Chapter 11 Outline 7e

8/16/2019 Chapter 11 Outline 7e

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Chapter

11Property, Plant, and Equipment and Intangible

Assets: Utilization and Impairment

LEARI! "#$EC%I&E'

After studying this chapter, you should be able to:

L"11(1 Explain the concept of cost allocation as it pertains to property, plant, andequipment and intangible assets.

L"11() Determine periodic depreciation using both time-based and activity-basedmethods.

L"11(* Calculate the periodic depletion of a natural resource.

L"11(+ Calculate the periodic amortiation of an intangible asset.

L"11( Explain the appropriate accounting treatment required !hen a change is made inthe service life or residual value of plant and equipment and intangible assets.

L"11(- Explain the appropriate accounting treatment required !hen a change indepreciation, amortiation, or depletion method is made.

L"11(. Explain the appropriate treatment required !hen an error in accounting for property, plant, and equipment and intangible assets is discovered.

L"11(/ "dentify situations that involve a significant impairment of the value of property, plant, and equipment and intangible assets and describe the required accounting procedures.

L"11(0 Discuss the accounting treatment of repairs and maintenance, additions,improvements, and rearrangements to property, plant, and equipment andintangible assets.

L"11(1 Discuss the primary differences bet!een #.$. %AA& and "'($ !ith respect to the

utiliation and impairment of property, plant, and equipment and intangibleassets.

© The McGraw-Hill Companies, Inc., 2013

Stuent Stu! Guie 11-"


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Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

C2AP%ER 2I!2LI!2%'

PAR% A: 3EPRECIA%I", 3EPLE%I", A3 A4"R%I5A%I"

&roperty, plant, and equipment and intangible assets are purchased !ith the expectation that they!ill provide future benefits, usually for several years. )he costs of acquiring the assets should beallocated to expense during the reporting periods benefited by their use. )hat is, their costs arematched !ith the revenues they help generate. *o!ever, very seldom is there a clear-cutrelationship bet!een the use of these assets and revenue production. As a consequence, !e mustresort to arbitrary allocation methods to approximate a matching of expense !ith revenue.

Cost allocation is +no!n as depre6iation for plant and equipment, depletion for natural resources,and amortization for intangible assets. "t is important to understand that depreciation, depletion

and amortiation are processes of cost allocation, not valuation. )he cost of the asset, less anyanticipated residual value, is allocated over its estimated useful life in a systematic and rationalmanner that attempts to match revenues !ith the use of the asset, not the decline in its value.

'or assets used in the manufacture of a product, depreciation, depletion, or amortiation isconsidered a product cost to be included as part of the cost of inventory. 'or assets not used in production, primarily plant and equipment and certain intangible assets used in the selling andadministrative functions of the company, periodic depreciation or amortiation is reported asexpense in the income statement.

4easuring Cost Allo6ation

)he process of cost allocation requires that three factors be established at the time the asset is putinto use. )hese factors are:

17 'er8i6e li9e )he estimated use that the company expects to receive from the asset.

$ervice life, or use#ul li#e, can be expressed in units of time or in units of activity. 'or example, theestimated service life of a delivery truc+ could be expressed in terms of !ears or in terms of thenumber of miles that the company expects the truc+ to be driven before disposition.

)7 Allo6ation base )he value of the usefulness that is expected to be consumed.

Allocation base depreciable base, depletion base, and amortiation base is the difference bet!eenthe cost of the asset and its anticipated residual 8alue. (esidual value, or salvage value, is theamount the company expects to receive for the asset at the end of its service life less any anticipateddisposal costs.

*7 Allo6ation method )he pattern by !hich the usefulness is expected to be consumed.




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)he allocation method used should be systematic and rational and correspond to the pattern of assetuse. "n practice, there are t!o general approaches that attempt to obtain this systematic and rationalallocation. )he first approach allocates the cost base according to the passa$e o# time. /ethodsfollo!ing this approach are referred to as time(based methods. )he second approach allocates anasset0s cost base using a measure of the asset0s output . )hese are a6ti8ity(based methods.

3epre6iation

%ime(#ased 3epre6iation 4ethods

1y far the most easily understood and !idely used depreciation method is straight line. 1y thisapproach, an equal amount of depreciable base is allocated to each year of the asset0s service life.)he depreciable base is simply divided by the number of years in the asset0s life to determineannual depreciation.

