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Flashcards in Fixed Assets Deck (137):
1

Which of the following is a required footnote disclosure on property, plant, and equipment?

  1. Range of useful lives of plant assets.
  2. Depreciation methods of plant assets.
  3. Accumulated depreciation related to plant assets.
  4. All of the above.

All of the above.

All items listed are required disclosures: useful life, depreciation methods, and the accumulated depreciation of plant asset. Read through select disclosures of the financial statements of real companies-this will help reinforce the disclosure requirements and jog your memory because you will remember reading about the disclosure.

2

Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin.

The proceeds from the sale of the building should be:

  1. Classified as other income.
  2. Deducted from the cost of the land.
  3. Netted against the costs to clear the land and expensed as incurred.
  4. Netted against the costs to clear the land and amortized over the life of the plant.

Deducted from the cost of the land.

The proceeds from the building removed and sold reduce the cost of the land to the buyer. Had the building been razed, the net razing cost would be added to the land. Compared to the latter situation, the case in the problem results in a cost savings.

3

On December 1, 2005, East Co. purchased a tract of land as a factory site for $300,000. The old building on the property was razed and salvaged materials resulting from demolition were sold.

Additional costs incurred and salvage proceeds realized during December 2005 were as follows:

  • Cost to raze old building $25,000
  • Legal fees for purchase contract and to record ownership $5,000
  • Title guarantee insurance $6,000
  • Proceeds from sale of salvaged materials $4,000

In East's December 31, 2005 Balance Sheet, what amount should be reported as land?

  1. $311,000
  2. $321,000
  3. $332,000
  4. $336,000

$332,000

The correct answer, $332,000, equals: $300,000 + $25,000-$4,000 + $5,000 + $6,000. 
The net cost to raze the old building ($21,000) is capitalized to land because it is a cost necessary to bring the land into its intended condition. The legal fees and title guarantee cost, likewise, must be incurred to avoid future legal problems, and thus contribute to the value of the land.

4

Newt Co. sold a warehouse and used the proceeds to acquire a new warehouse. The excess of the proceeds over the carrying amount of the warehouse sold should be reported as a(an):

  1. Reduction of the cost of the new warehouse.
  2. Gain from discontinued operations, net of income taxes.
  3. Part of continuing operations.
  4. Extraordinary gain, net of taxes.

Part of continuing operations.

The gain or loss on the sale of an asset is part of continuing operations as it is expected that a company will sell existing assets from time to time as the assets are replaced.

5

Lano Corp.'s forestland was condemned for use as a national park. Compensation for the condemnation exceeded the forestland's carrying amount. Lano purchased similar, but larger, replacement forestland for an amount greater than the condemnation award.

As a result of the condemnation and replacement, what is the net effect on the carrying amount of the forestland reported in Lano's Balance Sheet?

  1. The amount is increased by the excess of the replacement forestland's cost over the condemned forestland's carrying amount.
  2. The amount is increased by the excess of the replacement forestland's cost over the condemnation award.
  3. The amount is increased by the excess of the condemnation award over the condemned forestland's carrying amount.
  4. No effect, because the condemned forestland's carrying amount is used as the replacement forestland's carrying amount.

The amount is increased by the excess of the replacement forestland's cost over the condemned forestland's carrying amount.

The two transactions are not related. The land account is decreased by the book value of the land condemned and increased by the cost of the land purchased. The relative magnitudes of the book values are shown below:

  • award > book value of condemned land
  • cost of new land > award

Therefore: cost of new land > book value of condemned land

Thus, the land is increased by the net amount: cost of new land-book value of old land

6

Derby Co. incurred costs to modify its building and to rearrange its production line. As a result, an overall reduction in production costs is expected. However, the modifications did not increase the building's market value, and the rearrangement did not extend the production line's life.

Should the building modification costs and the production line rearrangement costs be capitalized?

  • Building modification costs
  • Production line rearrangement costs

  • Building modification costs - YES
  • Production line rearrangement costs - YES

The criterion for capitalizing post-acquisition costs is not whether the market value of the overall asset is increased. Rather, the criteria are

  1. increase in useful life or
  2. increase in productivity or efficiency including cost reduction.

An overall reduction in production costs meets the second criterion. Therefore, both costs are capitalized rather than immediately expensed.

7

On December 1, 2005, East Co. purchased a tract of land as a factory site for $300,000. The old building on the property was razed and salvaged materials resulting from demolition were sold.

Additional costs incurred and salvage proceeds realized during December 2005 were as follows:

  • Cost to raze old building $25,000
  • Legal fees for purchase contract and to record ownership $5,000
  • Title guarantee insurance $6,000
  • Proceeds from sale of salvaged materials $4,000

In East's December 31, 2005 Balance Sheet, what amount should be reported as land?

  1. $311,000
  2. $321,000
  3. $332,000
  4. $336,000

$332,000

The correct answer, $332,000, equals: $300,000 + $25,000-$4,000 + $5,000 + $6,000. 
The net cost to raze the old building ($21,000) is capitalized to land because it is a cost necessary to bring the land into its intended condition. The legal fees and title guarantee cost, likewise, must be incurred to avoid future legal problems, and thus contribute to the value of the land.

8

On December 1, 2005, Boyd Co. purchased a $400,000 tract of land for a factory site. Boyd razed an old building on the property and sold the materials it salvaged from the demolition. 
Boyd incurred additional costs and realized salvage proceeds during December 2005 as follows:

  • Demolition of old building $50,000
  • Legal fees for purchase contract and recording ownership $10,000
  • Title guarantee insurance $12,000
  • Proceeds from sale of salvaged materials $8,000

In its December 31, 2005, Balance Sheet, Boyd should report a balance in the land account of:

  1. $464,000
  2. $460,000
  3. $442,000
  4. $422,000

$464,000

  • Land purchase price $400,000
  • Plus demolition of old building $50,000
  • Less salvage proceeds ($8,000)
  • Plus title insurance $12,000
  • Plus legal fees $10,000
  • Equals recorded land cost $464,000

9

Immediately after a note payable was signed, its present value was $30,000. This note and $20,000 cash were used to acquire a used plant asset at the beginning of the current year. The interest rate implied in the note is 6%. Total interest payments due on the note over its term amount to $4,000. The term exceeds one year. No payments on the note are due during the current year. What amount of interest expense is recognized for the first year (current year) on this note, and what amount is capitalized to the plant asset account?

  • Interest Expense
  • Capitalized Amount  

  • Interest Expense - $1,800
  • Capitalized Amount - $50,000

The interest expense recognized for the first year is .06($30,000) = $1,800. Although no interest is paid, interest is accrued, increasing the carrying value of the note. The asset is capitalized at $50,000, the sum of cash down payment and present value of the note. The interest over the note term is not capitalized because it does not assist in the process of placing the asset into its intended condition and location.

10

Young Corp. purchased equipment by making a down payment of $4,000 and issuing a note payable for $18,000. A payment of $6,000 is to be made at the end of each year for three years. The applicable rate of interest is 8%. The present value of an ordinary annuity factor for three years at 8% is 2.58, and the present value for the future amount of a single sum of one dollar for three years at 8% is .735. Shipping charges for the equipment were $2,000, and installation charges were $3,500. What is the capitalized cost of the equipment?

  1. $19,480
  2. $21,480
  3. $24,980
  4. $27,500

$24,980

The capitalized cost is the sum of the down payment, present value of the note payments, and the shipping and installation charges. $4,000 + $6,000(2.58) $2,000 $3,500 = $24,980. The present value of the three payments required on the note is capitalized, which excludes the interest included in those payments. The two charges are capitalized because they were incurred to place the asset into its intended condition and location.

11

Oak Co., a newly formed corporation, incurred the following expenditures related to land and building:

  • County assessment for sewer lines $2,500
  • Title search fees $625
  • Cash paid for land with a building to be demolished $135,000
  • Excavation for construction of basement $21,000
  • Removal of old building $21,000 less salvage of $5,000 = $16,000

At what amount should Oak record the land?

  1. $138,125
  2. $153,500
  3. $154,125
  4. $175,625

$154,125

The amounts necessary to get the land ready for its intended purpose attach themselves as a part of the total cost of the land. This would be the: $2,500+625+135,000+16,000=$154,125

12

Two approaches are available for applying interest rates to average accumulated expenditures for the purpose of capitalizing interest. These approaches are called the specific method and the weighted average method. In some cases, these approaches yield the same results. Two situations may be encountered in practice for a specific period:

  1. average accumulated expenditures exceed total interest bearing debt (principal) and
  2. the interest rates on all interest bearing debt instruments are the same.

Which situation yields the same results for the two approaches?

  1. only (1).
  2. only (2).
  3. both (1) and (2).
  4. neither (1) nor (2).

Both 1 and 2.

When average accumulated expenditures exceeds interest bearing debt, all interest for the period is capitalized because all debt could have been avoided if the construction had not taken place. Also, if the interest rates on all debt are the same, then the two approaches yield the same results because, ultimately, only one interest rate is applied to average accumulated expenditures for computing capitalized interest.

13

A firm began the construction of its new manufacturing facility in January of 20x2. The following expenditures were made on construction in that year:

  • Jan. 1 - $40,000
  • Mar. 1 - $120,000
  • Oct. 31 - $96,000

Debt outstanding the entire year:

  • 6%, $60,000 construction loan
  • 4%, $90,000 note payable not related to construction
  • 6%, $90,000 note payable not related to construction

Compute interest to be capitalized using the weighted average method.

  1. $6,720
  2. $12,600
  3. $8,400
  4. $8,190

$8,190

Average accumulated expenditures is $156,000 = $40,000 + $120,000(10/12) + $96,000(2/12). This method uses the average interest rate on all interest bearing debt, weighted by principal. That rate is the quotient of the interest on all the debt divided by the principal on all the debt. The rate = ($3,600 + $3,600 + $5,400)/$240,000 = .0525. Interest capitalized = (.0525)$156,000 = $8,190.

14

During 2004, Bay Co. constructed machinery for its own use and for sale to customers. Bank loans financed these assets both during construction and after construction was complete.

How much of the interest incurred should be reported as interest expense in the 2004 Income Statement?

  • Interest incurred for machinery for own use
  • Interest incurred for machinery held for sale 

  • Interest incurred for machinery for own use - interest incurred after completion
  • Interest incurred for machinery held for sale -  All interest incurred

15

Sun Co. was constructing fixed assets that qualified for interest capitalization. Sun had the following outstanding debt issuances during the entire year of construction:

  • $6,000,000 face value, 8% interest.
  • $8,000,000 face value, 9% interest.

None of the borrowings were specified for the construction of the qualified fixed asset. Average expenditures for the year were $1,000,000. What interest rate should Sun use to calculate capitalized interest on the construction?

  1. 8.00%
  2. 8.50%
  3. 8.57%
  4. 9.00%

8.57%

Neither debt issuances were identified as the construction loan. Therefore, the interest rate must be determined based on the weighted average of the interest on all of the debt outstanding during the year. The calculation is as follows:

$6,000,000 x .08 = $480,000

$8,000,000 x .09 = $720,000

Totals $14,000,000 / $1,200,000

$1,200,000 / $14,000,000 = 8.57%

16

A company obtained a $300,000 loan with a 10% interest rate on January 1, year 1, to finance the construction of an office building for its own use. Building construction began on January 1, year 1, and the project was not completed as of December 31, year 1. The following payments were made in year 1 related to the construction project:

  • January 1 - Purchased land for $120,000
  • September 1 - Progress payment to contractor for $150,000

What amount of interest should be capitalized for the year ended December 31, year 1?

  1. $13,500
  2. $15,000
  3. $17,000
  4. $30,000

$17,000

Interest can be capitalized on the accumulated average expenditures during the year. During year 1 the weighted average expenditures were ($120,000 x 12/12) + ($150,000 x 4/12) = $170,000. Interest is capitalized based on the weighted average expenditures times the interest rate of 10% ($170,000 x .10 = $17,000).

17

Debt is frequently incurred when plant assets are acquired. For example, debt may be incurred on the purchase of plant assets. Debt may also be incurred during the construction of plant assets. How is the interest in these two cases treated for financial reporting?

  1. Debt for purchase   
  2. Debt during construction

  1. Debt for purchase - EXPENSE
  2. Debt during construction - CAPITALIZE

Interest on debt incurred when purchasing a plant asset, is incurred after the asset has reached its intended condition and location. Therefore, it is expensed as incurred. Debt incurred during the construction of plant assets is considered avoidable and also incurred before the asset has reached its intended condition and location. Therefore, it is capitalized to the asset in the same way material, labor, and overhead are capitalized. The interest is expensed as part of depreciation during the service life of the asset.

18

Cole Co. began constructing a building for its own use in January 2004. During 2004, Cole incurred interest of $50,000 on specific construction debt and $20,000 on other borrowings. Interest computed on the weighted-average amount of accumulated expenditures for the building during 2004 was $40,000.

What amount of interest cost should Cole capitalize?

  1. $20,000
  2. $40,000
  3. $50,000
  4. $70,000

$40,000

Capitalized interest is limited to the interest that would have been avoided had the construction not occurred. This is the amount of interest based on average accumulated expenditures.

