CHAPTER 9

LONG-LIVED ASSETS

BRIEF EXERCISES

BE9–1
a. The new method, straight-line depreciation, will increase net income in the early years and reduce
income in the later years versus using an accelerated method. An accelerated method of depreciation
increases the depreciation charges in the early years of the life of an asset and reduces the depreciation
charges in the later years.

b. Allegheny may have decided that it wanted depreciation charges to be spread evenly over the life of an
asset so that the impact on net income in any one reporting period was less. It may also feel that it will
make its financial statements easier to compare with its competitors. During periods of high fixed asset
investment Allegheny’s results may look unfavorable versus other companies that use a straight-line
method instead of an accelerated method.

c. In the annual report one could look through the first footnote. This footnote typically highlights all of
the significant accounting policies and methods used by the company to prepare the financial
statements.

BE9–2
a. The recognition of depreciation and amortization affects the basic accounting equation by reducing
assets and reducing retained earnings in the stockholders’ equity section. Fixed assets such as property,
plant and equipment are reduced through depreciation charges (which are collected in the contra asset
account Accumulated Depreciation) which lower net income. Intangible assets are reduced by
amortization charges which reduce the net income of the company. This reduction in net income
reduces the retained earnings of the company.

b. Boeing recognized a loss of $11 million, computed as follows:

Accumulated depreciation 2011 $13,993 million

+ Depreciation charges for 2012 1,248 million
– Accumulated depreciation 2012 14,645 million
Accumulated depreciation on assets sold $ 596 million

PP&E 2011 $23,306 million

+ PP&E purchases for 2012 1,703 million
– PP&E 2012 24,305 million
PP&E sold $ 704 million

1
 Cost of PP&E $704 million
– Accumulated depreciation on assets sold 596 million
Net book value of PP&E sold 108 million
Cash received from sale 97 million
Loss on sale of PP&E $ 11 million

Derived Journal Entry:

Cash (+A) 97
Accumulated Depreciation (+A) 596
Loss on Sale (E, -SE) 11
Property, Plant & Equipment (-A) 704

The loss on the sale of property, plant and equipment would be shown in the income statement, usually
in an “other gains and losses” section. These transactions would affect the statement of cash flows in
the “funds from investing activities section”. Any sales would be a source of funds in the amount of
cash received.

BE9–3
a. Johnson and Johnson invested $39 million ($793– $754) of land during 2012.

b. Accumulated depreciation increased during 2012 because of depreciation expense taken by Johnson
and Johnson. Instead of reducing the asset account directly, depreciation expense is added to
accumulated depreciation, which offsets the asset account to show its reduction in value.

c. If the company used an accelerated method of depreciation, the assets would be shown at a lower net
value in the early years. Accelerated methods take more depreciation charges in the early years of an
asset’s life and less in the later years, when compared to the straight-line method.

d. Johnson and Johnson would show $16,097 million for property, plant and equipment on its financial
statement for 2012. The gross amount and the accumulated depreciation would be disclosed in the
footnote.

BE9–4
a. The Depreciation & Amortization adjustment and the Impairment adjustment both were recorded
by charging an expense to earnings and lowering the carrying value of the long-term assets. The
gain was recorded when the long term assets were sold for a price greater than the carrying value;
the debit to cash and credit to the sold assets were balanced out with a credit to the temporary
account “Gain on sale”.
b. The Depreciation & Amortization adjustment and the Impairment charge are both non-cash
expenses that need to be added back to earnings on the statement of cash flow. (The expenses
reduced earnings but did not reduce cash, so the add-back is necessary in the statements conversion
of accrual earnings to actual cash flow.) The gain is a deduction because activities involving long-
term assets are not included in the Operating section.
c. The gain is adjusted out of the Operating section of the statement of cash flow because the cash
received from the sale of long-term assets is an Investing activity and needs to be reflected in a
different section of the statement of cash flow; additionally, the Investing section will reflect the
entire amount of cash received in the sale, not simply the gain.
d. If the company followed U.S. GAAP, similar adjustments would appear.
 EXERCISES