Depreciable base

2 Depreciation per year

$ervice life

A66elerated depre6iation methods produce a declining pattern of depreciation !ith higher depreciation in the early years of the asset3s life and lo!er depreciation in later years. )!ocommonly used !ays to achieve a declining pattern are the sum-of-the-years3 digits method anddeclining balance methods.

)he sum(o9(the(years(digits ;'


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depreciation rate per measure of output and then multiplies this rate by actual output to determine periodic depreciation.

Depreciable base

2 Depreciation per unit of output #nits of output

1ecause !e are estimating service life based on units produced rather than in years, depreciation isnot constrained by time. *o!ever, total depreciation is constrained by the asset3s cost and theanticipated residual value. "n the last year of the asset3s life, therefore, depreciation expense !illusually be a residual amount necessary to bring the boo+ value of the asset do!n to residual value.

ILLU'%RA%I"

?n @anuary 4, 5;46, the /oncrief /anufacturing Company purchased machinery for 46;,;;;.

)he estimated service life of the machinery is four years and the estimated residual value is4;,;;;. )he equipment is expected to produce 7B;,;;; units during its service life. Actual units produced !ere as follo!s:

(digits method:


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3ouble(de6lining(balan6e method:

$traight-line rate of 58< 4 7 years x 5 2 8;< DD1 rate.


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Activity-based depreciation methods are theoretically superior to time-based methods but often areimpractical to apply in practice. )he most popular time-based method is the straight-line method."t is the easiest method to understand and apply, and it produces a higher net income thanaccelerated methods in the early years of an asset3s life. ?n the other hand, accelerated methodsusually are better for income tax purposes, reducing taxable income more in the early years of an

asset3s life than straight line.

#nli+e the choice of inventory methods, there is no conformity rule !ith respect to depreciationmethods. A company does not have to use the same depreciation method for both financialreporting and income tax purposes. As a result, most companies use the straight-line method for financial reporting and the "nternal (evenue $ervice0s prescribed accelerated method for incometax purposes.

!roup and Composite 3epre6iation 4ethods

%roup and composite depreciation methods aggregate assets in order to reduce the record+eepingcosts of determining periodic depreciation. )he t!o methods are the same except for the !ay thecollection of assets is aggregated for depreciation. )he group depre6iation method defines thecollection as depreciable assets that share similar service lives and other attributes. 'or example,group depreciation could be used for fleets of vehicles or collections of machinery. )he 6ompositedepre6iation method is used !hen assets are physically dissimilar but are aggregated any!ay togain the convenience of group depreciation. 'or instance, composite depreciation can be used for all of the depreciable assets in one manufacturing plant, even though individual assets in thecomposite may have !idely diverse service lives.

1oth approaches involve applying a single straight-line rate, based on the average service lives of the assets in the group or composite, to the total cost of the group or composite. 1ecausedepreciation records are not +ept on an individual asset basis, dispositions are recorded under the

assumption that the boo+ value of the disposed item exactly equals any proceeds received and nogain or loss is recorded.

International inan6ial Reporting 'tandards

"'($ requires that each component of an item of property, plant, and equipment must bedepreciated separately if its cost is significant in relation to the total cost of the item.

"'($ allo!s a company to value property, plant, and equipment &&GE subsequent to initialvaluation at 4 cost less accumulated depreciation or 5 fair value revaluation. #.$. %AA& prohibits revaluation.

3epletion o9 atural Resour6es

Depletion of the cost of natural resources usually is determined using the units-of-productionmethod. $ervice life is the estimated amount of natural resource to be extracted and depletion baseis cost less any anticipated residual value. (esidual value usually relates to the value of the landafter the natural resource has been extracted.




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As an example, if the depletion base of a mineral mine !as 7,;;;,;;;, and the mining companyestimated that 5,;;;,;;; tons of mineral !ould be extracted, the depletion rate per ton of mineral!ould be 5:

7,;;;,;;;

2 5 per ton depletion rate 5,;;;,;;; tons

'or each ton of mineral extracted, 5 in depletion is recorded and the asset, mineral mine, isreduced by 5. Depletion is a product cost and is included in the inventory of the mineral.

