sometimes it will lead to
Q11-5 A capital expenditure is one in which new plant assets are acquired or in
which the expected useful life or value of a plant asset is enhanced. Capi-
Q11-6 In a way the friend is correct. The terms depletion and depreciation both
describe the process of allocating a portion of an asset’s cost to expense
each period of the asset’s useful life. In this way, both terms describe the
Investing Activities 305
Q11-7 Depletion arises when a natural resource is consumed or used up. In
most cases, it arises when the natural resource is harvested. For exam-
ple, ore is taken from a mine, oil is pumped from a well, or gravel is taken
Q11-8 The problem with using market value (for most classes of assets) is ob-
taining a reasonable estimate of market value at each balance sheet date.
For example, what is the market value on a given balance sheet date for
the Empire State Building? Or for a patent, or machinery in the factory?
Q11-9 Investments in the securities of other firms (e.g., stocks, bonds, certifi-
cates of deposit, notes) are classified on a balance sheet according to
management’s intention for holding the item. If the investment was made
Q11-10 When marketable securities are held as trading securities it means that
the company routinely sells securities as part of its primary business. In
fact, they are more like inventory than investments. The securities are a
current asset and expected to be sold soon. Therefore, it is appropriate
306 Chapter 11
Q11-11 Marketable securities and intangible assets have very different character-
istics. It is these differences that cause them to be reported using differ-
ent valuation methods. First, marketable securities are homogeneous in
Q11-12 Goodwill arises when one company buys another at a price in excess of
the market value of the second company’s identifiable net assets. The
amount of goodwill recorded is equal to the difference between the price
paid and fair value of identifiable net assets acquired. Goodwill repre-
Investing Activities 307
Q11-13 The effects of this transaction will show up in two places on the next
statement of cash flows. First, the gain on sale ($25,800) will be reported
in the operating activities section as a deduction from net income. The
Q11-14 Accounting information identifies the amounts of assets that a company
has recorded. These amounts and other records about a company’s as-
sets provide a benchmark against which actual assets can be compared.
For example, if accounting records indicate a cash balance of $30,000, an
308 Chapter 11
EXERCISES
E11-2 Deep Drillers, Inc.
Long-Term Assets Section of Balance Sheet
At Year-End
Investments:
Investment in Susanna Company $ 195,600
Property, Plant, and Equipment:
E11-3 a. Intangible assets: A long-term asset category including items such
as patents, copyrights, trademarks, and goodwill
b. Inventories: A current asset composed of items that are being held
for sale to customers
c. Investment in marketable securities: a current or long-term asset,
depending on the holding period intended by management
Investing Activities 309
d. Property, plant, and equipment: A long-term asset including such
items as trucks, buildings, machinery, and equipment
E11-4 Long-term investments: (h) Common stock of Flower Corporation
(l) Investment in bonds of Beech Brothers, Inc.
Property, plant, and
equipment: (a) Machinery, net
E11-5
Depreciation
Method
Depreciation
Expense
Computations
Straight-line
$42,857
($300,000 ÷ 7 years = $42,857)
($300,000 × 2/7 = $85,714)
production
= $96,000)
(continued)
310 Chapter 11
Income Statements
Straight-
Line Method
DDB
Method
Units-of–
Production
Method
Revenues
$376,300
$376,300
$ 376,300
E11-6
Calculation of Gain on Sale
Financial
Reporting
Purposes
Tax
Purposes
Original cost
$4,186,000
$4,186,000
Companies typically use straight-line depreciation for financial reporting
purposes to minimize the effect of depreciation on net income. Accelerat-
ed methods result in larger amounts of depreciation expense for tax pur-
poses in the early years of asset lives. Therefore, cash outflow for taxes
is reduced because of the lower amount of taxable income than if
Investing Activities 311
E11-7 a. Cost of equipment $ 480,000
Less: Depreciation per year
[($480,000 − $30,000) ÷ 8 years = $56,250]
Accumulated depreciation total over 5 years 281,250
E11-8 a. The total construction costs, $1,228,000, would be recorded as an
asset, construction work–in-process. Special tools and equipment
necessary for the construction and interest for financing the con-
struction would be included as part of the asset. The cost would be
E11-9 a. 2004 = $9,000 ($48,000 − $3,000) ÷ 5 years = $9,000
2005 = $9,000
312 Chapter 11
c. 2004 2005 2006 2007
Operating activities:
Depreciation expense $ 9,000 $ 9,000 $ 9,000 $ 5,250
E11-10 Depletion expense: $16.8 million ($140 million × 6 ÷ 50)
Book value of reserves: $39.2 million ($140 million − $100.8 million*)
E11-11 a. $1,650,000 The cost of the land ($4,500,000) should be recorded in
an account separate from the cost of the trees growing
on the land. The cost to be depleted includes the cost of
planting the trees and the cost of thinning and monitor-
Investing Activities 313
E11-12
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
a.
Cash
−30,000
Long-Term Investment
30,000
E11-13
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
a.
Cash
−330,000
330,000
Cash
−440,000
Short-Term Investment in
440,000
20,000
Unrealized Holding Gain*
−80,000
Unrealized Holding Loss*
Short-Term Investment in
At year-end, the two investments should be combined and reported in the
asset section as short-term investments, $710,000 ($330,000 + $440,000 +
Unrealized Holding Gain*
c.
Long-Term Investment
−33,500
Gain on Sale of Stock
Unrealized Holding Gain*
E11-14
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
a.