E9–1
a. Lowery, Inc., should capitalize all costs associated with getting the equipment in a serviceable condition
and location. These costs would be the actual purchase price of $920,000, the transportation cost of
$62,000, and the insurance cost of $10,000. Therefore, the total cost of the equipment is $992,000.

b. The depreciation base equals the dollar amount of a fixed asset's cost that the company does not expect
to recover over the asset's useful life, but instead expects to consume over the asset's useful life. Since
the plant equipment's total cost is $992,000 and since Lowery, Inc., expects to sell the equipment for
$50,000 at the end of its useful life, Lowery, Inc., does not expect to recover $942,000 of the asset's
cost. Therefore, the depreciation base equals $942,000. The depreciation base always equals the
capitalized cost of a fixed asset less its estimated salvage value.

c. The amount that will be depreciated over the life of the plant equipment is its depreciation base. The
depreciation base equals the amount of the equipment's future benefits that the company will consume.
The outflow of future benefits are expenses, in this case depreciation expense. Therefore, the total
amount that Lowery, Inc., will depreciate over the equipment's useful life is $942,000.
E9–2
Lot 1 Lot 2 Lot 3 Lot 4
Revenue $ 160,000 $ 120,000 $ 60,000 $ 60,000
Expenses 128,000* 96,000* 48,000* 48,000*
Net income $ 32,000 $ 24,000 $ 12,000 $ 12,000
_________________
* Expenses were calculated as follows:
1. Calculate total market value.
Total Market value = $160,000 + $120,000 + $60,000 + $60,000 = $400,000
2. Allocate costs to each lot based upon relative market values.
Lot 1 = $320,000  (160,000/400,000) = $128,000
Lot 2 = $320,000  (120,000/400,000) = $ 96,000
Lot 3 = $320,000  (60,000/400,000) = $ 48,000
Lot 4 = $320,000  (60,000/400000) = $ 48,000

E9–3
a. All costs that are necessary and reasonable to get an asset ready for its intended use should be
capitalized as part of the cost of that asset. In the case of property, plant, and equipment, "ready for its
intended use" means that the asset is in a serviceable condition and location.

Land
Item Land Improvements Building
Tract of land $90,000
Demolition of warehouse 10,000
Scrap from warehouse (7,000)
Construction of building $140,000
Driveway and parking lot $32,000
Permanent landscaping 4,000
Total $ 97,000 $32,000 $140,000

b. Land:
Since land is assumed to have an indefinite life, it is never depreciated.

Land Improvements:
Depreciation Expense—Land Improvements (E, –SE)............................. 1,600
Accumulated Depreciation—Land Improvements (–A)...................... 1,600
Depreciated land improvements.

Building:
Depreciation Expense—Building (E, –SE)................................................ 7,000
Accumulated Depreciation—Building (–A)......................................... 7,000
Depreciated building.

E9–4
a. Maintenance
b. Maintenance
c. Maintenance
d. Betterment
e. Maintenance
f. Maintenance
g. Betterment
h. Maintenance
i. Betterment

Note: The classification of these expenditures can be quite subjective. Some accountants might very well
classify some of these expenditures differently. For example, one might argue that the cost of the
muffler in (h) is actually a betterment expenditure if the reduced noise allows workers to work
more efficiently, thereby increasing the productive capacity of the machine.

E9–5
a. (1) Expensed immediately:

Income Statement
2017 2016 2015
Revenues $ 65,000 $ 65,000 $ 65,000
Amortization 0 0 40,000
Other expenses 20,000 20,000 20,000
Net income $ 45,000 $ 45,000 $ 5,000

Balance Sheet
12/31/17 12/31/16 12/31/15
Assets
Current assets $ 135,000 $ 90,000 $ 45,000
Long-lived assets
(including land) 50,000 50,000 50,000
Total assets $ 185,000 $ 140,000 $ 95,000

