stice 18e ch10 sol final

8/10/2019 Stice 18e Ch10 SOL Final

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QUESTIONS

1. a. The cost of land includes the originalpurchase price; brokers commissions;legal fees; title, recording, and escrowfees; surveying costs; local governmentspecial assessment taxes; cost ofclearing or grading; and other coststhat permanently improve the land orprepare it for use. Expenditures for landimprovements that have a limited life,such as paving, fencing, and landscap-ing, may be separately summarized asland improvements and depreciatedover their estimated useful lives.

b. The cost of buildings includes the origi-nal purchase price, brokers commis-sions, legal fees, title and escrow fees,reconditioning costs, alteration and im-provement costs, and any other coststhat improve the buildings and hencebenefit future periods.

c. The cost of equipment includes theoriginal purchase price, taxes and du-ties on purchases, freight charges, in-surance while in transit, installationcharges and other costs in preparingthe asset for use, subsequent im-

provements or additions, and any otherexpenditures that will improve theequipment and thus benefit more thanone period.

2. a. A copyright, when purchased, is re-corded at its purchase price. When in-ternally developed, all costs of legallyestablishing the copyright are includedas costs of the copyright.

b. The cost of purchasing a franchise andall other sums paid specifically for afranchise including legal fees are con-sidered the franchise cost. Property

improvements required under the fran-chise also are recorded as part of thefranchise cost.

c. The cost of a trademark includes allexpenditures required to establish thetrademark, such as filing and registra-tion fees, as well as legal expenses forthe defense of the trademark. Pur-

chased trademarks are recorded at thepurchase price.

3. Accountants frequently are required to allo-cate costs among two or more accounts.The principal method of allocation is basedon relative fair values of the individual as-sets, if they can be determined. A ratio ofeach individual assets fair value to the sumof the fair values for all assets involved inthe purchase is used to determine cost foreach individual asset. If fair values, orsome approximation of fair values, cannotbe obtained for all assets in the basket pur-

chase, allocation can be made to those as-sets where fair values are available, andany remaining balance can be allocated, onsome systematic basis, to remaining as-sets.

4. When equipment is purchased on a de-ferred payment contract, care must betaken to exclude the stated or implicit inter-est from the purchase price. The assetshould be recorded at its equivalent cashprice. Interest on the unpaid contract bal-ance should be recognized as interest ex-pense over the life of the contract.

5. a. Sales practice for some products con-sistently inflates the list price that is ini-tially assigned. Because most buyersare aware of this practice, considerablenegotiations take place between buyersand sellers before a market price is es-tablished. If accountants use the listprice without careful evaluation, valuescould be inflated.

b. The goal of accounting for the acquisi-tion of property and equipment is to re-cord the acquisition at the equivalentcash price or the closest approximation

to cash that can be obtained. This isespecially important when trade-ins areinvolved.

6. a. In constructing a new building for itsown use, Gaylen Corp. will charge thebuilding with all costs incurred in con-nection with the construction activities.These costs will include building costsin the form of direct labor, direct mate-
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rials, factory overhead, and any otherexpenditures that can be identified withthe construction of the asset.

b. When a company constructs its own as-sets, there are two positions that may betaken in assigning general overhead to

the cost of the asset: (1) Overhead maybe assigned to special construction justas it is assigned to normal activities onthe grounds that both activities benefitfrom the overhead; this would mean thatconstruction would be charged with theincrease in overhead arising from con-struction activities as well as a pro ratashare of the companys fixed overhead.(2) Only the increase in overhead maybe charged to construction on thegrounds that management decides toconstruct its own assets after giving dueconsideration to the differential or addi-tional costs involved. An equitable allo-cation of the fixed overhead betweenregular operations and construction af-fords no special favor to construction ac-tivities; on the other hand, a charge toconstruction for only the increase in totaloverhead grants no special concessionsto regular activities during the construc-tion period.

7. Before interest charges are capitalized, aconstruction project should be a discreteproject. Interest should not be capitalized

for inventories manufactured or producedon a repetitive basis, for assets that arecurrently being used, or for assets that areidle and not undergoing activities to pre-pare them for use.

8. Under IAS 23, a company capitalizes thenet amount of interest which is the grossamount of interest, computed as under U.S.GAAP, less the amount of investment in-come generated by borrowed constructionfunds that are temporarily invested beforethey are needed to pay for construction ex-penditures. Accordingly, the amount of in-

terest capitalized under the internationalstandard is generally less than the amountthat would be capitalized under the U.S.standard.

9. a. If the donation of the property by thephilanthropist is unconditional, thepresidents position cannot be de-fended. If the donation is not recog-nized, both assets and income will be

understated. Furthermore, subsequentincome will be overstated through thefailure to recognize depreciation, andthis misstatement will be accompaniedby misrepresentations of earnings-to-assets and earnings-to-owners-equityrelationships reflected on the financialstatements. Properties unconditionallytransferred should be recognized bydebits to asset accounts and a credit toa revenue account in terms of the fairmarket values of the properties ac-quired, and depreciation should be rec-ognized in using such properties.

b. If the donation of the property is contin-gent upon certain conditions, the presi-dents position relative to the nonrec-ognition of the asset is proper until thetime the conditions are met. Until theconditions are met, the fair value of theconditional gift, along with a descriptionof the conditions, should be disclosedin the notes to the financial statements.

10. Under IAS 41, biological assets, such ascattle, fruit trees, and lumber forests, arerecorded in the balance sheet at their fairvalue (less estimated selling costs) as ofthe balance sheet date. Increases in thisfair value are recognized as gains, and de-creases are recognized as losses.

11. An asset retirement obligation is a legalobligation a company has to restore the site

of a piece of property or equipment whenthe asset is retired. The estimated fairvalue of the asset retirement obligation isrecognized as a liability and is added to thecost of the asset when it is acquired.

12. Many companies establish a minimummonetary amount for recording expendi-tures as assets, even though the item pur-chased meets the definition of an asset.The principal reasons for this are material-ity and the cost involved in recording anasset and depreciating it over its estimatedlife. It is more expedient to expense thesesmaller capital expenditures immediately,thus avoiding the recordkeeping associatedwith assets.

13. a. The cost of a depreciable asset incor-rectly recorded as an expense will un-derstate assets and owners equity forthe current year and for succeedingyears, but by successively decreasingamounts until the asset no longer


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makes a contribution to periodic reve-nue. Net income will be understated inthe first year by the excess of the ex-penditure over depreciation for the cur-rent period; net income in succeedingyears will be overstated by the amountof depreciation charges applicable tothe asset that should be charged off asexpense.

b. An expense expenditure incorrectlyrecorded as an addition to the cost of adepreciable asset will overstate assets

and owners equity for the first year andfor succeeding years, but by succes-sively decreasing amounts until thecharge has been fully written off. Netincome will be overstated for the firstyear by the difference between the rec-ognized depreciation for the current pe-riod and the amount of the expenditure;net income for succeeding years will beunderstated by the depreciation chargesrecognized in such periods.