Huite often, companies use the units-of-production method to calculate depreciation on assets usedin the extraction of natural resources. )he activity base used is the same as that used to calculatedepletion, the estimated recoverable natural resource.

Amortization o9 Intangible Assets

Intangible Assets 'ubDe6t to Amortization

'or an intangible asset !ith a #inite useful life, !e allocate its capitalied cost less any estimatedresidual value to periods in !hich the asset is expected to contribute to the company0s revenue-generating activities. )his requires that !e determine the asset0s useful life, its amortiation basecost less estimated residual value, and the appropriate allocation method, similar to depreciatingtangible assets.

"ntangible assets usually have no residual value, so the amortiation base is simply cost. /ostintangibles have a legal life for example, 5; years for a patent or a contractual life for example,the contractual life of a franchise agreement that limits service life. )he method of amortiationshould reflect the pattern of use of the asset in generating benefits. /ost companies use the straight-line method.

Intangible Assets ot 'ubDe6t to Amortization

An intangible asset that is determined to have an ine#inite useful life is not subIect to periodicamortiation. #seful life is considered indefinite if there is no foreseeable limit on the period of time over !hich the asset is expected to contribute to the cash flo!s of the entity. %ood!ill is themost common intangible asset !ith an indefinite useful life.


"'($ allo!s a company to value intangible assets subsequent to initial valuation at 4 cost lessaccumulated amortiation or 5 fair value revaluation. #.$. %AA& prohibits revaluation.

PAR% #: A33I%I"AL I''UE'

Partial Periods© The McGraw-Hill Companies, Inc., 2013



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?nly in textboo+s are assets purchased and disposed of at the very beginning or very end of acompany0s fiscal year. >hen acquisition and disposals occur at other times, a companytheoretically must determine ho! much depreciation, depletion, and amortiation to record for the part of the year that each asset actually is used. 'or example, in our previous illustration involvingthe machinery purchased by the /oncrief /anufacturing Company, if the acquisition date had been

April 6;, 5;46, instead of @anuary 4, the full-year time-based depreciation results must bemultiplied by 56 to determine depreciation for 5;46:

ull(year Partial(year

4ethod 3epre6iation )F* 3epre6iation

$traight line 6;,;;; 5;,;;;$JD 7B,;;; 65,;;;DD1 8,;;; 76,666

'or the accelerated methods, the remaining 46 of the first year3s depreciation is included in 5;47

along !ith 56 of the depreciation for the second year of the asset3s life. )his calculation is not

necessary for the straight-line method since a full year0s depreciation is the same for each year of the asset0s life. "n an activity-based method the rate per unit of output simply is multiplied by theactual output for the period, regardless of the length of that period.

&ractically, most companies adopt a simplifying assumption, or convention, for computing partialyear3s depreciation and use it consistently. 'or example, a common convention, +no!n as the hal9(year 6on8ention, records one-half of a full year3s depreciation in the year of acquisition andanother half year in the year or disposal.

Changes in Estimates

A change in an estimate of the service life or the residual value of plant and equipment andintangible assets should be reflected in the financial statements of the current period and future periods. &rior years3 financial statements are not restated. 'or example, if the /oncrief /anufacturing Company in our first illustration decided to use the straight-line method and, duringyear 5;48, revised the estimated service life from four years to seven years, ne! annualdepreciation !ould be determined by dividing boo+ value at the beginning of the year of changeless anticipated residual value by the remaining service life, as follo!s:

Cost 46;,;;; Kess: Accumulated depreciation 6;,;;; x 5 years ;,;;;#ndepreciated cost at beginning of 5;48 F;,;;;

Kess: (esidual value unchanged 4;,;;;(emaining depreciable base ;,;;;Divided by remaining service life F years - 5 years 8 yrs. Le! annual depreciation 45,;;;

A disclosure note is presented that describes the change in estimate and the effect of the change onincome before extraordinary items, net income, and earnings per share. "n the above example, the




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before-tax effect on income of the change in estimate is to increase income by 4B,;;; olddepreciation of 6;,;;; less ne! depreciation of 45,;;;.

