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Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only) 9-1

CHAPTER 9

Reporting and Analyzing Long-Lived Assets

ANSWERS TO QUESTIONS

1. For plant assets, the cost principle states that plant assets are recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use.

2. In a cash transaction, cost is equal to the cash paid. In a noncash transaction, cost is equal to the cash equivalent price paid, which is the fair market

value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable.

3. The primary advantages of leasing are (1) reduced risk of obsolescence, (2) little or no down pay-

ment, (3) shared tax advantages, and (4) reduced recorded assets and liabilities. 4. When only the land is to be used, all demolition and removal costs of the building less any proceeds

from salvaged materials are necessary expenditures to make the land ready for its intended use. Any costs for clearing, draining, filling, and grading are also part of the cost of the land.

When both the land and building are to be used, necessary costs of the building include remodeling

expenditures and the cost of replacing or repairing the roofs, floors, wiring, and plumbing. 5. The potential benefits of leasing are (1) reduced risk of obsolescence (an obvious concern to

Kellum), (2) little or no required down payment, (3) shared tax advantages, (4) assets and liabilities are not reported on the balance sheet.

6. You should explain to the president that depreciation is a process of allocating the cost of a plant

asset to expense over its service (useful) life in a rational and systematic manner. Recognition of depreciation is not intended to result in the accumulation of cash for replacement of the asset.

7. (a) Salvage value is the expected cash value of the asset at the end of its useful life. (b) Salvage value is used in determining depreciable cost in the straight-line method by subtracting

it from the plant asset’s cost. 8. (a) Useful life is expressed in years under the straight-line method and in units of activity under

the units-of-activity method. (b) The pattern of periodic depreciation expense over an asset’s useful life is constant under the

straight-line method and variable under the units-of-activity method. 9. The effects of the three methods on annual depreciation expense are: Straight-line—constant

amount; units-of-activity—varying amount; declining-balance—decreasing amounts. 10. A revision of depreciation is made in current and future years but not retroactively. The rationale

is that continual restatement of prior periods would adversely affect the reader’s confidence in the financial statements.

9-2 Copyright © 2010 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 5/e, Solutions Manual (For Instructor Use Only)

Questions Chapter 9 (Continued) 11. Ordinary repairs are made to maintain the operating efficiency and expected productive life of the

asset. Capital expenditures are additions and improvements made to increase efficiency, pro-ductive capacity, or expected useful life of the asset. Revenue expenditures are recognized as expenses when incurred; capital expenditures are generally debited to the plant asset affected.

12. In a sale of plant assets, the book value of the asset is compared to the proceeds received from

the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.

13. The plant asset and related accumulated depreciation should continue to be reported on the

balance sheet without further depreciation or adjustment until the asset is retired. Reporting the asset and related accumulated depreciation on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset. In no situation can the depreciation on the plant asset exceed the cost of the plant asset.

14. Tootsie Roll depreciates its buildings over 20 to 35 years and its machinery and equipment over

5 to 20 years. 15. Depreciation and amortization are both concerned with writing off the cost of an asset to expense

over the periods benefited. Depreciation refers to allocating the cost of a plant asset to expense and amortization to allocating the cost of an intangible asset to expense.

16. It is true that successful marketing campaigns often benefit multiple accounting periods in the future,

enhancing the company’s value, and potentially creating goodwill. However, from an accounting perspective Ralph’s proposal is unacceptable. First of all, accounting standards only allow the recording of “purchased goodwill” that results from the purchase of another business. Internally created goodwill is not allowed to be recorded. Second, marketing expenditures are to be treated as expenses of the period in which they are incurred. They can not be capitalized. It is unethical to capitalize costs simply to boost reported income by spreading the cost over multiple periods.

17. The intern is not correct. If an intangible asset has a limited life, the cost of the asset should be

amortized over that asset’s useful life (the period of time when operations are benefited by use of the asset) or its legal life, whichever is shorter. The cost of intangible assets with indefinite lives should not be amortized.

18. The favorable attributes which could result in goodwill include exceptional management, desirable

location, good customer relations, skilled employees, high quality products, fair pricing policies, and harmonious relations with labor unions.

19. Goodwill is the value of many favorable attributes that are intertwined in the business enterprise.

Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold.

20. Goodwill is recorded only when there is an exchange transaction that involves the purchase of an

entire business. Goodwill is the excess of cost over the fair market value of the net assets (assets less liabilities) acquired. The recognition of goodwill without an exchange transaction would lead to subjective valuations which would reduce the reliability of financial statements.


Questions Chapter 9 (Continued) Goodwill is not amortized because it has an indefinite life. It remains at its original value as an

intangible asset unless it is considered to be impaired. If it is impaired, it is written down. 21. Research and development costs present several accounting problems. It is sometimes difficult

to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, research and development costs are usually recorded as an expense when incurred.

22. Campbell Soup Company’s return on assets ratio is computed as follows:

Net income

Average total assets=

$854

$3,095= 27.6%

23. The return on assets ratio is closely monitored by management. It is the product of the profit

margin ratio and the asset turnover ratio. At first glance, if this new product line has a lower profit margin, then it will reduce the company’s asset turnover ratio. However, it is likely that it will have a higher turnover than the company’s more expensive offerings. As a consequence, it is not possible to know what effect the new product line will have on the company’s return on assets without knowing the expected effect on the company’s asset turnover.

24. (a) Grocery stores usually have a high asset turnover ratio and a low profit margin ratio. (b) Car dealerships normally have a low asset turnover ratio and a high profit margin ratio. 25. Since Aldrich uses the straight-line depreciation method, its depreciation expense will be lower in

the early years of an asset’s useful life as compared to using an accelerated method. Benjamin’s depreciation expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Aldrich’s net income will be higher than Benjamin’s in the first few years of the asset’s useful life.

26. Yes, the tax regulations of the IRS allow a company to use a different depreciation method on the

tax return than is used in preparing financial statements. Garza Corporation uses an accelerated depreciation method for tax purposes to minimize its income taxes.

27. By selecting a higher estimated useful life, Mane Corp. is spreading the plant asset’s cost over a

longer period of time. The depreciation expense reported in each period is lower and net income is higher. Nienstedt’s choice of a shorter estimated useful life will result in higher depreciation expense reported in each period and lower net income.

28. In the operating activities section of the statement of cash flows, depreciation expense (from

plant assets) and amortization expense (from intangible assets) are added back to net income to determine net cash provided by operating activities. In the investing section, cash paid to purchase plant assets or intangible assets is shown as a use of cash. If the company sells any of its used plant assets, or if it sells intangibles, it would report the amount of cash received as a source of cash from investing activities.


SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures should be included in the cost of the land. Therefore, the cost of the land is $73,400 ($60,000 + $5,000 + $2,100 + $2,800 + $3,500). BRIEF EXERCISE 9-2 The cost of the truck is $26,280 (cash price $24,000 + sales taxes $1,080 + painting and lettering $1,200). The expenditures for insurance and motor vehicle license should not be added to the cost of the truck. BRIEF EXERCISE 9-3 The depreciable cost is $27,000 ($31,000 – $4,000). With a 5-year useful life, annual depreciation is $5,400 ($27,000 ÷ 5). Under the straight-line method, depreciation is the same each year. Thus, depreciation is $5,400 for both the first and second years. BRIEF EXERCISE 9-4 It is likely that management requested this accounting treatment to boost reported net income. Land is not depreciated; thus, by reporting land at $120,000 above its actual value the company increased yearly income by

$6,000 $120,00020 years

⎛

⎝⎜⎞

⎠⎟ or the reduction in depreciation expense. This practice is

not ethical because management is knowingly misstating asset values. BRIEF EXERCISE 9-5 Book value, 1/1/10 ($36,000 – $14,000) ........................................... $22,000 Less: Salvage value......................................................................... 2,000 Depreciable cost ............................................................................... $20,000 Remaining useful life........................................................................ 2 years Revised annual depreciation ($20,000 ÷ 2) ..................................... $10,000


BRIEF EXERCISE 9-6 (a) Repair Expense......................................................... 45 Cash ..................................................................... 45 (b) Delivery Truck........................................................... 400 Cash ..................................................................... 400 BRIEF EXERCISE 9-7 (a) Accumulated Depreciation—Delivery Equipment .............................................................. 41,000 Delivery Equipment............................................. 41,000 (b) Accumulated Depreciation—Delivery Equipment .............................................................. 38,800 Loss on Disposal ...................................................... 2,200 Delivery Equipment............................................. 41,000 Cost of delivery equipment $41,000 Less accumulated depreciation 38,800 Book value at date of disposal 2,200 Proceeds from sale 0 Loss on disposal $ 2,200 BRIEF EXERCISE 9-8 (a) Depreciation Expense .............................................. 6,000 Accumulated Depreciation—Office Equipment ... 6,000 (b) Cash........................................................................... 21,000 Accumulated Depreciation—Office Equipment ..... 48,000 Loss on Disposal ...................................................... 3,000 Office Equipment .............................................. 72,000 Cost of office equipment $72,000 Less accumulated depreciation 48,000* Book value at date of disposal 24,000 Proceeds from sale 21,000 Loss on disposal $ 3,000 *$42,000 + $6,000


BRIEF EXERCISE 9-9

(a) Return on assets ratio =$3.5

($30.0 + $29.0)÷2= 11.9%

(b) Asset turnover ratio = $21.6($30.0 + $29.0) ÷ 2 = .73 times

BRIEF EXERCISE 9-10 (a) Amortization Expense—Patent ($150,000 ÷ 5)....... 30,000 Patent................................................................. 30,000 (b) Intangible Assets Patent (Net of $30,000 of amortization) .......... $120,000 BRIEF EXERCISE 9-11 NIKE, INC. Partial Balance Sheet As of May 31, 2007 (in millions) Property, plant, and equipment Land........................................................ $ 193.8 Buildings................................................ $ 840.9 Machinery and equipment.................... 1,817.2 Other plant assets................................. 767.2 Less: Accumulated depreciation........ 1,940.8 1,484.5 Total property, plant, and equipment ................................... $1,678.3 Intangible assets Goodwill ................................................. $ 130.8 Patents and trademarks........................ $115.5 Less: Accumulated amortization........ 47.1 68.4 Total intangible assets.................. $ 199.2* *Alternatively, many companies would simply show a single line for net intangibles.


BRIEF EXERCISE 9-12 To determine net cash provided by operating activities, add depreciation expense and amortization expense to net income:

Net cash provided by Operating activities = $157,000 + $12,000 + $6,000 = $175,000

*BRIEF EXERCISE 9-13 The declining-balance rate is 40% (1/5 X 2) and this rate is applied to the book value at the beginning of the year. The computations are: Book Value X Rate = Depreciation Year 1 $31,000 40% $12,400 Year 2 ($31,000 – $12,400) 40% $ 7,440 *BRIEF EXERCISE 9-14 The depreciation cost per unit is 18 cents per mile computed as follows: Depreciable cost ($27,500 – $500) ÷ 150,000 = $.18 Depreciation expense for each year is as follows: 2009 28,000 miles X $.18 = $5,040 2010 30,000 miles X $.18 = $5,400


SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 9-1 The following four items are expenditures necessary to acquire the truck and get it ready for use: Negotiated purchase price......................................... $24,000 Installation of special shelving.................................. 1,100 Painting and lettering ................................................. 900 Sales tax ...................................................................... 1,300 Total paid ......................................................... $27,300 Thus, the cost of the truck is $27,300. The payments for the motor vehicle license and for the insurance are operating costs and are expensed over the first year of the truck’s life. DO IT! 9-2

Cost – Salvage $15,000 – $1,000Depreciation expense = Useful life = 8 years = $1,750

The entry to record the first year’s depreciation would be: Depreciation Expense ........................................................... 1,750 Accumulated Depreciation........................................... 1,750


DO IT! 9-3 (a) Sale of truck for cash at a gain: Cash............................................................................... 26,000 Accumulated Depreciation—Truck............................. 28,000 Truck ....................................................................... 50,000 Gain on Sale ........................................................... 4,000 (b) Sale of truck for cash at a loss: Cash............................................................................... 15,000 Accumulated Depreciation—Truck............................. 28,000 Loss on Sale ................................................................. 7,000 Truck ....................................................................... 50,000 DO IT! 9-4 1. Intangible assets 2. Amortization 3. Franchise 4. Research and development costs 5. Goodwill


SOLUTIONS TO EXERCISES EXERCISE 9-1 (a) The following points explain the application of the cost principle to

plant assets. 1. Under the cost principle, the acquisition cost for a plant asset in-

cludes all expenditures necessary to acquire the asset and make it ready for its intended use.

2. Cost is measured by the cash paid in a cash transaction, or by the cash equivalent price paid when noncash assets are used in payment.

3. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable.

(b) 1. Land 5. Delivery Truck 2. Factory Machinery 6. Factory Machinery 3. Delivery Truck 7. Prepaid Insurance 4. Land Improvements 8. License Expense EXERCISE 9-2 1. Factory Machinery 2. Truck 3. Factory Machinery 4. Land 5. Prepaid Insurance 6. Land Improvements 7. Land Improvements 8. Land 9. Building


EXERCISE 9-3 (a) Cost of land Cash paid................................................................... $80,000 Net cost of removing warehouse ($8,200 – $1,700)... 6,500 Attorney’s fee ............................................................ 1,500 Real estate broker’s fee............................................ 5,000 Total .................................................................... $93,000 (b) The architect’s fee ($9,100) should be debited to the building account.

The cost of the driveways and parking lot ($14,000) should be debited to Land Improvements.

EXERCISE 9-4 1. False. Depreciation is a process of cost allocation, not asset valuation. 2. True. 3. False. The book value of a plant asset may be quite different from its

market value. 4. False. Depreciation applies to three classes of plant assets: land

improvements, building, and equipment. 5. False. Depreciation does not apply to land because its usefulness and

revenue-producing ability generally remain intact over time. 6. True. 7. False. Recognizing depreciation on an asset does not result in an

accumulation of cash for replacement of the asset. 8. True. 9. False. Depreciation expense is reported on the income statement, and

accumulated depreciation is reported as a deduction from plant assets on the balance sheet.

10. False. Three factors affect the computation of depreciation: cost, useful life, and salvage value (also called residual value).

EXERCISE 9-5

Straight-line method: $90,000 – $6,0008

⎛⎝⎜

⎞⎠⎟

=$10,500 per year.

2010 depreciation = $10,500 X 4/12 = $3,500 2011 depreciation = $10,500.


