ch09

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Third Canadian Edition

CHAPTER 9

Reporting and Analyzing Long-Lived Assets

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives QuestionsBrief

Exercises ExercisesA

ProblemsB

Problems

1. Describe how the cost principle applies to property, plant, and equipment.

1, 2, 3 1, 2, 3 1, 8 1A, 2A 1B, 2B

2. Explain the concept of, and calculate, amortiza-tion.

4, 5, 6 4 2, 3, 8, *12

3A, 4A, 5A6A, *11A, *12A

3B, 4B, 5B, 6B, *11B, *12B

3. Describe other account-ing issues related to amortization.

7, 8, 9, 10 5 3, 4 5A 5B

4. Explain how to account for the disposal of prop-erty, plant, and equip-ment.

11, 12, 13 6, 7 5 4A, 6A 4B, 6B

5. Identify the basic issues related to accounting for intangible assets.

14, 15, 16 8, 9 6, 7, 8 7A, 8A 7B, 8B

6. Indicate how long-lived assets are reported in the financial state-ments.

17, 18 9, 10, 11 6, 9 4A, 8A 4B, 8B

7. Describe the methods for evaluating the use of assets.

19, 20, 21 12 10 9A, 10A 9B, 10B

*8. Calculate amortization using the declining-bal-ance method and the units-of-activity method (Appendix 9A).

*22, *23 *13, *14 *11, *12 *11A, *12A *11B, *12B

Solutions Manual 9-1 Chapter 9

Copyright © 2006 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.


ASSIGNMENT CHARACTERISTICS TABLE

ProblemNumber Description

DifficultyLevel

TimeAllotted (min.)

1A Analyze and record property transactions. Simple 20-30

2A Classify operating and capital expenditures. Moderate 15-20

3A Calculate straight-line amortization and compare ef-fects of different methods.

Moderate 40-50

4A Record property, plant, and equipment transactions; prepare partial balance sheet.

Moderate 30-40

5A Calculate amortization; discuss revision of estimate. Moderate 10-15

6A Record acquisition, amortization, and disposal of equipment.

Simple 15-20

7A Correct errors in recording intangible asset transac-tions.

Moderate 30-40

8A Record intangible asset transactions; prepare partial balance sheet.

Moderate 30-40

9A Calculate and evaluate ratios. Moderate 30-40

10A Evaluate ratios. Moderate 20-30

*11A Calculate and compare amortization under straight-line and declining-balance methods.

Moderate 30-40

*12A Calculate and compare amortization under straight-line and units-of-activity methods.

Moderate 30-40

1B Analyze and record property transactions. Simple 20-30

2B Classify operating and capital expenditures. Moderate 15-20

3B Calculate straight-line amortization and compare ef-fects of different methods.

Moderate 40-50

4B Record property, plant, and equipment transactions; prepare partial balance sheet.

Moderate 30-40

5B Calculate amortization; discuss revision of estimate. Moderate 10-15




ProblemNumber Description

DifficultyLevel

TimeAllotted (min.)

6B Record acquisition, amortization, and disposal of equipment.

Simple 15-20

7B Correct errors in recording intangible asset transac-tions.

Moderate 30-40

8B Record intangible asset transactions; prepare partial balance sheet.

Moderate 30-40

9B Calculate and evaluate ratios. Moderate 30-40

10B Evaluate ratios. Moderate 20-30

*11B Calculate and compare amortization under straight-line and declining-balance methods.

Moderate 30-40

*12B Calculate and compare amortization under straight-line and units-of-activity methods.

Moderate 30-40




ANSWERS TO QUESTIONS

1. For long-lived assets, the cost principle requires that long-lived assets be recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use. The matching principle requires that the cost of a long-lived asset be amortized to expense over the asset’s useful life.

2. RIM added $20 million in legal defence costs to its Patent account because the costs were considered necessary to prove the patent’s validity. The costs were not recorded as an operating cost because they benefit future periods of RIM.

3. The main advantages of leasing are (1) reduced risk of obsolescence, (2) 100 percent financing, (3) income tax advantages, and (4) reduced recorded assets and liabilities.

4. You should explain to the president that amortization is a process of allocating the cost of a long-lived asset to expense over its service (useful) life in a rational and systematic manner. Recognition of amortization is not intended to result in the accumulation of cash for replacement of the asset.

5. The effects of the three methods on annual amortization expense are: Straight-line res-ults in a constant amount of amortization expense over the life of the asset. Units-of-activity results in varying amounts of amortization expense, which changes with the level of activity so it is difficult to predict the effects in any year. Declining-balance res-ults in decreasing amounts of amortization expense. So the amortization expense is high in the early years and declines over time. All three methods will charge the same total amount to amortization expense over the life of the assets, it is just the allocation of expense each period that varies.

The effects of the three methods on net earnings are: Straight-line results in a constant net earnings since amortization expense is the same each year. Units-of-activity will result in a variable net earnings since amortization expense will change with the level of activity in each year. Declining-balance results in lower net earnings in the early years since amortization expense is higher and higher net earnings in the later years since amortization expense declines over the life of the asset. All three methods will result in the same total net earnings over the life of the assets, it is just the amount of expense and resultant net earnings that varies each period.

(The answer to Question 5 is continued on the next page.)




Questions (Continued)

5. (Continued) The effects of the three methods on the book value are: Straight-line res-ults in a declining book value at a constant rate each year since amortization expense and the amount added to the accumulated amortization account is the same. Recall that book value is cost less accumulated amortization. Units-of-activity will also result in a declining book value but at a variable amount since the amortization expense and amount added to the accumulated amortization account each year will also vary. De-clining-balance will also result in a declining book value but at an increasing amount in the early years and a decreasing amount in the later years since amortization expense and the amount added to the accumulated amortization account each year is higher in the early years. All three methods will end up with the same book value at the end of the asset’s useful life, it is just the allocation of expense each period that varies.

6. Since Morgan uses the straight-line amortization method, its amortization expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method. Petrunik’s amortization expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Morgan’s net earnings will be higher than Petrunik’s in the first few years of the asset’s useful life. These differences will im-pact the amortization expense, accumulated amortization and net earnings of the com-panies making comparison of their results and financial position difficult. In reality, the choice of amortization method results in an artificial, timing difference only and should be ignored, if possible, in comparing financial positions.

7. Yes, income tax regulations require a company to use a different amortization method (the single-declining-balance method), regardless of which method is used in preparing financial statements. Lucien Corporation’s motivation for using the straight-line method for financial reporting is to ensure that the amortization method selected provides the best matching of expense to revenue.

8. An impairment loss is a permanent decline in the market value of an asset. This may happen when a machine has become obsolete, or the market for a product made by a machine has dried up or has become very competitive.

9. Unlike inventories, the application of the lower of cost and market rule does not apply automatically to property, plant, and equipment. Because inventory is expected to be converted into cash within the year, it is important to value it annually at the lesser of its cost and market, or saleable value. In contrast, property, plant, and equipment are used in operations over a longer term and are not available for resale. The going concern as-sumption assumes that a company will recover at least the cost of its long-lived assets. It is only when a permanent impairment occurs in the value of the asset that long-lived assets are written down to market.

10. A revision of amortization is made in current and future years but not retroactively. The rationale is that continual restatement of prior periods for what is merely a change in es-timate would adversely affect the reader’s confidence in the financial statements.





11. Amortization must be updated from the last time adjusting entries were recorded to the date of the sale because the amortization expense must be properly matched to the rev-enue earned in the period the asset was still in use. Updating amortization also aids in determining the amount of the gain or loss on disposition.

12. In a sale of long-lived assets, the net book value of the asset is compared to the pro-ceeds received from the sale. If the proceeds of the sale exceed the net book value of the asset, a gain on disposal occurs. If the proceeds of the sale are less than the net book value of the asset sold, a loss on disposal occurs. The calculation is the same for an asset that is retired except that there are no proceeds received. Since no proceeds are received in a retirement, a gain will never occur.

13. The machine and related accumulated amortization should continue to be reported on the balance sheet without further amortization or adjustment until the asset is retired. Reporting the asset and related accumulated amortization on the balance sheet informs the reader of the financial statements that the company is still using the asset. Once an asset is fully amortized, even if it is still being used, no additional amortization should be taken on this asset. In no situation, can the accumulated amortization on the asset ex-ceed the cost of the asset.

14. Only intangible assets with limited lives such as patents and copyrights are amortized because their cost benefits a limited period of time. Intangibles with unlimited lives such as trademarks are not amortized because their cost benefits an unlimited period of time, but their book value is assessed annually for impairment and a loss recognized if a de-cline in value has occurred.

15. The student is not correct. The cost of intangibles with limited lives should be amortized over the shorter of that asset's useful life (the period of time when operations are be-nefited by use of the asset) or its legal life.

16. Goodwill is the value of many favourable 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.





17. (a) Long-lived assets are normally reported on the balance sheet under the headings “property, plant, and equipment” and “intangible assets.” The balances of the major classes of assets should be disclosed, as well as the accumulated amortization for amortizable assets, either on the balance sheet or in the notes to the financial statements.

(b) The statement of earnings reports amortization expense and any gain or loss on disposal of long-lived assets. The statement of earnings also reports any impair-ment losses, when the market value of a long-lived asset permanently declines be-low its cost.

(c) The cash flow statement reports any cash paid to purchase long-lived assets and any cash received on their disposal in the investing activities section.

18. The notes to financial statements should disclose the balance of the major classes of assets as well as the accumulated amortization for amortizable assets. The amortiza-tion method(s) used must also be described and any impairment losses.

19. (a) Grocery stores usually have a high asset turnover and a low profit margin.

(b) Car dealerships normally have a low asset turnover and a high profit margin.

