211solutions9-03

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© The McGraw-Hill Companies, Inc., 2003 1

CHAPTER 9PLANT AND INTANGIBLE ASSETS

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. Coca-Cola’s trademark name was not purchased from another company, but rather was developedinternally. Thus, the development costs probably were not material and were treated as revenueexpenditures. Even if these costs had been capitalized, they would be amortized over a period of 40years or less. Thus, any costs associated with this trademark now would be fully amortized, leaving azero book value.

2. There are three basic “accountable events” in the life of a plant asset: (1) acquisition, (2) allocation of the acquisition cost to expense, and (3) disposal. The second event, allocation of the acquisition cost toexpense, typically has the greatest effect upon net income. However, any gain or loss on disposal alsoaffects net income. The allocation of acquisition cost to expense has no effect upon cash flows (other than income taxes). However, the acquisition of plant assets requires cash outlays, and disposals oftenresult in cash receipts.

3. (d ) Held for sale in the regular course of business and (e) not capable of rendering benefits to the

business in the future.

4. (a) Freight charges, (b) sales taxes on the machine, and (d ) wages of employees for time spent ininstalling and testing the machine before it was placed in service.

5. A capital expenditure is one that is material in amount and will benefit several accounting periods andis therefore charged to an asset account. A revenue expenditure is assumed to benefit only the current period (or is not material in amount) and is charged to an expense account so that it will be deductedfrom revenue of the current period in the determination of net income.

6. If a capital expenditure (acquisition of an asset) is erroneously treated as a revenue expenditure (anexpense), expenses of the current year will be overstated and net income, therefore, will beunderstated. Since this error also results in the failure to record an asset, net income will be overstatedin all future periods in which depreciation should have been recognized on this asset.

7. The entire $245,000 cost should be charged to the land account. The existing structures are of no valueto Shoppers’ Market, and soon will be torn down. Thus, the only asset being acquired by Shoppers’ isthe building site, which is classified as land.

8. (d ) Allocation of the cost of a plant asset to the periods in which benefits are received.

9. Yes, depreciation of the building should be continued regardless of rising market value. The buildingwill render useful services for only a limited number of years and its cost should be recognized asexpense of those years regardless of fluctuations in market value.

10. An accelerated depreciation method is one that recognizes greater amounts of depreciation expense inthe early years of an asset’s life, and less in the later years. These methods are most widely used inincome tax returns, as larger deductions for depreciation will reduce both taxable income and the

income tax payments due in the immediate future.

11. Under the fixed-percentage-of-declining-balance depreciation method, a fixed depreciation rate isapplied to the asset’s undepreciated cost. The “fixed-percentage” is a percentage of the straight-linedepreciation rate. This percentage is said to be “fixed” because it does not change over the life of theasset. The declining balance is the asset’s undepreciated cost (or book value), which gets lower everyyear.

The declining-balance method is most widely used in income tax returns.

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12. Most companies use only the straight-line method of depreciation in their financial statements.However, these companies also may compute depreciation by several other methods for income tax purposes. For example, they may use MACRS depreciation in their federal income tax returns, andvarious forms of the declining-balance method in their state income tax returns.

13. The balance of the Accumulated Depreciation account does not consist of cash. It is an account with a

credit balance showing how much of the original cost of the plant assets now owned has been writtenoff as depreciation expense. Cash is required to pay for new assets, and the cash owned by thecompany is shown by the asset account Cash.

14. Two widely used approaches to computing depreciation for a fraction of a year are (1) to round thecomputation to the nearest full month and (2) the half-year convention, which takes six months of depreciation on all assets (of a given type) acquired during the year. (The half-year convention alsorequires that six months’ depreciation be recorded in the last year of the asset’s life or year of disposal.)

15. a. No; a company may use different depreciation methods for different assets. The principle of consistency means only that once depreciation begins on a given asset, the same method should beapplied throughout its useful life.

b. Yes; a corporation may use different depreciation methods in its financial statements and itsincome tax returns. In fact, most corporations use straight-line depreciation in their financialstatements and a variety of accelerated depreciation methods in their tax returns.

