Chapter 10

Plant Assets, Natural Resources and Intangibles

QUESTIONS
1. The cost of a plant asset includes all normal, reasonable, and necessary costs of getting the
asset in place and ready for its intended use.
2. A plant asset is tangible; it is used in the production or sale of other assets or services; and it
has a useful life longer than one accounting period.
3. Land held for future expansion is classified as a long-term investment. It is not a plant asset
because it is not being used in the production or sale of other assets or services.
٤. Land is an asset with an unlimited life and, therefore, is not subject to depreciation. Land
improvements have limited lives and are subject to depreciation.
5. The Modified Accelerated Cost Recovery System is not generally acceptable for financial
accounting purposes because it allocates depreciation over an arbitrary period that is usually
much shorter than the predicted useful life of the asset.
6. The Accumulated Depreciation—Machinery account is a contra asset account with a credit
balance that cannot be used to buy anything. The balance of the Accumulated
Depreciation—Machinery account reflects that portion of the machinery's original cost that
has been charged to depreciation expense. It also gives some indication of the asset’s age
and how soon it will need to be replaced. Any funds available for buying machinery are
shown on the balance sheet as liquid assets with debit balances.
7. The materiality principle justifies charging low-cost plant asset purchases to expense
because such amounts are unlikely to impact the decisions of financial statement users.
8. Ordinary repairs are made to keep a plant asset in normal, good operating condition, and
should be charged to expense of the current period. Extraordinary repairs are made to
extend the life of a plant asset beyond the original estimated life; they are recorded as
capital expenditures (and added to the asset account).
9. A company might sell or exchange an asset when it reaches the end of its useful life, or if it
becomes inadequate or obsolete, or if the company has changed its business plans. An asset
also can be damaged or destroyed by fire or some other accident that would require its
disposal.
10. The process of allocating the cost of natural resources to expense over the periods when
they are consumed is called depletion. The method to compute depletion is similar to units-
of-production depreciation.
11. An intangible asset: (1) has no physical existence; (2) derives value from the unique legal
and contractual rights held by its owner; and (3) is used in the company’s operations.

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Solutions Manual, Chapter 10 563
12. No, depletion expense should be calculated on the units that are extracted (similar to the
units-of-production basis) and sold.
13. Intangible assets are generally recorded at their cost and amortized over their predicted
useful life. (However, some costs are not included, such as the research and development
costs leading up to a patent.) The costs of intangible assets are generally allocated to
amortization expense using the straight-line method over their useful lives. If the useful life
of an intangible asset is indefinite, then it is not amortized—instead, it is annually tested for
impairment.
14. A company has goodwill when its income return rate is greater than the income return rate
normally earned in its industry. (Alternatively, goodwill is when the value of a company
exceeds the value of its individual net assets [assets less liabilities].) Goodwill appears in
the balance sheet when one company acquires another company or separate segment and
pays a price that exceeds the combined values of all its net assets (assets less liabilities)
excluding goodwill.
١٥. No; this type of goodwill would not be amortized. Instead, the FASB (SFAS 142) requires
that goodwill be annually tested for impairment. If the book value of goodwill does not
exceed its fair (market) value, goodwill is not impaired. However, if the book value of
goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details
of this two-step test are in advanced courses.)
16. The statement of cash flows is potentially impacted in three ways when accounting for long-
term assets. If there are (1) additions or (2) disposals of long-term assets, these transactions
(assuming they involve cash) are reported in the investing activities section of the statement
of cash flows. Also, if the indirect method is used to prepare the statement of cash flows—
see Chapter 16—then depreciation, depletion, and amortization of long-term assets are
reported in the operating section of the statement of cash flows as adjustments to net
income. (3) Cash payments for capital and revenue expenditures can also impact the
statement of cash flows.
17. Total asset turnover is calculated by dividing net sales by average total assets. Financial
statement users can use total asset turnover to evaluate the efficiency of a company in using
its assets to generate sales.
18. Krispy Kreme titles its plant assets "Property and equipment, net." The book value of its
property and equipment as of February 2, 2003, is $202,558,000 and as of February 3, 2002,
is $112,577,000.
19. Tastykake’s plant assets are categorized as “Property, plant and equipment” and are
reported at their gross values separately under “Land”, “Buildings and improvements,” and
“Machinery and equipment.” The accumulated depreciation amount is deducted from the
gross value of the long-term assets. The net value (book value) of the property, plant, and
equipment on its 2002 balance sheet is $58,391,222.
20. The December 31, 2002, long-term assets of Harley-Davidson, Inc., are reported in its Note
2 as follows:
Under property, plant and equipment, at cost (in thousands):

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564 Fundamental Accounting Principles, 17th Edition
 Land and land improvements ..................... $ 20,674
Buildings and improvements ..................... 273,959
Machinery and equipment.......................... 1,448,312
Construction-in-progress............................ 263,311
Total property and equipment .................... 2,006,256
Less accumulated depreciation .................. 973,660
Property and equipment, net ...................... $1,032,596

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Solutions Manual, Chapter 10 565
QUICK STUDIES

Quick Study 10-1 (10 minutes)

Recorded cost = $180,000 + $18,000 + $3,000 + $12,600 = $213,600

Note: The $2,250 repair charge is an expense because it is not a normal and reasonable
expenditure necessary to get the asset in place and ready for its intended use.

Quick Study 10-2 (10 minutes)

1. The main difference between plant assets and current assets is that current assets are
consumed or converted into cash within a short period of time while plant assets have a
useful life of more than one accounting period.
2. The main difference between plant assets and inventory is that inventory is held for resale
and plant assets are not.
3. The main difference between plant assets and long-term investments is that plant assets are
used in the primary operation of the business and investments are not.

Quick Study 10-3 (10 minutes)

1. Straight-line:
($55,900 - $1,900) / 4 years = $13,500 depreciation per year

2. Units-of-production:
($55,900 - $1,900) / 120 concerts = $ 450 depreciation per concert
x 40 concerts in 2005
$18,000 depreciation in 2005

Quick Study 10-4 (10 minutes)

$55,900 Cost
- 13,500 Accumulated depreciation (first year)
42,400 Book value at point of revision
- 1,900 Salvage value
40,500 Remaining depreciable cost
÷2 Years of life remaining
$20,250 Depreciation per year for years 2 and 3

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566 Fundamental Accounting Principles, 17th Edition
Quick Study 10-5 (10 minutes)
Note: Double-declining-balance rate = (100% / 8 years) x 2 = 25%
First year:
$930,000 x 25% = $232,500

Second year:
($930,000 - $232,500) x 25% = $174,375

Third year:
($930,000 - $232,500 - $174,375) x 25% = $130,781* (rounded)

* Total accumulated depreciation of $537,656 ($232,500 + $174,375 + $130,781) does

not exceed the depreciable cost of $780,000 ($930,000 - $150,000).

Quick Study 10-6 (10 minutes)

1. (a) Capital expenditure
(b) Revenue expenditure
(c) Revenue expenditure
(d) Capital expenditure

2. (a) Building .................................................................................. 250,000

Cash ............................................................................... 250,000
To record addition of a new wing.
(d) Equipment............................................................................... 50,000
Cash ............................................................................... 50,000
To record an extraordinary repair.

Quick Study 10-7 (10 minutes)

1. Machinery................................................................................. 48,000
Accumulated Depreciation–Machinery.................................... 20,400
Loss on Exchange of Assets..................................................... 2,000
Machinery...................................................................... 38,400
Cash............................................................................... 32,000
To record similar asset exchange.

2. Machinery................................................................................. 42,000
Accumulated Depreciation–Machinery.................................... 20,400
Machinery...................................................................... 38,400
Cash............................................................................... 24,000
To record similar asset exchange.

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Solutions Manual, Chapter 10 567
Quick Study 10-8 (10 minutes)
1. Ore Mine 1,500,000
Cash 1,500,000
To record cost of ore mine.

2. $1,500,000 - $150,000
Depletion per unit = = $2.70 per ton
500,000 tons

Depletion Expense—Ore Mine ................................................. 243,000

Accumulated Depletion—Ore Mine................................ 243,000
To record depletion of ore mine (90,000 x $2.70).