Liabilities and Stockholders' Equity

Liabilities $ 35,000 $ 35,000 $ 35,000
Stockholders' equity 150,000 105,000 60,000
Total liabilities & stockholders'
equity $ 185,000 $ 140,000 $ 95,000
E9–5 Continued
(2) Amortized over two years:
Income Statement
2017 2016 2015
Revenues $ 65,000 $ 65,000 $ 65,000
Amortization 0 20,000 20,000
Other expenses 20,000 20,000 20,000
Net income $ 45,000 $ 25,000 $ 25,000

Balance Sheet
12/31/17 12/31/16 12/31/15
Assets
Current assets $ 135,000 $ 90,000 $ 45,000
Long-lived assets (including
land) 50,000 50,000 70,000
Total assets $ 185,000 $ 140,000 $ 115,000

Liabilities and Stockholders' Equity

Liabilities $ 35,000 $ 35,000 $ 35,000
Stockholders' equity 150,000 105,000 80,000
Total liabilities & stockholders'
equity $ 185,000 $ 140,000 $ 115,000

(3) Amortized over three years:

Income Statement
2017 2016 2015
Revenues $ 65,000 $ 65,000 $ 65,000
Amortization 13,334 13,333 13,333
Other expenses 20,000 20,000 20,000
Net income $ 31,666 $ 31,667 $ 31,667

Balance Sheet
12/31/17 12/31/16 12/31/15
Assets
Current assets $ 135,000 $ 90,000 $ 45,000
Long-lived assets (including
land) 50,000 63,334 76,667
Total assets $ 185,000 $ 153,334 $ 121,667

Liabilities and Stockholders' Equity

Liabilities $ 35,000 $ 35,000 $ 35,000
Stockholders' equity 150,000 118,334 86,667
Total liabilities & stockholders'
equity $ 185,000 $ 153,334 $ 121,667

b. 2017 2016 2015 Total

Method 1: $45,000 $45,000 $ 5,000 $95,000
Method 2: 45,000 25,000 25,000 95,000
Method 3: 31,666 31,667 31,667 95,000
E9–5 Concluded
c. The balance sheets under all three methods report identical amounts for each balance sheet account.
Since the asset was fully amortized by December 31, 2017, the method used to amortize the asset does
not affect the amounts reported on the balance sheet as of December 31, 2017.

E9–6
a. and b.

Stork Freight Company

Income Statement
For the Year Ended December 31
12-Year Useful Life 6-Year Useful Life
Revenues $ 50,000,000 $ 50,000,000
Expenses:
Operating expenses $ 25,000,000 $ 25,000,000
Depreciation expense 1,250,000 2,500,000
Total expenses 26,250,000 27,500,000
Net income $ 23,750,000 $ 22,500,000

The percentage decrease in net income would be approximately 5.26% [($22,500,000 – $23,750,000) ÷
$23,750,000].

c.
12-Year Useful Life 6-Year Useful Life
Net income $ 23,750,000 $ 22,500,000
Dividend payout percentage 30% 30%
Dividends $ 7,125,000 $ 6,750,000

The difference in dividends due simply to using different estimated useful lives for the planes would be
$375,000 ($7,125,000 – $6,750,000). However, it should be noted that in the 6-year useful life
example, dividends in years 7 – 12 would be higher (due to the lack of depreciation expense).

E9–7
a. An asset's book value equals the asset's initial capitalized value less the associated accumulated
depreciation. With straight-line depreciation, accumulated depreciation equals depreciation expense per
year times the number of years the asset has been used. Therefore, the asset's book value would be
calculated as follows:

Depreciation expense per year = (Cost – Salvage Value) ÷ Useful Life

= ($60,000 – $12,000) ÷ 5 years
= $9,600 per year

Book Value = Capitalized Cost – Accumulated Depreciation

= $60,000 – ($9,600  3 years)
= $31,200

E9–7 Concluded
b. Depreciation Expense = [(Cost – Accumulated Depreciation) – Salvage Value] ÷
Remaining Useful Life
= (Book value – Salvage value) ÷ Remaining useful life
= ($31,200 – $12,000) ÷ 5 remaining years
= $3,840

Depreciation Expense (E, –SE).................................................................. 3,840

Accumulated Depreciation (–A).......................................................... 3,840
Depreciated asset for 2014.