14. Expenditure Classificationa. Cost of installing machinery.......................................... Assetb. Cost of unsuccessful litigation to protect patent........... Expensec. Extensive repairs as a result of a fire ........................... Expensed. Cost of grading land ..................................................... Assete. Insurance on machinery in transit ................................ Assetf. Interest incurred during construction period................. Asset (if interest added to construction

cost)Expense (if interest charged to expense)

g. Cost of replacing a major machinery component......... Asseth. New safety guards on machinery ................................. Asseti. Commission on purchase of real estate....................... Asset

j. Special tax assessment for street improvements......... Assetk. Cost of repainting offices.............................................. Expense

15. The remaining net book value of a compo-nent that is replaced is added to deprecia-tion expense for the period.

16. a. Research activities are those used todiscover new knowledge that will be

useful in developing new products, ser-vices, or processes, or significantly im-prove an existing product or process.Development activities seek to applyresearch findings to develop a plan ordesign for new or improved productsand processes. Development activitiesinclude the formulation, design, andtesting of products, construction of pro-totypes, and operation of pilot plants.

b. Research and development costs aregenerally expensed in the period in-curred. An exception is when the ex-

penditure is for equipment and facilitiesthat have alternate future uses beyondthe specific current research project.This exception permits the deferral ofcosts incurred for materials, equipment,facilities, and intangibles purchased,but only if the alternative future use canbe specifically identified. In addition,software development costs are capi-

talized if they are incurred after techno-logical feasibility has been established.

17. With the full cost method of accounting foroil and gas exploration costs, the cost ofdrilling dry holes is capitalized and amor-

tized. With the successful efforts method,only the exploratory costs associated withsuccessful wells are capitalized; the cost ofdry holes is expensed as incurred.

18. In general, the cost of internally generatedintangibles is expensed as incurred.

19. The five general categories of intangibleassets are as follows:1. Marketing related.2. Customer related.3. Artistic related.4. Contract based.

5. Technology based.20. The two approaches used in estimating fair

values using present value computationsare the traditional approach and the ex-pected cash flow approach. In the tradi-tional approach, which is often used insituations in which the amount and timingof the future cash flows is determined bycontract, the present value is computed


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using a risk-adjusted interest rate that in-corporates expectations about the uncer-tainty of receipt of the future contractualcash flows.

In the expected cash flow approach, arange of possible outcomes is identified,

the present value of the cash flows in eachpossible outcome is computed (using therisk-free interest rate), and a weighted-average present value is computed bysumming the present value of the cashflows in each outcome, multiplied by the es-timated probability of that outcome.

21. a. Goodwill may be reported properly asan asset only when it is purchased orotherwise established by a transactionbetween independent parties.

b. Expenditures for advertising should notbe capitalized as goodwill. Some ad-

vertising expenditures may be deferredif the costs applicable to future benefitsfrom such advertising can be deter-mined objectively. Normally, however, itis advisable to expense such expendi-tures because of the short-lived natureof the benefits and because futurebenefits may be difficult to estimate.

22. The fair value of acquired in-process re-search and development is recognized asan asset when acquired as part of a busi-ness combination but as an expense whenacquired as a basket purchase outside abusiness combination.

23. Recording noncurrent operating assets attheir current values represents a trade-offbetween relevance and reliability. In theUnited States, reliability concerns have re-sulted in the prohibition of asset write-ups. Inmany countries around the world, account-ants have learned to rely on the judgment ofprofessional appraisers who estimate thecurrent value of long-term assets.

24. Under the provisions of IAS 16, the creditentry is to a revaluation equity account whennoncurrent operating assets are written upto reflect an increase in market value. (Theimportant point is that the revaluationamount is not to be reported as a gain in theincome statement.)

25.Under the provisions of IAS 40, a companycan elect to use a fair value approach inwhich the investment property is reported inthe balance sheet at its fair value, and anyresulting gains or losses are reported in theincome statement.

26. The fixed asset turnover ratio is computedas sales divided by average property, plant,and equipment (fixed assets); it is inter-preted as the number of dollars in salesgenerated by each dollar of fixed assets.

27. As with all ratios, the fixed asset turnoverratio must be used carefully to ensure thaterroneous conclusions are not made. Forexample, fixed asset turnover ratio valuesfor two companies in different industriescannot be meaningfully compared. Anotherdifficulty in comparing values for the fixedasset turnover ratio among different compa-nies is that the reported amount for property,plant, and equipment can be a poor indicatorof the actual fair value of the fixed assetsbeing used by a company. Another compli-cation with the fixed asset turnover ratio iscaused by leasing. Many companies leasethe bulk of their fixed assets in such a waythat the assets are not included in the bal-ance sheet. This practice biases the fixedasset turnover ratio for these companiesupward because the sales generated by theleased assets are included in the numeratorof the ratio but the leased assets generatingthe sales are not included in the denomina-tor.


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PRACTICE EXERCISES

PRACTICE 101 CATEGORIES OF TANGIBLE NONCURRENT OPERATING ASSETS

1. Land

Cost to purchase land ..................................................... $ 85,000Cost to purchase land ..................................................... 50,000Cost to prepare land for use ........................................... 10,000Total ................................................................................... $145,000

2. BuildingsCost to construct building .............................................. $132,000

3. EquipmentCost to purchase equipment........................................... $ 30,000Cost to ship and install equipment ................................ 1,000Cost of testing .................................................................. 1,750Total ................................................................................... $ 32,750

4. Land ImprovementsCost to construct parking lot and sidewalks ................ $ 10,000

PRACTICE 102 BASKET PURCHASE

Al locatedCost

Equipment $250,000 (250,000/800,000) $750,000 $234,375Building 425,000 (425,000/800,000) $750,000 398,438

Land 125,000 (125,000/800,000) $750,000 117,187Total $800,000 $750,000

(Note: Some rounding is necessary to ensure that the total allocated cost is$750,000.)


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PRACTICE 103 DEFERRED PAYMENT

1. Equipment................................................................................ 120,696Discount on Notes Payable.................................................... 49,304

Cash .................................................................................... 10,000Notes Payable .................................................................... 160,000

Business calculator keystrokes:N= 8 yearsI= 9%PMT= $20,000FV= 0 (There is no balloon payment associated with the note.)

PV= $110,696

2. Notes Payable.......................................................................... 20,000Cash .................................................................................... 20,000

Interest Expense ..................................................................... 9,963

Discount on Notes Payable .............................................. 9,963

Interest expense: ($160,000 $49,304) 0.09 = $9,963

PRACTICE 104 EXCHANGE OF NONMONETARY ASSETS

Equipment ........................................................................................ 97,300Gain on Asset Exchange ........................................................ 62,300Land.......................................................................................... 35,000

PRACTICE 105 COST OF A SELF-CONSTRUCTED ASSET

Cost of materials............................................................................................ $ 400,000Labor cost ...................................................................................................... 600,000

Al located overhead cost ($8,000,000/$4,000,000) $600,000 ................... 1,200,000Interest cost ................................................................................................... 140,000

Total......................................................................................................... $2,340,000


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PRACTICE 106 CAPITALIZED INTEREST: SINGLE-YEAR COMPUTATION

Appl icable Months ofInterest Avoidable Capitalized

Amount Rate Interest InterestJanuary 1 $100,000 10% 12/12 $10,000May 1 200,000 13 8/12 17,333November 1 300,000 13 2/12 6,500

Total $600,000 $33,833

1. Amount of capitalized interest = $33,833

2. Cost of building = $600,000 + $33,833 = $633,833

PRACTICE 107 CAPITALIZED INTEREST: JOURNAL ENTRY

Building ............................................................................................ 33,833Interest Expense ($270,000 $33,833) .......................................... 236,167

Cash.......................................................................................... 270,000

Total in terest: ($100,000 0.10) + ($2,000,000 0.13) = $270,000

PRACTICE 108 CAPITALIZED INTEREST: MULTIPLE-YEAR COMPUTATION

Appl icable Months ofInterest Avoidable Capitalized

Amount Rate Interest InterestFrom Year 1 $ 100,000 10% 12/12 $ 10,000

533,833 13 12/12 69,398

July 1 500,000 13 6/12 32,500Total $1,133,833 $111,898

1. Amount of capitalized interest = $111,898

2. Cost of building = $1,133,833 + $111,898 = $1,245,731

PRACTICE 109 ACQUISITION BY DONATION

Land .................................................................................................. 111,000Revenue (or Gain) ................................................................... 111,000