Quick Study 10-9 (10 minutes)

Intangible Assets: b) Trademark c) Leasehold f) Copyright g) Franchise
Natural Resources: a) Oil well d) Gold mine h) Timberland
Note: Building is reported under plant assets.

Quick Study 10-10 (10 minutes)

1.
Jan. 4 Leasehold Improvements ................................................................ 95,000
Cash 95,000
To record leasehold improvements.
2.
Dec. 31 Amortization Expense–Leasehold Improvements .......................... 11,875
Accumulated Amortization—Leasehold
Improvements..................................................................... 11,875
To record amortization of leasehold over
the remaining life of the lease.*
*
Amortization = $95,000 / 8-year-lease-term = $11,875 per year.

Quick Study 10-11 (10 minutes)

$13,557
Total asset turnover = = 0.80 times
($14,968 + $18,810) / 2
($ millions)

Interpretation: The company’s turnover of 0.80 times is markedly lower than its competitors’
turnover of 2.0. This company must perform better if it is to be successful in the long run.

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568 Fundamental Accounting Principles, 17th Edition
EXERCISES

Exercise 10-1 (15 minutes)

Invoice price of machine....................................... $ 11,500

Less discount (.02 x $11,500) ............................... (230)
Net purchase price................................................. 11,270
Freight charges (transportation-in)........................ 260
Mounting and power connections ......................... 795
Assembly............................................................... 375
Materials used in adjusting ................................... 30
Total cost to be recorded....................................... $ 12,730

Exercise 10-2 (15 minutes)

Cost of land
Purchase price for land.......................................... $ 225,000
Purchase price for old building ............................. 120,000
Demolition costs for old building ......................... 34,500
Landscaping .......................................................... 51,000
Total cost of land .................................................. $ 430,500

Cost of new building and land improvements

Cost of new building............................................. $1,354,500
Cost of land improvements ................................... 85,500
Total construction costs ........................................ $1,440,000

Journal entry
Land ................................................................................................. 430,500
Land Improvements ......................................................................... 85,500
Building............................................................................................ 1,354,500
Cash............................................................................................ 1,870,500
To record costs of plant assets.

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Solutions Manual, Chapter 10 569
Exercise 10-3 (20 minutes)
Purchase price ........................................................... $368,250
Closing costs ............................................................. 19,600
Total cost of acquisition............................................ $387,850

Allocation of total cost

Appraised Percent Applying % Apportioned
Value of Total to Cost Cost
Land.................................. $166,320 42% $387,850 x .42 $162,897
Land improvements .......... 55,440 14 $387,850 x .14 54,299
Building ............................ 174,240 44 $387,850 x .44 170,654
Totals ................................ $396,000 100% $387,850

Journal entry
Land 162,897
Land Improvements .............................................................. 54,299
Building................................................................................. 170,654
Cash.............................................................................. 387,850
To record costs of lump-sum purchase.

Exercise 10-4 (20 minutes)

1. Straight-line depreciation: ($147,000 - $30,000) / 4 years = $29,250 per year
Year Annual Depreciation Year-End Book Value
2004........... $ 29,250 $117,750
2005........... 29,250 88,500
2006........... 29,250 59,250
2007........... 29,250 30,000
Total .......... $117,000

2. Double-declining-balance depreciation
Depreciation rate: 100% / 4 years = 25% x 2 = 50%
Beginning-Year Depreciation Annual Year-End
Year Book Value Rate Depreciation Book Value
2004........... $147,000 50% $ 73,500 $73,500
2005........... 73,500 50 36,750 36,750
2006........... 36,750 50 6,750* 30,000
2007........... 30,000 -- -- 30,000
Total .......... $117,000
* Do not depreciate more than $6,750 in the third year since the salvage
value is not subject to depreciation.

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570 Fundamental Accounting Principles, 17th Edition
Exercise 10-5 (15 minutes)
1. Straight-line
($42,300 - $6,000) / 10 years = $3,630
2. Units-of-production
Depreciation per unit = ($42,300 - $6,000) / 363,000 units = $0.10 per unit
For 35,000 units in second year: Depreciation = 35,000 x $0.10 = $3,500
3. Double-declining-balance
Double-declining-balance rate = (100% / 10 years) x 2 = 20% per year
First year’s depreciation = $42,300 x 20% = $8,460
Book value at beginning of second year = $42,300 - $8,460 = $33,840
Second year’s depreciation = $33,840 x 20% = $6,768

Exercise 10-6 (15 minutes)

1. Straight-line depreciation for 2005
($250,000 - $25,000) / 5 years = $45,000
2. Double-declining-balance depreciation for 2004
Rate = (100% / 5 years) x 2 = 40%
2004 depreciation ($250,000 x 40% x 9/12).......................................... $ 75,000
Book value at January 1, 2005 ($250,000 - $75,000)............................ $175,000
Depreciation for 2005 ($175,000 x 40%) .............................................. $ 70,000

Alternate calculation
2004 depreciation ($250,000 x 40% x 9/12).......................................... $ 75,000
2005 depreciation
$250,000 x 40% x 3/12 ..................................................................... $ 25,000
($250,000 - $75,000 - $25,000) x 40% x 9/12.................................. 45,000
Total 2005 depreciation ......................................................................... $ 70,000

Exercise 10-7 (15 minutes)

1. Original cost of machine ........................................................ $21,750
Less two years' accumulated depreciation
[($21,750 - $2,250) / 4 years] x 2 years .............................. (9,750)
Book value at end of second year........................................... $12,000

2. Book value at end of second year........................................... $12,000

Less revised salvage value ..................................................... (1,800)
Remaining depreciable cost ................................................... $10,200

Revised annual depreciation = $10,200 / 3 years = $3,400

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Solutions Manual, Chapter 10 571
Exercise 10-8 (30 minutes)

1. Straight-line depreciation
Income
before Depreciation Net
Depreciation Expense* Income
Year 1 ............ $ 85,500 $ 36,540 $ 48,960
Year 2 ............ 85,500 36,540 48,960
Year 3 ............ 85,500 36,540 48,960
Year 4 ............ 85,500 36,540 48,960
Year 5 ............ 85,500 36,540 48,960
Totals.............. $427,500 $182,700 $244,800

*($235,200 - $52,500) / 5 years = $36,540

2. Double-declining-balance depreciation
Income
before Depreciation Net
Depreciation Expense* Income
Year 1 ........... $ 85,500 $ 94,080 $ (8,580)
Year 2 ............ 85,500 56,448 29,052
Year 3 ............ 85,500 32,172 53,328
Year 4 ............ 85,500 0 85,500
Year 5 ............ 85,500 0 85,500
Totals ............. $427,500 $182,700 $244,800

Supporting calculations for depreciation expense

*Note: (100% / 5 years) x 2 = 40% depreciation rate
Annual Accumulated Ending Book Value
Beginning Depreciation Depreciation at ($235,200 Cost Less
Book (40% of the End of the Accumulated
Value Book Value) Year Depreciation)
Year 1 .......... $235,200 $ 94,080 $ 94,080 $141,120
Year 2 .......... 141,120 56,448 150,528 84,672
Year 3 .......... 84,672 32,172** 182,700 52,500
Year 4 .......... 52,500 0 182,700 52,500
Year 5 .......... 52,500 0 182,700 52,500
Total............. $182,700
**Must not use $33,869; instead take only enough depreciation in Year 3 to reduce
book value to the $52,500 salvage value.

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572 Fundamental Accounting Principles, 17th Edition
Exercise 10-9 (25 minutes)

1. Annual depreciation = $561,000 / 20 years = $28,050 per year

Age of the building = Accumulated depreciation / Annual depreciation

= $420,750 / $28,050 = 15 years

2. Entry to record the extraordinary repairs

Building ............................................................................................ 67,200
Cash 67,200
To record extraordinary repairs.