E9–8
Straight- Double-Declining- Activity
Objective Line Balance Method
(a) x1 x1 x1
(b) x x x
(c) x x2
(d) x
(e) x
(f) x
(g) x x3
(h) x x x
1
Under certain conditions, all three methods could meet this objective. However, for the straight-line
method and the double-declining-balance method, this objective will be met only by chance. The activity
method will always meet this objective because depreciation is based upon the actual use of the asset.
2
It is possible that the activity method would generate the largest net income in the last year of an asset's
useful life. However, this result would be due to the company's use patterns of the asset and would not be
due to the depreciation method per se.
3
See note (2). The same rationale would hold in this case too.

E9–9
a. (1) Straight-line depreciation:
Depreciation per Year = (Cost – Salvage Value) ÷ Useful Life
= ($300,000 – $60,000) ÷ 4 years
= $60,000 per year for 2014, 2015, 2016, and 2017

E9–9 Concluded
(2) Double-declining-balance depreciation:
Depreciation Depreciation Accumulated Book
 Date Factor Expense Cost Depreciation Value
1/1/14 $300,000 $ 0 $300,000
12/31/14 50% $150,000 a 300,000 150,000 150,000
12/31/15 50% 75,000 300,000 225,000 75,000
12/31/16 50% 15,000 b 300,000 240,000 60,000
12/31/17 50% 0 300,000 240,000 60,000
_________________
a Depreciation Expense = Book Value at Beginning of the Period  Depreciation Factor
b Book Value  Depreciation Factor = $75,000  50% = $37,500. If Benick Industries depreciated
$37,500 in 2016, the asset's book value would drop below its salvage value. To prevent this from
happening, depreciation expense for 2016 can be only $15,000.

b. A manager should consider the costs and benefits associated with each depreciation method. The most
likely benefit is the impact of depreciation methods on income taxes. An accelerated method decreases
the present value of tax payments. However, since there is no requirement that a company use the same
depreciation method for financial reporting purposes as it does for tax reporting, tax considerations are
not an issue for financial reporting. A manager should also consider the bookkeeping costs associated
with each method. However, with computers the bookkeeping costs should be relatively consistent
across methods. Finally, since the choice of depreciation methods affects net income, managers might
consider the impact of the different depreciation methods on contracts such as debt covenants and
incentive compensation contracts. Comparability with other firms in the same industry may also be a
factor.

E9–10
a. Computer System (+A)............................................................................ 335,000
Cash (–A)..................................................................................... 335,000
Purchased computer system.

Note: Capitalizing the $10,000 of training costs could be debated. But, without incurring these costs,
the computer system would not be in a serviceable condition. Hence, the training costs meet
the requirement to be capitalized as part of the fixed asset.

b. (1) Straight-line depreciation:

Depreciation per Year = (Cost – Salvage Value) ÷ Useful Life
= ($335,000 – $70,000) ÷ 5 years
= $53,000 per year for 2014, 2015, 2016, 2017, and 2018
E9–10 Concluded

(2) Double-declining-balance depreciation:

Depreciation Depreciation Accumulated Book

Date Factor Expense Cost Depreciation Value
1/1/14 $335,000 $ 0 $335,000
12/31/14 40% $134,000a 335,000 134,000 201,000
12/31/15 40% 80,400 335,000 214,400 120,600
12/31/16 40% 48,240 335,000 262,640 72,360
12/31/17 40% 2,360 b 335,000 265,000 70,000
12/31/18 40% 0 335,000
_______________
a Depreciation expense = Book value at beginning of the period  Depreciation factor
b Book value  Depreciation factor = $72,360  40% = $28,944. If Stockton Corporation depreciated
$28,944 in 2017, the asset's book value would drop below its salvage value. To prevent this from
happening, depreciation expense for 2017 can be only $2,360.

c. Depreciation Expense (E, –SE)........................................................... 134,000

Accumulated Depreciation (–A)................................................. 134,000
Depreciated fixed asset for 2014.