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PRACTICE 1010 ACCOUNTING FOR AN ASSET RETIREMENT OBLIGATION

Mining Site........................................................................................ 800,000Cash.......................................................................................... 800,000

Mining Site........................................................................................ 72,489

Asset Retirement Obligation .................................................. 72,489Business Calculator Keystrokes:FV= $200,000; I = 7%; N= 15 years $72,489

PRACTICE 1011 RENEWALS AND REPLACEMENTS

Heating/Cooling System ................................................................. 210,000Accumulated DepreciationBuildings (old system) ................... 128,000Depreciation Expense ..................................................................... 32,000

Buildings (old system)............................................................ 160,000Cash.......................................................................................... 210,000

PRACTICE 1012 RESEARCH AND DEVELOPMENT

(1) Normal : Expense all$120,000 + $100,000 = $220,000(2) Software: Expense amounts before technolog ical feasibi lit y: $120,000(3) International: Expense amounts before technological feasibi lit y: $120,000

PRACTICE 1013 OIL AND GAS EXPLORATION COSTS

(1) Successful efforts : Expense all costs of dry holes = $400,000.(2) Full cost: Capitalize all costs, and amortize the amount to expense in subse-

quent years. Accordingly, expense for this year is $0. (Note: Because all costswere incurred on the last day of the year, there is no amortization this year.)

PRACTICE 1014 ACCOUNTING FOR THE ACQUISITION OF AN ENTIRE COMPANY

Cash price .................................................................................. $1,400,000Fair value of net assets ($1,360,000 $500,000) .................... 860,000Goodwil l...................................................................................... $ 540,000

Cash .................................................................................................. 20,000Accounts Receivable ...................................................................... 190,000

Inventory........................................................................................... 320,000Patent ................................................................................................ 80,000Property, Plant, and Equipment ..................................................... 750,000Goodwill............................................................................................ 540,000

Liabilities.................................................................................. 500,000Cash.......................................................................................... 1,400,000


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PRACTICE 1015 ACCOUNTING FOR A BARGAIN PURCHASE

Cash pr ice .................................................................................. $ 720,000Market value of net assets ($1,360,000 $500,000) ............... 860,000Bargain purchase amount ........................................................ $(140,000)

Cash .................................................................................................. 20,000Accounts Receivable ...................................................................... 190,000Inventory........................................................................................... 320,000Patent ................................................................................................ 80,000Property, Plant, and Equipment ..................................................... 750,000

Gain .......................................................................................... 140,000Liabilities.................................................................................. 500,000Cash.......................................................................................... 720,000

PRACTICE 1016 INTANGIBLES AND A BASKET PURCHASE

Cost Allocation CostEstimated According to Assigned to

Fair Values Relative Estimated Values Individual Items

Building ......................... $200,000 200,000/570,000 $500,000 $175,439Operating permit ........... 100,000 100,000/570,000 $500,000 87,719In-process R&D............. 150,000 150,000/570,000 $500,000 131,579Order backlog ............... 120,000 120,000/570,000 $500,000 105,263

$570,000 $500,000

Building ............................................................................................ 175,439Operating Permit .............................................................................. 87,719R&D Expense*.................................................................................. 131,579Order Backlog .................................................................................. 105,263

Cash.......................................................................................... 500,000

*The acquired in-process R&D is recognized as an expense because it has been ac-quired in a basket purchase outside a business combination.

PRACTICE 1017 INTANGIBLES AND A BUSINESS ACQUISITION

Cash .................................................................................................. 100,000Inventory........................................................................................... 50,000In-Process R&D Asset ..................................................................... 500,000Goodwill............................................................................................ 450,000

Liabilities.................................................................................. 300,000Cash.......................................................................................... 800,000


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PRACTICE 1018 FIXED ASSET TURNOVER RATIO

Fixed asset turnover ratio = Sales/Average net property, plant, and equipment= $480,000/[($160,000 + $200,000)/2]= 2.67

PRACTICE 1019 DANGER IN USING FIXED ASSET TURNOVER RATIO

Company BFixed asset turnover ratio = Sales/Average net property, plant, and equipment

= $360,000/[($200,000 + $220,000)/2]= 1.71

Company Ausing historical cost of fixed assetsFixed asset turnover ratio = Sales/Average net property, plant, and equipment

= $480,000/[($160,000 + $200,000)/2]= 2.67

Company Ausing market value of fixed assetsFixed asset turnover ratio = Sales/Average net property, plant, and equipment

= $480,000/[($290,000 + $310,000)/2]= 1.60

Company A is more efficient (i.e., has a higher fixed asset turnover ratio) if one useshistorical cost of fi xed assets (2.67 compared to 1.71). However, Company Bs fixedassets are younger and are therefore reported at amounts close to their marketvalues. If we assume that the reported amounts of Company Bs f ixed asset are a fairapproximation of their market values, then it appears that Company B is more effi-cient than is Company A (1.71 compared to 1.60).


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EXERCISES

1020. During the cons tru ction period, the expendit ures wil l be charged asfollows:

Land

Land Improvements BuildingPurchase of land ...................................... $282,000Land survey .............................................. 4,800Fees for search of tit le for land............... 500Building permit ......................................... $ 4,000Temporary quarters for construction

crews ....................................................... 11,200Payment to tenants of old bui lding for

vacating premises .................................. 4,450Razing old bui lding .................................. 41,000Excavating basement............................... 13,000Special assessment tax for street

project ..................................................... 2,400Costs of construct ion .............................. 2,395,000Cost of paving parking lot adjoining

building ................................................... $55,000Cost of shrubs, trees, and other

landscaping ............................................ 36,000Total ....................................................... $335,150 $91,000 $2,423,200

Dividends, $4,000, should be closed to Retained Earnings. Damagesawarded for injuries sustained in construction, $8,750, are charged to aloss account.

1021. Patents ....................................................................................... 19,100*Cash ..................................................................................... 19,100

*$13,400 legal expenses + $2,500 drawings + $3,200 fees = $19,100

Research and Development Expense..................................... 50,800*Machinery .................................................................................. 33,800

Cash (or other credits) ....................................................... 84,600

*$34,000 lab expenses + $16,800 wages (40% of $42,000) = $50,800$6,000 metal + $2,600 bluepr ints + $25,200 wages (60% of $42,000) = $33,800

Patents ....................................................................................... 19,300

Cash ..................................................................................... 19,300To record cost of defending patent.


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1022. CostCost Allocation Assigned to

Appraised Accord ing to IndividualProperty Value Appraised Values Assets

Land.......................... $ 250,000 (250,000/1,050,000) $920,000 = $ 219,048Buildings.................. 600,000 (600,000/1,050,000) $920,000 = 525,714Equipment................ 200,000 (200,000/1,050,000) $920,000 = 175,238

Total ....................... $1,050,000 $ 920,000

1023. Land [($600,000 2/3) $600,000] ............................. 300,000Building ........................................................................ 600,000Patent ............................................................................ 337,000Franchise...................................................................... 213,000*

Cash ........................................................................ 1,450,000To record purchase of assets for $1,450,000,allocated on the basis of fair market valueof individual assets.