EXERCISE 9-6 (a) Type of Asset Building Warehouse Cost......................................................... $900,000 $120,000 —Accumulated depreciation ................ –172,000 –23,000 Book value, 1/1/10.................................. $728,000 $ 97,000 Less: Salvage value.............................. 35,000 3,600 Depreciable cost (1)............................... $693,000 $ 93,400 Revised remaining useful life in years (2) 42* 15** *(50 – 8) **(20 – 5) Revised annual depreciation (1) ÷ (2) $16,500 $6,227 (b) Dec. 31 Depreciation Expense—Building .......... 16,500 Accumulated Depreciation— Building .................................... 16,500 EXERCISE 9-7 (a) Accumulated Depreciation—Delivery Equipment ... 20,000 Loss on Disposal ..................................................... 30,000 Delivery Equipment .......................................... 50,000 (b) Cash .......................................................................... 37,000 Accumulated Depreciation—Delivery Equipment............................................................ 20,000 Delivery Equipment .......................................... 50,000 Gain on Disposal .............................................. 7,000 (c) Cash .......................................................................... 18,000 Accumulated Depreciation—Delivery Equipment ........................................................... 20,000 Loss on Disposal ..................................................... 12,000 Delivery Equipment .......................................... 50,000


EXERCISE 9-8 Jan. 1 Accumulated Depreciation—Machinery............ 62,000 Machinery....................................................... 62,000 June 30 Depreciation Expense......................................... 6,500 Accum. Depreciation—Computer ($39,000 X 1/3 X 6/12)............................... 6,500 Cash ..................................................................... 5,000 Accumulated Depreciation—Computer ($39,000 X 2/3 = $26,000; $26,000 + $6,500) .... 32,500 Loss on Disposal [$5,000 – ($39,000 – $32,500)] ........................ 1,500 Computer ................................................. 39,000 Dec. 31 Depreciation Expense......................................... 4,400 Accumulated Depreciation—Truck [($25,000 – $3,000) X 1/5] .......................... 4,400 31 Cash ..................................................................... 9,000 Accumulated Depreciation—Truck [($25,000 – $3,000) X 4/5] .............................. 17,600 Truck....................................................... 25,000 Gain on Disposal ................................... 1,600 EXERCISE 9-9 1. Depreciation is the process of allocating the cost of a long-lived asset

to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and revenue pro-ducing ability does not decline. In addition, the useful life of land is indefinite. Therefore, it would be incorrect for the student to depreciate the land.

2. Goodwill is an intangible asset with an indefinite life. According to

generally accepted accounting principles, goodwill is not amortized but reviewed annually for impairment. If a permanent decline in value has occurred the goodwill is written down and an impairment loss is re-corded on the income statement. Therefore the amortization entry should be reversed and no decline in value recorded until an impairment in value occurs.


EXERCISE 9-9 (Continued) 3. This is a violation of the cost principle. Because current market values

are subjective and not reliable, they are not used to increase the re-corded value of an asset after acquisition. The appropriate accounting treatment is to leave the building on the books at its zero book value.

EXERCISE 9-10 (a) Asset turnoverratio= $35,214

($22,690+$24,000)÷ 2 =1.51 times

(b) R etu rn o n a sse t s ratio =

$2,016( $ 22,690 +$24,000) ÷ 2 =8.6%

EXERCISE 9-11 (a) Without new products With new products $600,000 $1,350,000 Return on assets ratio $5,000,000

= .12 $15,000,000

= .09

$600,000 $1,350,000 Profit margin ratio $10,000,000 = .06 $18,000,000 = .08

$10,000,000 $18,000,000 Asset turnover ratio $5,000,000

= 2.0 $15,000,000

= 1.2

(b) The return on assets ratio declined from 12% to 9%. This means that

the company is not generating as much income from each dollar invested in assets. It is common for companies to try to maximize their return on assets, thus top management might not find this proposal very desirable. The new product line would increase the company’s profit margin (the amount of net income generated from each dollar of sales) from 6% to 8%. However, because of the huge investment in new assets that the proposal requires, the asset turnover ratio plummets from 2.0 times down to 1.2 times.


EXERCISE 9-12 (a) ($ in millions) $244.9 1. Return on assets ($4,312.6 + $4,254.3) ÷ 2 = 5.7%

$11,408.5 2. Asset turnover ($4,312.6 + $4,254.3) ÷ 2 = 2.7 times

$244.9 3. Profit margin $11,408.5 = 2.1%

(b) Profit Margin X Asset Turnover = Return on Assets = 2.1% X 2.7 times = 5.7% (c) Asset turnover and profit margin vary considerably across industries.

Therefore, when you have a diverse group of businesses from several industry types combined into one company, such as in Hopson Com-pany, the ability to compare these ratios to other businesses becomes very difficult. Hopson Company would almost need to calculate ratios for each of the separate industry segments to allow for a meaningful analysis.

EXERCISE 9-13 Dec. 31 Amortization Expense—Copyright ................. 15,000 Copyright ($120,000 X 1/8)........................ 15,000 31 Amortization Expense—Patent ....................... 9,000 Patent ($54,000 X 1/4 X 8/12) .................... 9,000 The goodwill would not require an adjusting entry because it has an indefi-nite life.


EXERCISE 9-14 (a) 1/2/10 Patent......................................................... 300,000 Cash .................................................... 300,000 4/1/10 Goodwill..................................................... 360,000 Cash .................................................... 360,000 (Part of the entry to record purchase of another company) 7/1/10 Franchise................................................... 540,000 Cash .................................................... 540,000 9/1/10 Research and Development Expense ..... 185,000 Cash .................................................... 185,000 (b) Amortization Expense—Patent ($300,000 ÷ 5) ..... 60,000 Amortization Expense—Franchise [($540,000 ÷ 9) X 6/12] ....................................... 30,000 Patent................................................................ 60,000 Franchise.......................................................... 30,000 (c) Ending balances, 12/31/10: Patent = $240,000 ($300,000 – $60,000) Goodwill = $360,000 Franchises = $510,000 ($540,000 – $30,000) EXERCISE 9-15 Alliance Atlantis Communications Inc.’s change of accounting policy to amortize broadcast rights will probably increase its reported income. Prior to the change, Alliance Atlantis had amortized broadcast rights over a maxi-mum of two years. Their new policy calls for amortization over the contracted exhibition period. If this is greater than two years, annual amortization expense will decrease and income will increase. A change of this nature will make comparison of financial results with previous years’ difficult. To evaluate the company’s performance one will need to make an adjustment for such changes in estimated lives.


EXERCISE 9-16 (a) A company should depreciate its buildings because depreciation is

necessary in order to allocate the cost of the buildings to the periods in which they are in use. This allows the cost of the buildings to be matched against the revenues generated each year in accordance with the matching principle.

(b) A building can have a zero book value if it has no salvage value and it

is fully depreciated—that is, if it has been used for a period at least as long as its expected life. Because depreciation is used to allocate cost rather than to reflect actual value, it is not at all unlikely that a building could have a low or zero book value, but a substantial market value.

(c) Examples of intangibles that might be found on a college campus are

franchise of a bookstore chain, license to operate radio station, a patents developed by professors, and a permit to operate a bus service.

(d) Typical company or product trade names are: Clothes—Gap, Gitano, Dockers, Calvin Klein, Chaus, Guess. Perfume—Passion, Ruffles, Chanel No. 5, Diamonds. Cars—TransAm, Nova, Prelude, Coupe DeVille, Eclipse. Shoes—Nike, Florsheim, L.A. Gear, Adidas. Breakfast cereals—Cheerios, Wheaties, Frosted Mini-Wheats, Rice Krispies. Trade names and trademarks are reported on a balance sheet if there is

a cost attached to them. If the trade name or trademark is purchased, the cost is the purchase price. If it is developed by the enterprise, the cost includes attorney’s fees, registration fees, design costs, success-ful legal defense costs, and other expenditures directly related to securing the trade name or trademark.