E9–11
1. Activity Method:
Depreciation Expense per Mile = ($100,000 – $20,000) ÷ 200,000 Miles
= $0.4/Mile

Depreciation Expense (E, –SE).................................................................. 19,200

Accumulated Depreciation (–A).......................................................... 19,200
Depreciated asset for 2014.

Depreciation Expense (E, –SE).................................................................. 14,000

Accumulated Depreciation (–A).......................................................... 14,000
Depreciated asset for 2015.

Depreciation Expense (E, –SE).................................................................. 16,000

Accumulated Depreciation (–A).......................................................... 16,000
Depreciated asset for 2016.

Depreciation Expense (E, –SE).................................................................. 10,000

Accumulated Depreciation (–A).......................................................... 10,000
Depreciated asset for 2017.
E9–11 Concluded
Depreciation Expense (E, –SE).................................................................. 14,000
Accumulated Depreciation (–A).......................................................... 14,000
Depreciated asset for 2018.

Depreciation Expense (E, –SE).................................................................. 4,000

Accumulated Depreciation (–A).......................................................... 4,000
Depreciated asset for 2019.

Cash (+A) .................................................................................................. 12,000

Accumulated Depreciation (+A)................................................................ 77,200
Loss on Sale of Truck (Lo, –SE)................................................................ 10,800
Truck (–A)............................................................................................ 100,000
Sold truck.

2. Straight-line Method:
Depreciation Expense per Year = ($100,000 – $20,000) ÷ 5 Years
= $16,000/year

Depreciation Expense (E, –SE).................................................................. 16,000

Accumulated Depreciation (–A).......................................................... 16,000
Depreciated asset.

Note: This entry would be made each year for five years. No entry would be made in Year 6 since the
truck's estimated useful life ended at the end of Year 5, which means that the truck would have
been depreciated down to its estimated salvage value.

Cash (+A) ................................................................................................ 12,000

Accumulated Depreciation (+A)................................................................ 80,000
Loss on Sale of Truck (Lo, –SE)................................................................ 8,000
Truck (–A).......................................................................................... 100,000
Sold truck.

E9–12
a. Depletion (E, –SE)...................................................................................... 1,200,000*
Oil Deposits (–A)................................................................................. 1,200,000
Depleted oil deposits.
_____________
* $1,200,000 = ($4,000,000 ÷ 100,000 barrels)  30,000 barrels extracted

b. Depletion (E, –SE)...................................................................................... 2,000,000*

Oil Deposits (–A)................................................................................. 2,000,000
Depleted oil deposits.
_____________
* $2,000,000 = ($4,000,000 ÷ 100,000 barrels)  50,000 barrels extracted

c. $800,000
E9–13
a.
Depreciation Expense Correct Annual Cumulative
Year Per Company's Books Depr. Exp. Difference Difference
2014 $120,000 $25,000 $95,000 $95,000
2015 0 25,000 (25,000) 70,000
2016 0 25,000 (25,000) 45,000
2017 0 25,000 (25,000) 20,000

b. After adjusting entries are prepared and posted on December 31, 2016, Accumulated Depreciation will
be understated by $45,000.

c. After adjusting entries, but before closing entries have been prepared and posted on December 31,
2016, Retained Earnings will be understated by $70,000.

d. After both adjusting and closing entries have been prepared and posted on December 31, 2016,
Retained Earnings will be understated by $45,000.

E9–14
a. Cash (+A) ................................................................................................ 235,000
Accumulated Depreciation—Office Equipment (+A)............................... 300,000
Office Equipment (–A)........................................................................ 500,000
Gain on Sale of Fixed Assets (Ga, +SE)............................................. 35,000
Sold office equipment.

b. Cash (+A) .................................................................................................. 185,000

Accumulated Depreciation—Office Equipment (+A)............................... 300,000
Loss on Sale of Fixed Assets (Lo, –SE)..................................................... 15,000
Office Equipment (–A)........................................................................ 500,000
Sold office equipment.
E9–15
Assuming that Paris Company kept the equipment for its entire five-year estimated useful life, the
depreciation schedule on the equipment would be as follows.