20. ($ in U.S. millions)

Return on assets:

Asset turnover:

21. The return on assets ratio measures the return being generated by each dollar invested in the business (net earnings ÷ average total assets). The return on assets can also be calculated by multiplying the profit margin by the asset turnover ratio. The profit margin measures how effective the business is at generating earnings from its sales and the asset turnover measures how well the company can generate sales from a given level of assets. Together, the two ratios can be combined to measure how effective a com-pany is at generating earnings from a given level of assets (return on assets). There-fore if a company wants to improve its return on assets, it can do so either by increas-ing the margin it generates from each dollar of sales (profit margin) or by increasing the volume of goods that is sells (asset turnover).




*22. Straight-line and units-of-activity measures apply the amortization criteria to the original cost of the assets over a fixed period (in years or in units), which must be reduced by salvage value to get an accurate representation of the amortizable cost of the assets to the company. Because the declining-balance method applies the amortization criteria, not to the original cost, but to a declining book value, the original cost is used instead of the amortizable cost. Applying a fixed percentage rate to a declining balance will al-ways result in an ending, residual amount. Salvage value is considered in the declin-ing-balance method in that the asset is never amortized below its salvage value, so in effect; this residual amount is adjusted to equal salvage value.

*23. The straight-line and declining-balance methods use annual amortization rates in their amortization calculations. Therefore, the result must be adjusted for any period less than one year. The units-of-activity method does not need to be adjusted for partial periods as this method multiplies the total production output by the actual production for the period. This already reflects how much the asset was used during the period. For example, if an asset was purchased July 1 and produced 10,000 units for the period July through December, it already produces a result for that six month period (the com-pany could not have produced units before it purchased the asset) and therefore does not need to be adjusted for the half year ownership period.




SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 9-1

All of the expenditures, except the fence, should be included in the cost of the land. There-fore, the cost of the land is $56,000 ($50,000 + $2,500 + $3,500). The fence would be in-cluded in the cost of land improvements.

BRIEF EXERCISE 9-2

The cost of the truck is $28,400 (cash price $28,000 + painting and lettering $400). The ex-penditures for insurance and motor vehicle licence should be expensed, not added to the cost of the truck.

BRIEF EXERCISE 9-3

(a) O(b) C(c) C(d) O(e) C(f) O(g) O(h) C(i) C(j) O

BRIEF EXERCISE 9-4

The amortizable cost is $40,000 ($42,000 – $2,000). With a 4-year useful life, annual amortiz-ation is $10,000 ($40,000 ÷ 4). Under the straight-line method, amortization expense is the same each year, but must be prorated for the initial year. Thus, amortization expense for 2005 is $6,667 ($10,000 X 8/12) and $10,000 for 2006.




BRIEF EXERCISE 9-5

Net book value ($90,000 - $54,000) $36,000Market value 30,000Impairment loss $ 6,000

The journal entry to record the impairment loss, assuming the decline in value is permanent is:

Loss on Impairment 6,000Accumulated Amortization 6,000

(To record the impairment loss on machinery)

BRIEF EXERCISE 9-6

(a) Amortization Expense (($72,000 - $2,000) ÷ 5) X 9/12)............ 10,500Accumulated Amortization—Office Equipment.................... 10,500

(b) Cash.......................................................................................... 21,000Accumulated Amortization—Office Equipment......................... 52,500

Gain on Disposal.............................................................. 1,500Office Equipment.............................................................. 72,000

Cost of office equipment $72,000Less: Accumulated amortization 52,500*Book value at date of disposal 19,500Proceeds from sale 21,000Gain on disposal $ 1,500

* Amortization Jan. 1, 2003 – Dec. 31, 2005 ($72,000 - $2,000) ÷ 5 X 3 years $42,000Amortization Jan. 1, 2006 – Sept. 30, 2006 10,500Accumulated amortization $52,500




BRIEF EXERCISE 9-7

(a) Accumulated Amortization—Delivery Equipment...................... 42,000Delivery Equipment.............................................................. 42,000

(b) Accumulated Amortization—Delivery Equipment...................... 40,000Loss on Disposal....................................................................... 2,000

Delivery Equipment.............................................................. 42,000

Cost of delivery equipment $42,000Less: Accumulated amortization 40,000Book value at date of disposal 2,000Proceeds from sale 0Loss on disposal $ 2,000

BRIEF EXERCISE 9-8

Goodwill is an intangible asset with an indefinite useful life. Intangible assets with indefinite useful lives are not amortized but their value must be reviewed annually and an impairment loss recorded if the asset’s market value permanently falls below its book value. If the decline in value of Royal Bank of Canada’s goodwill is assessed as being permanent an impairment loss of $130 million should be recorded on the company’s statement of earnings and the goodwill should be reported at $4,416 ($4,546 - $130) million.

BRIEF EXERCISE 9-9

(a) (1) Jan. 2 Patents................................................................. 180,000Cash............................................................. 180,000

(2) Dec. 31 Amortization Expense ($180,000 10)............... 18,000Accumulated Amortization—Patents............ 18,000

(b) SURKIS CORPORATIONBalance Sheet (Partial)

December 31, 2006

Assets

Intangible assetsPatents $180,000Less: Accumulated amortization 18,000Net book value $162,000




BRIEF EXERCISE 9-10

(a) PPE(b) I(c) NA (current asset)(d) NA (shareholders’ equity)(e) PPE(f) NA (investment)(g) I(h) NA (current asset)(i) I(j) PPE(k) PPE(l) I(m) NA (expense)(n) I

BRIEF EXERCISE 9-11

CANADIAN TIRE CORPORATION, LIMITEDBalance Sheet (Partial)

January 1, 2005(in millions)

Property, plant, and equipmentLand.............................................................................. $ 672.1Buildings....................................................................... $1,987.5Less: Accumulated amortization—buildings................. 652.5 1,335.0Furniture and equipment.............................................. $470.2Less: Accumulated amortization—fixtures and

equipment................................................... 316.4 153.8Leasehold improvements............................................. $201.0Less: Accumulated amortization—

leasehold improvements............................. 69.0 132.0Other property, plant, and equipment, net.................... 292.3 Total property, plant, and equipment......................... 2,585.2

IntangiblesMark’s Work Wearhouse store brands and banners... . $50.0Mark’s Work Wearhouse franchise agreements........... 2.0 52.0Goodwill........................................................................ 41.7

Total intangibles....................................................... 93.7




BRIEF EXERCISE 9-12

($ in U.S. millions)

Return on assets

Asset turnover

*BRIEF EXERCISE 9-13

The declining-balance rate is 25% (1/4 X 1) and this rate is applied to book value at the be-ginning of the year. The calculations are:

Book Value X Rate = Amortization Expense

2005 $42,000 25% x 8/12 $7,0002006 $42,000 – $7,000 25% $8,750

*BRIEF EXERCISE 9-14

The amortizable cost per unit is $0.10 per km. calculated as follows:

Amortizable cost ($33,000 – $500) ÷ 325,000 = $0.10

2005 125,000 km X $0.10 = $12,500 amortization expense2006 105,000 km X $0.10 = $10,500 amortization

expense




SOLUTIONS TO EXERCISES

EXERCISE 9-1

(a) Under the cost principle, the acquisition cost for property, plant, and equipment includes all expenditures necessary to acquire the asset and make it ready for its intended use. For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and installation costs.

(b) 1. Delivery Truck2. Delivery Truck3. Licence Expense4. Prepaid Insurance5. Land6. Land7. Land Improvements8. Land9. Machinery

10. Machinery

EXERCISE 9-2

(a) 2005 amortization = $15,600 X 9/12 = $11,7002006 amortization = $15,600

(b) If Costello used the declining-balance method instead of the straight-line method the straight-line method would result in the highest book value for the first two years and the highest net earnings. There would be no difference in the cash flow.




EXERCISE 9-3

(a)Equipment

Cost, January 1, 2003 $120,000Less: Salvage value 5,000Amortizable cost $115,000

Useful life in years 5

Annual amortization ($115,000 ÷ 5) $23,000

Dec. 31 Amortization Expense........................................... 23,000Accumulated Amortization............................ 23,000

(b) The accumulated amortization on December 31, 2005 will be $46,000 ($23,000 X 2 years).

(c) If the company accepts Lindy’s proposed changes in useful life and salvage value, the amortization expense will be higher, due to the proposed shorter useful life and lower salvage value.

Although students have not been asked to calculate the revised amortization expense, and there is insufficient information in the textbook to enable them to do so, the calcu-lation follows if you wish to expand on this concept in class:

2006 amortization expense

The revised salvage value is deducted from t he net book vale in the numer-ator. In the denominator the remaining useful life, 2 years, is used. Note that two years have already past.




EXERCISE 9-4

(a)Equipment

Cost, January 1, 2004 $900,000Less: Salvage value 50,000Amortizable cost $850,000



The equipment’s book value on December 31, 2006 will be $390,000 [($900,000 – ($170,000 X 3 years)].

(b) Book value ($900,000 - $510,000) $390,000Market value 340,000Impairment loss $ 50,000

The journal entry to record the impairment loss, since the decline in value is perman-ent is:

Loss on Impairment 50,000Accumulated Amortization 50,000

(To record the impairment loss on equipment)

(c) The impairment loss should be reported in the statement of earn-ings as part of earnings from continuing operations. Often, the loss is combined with amortization expense for reporting purposes.