16. The usual method of revising depreciation rates to reflect a changed estimate of useful life is to spreadthe undepreciated cost over the years of remaining useful life. This results in raising or lowering theannual depreciation charge. In this case, the undepreciated cost is $9,000, that is, cost of $15,000 lessaccumulated depreciation of $6,000. The revised estimate calls for 8 more years of use, so the new

depreciation charge will be $9,000 ÷ 8, or $1,125. It also has the theoretical merit of ensuring thatdepreciation expense as shown in the income statements over the life of the asset will equal the totaldepreciable cost of the asset.

17. Intangible assets are a subcategory of plant assets which are lacking in physical substance and arenoncurrent. An account receivable of the type described is clearly a current asset and hence excludedon that ground from qualifying as an intangible asset even though it is lacking in physical substance.

18. The cost of each type of intangible asset should be amortized over the period estimated to be benefited.

The straight-line method is generally used for the amortization of intangible assets.

19. Goodwill is recorded in the accounts only when purchased. The most common example is that of anongoing business being purchased as an entity by new owners. If the purchase price is in excess of afair value of the net identifiable assets of the business, the transaction provides objective evidence thatgoodwill exists and also provides a basis for objective valuation of this asset.

20. Since average annual earnings of $50,000 represent a return of only 5% on the net tangible assets of $1million, the goodwill appears to be unsupported by operating performance. Goodwill is defined as the

present value of expected excess future earnings, and Digital Products Company appears to havesubstandard earnings rather than excess earning power. The financial statements therefore give theimpression of overstated assets and owners’ equity. Elimination of the item of goodwill would appear to be called for.

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21. Depletion in the amount of $10,000,000 should be deducted from revenue in the current year. Theother $2,000,000 of depletion applicable to the current year’s operations will be included in thevaluation of the ending inventory. Depletion is a cost of producing inventory. Costs assigned toinventory represent current assets until the goods are sold, at which time the costs are transferred to theCost of Goods Sold account.

22. An asset is “impaired” when the owner cannot recover the undepreciated cost either through use or sale. In such situations, the carrying value of the asset should be reduced (written down) to netrealizable value, which results in the recognition of a loss.

23. The owner of March Metals is in error. When the company discontinued use of the trademark, theunamortized cost of this asset should have been written off immediately. A trademark or other intangible should not be carried as an asset after its usefulness has ended.

Ex. 9–1 a. Two factors have caused the truck to depreciate: (1) physical deterioration and (2)obsolescence. The miles driven during the past six years have caused wear and tear on all of the truck’s major components, including its engine, transmission, brakes, and tires. As thesecomponents deteriorate, their fair market values, in turn, depreciate. Furthermore, during thetime that you have owned the truck, innovations have been developed leading to improvedfuel economy, higher horsepower, better handling, and more corrosion-resistant materials.These innovations have made the truck obsolete in many respects. As the design andengineering technologies associated with the truck become more and more outdated, its fair market value will continue to depreciate.

b. No. It is not likely that the bank will lend you an additional $5,000, even if you agree to pledge your truck as collateral. Your truck will continue to depreciate in value each year. Bythe time you begin repayment of your loan, it will be worth less to the bank than its currentfair market value.

c. Depreciation is a process of cost allocation, not a process of valuation. As such, accountingrecords do not attempt to show the current fair market values of business assets. Only bycoincidence would the balance sheet show $10,000 in accumulated depreciation on this truck.

Ex. 9–2 a. Capital expenditure

b. Revenue expenditurec. Revenue expenditured. Capital expendituree. Revenue expenditure (too small in amount to capitalize regardless of length of useful life)