Change in 3epre6iation, Amortization, or 3epletion 4ethod

A change in depreciation, amortiation, or depletion method is considered a change in accountingestimate that is achieved by a change in accounting principle. >e account for these changes prospectively, exactly as !e !ould any other change in estimate. 'or example, referring once againto the /oncrief /anufacturing Company illustration, assume that the company originally chose thesum-of-the-years3-digits method but at the beginning of 5;48 s!itched to the straight-line method.Estimates of service life and residual value remain unchanged. Depreciation for 5;46 and 5;47using the sum-of-the-years3-digits method !ould be:


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Impairment o9 &alue

&roperty, plant, and equipment and intangible assets should be !ritten do!n if there has been a si$ni#icant impairment of value. )he !ay !e recognie and measure an impairment loss differsdepending on !hether the assets are to be held and used or are being held for sale.

Assets to #e 2eld and Used

'or assets to be held and used, different guidelines apply to 4 property, plant, and equipment andintangible assets !ith finite useful lives subIect to depreciation, depletion, or amortiation and 5intangible assets !ith indefinite useful lives not subIect to amortiation.

Property, plant, and equipment and intangible assets Gith 9inite use9ul li8es are tested for impairment only !hen events or changes in circumstances indicate boo+ value may not berecoverable. )he measurement of an impairment loss is a t!o-step process. $tep 4 - Animpairment loss is required only !hen the undiscounted sum of future cash flo!s is less than boo+ value. )he measurement of impairment lossstep 5is the difference bet!een the asset0s boo+

value and its fair value. "f an impairment loss is recognied, the !ritten-do!n boo+ value becomesthe ne! cost base for future cost allocation. Kater recovery of an impairment loss is prohibited.

"n step 5, fair value is the amount at !hich the asset could be bought or sold in a current transaction bet!een !illing parties. Huoted mar+et prices could be used if they0re available. "f fair value is notdeterminable, it must be estimated. )he present value of future cash flo!s often is used as ameasure of fair value.

Inde9inite(li9e intangible assets should be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Companies have theoption to perform a qualitative assessment to determine if step 4 of the good!ill impairment test is

necessary.

'or indefinite life intangible assets other than $oowill , if boo+ value exceeds fair value, animpairment loss is recognied for the difference.

'or goodGill, an impairment loss is indicated M step 4 - !hen the fair value of the reporting unit isless than its boo+ value. A reporting unit is an operating segment of a company or a component of an operating segment for !hich discrete financial information is available and segmentmanagement regularly revie!s the operating results of that component. 'or step 5, a good!illimpairment loss is measured as the excess of the boo+ value of the good!ill over its NimpliedO fair value. )he implied fair value of good!ill is calculated in the same !ay that good!ill is determined

in a business combination. )hat is, it0s a residual amount measured by subtracting the fair value of all identifiable net assets from the consideration exchanged purchase price using the unit0s previously determined fair value as the consideration exchanged.

ILLU'%RA%I"

)he Petrex Corporation acquired Calnet Corporation for B;; million. )he fair value of theidentifiable net assets of Calnet !as 8; million. After the acquisition, Calnet continued to




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operate as a separate company and is considered a reporting unit. Petrex performed a requiredgood!ill impairment test at the end of 5;46. )he boo+ value of Calnet0s net assets at the end of theyear !as 5; million, including the 48; million in good!ill recorded on acquisition. ?n thatdate, the fair value of Calnet had dropped to 85; million and the fair value of all of its identifiabletangible and intangible assets, excluding good!ill, !as 7B; million.

$tep 4. Re6o8erability7 1ecause the boo+ value of the net assets on the test date of 5; millionexceeds the 85; million fair value of the reporting unit, an impairment loss is indicated.

$tep 5. 4easurement o9 impairment loss7 )he impairment loss is 44; million, determined asfollo!s:

3etermination o9 implied goodGill:

'air value of Calnet 85; million 'air value of Calnet0s net assets excluding good!ill 7B; million "mplied value of good!ill 7; million

4easurement o9 impairment loss:

1oo+ value of good!ill 48; million "mplied value of good!ill 7; million "mpairment loss 44; million

Assets to #e 'old

An asset or group of assets classified as held for sale is measured at the lo!er of its boo+ value or

fair value less cost to sell. An impairment loss is recognied for any !rite-do!n to fair value lesscost to sell. >e don0t depreciate or amortie these assets !hile classified as held for sale and !ereport them separately in the balance sheet.