19

A firm has spent the last two years constructing a building to be used as the firm's headquarters. At the end of the first year of construction, the balance of building under construction was $400,000, which includes capitalized interest. During year two, the firm paid $240,000 to the contractor on March 1, and $600,000 on October 1. The building was not finished by the end of the second year. The firm had one loan outstanding all year, an 8%, $3,000,000 construction loan. Compute capitalized interest for year two.

  1. $28,000
  2. $240,000
  3. $60,000
  4. $65,600

$60,000

Average accumulated expenditures for the second year = $400,000(12/12) + $240,000(10/12) + $600,000(3/12) = $750,000. Interest capitalized = .08($750,000) = $60,000. Note that the interest capitalized in year one is compounded in year two because year one capitalized interest is included in average accumulated expenditures for the second year.

20

A firm is constructing a warehouse for its own use and purchased the land for the site immediately before beginning construction. Interest is capitalized on which of the following:

  • Warehouse
  • Land

  • Warehouse - YES
  • Land - NO

21

Average accumulated expenditures for year five on a construction project amounted to $70,000. The total cash invested in the project by the end of year five, was $160,000. During year six, the firm spent another $240,000 (total) on the project, uniformly throughout the year. Compute average accumulated expenditures for year six.

  1. $240,000
  2. $400,000
  3. $190,000
  4. $280,000

$280,000

Average accumulated expenditures is the amount of debt for the annual period that could have been avoided. In this case, the firm has $160,000 already invested in the project at the beginning of year six. That amount represents $160,000 in debt, that could have been avoided for year six if the firm had not been involved in the construction project. The expenditures during year six were incurred evenly. Average accumulated expenditures therefore = $160,000(12/12) + $240,000/2 = $280,000. Also, [$160,000 + ($160,000 + $240,000)]/2 = $280,000.

22

On June 18, 2005, Dell Printing Co. incurred the following costs for one of its printing presses:

  • Purchase of collating and stapling attachment $84,000
  • Installation of attachment $36,000
  • Replacement parts for overhaul of press $26,000
  • Labor and overhead in connection with overhaul $14,000

The overhaul resulted in a significant increase in production. Neither the attachment nor the overhaul increased the estimated useful life of the press. What amount of the above costs should be capitalized?

  1. $0
  2. $84,000
  3. $120,000
  4. $160,000

$160,000

All four costs should be capitalized because they result in an increase in the productivity of the asset. Costs that increase EITHER the life OR productivity are capitalized. Either type of increase results in enhanced asset values. $160,000 is the sum of the four costs listed.

23

A building suffered uninsured fire damage. The damaged portion of the building was refurbished with higher quality materials. The cost and related accumulated depreciation of the damaged portion are identifiable. To account for these events, the owner should:

  1. Reduce accumulated depreciation equal to the cost of refurbishing.
  2. Record a loss in the current period equal to the sum of the cost of refurbishing and the carrying amount of the damaged portion of the building.
  3. Capitalize the cost of refurbishing, and record a loss in the current period equal to the carrying amount of the damaged portion of the building.
  4. Capitalize the cost of refurbishing by adding the cost to the carrying amount of the building.

Capitalize the cost of refurbishing, and record a loss in the current period equal to the carrying amount of the damaged portion of the building.

When the cost and accumulated depreciation of a component or portion of a larger asset is identifiable, and that component or portion is replaced, the replacement is treated as two separate transactions: 

  1. disposal of the old component (for zero proceeds in this case, due to the fire damage) and
  2. purchase of the new component.

Thus, a loss equal to the book value of the old component is recognized for (1) and the amount paid to purchase the new component is capitalized as a separate purchase for (2).

24

On January 1, 2005, Dix Co. replaced its old boiler. The following information was available on that date:

  • Carrying amount of old boiler $8,000
  • Fair value of old boiler $2,000
  • Purchase and installation price of new boiler $100,000

The old boiler was sold for $2,000. What amount should Dix capitalize as the cost of the new boiler?

  1. $92,000
  2. $94,000
  3. $98,000
  4. $100,000

$100,000

The disposal of the old boiler and purchase of the new boiler are separate transactions. The loss on disposal has no effect on the capitalized cost of the new boiler, which is recorded at its $100,000 purchase cost.

25

Net income is understated if, in the first year, estimated salvage value is excluded from the depreciation computation when using the

  • Straight-line method
  • Production or use method  

  • Straight-line method - YES
  • Production or use method - YES

When salvage value is excluded from the computation of depreciation, excessive depreciation is recognized each year under BOTH methods. Therefore, income is understated for both methods.

Annual depreciation under straight-line is: 
(1/n)(cost-salvage) 
where n is the number of years in the useful life. 

Annual depreciation under the production method is: 
(current year production/tot.est.production)(cost-salvage)

26

On January 2, 2005, Lem Corp. bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each, for total cash payments of $130,000.

The cash-equivalent price of the machinery was $110,000. The machinery has an estimated useful life of 10 years and estimated salvage value of $5,000. Lem uses straight-line depreciation.

In its 2005 Income Statement, what amount should Lem report as depreciation for this machinery?

  1. $10,500
  2. $11,000
  3. $12,500
  4. $13,000

$10,500

The capitalized cost of the equipment is $110,000, not the total of the cash payments to be made. The latter amount includes interest.

Thus, annual depreciation is $10,500:
($110,000-$5,000)/10.

27

A manufacturing firm purchased used equipment for $135,000. The original owners estimated that the residual value of the equipment was $10,000. The carrying amount of the equipment was $120,000 when ownership transferred. The new owners estimate that the expected remaining useful life of the equipment was 10 years, with a salvage value of $15,000. What amount represents the depreciable base used by the new owners?

  1. $105,000
  2. $110,000
  3. $120,000
  4. $125,000

$120,000

The purchase price of the asset acquired less its salvage value is the asset's depreciable cost. In this case, total depreciation on the asset is limited to $120,000 ($135,000 purchase price-$15,000 salvage value). The cost to the seller and the previous salvage value are not relevant to the new owner.

28

In which of the following situations is the units of production method of depreciation most appropriate?

  1. An asset's service potential declines with use.
  2. An asset's service potential declines with the passage of time.
  3. An asset is subject to rapid obsolescence.
  4. An asset incurs increasing repairs and maintenance with use.

An asset's service potential declines with use.

This method is most appropriate when the service potential of an asset can be estimated reliably in terms of a physical variable, such as miles to be driven, or number of units of output that can be produced by the asset.

Over time, as more units are produced, the service potential of the asset declines because the total number of units that can be produced is finite. Over time, the number of units that can be produced by the asset in the future declines. The primary causative agent for depreciation under the units of production method is, thus, the actual use of the asset in production.

29

On January 1, 2005, Brecon Co. installed cabinets to display its merchandise in customers' stores. Brecon expects to use these cabinets for five years.

Brecon's 2005 multi-step Income Statement should include:

  1. One-fifth of the cabinet costs in cost of goods sold.
  2. One-fifth of the cabinet costs in selling, general, and administrative expenses.
  3. All of the cabinet costs in cost of goods sold.
  4. All of the cabinet costs in selling, general, and administrative expenses.

One-fifth of the cabinet costs in selling, general, and administrative expenses.

With a five year life, 1/5 of the cost of the cabinets is expensed as depreciation. The cabinets are not involved in the manufacturing of the goods. Rather, they are used to help sell the merchandise.

Thus, the depreciation is not included in cost of goods sold; rather, it is included in selling, general, and administrative expenses.

30

What factor must be present to use the units of production (activity) method of depreciation?

  1. Total units to be produced can be estimated.
  2. Production is constant over the life of the asset.
  3. Repair costs increase with use.
  4. Obsolescence is expected.

Total units to be produced can be estimated.

Without an estimate for total units to be produced, depreciation could not be computed. Annual depreciation under this method is:

[(Cost-salvage value)/(Total estimated production)](units produced year).

The quantity in square brackets is the rate of depreciation per unit.

31

Zahn Corp.'s comprehensive Balance Sheet at December 31, 2005 and 2004 reported accumulated depreciation balances of $800,000 and $600,000, respectively. Property with a cost of $50,000 and a carrying amount of $40,000 was the only property sold in 2005.

Depreciation charged to operations in 2005 was:

  1. $190,000
  2. $200,000
  3. $210,000
  4. $220,000

$210,000

The accumulated depreciation on the property sold was $10,000 ($50,000 cost less $40,000 carrying value). The sale of property requires that the accumulated depreciation on the property be removed from the accounts.

Thus, the $10,000 amount is a decrease in accumulated depreciation. With an overall increase of $200,000 in accumulated depreciation during the period ($800,000-$600,000), depreciation must have been $210,000 ($200,000 + $10,000).

32

Carr, Inc. purchased equipment for $100,000 on January 1, 2002. The equipment had an estimated 10-year useful life and a $15,000 salvage value. Carr uses the 200% declining-balance depreciation method. In its 2003 Income Statement, what amount should Carr report as depreciation expense for the equipment?

  1. $13,600
  2. $16,000
  3. $17,000
  4. $20,000

$16,000

The 200% declining balance depreciation method is also called the double declining balance method or DDB. Because this is a declining balance method, the book value at the beginning of 2003 must be computed, and that is affected by depreciation in 2002. For 2002, depreciation under DDB is 2/10 x $100,000 or $20,000. Note that salvage value is not subtracted when computing depreciation because the "declining balance" is book value. For 2003, depreciation is 2/10 x ($100,000-$20,000) = $16,000 because the book value at the beginning of 2003 is reduced by 2002 depreciation.

33

Ajax Corp. has an effective tax rate of 30%. On January 1, 2000, Ajax purchased equipment for $100,000. The equipment has a useful life of 10 years. What amount of current tax benefit will Ajax realize during 2000 by using the 150% declining-balance method of depreciation for tax purposes instead of the straight-line method?

  1. $1,500
  2. $3,000
  3. $4,500
  4. $5,000

$1,500

The two depreciation amounts for 2000, the first service year of the asset, are: SL, $10,000 ($100,000/10); and 150% DB, $15,000 (1.5 x SL amount or 1.50/10 x $100,000). The difference, $5,000 is the excess of the 150% DB deduction over the SL deduction. The tax benefit of the $5,000 excess is $1,500 ($5,000 x .30). The firm will pay $1,500 less in taxes if it uses the 150% DB method compared with the SL method.

34

On January 1, 1998, Crater, Inc. purchased equipment having an estimated salvage value equal to 20% of its original cost at the end of a 10-year life. The equipment was sold December 31, 2002, for 50% of its original cost.

If the equipment's disposition resulted in a reported loss, which of the following depreciation methods did Crater use?

  1. Double declining balance.
  2. Sum-of-the-years'-digits.
  3. Straight-line.
  4. Composite.

Straight-line.

The asset was sold when 1/2 of its useful life was expired. (The asset was used 5 years and had an original useful life of 10 years.) If an asset is sold at a loss, then the book value at the date of sale exceeds the proceeds from sale by the amount of the loss. Let C = original cost, and BV = book value at date of sale.

Then BV-proceeds = loss Proceeds = .50C according to the question data.

Thus, BV-.50C = loss. Thus, BV must exceed 50% of the original cost because BV-.50C is a positive number.

The only method from among those listed in the answer alternatives that leaves a BV greater than 50% of original cost after 50% of the useful life has expired is the SL method. The book value after the fifth year under SL is C-(C-.2C)(5/10) = .6C.

DDB's book value after five years is much less than 50% of original cost because it is an accelerated method. The same holds for SYD. And under composite methods of depreciation, individual assets do not have a separately recorded book value. When sold, accumulated depreciation is debited for the difference between original cost and proceeds. No gain or loss is recognized. Thus, the composite method could not apply in this question.

35

A depreciable asset has an estimated 15% salvage value. Under which of the following methods, properly applied, would the accumulated depreciation equal the original cost at the end of the asset’s estimated useful life?

  • Straight-line
  • Double-declining balance

  • Straight-line - NO
  • Double-declining balance - NO

Salvage value is the portion of the asset's cost not subject to depreciation. Total depreciation, under any method, is limited to depreciable cost (cost less salvage value). The declining balance methods do not subtract salvage when computing depreciation. Care must be taken to avoid depreciating an asset beyond salvage value.

36

Cantor Co. purchased a coal mine for $2,000,000. It cost $500,000 to prepare the coal mine for the extraction of the coal. It was estimated that 750,000 tons of coal would be extracted from the mine during its useful life. Cantor planned to sell the property for $100,000 at the end of its useful life. During the current year, 15,000 tons of coal were extracted and sold.

What would Cantor's depletion amount be per ton for the current year?

  1. $2.50
  2. $2.60
  3. $3.20
  4. $3.30

$3.20

The depletion rate is the sum of the cost incurred to acquire the mineral rights, find the minerals, and develop the site less the salvage value, all divided by the estimated number of units of resource expected to be removed from the site.

The depletion rate per ton is ($2,000,000 + $500,000-$100,000)/750,000 = $3.20. This rate is applied to the units removed each period to determine depletion for that period.

As such, it allocates the total cost of the obtaining and developing the resource to each unit of resource removed.

37

Choose the best association of terms in the natural resources accounting area with the conceptual framework.

  1. Successful efforts method-matching.
  2. Full costing method-definition of asset.
  3. Depletion-fair value accounting.
  4. Successful efforts method-definition of asset.

Successful efforts method-definition of asset.

The successful efforts method capitalizes only the cost of exploration efforts that locate the resource. As such, only those efforts that yield a probable future benefit are capitalized. This is a direct application of the asset definition, which requires that an asset have a probable future benefit.