EXERCISE 9-17

10-year life 15-year lifeNet Income $62,000 $108,000* *$62,000 + ($134,000 – $88,000) Calculation of net cash provided by operating activities: Net income $ 62,000 $108,000 Plus: depreciation expense 134,000 88,000 Net cash provided by operating activities $196,000 $196,000 The CEO is correct regarding the impact on net income. By increasing the expected useful life depreciation, expense would be lowered and net income would increase. However, this move would be appropriate only if, in fact, a 15-year life was a better estimate of the expected period of use. The CEO is incorrect in stating that cash provided by operating activities would be increased. Depreciation expense does not use up cash. Therefore, net cash provided by operating activities would be the same no matter what expected life was used. *EXERCISE 9-18 (a) Depreciation cost per unit is $.80 per mile [($136,000 – $8,000) ÷

160,000]. (b) Computation End of Year Annual Units of Depreciation Depreciation Accumulated Book Years Activity X Cost/Unit = Expense Depreciation Value 2010 40,000 $.80 $32,000 $ 32,000 $104,000 2011 52,000 .80 41,600 73,600 62,400 2012 41,000 .80 32,800 106,400 29,600 2013 27,000 .80 21,600 128,000 8,000


*EXERCISE 9-19 (a) Declining-balance method:

2010 depreciation = $90,000 X 25%* X 4/12 = $7,500 Book value January 1, 2011 = $90,000 – $7,500 = $82,500 2011 depreciation = $82,500 X 25% = $20,625. *(1/8) X 2 = 25%

(b) Units-of-activity method:

$90,000– $6,00070,000

⎛

⎝⎜⎞

⎠⎟=$1.20 per hour

2010 depreciation = 2,900 hours X $1.20 = $3,480.


SOLUTIONS TO PROBLEMS

Item Land Building Other Accounts 1 $280,000 2 $ 6,800 Land Improvements 3 24,000 4 $ 23,000 5 2,179 6 29,000 Land Improvements 7 33,000 8 5,800 Property Tax Expense 9 640,000 10 (8,000) $298,179 $696,000

PROBLEM 9-1A


(a) April 1 Land ....................................................... 2,200,000 Cash ................................................ 2,200,000 May 1 Depreciation Expense........................... 20,000 Accumulated Depreciation— Equipment................................. 20,000 ($600,000 X 1/10 X 4/12) 1 Cash ....................................................... 170,000 Accumulated Depreciation— Equipment....................................... 440,000 Equipment................................. 600,000 Gain on Disposal ...................... 10,000 Cost ........................................... $600,000 Accum. depr.—Equipment ...... 440,000 [($600,000 X 1/10) X 7 + $20,000)] Book value................................ 160,000 Cash proceeds ......................... 170,000 Gain on disposal ...................... $ 10,000 June 1 Cash ....................................................... 1,800,000 Land................................................. 1,000,000 Gain on Disposal............................ 800,000 July 1 Equipment.............................................. 1,300,000 Cash ................................................ 1,300,000 Dec. 31 Depreciation Expense........................... 50,000 Accumulated Depreciation— Equipment................................. 50,000 ($500,000 X 1/10) 31 Accumulated Depreciation— Equipment....................................... 500,000 Equipment................................. 500,000

PROBLEM 9-2A


PROBLEM 9-2A (Continued) Cost......................................... $500,000 Accum. depr.—Equipment ($500,000 X 1/10 X 10) ........ 500,000 Book value.............................. $ 0 (b) Dec. 31 Depreciation Expense ............................ 662,500 Accumulated Depreciation— Buildings .................................... 662,500 ($26,500,000 X 1/40) 31 Depreciation Expense ............................ 3,955,000 Accumulated Depreciation— Equipment .................................. 3,955,000 $38,900,000* X 1/10............... $3,890,000 $ 1,300,000 X 1/10 X 6/12..... 65,000 $3,955,000 *($40,000,000 – $600,000 – $500,000) (c) RIJO CORPORATION Partial Balance Sheet December 31, 2011 Plant Assets* Land ......................................................... $ 4,200,000 Buildings.................................................. $26,500,000 Less: Accumulated depreciation— buildings ...................................... 12,762,500 13,737,500 Equipment................................................ 40,200,000 Less: Accumulated depreciation— equipment .................................... 8,085,000 32,115,000 Total plant assets .............................. $50,052,500 *See T-accounts which follow.


PROBLEM 9-2A (Continued) Land

12/31/10 3,000,000 6/1/10 1,000,000 04/01/11 2,200,000

12/31/11 Bal. 4,200,000

Buildings

12/31/10 26,500,000

12/31/11 Bal. 26,500,000

Equipment

12/31/10 40,000,000 05/01/11 600,000 07/01/11 1,300,000 12/31/11 500,000

12/31/11 Bal. 40,200,000

Accumulated Depreciation—Buildings

12/31/10 12,100,000 12/31/11 662,500

12/31/11 Bal. 12,762,500

Accumulated Depreciation—Equipment

05/01/11 440,000 12/31/10 5,000,000 12/31/11 500,000 5/1/11 20,000 12/31/11 50,000 12/31/11 3,955,000

12/31/11 Bal. 8,085,000


Jan. 1 Accumulated Depreciation—Machinery ....... 71,000 Machinery................................................. 71,000 June 30 Depreciation Expense .................................... 3,000 Accum. Depreciation—Computer ($30,000 X 1/5 X 6/12).......................... 3,000 June 30 Cash................................................................. 10,000 Accumulated Depreciation—Computer........ 21,000 Computer.................................................. 30,000 Gain on Disposal ..................................... 1,000 Cost.................................................................. $30,000 Accumulated Depreciation—Computer [($30,000 X 1/5) X 3 + $3,000] .................... 21,000 Book Value ...................................................... 9,000 Cash Proceeds................................................ 10,000 Gain on Disposal ............................................ $ 1,000 Dec. 31 Depreciation Expense .................................... 3,500 Accumulated Depreciation—Truck [($31,000 – $3,000) X 1/8].................... 3,500 31 Loss on Disposal............................................ 10,000 Accumulated Depreciation—Truck ............... 21,000 Delivery Truck.......................................... 31,000 Cost.................................................................. $31,000 Accumulated Depreciation—Truck [($31,000 – $3,000) X 1/8 X 6] .................. 21,000 Book Value ...................................................... 10,000 Proceeds ......................................................... 0 Loss on Disposal............................................ $10,000

PROBLEM 9-3A


(a) Jan. 2 Patents ......................................................... 45,000 Cash ....................................................... 45,000 Jan.– Research and Development Expense ....... 210,000 June Cash ....................................................... 210,000 July 1 Patents ......................................................... 20,000 Cash ....................................................... 20,000 Sept. 1 Advertising Expense................................... 40,000 Cash ....................................................... 40,000 Oct. 1 Copyright ..................................................... 200,000 Cash ....................................................... 200,000 (b) Dec. 31 Amortization Expense—Patents................ 11,500 Patents ................................................... 11,500 [($60,000 X 1/10) + ($45,000 X 1/9) + ($20,000 X 1/20 X 6/12)] 31 Amortization Expense—Copyright............ 4,600 Copyrights ............................................. 4,600 [($36,000 X 1/10) + ($200,000 X 1/50 X 3/12)] (c) Intangible Assets Patents ($125,000 cost less $17,500 amortization) (1) ......... $107,500 Copyrights ($236,000 cost less $29,800 amortization) (2)..... 206,200 Total intangible assets................................................... $313,700 (1) Cost ($60,000 + $45,000 + $20,000); amortization ($6,000 + $11,500). (2) Cost ($36,000 + $200,000); amortization ($25,200 + $4,600). (d) The intangible assets of Salmiento Corporation consist of two patents

and two copyrights. One patent with a cost of $60,000 is being amor-tized over 10 years. In addition, legal costs of $45,000 incurred in the suc-cessful defense of this patent are being amortized over the remaining useful life, 9 years. The other patent with a cost of $20,000 is being amor-tized over 20 years. A copyright with a cost of $36,000 is being amortized over 10 years; the other copyright with a cost of $200,000 is being amortized over 50 years.