*Franchise: $1,450,000 $1,237,000 (sum of patent ,bui lding, and land) = $213,000

1024. 2013July 1 Equipment ............................................................ 96,000

Discount on Notes Payable ................................ 26,420Notes Payable ................................................ 112,420Cash ................................................................ 10,000

2014June 30 Notes Payable...................................................... 11,242

Cash ................................................................ 11,242Interest Expense.................................................. 4,466*

Discount on Notes Payable .......................... 4,466

*5.193% ($112,420 $26,420) = $4,466

2015June 30 Notes Payable...................................................... 11,242

Cash ................................................................ 11,242

Interest Expense.................................................. 4,114*Discount on Notes Payable .......................... 4,114

*5.193% ($101,178 $21,954) = $4,114


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1025. Value of the equipment considering interest at 9%PV of $8,600 for 10 years at 9%

PVn = R(PVAF 10 9% )

= $8,600(6.4177)= $55,192 (rounded)

or with a business calculator:PMT= $8,600; N= 10; I= 9% PV= $55,192

$86,000 $55,192 = $30,808

Correcting entry:

Discount on Notes Payable............................................. 30,808Equipment ................................................................... 30,808

1026. Trademarks ....................................................................... 183,000Land ($732,000 0.20) ..................................................... 146,400Buildings........................................................................... 585,600

Franchise .......................................................................... 145,000*Common Stock ........................................................... 20,000Paid-ln Capital in Excess of Par................................ 1,040,000

*Market value of stock .....................................................$1,060,000Amount assigned on basis of known marketvalues:

Trademarks ............................. $183,000Land ......................................... 146,400Buildings ................................. 585,600 915,000Value assigned to franchise.. $ 145,000

1027. Buildings ............................................................................ 680,000Premium on Bonds Payable ($350,000 0.06).......... 21,000Bonds Payable ............................................................. 350,000Common Stock ............................................................. 90,000Paid-ln Capital in Excess of Par ................................. 219,000*

*$680,000 (cost of bui lding) $371,000 (market value ofbonds) = $309,000 (value assigned to common stock);$309,000 $90,000 (par value) = $219,000 paid-in capi talin excess of par.


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1028. Land ................................................................................ 885,000*Common Stock (50,000 $0.50) .............................. 25,000Paid-ln Capital in Excess of Par .............................. 725,000Cash ........................................................................... 135,000

*Market value of stock: 50,000 shares $15 .......... $ 750,000

Cash paid:Purchase price (partial) ........... $80,000Legal cost ................................. 10,000Property taxprevious year ... 30,000Building demolition .. $21,000Less: Salvage ............ 6,000 15,000 135,000

Total .......................................................................... $ 885,000

1029. Cost to construct special equipment:Direct material .......................................................... $ 320,000Direct labor ............................................................... 200,000

Variable overhead ($200,000 1.40) ...................... 280,000Fixed overhead ($700,000 0.35)........................... 245,000Total costs exclus ive of interest ...................... $1,045,000

Interest charges capitalized ................................... 25,000*Total cost of self-constructed equipment ....... $1,070,000

*Interest charge: $1,045,000 10% 3/12 year = $26,125Limited to amount of interest paid: $500,000 10% 6/12 = $25,000

1030. (1) Computation of the amount of interest to be capitali zed for 2013 is asfollows:

Interest FractionCapitalization of the Year Capitalized

Expenditure Date Amount Rate Outstanding InterestJanuary 2, 2013 ................. $500,000 10.0% 12/12 $ 50,000May 1, 2013........................ 450,000 10.0 8/12 30,000November 1, 2013 ............. 550,000 10.0 2/12 9,167

150,000 12.4* 2/12 3,100

Total capitali zed in terest for 2013 ............................................................. $92,267

*Weighted-average interest rate on general bond liabilit ies:

InterestBond Issue Principal Rate Cost

10-year $ 500,000 13.0% $ 65,0005-year 800,000 12.0 96,000

$1,300,000 12.4 $ 161,000

Weighted-average rate = $161,000 $1,300,000 = 12.4% (rounded)


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1030. (Concluded)

(2) Computation of the amount of interest to be capitalized for 2014 is asfollows:

Interest Fraction

Capitalization of the Year CapitalizedExpenditure Date Amount Rate Outstanding InterestAccumulated in 2013 ........ $ 1,500,000 10.0% 12/12 $ 150,000

242,267 12.4 12/12 30,041March 1, 2014 .................... 950,000 12.4 10/12 98,167September 1, 2014 ............ 800,000 12.4 4/12 33,067November 30, 2014 ........... 600,000 12.4 1/12 6,200

Total capitalized interest for 2014 ....................................................... $ 317,475

Interest capitalized in 2014 is restricted to the total interest incurred of $311,000*because this amount is less than the indicated amount to be capitalized of$317,475.

*($1,500,000 x 0.10) + ($500,000 x 0.13) + ($800,000 x 0.12) = $311,000

1031. (a) NC. The construct ion does not cover an extended period of time.(b) C.(c) NC. The construction costs are not separately accumulated.(d) NC. The construction costs are not substantial.(e) NC. The equipment is produced on a repetit ive basis.(f) NC. The building is in use throughout the construction.(g) NC. The land is idle.

1032.

Initial AcquisitionDetoxi fication Facil ity .................................. 900,000

Cash......................................................... 900,000

Detoxi fication Facil ity .................................. 335,945Asset Retirement Obl igation ................. 335,945

Business Calculator Keystrokes:FV = $1,300,000;I= 7%; N= 20 years $335,945

Af ter 1 Year

Detoxi fication Facil ity .................................. 27,651Asset Retirement Obl igation ................. 27,651

Business Calculator Keystrokes:FV= $100,000; I= 7%; N= 19 years $27,651


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1033. (a) Wall .................................................................................... 84,000Accumulated DepreciationBuildings (old wal l) ......... 18,000Depreciation Expense...................................................... 42,000

Buildings (old wal l)..................................................... 60,000Cash ............................................................................. 84,000

(b) Filters................................................................................. 20,000Accumulated Depreciation (old f il ters) .......................... 2,750Depreciation Expense...................................................... 8,250

Filters (old fi lters) ....................................................... 11,000Cash ............................................................................. 20,000

1034. 1. All $325,000 should be charged to research and development expenses.Only expenditures for equipment that can be used on other projects canbe deferred. No such alternative uses are identified in the problem.

2. Materials and equipment, exclusive of equipment usefulon other projects ............................................ $ 80,000

Personnel............................................................ 105,000Indirect costs...................................................... 60,000Equipment depreciation ($80,000 5)* ............ 16,000

Total.................................................................. $261,000

*The equipments useful life on other pro jects would be the basis forthe cost allocation to research and development expense for 2013.

1035. 1. (a) E(b) C(c) E(d) E

(e) E(f) E(g) I(h) I

2. (a) E(b) C(c) E(d) C(e) C(f) C(g) I

(h) I


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Chapter 10 397

1036. 1. Successful effor ts method:

Exploration expense...................................................... $18.4 mill ionCapitalized exploration cost ......................................... $5.6 mill ion

2. Full cost method:

Exploration expense...................................................... 0

Capitalized exploration cost ......................................... $24 mill ion

1037. (a) Record painting of partitions as an asset. Original painting is consid-ered an asset expenditure. Repainting is an expense.

(b) Normally record cost of tearing down the wall as a loss. The old wall willnot benefit future periods. Some accountants justify capitalization be-cause all incremental costs to construct extension should be consid-ered cost of extension.

(c) Separate asset accounts should be maintained for the machine and themotor because they have substantially different useful lives. When the

old motor is replaced, any remaining book value should be added todepreciation expense for the year. The cost of the new motor is re-corded in a separate asset account.

(d) Record the cost of grading land as an asset. It is a proper addition toland.

(e) Record the assessment for st reet paving as an asset. It is a proper addi-tion to land.

(f) Record cost of tearing down the previously occupied old building inpreparation for a new one as an expense. Expense relates to the oldbuilding, not to new construction. As in (b), some accountants justify

capitalization because cost of tearing down is necessary for new con-struction.