f. Capital expenditure

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Ex. 9–4

a. (1) Straight-Line Schedule

Year ComputationDepreciation

Expense AccumulatedDepreciation

BookValue

1 $35,000× 1 ⁄ 5 $7,000 $ 7,000 $33,0002 35,000× 1 ⁄ 5 7,000 14,000 26,000

3 35,000× 1 ⁄ 5 7,000 21,000 19,000

4 35,000× 1 ⁄ 5 7,000 28,000 12,000

5 35,000× 1 ⁄ 5 7,000 35,000 5,000

(2) 200% Declining-Balance Schedule



BookValue

1 $40,000× 40% $16,000 $16,000 $24,000

2 24,000× 40% 9,600 25,600 14,400

3 14,400× 40% 5,760 31,360 8,640

4 8,640× 40% 3,456 34,816 5,184

5 $5,184 – $5,000 184 35,000 5,000

(3) 150% Declining-Balance Schedule



BookValue

1 $40,000× 30% $12,000 $12,000 $28,000

2 28,000× 30% 8,400 20,400 19,600

3 19,600 × 30% 5,880 26,280 13,720

4* ($13,720 – $5,000) ÷ 2 yrs. 4,360 30,640 9,360

5* ($13,720 – $5,000) ÷ 2 yrs. 4,360 35,000 5,000

* Switch to straight-line

b. Both accelerated methods result in a higher depreciation expense than the straight-linemethod in the first two years of the asset’s life. This pattern reverses in years 3 through 5.After four years, 99% of the asset’s total depreciation expense has been recorded under the200% declining-balance method, as compared to only 88% under the 150% declining-balancemethod.

Ex. 9–8 Average earnings ...................................................................................................... $ 540,000

Normal earnings, 15% of $3,000,000 ....................................................................... 450,000Excess earnings......................................................................................................... $ 90,000Goodwill ($90,000 x 5)............................................................................................. $ 450,000Fair market value of net identifiable assets............................................................... 3,000,000Price to be offered for Goldtone Appliance Co. ....................................................... $3,450,000

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Ex. 9–11 a. Inventory...................................................................................... 400,000

Accumulated Depletion: Northern Tier Mine .................. 400,000To record depletion on the Northern Tier Mine: 50,000 tons

mined × $8 per ton [($21,000,000 − $1,000,000) ÷ 2,500,000tons = $8 per ton].

b. Property, plant, & equipment:Mining property: Northern Tier Mine...................................... $21,000,000Less: Accumulated depletion................................................... 400,000 $20,600,000

c. No; the $400,000 of depletion of the mine should not all be deducted from revenue during thefirst year of operations. Since only 40,000 of the 50,000 tons of ore mined were sold, only80% of the depletion cost ($320,000) should be deducted from revenue as part of the cost of goods sold. The remaining 20% of this amount ($80,000) relates to the 10,000 tons of orestill on hand and remains in the inventory account.

d. The journal entry in part a increases the current ratio, because it reclassifies an amount of plant assets as inventory, which is a current asset. Thus, current assets are increased.Extracting ore from the ground does make the company more liquid. Mined ore is a moreliquid asset than ore that is still in the ground.

Ex. 9–13 a. $13,000 − $5,000 $8,000

=50,000 miles 50,000 miles = $0.16 per mile

b. 1,670,000 miles × $0.16 per mile = $267,200

c. Yes. The units-of-output method recognizes more depreciation in periods in which the cars

are driven more—which means that the cars are generating more revenue. The straight-linemethod would recognize the same amount of depreciation expense regardless of how muchthe automobiles were used (driven).

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PROBLEM 9–3SMART HARDWARE (concluded)

d. A book value of $400 means that accumulated depreciation at the time of the disposal was$8,600.

1. Journal entries assuming that the shelving was sold for $1,200:

Cash 1,200

Accumulated Depreciation: Shelving 8,600

Shelving 9,000

Gain on Disposal of Assets 800

To record sale of shelving for $1,200 cash.

2. Journal entries assuming that the shelving was sold for $200:

Cash 200

Accumulated Depreciation: Shelving 8,600Loss on Sale of Asset 200

Shelving 9,000

To record sale of shelving for $200 cash.

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25 Minutes, Medium PROBLEM 9–4ESCOLA DEVELOPERS

a.

General Journal

Feb 10 Loss on Disposal of Plant Assets 2 0 0

Accumulated Depreciation: Office Equipment 2 5 8 0 0

Office Equipment 2 6 0 0 0

Scrapped office equipment; received no salvage value.