PROBLEM 9-4A


1. Research and Development Expense ........................ 150,000 Patents.................................................................. 150,000 Patents .......................................................................... 7,500 Amortization Expense—Patents [$9,500 – ($40,000 X 1/20)]................................ 7,500 2. Goodwill........................................................................ 1,000 Amortization Expense—Goodwill ...................... 1,000

PROBLEM 9-5A


(a) Titus Vane

1. $240,000 $300,000

Return on assets ratio = 7.3% = 10.0%$3,300,000 $3,000,000

2. $240,000 $300,000

Profit margin = 19.2% = 25.0%$1,250,000 $1,200,000

3. $1,250,000 $1,200,000

Asset turnover ratio = .38 times = .40 times$3,300,000 $3,000,000

(b) Based on the asset turnover ratio, Vane Corp. is more effective in using

assets to generate sales. Its asset turnover ratio is 5% higher than Titus’s ratio.

A factor that inhibits comparing the two companies is the differing

composition of total assets for each company. Eighty-two percent [($2,400,000 + $300,000) ÷ $3,300,000] of Titus’s total assets are plant or intangible assets compared to only sixty percent ($1,800,000 ÷ $3,000,000) for Vane. Also, Vane reports no intangible assets.

PROBLEM 9-6A


(a) Accumulated Depreciation Year Computation 12/31

MACHINE 1 2008 $84,000* X 1/6 = $14,000 $14,000 2009 $84,000 X 1/6 = $14,000 28,000 2010 $84,000 X 1/6 = $14,000 42,000 2011 $84,000 X 1/6 = $14,000 56,000 *($96,000 – $12,000) MACHINE 2 2009 $85,000 X 40%* X 6/12 = $17,000 $17,000 2010 $68,000 X 40% = $27,200 44,200 2011 $40,800 X 40% = $16,320 60,520 *(1/5) X 2 MACHINE 3 2009 400 X $2.50a = $ 1,000 $ 1,000 2010 4,500 X $2.50 = $11,250 12,250 2011 5,000 X $2.50 = $12,500 24,750 a($66,000 – $6,000) ÷ 24,000 Depreciation (b) Year Expense MACHINE 2 2009 $85,000 X 40% X 3/12 = $8,500 2010 $76,500 X 40% = $30,600

PROBLEM 9-7A


(a) STRAIGHT-LINE DEPRECIATION Computation End of Year Annual Depreciable Depreciation Depreciation Accumulated Book Years Cost X Rate = Expense Depreciation Value 2010 $240,000* 25%** $60,000 $ 60,000 $190,000 2011 240,000 25% 60,000 120,000 130,000 2012 240,000 25% 60,000 180,000 70,000 2013 240,000 25% 60,000 240,000 10,000 *($250,000 – $10,000) **1/4 = 25% DOUBLE-DECLINING-BALANCE DEPRECIATION Computation End of Year Book Value Annual Beginning Depreciation Depreciation Accumulated Book Years of Year X Rate = Expense Depreciation Value 2010 $250,000 50%* $125,000 $125,000 $125,000 2011 125,000 50% 62,500 187,500 62,500 2012 62,500 50% 31,250 218,750 31,250 2013 31,250 50% 21,250** 240,000 10,000 *(1/4) X 2 = 50% **Adjusted so ending book value will equal salvage value. (b) Straight-line depreciation provides the lowest amount for 2010 deprecia-

tion expense ($60,000) and, therefore, the highest 2010 income. Over the four-year period, both methods result in the same total depreciation expense ($240,000) and, therefore, the same total income.

(c) Double-declining-balance depreciation provides the highest amount

for 2010 depreciation expense ($125,000) and, therefore, the lowest 2010 income. Both methods result in the same total income over the four-year period.

*PROBLEM 9-8A


Item Land Building Other Accounts 1 $250,000 2 6,000 3 32,000 4 7,100 5 21,900 6 40,000 7 629,500 8 $36,000 Land Improvements 9 7,300 Property Tax Expense 10 (12,700) $282,400 $691,400

PROBLEM 9-1B


(a) April 1 Land ........................................................ 2,630,000 Cash ................................................. 2,630,000 May 1 Depreciation Expense............................. 25,000 Accumulated Depreciation— Equipment................................... 25,000 ($750,000 X 1/10 X 4/12) 1 Cash ......................................................... 370,000 Accumulated Depreciation— Equipment......................................... 400,000 Equipment................................... 750,000 Gain on Disposal ........................ 20,000 Cost .............................................. $750,000 Accum. depr.—Equipment ......... 400,000 [($750,000 X 1/10) X 5 + $25,000)] Book value................................... 350,000 Cash proceeds ............................ 370,000 Gain on disposal ......................... $ 20,000 June 1 Cash ......................................................... 1,800,000 Land................................................... 800,000 Gain on Disposal.............................. 1,000,000 July 1 Equipment................................................ 800,000 Cash .................................................. 800,000 Dec. 31 Depreciation Expense............................. 47,000 Accumulated Depreciation— Equipment ($470,000 X 1/10)......................... 47,000 31 Accumulated Depreciation— Equipment......................................... 470,000 Equipment................................... 470,000

PROBLEM 9-2B


PROBLEM 9-2B (Continued) Cost......................................... $470,000 Accum. depr.—Equipment ($470,000 X 1/10 X 10) .... 470,000 Book Value ............................. $ 0 (b) Dec. 31 Depreciation Expense .......................... 712,500 Accumulated Depreciation— Buildings ($28,500,000 X 1/40) ................. 712,500 31 Depreciation Expense .......................... 4,718,000 Accumulated Depreciation— Equipment ................................ 4,718,000 ($46,780,000* X 1/10) ........... $4,678,000 [($800,000 X 1/10) X 6/12] .... 40,000 $4,718,000 *($48,000,000 – $750,000 – $470,000) (c) KRETSINGER CORPORATION Partial Balance Sheet December 31, 2010

Plant Assets* Land ......................................................... $ 5,830,000 Buildings.................................................. $28,500,000 Less: Accumulated depreciation— buildings ...................................... 12,812,500 15,687,500 Equipment................................................ 47,580,000 Less: Accumulated depreciation— equipment .................................... 8,920,000 38,660,000 Total plant assets .............................. $60,177,500 *See T-accounts which follow.


PROBLEM 9-2B (Continued) Land

12/31/09 4,000,000 6/1/10 800,000 4/1/10 2,630,000

12/31/10 Bal. 5,830,000

Buildings

12/31/09 28,500,000

12/31/10 Bal. 28,500,000

Equipment

12/31/09 48,000,000 5/1/10 750,000 7/1/10 800,000 12/31/10 470,000

12/31/10 Bal. 47,580,000

Accumulated Depreciation—Buildings

12/31/09 12,100,000 12/31/10 712,500

12/31/10 Bal. 12,812,500

Accumulated Depreciation—Equipment

5/1/10 400,000 12/31/09 5,000,000 12/31/10 470,000 5/1/10 25,000 12/31/10 47,000 12/31/10 4,718,000

12/31/10 Bal. 8,920,000


Jan. 1 Accumulated Depreciation— Machinery ($52,000 X 1/10 X 10 years) ..... 52,000 Machinery....................................... 52,000 June 30 Depreciation Expense .......................... 3,000 Accumulated Depreciation— Computer ($42,000 X 1/7 X 6/12)............... 3,000 Cash....................................................... 23,000 Accumulated Depreciation— Computer........................................ 21,000 Computer.................................. 42,000 Gain on Disposal...................... 2,000 Cost........................................................ $42,000 Accumulated Depreciation— Computer [($42,000 X 1/7) X 3 + $3,000] ........ 21,000 Book Value ............................................ 21,000 Cash Proceeds...................................... 23,000 Gain on Disposal .................................. $ 2,000 Dec. 31 Depreciation Expense .......................... 4,500 Accumulated Depreciation— Truck [($30,000 – $3,000) X 1/6]......... 4,500