1038. 1. Cash ............................................................................... 12,000Receivables ................................................................... 96,000Inventory ........................................................................ 145,000Land, Buildings, and Equipment ................................. 519,000Goodwil l ......................................................................... 354,000*

Current Liabil it ies .................................................... 75,000Long-Term Debt ....................................................... 116,000Cash.......................................................................... 935,000

*Balance of purchase price not allocated to identifiable assets.


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398 Chapter 10

1038. (Concluded)

2. Cash ................................................................................ 12,000Receivables .................................................................... 96,000Inventory ......................................................................... 145,000Land, Buildings, and Equipment .................................. 519,000

Current Liabil it ies ..................................................... 75,000Long-Term Debt ........................................................ 116,000Cash ........................................................................... 445,000Gain............................................................................ 136,000

1039. 1. Accounts Receivable ..................................................... 200,000Inventory ......................................................................... 260,000Prepaid Insurance.......................................................... 12,000Buildings and Equipment (net) ..................................... 168,000Goodwil l .......................................................................... 140,000

Accounts Payable .................................................... 130,000Cash ........................................................................... 650,000

2. Accounts Receivable..................................................... 200,000Inventory ......................................................................... 260,000Prepaid Insurance.......................................................... 12,000Buildings and Equipment (net) ..................................... 168,000

Gain............................................................................ 190,000Accounts Payable .................................................... 130,000Cash ........................................................................... 320,000

1040.

Cost Allocation CostEstimated According to Assigned to

Fair Values Relative Estimated Values Individual Items

Internet domain name .. $150,000 150,000/530,000 $500,000 $141,509Order backlog ............... 100,000 100,000/530,000 $500,000 94,340In-process R&D............. 200,000 200,000/530,000 $500,000 188,679Operating permit ........... 80,000 80,000/530,000 $500,000 75,472

$530,000 $500,000

Internet Domain Name ................................................... 141,509Order Backlog ................................................................. 94,340

R&D Expense*................................................................. 188,679Operating Permit ............................................................. 75,472

Cash ........................................................................... 500,000

*The acquired in-process R&D is recognized as an expense because it has been ac-quired in a basket purchase outside a business combination.

Advertising Expense ...................................................... 300,000Cash ........................................................................... 300,000


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Chapter 10 399

1041.

1. Accounts Receivable.......................................... 180,000Inventory .............................................................. 75,000Equipment............................................................ 84,000Goodwil l ............................................................... 626,000

Short-Term Loan Payable............................. 160,000Cash ................................................................ 805,000

The government contacts intangible is not separately recognizedbecause it is not contract based nor is it separately tradable. The$92,000 fair value estimated for this intangible is imbedded in thereported amount of goodwill.

2. Accounts Receivable.......................................... 180,000Inventory .............................................................. 75,000Equipment............................................................ 84,000

Gain................................................................. 154,700

Short-Term Loan Payable............................. 160,000Cash ................................................................ 24,300

1042.

2013 2012

Land .................................................... $150,000 $125,000Buildings ............................................ 500,000 450,000Equipment .......................................... 260,000 250,000Total fixed assets ............................... $910,000 $825,000

Fixed asset turnover ratio = Sales/Average fixed assets$3,500,000/[($825,000 + $910,000)/2] = 4.03


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Chapter 10 401

1044. (Concluded)

(c) and (d) CDCapitalize and depreciate.If the lives of the plants can be reasonably estimated, the cost of theplants should be depreciated over those lives. However, if no reason-able estimates exist, the cost should be capitalized but not depreciated.

(e) and (f) CDCapitalize and depreciate.Land improvements that wear out over time should be capitalized anddepreciated.

(g) EExpense.The $50 cost of rakes is immaterial in relation to the other golf courseexpenditures. The costs of estimating the life of the rakes and maintain-ing a rake account in the financial records would far exceed the value ofthe theoretical improvement in the records. The best approach is to ex-pense the cost o f the rakes.

(h) and (i) CNCapitalize and dont depreciate.

Al l costs of getting the land ready for its in tended use should be in-cluded as part of the land cost.

1045.

1. Cost of land:Purchase pr ice ......................................................................................... $ 140,000Delinquent property taxes ..................................................................... 22,000Tit le search and insurance ..................................................................... 7,000City improvements ................................................................................. 19,500Cost of destroying build ings, net of salvage used in new building ... 19,000

Total cost of land................................................................................... $ 207,500Cost of land improvements:

Landscaping ............................................................................................. $ 81,600Sidewalks and parking lo t ....................................................................... 41,000

Total cost of land improvements ......................................................... $ 122,600

2. Cost of building:Building permit ......................................................................................... $ 6,000Salvage material from old bui lding ........................................................ 5,000Contract cost ............................................................................................ 1,800,000

Total cost of buildings .......................................................................... $1,811,000

Fire insurance premium on building is charged to expense.


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Chapter 10 403

1047.

Organization Expenses ........................................................................ 211,000*Land, Buildings, and Equipment.................................................. 211,000

To record costs identified with the establishmentof company. These organization costs should beexpensed as incurred.

*Organization fees paid to state ....... $ 21,000Corporate organization costs ......... 40,000Stock promot ion bonus ................... 150,000

$211,000

Land ....................................................................................................... 355,300Land, Buildings, and Equipment.................................................. 355,300*

*Land site and old bui lding ............... $ 325,000Tit le clearance fees .......................... 15,300Cost of razing old bui lding .............. 15,000

$ 355,300Miscel laneous Revenue ....................................................................... 7,000

Land ................................................................................................ 7,000To reduce the cost o f the land by proceedsfrom the sale of scrap.

Executive Salaries Expense ................................................................ 100,000Land, Buildings, and Equipment.................................................. 100,000

To record executive salaries in expense account.

Patent ..................................................................................................... 54,000Land, Buildings, and Equipment.................................................. 54,000

To reclassify patent cost to separate account .

Property Tax Expense ........................................................................ 13,200Land, Buildings, and Equipment.................................................. 13,200

To reclassify county real estate tax.

Buildings ............................................................................................... 1,450,000Land, Buildings, and Equipment.................................................. 1,450,000

To reclassify building cost to separate account.


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404 Chapter 10

1048.

(a) Retained Earnings ........................................................................ 120,000Patents ....................................................................................... 120,000

To correct error debiting research and develop-ment costs of patents to patents in prior period.

(b) Patents ........................................................................................... 14,280Retained Earnings .................................................................... 14,280

To correct error debiting legal fees inconnection wi th the issuance of patents toexpenses in prior period.

(c) Patents ........................................................................................... 15,000Deferred Costs .......................................................................... 15,000

To debit patents wi th the legal costs inconnection with the successful settlement ofan infringement suit.

(d) Patents ........................................................................................... 24,260Liabi lit y for Settlement of Patent Infringement Suit .............. 23,000

Accrued Attorneys Fees ......................................................... 1,260To record the settlement costs and theadditional legal fees in connection wi th thesuccessful settlement of an infringement suit.