38

A manufacturing firm purchased used equipment for $135,000. The original owners estimated that the residual value of the equipment was $10,000. The carrying amount of the equipment was $120,000 when ownership transferred.  The new owners estimate that the expected remaining useful life of the equipment was 10 years, with salvage value of $15,000. What amount represents the depreciable base used by the new owners?

  1. $105,000
  2. $110,000
  3. $120,000
  4. $125,000

$120,000

The depreciable base is calculated as historical cost to the new owners less the estimated salvage value determined by the new owners. Therefore, this answer is correct, because the depreciable base is equal to $120,000 ($135,000 – $15,000). The carrying value and estimated residual value to the previous owner are ignored.

39

Saba Co. bought a tract of land, paying $800,000 in cash and assuming an existing mortgage of $200,000. The municipal tax bill disclosed an assessed valuation of $700,000. How much should Saba record as an asset for this land acquisition?

  1. $600,000
  2. $700,000
  3. $800,000
  4. $1,000,000

$1,000,000

The cost principle requires that assets be recorded at historical cost. The purchased cost is deemed to be an objective measure of fair market value. Therefore, the assessed valuation has no impact on the recorded cost. Historical cost includes all costs incident to the acquisition of the asset. In this case, Saba Co. gave up $800,000 of cash and assumed liabilities of $200,000. The assumption of a liability is the equivalent of a payment of cash. The total amount incurred in acquiring the land was $1,000,000 ($800,000 + $200,000). 

40

An impairment loss for a long-lived asset, which is being used in the operations of a business, is measured by the excess of the asset’s carrying amount over its

  1. Expected undiscounted selling price, less expected costs of disposal.
  2. Fair value.
  3. Expected undiscounted future cash flows from use and disposal.
  4. Fair value less cost to sell.

Fair value.

ASC Topic 360 explains that an impairment loss shall be measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. The fair value of an asset is determined by the guidelines set in ASC Topic 820. Fair value is determined by using the principal or most advantageous market and assumes the asset is used in its highest and best use.

41

Korn Company incurred the following costs during year 1:

  • Modification to the formulation of a chemical product$135,000
  • Troubleshooting in connection with breakdowns during commercial production150,000
  • Design of tools, jigs, molds and dies involving new technology170,000
  • Seasonal or other periodic design changes to existing products185,000
  • Laboratory research aimed at discovery of new technology215,000

In its income statement for the year ended December 31, year 1, Korn should report research and development expense of

  1. $520,000
  2. $470,000
  3. $385,000
  4. $335,000

$520,000

Research and development costs (R&D costs) are defined in ASC Topic 730. It goes on to provide detailed lists of examples of activities that typically would be included in R&D costs and expensed and excluded from R&D costs and possibly capitalized. Among those items listed in ASC Topic 730 as being part of R&D costs are modification of the design of a product or process ($135,000), design of tools, jigs, molds, and dies involving new technology ($170,000) and laboratory research aimed at discovery of a new knowledge ($215,000). These three R&D expenses total $520,000. Included in the items listed in ASC Topic 730 as not being part of R&D costs are troubleshooting breakdowns during production ($150,000) and periodic design changes to existing products ($185,000).

ASC Topic 730 requires R&D costs to be expensed as incurred except for intangibles or fixed assets purchased from others having alternative future uses.  These should be capitalized and amortized over their useful life.  Thus, the cost of patents and R&D equipment purchased from third parties may be deferred and amortized over the asset’s useful life. Internally developed R&D may not be deferred.

Finally, R&D done under contract for others is not required to be expensed per ASC Topic 730.  The costs incurred would be matched with revenue using the completed-contract or percentage-of-completion method.

42

On January 2, year 1, Parke Corp. replaced its boiler with a more efficient one.  The following information was available on that date:

  • Purchase price of new boiler $60,000
  • Carrying amount of old boiler 5,000
  • Fair value of old boiler 2,000
  • Installation cost of new boiler 8,000

The old boiler was sold for $2,000.  What amount should Parke capitalize as the cost of the new boiler?

  1. $68,000
  2. $66,000
  3. $63,000
  4. $60,000

$68,000

Generally, fixed assets are recorded at the cost of acquiring the asset and getting it ready for its intended use.  In this case, the total cost of the new boiler is $68,000 ($60,000 purchase price + $8,000 installation costs). The information concerning the old boiler does not affect the cost of the new boiler. The only situation where information concerning the old boiler would affect the amount recorded for the new boiler would be if an exchange had taken place.  The journal entries are

  • Cash 2,000 
  • Loss on sale 3,000 
    •  Old boiler (net) 5,000
  • New boiler 68,000 
    •  Cash  68,000

43

On June 30, year 2, a fire in Ruffing Company’s plant caused a total loss to a production machine. The machine had a book value of $80,000 at December 31, year 1, and was being depreciated at an annual rate of $10,000.  The machine had a fair value of $110,000 at the date of the fire, and Ruffing received insurance proceeds of $100,000 in October year 2.  The same month Ruffing purchased a replacement machine for $130,000.  Ignoring income taxes, what amount should Ruffing report on its year 2 income statement as involuntary conversion gain or loss?

  1. $0.
  2. $10,000 loss.
  3. $20,000 gain.
  4. $25,000 gain.

 

$25,000 gain.

Per ASC 605-40-45-1, a gain (loss) on such conversions should be recognized as the difference between the proceeds and the book value of the converted asset, regardless of whether or not the proceeds are reinvested.

  • Proceeds $100,000
  • Book value ($80,000 -$5,000)75,000
  • Gain $25,000

The book value of $80,000 is decreased by a half-year’s depreciation (1/2 × $10,000 = $5,000) for 12/31/Y1 to 6/30/Y2.

44

Which type of expenditure occurs when a company installs a higher capacity boiler to heat its plant?

  1. Rearrangement.
  2. Ordinary repair and maintenance.
  3. Addition.
  4. Betterment.

Betterment (improvement) is the replacement of a major part or component of an existing asset with a significantly better or improved part or component.

An addition is an extension, enlargement, or expansion made to an existing asset.

45

Crowder Company acquired a tract of land containing an extractable natural resource.  Crowder is required by the purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource.  Geological surveys estimate that the recoverable reserves will be 5,000,000 tons, and that the land will have a value of $1,000,000 after restoration.  Relevant cost information follows:

  • Land $9,000,000
  • Estimated restoration costs $1,500,000

If Crowder maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material?

  1. $2.10
  2. $1.90
  3. $1.80
  4. $1.60

$1.90

 

The depletion computation is

  • Net cost of resource / Units of resource = Depletion charge per unit

The estimated net cost is the cost of the land ($9,000,000) and the related restoration costs ($1,500,000), less the salvage value of the land ($1,000,000).  This results in a net cost of $9,500,000. The estimated recoverable reserves total 5,000,000 tons. Therefore, the depletion charge is $1.90 per ton ($9,500,000/5,000,000).

  • $9,500,000 / 5,000,000 = $1.90

46

Assume a private firm elects to adopt ASU 2014-08: Business Combinations: Accounting for Intangible Assets in a Business Combination. Can customer names and noncompetition be included as part of goodwill?

  • Customer Names
  • Noncompetition Agreement

  • Customer Names - YES
  • Noncompetition Agreement - YES

ASU 2014-18 allows private firms, in a business combination, to measure customer-related intangible assets and noncompetition agreements as part of goodwill.

47

Which of the following accurately describes the appropriate accounting for goodwill acquired through a business combination?

  1. It should be recorded at cost and tested for impairment every three years.
  2. It should be recorded at cost and tested for impairment on an annual basis and more often if certain events occur.
  3. It should be recorded at cost and amortized over a 10-year period.
  4. It should be recorded at cost and amortized over a 40-year period.

It should be recorded at cost and tested for impairment on an annual basis and more often if certain events occur.

Impairment of goodwill.  The goodwill assigned to a reporting unit should be tested for impairment on an annual basis and between annual tests in certain circumstances.  These circumstances are listed in the outline of ASC 350-20-35-30.  The annual test may be performed any time during the company’s fiscal year as long as it is done at the same time every year. Different reporting units may be tested at different times during the year.  The test of impairment is a two-step process as described below.

  1. Compare the fair value of the reporting unit with its carrying amount.  If the carrying amount of the unit exceeds its fair value, the second step is performed.  ASC Topic 820 requires that in determining fair value, a valuation premise should be used that is consistent with the asset’s highest and best use.  The valuation premise can either be an in-use or an in-exchange premise.  An in-use premise is used if the asset is used in a business in combination with other assets, such as a reporting unit.
  2. Compare the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination.  That is, all assets in the segment are valued in accordance with ASC Topic 805, and the excess of the fair value of the reporting unit as a whole over the amounts assigned to its assets and liabilities is the implied goodwill.  If the implied value of goodwill is less than its carrying amount, goodwill is written down to its implied value and an impairment loss is recognized.

48

During year 1, Fox Company made the following expenditures relating to plant machinery and equipment:

  • Renovation of a group of machines at a cost of $50,000 to secure greater efficiency in production over their remaining 5-year useful lives.  The project was completed on December 31, year 1.
  • Continuing, frequent, and low-cost repairs at a cost of $35,000.
  • A broken gear on a machine was replaced at a cost of $5,000.

What total amount should be charged to repairs and maintenance in year 1?

  1. $35,000
  2. $40,000
  3. $85,000
  4. $90,000

$40,000

Generally, a cost should be capitalized if it improves the efficiency of the asset or extends its useful life, and expensed if it merely maintains the asset at its current level. The renovation cost ($50,000) improves the production efficiency of the machines and therefore should be capitalized. However, the continuing, frequent, and low-cost repairs ($35,000) and the replacement of a broken gear ($5,000) merely maintain the assets at their current level, and therefore $40,000 should be charged to repairs and maintenance expense.

49

Mellow Co. depreciated a $12,000 asset over five years, using the straight-line method with no salvage value.  At the beginning of the fifth year, it was determined that the asset will last another four years.  What amount should Mellow report as depreciation expense for year 5?

  1. $600
  2. $900
  3. $1,500
  4. $2,400

$600

According to ASC Topic 250, a change in the estimated life of an asset is accounted for on a prospective basis. Depreciation expense in years 1 through 4 is calculated as $12,000 ÷ 5 years = $2,400 per year.  At the end of year 4, the book value of the asset is $2,400 and this amount is depreciated over the newly estimated remaining life of 4 years.  Therefore, the depreciation expense in year 5 would be $2,400 ÷ 4 remaining years = $600.  Therefore, this answer is correct.

50

How should NSB, Inc. report significant research and development costs incurred?

  1. Expense all costs in the year incurred.
  2. Capitalize the costs and amortize over a five-year period.
  3. Capitalize the costs and amortize over a 40-year period.
  4. Expense all costs two years before and five years after the year incurred.

Expense all costs in the year incurred.

Research and Development Costs

  1. R&D costs are expensed as incurred except for intangibles or fixed assets purchased from others having alternative future uses. These should be capitalized and amortized over their useful life. Thus, the cost of patents and R&D equipment purchased from third parties may be deferred and amortized over the asset's useful life. Internally developed R&D may not be deferred.
  2. Finally, R&D done under contract for others is not required to be expensed. The costs incurred would be matched with revenue using the completed-contract or percentage-of-completion method.

51

Restorations of carrying value for long-lived assets are permitted if an asset's fair value increases subsequent to recording an impairment loss for which of the following?

  • Held for use
  • Held for disposal 

  • Held for use - NO
  • Held for disposal - YES

If an asset is held for disposal, previous losses can be recovered. The logic is that the recovery will be realized in the near future if the asset is in the process of being disposed. In contrast, an asset held for use CANNOT recover previous impairment because there is no certainty regarding the ultimate realization of those losses.

52

A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?

  1. $0
  2. $5,000
  3. $15,000
  4. $20,000

$0

The recoverable cost (expected future cash flows) of $130,000 exceeds the $120,000 book value. Therefore, the asset is not impaired, and no loss is recorded. Although both the market value and present value of the future cash flows are less than book value, as long as the nominal sum of future cash flows ($130,000) exceeds book value, no impairment is recorded. The firm is expected to recover its book value.

53

A state government condemned Cory Co.'s parcel of real estate. Cory will receive $750,000 for this property, which has a carrying amount of $575,000. Cory incurred the following costs as a result of the condemnation:

  • Appraisal fees to support a $750,000 value $2,500
  • Attorney fees for the closing with the state $3,500
  • Attorney fees to review contract to acquire replacement property $3,000
  • Title insurance on replacement property $4,000

What amount of cost should Cory use to determine the gain on the condemnation?

  1. $581,000
  2. $582,000
  3. $584,000
  4. $588,000

$581,000

The total value to be compared to the amount received from the government in computing the gain:

  • Carrying amount $575,000
  • Plus appraisal fees to support a $750,000 value $2,500
  • Plus attorney fees for the closing with the state $3,500
  • Equals total cost to compare to $750,000 received from state $581,000

The second and third items in the above list essentially reduce the net proceeds from the state and thus decrease the gain. The $3,000 and $4,000 amounts pertaining to the replacement property are not associated with the existing property and do not affect the gain on its condemnation.

54

Which of the following conditions must exist in order for an impairment loss to be recognized?