3. Cost of building
Before repairs...................................................................... $561,000
Add cost of repairs .............................................................. 67,200 $628,200
Less accumulated depreciation .............................................. 420,750
Revised book value of building ............................................. $207,450

4. Revised book value of building (part 3) ................................ $207,450

New estimate of useful life (20 - 15 + 7) ............................... 12 years
Revised annual depreciation .................................................. $17,287.5

Journal entry
Depreciation Expense....................................................................... 17,287.5
Accumulated Depreciation–Building .......................................... 17,287.5
To record depreciation.

Exercise 10-10 (15 minutes)

1. Equipment ....................................................................................... 21,000

Cash 21,000
To record betterment.

2. Repairs Expense ............................................................................. 5,250

Cash 5,250
To record ordinary repairs.

3. Equipment....................................................................................... 13,950
Cash 13,950
To record extraordinary repairs.

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Solutions Manual, Chapter 10 573
Exercise 10-11 (15 minutes)
1. Book value of the old tractor ($95,000 - $52,500) ...................................................... $ 42,500
2. Loss on the exchange
Book value - Trade-in allowance ($42,500 - $28,000) ....................................... $ 14,500
3. Debit to new Tractor account
Cash paid + Trade-in allowance ($82,000 + $28,000) ........................................ $110,000

Alternatively, answers can be taken from the following journal entry:

Tractor (new)* ................................................................................ 110,000
Loss on Exchange of Assets ........................................................... 14,500
Accumulated Depreciation–Tractor................................................ 52,500
Tractor (old)............................................................................ 95,000
Cash 82,000
To record asset exchange. *($28,000+$82,000)

Exercise 10-12 (25 minutes)

Note: Book value of Machine equals $42,000 - $22,625 = $19,375
1. Sold for $16,250 cash
Jan. 2 Cash ..................................................................................... 16,250
Loss on Sale of Machinery.................................................. 3,125
Accumulated Depreciation--Machinery .............................. 22,625
Machinery ....................................................................... 42,000
To record cash sale of machine.
٢. $20,000 trade-in allowance exceeds book value; but no gain is recognized on similar asset
exchange ($625 gain is ‘buried’
in the cost of the new machinery)
Jan. 2 Machinery*.......................................................................... 57,875
Accumulated Depreciation--Machinery .............................. 22,625
Machinery ....................................................................... 42,000
Cash**............................................................................. 38,500
To record similar asset exchange.
*[$58,500 - ($20,000-$19,375)] **($58,500- $20,000)

3. $15,000 trade-in allowance is less than book value (yielding a loss)

Jan. 2 Machinery............................................................................ 58,500
Loss on Exchange of Machinery ......................................... 4,375
Accumulated Depreciation--Machinery .............................. 22,625
Machinery ....................................................................... 42,000
Cash*............................................................................... 43,500
To record similar asset exchange. *($58,500-$15,000)

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574 Fundamental Accounting Principles, 17th Edition
Exercise 10-13 (25 minutes)
2008
July 1 Depreciation Expense ............................................................... 6,625
Accumulated Depreciation--Machinery............................... 6,625
To record one-half year depreciation.*

*Annual depreciation = $92,750 / 7 years = $13,250

Depreciation for 6 months in 2008 = $13,250 x 6/12 = $6,625

1. Sold for $35,000 cash

July 1 Cash ......................................................................................... 35,000

Accumulated Depreciation—Machinery................................. 59,625
Gain on Sale of Machinery .................................................. 1,875
Machinery ............................................................................ 92,750
To record disposal of machinery.*

*Total accumulated depreciation at date of disposal:

Four years 2004-2007 (4 x $13,250).................. $53,000
Partial year 2008 (6/12 x $13,250) .................... 6,625
Total accumulated depreciation ......................... $59,625

2. Destroyed by fire with $30,000 cash insurance settlement

July 1 Cash ......................................................................................... 30,000

Loss from Fire ......................................................................... 3,125
Accumulated Depreciation—Machinery................................. 59,625
Machinery ............................................................................ 92,750
To record disposal of machinery from fire.

Exercise 10-14 (10 minutes)

Dec. 31 Depletion Expense—Mineral Deposit ................................... 398,310

Accumulated Depletion—Mineral Deposit ....................... 398,310
To record depletion [$3,633,750/1,425,000 tons=
$2.55 per ton; 156,200 tons x $2.55 = $398,310].

Dec. 31 Depreciation Expense—Machinery ...................................... 18,744

Accumulated Depreciation—Machinery........................... 18,744
To record depreciation [$171,000/1,425,000 tons
= $0.12 per ton; 156,200 tons x $0.12 = $18,744].

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Solutions Manual, Chapter 10 575
Exercise 10-15 (10 minutes)
Jan. 1 Copyright ............................................................................... 236,700
Cash ................................................................................... 236,700
To record purchase of copyright.
Dec. 31 Amortization Expense—Copyright ....................................... 19,725
Accumulated Amortization—Copyright ........................... 19,725
To record amortization of copyright
[$236,700 / 12 years].

Exercise 10-16A (15 minutes)

Net assets (excluding goodwill) .................................................................. $ 437,000
Normal rate of return in this industry.......................................................... x 10%
Normal net income on net assets................................................................. 43,700
Expected (typical) future net income .......................................................... 85,000
Expected net income above-normal............................................................ $ 41,300

1. Value of goodwill = $41,300 x 10 = $413,000

2. Value of goodwill = $41,300 / 8% = $516,250

Note: These estimates of goodwill assume that Corey Alt’s departure does not impact the
business’s goodwill.

Exercise 10-17 (15 minutes)

1. $323,866,000 for capital expenditures
2. $175,778,000 for depreciation and amortization
3. $1,017,992,000 used in investing activities

Exercise 10-18 (15 minutes)

$4,862,000
Total asset turnover for 2004 = = 2.96
($1,586,000 + $1,700,000)/2

$7,542,000
Total asset turnover for 2005 = = 4.21
($1,700,000 + $1,882,000)/2
Analysis comments. Based on these calculations, Joy turned its assets over 1.25 (4.21 – 2.96)
more times in 2005 than in 2004. This increase indicates that Joy became more efficient in using
its assets. Moreover, Joy has improved its efficiency in using assets relative to its competitors
who average 3.0. Together, these results based on total asset turnover indicate that Joy has
markedly improved its performance and is currently superior to its competitors.

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576 Fundamental Accounting Principles, 17th Edition
PROBLEM SET A
Problem 10-1A (50 minutes)
Part 1
Appraised Percent Apportioned
Value of Total Cost
Building.................................. $408,000 48% $378,000
Land ....................................... 289,000 34 267,750
Land improvements................ 42,500 5 39,375
Vehicles.................................. 110,500 13 102,375
Total ....................................... $850,000 100% $787,500

2005
Jan. 1 Building............................................................................ 378,000
Land ................................................................................. 267,750
Land Improvements ......................................................... 39,375
Vehicles............................................................................ 102,375
Cash............................................................................ 787,500
To record asset purchases.

Part 2

Year 2005 straight-line depreciation on building

[($378,000 - $25,650) / 15 years] = $23,490

Part 3

Year 2005 double-declining-balance depreciation on land improvements

(100% / 5 years) x 2 = 40% rate
$39,375 x 40% = $ 15,750

Part 4
Accelerated depreciation does not lower the total amount of taxes paid over the asset's life.
Instead, it defers or postpones taxes to the later years of an asset’s useful life. This is because
accelerated methods charge a higher portion of asset costs against revenue in earlier years and a
lower portion in later years. The result is to reduce taxable income more in earlier years but less
in later years. [Note: From a present value perspective, there is a tax savings from use of
accelerated depreciation. The company gets to use the tax deferred amounts for investment
purposes until they are due.]

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Solutions Manual, Chapter 10 577
Problem 10-2A (45 minutes)
Part 1
Land Land
Building Building Improve- Improvements
Land 2 3 ments 1 2
Purchase price* ......... $1,792,000 $616,000 $392,000
Demolition ................ 422,600
Land grading ............. 167,200
New building............. $2,019,000
New improvements ... _________ _______ _________ _______ $158,000
Totals......................... $2,381,800 $616,000 $2,019,000 $392,000 $158,000

Appraised Percent Apportioned

*Allocation of purchase Value of Total Cost**
price
Land ......................................... $1,865,600 64% $1,792,000
Building 2 ................................ 641,300 22 616,000
Land Improvements 1.............. 408,100 14 392,000
Totals ....................................... $2,915,000 100% $2,800,000
**Multiply the percentages in column 3 by the $2,800,000 purchase price.