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408 Chapter 10

1052. (Concluded)

Salvino CompanyAnalysis of Bui ld ings Account

For 2013

Balance at January 1, 2013.................................................... $ 910,000Cost of new building constructed on land site 654:Construction costs ........................................................... $600,000Excavation fees ................................................................. 35,000

Architectural design fees ................................................. 19,000Building permit fee ........................................................... 15,000 669,000

Balance at December 31, 2013 .............................................. $1,579,000

Salvino CompanyAnalysis of Leasehold Improvements Account

For 2013

Balance at January 1, 2013............................................................................ $500,000Electr ical work ................................................................................................ 60,000Construction of extension to current work area ($80,000 1/2)................ 40,000Office space .................................................................................................... 70,000Balance at December 31, 2013 ...................................................................... $670,000

Salvino CompanyAnalysis of Machinery and Equipment Account

For 2013

Balance at January 1, 2013........................................................... $600,000Cost of new machines acquired:

Invoice pr ice ............................................................................. $90,000Freight costs............................................................................. 2,000Unloading charges................................................................... 2,500 94,500

Balance at December 31, 2013 ..................................................... $694,500

2. Items that were not used to determine the answer to (1) and where, or if, theseitems should be included in Salvino s financial statements are as follows:

a. Imputed interest of $60,000 on funds used during construct ion should not beincluded anywhere in Salvinos financial statements. Only actual interestincur red can be capitalized.

b. Land site 655, which was acquired for $600,000, should be included in Salvi -nos balance sheet as land held for resale.

c. Painting of ceilings for $10,000 should be included as a normal operating ex-pense in Salvinos income statement.

d. Royalty payments of $13,000 should be inc luded as a normal operatingexpense in Salvinos income statement.


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Chapter 10 409

1053.

Davis CompanyAnalysis of Changes in Noncurrent Operat ing Assets

For the Year Ended December 31, 2013

Balance BalanceDec. 31, 2012 Increase Decrease Dec. 31, 2013Land ......................................... $ 280,000 $ 237,250* $ 517,250Land improvements................ 141,000 141,000Buildings ................................. 1,150,000 492,750* 1,642,750Machinery and equipment ..... 924,000 223,000 $22,000 1,125,000

Automobiles ............................ 113,000 26,400 139,400Leasehold improvements ...... 277,000 277,000

$2,744,000 $1,120,400 $22,000 $ 3,842,400

COMPUTATIONS:

*Plant facili ty acquired from Matthews January 6, 2013allocation to land and

building fair value10,000 shares of Davis common stock at $73per share market pr ice ......................................................................... $730,000

Al locat ion in proport ion to appraised values at the exchange date:

Amount % of TotalLand.................................... $195,000 32.5%Building .............................. 405,000 67.5

$600,000 100.0%

Land ($730,000 0.325) ...................................................... $237,250Building ($730,000 0.675) ................................................ 492,750

$ 730,000

Machinery and equipment purchased July 1, 2013:Invoice cost .................................................................... $187,000Delivery cost .................................................................. 14,000Instal lat ion cost ............................................................. 22,000

Total acquisit ion cos t ............................................... $223,000

(Note:The land purchased November 4 would be reported as an investment, notas a noncurrent operating asset.)


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410 Chapter 10

1054.

1. 2013 interest accrued:12%, 5-year note ($2,000,000 0.12) ................................................... $ 240,00010%, 10-year bonds ($8,000,000 0.10).............................................. 800,00013%, 3-year loan ($2,000,000 0.13) ................................................... 260,000

Total in terest accrued2013*........................................................ $1,300,000

*Maximum that can be capitalized.

2. Weighted-average interest rate, general liabi lit ies:

Loan Amount Rate Interest Expense$ 2,000,000 12% = $ 240,000

8,000,000 10 = 800,000$10,000,000 $1,040,000

Weighted-average interest rate($1,040,000 $10,000,000) = 10.4%

3. Ship 340: Completed in October 2012. No capitalized interest in 2013.

Interest FractionCapitalization of the Year Capitalized

Expenditures Amount Rate Outstanding Interest

Ship 341:Accum. expendi ture............ $1,150,000 10.4% 6/12 $ 59,800Apri l 1, 2013......................... 1,200,000 10.4 3/12 31,200

Ship 342:Accum. expenditure............ 1,200,000 10.4 9/12 93,600May 1, 2013.......................... 1,600,000 10.4 5/12 69,333

Ship 343:Accum. expenditure............ 750,000 13.0 12/12 97,500July 1, 2013.......................... 1,250,000 13.0 6/12 81,250

950,000 10.4 6/12 49,400

Ship 344:Sept. 1, 2013 ........................ 810,000 10.4 4/12 28,080

Ship 345:Nov. 1, 2013 ......................... 360,000 10.4 2/12 6,240

Total capitalized interest for 2013 ........................................................... $516,403


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Chapter 10 411

1055.

1. Self-Constructed Equipment Cost

Stated at Full Cost

Services of consulting engineer ................................................................... $ 10,000

Work subcontracted ....................................................................................... 20,000Materials .......................................................................................................... 200,000Product ion labor ............................................................................................. 65,000Maintenance labor used on self -construct ion ............................................. 100,000Payroll taxes and employee fringe benefits for indirect labor (30%) ........ 30,000Manufacturing overhead................................................................................ 52,000*

Al located execut ive salaries.......................................................................... 22,500Postage, telephone, supplies, and miscellaneous expenses .................... 10,500

Total............................................................................................................ $510,000

*Manufacturing overhead cost:

Total manufacturing overhead ....................................................... $5,630,000Less: Maintenance labor used onself-construction............................................. $100,000

Payroll taxes and employee fringe benefitsfor maintenance labor (30%) to be chargeddirect ly to equipment...................................... 30,000 130,000

Balance to be allocated ................................................................... $5,500,000

Production labor for normal products........................................... $6,810,000Add: Product ion labor used on self-construct ion........................ 65,000Total production labor..................................................................... $6,875,000

Manufacturing overhead = 80% ($5,500,000 $6,875,000) of

product ion labor = 0.80 $65,000 = $52,000.

2. Self-Constructed Equipment CostStated at Incremental Cost

Services of consulting engineer .................................................................. $10,000Work subcontracted ...................................................................................... 20,000Materials ......................................................................................................... 200,000Product ion labor ............................................................................................ 65,000Variable manufacturing overhead (50% of $52,000) .................................. 26,000Postage, telephone, supplies, and miscellaneous expenses ................... 10,500

Total........................................................................................................... $331,500


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412 Chapter 10

1055. (Concluded)

3. The greatest amount that should be capitalized as the cost of equipment is$400,000the low bid from a reputable manufacturer. This includes at least apart of the overhead incurred other than the strictly variable overhead. Most ac-counting authorities recommend that for self-constructed assets, overheadshould be allocated on the same basis as other production when a plant is notoperating at capacity. This has the effect, however, of increasing net income be-cause of the reduced overhead allocation to normal production. Any cost in-curred from the self-construction of an asset computed on a full cost basis thatis in excess of the cost of a comparable asset from a reputable supplier might beconsidered a loss and thus charged against revenues of the current period.

1056.

Business Calculator Keystrokes:Approach 1: FV= $10,000; I= 6%; N= 20 years $3,118

Approach 2: FV= $250,000; I= 6%; N= 20 years $77,951Approach 3: FV= $1,200,000;I= 6%; N= 20 years $374,166

Present Probability-WeightedValue Probabi lity Present Value

Approach 1 $ 3,118 0.15 $ 468Approach 2 77,951 0.25 19,488Approach 3 374,166 0.60 224,500

Total estimated fair value $244,456

Nuclear Waste Repository Site ................................................ 700,000

Cash ...................................................................................... 700,000

Nuclear Waste Repository Site ................................................ 244,456Asset Retirement Obl igation ............................................... 244,456


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Chapter 10 413

1057.

1. Current Assets .................................................................... 340,000Land, Buildings, and Equipment (net).............................. 260,000Goodwil l............................................................................... 1,085,000

Current Liabil it ies ......................................................... 25,000Long-Term Liabil it ies.................................................... 160,000Cash ............................................................................... 1,500,000

2. The possible reasons Aurora was wil ling to pay an extra $1,085,000 for Payetteinclude

Payette has a strong organization with trained staff already in place. Payette has an efficient production and distr ibution network that is up and

running. Payette has good relationships with its banks and suppliers. Payette sells a superior product that has a well-established market niche.