  • I. The carrying amount of the long-lived asset is less than its fair value.
  • II. The carrying amount of the long-lived asset is not recoverable.

II ONLY.

The test for impairment for an asset in use is whether the carrying value (book value) is less than its recoverable cost. An asset's recoverable cost is the sum of its estimated net cash inflows projected for its remaining life.

When book value > recoverable cost, the carrying value is not recoverable. In other words, the asset is booked at more than the sum of its future net cash inflows.

For example, if an asset's carrying value is $100 and its recoverable cost is $80, then its carrying value is not recoverable (only $80 is recoverable). The AMOUNT of the loss recognized is the difference between carrying value and fair value, but that difference is not used for TESTING whether an asset is impaired.

That difference is not the condition leading to the impairment loss.

55

The sum-of-the-years’ digits method of depreciation is being used for a machine with a 5-year estimated useful life.  What would be the fraction applied to the cost to be depreciated in the second year?

  1. 2/3
  2. 2/15
  3. 4/15
  4. 4/5

4/15

the equation for calculating the sum-of-the-years’ digits depreciation is

Remaining useful life at the beginning of the year for which depreciation is to be taken / SYD = (Cost – Salvage value)

The machine has 4 years of useful life remaining at the beginning of the second year; therefore, the fraction to be applied is 4/15.

56

The Plaza Company was organized late in year 1 and began operations on January 1, year 2. Plaza is engaged in conducting market research studies on behalf of manufacturers.  Prior to the start of operations, the following costs were incurred:

  • Attorney’s fees in connection with organization of Plaza $4,000
  • Improvements to leased offices prior to occupancy $7,000
  • Meetings of incorporators, state filing fees and other organization expenses $5,000

Under generally accepted accounting principles, what is the amount of organization costs charged to income for year 2?

  1. $9,000
  2. $16,000
  3. $11,000
  4. $5,000

$9,000

Organizational costs include the attorney’s fees and meetings of incorporators, state filing fees, and other organizational expenses.  Under generally accepted accounting principles, per ASC Subtopic 720-15, they should be expensed immediately. Leasehold improvements are amortizable assets but do not qualify as organization costs.

  • Attorney’s fees $4,000
  • Meetings, etc. $5,000
  • = $9,000

57

The test for recoverability of operational assets per ASC Topic 360 uses

  1. Undiscounted cash inflows less related outflows.
  2. Discounted cash inflows less related outflows.
  3. Discounted cash inflows only.
  4. Undiscounted cash inflows only.

Undiscounted cash inflows less related outflows.

If circumstances indicate that the carrying amount of an asset may not be recoverable, an entity shall estimate the future cash flows expected to result from the use of the asset and its eventual disposition. Future cash flows are defined as the undiscounted future cash inflows less the undiscounted future cash outflows necessary to obtain those inflows. Note that the use of undiscounted cash flows in the recoverability test is consistent with the measurement of property, plant, and equipment at historical cost which is an undiscounted amount.

58

During year 1, Yvo Corp. installed a production assembly line to manufacture furniture.  In year 2, Yvo purchased a new machine and rearranged the assembly line to install this machine.  The rearrangement did not increase the estimated useful life of the assembly line, but it did result in significantly more efficient production.  The following expenditures were incurred in connection with this project:
Machine$75,000

  • Labor to install machine $14,000
  • Parts added in rearranging the assembly line to provide future benefits $40,000
  • Labor and overhead to rearrange the assembly line $18,000

What amount of the above expenditures should be capitalized in year 2?

  1. $147,000
  2. $107,000
  3. $ 89,000
  4. $ 75,000

$147,000

The key factor in determining what costs Yvo should capitalize in connection with their assembly line project is whether the expenditures provide future benefit. In this case, all expenditures meet this criterion, and should therefore be capitalized for a total of $147,000 ($75,000 + $14,000 + $40,000 + $18,000). The cost of the machine and the labor to install it are proper additions to the equipment account. The labor costs are capitalized because they are necessary to ready the machine for its intended use. The parts added in rearranging the assembly line are expected to provide future benefits (as stated in the problem), and should therefore also be capitalized. The cost of labor and overhead to rearrange the assembly line is also capitalized, because the problem indicates that the rearrangement resulted in significantly more efficient production.

59

On July 14, year 1, JX Corporation exchanged 1,000 shares of its $8 par value common stock for a plot of land.  JX’s common stock is listed on the NYSE and traded at an average price of $21 per share on July 14. The land was appraised by independent real estate appraisers on July 14 at $23,000. As a result of this exchange, JX’s additional paid-in capital will increase by

  1. $0
  2. $8,000
  3. $13,000
  4. $15,000

$13,000

Since the common stock is listed on the NYSE, its valuation appears to be more clearly determinable than the appraised valuation of the land. Therefore, the value of the common stock (1,000 shares × $21 = $21,000) should be used to measure the transaction. The increase in additional paid-in capital is $21,000 less $8,000 par value of stock, or $13,000. Note that if fair values of the stock and land are considered equally determinable, fair value of the stock is still used as the measurement basis because it is the consideration given in the transaction.

60

Saba Co. bought a tract of land, paying $800,000 in cash and assuming an existing mortgage of $200,000. The municipal tax bill disclosed an assessed valuation of $700,000. How much should Saba record as an asset for this land acquisition?

  1. $600,000
  2. $700,000
  3. $800,000
  4. $1,000,000

$1,000,000

The cost principle requires that assets be recorded at historical cost. The purchased cost is deemed to be an objective measure of fair market value. Therefore, the assessed valuation has no impact on the recorded cost. Historical cost includes all costs incident to the acquisition of the asset. In this case, Saba Co. gave up $800,000 of cash and assumed liabilities of $200,000. The assumption of a liability is the equivalent of a payment of cash. The total amount incurred in acquiring the land was $1,000,000 ($800,000 + $200,000). 

61

A purchased patent has a remaining legal life of 15 years.  It should be

  1. Expensed in the year of acquisition.
  2. Amortized over 15 years regardless of its useful life.
  3. Amortized over its useful life if less than 15 years.
  4. Amortized over 40 years.

Amortized over its useful life if less than 15 years.

Per ASC Topic 350, a patent is to be amortized over its useful life, not to exceed its legal life of 17 years. The remaining legal life of this patent is 15 years. Thus, it should be amortized over 15 years or its useful life, whichever is shorter.

62

An activity that would be expensed currently as research and development costs is the

  1. Adaptation of an existing capability to a particular requirement or customer’s need as a part of continuing commercial activity.
  2. Legal work in connection with patent applications or litigation, and the sale or licensing of patents.
  3. Engineering follow-through in an early phase of commercial production.
  4. Testing in search for or evaluation of product or process alternatives.

Testing in search for or evaluation of product or process alternatives.

Per ASC Topic 730, testing in search for or evaluation of product or process alternatives is an example of research and development, and should be expensed as incurred.

ASC Topic 730 requires R&D costs to be expensed as incurred except for intangibles or fixed assets purchased from others having alternative future uses.  These should be capitalized and amortized over their useful life.  Thus, the cost of patents and R&D equipment purchased from third parties may be deferred and amortized over the asset’s useful life. Internally developed R&D may not be deferred.

Finally, R&D done under contract for others is not required to be expensed per ASC Topic 730.  The costs incurred would be matched with revenue using the completed-contract or percentage-of-completion method.

63

Company N donated computer equipment to a university (a nonreciprocal transfer). The fair value of the computer equipment was determinable. The difference between the fair value of the nonmonetary asset transferred and its recorded amount at the date of donation should be recognized in Company N’s income statement when the difference results in a

  • Gain
  • Loss

  • Gain - YES
  • Loss - YES

ASC Topic 958 states that both gains and losses on nonmonetary, nonreciprocal transfers (donations) are to be recorded. The gain or loss is calculated as the difference between the fair value of the nonmonetary asset transferred and its recorded amount at the date of donation. Gains or losses related to the nonreciprocal transfer of nonmonetary assets are recognized because they have been earned or incurred by the entity at the date of transfer.

64

Which of the following statements is(are) correct about the carrying amount of a long-lived asset after an impairment loss has been recognized? Assume the long-lived asset is being held for use in the business and that the asset is depreciable.

  • I.The reduced carrying amount of the asset may be increased in subsequent years if the impairment loss has been recovered.
  • II.The reduced carrying amount of the asset represents the amount that should be depreciated over the asset’s remaining useful life.

II ONLY.

Per ASC Topic 360, the reduced carrying amount of an asset shall be accounted for as its new cost. Depreciation will reduce the new carrying value over the asset’s remaining useful life.

65

On September 1, year 3, Bertz, Inc. exchanged a delivery truck for a parcel of land.  Bertz bought this truck in year 1 for $10,000.  At September 1, year 3, the truck had a book value of $6,500 and a fair market value of $5,000.  Bertz gave $6,000 in cash in addition to the truck as part of this transaction.  It is expected that the cash flows from the assets will be significantly different.  The previous owner of the land had listed the land for sale at $12,000. At what amount should Bertz record the land?

  1. $11,000
  2. $11,500
  3. $12,000
  4. $12,500

$11,000

Per ASC Topic 845, when the cash flows are significantly different, the transaction has commercial substance and is recorded at fair value.  Both gains and losses are recognized in the exchange.  The solutions approach is to prepare the journal entry to record the trade of the delivery truck for the land.

  • Land 11,000 
  • Accumulated depreciation 3,500 
  • Loss on exchange 1,500 
    • Delivery truck 10,000
    • Cash 6,000

The loss on the exchange of the delivery truck for the land is $1,500 ($6,500 book value − $5,000 fair market value).  The value assigned to the land is the fair value of the asset(s) given up (i.e., the delivery truck [$5,000] plus cash paid [$6,000], or $11,000).

66

When a company purchases land with a building on it and immediately tears down the building so that the land can be used for the construction of a plant, the costs incurred to tear down the building should be

  1. Expensed as incurred.
  2. Added to the cost of the plant.
  3. Added to the cost of the land.
  4. Amortized over the estimated time period between the tearing down of the building and the completion of the plant.

Added to the cost of the land.

In general, an asset should be recorded at the cost of getting it ready for its intended use. If land is purchased with the intention of constructing a building on it, the cost of tearing down an old building on that land is part of the cost of getting the land ready for its intended use and should be added to the cost of that land. This cost attaches to the land and, therefore, should not be depreciated.

67

Land was purchased to be used as the site for the construction of a plant.  A building on the property was sold and removed by the buyer so that construction on the plant could begin.  The proceeds from the sale of the building should be

  1. Classified as other income.
  2. Deducted from the cost of the land.
  3. Netted against the costs to clear the land and expensed as incurred.
  4. Netted against the costs to clear the land and amortized over the life of the plant.

Deducted from the cost of the land.

Generally, any cost involved in preparing land for its ultimate use is considered a cost of the land. In this case, the cost assigned to the land should be the purchase price plus any costs associated with clearing the land and removal of the building (if any) less the proceeds from the sale of the building.

68

Legal fees incurred in successfully defending a patent suit should be capitalized when the patent has been

  • Internally developed
  • Purchased from an inventor

  • Internally developed - YES
  • Purchased from an inventor - YES

Legal fees from a successful defense of a patent suit may be capitalized in the patent account because such a suit establishes the legal rights of the holder. It is irrelevant how the patent was acquired as long as there is ownership.

69

In January year 1, the Under Mine Corporation purchased a mineral mine for $3,400,000 with removable ore estimated by geological surveys at 4,000,000 tons.  The property has an estimated value of $200,000 after the ore has been extracted.  The company incurred $800,000 of development costs preparing the mine for production. During year 1, 400,000 tons were removed and 375,000 tons were sold. What is the amount of depletion that Under Mine should record for year 1?

  1. $375,000
  2. $393,750
  3. $400,000
  4. $420,000

$400,000

The solutions approach is to determine the depletion cost per ton as illustrated below. The $4,000,000 estimated net cost of the mine divided by the 4,000,000 estimated removable tons results in a depletion rate of $1 per ton. Since 400,000 tons were removed, the total depletion cost would be $400,000. Note that depletion cost does not become an expense until the minerals are sold. Since 375,000 tons were sold, there would be an inventory of $25,000 at $1 per ton.

  • Mine cost $3,400,000
  • Development cost + $800,000
  • Salvage value – $200,000
  • Cost to be depleted $4,000,000

Depletion rate = $4,000,000 tons/4,000,000 = $1/ton

70

Which of the following is a research and development cost?

  1. Development or improvement of techniques and processes.
  2. Offshore oil exploration that is the primary activity of a company.
  3. Research and development performed under contract for others.
  4. Market research related to a major product for the company.

Development or improvement of techniques and processes.

ASC Topic 730 identifies specific items which are considered research and development costs. This answer is correct because development or improvement of techniques and processes is included in research and development cost.

71

An impairment loss for long-lived assets which are to be held and used should be reported on the income statement as a(n)

  1. Extraordinary item.
  2. Component of the income or loss from the operations of a discontinued segment.
  3. Cumulative effect of a change in accounting principle.
  4. Component of income from continuing operations before income taxes.

Component of income from continuing operations before income taxes.

Per ASC Topic 360, an impairment loss for assets which are to be held and used should be reported as a component of income from continuing operations before income taxes for entities presenting an income statement.