EXERCISE 9-5

Jan. 1 Loss on Retirement........................................................ 6,200Accumulated Amortization—Machinery ($62,000 ÷ 10 X 9) 55,800

Machinery.............................................................. 62,000

June 30 Amortization Expense ($5,475 ÷ 3 X 6/12).................... 913Accumulated Amortization—Computer.................. 913

30 Cash.............................................................................. 500Accumulated Amortization—Computer.......................... 4,563

($5,475 ÷ 3 X 2 = $3,650; $3,650 + $913)Loss on Disposal [$500 - ($5,475 - $4,653)].................. 412

Computer....................................................... 5,475

Dec. 31 Amortization Expense [($27,000 - $3,000) ÷ 4].............. 6,000Accumulated Amortization—Truck......................... 6,000

31 Cash.............................................................................. 10,000Accumulated Amortization—Truck................................. 18,000

[($27,000 - $3,000) ÷ 4 X 3]Gain on Disposal........................................... 1,000Truck.............................................................. 27,000




EXERCISE 9-6

(a)

Jan. 2 Patents ........................................................................ 40,000Cash........................................................................ 40,000

April 1 Goodwill ........................................................................ 300,000Cash........................................................................ 300,000

July 1 Franchise........................................................................ 250,000Cash........................................................................ 250,000

Sept. 1 Research Expense.......................................................... 150,000Cash........................................................................ 150,000

30 Development Expense.................................................... 50,000Cash........................................................................ 50,000

Dec. 31 Amortization Expense–Patents ($40,000 ÷ 5)................. 8,000Amortization Expense–Franchise [($250,000 ÷ 10) X 6/12] 12,500

Accumulated Amortization—Patents....................... 8,000Accumulated Amortization—Franchise................... 12,500

31 Given that market value exceeded book value in all cases, no impairment loss is recognized.

(b)COLLINS LTD.

Balance Sheet (Partial)December 31, 2006

IntangiblesFinite-life intangibles

Patents................................................................. $40,000Less: Accumulated amortization—patents........... 8,000 $ 32,000Franchise.............................................................. $250,000Less: Accumulated amortization—franchise......... 12,500 237,500

269,500Goodwill.................................................................... 300,000

Total intangibles.......................................................... $569,500




EXERCISE 9-7

MEMO

To: ClientFrom: Financial AdvisorDate: Today

The change in the amortization policy will increase the period in cases where the contracted exhibition period is greater than two years. This will have the effect of spreading the cost over a longer period and in the short term increasing net earnings. It will be more difficult to com-pare the current year’s results with previous years’ because of the change in estimated useful life. In evaluating Alliance’s performance you would want to make an adjustment for this change in estimated life. If the contracted exhibition period is a good measure of the useful life of the broadcast rights and the revenue potential is consistent over this period, then the policy is reasonable.

EXERCISE 9-8

1. Amortization 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 producing ability does not decline. In addition, the useful life of land is indefinite. Therefore it would be incorrect for the student to amortize 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 impair-ment loss is recorded on the statement of earnings. Therefore the amortization entry should be reversed and no decline in value recorded until an impairment in value oc-curs.

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 recorded value of an asset after ac-quisition. The appropriate accounting treatment is to leave the building on the books at its zero book value.




EXERCISE 9-9

(a)

Account Financial Statement Section

Accumulated amortization – Balance Sheet Property, plant, and buildings equipment

Accumulated amortization – Balance Sheet Intangibles finite-life intangible assets

Accumulated amortization – Balance Sheet Property, plant, and machinery and equipment equipment

Accumulated amortization – Balance Sheet Property, plant, and other property, plant, and equipment equipment

Accumulated amortization – Balance Sheet Property, plant, and satellites equipment

Accumulated amortization – Balance Sheet Property, plant, and telecommunication assets equipment

Amortization expense Statement of Earnings Operating expenses

Buildings Balance Sheet Property, plant, and equipment

Cash paid for capital expenditures Cash Flow Statement Investing activities

Finite-life intangible assets Balance Sheet Intangibles

Goodwill Balance Sheet Intangibles

Indefinite-life – intangible assets Balance Sheet Intangibles

Land Balance Sheet Property, plant, andequipment

Machinery and equipment Balance Sheet Property, plant, and equipment

Other property, plant, and equipment Balance Sheet Property, plant, and equipment

Plant under construction Balance Sheet Property, plant, and equipment




EXERCISE 9-9 (Continued)

(a) (Continued)

Account Financial Statement Section

Satellites Balance Sheet Property, plant, and Equipment

Telecommunications assets Balance Sheet Property, plant, and equipment

(b)BCE INC.

Balance Sheet (Partial)December 31, 2004

(in millions)

Property, plant, and equipment Land ......................................................................................... $ 95Buildings................................................................................... $2,682Less: Accumulated amortization............................................... 1,384 1,298Plant under construction........................................................... 1,605Machinery and equipment......................................................... $5,529Less: Accumulated amortization............................................... 3,039 2,490Satellites................................................................................... $1,769Less: Accumulated amortization............................................... 758 1,011Telecommunications assets...................................................... $35,481Less: Accumulated amortization............................................... 23,469 12,012Other property, plant, and equipment....................................... $278Less: Accumulated amortization............................................... 97 181

Total property, plant, and equipment 18,692

Intangible assetsFinite-life intangible assets........................................................ $4,124Less: Accumulated amortization............................................... 1,418 2,706Indefinite-life intangible assets (other than goodwill)................. 2,916Goodwill.................................................................................... 8,413

Total intangible assets..................................................... 14,035




EXERCISE 9-10

(a) ($ in millions)

(1) Return on assets

(2) Asset turnover

(3) Profit margin

(b) Profit Margin X Asset Turnover = Return on Assets

= 1.6% X 2.4 times = 3.8%

(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 Empire Company, the ability to compare these ratios to other busi-nesses becomes very difficult. Empire Company would almost need to calculate ratios for each of the separate industry segments to allow for a meaningful analysis.




*EXERCISE 9-11

(a)

Year Units-of-ActivityDouble

Declining-Balance2005 $10,140 $27,0002006 14,040 25,200

Calculations: Units-of-Activity Method

$90,000 - $12,000 = $7.80 per hour 10,000 hours

2005 amortization expense = 1,300 hours X $7.80 = $10,140

2006 amortization expense = 1,800 hours X $7.80 = $14,040

Calculations: Double Declining-Balance Method

The declining-balance rate is 1/5 X 2 = 40%

2005 amortization expense = $90,000 X 40% X 9/12 = $27,000

Book value January 1, 2006 = $90,000 – $27,000 = $63,000

2006 amortization expense = $63,000 X 40% = $25,200

(b) The matching principle dictates that the cost of a long-lived asset should be matched to the revenue produced by that asset. Since the pattern of revenue production is different for each type of asset, each amortization method should be chosen based on the rev-enue pattern of the specific asset. For an asset that generates revenues fairly con-stantly over time, the straight-line method is appropriate. The declining-balance method best fits assets that are more productive (will generate more revenue) in the earlier years of their life. The units-of-activity method best fits assets whose usage varies over time.




*EXERCISE 9-12

(a)

(1) Straight-line method

each year

(2) Double declining-balance (DDB) method

DDB Rate: ¼ x 2 = 50%

Year 1: $5,000 x 50% = $2,500Year 2: $5,000 - $2,500 = $2,500 x 50% = $1,250Year 3: $5,000 - $2,500 - $1,250 = $1,250 x 50% = $625

Straight-Line Double Declining-BalanceAmortization

ExpenseNet Book

ValueAmortization

ExpenseNet Book

ValueYear 1 $1,125 $3,875 $2,500 $2,500 Year 2 1,125 2,750 1,250 1,250Year 3 1,125 1,625 625 625Total $3,375 $4,375

(b) (1) Straight-line method

Proceeds - book value = Gain (loss)$1,225 - $1,625 = ($400)

(2) Double declining-balance method

Proceeds - book value = Gain (loss)$1,225 - $625 = $600

(c) (1) Straight-line method

Amortization expense: $3,375 + Loss: $400 = $3,775

(2) Double-declining balance method

Amortization expense: $4,375 - (Gain: $600) = $3,775

Note: There is no difference in the total expense over the life of the asset.




SOLUTIONS TO PROBLEMS

(a)

Item Land Land Improvements Building

1. $280,0002. 3,8003. $ 4,2004. 19,0005. $ 23,0006. 18,0007. 600,0008. 15,0009. 10,000

10. (5,000) $297,800 $14,200 $656,000

(b)Land................................................................. 297,800Land Improvements.......................................... 14,200Building............................................................. 656,000

Cash......................................................... 968,000

Note: Students could also have prepared individual journal entries for each transaction.



PROBLEM 9-1A


Account Debited Explanation

1. Equipment Cost to prepare the equipment for use.

2. Land improvements Non-permanent land expenditure.

3. Building Improvement or betterment expenditure, which makes the factory office more productive.

4. Repair expense Does not benefit future periods.

If the loss was considered to be significant, it would be recorded separately as a loss due to labour dispute, rather than as repair expense.

5. Equipment Cost to prepare the equipment for use.


If the damage was covered by insurance, a re-ceivable (from the insurance company) ac-count would be debited.

If the loss was considered to be significant, it would be recorded separately as a loss due to damages, rather than as repair expense.




PROBLEM 9-2A


PROBLEM 9-3A

(a) Cost:Purchase price $180,000Delivery costs 900Installation and testing 3,300Total cost $184,200

The one-year insurance policy is not included as it benefits only the current period. It would be recorded as Prepaid Insurance and allocated to Insurance Expense throughout the period.