Apr 1 Cash 1 0 0 0 0 0

Notes Receivable 8 0 0 0 0 0

Accumulated Depreciation: Building 2 5 0 0 0 0

Land 5 0 0 0 0

Building 5 5 0 0 0 0

Gain on Sale of Plant Assets 5 5 0 0 0 0

Sold land and building for a $100,000 cash down payment

and a 5-year, 9% note for the balance.

Aug 15 Vehicles (new truck) 3 9 0 0 0

Accumulated Depreciation: Vehicles (old truck) 1 8 0 0 0

Vehicles (old truck) 2 6 0 0 0

Gain on Disposal of Plant Assets 2 0 0 0

Cash 2 9 0 0 0

To record trade-in of old truck on new; trade-in allowance

exceeded book value by $2,000.

Oct 1 Office Equipment (new computer) 8 0 0 0

Loss on Trade-in of Plant Assets 3 5 0 0

Accumulated Depreciation: Office Equip. (old computer) 1 1 0 0 0

Office Equipment (old computer) 1 5 0 0 0Cash 1 5 0 0

Notes Payable 6 0 0 0

Acquired new computer system by trading in old

computer, paying part cash, and issuing a 1-year,

8% note payable. Recognized loss equal to book value of

old computer ($4,000) minus trade-in allowance ($500).

b. Gains and losses on asset disposals do not affect gross profit because they are not part of the cost of

goods sold. Such gains and losses do, however, affect net income reported in a firm’s income statement.

c. Unlike realized gains and losses on asset disposals, unrealized gains and losses on marketable securitiesare not generally reported in a firm’s income statement. Instead, they are reported in the balance sheet asa component of stockholders’ equity.

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25 Minutes, Medium PROBLEM 9–5WHITE CORPORATION

a. Operating expense. Although the training of employees probably has some benefit extending beyond thecurrent period, the number of periods benefited is highly uncertain. Therefore, current accounting practice is to expense routine training costs.

b. Intangible asset. Goodwill represents the present value of future earnings in excess of what isconsidered normal. The goodwill associated with White’s purchase of the vinyl flooring companyshould not be amortized, but is subject to evaluation for impairment in value.

c. Operating expense. Because of the great uncertainty surrounding the potential benefits of R&D programs, research and development costs should be charged to expense in the period in which thesecosts are incurred. Although this accounting treatment is controversial, it at least has the benefit of reducing the number of alternative accounting practices previously in use, thereby increasing thecomparability of financial statements.

d. Intangible asset. A patent grants its owner the exclusive right to produce a particular product. If the

patent has significant cost, this cost should be regarded as an intangible asset and expensed over the period of time that ownership of the patent will contribute to revenue. In this case, revenue is expectedto be earned only over the 6-year period during which the product will be produced and sold.

e. Operating expense. Advertising costs are regarded as operating expense because of the difficulty inobjectively determining the existence or life of any future benefit.

20 Minutes, Easy CASE 9–3INTERNATIONAL PAPER COMPANY

a. The depreciation methods used in financial statements are determined by management, not by incometax laws.

b. No—different depreciation methods may be used for different assets. The principle of consistency onlymeans that a company should not change from year to year the method used to compute depreciationexpense on a particular asset. This principle does not prohibit using different methods for differentassets, or using different depreciation methods in income tax returns.

c. (1) 20 years (a 5% straight-line depreciation rate is equivalent to writing off 1/20 of the asset’s costeach year, indicating a useful life of 20 years).

(2) 3 years (a 33% straight-line depreciation rate is equivalent to writing off 1/3 of the asset’s cost eachyear, indicating a useful life of 3 years).

The useful lives over which assets are to be depreciated are determined by management. However, if thecompany is audited by a CPA firm, the auditors will review these estimates of useful lives to determinethat they are reasonable.

d. Accelerated depreciation methods transfer the costs of plant assets to expense more quickly than doesthe straight-line method. These larger charges to depreciation expense reduce the amount of “taxableincome” and, therefore, reduce the amount of income taxes currently due.

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