72

Tomson Co. installed new assembly line production equipment at a cost of $175,000.  Tomson had to rearrange the assembly line and remove a wall to install the equipment.  The rearrangement cost $12,000 and the wall removal cost $3,000.  The rearrangement did not increase the life of the assembly line but it did make it more efficient.  What amount of these costs should be capitalized by Tomson?

  1. $175,000
  2. $178,000
  3. $187,000
  4. $190,000

$190,000

Since the rearrangement costs increased efficiency they should be capitalized along with the cost of the new equipment. $190,000 ($175,000 + $12,000 + $3,000).

73

In year 3, a company incurred $500,000 of legal costs defending several patents. Included in that amount was $400,000 of legal costs associated with successful outcomes and $100,000 of legal costs associated with unsuccessful outcomes. What amount of legal costs, if any, should the company expense for year 3?

  1. $500,000
  2. $400,000
  3. $100,000
  4. $0

$100,000

Only legal costs associated with successful outcomes may be capitalized. Therefore, of the $500,000 in legal costs, $400,000 may be capitalized and $100,000 must be expensed.

74

During the current year, Beta Motor Co. incurred the following costs related to a new solar-powered car:

  • Salaries of laboratory employees researching how to build the new car $250,000
  • Legal fees for the patent application for the new car $20,000
  • Engineering follow-up during the early stages of commercial production (the follow-up occurred during the current year) $50,000
  • Marketing research to promote the new car $30,000
  • Design, testing, and construction of a prototype $400,000

What amount should Beta Motor report as research and development expense in its income statement for the current year?

  1. $250,000
  2. $650,000
  3. $720,000
  4. $750,000

$650,000

Research and development expenses include the salaries of laboratory employees researching how to build the new car (research), and the design, testing, and construction of a prototype (development). The Codification specifically excludes certain items from research and development, such as legal fees for the patent application and engineering follow-up during the early stages of commercial production. The cost of marketing research to promote the new car is a part of advertising expenses. Therefore, this answer is correct because the amount of research and development is $650,000 ($250,000 + $400,000).

75

The required disclosures for the impairment of long-lived assets include all of the following except

  1. The facts and circumstances leading to the impairment.
  2. The amount of the impairment loss and how fair value was determined.
  3. The recommendation of the auditor, signed and dated as of the date of discovery.
  4. The business segment(s) affected, if applicable.

The recommendation of the auditor, signed and dated as of the date of discovery.

Financial statements and the accompanying footnotes are the responsibility of management. Auditors may offer a recommendation, but it would not be required to be disclosed in the footnotes.

76

Yellow Co. spent $12,000,000 during the current year developing its new software package.  Of this amount, $4,000,000 was spent before it was at the application development stage and the package was only to be used internally.  The package was completed during the year and is expected to have a four-year useful life. Yellow has a policy of taking a full-year’s amortization in the first year.  After the development stage, $50,000 was spent on training employees to use the program. What amount should Yellow report as an expense for the current year?

  1. $1,600,000
  2. $2,000,000
  3. $6,012,500
  4. $6,050,000

$6,050,000

Per ASC Subtopic 350-4, software costs of $4,000,000 are considered to be at the preliminary project stage and should be expensed as incurred in the current year. The remaining $8,000,000 is capitalized and amortized over its four-year life ($8,000,000/4 years = $2,000,000 per year). The $50,000 spent on training employees is expensed during the current year. Therefore, the total amount expensed in the current year is $4,000,000 + $2,000,000 + $50,000 = $6,050,000, and this answer is correct.

77

Derby Co. incurred costs to modify its building and to rearrange its production line. As a result, an overall reduction in production costs is expected. However, the modifications did not increase the building’s market value, and the rearrangement did not extend the production line’s life. Should the building modification costs and the production line rearrangement costs be capitalized?

  • Building
  • Production line rearrangement costs

  • Building - YES
  • Production line rearrangement costs - YES

A cost should be capitalized if it improves the efficiency of the asset or extends its useful life. An overall reduction in production costs is expected, so it appears that both the building modification and the production line rearrangement contributed to improved efficiency in the production process.

78

Scott Co. exchanged similar nonmonetary assets with Dale Co.  No cash was exchanged.  The carrying amount of the asset surrendered by Scott exceeded both the fair value of the asset received and Dale’s carrying amount of that asset.  If the transaction lacks commercial substance, Scott should recognize the difference between the carrying amount of the asset it surrendered and

  1. The fair value of the asset it received as a loss.
  2. The fair value of the asset it received as a gain.
  3. Dale’s carrying amount of the asset it received as a loss.
  4. Dale’s carrying amount of the asset it received as a gain.

The fair value of the asset it received as a loss.

Per ASC Topic 845, exchanges that lack commercial substance are accounted for at book value. Although ASC Topic 845 prohibits recognition of a gain on these exchanges, it requires the recognition of any loss. Since the carrying value of the asset surrendered by Scott exceeds the fair market value of the asset received, Scott realized a loss on this exchange. Scott should value the asset received at its fair market value. The difference between the carrying amount of the asset surrendered and its fair market value (measured by the fair market value of the asset received in this case) should be recognized as a loss.

79

On June 30, 2005, Finn, Inc. exchanged 2,000 shares of Edlow Corp. $30 par value common stock for a patent owned by Bisk Co. The Edlow stock was acquired in 2003 at a cost of $50,000. 
At the exchange date, Edlow common stock had a fair value of $40 per share, and the patent had a net carrying amount of $100,000 on Bisk's books.

Finn should record the patent at

  1. $50,000.
  2. $60,000.
  3. $80,000
  4. $100,000

$80,000.

The patent is valued at the market value of the stock exchanged, which is $80,000 ($40 x 2,000 shares).

In general, the recorded value of purchased intangibles is the value of the consideration given or the value of the intangible, whichever is more reliable. The book value of the seller is not a reliable substitute for market value. There is no reliable amount given for the market value of the patent.

80

Which of the following statements describes the proper accounting for losses when nonmonetary assets are exchanged for other nonmonetary assets?

  1. A loss is recognized immediately, because assets received should not be valued at more than their cash-equivalent price.
  2. A loss is deferred so that the asset received in the exchange is properly valued.
  3. A loss, if any, which is unrelated to the determination of the amount of the asset received should be recorded.
  4. A loss can occur only when assets are sold or disposed of in a monetary transaction.

A loss is recognized immediately, because assets received should not be valued at more than their cash-equivalent price.

The loss recognized on the exchange equals the book value of the asset transferred less its fair value at the time of the exchange. The fair value is less than book value. The amount recorded for the asset acquired is its fair value, or the fair value of the asset transferred plus or minus cash paid or received, whichever is more reliably determinable. By using the lower fair value of the asset transferred to measure the value of the asset acquired, the asset acquired will not be overstated above its fair value.

81

Which of the following statements correctly describes the proper accounting for nonmonetary exchanges that are deemed to have commercial substance?

A.  It defers any gains and losses.

B.  It defers losses to the extent of any gains.

C.  It recognizes gains and losses immediately.

Gains and losses from nonmonetary exchanges that have commercial substance are recognized immediately.

D.  It defers gains and recognizes losses immediately.

It recognizes gains and losses immediately.

Gains and losses from nonmonetary exchanges that have commercial substance are recognized immediately.

82

Bensol Co. and Sable Co. exchanged similar trucks with fair values in excess of carrying amounts. In addition, Bensol paid Sable to compensate for the difference in truck values. 
The exchange has commercial substance.

As a consequence of the exchange, Sable recognizes

  1. A gain equal to the difference between the fair value and carrying amount of the truck given up.
  2. A gain determined by the proportion of cash received to the total consideration.
  3. A loss determined by the proportion of cash received to the total consideration.
  4. Neither a gain nor a loss.

A gain equal to the difference between the fair value and carrying amount of the truck given up.

With commercial substance, the exchange is measured at fair value. The full gain is recognized and is equal to the difference between the fair value of the asset given up and its book value.

For example, assume the following values: new asset fair value 20, old asset fair value 26, cash received 6, old asset cost 30, old asset accumulated depreciation 9. The full entry is: dr. New Truck 20; dr. Accumulated Depreciation 9; dr. Cash 6; cr. Old Truck 30; cr. Gain 5.

The gain equals the old asset's fair value of 26 and its book value of 21 (30 - 9).

83

During 2004, Beam Co. paid $1,000 cash and traded inventory, which had a carrying amount of $20,000 and a fair value of $21,000, for other inventory in the same line of business with a fair value of $22,000. 
The exchange was made to facilitate sales to their respective customers.

What amount of gain (loss) should Beam record related to the inventory exchange?

  1. $2,000
  2. $1,000
  3. $0
  4. ($1,000)

$0

There is a $1,000 gain inherent in the transfer of the old (Beam's) inventory item (fair value of $21,000 - carrying amount of $20,000). If Beam's item were sold, gross profit of $1,000 would result. However, under GAAP, exchanges of inventory made to facilitate sales are an exception to fair value measurement. Therefore, no gain or loss is recognized and the inventory received is valued at the book value of the inventory given up plus cash paid, for a total of $21,000. This amount is $1,000 less than the new inventory's fair value because the $1,000 gain is disallowed.

84

Vik Auto and King Clothier exchanged goods, held for resale, with equal fair values. Each will use the other's goods to promote their own products. The retail price of the car that Vik gave up is less than the retail price of the clothes received.
There is commercial substance to the exchange.

What profit should Vik recognize for the nonmonetary exchange?

  1. A profit is not recognized.
  2. A profit equal to the difference between the retail prices of the clothes received and the car.
  3. A profit equal to the difference between the retail price and the cost of the car.
  4. A profit equal to the difference between the fair value and the cost of the car.

A profit equal to the difference between the fair value and the cost of the car.

The profit (a gain) to Vik is the difference between its fair value and its cost or carrying value. This exchange has commercial substance and was not made solely to facilitate sales. Rather, the exchange was made for promotional purposes.

85

On December 31, 2005, Vey Co. traded equipment with an original cost of $100,000 and accumulated depreciation of $40,000 for productive equipment with a fair value of $60,000. 
In addition, Vey received $30,000 cash in connection with this exchange. There is commercial substance to the exchange.

What should be Vey's carrying amount for the equipment received at December 31, 2005?

  1. $30,000
  2. $40,000
  3. $60,000
  4. $80,000

$60,000

When there is commercial substance to the exchange, the acquired asset is measured at fair value. In this case, the value is $60,000 as given in the problem. This amount also equals the fair value of assets given up in the exchange. The implied fair value of the asset exchanged is $60,000 + $30,000 cash received, or $90,000. The fair value of assets given up is therefore $90,000 less $30,000 cash received, or $60,000.

The full journal entry for the exchange is:

  • dr. plant asset 60,000;
  • dr. accumulated depreciation, 40,000;
  • debit cash 30,000;
    • credit plant asset 100,000;
    • credit gain, 30,000.

The gain equals the difference between the fair value of the asset exchanged (90,000) and its book value (60,000).

86

A company exchanged land with an appraised value of $50,000 and an original cost of $20,000 for machinery with a fair value of $55,000. Assuming that the transaction has commercial substance, what is the gain on the exchange?

  1. $0
  2. $5,000
  3. $30,000
  4. $35,000

$30,000

The gain on an exchange of nonmonetary assets is based on the fair value and book value of the asset exchanged. The land with a fair value of $50,000 is given for machinery. The company is using the land as legal tender. The gain will be the difference between the book value and the fair value of the asset given or $50,000 - $20,000 = $30,000.

87

Markson Co. traded a concrete-mixing truck with a book value of $10,000 to Pro Co. for a cement-mixing machine with a fair value of $11,000. Markson needs to know the answer to which of the following questions in order to determine whether the exchange has commercial substance?

  1. Does the book value of the asset given up exceed the fair value of the asset received?
  2. Is the gain on the exchange less than the increase in future cash flows?
  3. Are the future cash flows expected to change significantly as a result of the exchange?
  4. Is the exchange nontaxable?

Are the future cash flows expected to change significantly as a result of the exchange?

The critical factor as to whether there is commercial substance in an exchange is when there is a significant change in the cash flows related to the asset exchanged.

88

May Co. and Sty Co. exchanged nonmonetary assets. The exchange did not culminate an earning process for either May or Sty (the exchange lacked commercial substance). May paid cash to Sty in connection with the exchange.

The book value of the asset exchanged exceeded its fair value for both firms. Therefore, a loss on the exchange should be recognized by

  • May
  • Sty

  • May - YES
  • Sty - YES

The fair value of each asset is less than book value implying that both firms have a loss. Losses are recognized in full regardless of whether there is commercial exchange.

89

Campbell Corp. exchanged delivery trucks with Highway, Inc. Campbell's truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway's truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received?

  1. $5,700
  2. $5,000
  3. $3,700
  4. $3,000

$3,700

When a transaction lacks commercial substance and cash is paid, the new asset is recorded at the book value of the old asset plus any cash given. Campbell has the same economic position as before the exchange - a different truck used in the same manner and $700 less cash. The new truck is the BV of the old asset ($3,000) plus the cash paid ($700) or $3,700.

90

Solen Co. and Nolse Co. exchanged trucks with fair values in excess of carrying amounts. In addition, Solen paid Nolse to compensate for the difference in truck values. 
The exchange lacks commercial substance.

As a consequence of the exchange, Solen recognizes

  1. A gain equal to the difference between the fair value and carrying amount of the truck given up.
  2. A gain determined by the proportion of cash paid to the total consideration.
  3. A loss determined by the proportion of cash paid to the total consideration.
  4. Neither a gain nor a loss.