(b)

STRAIGHT-LINE AMORTIZATION

Calculation End of Year

YearAmortizable

Cost XAmortization

Rate =Amortization

ExpenseAccumulatedAmortization

Net BookValue

200620072008200920102011

$172,700* 172,700 172,700 172,700172,700172,700

20%** X 8/1220%20%20%20%

20% X 4/12

$23,027034,540034,540034,540034,540

11,513

$ 23,027 57,567092,107

126,647161,187172,700

$161,173126,633

92,09357,55323,01311,500

* Amortizable cost = $184,200 - $11,500 = $172,700** 1 ÷ 5 years = 20%




PROBLEM 9-3A (Continued)

(c) Straight-line amortization results in a constant amount of amortization expense each period. The declining-balance method results in a higher amortization expense in the early years and lower amortization expense in the later years. In comparing these two methods, straight-line amort-ization would result in a lower amount of amortization expense than that produced by the declining-balance method in the early years and a higher amount in the later years. This would consequently affect net earnings inversely. That is, net earnings would be higher for straight-line amortization in the early years and lower in the later years. Over the six-year useful life of the machine, both methods would result in the same total amortization expense (equal to the amortizable cost) and same total net earnings.

Because amortization expense would be lower in the early years for straight-line amortization, net book value (cost less accumulated amort-ization) would be higher in the early years than the result produced by the declining-balance method of amortization and lower in the later years. Of course, at the end of the six-year life, both methods would end up with the same net book value, $11,500.

(d) It is difficult to compare the straight-line and units-of-activity methods of amortization. Straight-line amortization results in a constant amount of amortization expense and net earnings. The units-of-activity method will result in varying amount of amortization expense and resultant net earn-ings, depending on the actual amount of production activity in each par-ticular period. Nonetheless, over the life of the asset, both methods res-ult in the same total net earnings and will end up with the same net book value, $11,500.

(e) The matching principle dictates that the cost of a long-lived asset should be matched to the revenue produced by that asset. Since the pattern of revenue production is different for each type of asset, each amortization method should be chosen based on the revenue pattern of the specific asset.




(a) April 1 Land......................................................... 2,200,000Cash.................................................. 440,000Note Payable..................................... 1,760,000

May 1 Amortization Expense................................ 20,000Accumulated Amortization—Equipment ($600,000 X 1/10 X 4/12) 20,000

1 Cash.......................................................... 200,000Accumulated Amortization—Equipment.... 440,000

Equipment..................................... 600,000Gain on Disposal.......................... 40,000

Cost $600,000Accumulated amortization—equipment[($600,000 X 1/10) X 7 + $20,000)] 440,000Book value 160,000Cash proceeds 200,000Gain on disposal $ 40,000

June 1 Cash.......................................................... 360,000Note Receivable........................................ 1,440,000

Land.................................................... 500,000Gain on Disposal................................ 1,300,000

July 1 Equipment................................................. 1,100,000Cash................................................... 1,100,000

Dec. 31 Amortization Expense................................ 50,000Accumulated Amortization—Equipment ($500,000 X 1/10)......... 50,000



PROBLEM 9-4A



(a) (Continued)

Dec. 31 Accumulated Amortization—Equipment.... 500,000Equipment..................................... 500,000

Cost $500,000Accumulated amortization—equipment

($500,000 X 1/10 X 10) 500,000Book value 0Cash proceeds 0Gain (loss) on disposal $ 0

(b) Dec. 31 Amortization Expense............................. 662,500Accumulated Amortization—Buildings ($26,500,000 X 1/40).... 662,500

31 Amortization Expense............................. 3,945,000Accumulated Amortization—Equipment 3,945,000

($38,900,000* X 1/10) $3,890,000[($1,100,000 X 1/10) X 6/12] 55,000

$3,945,000

*$40,000,000 - $600,000 - $500,000 = $38,900,000

31 Interest Expense..................................... 79,200Interest Payable............................... 79,200

($1,760,000 X 6% X 9/12)

31 Interest Receivable................................. 42,000Interest Revenue.............................. 42,000

($1,440,000 X 5% X 7/12)





(c) HAMSMITH CORPORATIONBalance Sheet (Partial)

December 31, 2006

Property, plant, and equipment*Land........................................................ $ 4,700,000Buildings.................................................. $26,500,000Less: Accumulated amortization—buildings.............................................. 12,762,500 13,737,500Equipment............................................... $40,000,000Less: Accumulated amortization.............—equipment............................................ 8,075,000 31,925,000

Total property, plant, and equipment. $50,362,500

*See T accounts on the following page.





Land

Dec. 31, 2005 3,000,000 June 1, 2006 500,000April 1, 2006 2,200,000

Dec. 31, 2006 Bal. 4,700,000

Buildings

Dec. 31, 2005 26,500,000

Dec. 31, 2006 Bal. 26,500,000

Equipment

Dec. 31, 2005 40,000,000 May 1, 2006 600,000July 1, 2006 1,100,000 Dec. 31, 2006 500,000

Dec. 31, 2006 Bal. 40,000,000

Accumulated Amortization—Buildings

Dec. 31, 2005 12,100,000 Dec. 31, 2006 662,500

Dec. 31, 2006 Bal. 12,762,500

Accumulated Amortization—Equipment

May 1, 2006 440,000 Dec. 31, 2005 5,000,000Dec. 31, 2006 500,000 May 1, 2006 20,000

Dec. 31, 2006 50,000Dec. 31, 2006 3,945,000

Dec. 31, 2006 Bal. 8,075,000




(a) EquipmentCost, January 1, 2004 $65,000Less: Salvage value 3,000Amortizable cost $62,000


Annual amortization ($62,000 ÷ 8) $ 7,750

The equipment’s book value on January 1, 2006 will be $49,500 [$65,000 – ($7,750 X 2 years)].

(b)You would expect the amortization expense to increase in 2006 after the change in useful life because the amortizable cost will be expensed over a shorter period of time.

(c)The change in the useful life should only affect current and future periods. The rationale for this is that the original estimate was based on informa-tion known at the time the asset was purchased and the revision is based on new information and should only affect future periods. In addition, if prior periods where regularly restated users would feel less confident about financial statements.

(d)If the company had not revised the remaining useful life, the total amortiza-tion expense over the equipment’s life would be the amortizable cost of $62,000. The accumulated amortization at the end of the equipment’s useful life would be $62,000 and the net book value would be $3,000.

(e)The total amortization expense would not change after the useful life has been revised. There would be no changes to the accumulated amortiza-tion or the net book value at the end of the equipment’s useful life.



PROBLEM 9-5A


(a) 2004July 1 Equipment................................................. 65,000

Cash................................................... 65,000

(b) Cost, January 1, 2004 $65,000Less: Salvage value 5,000Amortizable cost $60,000



2004Dec. 31 Amortization Expense................................ 6,000

Accumulated Amortization—Equipment ($12,000 X 6/12)........... 6,000


Accumulated Amortization—Equipment ($12,000 X 12/12)......... 12,000

2006Sept. 30 Amortization Expense................................ 9,000

Accumulated Amortization—Equipment ($12,000 X 9/12).......... 9,000



PROBLEM 9-6A



(c)(1) Sept. 30 Loss on Disposal....................................... 1,000

Cash.......................................................... 37,000Accumulated Amortization—Equipment ($6,000 + $12,000 + $9,000).................. 27,000

Equipment......................................... 65,000

Cost..................................................... $65,000Accumulated amortization—Equipment 27,000Book value........................................... 38,000Cash proceeds.................................... 37,000Loss on disposal.................................. $ 1,000

(2) Sept. 30 Cash.......................................................... 40,000Accumulated Amortization—Equipment.... 27,000

Gain on Disposal............................... 2,000Equipment......................................... 65,000

Cost..................................................... $65,000Accum. amort.—Equipment................. 27,000Book value........................................... 38,000Cash proceeds.................................... 40,000Gain on disposal.................................. $ 2,000

(3) Sept. 30 Accumulated Amortization—Equipment.... 27,000Loss on Disposal....................................... 38,000

Equipment......................................... 65,000

Cost..................................................... $65,000Accum. amort.—Equipment................. 27,000Book value........................................... 38,000Cash proceeds.................................... 0Loss on disposal.................................. $38,000




1. Research Expense ($120,000 X 55%).......... 66,000Patents.................................................. 66,000

Accumulated Amortization—Patents............ 4,400Amortization Expense........................... 4,400

($66,000 X 1/15)

2. Because goodwill has an indefin-ite life it is not amortized. Instead goodwill should be review annually for any impairment in value. Therefore any amortization expense recorded must be reversed.

Accumulated Amortization—Goodwill.......... 2,000Amortization Expense............................ 2,000

($160,000 X 1/40 X 6/12)

3. Impairment losses should only be recorded if the impairment is considered permanent.

Trademark..................................................... 2,500Impairment Loss................................... 2,500

4. The donations should be recorded as an expense.

Donations Expense..................................... 6,000Goodwill................................................ 6,000



PROBLEM 9-7A


(a) Jan. 5 Trade Name................................................. 7,000Cash....................................................... 7,000

July 1 Research Expense...................................... 210,000Cash....................................................... 210,000

1 Patent (Development Costs)........................ 50,000Cash....................................................... 50,000

Sept. 1 Advertising Expense.................................... 60,000Cash....................................................... 60,000

Oct. 1 Copyright #2................................................ 180,000Cash....................................................... 180,000

Dec. 31 Impairment Loss ($125,000 - $85,000)........ 40,000Goodwill................................................. 40,000

(b) Dec. 31 Amortization Expense ($36,000 ÷ 3)............ 12,000Accumulated Amortization—Copyright #1 12,000

31 Amortization Expense.................................. 15,000Accumulated Amortization—Copyright #2 15,000($180,000 ÷ 3 x 3/12 = $15,000)

31 Amortization Expense.................................. 1,250Accumulated Amortization—Patent....... 1,250

($50,000 ÷ 20 x 6/12 = $1,250)



PROBLEM 9-8A



(c)

GHANI CORPORATIONBalance Sheet (Partial)

December 31, 2006

Intangible assets

Limited life intangiblesPatent........................................................ $50,000Accumulated amortization......................... 1,250 $ 48,750Copyrights................................................. $216,0001

Accumulated amortization......................... 51,0002 165,000Indefinite life intangibles

Trade name.................................................................. 67,0003

Goodwill....................................................................... 85,0004

Total intangible assets........................................ $365,750

1 Copyrights: $36,000 + $180,000 = $216,000

2 Accumulated amortizationCopyright #1: $12,000 X 3 years = $36,000Copyright #2: 15,000

$51,000

3 Trade name: $60,000 + $7,000 = $67,000

4 Goodwill: $125,000 - $40,000 = $85,000




(a) (U.S. $ in millions) Green Mountain......................Starbucks

1. Profit margin

2. Return on assets

3. Asset turnover

(b) Based on profit margin we can see that Starbucks is slightly more profitable than Green Mountain. Green Mountain’s profit margin at 5.7% is lower then the average company in the industry (7.3%). However, this could be due to the fact that Green Mountain is smaller in size than the other companies and may be at a competitive disadvantage.