)here are significant differences bet!een #.$. %AA& and "'($ in accounting for the impairment of property, plant, and equipment and intangible assets. ?ne important difference is that there is norecoverability test under "'($. 'or property, plant, and equipment and finite-life intangible assets,an impairment loss is required !hen an asset0s boo+ value exceeds the recoverable amount. )herecoverable amount is the higher of the assets value-in-use present value of estimated future cashflo!s and fair value less costs to sell. )he loss is the difference bet!een boo+ value and therecoverable amount. #nder "'($, good!ill is assessed at the Ncash-generating unitO rather than atthe reporting unit level !ith #.$. %AA&. )he measurement of an impairment loss under "'($ is aone-step process that compares the recoverable amount of the cash-generating unit to boo+ value."f the recoverable amount is less, good!ill is reduced first, then other assets.




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PAR% C: 'U#'EHUE% E?PE3I%URE' A3 3I'P"'I%I"

Ependitures 'ubsequent to A6quisition

/any long-lived assets require expenditures to repair, maintain, or improve them. "n general,

expenditures that are expected to produce future benefits beyond the current year are capitalied.Expenditures that simply maintain a given level of benefits are expensed in the period they areincurred. "n practice, many companies do not capitalie any expenditure unless it exceeds a predetermined amount that is considered material. $ubsequent expenditures can be classified asfollo!s:

Repairs and maintenan6e are expenditures made to maintain a given level of benefits andgenerally are expensed in the period incurred.

Additions involve adding a ne! maIor component to an existing asset and should be capitalied because future benefits are increased.

Impro8ements involve the replacement of a maIor component of an existing asset and usually arecapitalied using one of the follo!ing methods:

4. 1y the substitution method, both the disposition of the old component and the acquisition of the ne! component are recorded.

5. )he cost of the improvement sometimes is recorded !ithout removing the original cost andaccumulated depreciation of the original component.

6. Another !ay to record improvements is to reduce accumulated depreciation.

Rearrangements involve expenditures to restructure an asset !ithout addition, replacement, or improvement. An example !ould be the rearrangement of the production line on the factory floor.)he cost of material rearrangements should be capitalied if they clearly increase future benefits.

'inally, the costs incurred to success#ull! defend an intangible right, for example a patent, should becapitalied. )he costs incurred to unsuccess#ull! defend an intangible right should be expensed.


#nder #.$. %AA&, litigation costs to successfully defend an intangible right are capitalied andamortied over the remaining useful life of the related intangible. #nder "'($, these costs areexpensed, except in rare situations !hen an expenditure increases future benefits.

APPE3I? 11A: C"4PARI'" I%2 4ACR'

)he federal tax code allo!s taxpayers to compute depreciation for their tax returns on assetsacquired after 4QB using the modified accelerated cost recovery system /AC($. #nder /AC($, each asset is classified !ith a recovery period category that determines the fixed ratedepreciation schedule. /AC($ depreciation is equivalent to applying the double-declining- balance method !ith a s!itch to the straight-line method in the year straight-line yields an equal or higher deduction than DD1 and a half-year convention.




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APPE3I? 11#: R E%IRE4E% A3 R EPLACE4E% 3EPRECIA%I"

)he retirement depre6iation method records depreciation !hen assets are disposed of andmeasures depreciation as the difference bet!een the proceeds received and cost. 1y therepla6ement depre6iation method, depreciation is recorded !hen assets are replaced.

'EL('%U3


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47. A change in depreciation method is accounted for as a change in .

48. (ecognition of an impairment loss on property, plant, and equipment is required if the boo+ value of the asset exceeds the sum of from the asset.

4. A good!ill impairment loss is indicated !hen the fair value of the isless than its boo+ value.

4F. Additions involve adding a ne! maIor component to an existing asset and should be .

4B. Expenditures classified as involve the replacement of a maIor component of property, plant, and equipment.

4Q. Expenditures made to restructure an asset !ithout addition, replacement, or improvement aretermed .

5;. #nder #.$. %AA&, the cost incurred to successfully defend an intangible right should be.