Neither a gain nor a loss.

Solen has an implied gain given that the fair value of its asset exceeds its book value. But when there is no commercial substance, such gains are recognized only when cash is received. Solen paid cash on the exchange.

91

Amble, Inc. exchanged a truck with a carrying amount of $12,000 and a fair value of $20,000 for a truck and $5,000 cash. The fair value of the truck received was $15,000.

At what amount should Amble record the truck received in the exchange assuming the exchange lacks commercial substance?

  1. $7,000
  2. $9,000
  3. $12,000
  4. $15,000

$15,000

There is an implied gain of $8,000, the difference between the $20,000 fair value of the old asset and its $12,000 book value. Because the proportion of cash received is 25% ($5,000/$20,000), the entire gain is recognized and the acquired asset is recognized at fair value ($15,000).

Note that the answer would be the same had there been commercial substance.

92

Hudson Corp. operates several factories that manufacture medical equipment. The factories have a historical cost of $200 million. Near the end of the company's fiscal year, a change in business climate related to a competitor's innovative products indicated to Hudson's management that the $170 million carrying amount of the assets of one of Hudson's factories may not be recoverable. Management identified cash flows from this factory and estimated that the undiscounted future cash flows over the remaining useful life of the factory would be $150 million. The fair value of the factory's assets is reliably estimated to be $135 million. The change in business climate requires investigation of possible impairment. Which of the following amounts is the impairment loss?

  1. $15 million
  2. $20 million
  3. $35 million
  4. $65 million

$35 million

Impairment occurs when the carrying amount of a long-lived asset or asset group exceeds its fair value. An impairment loss is recorded on that difference if the carrying value of the asset is not recoverable. The carrying value is not recoverable if its carrying value exceeds the sum of the expected value of undiscounted cash flows from use of the asset. This answer is correct because it compares the carrying amount of the equipment to its fair value ($170 m − $135 m = $35 m) and the carrying value is not recoverable ($170m >$150m).

93

During year 1, Burr Co. had the following transactions pertaining to its new office building:

  • Purchase price of land $60,000
  • Legal fees for contracts to purchase land $2,000
  • Architects’ fees $8,000
  • Demolition of old building on site $5,000
  • Sale of scrap from old building $3,000
  • Construction cost of new building (fully completed) $350,000

In Burr’s December 31, year 1 balance sheet, what amounts should be reported as the cost of land and cost of building?

  • Land
  • Building

  • Land - $64,000
  • Building - $358,000

Any cost involved in preparing land for its ultimate use (such as an office building site) is considered part of the cost of the land. Before the land can be used as a building site, it must be purchased and the old building must be razed. Therefore, the cost of the land is $64,000.

  • Purchase price $60,000
  • Legal fees $2,000
  • Demolition of old building $5,000
  • Sale of scrap ($3,000)
  • Cost of land $64,000

Note that the proceeds from the sale of scrap is a reduction of the cost of the land, because it reduces the net cost of razing the old building. The other costs given in the problem are properly considered costs of completing the factory building.

  • Architects’ fees $8,000
  • Construction cost $350,000
  • Cost of building $358,000

94

On December 31, year 1, the New Bite Company had capitalized costs for a new computer software product with an economic life of 4 years.  Sales for year 2 were 10% of expected total sales of the software.  At December 31, year 2, the software had a net realizable value equal to 80% of the capitalized cost.  The unamortized cost reported on the December 31, year 2 balance sheet should be

  1. Net realizable value.
  2. 90% of net realizable value.
  3. 75% of capitalized cost.
  4. 90% of capitalized cost.

75% of capitalized cost.

Per ASC 985, the annual amortization of capitalized software costs shall be the greater of

  1. The ratio of the software’s current sales to its expected total sales,   
  2. The straight-line method over the economic life of the product.

In this case, the ratio of current to expected total sales is 10% (given).  The annual straight-line rate is 25% per year (1/economic life of 4 years).  The straight-line amortization should be used in year 2, since it is the higher of the two. The unamortized cost on the 12/31/Y2 balance sheet should, therefore, be 75% (100% − 25% amortization).

95

Young Corp. purchased equipment by making a down payment of $4,000 and issuing a note payable for $18,000.  A payment of $6,000 is to be made at the end of each year for three years.  The applicable rate of interest is 8%.  The present value of an ordinary annuity factor for three years at 8% is 2.58, and the present value for the future amount of a single sum of one dollar for three years at 8% is .735.  Shipping charges for the equipment were $2,000, and installation charges were $3,500.  What is the capitalized cost of the equipment?

  1. $19,480
  2. $21,480
  3. $24,980
  4. $27,500

$24,980

Young should capitalize all costs to place the asset in its intended and useful state. The fair value of the equipment is calculated by adding the down payment to the present value of the note payable. The fair value of the equipment is $4,000 + (2.58 × $6,000) = $19,480. The shipping charges and installation charges should also be capitalized. Therefore, the total capitalized cost of the equipment is $24,980 ($19,480 + $2,000 + $3,500).

96

During November year 1, Ball Company determined, as a result of a plant rearrangement, that there had been a significant change in the manner in which its machinery was going to be used in its manufacturing process.  In December year 1, Ball’s analysis of the future cash flows related to the machinery resulted in the following information:

  • Expected future cash inflows from use of the machinery$350,000
  • Expected future cash outflows from use of the machinery75,000
  • Expected future cash proceeds from sale of the machinery at the disposal date50,000

For purposes of determining whether or not Ball should recognize an impairment loss in year 1, what is the amount of expected future cash flows that would be used for Ball’s machinery?

  1. $350,000
  2. $400,000
  3. $275,000
  4. $325,000

$325,000

The expected cash flows from Ball’s machinery are computed in the following way:

  • Expected future cash inflows from use of the machinery $350,000
  • Expected proceeds from disposal of the machinery $50,000
  • Less the expected cash outflows from use of the machinery ($75,000)
  • = Expected cash flows for determining impairment loss $325,000

97

Company A and Company B exchanged nonmonetary assets with no monetary consideration involved and no impairment of value.  The exchange did not result in the cash flows of the new asset being significantly different than the cash flows of the old asset.  The accounting should be based on the

  1. Recorded amount of the asset received.
  2. Recorded amount of the asset relinquished.
  3. Fair value of the asset received.
  4. Fair value of the asset relinquished.

Recorded amount of the asset relinquished.

When nonmonetary assets are exchanged with no monetary consideration involved, no gain is recognized if the transaction lacks commercial substance. When the cash flows are not significantly different, the transaction is deemed to lack commercial substance. Therefore, the accounting for such an exchange must be based on the recorded amount of the asset relinquished (ASC Topic 845).

98

A lessee incurred costs to construct walkways to improve leased property.  The estimated useful life of the walkways is 15 years. The remaining term of the nonrenewable lease is 20 years.  The walkway costs should be

  1. Capitalized as leasehold improvements and depreciated over 20 years.
  2. Capitalized as leasehold improvements and depreciated over 15 years.
  3. Capitalized as leasehold improvements and expensed in the year in which the lease expires.
  4. Expensed as incurred.

Capitalized as leasehold improvements and depreciated over 15 years.

Leasehold improvements are properly capitalized and amortized over the remaining life of the lease, or the useful life of the improvements, whichever is shorter. Since the useful life of the walkways is only 15 years and the remaining term of the lease is 20 years, the cost should be depreciated over the 15-year period.

99

A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?

  1. $0
  2. $5,000
  3. $15,000
  4. $20,000

$0

An impairment occurs when the carrying amount of a long-lived asset exceeds its fair value. However, an impairment loss is only recognized if the carrying amount of the asset is not recoverable. The carrying value is considered not recoverable if it exceeds the sum of the expected value of the undiscounted cash flows of the asset. Since the undiscounted expected future cash flows are $130,000, and the carrying value is $120,000, the company will not report an impairment loss.

100

The following expenditures relating to the plant building were made by Pine Company during the year ended December 31, year 1:

  • Replacement of the old shingle roof with a fireproof tile roof $75,000
  • Repainted the plant building $5,000
  • Major improvements to the electrical wiring system $35,000

How much should be capitalized in year 1?

  1. $35,000
  2. $75,000
  3. $110,000
  4. $115,000

$110,000

Generally, an expenditure should be capitalized if it increases the original useful life of an asset or increases either the quantity or quality of services. If none of these three criteria are met, the expenditure shall be expensed because it merely maintains the asset at its current level. The old shingle roof was replaced with a fireproof tile roof; thus, the $75,000 should be capitalized. Similarly, the $35,000 cost of major improvements to the electrical wiring system should be capitalized. However, the cost of repainting the plant building ($5,000) should be expensed since it is an ordinary, regularly occurring expenditure which maintains the plant, rather than increasing either the quantity or quality of service to be provided by the plant. Therefore, the total cost capitalized is $110,000 ($75,000 + $35,000).

101

A private company that chooses to apply private company guidance must measure goodwill impairment using:

  1. A two-step impairment approach
  2. No approach—goodwill is not examined for impairment.
  3. The same approach required for public companies.
  4. An approach where the private company uses a hypothetical application of the acquisition method.

An approach where the private company uses a hypothetical application of the acquisition method.

Although private companies may choose to use the same approach required for public companies (two-step approach), if private company guidance is adopted, the private company will examine goodwill for impairment using an approach where the private company uses a hypothetical application of the acquisition method.

102

Standard Co. spent $10,000,000 on its new software package that is to be used only for internal use.  The amount spent is for costs after the application development stage.  The economic life of the product is expected to be three years.  The equipment on which the package is to be used is being depreciated over five years. What amount of expense should Standard report on its income statement for the first full year?

  1. $0
  2. $2,000,000
  3. $3,333,333
  4. $10,000,000

$3,333,333

According to ASC Subtopic 350-40, costs of internally developed software after the development stage may be capitalized and amortized over the asset’s economic life.  The software should be recorded at cost and amortized over its useful life of three years.  Therefore, the amount of expense for the first full year would be $10,000,000 ÷ 3 years = $3,333,333. Therefore, this answer is correct.

103

Shaw Company purchased a machine on January 1, year 1, for $350,000. The machine has an estimated useful life of 5 years and a salvage value of $50,000.  The machine is being depreciated using the double-declining balance method.  The asset balance net of accumulated depreciation at December 31, year 2, should be

  1. $126,000
  2. $158,000
  3. $170,000
  4. $224,000

$126,000

The double-declining balance (DDB) method depreciates assets at twice the straight-line rate. The straight-line rate is 20% (100%/5 years).  Thus, the DDB rate is 40% (20% × 2).  The salvage value is not relevant when using DDB.  Under this method the applicable percentage is applied to the asset’s beginning-of-the-year book value (cost-accumulated depreciation). Depreciation expense for the first 2 years is

  • Year 1: ($350,000) × (40%) $140,000
  • Year 2: ($350,000 -$140,000) $84,000

Thus, the net book value at 12/31/Y2 is the cost ($350,000) less the accumulated depreciation at 12/31/Y2 ($140,000 + $84,000) = $126,000.

104

Veronica Corp. uses the revaluation model for intangible assets.  On March 1, year 1, Veronica acquired intangible assets with an indefinite life for $200,000.  On December 31, year 1, it was determined that the recoverable amount for these intangible assets was $180,000.  On December 31, year 2, it was determined that the intangible assets had a recoverable amount of $187,000.  How should Veronica recognize the gain or loss in the December 31, year 2 financial statements?

  1. Gain on the income statement of $7,000.
  2. Loss on the income statement of $20,000.
  3. Unrealized gain in other comprehensive income of $7,000.
  4. Unrealized loss in other comprehensive income of $20,000.

Unrealized gain in other comprehensive income of $7,000.

The revaluation model recognizes gains and losses in other comprehensive income for the period.

105

Grey Company purchased a machine on January 1, year 1, for $500,000.  The machine has an estimated useful life of 5 years and a salvage value of $50,000.  Depreciation was computed by the 150% declining balance method.  The accumulated depreciation balance at December 31, year 2, should be

  1. $180,000
  2. $229,500
  3. $245,000
  4. $255,000

$255,000

Salvage value is ignored when using a DB approach.  The formula for 150% DB depreciation is 150% of the straight-line rate multiplied by the beginning-of-the-year book value.  Since the straight-line rate is 20% (100%/5 years), the DB rate is 30% (150% × 20%).  The book value for the first year is $500,000 (original cost).  Therefore, year 1 depreciation is $150,000 ($500,000 cost × 30%).  The book value for the second year is $350,000 ($500,000 original cost – $150,000 accumulated depreciation).  Therefore, year 2 depreciation is $105,000 ($350,000 × 30%).  The total accumulated depreciation at 12/31/Y2 is $255,000 ($150,000 + $105,000).

106

A machine with a 4-year estimated useful life and an estimated 15% salvage value was acquired on January 1, year 1.  On December 31, year 3, the accumulated depreciation using the sum-of-the-years’ digits method would be

  1. (Original cost less salvage value) multiplied by 9/10.
  2. Original cost multiplied by 9/10.
  3. Original cost multiplied by 9/10 less total salvage value.
  4. (Original cost less salvage value) multiplied by 1/10.

(Original cost less salvage value) multiplied by 9/10.

