Chapter Nine
Challenge Exercise 1
Fluffer Company incurred the following costs.
1. Sales tax on factory machinery purchased, $7,000.
2. Painting of and lettering on truck immediately upon purchase, $800.
3. Installation and testing of factory machinery, $2,500.
4. Real estate broker’s commission on land purchased $4,500.
5. Insurance premium paid for first year’s insurance on new truck $930.
6. Cost of landscaping on property purchased, $9,200.
7. Cost of paving parking lot for new building, $18,700.
8. Cost of clearing, draining, and filling land, $14,400.
9. Architect’s fees on self-constructed building, $11,000.
Instructions:
a) Indicate to which account Trudy would debit each of the costs.
b) Explain why item 1 is not debited to an expense account.
c) Explain why items 7 and 8 are debited to different accounts.
Challenge Exercise 1 – Solution
2. Equipment
4. Land
6. Land Improvements
8. Land
9. Buildings
b) Sales tax on factory machinery purchased does not help the company earn revenue only in the current
year. If it did, debiting an expense account would be appropriate. The sales tax enables the company to
c) The cost of clearing, draining, and filling land is a permanent cost of the land and never has to be repeated.
Once it is done it continues to make the land useful as long as it is owned. Depreciation does not apply to land
Challenge Exercise 1 – Solution (Continued)
Challenge Exercise 2
Getz Company purchased a new machine on September 1, 2014, at a cost of $120,000.The company
estimated that the machine will have a salvage value of $12,000. The machine is expected to be used for
10,000 working hours during its 5-year life.
Instructions:
Compute the depreciation expense under the following methods for the year indicated.
(a) Straight-line for 2014, 2015, and 2016.
(b) Units-of-activity for 2014, assuming machine usage was 700 hours.
(c) Declining-balance using double the straight-line rate for 2014, 2015, and 2016.
(d) Assume the straight-line method is used. What amount of gain or loss would Getz recognize if they sell the
asset for
$45,000 on 1/1/14?
(e) Assume the double-declining balance method is used. What amount of gain or loss would Getz recognize if
they sell
the asset for $45,000 on 1/1/14?
Challenge Exercise 2 – Solution
(a) Straight-line method:
($120,000 – $12,000) X 1/5 = $21,600 per year.
(b) Units-of-activity method:
($120,000 – $12,000) / 10,000 = $10.80 per hour.
(c) Declining-balance method:
2014 depreciation = $120,000 X 40%* X 4/12 = $16,000.
Book value January 1, 2015 = $120,000 – $16,000 = $104,000.
(d) $45,000 – [$120,000 – ($7,200 + $21,600 + $21,600)] = $24,600 loss
Challenge Exercise 3
Paul McCartney, the new controller of Blackbird Company, has reviewed the expected useful lives and salvage
values of selected depreciable assets at the beginning of 2014. His findings are as follows.
Type of Date Accumulated Useful life (yrs.) Salvage Value
Asset Acquired Cost Depr. 1/1/14 Old Proposed Old Proposed
Building 1/1/08 $1,200,000 $171,000 40 50 $60,000 $105,000
Warehouse 1/1/09 150,000 28,500 25 20 7,000 13,500
All assets are depreciated by the straight-line method. Blackbird Company uses a calendar year in preparing
annual financial statements. After discussion, management has agreed to accept Paul’s proposed changes.
Instructions:
(a) Compute the revised annual depreciation on each asset in 2014. (Show computations.)
(b) Prepare the entry (or entries) to record depreciation on the building in 2014.
(c) Show how the building is reported in the 12/31/1 balance sheet.
Challenge Exercise 3 – Solution
(a)
Type of Asset
Building
Warehouse
Book value, 1/1/14
$1,029,000
$121,500
(b) Dec. 31 Depreciation Expense …………………………………………… 21,000
Accumulated Depreciation—
Challenge Exercise 4
Grace Company owns equipment that cost $70,000 when purchased on January 1, 2011. It has been
depreciated using the straight-line method based on estimated salvage value of $7,000 and an estimated
useful life of 5 years.
Instructions:
Prepare Grace Company’s journal entries to record the sale of the equipment in these four independent
situations. Update depreciation on assets disposed of at time of sale.
(a) Sold for $40,000 on January 1, 2014.
(b) Sold for $40,000 on April 1, 2014.
(c) Sold for $15,000 on January 1, 2014.
(d) Sold for $15,000 on September 1, 2014.
(e) Repeat (a), assuming Grace uses double-declining balance depreciation.
(f) Repeat (c), assuming Grace uses double-declining balance depreciation.
Challenge Exercise 4 – Solution
(a) Cash …………………………………………………………………………………….. 40,000
Accumulated Depreciation—Equipment …………………………………… 37,800
(b) Depreciation Expense ……………………………………………………………. 3,150
[($70,000 – $7,000) X 1/5 X 3/12]
Accumulated Depreciation—Equipment ………………………… 3,150
(c) Cash…. …………………………………………………………………………………… 15,000
Accumulated Depreciation—Equipment ………………………………………. 37,800
Challenge Exercise 4 – Solution (Continued)
(d) Depreciation Expense ………………………………………………………………. 8,400
[($70,000 – $7,000) X 1/5 X 8/12]
(e) Cash …………………………………………………………………………………….. 40,000
Accumulated Depreciation—Equipment …………………………………… 54,880
(f) Cash… ……………………………………………………………………………………. 15,000
Accumulated Depreciation—Equipment ………………………………………. 54,880
Challenge Exercise 5
The following are selected 2014 transactions of Pagnucci Corporation.
Jan. 1 Purchased a small company and recorded goodwill of $200,000. Its useful life is indefinite.
April 1 Purchased for $120,000 a patent with an estimated useful life of 5 years and a legal life of 20
years.
Instructions:
a) Prepare necessary adjusting entries at December 31 to record amortization required by the events
above.
b) Indicate how the intangible assets will appear on Pagnucci’s 12/31/11 balance sheet.
c) Stefan Franco, an intern at Pagnucii Company feels the company can solve its cash shortage by selling
some of the goodwill it reports on its balance sheet. Evaluate Stefan’s plan.
Challenge Exercise 5 – Solution
(a) Dec. 31 ………………………………….. Amortization Expense 18,000
Patents ($120,000 X 1/5 X 9/12) ……………….. 18,000
Challenge Exercise 6
During 2014 Aslan Corporation reported sales revenue of $5,000,000, sales returns of $200,000 and net
income of $1,600,000. Aslan’s capital structure at the beginning and end of the year was:
1/1/14 12/31/14
Liabilities $1,500,000 $1,650,000
Stockholders’ equity 2,350,000 2,500,000
Instructions:
a) Calculate the asset turnover ratio.
b) Calculate return on assets.
c) Explain what each ratio should tell you about the company.
Challenge Exercise 6 – Solution
a) Asset turnover is: Net Sales
Average Total Assets
Net sales is sales revenue less sales returns ($5,000,000 – $200,000 =$4,800,000). Since assets equals
b) Return on assets is: Net Income = $1,600,000 = 40%