PROBLEM 9-3B


Problem 9-3B (Continued) Dec. 31 Accumulated Depreciation—Truck [($30,000 – $3,000) X 1/6 X 4] ........ 18,000 Loss on Disposal .............................. 12,000 Truck............................................. 30,000 Cost .................................................... $30,000 Accumulated Depreciation—Truck [($30,000 – $3,000) X 1/6 X 4] ........ 18,000 Book Value......................................... 12,000 Proceeds............................................ 0 Loss on Disposal .............................. $12,000


(a) Jan. 2 Patents........................................................... 27,000 Cash ......................................................... 27,000 Jan.- Research and Development Expense......... 220,000 June Cash ......................................................... 220,000 July 1 Patents........................................................... 12,000 Cash ......................................................... 12,000 Sept. 1 Advertising Expense .................................... 110,000 Cash ......................................................... 110,000 Oct. 1 Copyright....................................................... 120,000 Cash ......................................................... 120,000 (b) Dec. 31 Amortization Expense—Patents ................. 10,300 Patents ..................................................... 10,300 [($70,000 X 1/10) + ($27,000 X 1/9) + ($12,000 X 1/20 X 6/12)] 31 Amortization Expense—Copyrights ........... 6,600 Copyrights ............................................... 6,600 [($48,000 X 1/8) + ($120,000 X 1/50 X 3/12)] (c) Intangible Assets Patents ($109,000 cost less $17,300 amortization) (1).......... $ 91,700 Copyrights ($168,000 cost less $24,600 amortization) (2).... 143,400 Total intangible assets ................................................... $235,100 (1) Cost ($70,000 + $27,000 + $12,000); amortization ($7,000 + $10,300). (2) Cost ($48,000 + $120,000); amortization ($18,000 + $6,600). (d) The intangible assets of Gore Company consist of two patents and two

copyrights. One patent with a cost of $70,000 is being amortized over 10 years; an additional $27,000 incurred in successfully defending this patent is being amortized over 9 years. The other patent, obtained at cost of $12,000, is being amortized over 20 years. A copyright with a cost of $48,000 is being amortized over 8 years; the other copyright with a cost of $120,000 is being amortized over 50 years.

PROBLEM 9-4B


1. Research and Development Expense........................ 120,000 Patents ................................................................. 120,000 Patents.......................................................................... 10,000 Amortization Expense—Patents [$18,000 – ($96,000 X 1/12)] ............................. 10,000 2. Goodwill ....................................................................... 500 Amortization Expense—Goodwill ...................... 500

PROBLEM 9-5B


(a) Riverton Salina

1. $800,000 $900,000Return on assets ratio = 27% = 33%

$3,000,000 $2,700,000

2. $800,000 $900,000Profit margin = 33% = 36%

$2,400,000 $2,500,000

3. $2,400,000 $2,500,000Asset turnover ratio = .80 times = .93 times

$3,000,000 $2,700,000

(b) Based on the asset turnover ratio, Salina Corp. is more effective in

using assets to generate sales. Its asset turnover ratio is 16% higher than Riverton’s ratio.

A factor that inhibits comparing the two companies is the differing

composition of total assets for each company. Fifteen percent ($450,000 ÷ $3,000,000) of Riverton’s total assets are intangible assets. Salina has no recorded intangible assets.

PROBLEM 9-6B


(a) Accumulated Depreciation Year Computation 12/31

BUS 1 2009 $90,000a X 25% b = $22,500 $22,500 2010 $90,000 X 25% = $22,500 45,000 2011 $90,000 X 25% = $22,500 67,500 a$96,000 – $6,000 b(1/4) BUS 2 2009 $135,000 X 50%c = $67,500 $ 67,500 2010 $ 67,500 X 50% = $33,750 101,250 2011 $ 33,750 X 50% = $16,875 118,125 c(1/4) X 2 BUS 3 2009 26,000 miles X $.65d = $16,900 $16,900 2010 34,000 miles X $.65 = $22,100 $39,000 2011 30,000 miles X $.65 = $19,500 $58,500 d($100,000 – $9,000) ÷ 140,000 miles = $.65 per mile. (b) Depreciation Year Expense

BUS 2 (1) 2009 $135,000 X 50% X 10/12 = $56,250 (2) 2010 $78,750 X 50%e = $39,375 e(1/4) X 2

*PROBLEM 9-7B


(a) STRAIGHT-LINE DEPRECIATION Computation End of Year Annual Depreciable Depreciation Depreciation Accumulated Book Years Cost X Rate = Expense Depreciation Value 2010 $300,000a 20%b $60,000 $ 60,000 $270,000 2011 300,000 20% 60,000 120,000 210,000 2012 300,000 20% 60,000 180,000 150,000 2013 300,000 20% 60,000 240,000 90,000 2014 300,000 20% 60,000 300,000 30,000 a$330,000 – $30,000 b1/5 = 20% DOUBLE-DECLINING-BALANCE DEPRECIATION Computation End of Year Book Value Annual Beginning Depreciation Depreciation Accumulated Book Years of Year X Rate = Expense Depreciation Value 2010 $330,000 40%c $132,000 $132,000 $198,000 2011 198,000 40% 79,200 211,200 118,800 2012 118,800 40% 47,520 258,720 71,280 2013 71,280 40% 28,512 287,232 42,768 2014 42,768 40% 12,768d 300,000 30,000

c(1/5) X 2 = 40% dAdjusted so ending book value will equal salvage value. (b) Straight-line depreciation provides the lower amount for 2010 depreci-

ation expense and, therefore, the higher 2010 income. Over the five-year period, both methods result in the same total depreciation expense ($300,000) and, therefore, the same total income.

(c) Double-declining-balance depreciation provides the higher amount for

2010 depreciation expense and, therefore, the lower 2010 income. Both methods result in the same total income over the five-year period.

*PROBLEM 9-8B


CHAPTER 9 COMPREHENSIVE PROBLEM SOLUTION (a) 1. Equipment.................................................................... 16,800 Cash ....................................................................... 16,800 2. Depreciation Expense—Equipment........................... 450 Accumulated Depreciation—Equipment............. 450 Cash ............................................................................. 3,500 Accumulated Depreciation—Equipment................... 2,250 Equipment.............................................................. 5,000 Gain on Disposal [$3,500 – ($5,000 – $2,250)] .... 750 3. Accounts Receivable .................................................. 5,000 Sales....................................................................... 5,000 Cost of Goods Sold..................................................... 3,500 Merchandise Inventory......................................... 3,500 4. Bad Debts Expense ($4,000 – $500) .......................... 3,500 Allowance for Doubtful Accounts ....................... 3,500 5. Interest Receivable ($10,000 X .08 X 9/12) ................ 600 Interest Revenue ................................................... 600 6. Insurance Expense ($3,600 X 4/6).............................. 2,400 Prepaid Insurance................................................. 2,400 7. Depreciation Expense—Building............................... 4,000 Accumulated Depreciation—Building [($150,000 – $30,000) ÷ 30] ................................... 4,000 8. Depreciation Expense—Equipment........................... 9,900 Accumulated Depreciation—Equipment [($55,000 – $5,500) ÷ 5] ...................................... 9,900 9. Depreciation Expense—Equipment........................... 2,000 Accumulated Depreciation—Equipment [($16,800 – $1,800) ÷ 5] X 8/12 ........................... 2,000 10. Amortization Expense—Patents ($9,000 ÷ 9)............ 1,000 Patent ..................................................................... 1,000