When using sum-of-the-years’ digits depreciation, the amount of depreciation taken over the life of the asset is determined by multiplying original cost less salvage value by the following fraction:

  • SYD depr. = Number of years of remaining asset life / n(n + 1)/2

(Where n = original years of useful life of the asset) For an asset with a 4-year life (n = 4), the denominator is 10.  Therefore, in the first 3 years of the asset’s life (January 1, year 1 through December 31, year 3), depreciation of 4/10, 3/10, and 2/10 of the original cost of the machine less its salvage value will be accumulated for a total of 9/10.

107

On August 1, year 1, Bamco Corporation purchased a new machine on a deferred payment basis. A down payment of $1,000 was made and 4 monthly installments of $2,500 each are to be made beginning on September 1, year 1.  The cash equivalent price of the machine was $9,500.  Bamco incurred and paid installation costs amounting to $300. The amount to be capitalized as the cost of the machine is

  1. $9,500
  2. $9,800
  3. $11,000
  4. $11,300

$9,800

The total of the payments made by Bamco for the machine was $11,000 (4 payments of $2,500 + $1,000 down payment).  However, the cash equivalent price of the machine was $9,500.  The difference of $1,500 ($11,000 – $9,500) is considered interest and is not capitalized because it is ready for use when acquired. In addition, the $300 installation cost is capitalized, as all costs required to get goods in their operating condition and location should be capitalized.  Thus the total cost of the machine is $9,800 ($9,500 + $300).

108

During year 1, Jase Co. incurred research and development costs of $136,000 in its laboratories relating to a patent that was granted on July 1, year 1.  Costs of registering the patent equaled $34,000.  The patent’s legal life is 17 years, and its estimated economic life is 10 years.  In its December 31, year 1 balance sheet, what amount should Jase report as patent, net of accumulated amortization?

  1. $32,300
  2. $33,000
  3. $161,500
  4. $165,000

$32,300

Per ASC Topic 730, all research and development (R&D) costs must be expensed in the period in which they are incurred, because it is difficult to associate these costs with particular achievements and to identify the amount of future benefits and the time period over which those benefits will be realized.  Therefore, the R&D costs of $136,000 would be expensed, and the patent would be recorded at the direct cost of acquiring it ($34,000) on 7/1/Y1.  At 12/31/Y1, amortization would be recorded for 6 months (7/1 to 12/31) based on the estimated economic life of 10 years. The legal life of 17 years is not used because the patent will provide future benefits to Jase for only 10 years. Therefore, year 1 amortization is $1,700 ($34,000 × 1/10 × 6/12) and the 12/31/Y1 net book value of the patent is $32,300 ($34,000 – $1,700).

109

Stam Co. incurred the following research and development project costs during the current year:

  • Equipment purchased for current and future projects $100,000
  • Equipment purchased for current projects only $200,000
  • Research and development salaries for current projects $400,000
  • Legal fees to obtain patent $50,000
  • Material and labor costs for prototype product $600,000

The equipment has a five-year useful life and is depreciated using the straight-line method. What amount should Stam recognize as research and development expense at year-end?

  1. $450,000
  2. $1,000,000
  3. $1,220,000
  4. $1,350,000

$1,220,000

ASC Topic 730 requires equipment purchased for current and future periods to be allocated to the periods in which the assets are used. Therefore, $20,000 ($100,000/5) would be allocated to the current year. Equipment purchased for current research and development projects should be expensed as R&D. Research and development salaries, and material and labor costs for prototype products are also classified as R&D and expensed. Legal fees to obtain a patent are not considered part of R&D. Therefore, the total R&D at year-end is equal to $1,220,000 ($20,000 + $200,000 + $400,000 + $600,000).

110

In an arm’s-length transaction, Company A and Company B exchanged nonmonetary assets with no monetary consideration involved.  The exchange was deemed to have commercial substance for both Company A and Company B, and the fair values of the nonmonetary assets were both clearly evident.  The accounting for the exchange should be based on the

  1. Fair value of the asset surrendered.
  2. Fair value of the asset received.
  3. Recorded amount of the asset surrendered.
  4. Recorded amount of the asset received.

Fair value of the asset surrendered.

An exchange of nonmonetary assets that has commercial substance is recorded at the fair value of the asset surrendered (ASC 845).

111

A manufacturing firm purchased used equipment for $135,000. The original owners estimated that the residual value of the equipment was $10,000. The carrying amount of the equipment was $120,000 when ownership transferred.  The new owners estimate that the expected remaining useful life of the equipment was 10 years, with salvage value of $15,000. What amount represents the depreciable base used by the new owners?

  1. $105,000
  2. $110,000
  3. $120,000
  4. $125,000

$120,000

The depreciable base is calculated as historical cost to the new owners less the estimated salvage value determined by the new owners. Therefore, this answer is correct, because the depreciable base is equal to $120,000 ($135,000 – $15,000). The carrying value and estimated residual value to the previous owner are ignored.

112

On June 30, year 3, Finn, Inc. exchanged 2,000 shares of Edlow Corp. $30 par value common stock for a patent owned by Bisk Co. The Edlow stock was acquired in year 1 at a cost of $50,000.  At the exchange date, Edlow common stock had a fair value of $40 per share, and the patent had a net carrying amount of $100,000 on Bisk’s books.  Assuming that the transaction has commercial substance, Finn should record the patent at

  1. $50,000
  2. $60,000
  3. $80,000
  4. $100,000

$80,000

Generally, noncurrent assets acquired in a noncash transaction should be recorded at fair value of the consideration given (common stock), unless fair value of the asset acquired (patent) is more clearly determinable. Fair value of the stock given is therefore the correct value to assign to the patent received (2,000 shares × $40 per share = $80,000).

113

Which of the following research and development related costs should be capitalized and amortized over current and future periods?

  1. Research and development general laboratory building.
  2. Inventory used for a specific research project.
  3. Administrative salaries allocated to research and development.
  4. Research findings purchased from another company to aid a particular research project currently in process.

Research and development general laboratory building.

Per ASC Topic 730 all R&D costs are expensed except equipment or facilities that are acquired for R&D and have alternative future uses. Such costs would be capitalized and amortized. Presumably a general laboratory building would have alternative future uses and should be capitalized and amortized.

114

Cart Co. purchased an office building and the land on which it is located for $750,000 cash and an existing $250,000 mortgage. For realty tax purposes, the property is assessed at $960,000, 60% of which is allocated to the building.  At what amount should Cart record the building?

  1. $500,000
  2. $576,000
  3. $600,000
  4. $960,000

$600,000

The office building and the land are a lump-sum purchase. The acquisition cost of both the land and the building is equal to the cash paid plus the mortgage assumed, $750,000 + $250,000 = $1,000,000.  Since 60% of the assessed value can be allocated to the building, 60% of the amount paid ($1,000,000 × 60% = $600,000) should be allocated to the building account.  Therefore, this answer is correct.

115

On January 1, Feld traded a delivery truck and paid $10,000 cash for a tow truck owned by Baker.  The delivery truck had an original cost of $140,000, accumulated depreciation of $80,000, and an estimated fair value of $90,000.  Feld estimated the fair value of Baker’s tow truck to be $100,000. The transaction had commercial substance. What amount of gain should be recognized by Feld?

  1. $0
  2. $3,000
  3. $10,000
  4. $30,000

$30,000

The fair value of the delivery truck, $90,000, less the book value of the truck, $60,000 on the date of disposition, equals the gain on disposition of the delivery truck of $30,000. The requirement is to determine the amount of gain that should be recognized. If a nonmonetary transaction has commercial substance, a gain or loss should be recognized on the exchanged asset. The delivery truck had an original cost of $140,000 and accumulated depreciation of $80,000. The book value of the delivery truck is calculated as original cost less accumulated depreciation, or $60,000 ($140,000 − $80,000).

116

Assume a private firm elects to adopt ASU 2014-08: Business Combinations: Accounting for Intangible Assets in a Business Combination. Noncompetition agreements:

  1. Must be separately measured as an intangible asset apart from goodwill.
  2. May be excluded from both intangible asset and goodwill accounting.
  3. Must be measured and included within goodwill.
  4. May be measured and included within goodwill.

May be measured and included within goodwill.

ASU 2014-18 allows (not requires) private firms, in a business combination, to measure noncompetition agreements as part of goodwill.

117

May Co. and Sty Co. exchanged nonmonetary assets. The exchange did not result in a significant difference in cash flows for either company. May paid cash to Sty in connection with the exchange. To the extent that the amount of cash exceeds a proportionate share of the carrying amount of the asset surrendered, a realized gain on the exchange should be recognized by

  • May
  • Sty

  • May - NO
  • Sty - YES

Per ASC Topic 845, when a nonmonetary exchange transaction does not result in a significant difference in cash flows, the book value is used to record the transaction. However, when the exchange of nonmonetary assets includes an amount of monetary consideration, the receiver of monetary consideration has realized a partial gain on the exchange. To determine the partial gain to be recognized, first compute the total gain which is the difference between the fair market value of the nonmonetary asset given up and its book value. Then multiply the ratio of the monetary consideration received to the total consideration received (i.e., monetary consideration plus the estimated fair market value of the asset received) times the total gain. The result is the realized gain to be recognized. The entity paying the monetary consideration should not recognize any gain. Note, however, that all losses on sales or exchanges are recognized immediately.

118

Slate Co. and Talse Co. exchanged similar plots of land with fair values in excess of carrying amounts.  In addition, Slate received cash from Talse to compensate for the difference in land values.  The cash flows of the plots of land are not expected to be significantly different.  As a result of the exchange, Slate should recognize

  1. A gain equal to the difference between the fair value and the carrying amount of the land given up.
  2. A gain in an amount determined by the ratio of cash received to total consideration.
  3. A loss in an amount determined by the ratio of cash received to total consideration.
  4. Neither a gain nor a loss.

A gain in an amount determined by the ratio of cash received to total consideration.

ASC 845 states that when the exchange of nonmonetary assets lacks commercial substance and includes a cash payment (boot), the entity which received cash has realized a partial gain on the exchange. To compute the partial gain to be recognized, first the total gain is computed by subtracting the book value of the nonmonetary asset given up from its fair value. This total gain is then multiplied by the ratio of the cash received to the total consideration received (Cash + FMV of nonmonetary asset received). In this case, since Slate received cash, it would recognize a partial gain as described above.

119

In January year 1, Huff Mining Corporation purchased a mineral mine for $3,600,000 with removable ore estimated by geological surveys at 2,160,000 tons. The property has an estimated value of $360,000 after the ore has been extracted.  Huff incurred $1,080,000 of development costs preparing the property for the extraction of ore.  During year 1, 270,000 tons were removed and 240,000 tons were sold. For the year ended December 31, year 1, Huff should include what amount of depletion in its cost of goods sold?

  1. $360,000
  2. $405,000
  3. $480,000
  4. $540,000

$480,000

The depletion charge per unit is the net cost of the resource divided by the estimated units of the resource.  The net cost of the resource is $4,320,000.

  • Cost of mine$3,600,000
  • Development costs1,080,000
  • Residual value(360,000)
  • Net Cost$4,320,000


Therefore the depletion charge is $2.00 per ton ($4,320,000 ÷ 2,160,000 tons).  Since 240,000 tons were sold, $480,000 of depletion (240,000 × $2.00) is included in cost of goods sold.  Note that $60,000 [(270,000 tons – 240,000 tons) × $2.00] of depletion would be included in inventory. Total depletion on both the cost of goods sold and inventory would be $540,000.

120

Cantor Co. purchased a coal mine for $2,000,000. It cost $500,000 to prepare the coal mine for extraction of the coal.  It was estimated that 750,000 tons of coal would be extracted from the mine during its useful life.  Cantor planned to sell the property for $100,000 at the end of its useful life. During the current year, 15,000 tons of coal were extracted and sold.  What would be Cantor’s depletion amount per ton for the current year?

  1. $2.50
  2. $2.60
  3. $3.20
  4. $3.30

$3.20

Cantor should capitalize all costs to prepare the mine for extraction. Cantor would then calculate the depletion rate as the cost minus residual value divided by the estimated units of output. Therefore, the depletion amount per ton would be ($2,000,000 + $500,000 – $100,000)/$750,000 tons = $3.20 per ton.

121

Mark Co. bought a franchise from Fred Co. on January 1, year 1, for $204,000.  An independent consultant retained by Mark estimated that the remaining useful life of the franchise was 50 years. Its unamortized cost on Fred’s books at January 1, year 1, was $68,000.  Mark has decided to amortize the franchise over the maximum period allowed.  What amount should be amortized for the year ended December 31, year 1?

  1. $5,100
  2. $4,080
  3. $4,000
  4. $1,700

$4,080

Mark Co. would record the franchise at its cost of $204,000.  The unamortized cost on the seller’s books ($68,000) is irrelevant to the buyer.  The franchise is amortized over 50 years ($4,080 [$4,080 ÷ 50]).

122

An impairment loss for a long-lived asset, which is being used in the operations of a business, is measured by the excess of the asset’s carrying amount over its

  1. Expected undiscounted selling price, less expected costs of disposal.
  2. Fair value.
  3. Expected undiscounted future cash flows from use and disposal.
  4. Fair value less cost to sell.

Fair value.

ASC Topic 360 explains that an impairment loss shall be measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. The fair value of an asset is determined by the guidelines set in ASC Topic 820. Fair value is determined by using the principal or most advantageous market and assumes the asset is used in its highest and best use.