The return on assets ratio indicates that Starbucks is generating a better re-turn than Green Mountain based on the amount of assets invested in the business. Based on the industry average of 11.7% Starbucks is generating a higher return on their assets than most other companies in the industry.



PROBLEM 9-9A



(b) (Continued)

The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar in-vested in assets. Green Mountain’s asset turnover ratio (2.0) was higher than Starbucks’ (1.7) in 2004. Therefore, it could be concluded that, in 2004, Green Mountain was more efficient than Starbucks in utilizing assets to generate sales. Green Mountain is higher than the industry average of 1.7 times and Starbucks is on par with the industry average.

Overall, it appears that Green Mountain is focusing its sales strategy on generating volume whereas Starbucks seems to be more focused on profit-ability.

The ability to compare the two companies is complicated by the fact that Starbucks is significantly larger than Green Mountain Coffee. However, this fact doesn’t appear to have impeded Green Mountain’s efficiency.




(a) It is the company’s low volume that appears to be causing its return on assets to be lower than that of other companies in the industry. Based on the profit margin ratio, 12.0% compared to 6.4%, we can see that the company appears to be significantly more profitable then most others in the industry. However, as evidenced by the difference in the asset turnover ratio, other companies in the industry appear to be better able to generate sales based on a given level of investment in as-sets.

(b) The company might be able to improve its asset turnover in one of two ways:

1. By improving its sales revenue. This could be done by increasing the selling price of its menu items. However, the restaurant would have to be careful to not price itself out of the market.

2. By improving its volume. This would be accomplished by increasing the volume of customers using the restaurant. To increase volume, the restaurant could change its hours of operations, offer a wider menu choice, or target its marketing efforts to under represented groups in its customer base.

Both of these suggested changes would result in increased sales, leading to increased net earnings. An improved profit margin would result. Return on assets would also improve because net earnings would in-crease while total assets would not change at all with the first option, and only slightly with the second option (increased inventory).



PROBLEM 9-10A


(a) STRAIGHT-LINE AMORTIZATION

Calculation End of YearAmortizable Amortization Amortization Accumulated Book

Year Cost X Rate (1/4) = Expense Amortization Value

2006 $150,000* 25% $37,500 $ 37,500 $132,5002007 0,150,000 25% 37,500 75,000 95,0002008 0,150,000 25% 37,500 112,500 57,5002009 , ,150,000 25% 37,500 150,000 20,000

*$170,000 - $20,000 = $150,000

DOUBLE DECLINING-BALANCE AMORTIZATION

Calculation End of YearBook ValueBeginning Amortization Amortization Accumulated Book

Year of Year X Rate = Expense Amortization Value

2006 $170,000 50%* $85,000 $ 85,000 $85,0002007 85,000 ………,,50% 42,500 127,500 42,5002008 42,500 ,,,,,,,,,,,,,50% 21,250 148,750 21,2502009 21,250 ,,,,,,,,,,,,,50% 1,250** 150,000 20,000

* 1/4 X 2 = 50%

**Adjusted so ending book value will equal salvage value ($21,250 X 50% = $10,625; $21,250 - $20,000 = $1,250).

Note to instructors: You might wish to point out to students that the double declining-balance method will result in odd amounts of amortization at the end of the asset’s useful life in order to adjust to salvage value. Often, this is not done in practice. Instead, the asset continues to be amortized as long as it is in use.



*PROBLEM 9-11A


*PROBLEM 9-11A (Continued)

(b) Straight-line amortization results in the lower amount of amortization ex-pense compared to the double declining-balance method in 2006. There-fore, it would result in the higher net earnings in 2006. Over the four-year period, both methods result in the same total amortization expense and, therefore, the same total earnings.

(c) Straight-line amortization results in the lower amount of amortization ex-pense and accumulated amortization compared to the double declining-balance method in 2006. Therefore, it would result in the higher net book value in 2006, as shown in (a). Over the four-year period, both methods result in the same total amortization and, therefore, the same ending net book value.

(d) Amortization is a non-cash expense. Therefore cash flow would be the same regardless of the method chosen.

(e) In choosing an amortization method, management needs to consider the pattern of revenue production and choose the amortization method that best matches this.




(a)Straight-Line Units-of-Activity

Amortization Book Amortization BookYear Expense Value Expense Value

1 $10,000 $21,000 $12,000 $19,0002 10,000 11,000 10,000 9,0003 10,000 1,000 8,000 1,000

Total $30,000 $30,000



Year Cost X Rate (1/3) Expense Amortization Value

1 $30,000* 1/3 $ 10,000 $10,000 $21,0002 ,,30,000 1/3 10,000 20,000 11,0003 ,,30,000 1/3 10,000 30,000 1,000

*$31,000 - $1,000 = $30,000

UNITS-OF-ACTIVITY AMORTIZATION

Calculation End of YearUnits-of- Amortization Amortization Accumulated Book

Year Activity X Cost/Unit1 = Expense Amortization Value

1 12,000 $1 $12,000 $12,000 $19,0002 10,000 1 10,000 22,000 9,0003 8,000 1 8,000 30,000 1,000

1Amortizable cost per unit = ($31,000 - $1,000) ÷ 30,000 units = $1 per unit.



*PROBLEM 9-12A


*PROBLEM 9-12A (Continued)

(b) 1. Straight- Units-of-Line Activity

Cost..................................................... $31,000 $31,000Accumulated amortization................... 20,000 22,000Net book value.................................... 11,000 9,000Cash proceeds.................................... 10,000 10,000Gain (loss) on disposal........................ $(1,000) $ 1,000

2.

Amortization expense.......................... $20,000 $22,000Add loss/Deduct gain on disposal....... 1,000 (1,000)Net expense........................................ $21,000 $21,000

In total, the effect on net earnings is exactly the same under both meth-ods. This is because the method of amortization only affects the timing of the expense recognition. In total, over the life of the asset the expense re-cognized is the same. Any difference between the proceeds and net book value at the time of disposal is adjusted through the gain (which reduces expense) or loss (which increases expense).




(a)

Item Land Land Improvements Building

1. $220,0002. 4,0003. 21,0004. $ 20,0005. 7,0006. 15,0007. 650,0008. 16,0009. $34,000

10. (10,500) $241,500 $34,000 $701,00 0

(b) Land............................................................................ 241,500Land Improvements.................................................... 34,000Building....................................................................... 701,000

Cash................................................................. 976,500

Note: Students could also have prepared individual journal entries for each transaction.



PROBLEM 9-1B


Account Debited Explanation

1. Equipment Improvement or betterment expenditure, which makes the equipment more productive.

2. Repairs Expense Does not make the equipment more product-ive. Likely benefits only the current period.

3. Equipment Improvement or betterment expenditure, which makes the equipment more productive.

4. Repairs Expense Does not make the equipment more product-ive.

5. Training Expense Does not increase the productivity of the equipment–and current accounting policies do not recognize the cost of human capital.

6. Repairs Expense Does not make the equipment more product-ive. Painting is a recurring expense.

7. Prepaid Insurance Benefits the current period only.



PROBLEM 9-2B


PROBLEM 9-3B

(a) Cost:

Cash price $85,000Delivery costs 400Installation and testing 2,500Total cost $87,900

The one-year insurance policy is not included as it benefits only the current period.

(b)



YearAmortizable

Cost XAmortization

Rate =Amortization


Net BookValue

20062007200820092010

$81,900*81,90081,90081,90081,900

25%** X 2/1225%25%25%

25% X 10/12

$3,41220,475

202020,47520,47517,063

$ 3,412 23,887

44,3626 64,837

81,900

$84,48864,01343,53823,0636,000

* Amortizable cost = $87,900 - $6,000 = $81,900** 1 ÷ 4 years = 25%




PROBLEM 9-3B (Continued)

(c) Straight-line amortization results in a constant amount of amortization expense each period. The declining-balance method results in a higher amortization expense in the early years and lower amortization expense in the later years. In comparing these two methods, straight-line amort-ization would result in a lower amount of amortization expense than that produced by the declining-balance method in the early years and a higher amount in the later years. This would consequently affect net earnings inversely. That is, net earnings would be higher for straight-line amortization in the early years and lower in the later years. Over the four-year useful life of the machine, both methods would result in the same total amortization expense (equal to the amortizable cost) and same total net earnings.

Because amortization expense would be lower in the early years for straight-line amortization, net book value (cost less accumulated amort-ization) would be higher in the early years than the result produced by the declining-balance method of amortization and lower in the later years. Of course, at the end of the four-year life, both methods would end up with the same net book value, $6,000.