COMPREHENSIVE PROBLEM (Continued) 11. Salaries Expense ................................................... 2,200 Salaries Payable .............................................. 2,200 12. Unearned Rent ($6,000 X 1/3) ............................... 2,000 Rent Revenue................................................... 2,000 13. Interest Expense.................................................... 4,600 Interest Payable [($11,000 + $35,000) X .10] ........................... 4,600 14. Income Tax Expense ............................................. 15,000 Income Tax Payable ........................................ 15,000


COMPREHENSIVE PROBLEM (Continued) (b) PINKERTON CORPORATION Trial Balance December 31, 2010

Debits Credits Cash ..................................................................Accounts Receivable .......................................Notes Receivable..............................................Interest Receivable...........................................Merchandise Inventory ....................................Prepaid Insurance ............................................Land...................................................................Building.............................................................Equipment.........................................................Patent ................................................................Allowance for Doubtful Accounts...................Accumulated Depreciation—Building ............Accumulated Depreciation—Equipment........Accounts Payable ............................................Salaries Payable ...............................................Unearned Rent..................................................Notes Payable (short-term) .............................Interest Payable................................................Notes Payable (long-term)...............................Income Tax Payable .........................................Common Stock .................................................Retained Earnings............................................Dividends ..........................................................Sales..................................................................Interest Revenue ..............................................Rent Revenue ...................................................Gain on Disposal ..............................................Bad Debts Expense..........................................Cost of Goods Sold..........................................Depreciation Expense—Building....................Depreciation Expense—Equipment................Insurance Expense...........................................Interest Expense...............................................Other Operating Expenses ..............................Amortization Expense—Patents .....................Salaries Expense..............................................Income Tax Expense........................................ Total ...........................................................

$ 14,70041,80010,000

60032,700

1,20020,000

150,00071,800

8,000

12,000

3,500633,500

4,00012,350

2,4004,600

61,8001,000

112,200 15,000$1,213,150

$ 4,000

54,00034,10027,300

2,2004,000

11,0004,600

35,00015,00050,00063,600

905,000600

2,000750

$1,213,150


COMPREHENSIVE PROBLEM (Continued) (c) PINKERTON CORPORATION

Income Statement For the Year Ended December 31, 2010

Sales........................................................Cost of goods sold ................................Gross profit ............................................Operating expenses Salaries expense.............................. Other operating expenses............... Depreciation expense—equipment .. Depreciation expense—building .... Bad debts expense .......................... Insurance expense........................... Amortization expense—patents .....Total operating expenses......................Income from operations ........................Other revenues and gains Rent revenue ...................................... Gain on disposal .............................. Interest revenue ............................... Other expenses and losses Interest expense...............................Income before income taxes.................Income tax expense...............................Net income..............................................

$112,200 61,800 12,350 4,000 3,500 2,400 1,000

2,000750

600 3,350

(4,600)

$905,000 633,500 271,500 197,250 74,250

(1,250) 73,000

15,000 $ 58,000

PINKERTON CORPORATION Retained Earnings Statement

For the Year Ending December 31, 2010

Retained earnings, 1/1/10...........................................Add: Net income ....................................................... Less: Dividends .........................................................Retained earnings, 12/31/10.......................................

$ 63,600 58,000 121,600 12,000 $109,600


COMPREHENSIVE PROBLEM (Continued) (d) PINKERTON CORPORATION Balance Sheet December 31, 2010

Current assets Cash............................................................. Accounts receivable .................................. Less: Allowance for doubtful accounts .... Notes receivable......................................... Interest receivable...................................... Merchandise inventory .............................. Prepaid insurance ...................................... Total current assets..............................Property, plant, and equipment Land............................................................. Building ....................................................... Less: Accum. depr.—building.................. Equipment................................................... Less: Accum. depr.—equipment ............. Total property, plant, and equipment ...Intangible assets Patent ..........................................................Total assets....................................................... Current liabilities Notes payable (short-term)........................ Accounts payable....................................... Income tax payable .................................... Interest payable .......................................... Unearned rent ............................................. Salaries payable ......................................... Total current liabilities .........................Long-term liabilities Notes payable (long-term) .........................Total liabilities ..................................................Stockholders’ equity Common stock ........................................... Retained earnings ......................................Total liabilities and stockholders’ equity .......

$150,000 54,000 71,800 34,100

$ 41,800 4,000 20,000 96,000 37,700

$ 11,00027,30015,000

4,6004,000

2,200 50,000 109,600

$ 14,700

37,800 10,000 600 32,700 1,200 97,000

153,700

8,000$258,700

64,100

35,000 99,100

159,600$258,700


(a) At December 31, 2007, total cost of property, plant and equipment was

$377,693,000; book value was $201,401,000. (b) Depreciation is calculated by use of the straight-line method over the

estimated useful lives of the assets. (c) Depreciation and amortization was: 2007, $15,859,000; 2006, $15,816,000;

2005, $14,687,000. (d) Tootsie Roll’s purchases of property, plant, and equipment were: 2007,

$14,767,000; 2006, $39,207,000. (e) Goodwill and intangible assets with indefinite lives are not amortized,

but rather tested for impairment at least annually. The company tested goodwill and trademarks during the fourth quarter of each year. It recorded an impairment in 2005 but none in 2006 or 2007.

BYP 9-1 FINANCIAL REPORTING PROBLEM


(a) Tootsie Roll Hershey Foods

1. $51,625 $214,154

Return on assets ratio = 6.4% = 5.1%($812,725+$791,639)/2 ($4,247,113+$4,157,565)/2

2. Profit margin$51,625

$497,717=10.4%

$214,154

$4,946,716= 4.3%

3. Asset turnover ratio $497,717

($812,725+$791,639)÷ 2=.62 times

$4,946,716

($4,247,113 +4,157,565) ÷2= 1.18 times

The asset turnover ratio measures how efficiently a company uses its

assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Hershey Foods’ asset turnover ratio (1.18) was 90% higher than Tootsie Roll’s (.62) in 2007. Therefore, it can be con-cluded that Hershey Foods was significantly more efficient than Tootsie Roll during 2007 in utilizing assets to generate sales. This efficiency was partially offset by a profit margin (4.3%) that was significantly lower than Tootsie Roll’s (10.4%). Tootsie Roll is more effective in generating profit from its sales but its lower asset turnover resulted in only a 6.4% return on assets compared to Hershey’s 5.1% return. What this shows is that a company can generate a reasonable return on assets with a lower profit margin, if it has a high turnover ratio.

BYP 9-2 COMPARATIVE ANALYSIS PROBLEM


(a) Examples of valuable assets that the article says currently do not show

up on a balance sheet include intellectual property, software investments, staff and managerial expertise, research and development, advertising and market research, and business processes.

(b) The toy maker Mattel has developed a reputation for quality toys. But

Mattel’s stock price fell when concerns arose concerning the safety of its toys. JetBlue had developed a reputation for high quality customer service. But its stock price fell when computer problems stranded thousands of customers, thus tarnishing its reputation.

(c) The article suggests that companies that are environmentally and

socially responsible are creating intangible assets, not because of ideol-ogy, but because they are reducing their exposure to financial risk. For example, they are reducing the probability that they will be sued. Com-panies that have strategies in place to deal with disasters are creating value relative to those that don’t because they have reduced risk exposure.

(d) The United Nations ratified an approach referred to as the triple bottom

line (for people, planet and profit) which is to be applied in urban and community accounting. Many companies use an approach internally called the balanced scorecard which places value on factors that improve a company’s profitability but that don’t show up in normal financial measures. (The balanced scorecard is discussed further in managerial accounting courses).