Part 2
2005
Jan. 1 Land .......................................................................................2,381,800
Building 2 ..............................................................................616,000
Building 3 ..............................................................................2,019,000
Land Improvements 1............................................................392,000
Land Improvements 2............................................................158,000
Cash ................................................................................. 5,566,800
To record costs of plant assets.

Part 3
2005
Dec. 31 Depreciation Expense—Building 2 ............................................ 26,800
Accumulated Depreciation—Building 2 .............................. 26,800
To record depreciation. [($616,000 - $80,000)/20]
31 Depreciation Expense—Building 3 ............................................ 65,156
Accumulated Depreciation—Building 3 .............................. 65,156
To record depreciation. [($2,019,000 - $390,100)/25]
31 Depreciation Expense—Land Improv. 1 .................................... 28,000
Accum. Depreciation—Land Improv. 1 ............................... 28,000
To record depreciation [$392,000/14 = $28,000].
31 Depreciation Expense—Land Improv. 2 .................................... 7,900
Accum. Depreciation—Land Improv. 2 ............................... 7,900
To record depreciation [$158,000/20].

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578 Fundamental Accounting Principles, 17th Edition
Problem 10-3A (50 minutes)
2004
Jan. 1 Equipment ................................................................................ 273,140
Cash 273,140
To record loader costs ($255,440 +$15,200 +$2,500).
Jan. 3 Equipment................................................................................. 3,660
Cash 3,660
To record betterment of loader.
Dec. 31 Depreciation Expense—Equipment ......................................... 60,238*
Accumulated Depreciation—Equipment............................ 60,238
To record depreciation.
*
2004 depreciation after January 3rd betterment
Total original cost ........................................................................ $273,140
Plus cost of betterment ................................................................. 3,660
Revised cost of equipment ........................................................... 276,800
Less revised salvage ($34,740 + $1,110) .................................... 35,850
Cost to be depreciated .................................................................. 240,950
Annual depreciation ($240,950 / 4 years) (rounded) ................... $ 60,238*

2005
Jan. 1 Equipment................................................................................. 4,500
Cash .................................................................................... 4,500
To record extraordinary repair on loader.
Feb. 17 Repairs Expense—Equipment.................................................. 920
Cash .................................................................................... 920
To record ordinary repair on loader.
Dec. 31 Depreciation Expense—Equipment ......................................... 37,042*
Accumulated Depreciation—Equipment............................ 37,042
To record depreciation.

*2005 depreciation after January 1st extraordinary repair

Total cost ($276,800 + $4,500) .................................................... $281,300
Less accumulated depreciation ................................................... 60,238
Book value ................................................................................... 221,062
Less salvage ................................................................................. 35,850
Remaining cost to be depreciated ................................................ $185,212
Revised remaining useful life (Original 4 years - 1yr. + 2yrs.) ... 5.0 yrs.
Revised annual depreciation ($185,212 / 5 yrs) (rounded) .......... $ 37,042

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 579
Problem 10-4A (40 minutes)
2004
Jan. 1 Trucks .......................................................................................... 20,580
Cash ....................................................................................... 20,580
To record cost of truck ($19,415 + $1,165).

Dec. 31 Depreciation Expense—Trucks................................................... 3,516

Accumulated Depreciation—Trucks ..................................... 3,516
To record depreciation [($20,580 - $3,000)/5].
2005
Dec. 31 Depreciation Expense—Trucks................................................... 4,521*
Accumulated Depreciation—Trucks ..................................... 4,521
To record depreciation.
*
2005 depreciation
Total cost ......................................................................... $ 20,580
Less accumulated depreciation (from 2004) ................... 3,516
Book value....................................................................... 17,064
Less revised salvage value............................................... 3,500
Remaining cost to be depreciated.................................... $ 13,564
Revised useful life ........................................................... 4.00 yrs.
Less one year used in 2004.............................................. 1.00 yrs.
Revised remaining useful life .......................................... 3.00 yrs.
Total depreciation for 2005 ($13,564/3)(rounded).......... $ 4,521
2006
Dec. 31 Depreciation Expense—Trucks................................................... 4,521
Accumulated Depreciation—Trucks ..................................... 4,521
To record annual depreciation.

Dec. 31 Cash ............................................................................................. 6,200

Accumulated Depreciation—Trucks ........................................... 12,558**
Loss on Disposal of Trucks ......................................................... 1,822***
Trucks .................................................................................... 20,580
To record sale of truck.
**
Accumulated depreciation on truck at 12/31/2006
2004.................................................................................. $ 3,516
2005.................................................................................. 4,521
2006.................................................................................. 4,521
Total ................................................................................. $12,558
***
Book value of truck at 12/31/2006
Total cost.......................................................................... $20,580
Less accumulated depreciation ........................................ (12,558)
Book value ...................................................................... $ 8,022
Loss ($6,200 cash received - $8,022 book value)............ $ 1,822

©McGraw-Hill Companies, Inc., 2005

580 Fundamental Accounting Principles, 17th Edition
Problem 10-5A (45 minutes)

Part 1
Cost of machine............................................... $210,000
Less estimated salvage value........................... 20,000
Total depreciable cost...................................... $190,000

Double-Declining-
a b
Year Straight-Line Units-of-Production Balancec
1 ....................... $ 47,500 $ 48,560 $105,000
2 ....................... 47,500 48,960 52,500
3 ....................... 47,500 47,840 26,250
4 ....................... 47,500 44,640 6,250
Totals .......... $190,000 $190,000 $190,000
a
Straight- line:
Cost per year = $190,000/4 years = $47,500 per year
b
Units-of-production:
Cost per unit = $190,000/475,000 units = $0.40 per unit
Year Units Unit Cost Depreciation
1................ 121,400 $0.40 $ 48,560
2................ 122,400 0.40 48,960
3................ 119,600 0.40 47,840
4................ 118,200 0.40 44,640*
Total ......... $190,000
*
Take only enough depreciation in Year 4 to reduce book
value to the asset’s $20,000 salvage value.
c
Double-declining-balance:
(100%/4) x 2 = 50% depreciation rate

Annual Accumulated Ending Book Value

Beginning Depreciation Depreciation ($210,000 Cost Less
Book (50% of at the End of Accumulated
Year Value Book Value) the Year Depreciation)
1.......... $210,000 $105,000 $105,000 $105,000
2.......... 105,000 52,500 157,500 52,500
3.......... 52,500 26,250 183,750 26,250
4.......... 26,250 6,250* 190,000 20,000
Total ... $190,000

*Take only enough depreciation in Year 4 to reduce book value to

the asset’s $20,000 salvage value.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 581
Problem 10-5A (Concluded)
Part 2
a.
Jan. 2 Machinery ............................................................................... 167,000
Cash................................................................................... 167,000
To record machinery purchase.
Jan. 3 Machinery ............................................................................... 3,420
Cash................................................................................... 3,420
To record machinery costs.
Jan. 3 Machinery ............................................................................... 1,080
Cash................................................................................... 1,080
To record machinery costs.
b. First year
Dec. 31 Depreciation Expense—Machinery ........................................ 26,150
Accumulated Depreciation—Machinery .......................... 26,150
To record depreciation [($171,500 - $14,600)/6].
Fifth year
Dec. 31 Depreciation Expense—Machinery ........................................ 26,150
Accumulated Depreciation—Machinery .......................... 26,150
To record year’s depreciation.
c. Accumulated depreciation at the date of disposal
Five years' depreciation (5 x $26,150) ................................... $130,750
Book value at the date of disposal
Original total cost................................................................... $171,500
Accumulated depreciation...................................................... (130,750)
Book value ............................................................................. $ 40,750
(i) Sold for $13,500 cash
Dec. 31 Cash ....................................................................................... 13,500
Loss on Sale of Machinery .................................................... 27,250
Accumulated Depreciation—Machinery............................... 130,750
Machinery......................................................................... 171,500
(ii) Sold for $45,000 cash
Dec. 31 Cash ....................................................................................... 45,000
Accumulated Depreciation—Machinery............................... 130,750
Machinery......................................................................... 171,500
Gain on Sale of Machinery............................................... 4,250
(iii) Destroyed in fire and collected $24,000 cash from insurance company
Dec. 31 Cash ....................................................................................... 24,000
Accumulated Depreciation—Machinery............................... 130,750
Loss from Fire ....................................................................... 16,750
Machinery......................................................................... 171,500