Depreciation Depreciation Accumulated Book

Date Factor Expense Cost Depreciation Value
1/1/12 $25,000 $ 0 $25,000
12/31/12 40% $10,000 25,000 10,000 15,000
12/31/13 40% 6,000 25,000 16,000 9,000
12/31/14 40% 3,600 25,000 19,600 5,400
12/31/15 40% 400* 25,000 20,000 5,000
12/31/16 40% 0 25,000 20,000 5,000
__________________
* Because the equipment's book value cannot drop below its estimated salvage value, depreciation expense
for 2015 cannot exceed $400.

a. Accumulated Depreciation—Equipment (+A).......................................... 19,600

Loss on Disposal of Equipment (Lo, –SE)................................................. 5,400
Equipment (–A).................................................................................... 25,000
Disposed of equipment.

b. Accumulated Depreciation—Equipment (+A).......................................... 20,000

Loss on Disposal of Equipment (Lo, –SE)................................................. 5,000
Equipment (-A).................................................................................... 25,000
Disposed of equipment.

c. Cash (+A) ................................................................................................ 8,000

Accumulated Depreciation—Equipment (+A).......................................... 19,600
Equipment (–A).................................................................................... 25,000
Gain on Sale of Fixed Assets (Ga, +SE)............................................. 2,600
Sold equipment.

d. Fixed Asset (new) (+A).............................................................................. 30,000

Accumulated Depreciation—Equipment (+A).......................................... 20,000
Loss on Disposal of Fixed Asset (Lo, –SE)............................................... 3,000
Cash (–A)............................................................................................. 28,000
Equipment (old) (–A)........................................................................... 25,000
Exchanged fixed assets.
E9–16
a. and b. First, let us compute the original cost of the equipment that was sold in 2014 as follows:

Equipment Equipment Equipment Equipment

at the End + Purchased – sold during = at the End
of 2013 during 2014 2014 of 2014

$32,700 + $12,000 – X = $37,500

X = $7,200

Now, let us compute the related accumulated depreciation for the equipment sold during 2014 as
follows:

Accumulated Depreciation Exp. Accumulated Accumulated

Depreciation at + for 2014 – Depreciation = Depreciation
the End of 2013 for the Sold at the End
Equipment of 2014
during 2014

$14,300 + $7,200 – X = $17,600

X = $ 3,900
Now, we can reconstruct the journal entry.
Cash............................................................................................................. 5,400*
Accumulated Depreciation......................................................................... 3,900
Equipment............................................................................................ 7,200
Gain on Sale of Equipment.................................................................. 2,100
_____________
* $7,200 + $2,100 – $3,900 = $5,400

E9–17
Account Financial Statement
a. Property, plant & equipment Balance Sheet
Less: accumulated depreciation Balance Sheet
Depreciation expense Income Statement
Investments in property, plant & equipment Statement of Cash Flows

b. Property, plant & equipment – 2011 $58,073

Plus: investments in property, plant & equipment 11,027
Less: property, plant & equipment – 2012 66,046
Property, plant & equipment sold in 2012 $ 3,054

c. Accumulated depreciation – 2011 $34,446

Plus: depreciation expense – 2012 6,357
Less: accumulated depreciation – 2012 38,063
Accumulated depreciation – sold property $ 2,740

E9–17 Concluded
d. Compute the gain on the sale:

Cost of property sold $3,054

Less: accumulated depreciation 2,740
Book value of property sold $ 314

Sales price of property $100

Less: book value of property 314
Loss on sale of property $214

This loss on sale of property would appear on the income statement.