(d) It is difficult to compare the straight-line and units-of-activity methods of amortization. Straight-line amortization results in a constant amount of amortization expense and net earnings. The units-of-activity method will result in varying amount of amortization expense and resultant net earn-ings, depending on the actual amount of production activity in each par-ticular period. Nonetheless, over the life of the asset, both methods res-ult in the same total net earnings and will end up with the same net book value, $6,000.

(e) The matching principle dictates that the cost of a long-lived asset should be matched to the revenue produced by that asset. Since the pattern of revenue production is different for each type of asset, each amortization method should be chosen based on the revenue pattern of the specific asset.




(a) April 1 Land......................................................... 2,630,000Cash.................................................. 630,000Note Payable..................................... 2,000,000

May 1 Amortization Expense................................ 25,000 Accumulated Amortization —Equipment ($750,000 X 1/10 X 4/12) 25,000

1 Cash.......................................................... 350,000Accumulated Amortization—Equipment.... 325,000Loss on Disposal....................................... 75,000

Equipment..................................... 750,000

Cost $750,000Accumulated amortization—Equipment[($750,000 X 1/10) X 4 + $25,000)] 325,000Net book value 425,000Cash proceeds 350,000Loss on disposal $ (75,000)

June 1 Cash.......................................................... 180,000Note Receivable........................................ 1,620,000

Land.................................................... 300,000Gain on Disposal................................ 1,500,000

July 1 Equipment................................................. 1,000,000Accounts Payable............................... 1,000,000

Dec. 31 Amortization Expense................................ 47,000Accumulated Amortization—Equipment ($470,000 X 1/10)......... 47,000

31 Accumulated Amortization—Equipment.... 470,000Equipment..................................... 470,000



PROBLEM 9-4B



(b) Dec. 31 Amortization Expense............................. 712,500Accumulated Amortization—Buildings ($28,500,000 ÷ 40)........ 712,500

31 Amortization Expense............................. 4,728,000Accumulated Amortization—Equipment.................................... 4,728,000

$46,780,000* ÷ 10 $4,678,000$1,000,000 ÷ 10 X 6/12 50,000

$4,728,000

*$48,000,000 - $750,000 - $470,000 = $46,780,000

31 Interest Expense..................................... 90,000Interest Payable............................... 90,000

($2,000,000 X 6% X 9/12) = $90,000

31 Interest Receivable................................. 56,700Interest Revenue.............................. 56,700

($1,620,000 X 6% X 7/12) = $56,700

(c) YOUNT CORPORATIONBalance Sheet (Partial)

December 31, 2006

Property, plant, and equipment*Land........................................................ $ 6,330,000Buildings.................................................. $28,500,000Less: Accumulated amortization—buildings.............................................. 12,812,500 15,687,500Equipment............................................... $47,780,000Less: Accumulated amortization—equipment............................................ 19,005,000 28,775,000

Total property, plant, and equipment. $50,792,500

*See T accounts on the following page.





(c) (Continued)

Land

Dec. 31, 2005 4,000,000 June 1, 2006 300,000April 1, 2006 2,630,000

Dec. 31, 2006 Bal. 6,330,000

Buildings

Dec. 31, 2005 28,500,000

Dec. 31, 2006 Bal. 28,500,000

Equipment

Dec. 31, 2005 48,000,000 May 1, 2006 750,000July 1, 2006 1,000,000 Dec. 31, 2006 470,000

Dec. 31, 2006 Bal. 47,780,000

Accumulated Amortization—Buildings

Dec. 31, 2005 12,100,000 Dec. 31, 2006 712,500

Dec. 31, 2006 Bal. 12,812,500

Accumulated Amortization—Equipment

May 1, 2006 325,000 Dec. 31, 2005 15,000,000Dec. 31, 2006 470,000 May 1, 2006 25,000

Dec. 31, 2006 47,000Dec. 31, 2006 4,728,000

Dec. 31, 2006 Bal. 19,005,000




(a) EquipmentCost, January 1, 2004 $60,000Less: Salvage value 4,500Amortizable cost $55,500



The equipment’s book value on January 1, 2006 will be $37,800 [$60,000 – ($11,100 X 2 years)].

(b) You would expect the amortization expense to decrease in 2006 after the change in useful life because the amortizable cost will be ex-pensed through amortization over a longer period of time.

(c) The change in the useful life should only affect current and future periods. The rationale for this is that the original estimate was based on informa-tion known at the time the asset was purchased and the revision is based on new information and should only affect future periods. In addition, if prior periods where regularly restated users would feel less confident in the financial statements.

(d) If they had not revised the remaining useful life, the total amortiza-tion expense over the equipment’s life would be the amortizable cost of $55,500. The accumulated amortization at the end of the equipment’s useful life would be $55,500 and the net book value would be $4,500

(e) The total amortization expense would not change after the useful life has been revised. There would be no changes to the accumulated amort-ization or the net book value at the end of the equipment’s useful life.



PROBLEM 9-5B


(a) 2004Mar. 1 Furniture.................................................... 85,000

Cash................................................... 85,000

(b) Cost, January 1, 2004 $85,000Less: Salvage value 1,000Amortizable cost $84,000




Accumulated Amortization—Furniture ($16,800 X 10/12)............ 14,000


Accumulated Amortization—Furniture.......................................... 16,800

2006July 2 Amortization Expense................................ 8,400

Accumulated Amortization—Furniture ($16,800 X 6/12).............. 8,400



PROBLEM 9-6B



(c) (1) July 2 Cash.......................................................... 50,000Accumulated Amortization1 ....................... 39,200

Equipment......................................... 85,000Gain on Disposal............................... 4,200

1 $14,000 + $16,800 + $8,400 = $39,200

Cost.......................................................... $85,000Accumulated amortization—Equipment... 39,200Book value............................................... 45,800Cash proceeds......................................... 50,000Gain on disposal...................................... $ 4,200

(2) July 2 Cash.......................................................... 45,000Accumulated Amortization—Equipment.... 39,200Loss on Disposal....................................... 800

Equipment......................................... 85,000

Cost.......................................................... $85,000Accumulated amortization—equipment. . . 39,200Book value............................................... 45,800Cash proceeds......................................... 45,000Loss on disposal...................................... $ 800

(3) July 2 Accumulated Amortization—Equipment.... 39,200Loss on Disposal....................................... 45,800

Equipment......................................... 85,000

Cost.......................................................... $85,000Accumulated amortization—equipment. . . 39,200Book value............................................... 45,800Cash proceeds......................................... 0Loss on disposal...................................... $45,800




1. Research Expense........................................ 60,000Patent................................................ 60,000

2. Patent............................................................ 21,000Legal Fees Expense.......................... 21,000

3. Patent............................................................ 38,000Legal Fees Expense.......................... 38,000

4. Patent............................................................ 50,000Revenue from Cyber Shoe Rights..... 50,000

5. Accumulated Amortization—Patent.............. 2,250Amortization Expense....................... 2,250

Amortization Expense................................... 18,800Accumulated Amortization—Patent... 18,800[($35,000 + $21,000 + $38,000) ÷ 5] = $18,800

6. Impairment Loss........................................... 5,200Patent................................................ 5,200

Cost ($35,000 + $21,000 + $38,000) $94,000Accumulated amortization 18,800Net book value 75,200Market value 70,000Impairment loss $ 5,200



PROBLEM 9-7B


1. Jan. 1 Patent #1..................................................... 22,500Cash....................................................... 22,500

July 1 Research Expense...................................... 220,000Cash....................................................... 220,000

1 Patent #2 (Development Costs)................... 60,000Cash....................................................... 60,000

Sept. 1 Advertising Expense.................................... 11,000Cash....................................................... 11,000

Oct. 1 Copyright #2................................................ 16,000Cash....................................................... 16,000

Dec. 31 Impairment Loss ($175,000 - $210,000)...... 35,000Goodwill................................................. 35,000

(b) Dec. 31 Amortization Expense (given)...................... 9,166Accumulated Amortization—Patent #1. . 9,166

31 Amortization Expense.................................. 1,500Accumulated Amortization—Patent #2. . 1,500 ($60,000 ÷ 20 x 6/12 = $1,500)

31 Amortization Expense.................................. 4,800Accumulated Amortization—Copyright #1 4,800 ($48,000 ÷ 10 = $4,800)

31 Amortization Expense.................................. 800Accumulated Amortization—Copyright #2 800 ($16,000 ÷ 5 x 3/12 = $800)



PROBLEM 9-8B



(c)IP INC.

Balance Sheet (partial)December 31, 2006

Intangible assets

Limited life intangiblesPatent........................................................ $152,5001

Accumulated amortization......................... 24,6662 $127,834Copyrights................................................. $64,0003

Accumulated amortization......................... 29,6004 34,400Indefinite life intangibles

Goodwill....................................................................... 175,0005

Total intangible assets........................................ $337,2341 Patents: $70,000 + $22,500 + $60,000 = $152,500

2 Accumulated amortizationPatent #1: ($70,000 ÷ 10 X 2) + $9,166 = $23,166Patent #2: 1,500

$24,666

3 Copyrights: $48,000 + $16,000 = $64,000

4 Accumulated amortizationCopyright #1: $4,800 X 6 years = $28,800Copyright #2: 800

$29,600

5 Goodwill: $210,000 - $35,000 = $175,000




(a) ($ in millions) Sleeman Breweries.............Big Rock Brewery

Profit margin

Return on assets

Asset turnover



PROBLEM 9-9B



(b) Based on profit margin we can see that Big Rock is substantially more prof-itable than Sleeman. Sleeman has profit margins below the industry aver-age of 10.9%, which indicates that they are less profitable than the average brewery. Big Rock’s profit margin is also significantly higher than the aver-age brewery indicating that they are much more profitable.