&nswers'17 depreciation, depletion, amortiation )7 residual value *7 overhead, inventory+7 straight-line 7 sum-of-the-years3 digits -7 units-of-production .7 Activity-based/7 income tax 07 %roup and composite 17 units-of-production 117 indefinite 1)7 straight-line1*7 current, future 1+7 estimate 17 undiscounted expected cash flo!s1-7 reporting unit 1.7 capitalied 1/7 improvements 107 rearrangements )7 capitalied

R E&IE E?ERCI'E'

Eer6ise 1

)he Ring Company purchased a ne! machine on April 4, 5;46, for 7B,;;;. )he machine isexpected to have a life of five years and a residual value of 6,;;;. )he company3s fiscal year endson December 64.

Required:

4. Determine the appropriate amount of depreciation for 5;46 and 5;47 applying each of the

follo!ing methods:


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5. Assume that Ring decided to use the straight-line method and that the machine !as sold at theend of December 5;47, for 5F,;;;. &repare the Iournal entry to record the sale.

Solution'

Requirement 1


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Requirement )

Cash .............................................................................................................. 5F,;;;Accumulated depreciation ,F8; S Q,;;; ................................................... 48,F8;Koss difference ............................................................................................ 8,58;

/achine cost.......................................................................................... 7B,;;;

Eer6ise )

"n 5;46 the $uffol+ /ining Company purchased a coal mine at a total cost of 8,;;;,;;;. )hemine is expected to produce 7,;;;,;;; tons of coal over a 4;-year period. Lo residual value isexpected. "n 5;46 the mine produced 7;;,;;; tons of coal. During 5;47 the company3s geologistsrevised the estimate of the total tons expected from 7,;;;,;;; to 6,7;;,;;;. 6;;,;;; tons of coal!ere produced in 5;47.

Required:

4. Determine the amount of depletion the company should record in 5;46.

5. Determine the amount of depletion the company should record in 5;47.

6. Describe the disclosure note the company should include in its 5;47 financial statements relatedto the change in estimate.

Solution'

Requirement 1

8,;;;,;;;

2 4.58 per ton x 7;;,;;; tons 2 J, depletion7,;;;,;;; tons

Requirement )

8,;;;,;;; - 8;;,;;;

2 4.8; per ton x 6;;,;;; tons 2 J+, depletion




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6,7;;,;;; - 7;;,;;; tons

Requirement *

A disclosure note should describe the change and the effect of the change in estimate on income items for the current year.)he change in before-tax income is a decrease in income of F8,;;; T78;,;;; less 4.58 per ton x 6;;,;;; tonsU

Eer6ise *

?n @une 6;, 5;44, the *ollo!ell Corporation acquired a patent from 1ur+e Company at a cost of 8;,;;;. At that time, the patent had a remaining legal life of 47 years. *o!ever, *ollo!elldetermined that the patent !ould be useful only for another 4; years. During 5;44 and 5;45, the patent !as amortied over a 47-year period using the straight-line method.

Required:

4. >hat is the amount of annual patent amortiation that the company should recordV

5. Assume that in 5;46 the company controller discovered the error in calculating patentamortiation. "gnoring income tax considerations, prepare the Iournal entry to correct the error.

Solution'Requirement 1

8;,;;;

-------------- 2 J-, per year amortiation 4; years

Requirement )

Corre6t amortization In6orre6t amortization

5;44 5B,;;; 8,;;; x 45 5;,;;; 7;,;;; x45

5;45 8,;;; 7;,;;;




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)otals B7,;;; ;,;;; difference

57,;;;

(etained earnings ........................................................................................ 57,;;;&atent...................................................................................................... 57,;;;

4UL%IPLE C2"ICE

Enter the letter corresponding to the response that best completes each of the follo!ing statementsor questions.

4. )he method that does not necessarily produce a declining pattern of depreciation over anasset3s service life is:a. )he double-declining-balance method. b. )he sum-of-the-years3-digits method.c. )he units-of-production method.d. All of the above produce a declining pattern.

5. A delivery van that cost 7;,;;; has an expected service life of eight years and a residuavalue of 7,;;;. Depreciation for the secon year of the asset3s life using the sum-of-the-years3-digits method is:a. 7,8;; b. F,;;;c. B,;;;

d. Lone of the above.

6. "n question 5, depreciation for the secon year of the asset3s life using the DD1 methodis:a. F,8;; b. ,F8;c. 7,8;;d. Lone of the above.