©McGraw-Hill Companies, Inc., 2005

582 Fundamental Accounting Principles, 17th Edition
Problem 10-6A (40 minutes)
Part 1
2005 (a)
June 25 Leasehold............................................................................... 185,000
Cash ................................................................................. 185,000
To record payment for sublease.
(b)
July 1 Prepaid Rent .......................................................................... 70,000
Cash ................................................................................. 70,000
To record prepaid annual lease rental.
(c)
July 5 Leasehold Improvements....................................................... 129,840
Cash ................................................................................. 129,840
To record costs of leasehold improvements.
(d)
Dec. 31 Rent Expense ......................................................................... 9,250
Accumulated Amortization—Leasehold ......................... 9,250
To record leasehold amortization ($185,000/10 x 6/12).
(e)
Dec. 31 Amortization Expense—Leasehold Improvements............... 6,492
Accumulated Amortization—Leasehold
Improvements ............................................................... 6,492
To record leasehold improvement amortization
($129,840/10 years remaining on lease x 6/12).
(f)
Dec. 31 Rent Expense ......................................................................... 35,000
Prepaid Rent .................................................................... 35,000
To record one-half year lease rental ($70,000 x 6/12).

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 583
Problem 10-6A (Concluded)

Part 2
(a)
July 23 Mineral Deposit ............................................................... 4,836,000
Cash ........................................................................... 4,836,000
To record purchase of mineral deposit.

(b)
July 25 Machinery........................................................................ 390,000
Cash ........................................................................... 390,000
To record costs of machinery.

(c)
Dec. 31 Depletion Expense—Mineral Deposit............................. 248,000
Accum. Depletion—Mineral Deposit........................ 248,000
To record depletion [$4,836,000/
7,800,000 tons = $0.62 per ton.
400,000 tons x $0.62 = $248,000].

(d)
Dec. 31 Depreciation Expense—Machinery................................. 20,000
Accum. Depreciation—Machinery............................ 20,000
To record depreciation [$390,000/
7,800,000 tons = $0.05 per ton.
400,000 tons x $0.05 = $20,000].

Analysis Component:
Similarities—Amortization, depletion, and depreciation are similar in that they are all methods of
allocating costs of long-term assets to the periods that benefit from their use. Differences—They
are different in that they apply to different types of long-term assets: amortization applies to
intangible assets with (definite) useful lives; depletion applies to natural resources; and
depreciation applies to plant assets. Also, amortization is typically computed using the straight-
line method, whereas the units-of-production method is usually used in depletion.

©McGraw-Hill Companies, Inc., 2005

584 Fundamental Accounting Principles, 17th Edition
Problem 10-7AA (30 minutes)
Part 1

Equity................................................................................................................ $395,930
Normal return in the industry ........................................................................... x 20%
Normal net income ........................................................................................... $ 79,186

Expected net income for this company............................................................. $100,000

Normal net income (from above) ..................................................................... 79,186
Above-normal net income ................................................................................ $ 20,814

Rent Center’s proposal

Goodwill ($20,814 / 15%) ................................................................................ $138,760

Part 2

Potential Buyer’s proposal

Goodwill ($20,814 x 5) .................................................................................... $104,070

Part 3

Net assets without goodwill (equals equity)..................................................... $395,930

Cost of goodwill acquired by buyer (from part 1)............................................ 138,760
Purchase price (buyer’s investment)................................................................. $534,690

Part 4

Net income divided by buyer’s

Investment ($100,225 / $534,690)................................................................. 18.7%

Goodwill is measured as the excess of the cost of an acquired entity over the value of the
acquired net assets. Goodwill is recorded as an asset and it is not amortized. Instead, the
FASB (SFAS 142) requires that goodwill be annually tested for impairment. If the book value
of goodwill does not exceed its fair value, goodwill is not impaired. However, if the book
value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess.
(Details of this test are in advanced courses.)

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 585
PROBLEM SET B

Problem 10-1B (50 minutes)

Part 1
Appraised Percent Apportioned
Value of Total Cost
Building .................................. $ 784,800 45% $ 724,500
Land........................................ 540,640 31 499,100
Land improvements................ 226,720 13 209,300
Trucks..................................... 191,840 11 177,100
Total........................................ $1,744,000 100% $1,610,000

2005
Jan. 1 Buildings.................................................................... 724,500
Land ........................................................................... 499,100
Land Improvements................................................... 209,300
Trucks ........................................................................ 177,100
Cash ..................................................................... 1,610,000
To record asset purchases.

Part 2
Year 2005 straight-line depreciation on building
[($724,500 - $100,500) / 12 years] = $52,000

Part 3
Year 2005 double-declining-balance depreciation on land improvements
(100% / 10 years) x 2 = 20% rate
$209,300 x 20% = $41,860

Part 4
Accelerated depreciation does not increase the total amount of taxes paid over the asset’s life.
Instead, it defers or postpones taxes to the later years of an asset’s useful life. This is because
accelerated methods charge a higher portion of asset costs against revenue in earlier years and a
lower portion in later years. The result is to reduce taxable income more in earlier years and less
in later years. [Note: From a present value perspective, there is a tax savings from use of
accelerated depreciation. The company gets to use the tax deferred amounts for investment
purposes until they are due.]

©McGraw-Hill Companies, Inc., 2005

586 Fundamental Accounting Principles, 17th Edition
Problem 10-2B (45 minutes)
Part 1
Land Land
Building Building Improve- Improve-
Land B C ments B ments C
Purchase price* ..........$ 769,500 $459,000 $121,500
Demolition ................. 117,000
Land grading .............. 172,500
New building.............. $1,356,000
New improvements .... ________ _______ _________ _______ $101,250
Totals..........................$1,059,000 $459,000 $1,356,000 $121,500 $101,250

Allocation of Appraised Percent Apportioned

purchase price Value of Total Cost
Land ...................................... $ 792,585 57% $ 769,500
Building B............................. 472,770 34 459,000
Land Improvements B .......... 125,145 9 121,500
Totals .................................... $1,390,500 100% $1,350,000

Part 2
2005
Jan. 1 Land .......................................................................................1,059,000
Building B..............................................................................459,000
Building C..............................................................................1,356,000
Land Improvements B ...........................................................121,500
Land Improvements C ...........................................................101,250
Cash ................................................................................. 3,096,750
To record cost of plant assets.
Part 3
2005
Dec. 31 Depreciation Expense—Building B ............................................ 24,600
Accumulated Depreciation—Building B............................... 24,600
To record depreciation [($459,000 - $90,000)/15].
31 Depreciation Expense—Building C ............................................ 53,025
Accumulated Depreciation—Building C............................... 53,025
To record depreciation [($1,356,000 - $295,500)/20].
31 Depreciation Expense--Land Improvements B ........................... 20,250
Accum. Depreciation--Land Improvements B ...................... 20,250
To record depreciation [$121,500/6].
31 Depreciation Expense--Land Improvements C. .......................... 10,125
Accum. Depreciation--Land Improvements C ...................... 10,125
To record depreciation [$101,250/10].

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 587
Problem 10-3B (50 minutes)
2004
Jan. 1 Equipment.................................................................................... 26,900
Cash ....................................................................................... 26,900
To record costs of van ($24,950 + $1,950).

Jan. 3 Equipment.................................................................................... 1,550

Cash ....................................................................................... 1,550
To record betterment of van.