The return on assets ratio indicates that Big Rock is generating a better re-turn then Sleeman based on the amount of assets invested in the business. In addition, based on the industry average of 7.8% Sleeman is generating a lower return on their assets than most other companies in the industry, and Big Rock is generating a much higher return on assets.

The asset turnover ratio measures how efficiently a company uses its as-sets to generate sales. It shows the dollars of sales generated by each dol-lar invested in assets. Sleeman’s asset turnover ratio (0.79) was lower than Big Rock’s (0.95) in 2004. Therefore, it could be concluded that Big Rock was more efficient than Sleeman during 2004 in utilizing assets to generate sales. Both companies are above the industry average of 0.7 times.

The ability to compare the two companies is complicated by the fact that Sleeman Breweries is far larger than Big Rock Brewery. Its size, and result-ing economies of scale, should allow Sleeman to be more profitable. Fur-ther investigation would be required to determine why Sleeman’s perform-ance is so far below Big Rock’s.




(a) As evidenced by the low profit margin compared to the high asset turnover (when compared to other companies in the industry), the company is fo-cusing its efforts on having a high volume of sales versus maximizing profits. The company could be maximizing asset turnover by charging a lower selling price for its products, by focusing on cost control or some combination of both.

(b) The company’s strategy appears to be to sell a high number of low-end computers. It appears to be accepting a higher volume of sales (as evid-enced by the high asset turnover ratio) to the detriment of profit margin. Given the company’s lower return on asset ratio, this strategy does not appear to be very successful.



PROBLEM 9-10B


(a) STRAIGHT-LINE AMORTIZATION


Year Cost X Rate = Expense Amortization Value

2006 $240,000a 20%b $48,000 $ 48,000 $212,0002007 240,000 20% 48,000 96,000 164,0002008 240,000 20% 48,000 144,000 116,0002009 240,000 20% 48,000 192,000 68,0002010 240,000 20% 48,000 240,000 20,000

a $260,000 – $20,000 = $240,000b 1/5 = 20%

DOUBLE DECLINING-BALANCE AMORTIZATION

Calculation End of YearBook Value

Beginning Amortization Amortization Accumulated BookYear of Year X Rate = Expense Amortization Value

2006 $260,000 40%c $104,000 $104,000 $156,0002007 156,000 40% 62,400 166,400 93,6002008 93,600 40% 37,440 203,840 56,1602009 56,160 40% 22,464 226,304 33,6962010 33,696 40% 13,696d 240,000 20,000

c 1/5 X 2 = 40%d Adjusted so ending book value will equal salvage value ($33,696 X 40% = $13,478; $33,696 - $20,000 = $13,696)



*PROBLEM 9-11B


*PROBLEM 9-11B (Continued)

(b) Straight-line amortization provides the lower amount for 2006 amortization expense and, therefore, the higher 2006 earnings. Over the five-year period, both methods result in the same total amortization expense ($240,000) and, therefore, the same total earnings.

Note to instructors: You might wish to point out to students that the double declining-balance method will result in odd amounts of amortization at the end of the asset’s useful life in order to adjust to salvage value. Often, this is not done in practice. Instead, the asset continues to be amortized as long as it is in use.

(c) Straight-line amortization results in the higher net book value at the end of 2006. At the end of the five-year period, both methods result in the same net book value.

(d) Amortization is a noncash expense. Therefore cash flow would be the same regardless of the method chosen.

(e) In choosing an amortization method, management needs to consider the pattern of revenue production and choose the amortization method that best matches this.




(a)



Year Cost X Rate (1/3) Expense Amortization Value

1 $72,000* 1/3 $ 24,000 $24,000 $56,0002 ,72,000 1/3 24,000 48,000 32,0003 ,,72,000 1/3 24,000 72,000 8,000

*$80,000 - $8,000 = $72,000

UNITS-OF-ACTIVITY AMORTIZATION

Calculation End of YearUnits-of- Amortization Amortization Accumulated Book

Year Activity X Cost/Unit1 = Expense Amortization Value

1 120,000 $0.24 $28,800 $28,800 $51,2002 100,000 0.24 24,000 52,800 27,2003 80,000 0.24 19,200 72,000 8,000

1Amortizable cost per unit = ($80,000 - $8,000) ÷ 300,000 km = $0.24 per kilometre.



*PROBLEM 9-12B


*PROBLEM 9-12B (Continued)

(b) 1. Straight Units-of -Line -Activity

Cost..................................................... $80,000 $80,000Accumulated amortization................... 48,000 52,800Book value........................................... 32,000 27,200Cash proceeds.................................... 25,000 25,000Gain (loss) on disposal........................ $ (7,000) $ (2,200)

2.

Amortization expense.......................... $48,000 $52,800Add: Loss on disposal........................ 7,000 2,200 Net expense........................................ $55,000 $55,000

In total, the effect on net earnings is exactly the same under both meth-ods. This is because the method of amortization only affects the timing of the expense recognition. In total, over the life of the asset the expense re-cognized is the same. Any difference between the proceeds and net book value at the time of disposal is adjusted through the gain (which reduces expense) or loss (which increases expense) on disposal.




($ in millions)

(a) Amortization is calculated principally on the straight-line basis over the estimated use-ful lives of the assets. Buildings are amortized over a period from 20 to 40 years and its equipment and fixtures over a period of 3 to 10 years. It amortizes its leasehold im-provements over the lesser of the asset’s applicable useful life and the lease term plus one renewal period to a maximum of 10 years

(b) Cost of fixed assets: 2003, $9,010, 2002, $7,857 Accumulated amortization: 2003, $2,588, 2002, $2,270

Net book value: 2003, $6,422, 2002, $5,587.

(c) Amortization (depreciation) expense: 2003, $393; 2002, $354.Accumulated amortization (depreciation): 2002; $2,588, 2003, $2,270.

The change in the accumulated amortization ($2,588 - $2,270 = $318) between 2003 and 2002 is not equal to the amortization expense ($393) for 2003 because of the ad-justment for disposals.

(d) The amount of cash received from fixed asset sales in 2003 was $35. The amount of cash spent for the purchase of fixed assets in 2003 was $1,271.

The purchases of fixed assets were: 2003, $1271; 2002, $1,079.

(e) Loblaw has Goodwill and Franchise Investments.

(f) Loblaw did not report any impairment losses in 2003.



BYP 9-1 FINANCIAL REPORTING PROBLEM


($ in

millions)

(a) Loblaw.........................................Sobeys

1. Profit margin

2. Return on assets

3. Asset turnover

(b) Based on profit margin we can see that Loblaw is more profitable than Sobeys. How-ever, both retailers have profit margins above the industry average of 0.6%, which indic-ates that both Sobeys and Loblaw are more profitable than the average grocery retailer.

The return on assets ratio indicates that Sobeys is generating a slightly worse return than Loblaw based on the amount of assets invested in the business. However, again, based on the industry average of 1.3% both companies are generating a better return on their assets than most other retailers in the industry.

The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Sobeys’ asset turnover (3.4) was 54% higher than Loblaw’s (2.2). Therefore, it could be con-cluded that Sobeys was more efficient than Loblaw in utilizing assets to generate sales. Loblaw is a little under the industry average of 2.5 times but this could be attributed to the rapid growth the company has been undergoing in the past several years.



BYP 9-2 COMPARATIVE ANALYSIS PROBLEM


(a)Intangible assets include brands, technology, contracts, artistic assets, customer lists and

marketing-related assets. Intangible asset value as a percent of overall asset value is approximately 75% of overall asset value for Canadian technology, financial, commu-nications and non-cyclical consumer companies; approximately 50% for industrial, en-ergy, base metal and consumer cyclical companies; approximately 25% for the utility sector.

(b)

Company Brand Value Brand value as a per-centage of market value

Royal Bank of Canada $4,418,000,000 10.6%Canadian Tire 1,358,000,000 26.0%Molson 1,081,000,000 20.5%McCain Foods 1,009,000,000 N/ASobeys 834,000,000 31.4%

(c) The cost principle requires that property, plant, and equipment, goodwill and intan-gible assets be recorded at cost, their cash-equivalent prices on the date that they are acquired. Brand value is the price that the brand would fetch in the open market today.

(d) Investors expect a return (income earned) on their investments. The higher the asset values and value of their investments, the more income that will have to be earned to achieve the targeted return. For example, in 2004 almost 50% of investors buying into a company expected a return of greater than 14%. Venture capitalists (VCs) expect a higher rate of return. In 2004, over 70% of VCs expected a return on investment greater than 14%.



BYP 9-3 RESEARCH CASE


(a) The $110 million investment should be treated as a capital expenditure. This will res-ult in the creation of an asset that will have a long life and the cost will be matched with the revenue it generates through annual amortization charges.

(b) Maple Leaf could use the straight-line, declining-balance or the units-of-activity method to amortize the property, plant, and equipment associated with its Saskat-chewan plant. The straight-line method is simple to use and if the assets are used at a consistent level will match costs with revenue. Declining-balance is appropriate in cases where the benefits are greater in the early years of an assets life. The units-of-activity method would be the most appropriate in this case as the levels of production vary widely. The units-of activity method will provide the best matching of costs with revenue.

(c) If the units-of-activity method is chosen and the plant moves to a double-shift opera-tion and processes additional hogs, the amortization expense will increase substan-tially as the number of hogs processed increases.



BYP 9-4 INTERPRETING FINANCIAL STATEMENTS


(a) Vivendi’s recording of impairment losses appears to be similar to accounting practices in Canada. The company recorded an impairment loss for goodwill and other assets after assessing their market values.

