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.
If University Hero initially records an expense incorrectly as an asset, expenses are understated or
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,
7-2 Financial Accounting, 5e
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)
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.
Examples of natural resources include oil, natural gas, timber, and salt.
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)
A patent is an exclusive right to manufacture a product or to use a process. A copyright is an
Question 7-11 (LO 7-2)
Goodwill is an intangible asset on the balance sheet that is recorded only when one company
acquires another company. The acquiring company records goodwill equal to the purchase price less
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,
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)
The dictionary definition of depreciation is a decrease in value of an asset, whereas the
accounting definition of depreciation is an allocation of an asset’s cost to an expense over time.
Question 7-16 (LO 7-4)
We must estimate the service life (also called useful life) of the asset as well as its residual value
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
depreciation each year. In contrast, University Hero uses double-declining balance depreciation that
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 will
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)
Book value is the cost of the asset minus accumulated depreciation. We record a gain if we sell
the asset for more than book value. Similarly, we record a loss if we sell the asset for less than book
value.
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–
term asset will generate, fall below its book value (cost minus accumulated depreciation).
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
7-6 Financial Accounting, 5e
BRIEF EXERCISES
Brief Exercise 7-1 (LO 7-1)
Purchase price of land (and warehouse to be removed)
$490,000
Cost of removing the warehouse
Brief Exercise 7-2 (LO 7-1)
Purchase price
$30,000
Freight
Testing
Total cost of the bread machine
$37,500
The $600 property tax is a recurring cost that benefits the company in the current
year. The Whole Grain Bakery will report the $600 as property tax expense over
the first year.
Brief Exercise 7-3 (LO 7-1)
Estimated
Fair
Value
Allocation
Percentage
Recorded
Amount
Building
$400,000
$400,000/$480,000 = 83.33% (= 5/6)
$375,000
Equipment
$80,000/$480,000 = 16.67% (=1/6)
Brief Exercise 7-4 (LO 7-2)
(in millions)
Purchase price
$19.0
Fair value of assets acquired
Less: fair value of liabilities assumed
Amount paid for goodwill
Brief Exercise 7-5 (LO 7-2)
Salaries for R&D
$540,000
Depreciation on R&D facilities and equipment
Utilities incurred for the R&D facilities
Payment to another company for part of the development work
Total research and development expense
The $27,000 in patent filing and related legal costs are recorded to the patent
intangible asset account.
Brief Exercise 7-6 (LO 7-3)
(1)
Expense in the period incurred.
(2)
Capitalize and depreciate over the service life of the asset.
(3)
Capitalize and depreciate over the service life of the asset.
(4)
Capitalize and depreciate over the service life of the asset.
Brief Exercise 7-7 (LO 7-3)
$240,000
Betty Foods can capitalize legal fees only for the successful defense.
Brief Exercise 7-8 (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 7-9 (LO 7-4)
Year
2021
($45,000 – $6,000)
=
3,900 x 4/12
=
2022
($45,000 – $6,000)
10
Brief Exercise 7-10 (LO 7-4)
1. Straight-line
2. Double-declining-balance
Depreciation
expense
Brief Exercise 7-11 (LO 7-4)
Straight-line
=
$30,000 – $3,000
Depreciation
expense
=
$50,000 – $10,000
=
$5,000
8 years
7-10 Financial Accounting, 5e
Brief Exercise 7-12 (LO 7-5)
Brief Exercise 7-13 (LO 7-6)
Sale amount
$16,000
Less:
Less: Accumulated depreciation
Loss (on sale of the equipment)
($ 3,000)
Brief Exercise 7-14 (LO 7-6)
Sale amount
$25,000
Cost of the ice cream equipment
Less: Accumulated depreciation
Gain (on sale of the equipment)
$ 4,000
Brief Exercise 7-15 (LO 7-6)
Debit
Credit
Loss
8,000
Accumulated Depreciation
12,000
Building
Brief Exercise 7-16 (LO 7-6)
Debit
Credit
Equipment (Delivery Truck)
31,000
Accumulated Depreciation
33,000
Cash
Equipment
Gain
Brief Exercise 7-17 (LO 7-6)
Debit
Credit
Equipment
22,000
Accumulated Depreciation
Loss
Cash
Equipment (Delivery Truck)
Brief Exercise 7-18 (LO 7-7)
Net income
=
20%
($840,000 + $930,000) 2
Brief Exercise 7-19 (LO 7-8)
Step 1: Test for Impairment
The long-term asset is not impaired since future cash flows ($38 million) are
Brief Exercise 7-20 (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
Cost of removing the building
Less: Salvaged materials
Level the land
$1,068,000
Exercise 7-2 (LO 7-1)
Purchase price
$75,000
Sales tax
6,000
Shipping
1,000
Installation
2,000
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
Building
X $600,000
Equipment
$70,000/$700,000 = 10%
X $600,000
$600,000
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
reducing taxes, is not ethical. Who is harmed? The government is clearly
Exercise 7-5 (LO 7-2)
Debit
Credit
Legal Fees Expense
9,000
Exercise 7-6 (LO 7-2)
(amounts in millions)
Purchase price
Less:
$45
Goodwill
Exercise 7-7 (LO 7-2)
1. Patent costs capitalized
Legal fees for successful defense
2. Expense items on income statement
Basic research to develop the technology
$3,900,000
Engineering design work
Development of prototype device
Testing and modification of the prototype
Exercise 7-8 (LO 7-2, 7-4)
List A
List B
__f_ 1. Depreciation
a. Exclusive right to display a word, a symbol, or an
Exercise 7-9 (LO 7-3)
1.
Equipment
$250,000
2.
Building
$750,000
3.
Repairs and Maintenance Expense
4.
Prepaid Insurance
6.
Land Improvements
Exercise 7-10 (LO 7-4)
1. Straight-line
2. Double-declining-balance
Depreciation
expense
=
$29,500 – $3,500
=
$2,600
10 years
7-18 Financial Accounting, 5e
Exercise 7-11 (LO 7-4)
Requirement 1
Straight-line
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
x
8,000
2
46,000
x
** $36,000 cost minus accumulated depreciation
Exercise 7-12 (LO 7-4)
Year
2021
($18,000 – $2,000)
=
$3,200 x 9/12
=
2022
5 years
Exercise 7-13 (LO 7-4)
Year
2021
2022
Exercise 7-14 (LO 7-4)
Cost of the equipment
$19,000
Less: Accumulated depreciation (Years 1 and 2)
(8,000)*
Less: New residual value
Exercise 7-15 (LO 7-4)
($21,500 – $2,500)
=
$0.19/mile
100,000
Year
2021
2022
$3,610
7-20 Financial Accounting, 5e
Exercise 7-16 (LO 7-5)
Requirement 1
January 1, 2021
Debit
Credit
Patents
237,000
Cash
237,000
December 31, 2021
Amortization Expense
39,500
Patents
39,500
December 31, 2022
Amortization Expense
39,500
Patents
January, 2023
Patents
Cash
December 31, 2023
Amortization Expense*
Patents
Requirement 2
Balance in the Patents account
Patents