Dec. 31 Depreciation Expense—Equipment ............................................ 4,970*

Accumulated Depreciation—Equipment............................... 4,970
To record depreciation.
*
2004 depreciation after January 3rd betterment
Total original cost ............................................................ $26,900
Plus cost of betterment..................................................... 1,550
Revised cost of equipment ............................................... 28,450
Less revised salvage ($3,400 + $200)) ........................... 3,600
Cost to be depreciated...................................................... $24,850
Annual depreciation ($24,850 / 5 years).......................... $ 4,970

2005
Jan. 1 Equipment.................................................................................... 1,970
Cash ....................................................................................... 1,970
To record extraordinary repair on van.

May 10 Repairs Expense—Equipment..................................................... 600

Cash ....................................................................................... 600
To record ordinary repair on van.

Dec. 31 Depreciation Expense—Equipment ............................................ 3,642*

Accum. Depreciation—Equipment ....................................... 3,642
To record depreciation.

*2005 depreciation after 1/1 extraordinary repair

Total cost ($28,450 + $1,970) .................................................... $30,420
Less accumulated depreciation................................................... 4,970
Book value.................................................................................. 25,450
Less salvage................................................................................ 3,600
Remaining cost to be depreciated............................................... $21,850
Revised remaining useful life (Original 5 years - 1yr. + 2yrs.).. 6.0 yrs.
Revised annual depreciation ($21,850 / 6 yrs) (rounded) .......... $ 3,642

©McGraw-Hill Companies, Inc., 2005

588 Fundamental Accounting Principles, 17th Edition
Problem 10-4B (40 minutes)
2004
Jan. 1 Machinery................................................................................. 113,000
Cash .................................................................................... 113,000
To record costs of machinery ($106,600 +$6,400).
Dec. 31 Depreciation Expense—Machinery.......................................... 17,200
Accumulated Depreciation—Machinery............................ 17,200
To record depreciation [($113,000-9,800)/6].
2005
Dec. 31 Depreciation Expense—Machinery.......................................... 27,583*
Accum. Depreciation—Machinery..................................... 27,583
To record depreciation.
*
2005 depreciation:
Total cost ............................................................................. $113,000
Less accumulated depreciation (from 2004) ....................... 17,200
Book value........................................................................... 95,800
Less revised salvage value .................................................. 13,050
Remaining cost to be depreciated........................................ $ 82,750
Revised useful life ............................................................... 4.0 yrs.
Less 1 year in 2004.............................................................. 1.0 yrs.
Revised remaining useful life.............................................. 3.0 yrs.
Total depreciation for 2005 ($82,750/ 3 yrs) [rounded]....... $ 27,583

2006
Dec. 31 Depreciation Expense—Machinery.......................................... 27,583
Accumulated Depreciation—Machinery............................ 27,583
To record depreciation.

Dec. 31 Cash .......................................................................................... 25,240

Accumulated Depreciation—Machinery.................................. 72,366**
Loss on Disposal of Machinery ................................................ 15,394***
Machinery........................................................................... 113,000
To record sale of machine.
**
Accumulated depreciation on machine at 12/31/2006:
2004.................................................................................... $ 17,200
2005.................................................................................... 27,583
2006.................................................................................... 27,583
Total ................................................................................... $ 72,366
***
Book value of machine at 12/31/2006:
Total cost............................................................................ $113,000
Less accumulated depreciation .......................................... (72,366)
Book value ........................................................................ $ 40,634
Loss ($25,240 cash received - $40,634 book value).......... $ 15,394

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 589
Problem 10-5B (45 minutes)
Part 1

Cost of machine ......................................... $312,000

Less estimated salvage value ..................... 28,000
Total depreciable cost ................................ $284,000
Double-Declining-
Year Straight-Linea Units-of-Productionb Balancec
1........................ $ 56,800 $ 61,400 $124,800
2........................ 56,800 57,600 74,880
3........................ 56,800 56,750 44,928
4........................ 56,800 58,150 26,957
5........................ 56,800 50,100 12,435
Totals................. $284,000 $284,000 $284,000

a
Straight- line:
Cost per year = $284,000/5 years = $56,800 per year
b
Units-of-production:
Cost per unit = $284,000/1,136,000 units = $0.25 per unit
Year Units Unit Cost Depreciation
1 ............... 245,600 $0.25 $ 61,400
2 ............... 230,400 0.25 57,600
3 ............... 227,000 0.25 56,750
4 ............... 232,600 0.25 58,150
5 ............... 211,200 0.25 50,100*
Total......... $284,000
* Take only enough depreciation in Year 5 to reduce book
value to the asset’s $28,000 salvage value.
c
Double-declining-balance (amounts rounded to the nearest dollar):
(100%/5) x 2 = 40% depreciation rate
Annual Accumulated Ending Book Value
Depreciation Depreciation ($312,000 Cost less
Beginning (40% of at the End of Accumulated
Year Book Value Book Value) the Year Depreciation)
1............. $312,000 $124,800 $124,800 $187,200
2............. 187,200 74,880 199,680 112,320
3............. 112,320 44,928 244,608 67,392
4............. 67,392 26,957 271,565 40,435
5............. 40,435 12,435** 284,000 28,000
Total ...... $284,000

©McGraw-Hill Companies, Inc., 2005

590 Fundamental Accounting Principles, 17th Edition
 ** Take only enough depreciation in Year 5 to reduce book value to the
asset’s $28,000 salvage value.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 591
Problem 10-5B (Concluded)
Part 2
a.
Jan. 1 Machinery .................................................................................. 130,000
Cash...................................................................................... 130,000
To record machinery costs.
Jan. 2 Machinery .................................................................................. 3,390
Cash...................................................................................... 3,390
To record machinery costs.
Jan. 2 Machinery .................................................................................. 4,800
Cash...................................................................................... 4,800
To record machinery costs.
b. First year
Dec. 31 Depreciation Expense—Machinery ........................................... 17,170
Accumulated Depreciation—Machinery ............................. 17,170
To record depreciation [($138,190-$18,000)/7 = $17,170].
Sixth year
Dec. 31 Depreciation Expense—Machinery ........................................... 17,170
Accumulated Depreciation—Machinery ............................. 17,170
To record the sixth year’s depreciation.

c. Accumulated depreciation at the date of disposal

First six years' depreciation (6 x $17,170) ................................$103,020
Book value at the date of disposal
Original total cost......................................................................$138,190
Accumulated depreciation......................................................... (103,020)
Total ..........................................................................................$ 35,170
(i) Sold for $30,000 cash
Dec. 31 Cash .......................................................................................... 30,000
Loss on Sale of Machinery ....................................................... 5,170
Accumulated Depreciation—Machinery.................................. 103,020
Machinery........................................................................... 138,190
(ii) Sold for $50,000 cash
Dec. 31 Cash .......................................................................................... 50,000
Accumulated Depreciation—Machinery.................................. 103,020
Machinery........................................................................... 138,190
Gain on Sale of Machinery................................................. 14,830
(iii) Destroyed in fire and collected $20,000 cash from insurance
Dec. 31 Cash .......................................................................................... 20,000
Loss from Fire .......................................................................... 15,170
Accumulated Depreciation—Machinery.................................. 103,020
Machinery........................................................................... 138,190

©McGraw-Hill Companies, Inc., 2005

592 Fundamental Accounting Principles, 17th Edition
Problem 10-6B (40 minutes)

Part 1

2007 (a)
Jan. 1 Leasehold.................................................................................. 30,000
Cash .................................................................................... 30,000
To record payment for sublease.
(b)
Jan. 1 Prepaid Rent ............................................................................. 26,400
Cash .................................................................................... 26,400
To record prepaid annual lease rental.
(c)
Jan. 3 Leasehold Improvements.......................................................... 18,000
Cash .................................................................................... 18,000
To record costs of leasehold improvements.
(d)
Dec. 31 Rent Expense ............................................................................ 6,000
Accumulated Amortization—Leasehold ............................ 6,000
To record leasehold amortization ($30,000/5).
(e)
Dec. 31 Amortization Expense—Leasehold Improvements.................. 3,600
Accumulated Amortization—Leasehold
Improvements ................................................................. 3,600
To record leasehold improvement amortization
($18,000/5 years remaining on lease).
(f)
Dec. 31 Rent Expense ............................................................................ 26,400
Prepaid Rent ....................................................................... 26,400
To record annual lease rental.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 593
Problem 10-6B (Concluded)

Part 2

Feb. 19 Mineral Deposit .................................................................4,450,000

Cash ............................................................................. 4,450,000
To record purchase of mineral deposit.