3. Current Assets .................................................................... 340,000Land, Buildings, and Equipment (net).............................. 260,000

Gain.................................................................................. 65,000Current Liabili ties ........................................................... 25,000Long-Term Liabil it ies ..................................................... 160,000Cash................................................................................. 350,000

4. Current Assets .................................................................... 340,000Land, Buildings, and Equipment (net).............................. 260,000

Gain.................................................................................. 265,000Current Liabili ties ........................................................... 25,000

Long-Term Liabil it ies ..................................................... 160,000Cash................................................................................. 150,000

1058.

1. 2013:Interest Expense................................................................. 470,000Construction in Progress .................................................. 350,000

Accrued Interest Payable................................................... 8,000Cash ............................................................................... 828,000

2012:

Interest Expense................................................................. 410,000Construction in Progress .................................................. 260,000

Accrued Interest Payable ............................................. 13,000Cash ............................................................................... 657,000


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414 Chapter 10

1058. (Concluded)

2. 2013 Statement of Cash Flows:In the Cash Flows from Operating Activities section:

Decrease in accrued interest payable ............................................... $ (8,000)

In the Cash Flows from Investing Activ ities section:Increase in construction in progress ................................................. (350,000)

Supplemental Disclosure:Cash paid dur ing the year for interest (amount of in terest paidnet of the amount capitalized) ............................................................ 478,000

2012 Statement of Cash Flows:In the Cash Flows from Operating Activities section:

Increase in accrued interest payable................................................. $ 13,000

In the Cash Flows from Investing Activ ities section:Increase in construction in progress ................................................. (260,000)

Supplemental Disclosure:Cash paid dur ing the year for interest (amount of in terest paidnet of the amount capitalized) ............................................................ 397,000

1059.

1. Return on equity = Net income Stockholders equity= $38 mill ion ($325 mill ion $180 mill ion)= 26.2%

Yes, Cole exceeded its profitabili ty goal of 25% ROE.

2. The follow ing adjustments are necessary.(a) Decrease net income and total assets by $15 million capitalized R&D.(b) Decrease paid-in capital and total assets by $12 million to reflect market value

of the stock.(c) The equipment should be recorded at the present value of the payment

stream.

Present value = $1,000,000 + [$3,000,000 (PVAF, n = 8, i = 12%)]= $1,000,000 + [$3,000,000 (4.9676)]= $15,902,800

or with a business calculator:PMT= $3,000,000; N= 8;I= 12% PV= $14,902,919$1,000,000 + $14,902,919 = $15,902,919

$25,000,000 $15,902,800 = $9,097,200Decrease total liabili ties and total assets by $9,097,200.


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Chapter 10 415

1059. (Concluded)

(d) Decrease net income and total assets by $7 million.

Af ter the adjustments, net income is $16 mill ion ($38 mil lion $15 mill ion $7million); total assets are $281.9028 million ($325 million $15 million $12

million $9.0972 million $7 million); total liabilities are $170.9028 million($180 million $9.0972 million); total equity is $111 million ($145 million $15mill ion $12 mill ion $7 million).

Return on equity = $16 mill ion $111 mill ion= 14.4%

Af ter the adjustments, Cole does not meet its prof itabili ty goal. Note that item(c) does not affect the value of ROE and that item (b) actually has the effect ofincreasing ROE (by decreasing equity).

3. The auditors should catch this kind of accounting abuse. However, even a goodaudit may fail to detect such abuses when employees col lude in order to bias the

accounting numbers in some way.

1060.

(a) Buildings................................................................................... 462,000Cash ...................................................................................... 462,000

To record cost of addition to building.

(Expenditures for addit ions are capitalized and are depreciated over the life ofthe asset.)

(b) Loss on Removal of Wall (or Operating Expense) ............... 26,020Cash ...................................................................................... 26,020

To record cost of removal of plantwall$23,410 + $2,610.

(Cost to tear down old wall not considered part of new wall cost. No benefit tofuture periods from o ld wall.)

(c) Accumulated DepreciationBuildings ................................. 17,300Cash .......................................................................................... 6,570Depreciation Expense ............................................................. 10,030

Buildings .............................................................................. 33,900To cancel book value identified with plant walland to record amount received from salvage.

(The removed wall will not benefit future operations and therefore should beeliminated from the books.)


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416 Chapter 10

1060. (Concluded)

(d) Accumulated DepreciationBuildings ...................................... 6,250Depreciation Expense .................................................................. 6,750

Buildings ................................................................................... 13,000To remove cost of old floor covering.

Floor Covering .............................................................................. 9,190Cash ........................................................................................... 9,190

To record cost to replace flooring.

(e) Painting Expense.......................................................................... 12,420Cash ........................................................................................... 12,420

To record maintenance charge for repainting.

(f) Accumulated DepreciationBuildings ...................................... 990Depreciation Expense .................................................................. 1,210

Buildings ................................................................................... 2,200

To remove cost of o ld shelving.Shelving ......................................................................................... 4,180

Cash ........................................................................................... 4,180To record cost of new shelving.

(g) Buildings........................................................................................ 13,440Cash ........................................................................................... 13,440

To record cost o f new wiring.

(Wiring has same remaining useful li fe as the building.)

Accumulated DepreciationBuildings ...................................... 1,900Depreciation Expense .................................................................. 3,210

Buildings ................................................................................... 5,110To record the removal of old wiring.

(h) Buildings........................................................................................ 9,440Discount on Notes Payable.......................................................... 800

Notes Payable ........................................................................... 10,240To record cost of new fixtures.

(Electrical fi xtures have the same remaining useful life as thebuilding.)

Accumulated DepreciationBuildings ...................................... 1,410Depreciation Expense .................................................................. 1,890

Buildings ................................................................................... 3,300To record the removal of old f ixtures.


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418 Chapter 10

1062.

1.2013 2012

Land $ 600,000 $ 400,000

Buildings 900,000 800,000Equipment 350,000 250,000Total fixed assets $1,850,000 $1,450,000

Fixed asset turnover: $4,800,000/[($1,850,000 + $1,450,000)/2] = 2.91

2. (Note: The LIFO reserves are fair value adjustments that relate to current assetsinstead of long-term assets. Also, it is reasonable to assume that the fair valuesof cash and accounts receivable are close to their book values.)

Fair value of fixed assets: Fair value of total assets Cash Accountsreceivable Inventory LIFO reserve

2013: $3,800,000 $50,000 $300,000 $650,000 $150,000 = $2,650,0002012: $3,000,000 $45,000 $220,000 $510,000 $100,000 = $2,125,000

Fixed asset turnover: $4,800,000/[($2,650,000 + $2,125,000)/2] = 2.01

3. It is difficu lt to tell whether Progressive is more or less efficient at using its fixedassets than is Steady State. Based on the reported financial numbers, Progres-sives fixed asset turnover is 2.91, whereas the ratio for Steady State is only 2.5.However, as shown in (2), this difference may result from a difference betweenbook value and fair value of reported long-term assets. If Steady State has rela-tively new fixed assets, for which the book value is quite close to the fair value,then Progressives 2.01 fixed asset turnover ratio (based on fair values) is worsethan the 2.5 ratio value for Steady State.

1063.

1. The correct answer is b. Capitali zed interest will be based on the amount ofavoidable interest caused by the building construction. When that amount ex-ceeds the specific funds bo rrowed, interest on unrelated liabilities wil l be ca-pitalized. When that amount is lower than the funds borrowed, as is the casehere, the amount to be capitalized will be the lower amount o f $40,000.