7. ?n @anuary 4, 5;46, the *olloran Corporation purchased a machine at a cost of 88,;;;)he machine !as expected to have a service life of 4; years and a 8,;;; residual value.

)he straight-line depreciation method !as used. "n 5;48 the estimate of residual value!as revised from 8,;;; to ero. Depreciation for 5;48 should be:a. 7,8;; b. 8,8;;c. 8,58d. 8,;;;




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8. "n question 7, assume that instead of revising residual value, in 5;48 the companys!itched to the $JD depreciation method. Depreciation for 5;48 should be:a. 8,8;; b. 8,58c. B,777

d. 4;,;;;

. 'elix /ining acquired a copper mine at a total cost of 6,;;;,;;;. )he mine is expectedto produce ,;;;,;;; tons of copper over its five-year useful life. During the first year ofoperations, F8;,;;; tons of copper !as extracted. Depletion for the first year should be:a. ;;,;;; b. 6F8,;;;c. 4,8;;,;;;d. Lone of the above.

F. "n 5;47, the controller of the %reen Company discovered that 5;46 depreciation expense!as overstated by 8;,;;;, a material amount. Assuming an income tax rate of 7;


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44. >hich of the follo!ing types of subsequent expenditures is not normally capitaliedVa. Additions. b. "mprovements.c. (epairs and maintenance.d. (earrangements.

45. "n @anuary of 5;46, the &hillips Company purchased a patent at a cost of 4;;,;;;. "naddition, 4;,;;; in legal fees !as paid to acquire the patent. )he company estimated a4;-year useful life for the patent and uses the straight-line amortiation method forintangible assets. "n 5;48, &hillips spent 58,;;; in legal fees for an unsuccessfudefense of the patent. )he amount charged to income expense and loss in 5;48 relatedto the patent should be:a. 4;6,;;; b. 6,;;;c. 446,;;;d. Lone of the above.

46. )he Crom!ell Company sold equipment for 68,;;;. )he equipment, !hich originallycost 4;;,;;; and had an estimated useful life of 4; years and no residual value, !asdepreciated for five years using the straight-line method. Crom!ell should report thefollo!ing in its income statement in the year of sale:a. A 48,;;; loss. b. A 48,;;; gain.c. A 68,;;; gain.d. Lone of the above.

47. @asper "nc. prepares its financial statements according to "nternational 'inancial(eporting $tandards. At the end of its 5;46 fiscal year, the company chooses to revalue

its equipment. )he equipment cost B4;,;;;, had accumulated depreciation of 6;,;;;at the end of the year after recording annual depreciation, and had a fair value of7Q8,;;;. After the revaluation, the equipment account !ill have a balance of:a. B4;,;;; b. BQ4,;;;c. 7Q8,;;;d. Lone of the above.




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48. Declarmen Corporation o!ns factory in the #nited Ringdom. A change in businessclimate indicates that Declarmen should investigate for possible impairment. 1elo! aredate related to the factory0s assets in millions:

1oo+ value 8F;#ndiscounted sum of future estimated cash flo!s 6;

&resent value of future cash flo!s 858'air value less cost to sell determined by appraisal 87;

)he amount of impairment loss that Declarmen should recognie according to #.$.%AA& is:a. Lone. b. 6; million.c. ; million.d. 78 million.

4. "n question 48, the amount of impairment loss that Declarmen should recognieaccording to "nternational 'inancial (eporting $tandards is:a. Lone. b. 6; million.c. ; million.d. 78 million.

4F. "n 5;44, Cordova "nc. acquired Cordant Corporation and 47; million in good!ill !asrecorded. At the end of its 5;46 fiscal year, management has provided the follo!inginformation for a required good!ill impairment test in millions:

'air value of Cordant approximates fair value less costs to sell QB;

'air value of Cordant0s net assets excluding good!ill Q;;1oo+ value of Cordant0s net assets including good!ill 4,;8;&resent value of estimated future cash flo!s 4,;;;

Assuming that Cordant is considered a reporting unit, the amount of good!illimpairment loss that Cordova should recognie according to #.$. %AA& is:a. Lone. b. 7; million.c. 8; million.d. ; million.

4B. Assuming that Cordant is considered a cash-generating unit, the amount of good!illimpairment loss that Cordova should recognie according to "nternational 'inancial(eporting $tandards is:a. Lone. b. 7; million.c. 8; million.d. ; million.