Mar. 21 Machinery.......................................................................... 200,000

Cash ............................................................................. 200,000
To record costs of machinery.

Dec. 31 Depletion Expense—Mineral Deposit............................... 313,280

Accum. Depletion—Mineral Deposit.......................... 313,280
To record depletion [$4,450,000/
5,000,000 tons = $0.89 per ton.
352,000 tons x $0.89 = $313,280].

Dec. 31 Depreciation Expense—Machinery................................... 14,080

Accum. Depreciation—Machinery.............................. 14,080
To record depreciation [$200,000/
5,000,000 tons = $0.04 per ton.
352,000 tons x $0.04 = $14,080].

Analysis Component:
Similarities—Amortization, depletion, and depreciation are similar in that they are all methods of
allocating costs of long-term assets to the periods that benefit from their use. Differences—They
are different in that they apply to different types of long-term assets: amortization applies to
intangible assets (with definite useful lives); depletion applies to natural resources; and
depreciation applies to plant assets. Also, amortization is typically computed using the straight-
line method, whereas the units-of-production method is usually used in depletion.

©McGraw-Hill Companies, Inc., 2005

594 Fundamental Accounting Principles, 17th Edition
Problem 10-7BA (30 minutes)
Part 1

Equity................................................................................................................ $667,375
Normal return in the industry (given)............................................................... x 32%
Normal net income (rounded)........................................................................... $213,560

Expected net income for this company............................................................. $230,000

Normal net income ........................................................................................... 213,560
Above-normal net income ................................................................................ $ 16,440

Pack’s proposal
Goodwill ($16,440 / 10%) ................................................................................ $164,400

Part 2

Buyer’s proposal
Goodwill ($16,440 x 8) .................................................................................... $131,520

Part 3

Net assets without goodwill.............................................................................. $667,375

Cost of goodwill acquired by buyer (from part 1)............................................ 164,400
Purchase price (buyer’s investment)................................................................. $831,775

Part 4

Net income divided by buyer’s

investment ($200,175 / $831,775) .................................................................. 24.1%

Goodwill is measured as the excess of the cost of an acquired entity over the value of the
acquired net assets. Goodwill is recorded as an asset and it is not amortized. Instead, the
FASB (SFAS 142) requires that goodwill be annually tested for impairment. If the book value
of goodwill does not exceed its fair value, goodwill is not impaired. However, if the book
value of goodwill exceeds its fair value, an impairment loss is recorded equal to that excess.
(Details of this test are in advanced courses.)

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 595
Serial Problem

Serial Problem, Success Systems (45 minutes)

١. For the three months ended March 31, 2005, depreciation expense was $400 for office
equipment and $1,250 for the computer equipment. Annualizing these three months results
in the following amounts for depreciation expense:

Depreciation Expense—Office Equipment ($400 x 4)..................................................$1,600

Depreciation Expense—Computer Equipment ($1,250 x 4) ..................................................$5,000

2.
December 31, December 31,
2004 2005
Office Equipment ............................................... $8,000 $8,000
Accumulated Depreciation–Office Equipment ..
400 2,000
Office Equipment (book value).......................... $7,600 $6,000

December 31, December 31,

2004 2005
Computer Equipment ......................................... $20,000 $20,000
Accumulated Depreciation– Computer
Equipment .................................................... 1,250 6,250
Computer Equipment (book value).................... $18,750 $13,750

3.
Note: Total asset turnover = Net sales / Average total assets

The 3-month total asset turnover for Success Systems at March 31, 2005

$43,853 / [($129,909 + $93,248)/2] = 0.39 times

An estimate of its annual total asset turnover is 1.56 (0.39 x 4 quarters). This value for the
total asset turnover is lower than usual for companies competing in this industry (2.5).
However, Success Systems is in its first year of operations, and its turnover will improve if
it can generate increased sales throughout the year while maintaining a similar asset level.

©McGraw-Hill Companies, Inc., 2005

596 Fundamental Accounting Principles, 17th Edition
Reporting in Action – BTN 10-1

1. The percent of original cost remaining to be depreciated is computed by taking the ratio of
the book value of property, plant, and equipment to their original cost reported in Krispy
Kreme’s Note 5 ($ thousands):
As of 02/02/03: $202,558 / $252,770 = 80.1%
As of 02/03/02: $112,577 / $156,484 = 71.9%

2. Its "Summary of Significant Accounting Policies" (Note 2) reports that intangible assets and
goodwill have been evaluated as having indefinite lives and, as a result, are not subject to
amortization provisions. For the fiscal year ended February 3, 2002, the Company recorded
an expense of $100,000 to amortize intangible assets related to an acquisition completed
prior to June 30, 2001. The company believes that no impairment of intangible assets exists
as of February 2, 2003. (Instructor note: SFAS 142 has changed the accounting for
goodwill—it is no longer amortized. Instead, an annual impairment test is applied to
goodwill. Moreover, intangible assets that are identified with an indefinite life are no
longer amortized, but are subject to an impairment test.)

3. According to Note 5, the change in total property, plant and equipment before accumulated
depreciation for the year ended February 3, 2003, is an increase of $96,286 ($252,770 -
$156,484). In comparison, according to the statement of cash flows, $83,196 is used for the
purchase of property, plant and equipment, and $701 is received from the disposal of
property, plant and equipment. This gives a net cash outflow of $82,495 (all $s in
thousands).

One possible explanation for the difference in these amounts is that Krispy Kreme acquired
plant assets for something other than cash—for example, it acquired certain plant assets for
a promise (note agreement) to pay later. Another possible explanation is that Krispy Kreme
disposed of some of its plant assets at a loss during the year.

4. Total asset turnover for year ended ($ thousands):

2/02/03: $491,549 = 1.48 times

($410,487 + $255,376)/2

2/03/02: $394,354 = 1.85 times

($255,376 + $171,493)/2
٥. Solution depends on the financial statement data obtained.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 597
Comparative Analysis — BTN 10-2

Note: Total asset turnover = Net sales / Average total assets

1. Total asset turnover for Krispy Kreme ($ thousands)

Current Year: $491,549 / [($410,487 + $255,376)/2] = 1.48 times

One Year Prior: $394,354 / [($255,376 + $171,493)/2] = 1.85 times

Total asset turnover for Tastykake ($ thousands)

Current Year: $162,263 / [($116,560 + $116,137)/2] = 1.39 times

One Year Prior: $166,245 / [($116,137 + $112,192)/2] = 1.46 times

2. Each dollar of Krispy Kreme’s assets produces $1.48 in net sales for the current year and
$1.85 in net sales for the prior year. Each dollar of Tastykake’s assets produces $1.39 in net
sales for the current year and $1.46 in net sales for the prior year. Consequently, we see that
Krispy Kreme employs its assets more efficiently than does Tastykake. However, both
companies have experienced a decline in asset efficiency for the current year.

©McGraw-Hill Companies, Inc., 2005

598 Fundamental Accounting Principles, 17th Edition
Ethics Challenge — BTN 10-3

1. When managers acquire new assets a number of decisions relative to depreciation must be
made. Specifically, the asset must be assigned a useful life, a salvage value, and a method of
depreciation.

2. When assets are placed in use on a day other than the first day of the month an assumption is
often made that the assets are placed in use on the first day of the month nearest to the date of
the purchase. For example, for assets purchased on the 1st through 15th days of the month,
the first day of the month is assumed to be the purchase date. For assets purchased on the
16th through month-end, the first day of the next month is assumed to be the purchase date.
By selecting the first day of the following month, Choi is getting a one-time deferral of some
partial months of depreciation. She is still employing a systematic and rational method of
allocating costs if she consistently chooses the first day of the following month. However,
since she appears to be using this method only with respect to current year additions, it
appears that she is using accounting rules to reduce depreciation expense this year. Also, her
practice is not in keeping with general business practices as described above. The facts of
the situation seem to suggest an ethical violation rather than a legitimate depreciation
decision rule.