BYP 9-3 RESEARCH CASE


(All dollar data are in millions of dollars.) (a) Percentage change in sales: 2005 to 2007 ($1,654.5 – $1,460.2) ÷ $1,460.2 = 13.3%. Percentage change in net income: 2005 to 2007 (60.5 – $37.0) ÷ $37.0 = 63.5%. (b) Gross profit rates: 2005 ($1,460.2 – $443.2) ÷ $1,460.2 = 69.6%. 2006 ($1,584.8 – $469.7) ÷ $1,584.8 = 70.4%. 2007 ($1,654.5 – $482.1) ÷ $1,654.5 = 70.9%. The increase in the gross profit rate contributed to the rise in earnings

from 2005 to 2007. From 2005 to 2007 the gross profit rate increased only slightly from 69.6% to 70.9%.

(c) Profit margin ratio (Percentage of net income to net sales): 2005 $37.0 ÷ $1,460.2 = 2.5%. 2006 $54.8 ÷ $1,584.8 = 3.5%. 2007 $60.5 ÷ $1,654.5 = 3.7%. Profit margin ratio increased from 2.5% to 3.5% from 2005 to 2006.

This large increase was followed in 2007 with a slight increase from 3.5% to 3.7%.

BYP 9-4 INTERPRETING FINANCIAL STATEMENTS


BYP 9-4 (Continued) (d) You would expect the return on assets ratio to improve with a 50%

decrease in the number of new restaurant openings. Return on assets: 2006 $54.8 ÷ [($1,150.9 + $1,185.1) ÷ 2] = 4.7%. 2007 $60.5 ÷ [($1,185.1 + $1,197.0) ÷ 2] = 5.1%. Total assets increased less than $12 million between 2006 and 2007.

This small increase in total assets, combined with a rise in profit margin explains the slight increase in the return on assets.


(a) In the United States, goodwill is the amount of the purchase price in

excess of the fair value of the net assets purchased. This is the same method used in the United Kingdom for determining the initial amount to be recorded as goodwill.

(b) The notes to the financial statements indicate that “In prior years good-

will has been deducted from reserves in the period of acquisition.” What this means, essentially, is that when the acquisition of another company resulted in the recording of goodwill, the acquiring company simply wrote the goodwill off against its stockholders’ equity in the year of the acquisition. By doing this, the goodwill never affected net income.

(c) Under the new standard the company is not allowed to write goodwill

off against stockholders’ equity in the year of acquisition. If goodwill is considered to have a finite life, the company is supposed to amortize the goodwill over the expected life of the goodwill. However, the com-pany can still avoid charging any amortization expense by assuming that the goodwill has an “indefinite economic life.”

(d) In the United States, goodwill is not amortized because it is considered

to have an indefinite life. If a company in the United Kingdom assumes that its goodwill has a finite life, it must amortize the goodwill over the finite life. Otherwise it is assumed to have an indefinite life, and is handled very similar to US GAAP in that it is not amortized.

BYP 9-5 A GLOBAL FOCUS


Answers will vary depending on the company chosen by student.

BYP 9-6 FINANCIAL ANALYSIS ON THE WEB


(a)

(in thousands) Current resultsProposed results

without cannibalization Proposed results

with cannibalization $12,000 $13,500 $12,000 Return on assets ratio $100,00

0 = .12 $100,000 = .135 $100,000 = .12

$12,000 $13,500 $12,000 Profit margin ratio $45,000 = .27 $60,000 = .225 $50,000 = .24

$45,000 $60,000 $50,000 Asset turnover ratio $100,00

0 = .45 $100,000 = .60 $100,000 = .50

(b) If there is no cannibalization, return on assets increases from 12% to

13.5%. This occurs even though the profit margin decreases from 27% to 22.5% because the asset turnover ratio increases significantly, from .45 times to .60 times. However, if there is cannibalization, the return on assets remains unchanged at 12% because the increase in the asset turnover ratio is offset by the decrease in the profit margin ratio.

(c) Yes, there are other alternatives. Here are some examples. 1. Increase spending on marketing in an effort to increase sales of

high end product, without offering the new, low-end product line. If this was successful it would increase the asset utilization, thus increasing the asset turnover and return on assets.

2. Consider marketing the new line under a different name, so as to

minimize the cannibalization. This might substantially increase the marketing costs, and therefore reduce the profit margin ratio. But the benefit of reducing cannibalization might make up for the increased marketing costs.

3. If neither of 1. or 2. seems feasible, they should consider closing

a plant. This would increase the asset turnover ratio and return on assets ratio.

BYP 9-7 DECISION MAKING ACROSS THE ORGANIZATION


Answers will depend on the position selected by the student. Some points that should be considered include: 1. Some relatively small companies may spend less on R&D because they

must expense these costs. However, the vast majority of companies realize that for continued growth and stability, R&D expenditures are a high priority regardless of how they are recorded for accounting purposes.

Requiring companies to expense R&D costs instead of allowing them

to be capitalized could leave U.S. companies at a competitive disadvan-tage as compared to non-U.S. companies. U.S. companies may be more reluctant to invest millions of dollars on research and development since the costs would negatively impact their financial statements in the short-run.

2. The tangible future benefits of R&D costs may not be realized for

several years, if ever. Conversely, the purchase of a long-lived asset (i.e., equipment, building) will provide benefits immediately as well as in future years. The conservatism concept dictates that when reasonable doubt exists, a company should choose the option that has the least favorable affect on income. Expensing R&D costs is an example of applying the conservatism concept.

BYP 9-8 COMMUNICATION ACTIVITY


(a) The stakeholders in this situation are: Danny Fort , president of Clean Air Anti-Pollution Company. Steve Penny, controller. The stockholders of Clean Air Anti-Pollution Company. Potential investors in Clean Air Anti-Pollution Company. (b) The intentional misstatement of the life of an asset or the amount of the

salvage value is unethical for whatever the reason. There is nothing unethical per se about changing the estimates used for the life of an asset or of an asset’s salvage value if the change is an attempt to better match cost and revenues and is a better allocation of the asset’s depreciable cost over the asset’s useful life. In this case, it appears from the controller’s reaction that the revision in the life is intended only to improve earnings which would be unethical.

The fact that the competition uses a longer life for its equipment is not necessarily relevant. The competition’s maintenance and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Clean Air Anti-Pollution Company.

(c) Income before income taxes in the year of change is increased $155,000

($387,500 – $232,500) by implementing the president’s proposed changes. Old Estimates

Asset cost .............................................................. $3,500,000 Estimated salvage................................................. 400,000 Depreciable cost ................................................... 3,100,000 Depreciation per year (1/8) ................................... $ 387,500 Revised Estimates

Asset cost .............................................................. $3,500,000 Estimated salvage................................................. 400,000 Depreciable cost ................................................... 3,100,000 Depreciation taken to date ($387,500 X 2)........... 775,000 2,325,000 Remaining life in years ......................................... 10 years Depreciation per year ($2,325,000 ÷ 10) .............. $ 232,500

BYP 9-9 ETHICS CASE


BYP 9-10 ALL ABOUT YOU ACTIVITY

(a) 1 c 2 b 3 a 4 d 5 c (b) For the most part, the value of a brand is not reported on a company’s

balance sheet. Most companies are required to expense all costs related to the maintenance of a brand name. Also any research and development that went into the development of the related product is generally expensed. The only way significant costs related to the value of the brand are reported on balance sheet is when a company purchases another company that has a significant tradename (brand). In that case, given an objective transaction, companies are able to assign value to the brand and report it on the balance sheet. A conservative approach is used in this area because the value of the brand can be extremely difficult to determine. It should be noted that international rules permit companies to report brand values on their balance sheets.

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Documents

plant assets cost

assets useful life

depreciable cost

expected cash value

reduced recorded assets

service useful life

expenditures necessary

necessary expenditures