Cash
−314,000
Long-Term Investment in
Othello Common Stock
314,000
Cash
−418,000
418,000
Long-Term Investment in
Unrealized Holding Gain*
Ferdinand Common Stock
Unrealized Holding Loss*
At year-end, the two investments should be combined and reported in the
E11-15 a.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Cash
−800,000
Investment in Bonds
800,000
Cash
Interest Income
Investing Activities 315
E11-16 1.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
May 15,
Cash
−380,000
2005
Long-Term Investment
380,000
Apr. 6,
Cash
400,000
2007
Long-Term Investment
–440,000
Realized Gain on Sale
20,000
Loss*
Ending Balances
46,400
46,400
Explanations:
May 15, 2005: Investment recorded at cost.
September 12, 2005: Dividends reported as realized income; reported in
the income statement in computing net income for the year.
2. 2005 2006
Cost of investment $380,000 $ 380,000
Sep. 12,
Cash
12,000
2005
Investment Income
12,000
Dec. 31,
Long-Term Investment
100,000
Gain*
Sep. 12,
Cash
14,400
2006
Investment Income
14,400
Dec. 31,
Long-Term Investment
Loss*
316 Chapter 11
E11-17 a. Goodwill arises when one firm buys another. It is the difference be-
b. The key to understanding goodwill is that certain valuable aspects of
c. Goodwill is reported as an intangible asset on the balance sheet of a
d. $30 million. The fair market value of the acquired company’s net as-
e. Sometimes, management of the acquiring firm simply makes a mis-
take by offering more for a company than it is worth. The estimated
E11-18 a. Amount paid to acquire 100% of Metrodome’s net assets $845,000
Fair market value of Metrodome’s net assets 783,000
Goodwill $ 62,000
b. In general, goodwill becomes impaired when the activities that creat-
Investing Activities 317
E11-19 a. 1. $23,017 1st year depreciation: SLN(314221,15000,13)
b. 1. $47,387 1st year depreciation: DDB(118468,5000,5,1)
E11-20 Investing activities are those that involve acquisition, use, and disposal
of long-term assets. Short-term investments in marketable securities are
also part of investing activities.
Balance sheet:
1. Most noncurrent asset accounts involve investing activities. Increases
Income statement:
1. Depreciation, amortization, and depletion are reported as part of oper-
318 Chapter 11
Statement of cash flows:
1. Depreciation, amortization, and depletion expense are added to net in-
come (under the indirect method) in the operating activities section.
E11-21 Zirconium Graphics Company
Partial Statement of Cash Flows
For the Year Ended December 31
Cash Flow from Operating Activities
Net income $ 60,000
Adjustments for noncash items:
Depreciation and amortization expense $ 7,500
E11-22 a. Equity method. This investment was large enough to acquire sig-
Investing Activities 319
b.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Jan. 1
Cash
–43,200
Long-Term Investment
43,200
PROBLEMS
P11-1 A. Depreciation Schedule
Straight-Line
Method
Declining-Balance
Method
Units-of-Production Meth–
od
Year
Depreciation
Expense
Book
Value
Depreciation
Expense
Book
Value
Depreciation
Expense
Book
Value
0
1
$ 30,000
$125,000
95,000
$ 62,500
$125,000
62,500
$ 31,200
$125,000
93,800
Double-declining-balance:
Year 1 = $125,000 × (2/4) = $62,500
Units-of-production (unit depreciation rate is $120,000 ÷ 1,000 hours =
$120 per hour):
Year 1 = $120 per hour × 260 hours = $31,200
Investment Income
Long-Term Investment
320 Chapter 11
B. The straight-line method generally has the advantage of creating the
smallest amount of depreciation expense in the early years of the
asset’s life. Therefore, it would usually result in higher reported net
C. Depreciation expense reduces the book value of an asset but does
not require cash outflow. Cash flow is affected indirectly by depreci-
P11-2 A. B.
Year
Book Value
at
Beginning
of Year
Usual
Double-
Declining-
Balance Method
(2/6 × Book Val-
ue)
Book Value
at Beginning
of Year
Modified
Double-
Declining-
Balance Meth-
od
2007
$2,100,000
$ 700,000
$2,100,000
$ 700,000
Under the modified approach, depreciation for tax purposes in 2007,
2008, and 2009 uses the standard double-declining-balance method (2/6 ×
Investing Activities 321
$311,111 = $622,222). This results in the same amount of depreciation
($207,407) for each of the last three years. In 2011 and 2012, the straight-
pense.
C.
Year
1
Modified Double-
Declining-
Balance Method
2
Straight-Line
Depreciation
(Cost ÷ 6 years)
3
Difference
in Income
(Column 1 −
Column 2)
4
Difference
in Taxes
(Column 3
× 35%)
2007
$ 700,000
$ 350,000
$ 350,000
$122,500
D. The higher the depreciation, the lower is taxable income and the
lower is the amount of cash paid out for taxes. Choosing an acceler-
ated depreciation method raises depreciation in the earlier years of
P11-3 A. Cost of diagnostic equipment = $107,191
322 Chapter 11
Item
Amount
Include?
Reason
1.
Invoice cost
$93,000
Yes
Necessary and reasonable
2.
Sales tax
8,091
Yes
Necessary and reasonable
The cost of the equipment is the present value of the cash flows neces-
sary to acquire it.
B.
Asset
DDB Depreciation
for the
First Year
SL Depreciation
for the
First Year
Difference in First-
Year Depreciation
Expense and Net
Income
Diagnostic
Equipment
$35,730
($107,191 × 2/6)
$17,865
($107,191 ÷ 6 yrs)
$17,865
Manufacturing
$53,043
$53,043
Totals
P11-4 A. Equal annual payment = $727,781 PV of an annuity = Amount × IF
(Table 4)
3.
Transportation cost
2,650
Yes
Necessary and reasonable
4.
Special permit fine
Not necessary to incur this cost
5.
Right-side wall cost
Yes
Necessary and reasonable
6.
Left-side wall cost
Carelessness not an asset
7.
Setup and testing
2,700
Yes
Necessary and reasonable