3. By always assuming the first day of the following month as the date of purchase, less
depreciation is (initially) accrued for the assets employed. This means depreciation expense
will be less than if assets were considered employed on the first of the month closest to the
date of purchase. With reduced depreciation charges, net income will be higher for this
current year. Therefore, this practice will result in a higher profit margin for her company for
this year.

Communicating in Practice — BTN 10-4

The solution to this activity will vary based on the industry and the companies chosen for
analysis. Many instructors find it useful to report the results from the teams to the class for
purposes of classroom discussion and analysis.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 599
Taking It to the Net — BTN 10-5

١. Adaptec is a technology company that specializes in data storage solutions. Adaptec’s

products include software and hardware products that are designed to move, manage, and
protect critical data and digital content.

٢. The company maintains a patent award program that encourages its engineers to document
patentable inventions so that Adaptec can continue to apply for patents both in the U.S. and
in foreign countries.

The company, at times, purchases technology licenses from other companies rather than
develop all needed patents internally.

٣. Adaptec’s statement of operations (income statement) for 2002 shows patent settlement
revenue of $9.3 million. This likely relates to monies recovered from other parties who have
been ruled (by judges or juries) to have infringed on Adaptec’s patents. In 2001, negative
revenues are shown for patent settlement fees. The negative revenues could be due to an
appeal of the original 2000 court decision with Adaptec having to return part of the 2000
settlement fee.

Teamwork in Action — BTN 10-6

1. Annual depreciation for each year of the asset’s useful life:

Year Straight-line Double-Declining-Balance Units-of-Production
2004 ($44,000-2,000)/4 (100%/4) x 2 = 50% is ($44,000-$2,000)/60,000 miles
= $10,500 declining-balance rate. = $.70 per mile.
BV x rate = $44,000 x 50% 12,000 miles x $.70 = $ 8,400
= $22,000

2005 $10,500 $22,000 x 50%= $11,000 18,000 miles x $.70 = $12,600

2006 $10,500 $11,000 x 50% = $5,500 21,000 miles x $.70 = $14,700

2007 $10,500 $5,500 (depreciate to 9,000* miles x $.70 = $ 6,300

salvage) = $3,500

* Depreciation is based on the estimated capacity of 60,000 miles. Even though the van is
driven 10,000 miles in the last year, depreciation can only be taken for the remaining 9,000
miles of estimated capacity. This will record depreciation to the estimated salvage value.

©McGraw-Hill Companies, Inc., 2005

600 Fundamental Accounting Principles, 17th Edition
Teamwork in Action (Continued)

2. Depreciation is recorded in an adjusting entry at the end of each period. The entry is:

Depreciation Expense .................................................... xxxx*

Accumulated Depreciation............................. xxxx*
*Amount varies by method and year (see part 1).

3. Each expert’s presentation of the comparison of methods will be slightly different. The
experts should make the following points: The straight-line method reduces net income by
the same amount each year. The declining-balance method reduces net income the largest
in 2004 (first year of use) and by a lesser amount in each subsequent year. The impact of
the units-of-production method varies year to year according to the amount of estimated
capacity consumed (miles driven).

4. Book value at the end of each year

= Cost - Accumulated depreciation
= $44,000 – (amount varies by method—see part 1 for annual amounts)

Double-Declining-
Year Straight-line Balance Units of Production
2004 ........... $33,500 $22,000 $35,600
2005 ........... 23,000 11,000 23,000
2006 ........... 12,500 5,500 8,300
2007 ........... 2,000 2,000 2,000

For reporting purposes, each expert will have different results. But each should show:

Plant Assets:
Transport Van ................................................................ $44,000
Less: Accumulated Depreciation XXXX*
XXXX*

* Amounts vary by the method and the year selected for illustration. Experts should explain
the amounts shown.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 601
Business Week Activity — BTN 10-7

١. In accounting terms, if a company pays $1 billion for another company that has tangible
assets, such as plant and equipment, valued at $600 million, then the amount of goodwill is
calculated to be $400 million. Therefore, goodwill represents the purchase price of a
company that exceeds the value of the identifiable net assets.

٢. Formerly, goodwill was required to be amortized deducting a portion of it from net income
every year for up to 40 years.

٣. The FASB has recently adopted a new standard in accounting for goodwill—these are
reflected in SFAS 141 and 142. Specifically, as before, goodwill is measured as the excess of
the cost of an acquired entity over the value of the acquired net assets. However, in contrast
to the prior standard, goodwill is recorded as an asset and it is not amortized. Instead, SFAS
142 requires that goodwill be annually tested for impairment. If the book value of goodwill
does not exceed its fair value, goodwill is not impaired. However, if the book value of
goodwill exceeds its fair value, an impairment loss is recorded equal to that excess. (Details
of this test are in advanced courses.)

4. It is a good idea to become familiar with the accounting for goodwill because goodwill write-
downs are widely anticipated by numerous companies in the coming years. Many of the
1990’s mega-mergers have not lived up to expectations and, therefore, the acquirers often
overpaid. This generated goodwill that must be tested for impairment (and likely written off
against earnings).

©McGraw-Hill Companies, Inc., 2005

602 Fundamental Accounting Principles, 17th Edition
Entrepreneurial Decision — BTN 10-8

Part 1

(a) Under current conditions, the total asset turnover is 3. This is computed as net sales of
$3,000,000 divided by its average total assets of $1,000,000.* This means the company turns
its assets over 3 times per year or, stated differently, each $1 of assets produces $3.00 of net
sales per year.
Net sales
* Total asset turnover = Average total assets

(b) Under this proposal, its asset turnover would increase to 3.67. This is computed by taking its
net sales of $5,500,000 ($3,000,000 + $2,500,000) and dividing by its average total assets of
$1,500,000 ($1,000,000 + $500,000). This means the company would now turn its assets
over 3.67 times per year or, stated differently, each $1 of assets would now produce $3.67 of
net sales per year.

Part 2

Cordova’s proposal would yield an improved total asset turnover of 3.67 vis-à-vis the current
total asset turnover of 3. However, we need to recognize that this proposal depends on our
confidence in both maintaining current sales, meeting future sales expectations, and not losing or
alienating current and/or future customers due to the expanded operations. Assuming all of our
estimates are reasonable, we need to focus on any potential customer concern and the impact on
other dimensions of analysis that such a proposal can bring about.*

*We must remember that total asset turnover is only one dimension of a complete analysis of this
proposal. For example, we would want to explore the impact of this proposal on net income and
other activities.

Hitting the Road — BTN 10-9

No formal solution exists for this activity. It is usually interesting for the class to exchange their
discoveries via class discussion. This is particularly the case with respect to patents, copyrights,
and trademarks.

©McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 10 603
Global Decision — BTN 10-10

Note: Total asset turnover = Net sales / Average total assets

1. Total asset turnover for Grupo Bimbo (millions of pesos):

Current Year: $41,373 / [($31,719 + $23,781)/2] = 1.49 times

One Year Prior: $34,968 / [($23,781 + $25,035)/2] = 1.43 times

2. Grupo Bimbo and Krispy Kreme were the most efficient in producing net sales from total
assets employed ($1.49 and $1.48 respectively). Specifically, each peso of Grupo Bimbo’s
assets produces 1.49 pesos in net sales for the current year and 1.43 pesos in net sales for
the prior year. In comparison, each dollar of Krispy Kreme’s assets produces $1.48 in net
sales for the current year and $1.85 in net sales for the prior year, whereas each dollar of
Tastykake’s assets produces $1.39 in net sales for the current year and $1.46 in net sales for
the prior year.

©McGraw-Hill Companies, Inc., 2005

604 Fundamental Accounting Principles, 17th Edition