Chapter 7
Long-Term Assets
REVIEW QUESTIONS
Question 7-1 (LO 7-1)
WorldCom recorded assets on the balance sheet that should have been recorded as expenses on
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,
Question 7-3 (LO 7-1)
We initially record a long-term asset at its cost plus all expenditures necessary to get the asset
Question 7-4 (LO 7-1)
Recording an expense incorrectly as an asset will overstate net income on the income statement.
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,
Answers to Review Questions (continued)
Question 7-6 (LO 7-1)
We don’t depreciate land because its service life never ends. Land improvements are additional
Question 7-7 (LO 7-1)
Question 7-8 (LO 7-1)
Question 7-9 (LO 7-2)
We value purchased intangible assets at their original cost plus all other costs, such as legal and
Question 7-10 (LO 7-2)
Question 7-11 (LO 7-2)
Goodwill is an intangible asset on the balance sheet that is recorded only when one company
Question 7-12 (LO 7-3)
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
Question 7-14 (LO 7-3)
If a firm successfully defends an intangible right, it should capitalize the litigation costs and
Question 7-15 (LO 7-4)
Question 7-16 (LO 7-4)
Question 7-17 (LO 7-4)
The service life tells how long the company expects to obtain benefits from the asset before
Question 7-18 (LO 7-4)
Residual value, also referred to as salvage value, is the amount the company expects to receive
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
Question 7-21 (LO 7-4)
University Hero depreciates over a shorter service life (20 years) and therefore will take more
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
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 service lives such as goodwill and most trademarks. For most other
Question 7-24 (LO 7-6)
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
Question 7-26 (LO 7-7)
Examples of high profit margin include companies that pursue a higher profit margin through
Question 7-27 (LO 7-8)
An asset impairment occurs when the future cash flows (future benefits) that we estimate a long-
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
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
Brief Exercise 7-3 (LO 7-2)
(in millions)
Purchase price
$19.0
Less:
Brief Exercise 7-4 (LO 7-2)
Technician salaries for R&D
$540,000
Depreciation on R&D facilities and equipment
145,000
Utilities incurred for the R&D facilities
7,000
Brief Exercise 7-5 (LO 7-3)
(1)
Expense in the period incurred.
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
Brief Exercise 7-7 (LO 7-4)
Year
2018
($45,000 – $6,000)
=
3,900 x 4/12
=
$1,300
10
Brief Exercise 7-8 (LO 7-4)
1. Straight-line
2. Double-declining-balance
3. Activity-based
Brief Exercise 7-9 (LO 7-5)
Brief Exercise 7-10 (LO 7-6)
Sale amount
$16,000
Less:
Brief Exercise 7-11 (LO 7-6)
Debit
Credit
Equipment (Delivery Truck)
31,000
Brief Exercise 7-12 (LO 7-6)
Debit
Credit
Equipment
22,000
Brief Exercise 7-13 (LO 7-7)
Net income
=
20%
($840,000 + $930,000) 2
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
greater than book value ($33.5 million).
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
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
Exercise 7-2 (LO 7-1)
Purchase price
$75,000
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
Exercise 7-4 (LO 7-1, 7-4)
1. Land is not depreciated. However, depreciation on the building is tax-
2. If the true allocation should have been 20% to land and 80% to building, then
the allocation of 10% to land and 90% to building, for the express purpose of
Exercise 7-5 (LO 7-2)
Debit
Credit
Legal Fees Expense
9,000
Exercise 7-6 (LO 7-2)
(amounts in millions)
Purchase price
$30
Less:
Exercise 7-7 (LO 7-2)
1. Patent costs capitalized
Legal fees for patent application
$ 79,000
2. Expense items on income statement
Basic research to develop the technology
$3,900,000
Engineering design work
1,180,000
3. Purchased intangible assets are usually capitalized. Internally developed
intangible assets are usually expensed.
Exercise 7-8 (LO 7-2, 7-4)
List A
List B
__f_ 1. Depreciation
__e_ 2. Goodwill
a. Exclusive right to display a word, a symbol, or an
emblem.
Exercise 7-9 (LO 7-3)
1.
Equipment
$250,000
Exercise 7-10 (LO 7-4)
1. Straight-line
2. Double-declining-balance
3. Activity-based
Exercise 7-11 (LO 7-4)
Requirement 1
Straight-line
Depreciation
$36,000 − $6,400
Requirement 2
Double-declining-balance
Calculation
End-of-Year Amounts
Year
Beginning
Book Value
X
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
Requirement 3
Activity-based
Calculation
End-of-Year Amounts
Year
Miles
Used
X
Depreciation
Rate*
=
Depreciation
Expense
Accumulated
Depreciation
Book
Value**
1
40,000
x
$0.20
8,000
8,000
28,000
Exercise 7-12 (LO 7-4)
Year
2018
($18,000 – $2,000)
=
$3,200 x 9/12
=
$2,400
5 years
Exercise 7-13 (LO 7-4)
Year
2018
($21,600 – $1,200)
Exercise 7-14 (LO 7-4)
Cost of the equipment
$19,000
Less: Accumulated depreciation (Years 1 and 2)
(8,000)*
Exercise 7-15 (LO 7-4)
($21,500 – $2,500)
=
$0.19/mile
100,000
Exercise 7-16 (LO 7-5)
Requirement 1
January 1, 2018
Debit
Credit
Patents
237,000
Cash
237,000
December 31, 2018
Amortization Expense
39,500
Patents
39,500
Requirement 2
Balance in the Patents account
Patents
237,000
39,500
Exercise 7-17 (LO 7-6)
Requirement 1
Debit
Credit
Cash
21,600
Requirement 2
Debit
Credit
Cash
13,600
Exercise 7-18 (LO 7-6)
Requirement 1
Fair value of the old land
$132,000
Requirement 2
Debit
Credit
Land, New
151,000
Land, Old
70,000
Exercise 7-19 (LO 7-7)
Net
Income
÷
Average
Total Assets
=
Return
on Assets
$28,000
÷
($389,000 + $496,000)/2
=
6.3%