123

In October year 1 Ewing Company exchanged an old packaging machine, which cost $120,000 and was 50% depreciated, for a dissimilar used machine and paid a cash difference of $16,000.  The market value of the old packaging machine was determined to be $70,000.  The two machines are expected to have significantly different cash flows.  For the year ended December 31, year 1, what amount of gain or loss should Ewing recognize on this exchange?

  1. $0.
  2. $ 6,000 loss.
  3. $10,000 loss.
  4. $10,000 gain.

$10,000 gain.

Per ASC Topic 845, when the cash flows of the assets are expected to be significantly different, the transaction has commercial substance and is recorded at fair value. In this transaction, an asset with a book value of $60,000 (50% × $120,000) is exchanged when it has a fair market value of $70,000.  Therefore, a $10,000 gain ($70,000 – $60,000) is recognized. The new asset acquired is recorded at the fair value of the assets surrendered ($16,000 cash and $70,000 machine, or $86,000).

  • New machine 86,000 ($70,000 + $16,000)
  • Accum. depr.60,000 (50% × $120,000)
    • Old machine 120,000 
    • Cash 16,000 
    • Gain on exchange 10,000 ($70,000 – $60,000)

124

Which of the following statements describes the proper accounting for losses when nonmonetary assets are exchanged for other nonmonetary assets?

  1. A loss is recognized immediately, because assets received should not be valued at more than their cash equivalent price.
  2. A loss is deferred so that the asset received in the exchange is properly valued.
  3. A loss, if any, which is unrelated to the determination of the amount of the asset received should be recorded.
  4. A loss can occur only when assets are sold or disposed of in a monetary transaction.

A loss is recognized immediately, because assets received should not be valued at more than their cash equivalent price.

When nonmonetary assets are exchanged for other nonmonetary assets, a loss is recognized immediately and the asset is valued at its fair value.

125

Darnell Company reported a loss of $40,000 on its year 1 income statement related to long-lived assets which it intended to sell.  On Darnell’s December 31, year 1 balance sheet, these long-lived assets were reported at $200,000.  During year 2, Darnell did not sell any of these long-lived assets, and, at December 31, year 2, Darnell compiled the following information related to these assets which it intended to sell:

  • Fair value $220,000
  • Cost to sell $15,000

On Darnell’s December 31, year 2 balance sheet, what amount should be reported for the long-lived assets which were being held for sale?

  1. $200,000
  2. $220,000
  3. $240,000
  4. $205,000

$205,000

According to ASC Topic 360, “A loss shall be recognized for any initial or subsequent write-down to fair value less cost to sell.  A gain shall be recognized for any subsequent increase in fair value less cost to sell, but not in excess of the cumulative loss previously recognized (for a write-down to fair value less cost to sell).  The loss or gain shall adjust only the carrying amount of a long-lived asset, whether classified as held for sale individually or as part of a disposal group.  A gain or loss not previously recognized that results from the sale of a long-lived asset (disposal group) shall be recognized at the date of sale.” In Darnell’s case, the estimate of fair value less cost to sell at December 31, year 2, was $205,000. This amount represents a revision of the estimate of fair value less cost to sell of $200,000 at December 31, year 1.  The carrying amount of Darnell’s long-lived assets should be increased from $200,000 to $205,000 at December 31, year 2. Note that the carrying amount of the long-lived assets on December 31, year 1, before recognition of the loss of $40,000, was $240,000. The increase in the carrying amount from $200,000 to $205,000 is, therefore, within the boundaries specified in the standard.

126

During June year 1, Maxwell Corporation determined that actual costs incurred associated with the equipment used in its assembly line significantly exceeded original expected costs.  At June 30, year 1, Maxwell had compiled the following information:

  • Original cost of the equipment $800,000
  • Accumulated depreciation $300,000
  • Expected net future cash inflows (undiscounted) related to the continued use and eventual disposal of the equipment $450,000
  • Fair value of the equipment $375,000

What is the amount of impairment loss that should be reported on Maxwell’s income statement prepared for the period ended June 30, year 1?

  1. $125,000
  2. $350,000
  3. $375,000
  4. $ 50,000

$125,000

The undiscounted expected net future cash inflows ($450,000) are less than the carrying amount of the equipment ($500,000). Therefore, the equipment is deemed impaired. The impairment loss is calculated by subtracting the fair value of the equipment ($375,000) from its carrying value ($500,000). (Note: Both values are at the impairment date, June 30, year 1.) The impairment loss that should be reported on Maxwell’s June 30, year 1 income statement is $125,000.

127

A machine with a 4-year estimated useful life and an estimated 15% salvage value was acquired on January 1, year 1.  The increase in accumulated depreciation for year 2 using the double-declining balance method would be

  • Original cost × 85% × 50%.
  • Original cost × 50%.
  • Original cost × 85% × 50% × 50%.
  • Original cost × 50% × 50%.

Original cost × 50% × 50%.

  • In year 1: Original cost × 50%(200%/4 = 50%)
  • In year 2: (Original cost × 50%) × 50% 

128

Frye Company incurred research and development costs in year 1 as follows:

  • Equipment acquired for use in research and development projects $1,000,000
  • Depreciation on the above equipment 150,000
  • Materials used 200,000
  • Compensation costs of personnel 500,000
  • Outside consulting fees 100,000
  • Indirect costs appropriately allocated250,000

The total research and development costs charged in Frye’s year 1 income statement should be

  1. $650,000
  2. $900,000
  3. $1,200,000
  4. $1,800,000

$1,200,000

Per ASC Topic 730, R&D costs are charged to expense when incurred.  Expenditures for items such as materials, equipment, and purchased intangibles may be capitalized if they have alternative future uses in R&D projects or other areas.  The cost of the equipment acquired for use in R&D projects ($1,000,000) is capitalized, but the depreciation ($150,000) on the equipment would be expensed along with the other R&D costs incurred.  The equipment has alternative future uses because the word “projects” is plural.

  • Depreciation $150,000
  • Materials $200,000
  • Compensation $500,000
  • Consulting fees $100,000
  • Indirect costs $250,000
  • R&D expense $1,200,000

129

Northstar Co. acquired a registered trademark for $600,000.  The trademark has a remaining legal life of five years, but can be renewed every 10 years for a nominal fee.  Northstar expects to renew the trademark indefinitely.  What amount of amortization expense should Northstar record for the trademark in the current year?

  1. $0
  2. $15,000
  3. $40,000
  4. $120,000

$0

For US GAAP purposes, assets with indefinite lives are not amortized but tested for impairment instead. Because the trademark is expected to be renewed indefinitely, it is treated as an asset with an indefinite life and is not amortized.

130

Oak Co., a newly formed corporation, incurred the following expenditures related to land and building:

  • County assessment for sewer lines $2,500
  • Title search fees $625
  • Cash paid for land with a building to be demolished $135,000
  • Excavation for construction of basement $21,000
  • Removal of old building $21,000 less salvage of $5,000 $16,000

At what amount should Oak record the land?

  1. $138,125
  2. $153,500
  3. $154,125
  4. $175,625

$154,125

Oak should capitalize all costs to place the land in its intended and useful state. The costs for the sewer lines, title search fee, land, and removal of the old building (less salvage) should all be included in the cost of the land. Therefore, the land should be recorded at $2,500 + $625 + $135,000 + $16,000 = $154,125.

131

Tech Co. bought a trademark on January 2, two years ago. Tech accounted for the copyright as instructed under the provisions of ASC Topic 350 during the current year. The intangible was being amortized over forty years.  The carrying value at the beginning of the year was $38,000.  It was determined that the cash flow will be generated indefinitely at the current level for the trademark.  What amount should Tech report as amortization expense for the current year?

  1. $0
  2. $922
  3. $1,000
  4. $38,000

$0

ASC Topic 350 states that intangibles with indefinite useful lives should not be amortized; they should be examined periodically for impairment. Therefore, the correct answer is that amortization expense should be $0.

132

Rye Co. purchased a machine with a 4-year estimated useful life and an estimated 10% salvage value for $80,000 on January 1, year 1.  In its income statement, what would Rye report as the depreciation expense for year 3 using the double-declining balance method?

  1. $9,000
  2. $10,000
  3. $18,000
  4. $20,000

$10,000

Salvage value is ignored when using DDB depreciation (except that the asset cannot be depreciated below salvage value)

The DDB rate is twice the straight-line rate (1/4 × 2 = 2/4 = 50%).  Note that in year 4, enough depreciation would be recorded to depreciate the asset from its beginning-of-year book value ($10,000) down to its salvage value (10% × $80,000 = $8,000), or $2,000 of depreciation.

133

On January 2 of the current year, Cruises, Inc. borrowed $3 million at a rate of 10% for three years and began construction of a cruise ship.  The note states that annual payments of principal and interest in the amount of $1.3 million are due every December 31. Cruises used all proceeds as a down payment for construction of a new cruise ship that is to be delivered two years after start of construction.  What should Cruise report as interest expense related to the note in its income statement for the second year?

  1. $0
  2. $300,000
  3. $600,000
  4. $900,000

$0

interest cost on debt used to finance the construction of fixed assets should be capitalized.

 

ASC Topic 835 requires the capitalization of interest as part of the cost of certain assets. Only assets which require a period of time to be prepared for use qualify for interest capitalization.  These include assets constructed for sale produced as discrete projects (e.g., ships) and assets constructed for a firm’s own use, whether by the entity itself or by an outsider. For example, a building purchased by an entity would not qualify, but one constructed over a period of time would.  Other assets that do notqualify include those in use or ready for use and ones not being used in the earnings activities of a firm (e.g., idle land).

The amount of interest to be capitalized is the amount which could have been avoided if the project had not been undertaken. This amount includes amortization of any discount, premium, or issue costs; but, it shall not exceed the actual interest incurred during the period.  The amount of “avoidable” interest is computed as

  

 Average accumulated expenditures during construction ×  Interest rate ×  Construction period

134

An asset is being constructed for an enterprise’s own use.  The asset has been financed with a specific new borrowing.  The interest cost incurred during the construction period as a result of expenditures for the asset is

  1. Interest expense in the construction period.
  2. A prepaid asset to be written off over the estimated useful life of the asset.
  3. A part of the historical cost of acquiring the asset to be written off over the estimated useful life of the asset.
  4. A part of the historical cost of acquiring the asset to be written off over the term of the borrowing used to finance the construction of the asset.

A part of the historical cost of acquiring the asset to be written off over the estimated useful life of the asset.

Per ASC Topic 835, the interest costs incurred during the period as a result of expenditures for the asset are a part of the historical cost of the asset. Furthermore, because such interest cost is an integral part of the total cost of acquiring an asset, its disposition should be the same as other components of asset cost. This means the capitalized interest cost should be written off over the life of the asset.

135

A fixed asset with a 5-year estimated useful life is sold during the second year.  How would the use of the straight-line method of depreciation instead of the double-declining balance method of depreciation affect the amount of gain or loss on the sale of the fixed asset?

  • Gain
  • Loss

  • Gain - Decrease
  • Loss - Increase

Under the straight-line method, a smaller portion of the asset’s cost is charged against income in the early years than would occur using DDB. Therefore, at the date of sale, the book value using SL will be higher than the DDB book value. If the proceeds from the sale are higher than both book values, the one with the higher book value (SL method) will show a smaller gain. If the proceeds are less than both book values, the one with the higher book value (SL method) will show a larger loss.

136

A donated fixed asset for which the fair value has been determined should be recorded as a debit to fixed assets and a credit to

  1. Retained earnings.
  2. Capital stock.
  3. Deferred income.
  4. Other income.

Other income.

Per ASC Topic 958, income is earned as a result of a donation.

Fixed assets represent the capitalized amount of expenditures made to acquire tangible property which will be used for a period of more than one year.  Their cost, therefore, is deferred to future periods in compliance with the matching principle.  Tangible property includes land, buildings, equipment, or any other property that physically exists.  All of the costs necessary to get the asset to the work site and to prepare it for use are capitalized, including the cost of negotiations, sales taxes, finders’ fees, razing an old building, shipment, installation, preliminary testing, and so forth. When capitalizing such costs it is necessary to associate them with the asset which is being prepared for use. Thus, the cost of razing an old building is added to the cost of acquiring the land on which the building stood.  Charges for self-constructed fixed assets include direct materials, direct construction labor, variable overhead, and a fair share of fixed overhead.  Assets received through donation should be recorded at fair value with a corresponding credit to revenue; if fair value is not determinable, book value should be used (ASC Topic 958).  If the entity incurs a liability associated with future retirement of the asset, the fair value (present value) of that obligation should be added to the carrying value of the asset (ASC 410-20-25-5).

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Milgram Corporation prepares its financial statements in accordance with IFRS.  Milgram has investment property that it leases to Jenson Corporation. Milgram uses the fair value model to report its investment property.  Which of the following statements is true?

  1. Milgram does not record depreciation on the investment property.
  2. Milgram should value the equipment at cost less accumulated depreciation and less accumulated impairment losses.
  3. Milgram should record the increase in fair value in other comprehensive income for the period.
  4. Milgram depreciates the equipment using normal depreciation methods for property, plant, and equipment.

Milgram does not record depreciation on the investment property.

When investment property is recorded using the fair value model, depreciation is not recorded.