(b) Impairment Loss – Goodwill................................ €26 millionImpairment Loss – Other intangible assets......... €5 million

Goodwill.................................................. €26 millionOther intangible assets........................... €5 million

(c) This write-down will cause Vivendi’s intangible assets and shareholders’ equity (through retained earnings) to be lower. Current earnings are also lower (which reduces retained earnings on the balance sheet). This should not impact future earnings unless further write-downs are required.



BYP 9-5 INTERPRETING FINANCIAL STATEMENTS


Due to the frequency of change with regard to information available on the world wide web, the Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources sec-tion of our home page <www.wiley.com/canada/kimmel>.



BYP 9-6 FINANCIAL ANALYSIS ON THE WEB

http://www.wiley.com/canada/kimmel).%0D


(a) Ty Corporation—Straight-line method

Annual amortizationBuilding [($320,000 - $20,000) ÷ 30]............................................... $10,000Equipment [($110,000 - $10,000) ÷ 5]............................................. 20,000Total annual amortization................................................................ $30,000

Total accumulated amortization ($30,000 X 3)........................................... $90,000

Hamline Corporation – Double Declining-Balance

Building:


Book ValueBeginning Amortization Amortization Accumulated Book

Year of Year X Rate* = Expense Amortization Value

2004 $320,000 6.7% $21,440 $ 21,440 $298,5602005 298,560 6.7% 20,004 41,444 278,5562006 278,556 6.7% 18,663 60,107 259,893

*Rate: 1/30 X 2 = 6.7%

Equipment:


Book ValueBeginning Amortization Amortization Accumulated Book

Year of Year X Rate = Expense Amortization Value

2004 $110,000 40% $44,000 $ 44,000 $66,0002005 66,000 40% 26,400 70,400 39,6002006 39,600 40% 15,840 86,240 23,760

*Rate: 1/5 X 2 = 40%

Total Accumulated Amortization = $60,107 + $86,240 = $146,347



*BYP 9-7 COLLABORATIVE LEARNING ACTIVITY


BYP 9-7 (Continued)

(b) HamlineTy Corporation

Corporation Net EarningsYear Net Earnings As Adjusted Calculations for Hamline Corporation

2004 $ 84,000 $103,440 $68,000 + $65,4401 - $30,000 = $103,4402005 …… 88,400 92,404 $76,000 + $46,4042 - $30,000 = $92,4042006 0 90,000 89,503 $85,000 + $34,5033 - $30,000 = $89,503

Total netearnings $262,400 $285,347

1 $21,440 + $44,000 = $65,4402 $20,004 + $26,400 = $46,4043 $18,663 + $15,840 = $34,503

(c) As shown above, when the two companies use the same amortization method, Ham-line is more profitable than Ty. Based on the above analysis, Ms. Tucci should invest in Hamline Corporation because it is more profitable.




Memorandum

To: President, Accounting Standards BoardFrom: President, Research Inc.Date: TodayRe: R&D Accounting Standards

We would like to provide the following comments for your consideration as you review the current accounting standards for research and development costs. Our company is in favour of capitalizing all research and development costs.

Some relatively small companies may spend less on R&D because they must expense these costs. Requiring companies to expense R&D costs instead of allowing them to be capitalized leaves Canadian companies such as ours at a competitive disadvantage as compared to non-Canadian companies. Canadian 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.

R&D is an important part of our base of knowledge assets. Without capitalizing them, we are understating our balance sheet and future potential because we are not presenting to the users of financial statements the intrinsic value of our company, much of which is tied to successful research and development.

We believe expensing R&D costs to be an excessive application of the conservatism concept. The conservatism concept dictates that when reasonable doubt exists, a company should choose the option that has the least favourable effect on earnings. Expensing R&D costs is an example of applying the conservatism concept without regard for reality.

We hope these comments assist you in your revision of this standard. We would be pleased to elaborate further on any of the above points at your convenience.



BYP 9-8 COMMUNICATION ACTIVITY


(a) The stakeholders in this situation are:Benny Benson, president of Imporia Container Ltd.Yeoh Siew Poon, controller.The shareholders of Imporia Container Ltd.Potential investors in Imporia Container Ltd.

(b) Earnings before income taxes in the year of change will increase by implementing the president’s proposed changes because increasing the useful life will decrease the amortization expense.

Note to instructor: Students are not expected to, nor are able to, calculate the impact of this change. However, the following calculations have been included in case you wish to expand upon this topic.

Old Estimates

Asset cost $3,000,000Estimated salvage 200,000Amortizable cost 2,800,000Amortization per year ($2,800,000 ÷ 5) $ 560,000

Revised Estimates

Asset cost $3,000,000Estimated salvage 200,000Amortizable cost 2,800,000Amortization taken to date ($560,000 X 2) 1,120,000

1,680,000Remaining useful life in years 5 yearsAmortization per year $ 336,000

(c) Earnings management is a strategy used by the management of a company to deliber-ately manipulate the company's earnings so the figures match a pre-determined target. The proposed change is an attempt at earnings management by the president because he is requesting the change in amortization entirely for the purpose of reducing net earnings.



BYP 9-9 ETHICS CASE


BYP 9-9 (Continued)

(d) The intentional misstatement of the life of an asset is unethical for whatever the reason and would represent an attempt at earnings management. There is nothing per se un-ethical about changing the estimate either of the life of an asset or of an asset’s sal-vage value if the change is an attempt to better match cost and revenues and is a bet-ter allocation of the asset’s amortizable cost over the asset’s useful life. In this case, it appears from the controller’s reaction that the revisions in the life are intended only to improve earnings which would be unethical.

The fact that the competition uses a longer life on its equipment is not necessarily rel-evant. The competition’s maintenance and repair policies and activities may be differ-ent. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Imporia Container Ltd.




(a) Purchase price $32,500Painting 2,500Shelving 1,500Total cost of van $36,500

(b) (1) Straight-line amortization

YearAmortizable

CostAmortization

RateAmortization


Net BookValue

$36,5002006 $30,000 20% * 4/12 $ 2,000 $ 2,000 34,5002007 30,000 20% 6,000 8,000 28,5002008 30,000 20% 6,000 14,000 22,5002009 30,000 20% 6,000 20,000 16,5002010 30,000 20% 6,000 26,000 10,5002011 30,000 20% * 8/12 4,000 30,000 6,500

$30,000

(2) Double declining-balance amortization

Year

Net Book Value

(beginning of year)

Amortization Rate

Amortization Expense

Accumulated Amortization

Net Book Value

$36,5002006 $36,500 40% * 4/12 $ 4,867 $ 4,867 31,6332007 31,633 40% 12,653 17,520 18,9802008 18,980 40% 7,592 25,112 11,3882009 11,388 40% 4,555 29,667 6,8332010 6,833 40% 3331 30,000 6,5002011 6,500 40% 0 30,000 6,500

$30,000

1 Note that amortization in 2010 is limited to the amount that will bring the residual value to $6,500. Consequently, no further amortization is deducted in 2011.



*BYP 9-10 SERIAL PROBLEM


BYP 9-10 (Continued)

(b) (Continued)

(3) Units-of-activity amortization

YearUnits-of-Ac-

tivity

Amortizable Cost per Unit(see below)

Amortization Expense

Accumulated Amortization

Net Book Value

$36,5002006 15,000 $0.15 $ 2,250 $ 2,250 34,2502007 45,000 0.15 6,750 9,000 27,5002008 50,000 0.15 7,500 16,500 20,0002009 45,000 0.15 6,750 23,250 13,2502010 35,000 0.15 5,250 28,500 8,0002011 10,000 0.15 1,500 30,000 6,500

$30,000

Note: $30,000 ÷ 200,000 = $0.15 per km

(c) Impact on Cookie Creation Ltd.'s balance sheet and statement of earnings in 2006:

Straight-LineDouble

Declining-Balance Units-of-ActivityCost of asset $36,500 $36,500 $36,500Accumulated amortization 2,000 4,867 2,250 Net book value $34,500 $31,633 $34,250

Amortization expense $2,000 $4,867 $2,250

The double declining-balance method of amortization will result in the lowest amount of earnings reported, the lowest amount of retained earnings and the lowest net book value of the asset reported.

The straight line method of amortization will result in the greatest amount of earnings reported, the greatest amount of retained earnings and the greatest net book value of the asset reported.

(d) Over the van's five year useful life the total amortization will be $30,000 under each ofthe methods. The impact will affect the timing of the amortization expense recognized




each year only.

(e) The choice of amortization method will not affect the cash flow. A reduction in cash flow occurs with the initial purchase of the van. Amortization is the systematic alloca-tion of asset costs over the asset's useful life.




BYP 9-10 (Continued)

(f) The units of activity method may provide Natalie with a more accurate assessment of usage of the van in relation to the amount of revenue earned. As long as Natalie is willing to track the number of kilometres driven over the course of the year, then this would be the method recommended.

(g) Advantages of leasing the van: Reduced risk of obsolescence. The lease term can provide for replacing the van be-

fore it physically wears out. 100% financing. There is no need to borrow and come up with a down payment on

the purchase of the van. (Down payments are usually up to 20% of purchase price) Income tax advantages. In some cases the entire amount of the lease payment may

be deductible for tax purposes. Off-balance sheet financing. If the lease is classified as an operating lease then both

the asset and liability are not recorded on the balance sheet.

Disadvantages of leasing the van: Natalie wishes to take out the back seat and install some shelves in the van. Under a

lease agreement this may not be possible.

Some lease agreements require a monthly minimum payment based upon mileage. If the mileage is exceeded then an additional charge is added onto the monthly mini-mum.

Some lease agreements can prove to be more expensive in terms of cost of financing than borrowing from a bank.




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