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uestion 1 is ase on &ppeni/11&.

4Q. /AC($ depreciation is equivalent to:a. )he straight-line method !ith a s!itch to $JD. b. )he DD1 method !ith a s!itch to straight line.c. )he straight-line method.d. )he DD1 method.

&nswers'4. c. . b. 44. c. 4. b.5. b. F. c. 45. c. 4F. d.6. a. B. d. 46. a. 4B. c.7. c. Q. c. 47. b. 4Q. b.8. b. 4;. d. 48. a.

CPA Eam Huestions4. a7 Double-declining-balance depreciation rate 2 5 x 4B 2 W or 58<'irst year depreciation !ill be F,8;; x ;.58 2 4,BF8$econd year depreciation !ill be F,8;; M 4,BF8 x ;.58 2 J1,+-

5. b7 )he depreciation method used must be straight line because year 4depreciation is F,7;; 7;,;;; M 6,;;; 8 2 F,7;;. Jear 5 depreciation!ould also be J.,+.

6. b7 5;,;;;8,;;;,;;; gallons 2 ;.;;7gallon;.;;7gallon x 58;,;;; gallons 2 J1,

7. d7 %ood!ill is an indefinite life intangible asset and is therefore not amortied.

8. 67 8;,;;; 4; years 2 8,;;; per year in amortiation. 8;,;;; M 8,;;; 2J+,. )he 6< franchise fee is a period expense and is not capitalied.

. 67 'irst t!o years 2 ;,;;; M ;

4; 2 ,;;; per year Jear 5;46 2 T;,;;; M 5 x ,;;; M 6,;;;U 6 2 J1,




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F. d7 )he boo+ value of the stamping machine is its cost less accumulateddepreciation. Depreciation ta+en through 5;46 !as T55,;;;,;;; M 7,;;;,;;; 45U x F 2 4;,8;;,;;; so boo+ value is 55,;;;,;;; M 4;,8;;,;;; 2 44,8;;,;;;. 1ecause the 44,8;;,;;; boo+ value is more thanexpected future cash flo!s of T8 x 4,8;;,;;; S 4,;;;,;;;U 2B,8;;,;;;, the stamping machine is impaired.

B. d7 J1+.,7 All of the expenditures are capitalied.

Q. 67 J1),.B;,;;; 4; years 2 B,;;;5;,;;; 8 years 2 7,;;;)otal depreciation 2 45,;;;

4;. a7 >hen as asset is revalued, the entire class of property, plant, and equipmentto !hich the asset belongs must be revalued.

44. b7 A decrease in income. "f boo+ value is higher than fair value, the differenceis reported as an expense in the income statement.

45. b7 An active mar+et must exist for an intangible asset to be revalued.

46. 67 F; million. 1oo+ value of 7;; million M 66; million recoverable amount

higher of fair value less costs to sell and present value of future cash flo!s.

47. d7 78 million. 1oo+ value of 8;; million M 788 million recoverable amounthigher of fair value less costs to sell and present value of future cash flo!s.

C4A Eam Huestions4. d7 1ecause 8;< of the original estimate of quality ore !as recovered duringthe years 5;;7 through 5;44, recorded depletion of 58;,;;; T8;< x;;,;;; M 4;;,;;; salvage valueU. "n 5;45, the earlier depletion of 58;,;;; is deducted from the ;;,;;; cost along !ith the 4;;,;;;salvage value. )he remaining depletable cost of 58;,;;; !ill be allocatedover the 58;,;;; tons believed to remain in the mine. )he 4 per tondepletion is then multiplied times the tons mined each year.




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5. a7 %iven that the company paid ,;;;,;;; for net assets acquired !ith a fair value of 8,7Q,;;;, good!ill !as 8;7,;;;. According to %AA&, acquiredgood!ill is not amortied but is qualitatively assessed andor tested annuallyfor impairment.

6. a7 )he cost should be amortied over the remaining legal life or useful life,!hichever is shorter. "n addition to the initial costs of obtaining a patent,legal fees incurred in the successful defense of a patent should be capitaliedas part of the cost, !hether it !as internally developed or purchased from aninventor. )he legal fees capitalied then should be amortied over theremaining useful life of the patent.



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Chapter 11 Outline 7e