2. The correct answer is b. The only time costs are capitalized as goodwil l is when abusiness combination occurs and the cost of the acquisition exceeds the fair

market value of the underlying net identifiable assets acquired. Neither the costof developing nor of maintaining goodwill is capitalized.


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Chapter 10 419

CASES

Discussion Case 1064

Each of the five items introduced in the case is discussed.

(a) Recorded book values on the books of the seller are irrelevant to the buyer. Fair values of all identi-fiable assets, both tangible and intangible, should be used to make the entry to record the purchase.Appraisal values are one source of estimated fair values. Other possible sources include recentsales of similar assets and engineers estimates of building costs. In this instance, the appraisal forfire insurance purposes is recent enough that it probably could be used for purposes of recording thepurchase. The land value would be $35,000, or 1/5 of the building value. One could object to thevalues in the appraisal for fire insurance coverage because of its potential bias toward higher valuesto sell more insurance coverage. Evaluation of the reputation of the fire insurance company and itsappraisers would be required to determine the extent of such bias.

(b) Replacement costs of equipment can be used as a basis for determining the fair value of such as-sets. Because it is easier to obtain replacement costs on new equipment than it is to determine themarket value for used equipment that exactly matches the age and condition of the assets owned, itis common practice to use the new market price and then depreciate it to the estimated age of the

used equipment. In this instance, the new cost is estimated to be $450,000, and the depreciatedvalue of 50% of the cost new, $225,000, would be a reasonable estimate of the market price of theold equipment.

(c) Franchises can be very valuable assets. As with tangible assets, the value recorded on the sellersbooks is irrelevant to the buyer. Because the franchise is for an unlimited time, its value to the buyeris unaffected by the time the seller used it. The current purchase price of similar franchises,$120,000, can be used to record the purchase.

(d) The two research scientists who will transfer employment to Fugate represent a value to Fugate.However, this human resource value is generally not recognized as an asset in our historical costsystem. Fugate would not own the scientists, and they could leave the company with no contractpenalties. Only in a few types of activities, such as professional sports, are contracts for humanresources capitalized and carried on the books as assets. In a business acquisition, the intangible

value of at-will employees is not recognized but is included as part of goodwill. In this case, the re-searchers salaries will be charged to expense as they are paid. The accounting for human re-sources is one accounting area that is certain to develop in the future.

(e) Patents are valuable assets that can be owned and transferred. The fair value of the patent is theappropriate measure of the asset value at the transaction date and the zero book balance onGleaves books is not relevant to Fugate.

The total fair value of the assets acquired would be as follows:

Land ............................................................. $ 35,000Building ........................................................ 175,000Equipment .................................................... 225,000Franchise ..................................................... 120,000Patents ......................................................... 150,000

Total .......................................................... $705,000


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Discussion Case 1064 (Concluded)

Because only $556,950 was paid for these assets, this was a bargain purchase. The journal entry wouldbe as follows:

Land ............................................................. 35,000Building ........................................................ 175,000

Equipment .................................................... 225,000Franchise ..................................................... 120,000Patents ......................................................... 150,000

Gain ....................................................... 148,050Cash ...................................................... 556,950


This case addresses the problems associated with accounting for software development costs. Strategywants its financial statements to present a favorable picture of the companys financial condition and op-erating performance. If the owner is correct in predicting that this years research and development costswill be recovered through sales in the following year, a strong argument could be made to defer the costs

incurred this year and match them against next years revenues. The central issue, however, is whetherthe sales will actually materialize next year. The uncertainty of predicting future sales led the FASB toconclude that until technological feasibility has been established, costs to develop software should beexpensed. It is unclear from this case how much of the $45,000 was related to products for which techno-logical feasibility had been established and how much related to new products still in the preliminary de-sign and testing stages. To the extent that the costs were incurred for new products for which technologi-cal feasibility had not been established, the CPA is correct in insisting that these costs be expensed asrequired by the FASB.


From the brief description of Arnold, it is reasonable to assume that Arnold spends a lot for research anddevelopment (R&D) and for advertising. On theoretical grounds, both of these can be argued to be capital

expenditures. However, R&D must be expensed as incurred and advertising expenditures are usuallytreated in the same way. This can result in a substantial amount of real economic assets that are not re-corded on the balance sheet. For example, assume that Arnold spends an average of $300,000 per yearon R&D and $400,000 per year on advertising and that the average economic life of the assets created isfive years for the R&D expenditures and three years for the advertising. This means that Arnold has unre-corded assets of $2,700,000. If these assets were reported on the balance sheet, Arnolds ROA would beabout the same as that for Baker.

Other assets that are not shown on companies balance sheets include the value of asset appreciation,key employees, favorable market position, and good reputation with suppliers, creditors, and employees.The lack of comparability is an issue because some companies have large amounts of unrecorded assetsand others do not. For example, two companies may both have pieces of land with a current market valueof $500,000. However, one company may show the land at $100,000 because it was purchased yearsago while the other may have purchased it just recently and thus will show it at $500,000.

A comparison of the book values of companies (total assets total liabilities) and the market values ofthose companies as measured by total market value of shares outstanding illustrates that there is consid-erable variability among companies, a fact that suggests companies often have large amounts of unre-corded assets.


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The rule requiring firms to expense R&D outlays results in a decrease in net income for most firms. Adecrease in reported net income can impact a firm in several ways:

Managers bonuses are frequently based on reported earnings. Loan covenants are often written in terms of reported earnings.

Some investors seem to rely on the naive use of reported earnings in picking stocks.Accordingly, managers compensation may suffer when R&D expenditures are expensed, and thosemanagers may be less willing to authorize R&D projects. This is in spite of the fact that the R&D might bebeneficial for the firms long-run profitability.

It might be expected that in response to an accounting standard change, management bonus plans, loancovenants, and investors decision rules would be adapted to allow for the change in reported earningsbrought about solely because of the accounting change. However, there is evidence that such adjust-ments are not always made.


The estimated Gillette brand value is relevant both to outsiders who wish to value Gillette stock and toGillettes management who wish to monitor the impact of their actions on Gillettes most valuable assetthe brand name.

However, reading the description of the 4-stage estimation process casts doubt on the reliability of theestimate. The valuation estimate requires assumptions about the following quantities:

An appropriate sales-to-asset ratio The baseline return on sales of a generic brand in Gillettes industry Gillettes marginal tax rate The brand strength multiple

Given the assumptions made by Financial Worldmagazine, the computed brand value is $10.3 billion, butslightly different estimates could result in numbers anywhere from $5 billion to $15 billion.

This may be a good example of a situation in which disclosure is better than recognition. Recognizing a

point estimate of the brand value gives an illusion of precision. Disclosing the brand value in the notes,along with the assumptions underlying the computation, gives financial statement users a more realisticimpression of the estimated value.


1. Appreciation in asset values is a large part of the business of a real estate firm. Because of this andbecause generally accepted accounting rules require long-term assets to be depreciated, many us-ers of financial statements think that historical cost financial statements for real estate companiescan be particularly uninformative. For a further discussion, see Edward P. Swanson and FrederickNiswander, Voluntary Current Value Disclosures in the Real Estate Industry,Accounting Horizons,December 1992, p. 49.

2. Daimler-Benz was willing to reveal the magnitude of its hidden reserves in order to comply with U.S.GAAP as a prerequisite to listing its shares on the New York Stock Exchange.

Hidden reserves are a result of the prudence principle: the primary goal of current management isto make sure that the firm survives into the future to the benefit of stockholders, creditors, employ-ees, local economies, and so on. One way to build up a financial cushion to increase the probabilityof

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