E9–18
a. First, let us compute the related accumulated depreciation for the equipment sold during 2014 as
follows:

Accumulated Depreciation Cap. Accumulated Accumulated

Depreciation at + for 2014 – Depreciation = Depreciation
the End of 2013 for the Sold at the End
Equipment of 2014
during 2014

$9,800 + $3,800 – X = $10,500

X = $ 3,100
Now, we can reconstruct the journal entry.
Cash............................................................................................................. 4,300
Loss on Sale of Equipment......................................................................... 900
Accumulated Depreciation......................................................................... 3,100
Equipment............................................................................................ 8,300

b. Equipment Equipment Equipment Equipment

at the End + Purchased – sold during = at the End
of 2013 during 2014 2014 of 2014

$23,400 + X – $8,300 = $26,900

X = $11,800
_____________
Equipment purchased during 2014 = $11,800
E9–19
a. Swift Corporation should capitalize these costs. Assets are defined as items that are expected to provide
future economic benefits to the entity. Organization costs are costs incurred by an entity prior to starting
operations. Such costs include legal fees to incorporate and accountant's fees to set up an accounting
system. Without incurring these costs, most companies could not be in business. Consequently,
organization costs allow a company to be in business, thereby helping it to generate future benefits.
Since these costs help in generating future benefits, they should most definitely be capitalized.

b. Theoretically, organization costs should be amortized over their useful life. In the extreme, organization
costs provide a benefit over the entire life of a company. Since under the going concern assumption
accountants assume that entities will exist indefinitely, it would seem that organization costs should be
amortized over an indefinite period. Since this position is not practical, the accounting profession has
decided that organization costs should be amortized over a period not to exceed forty years.

Assuming that Swift Corporation amortizes its organization costs over the maximum period of forty
years, the appropriate adjusting journal entry for a single year would be as follows:

Amortization Expense (E, –SE).................................................................. 1,125

Organization Costs (–A)...................................................................... 1,125
Amortized organization costs.

c. As mentioned in part (b), organization costs theoretically provide benefits over the entire life of the
company. Under the going concern assumption, the company is assumed to exist indefinitely. If the
company is assumed to exist indefinitely and if organization costs provide benefits over the entire life of
the company, then these costs should provide an indefinite benefit. Consequently, organization costs
should provide a benefit for an indefinite period of time, which implies that they should be reported as
an asset (i.e., future benefit) indefinitely. But if organization costs are amortized, the asset will at some
point in time have a zero balance, and the cost of the asset cannot be matched against the benefits the
asset will help generate in the future. This situation contradicts the matching principle and the concept
of an asset.

d. A patent gives a company the exclusive right to use or market a particular product or process, thereby
providing the company with an expected future benefit. Consequently, the costs incurred to acquire a
patent should be capitalized as an asset and amortized over the patent's useful life. If Swift were to
immediately expense the $65,000, the company would be implying that it did not expect to receive any
benefits from the patent in the future. If this were the case, one would have to question why Swift
purchased the patent in the first place.

e. Research and development costs may or may not provide a company with future benefits. The company
will not know whether or not a particular R & D expenditure will provide a future benefit until some
time in the future. Due to the uncertainty of projecting the usefulness of a given R & D expenditure, the
FASB, in Statement of Financial Accounting Standards No. 2, "Accounting for Research and
Development Costs," requires companies to expense R & D costs in the year in which they are incurred.

E9–19 Concluded
f. Engaging in research and development activities can lead companies to develop new products or
processes that will provide them with future benefits. In such cases, the R & D costs should,
theoretically, be capitalized. The R & D costs would then be allocated to those periods in which the
 costs help generate a benefit. From a practical standpoint, however, this matching of costs with the
associated benefits is not readily possible. For example, consider a company that spends $10,000,000
trying to develop a more efficient manufacturing process. The company's attempts end in failure, but the
company acquires some new technology from its R & D activities that permit it to develop a
revolutionary new product ten years later. In this case, it is clear that the $10,000,000 eventually
provided a future benefit. But this information is available only with hindsight. At the time the
$10,000,000 was expended, all the company knew was that the R & D project was a failure. So, while
capitalizing R & D costs and then amortizing the costs over their useful lives is theoretically superior to
immediately expensing the R & D costs, immediately expensing R & D costs is extremely practical and
lessens a manager's ability to manipulate the financial statements.

E9–20
a.
(1) Southern Robotics should report the costs incurred in acquiring the patent as an asset. Therefore,
the $50,000 of legal and filing fees should be capitalized as an asset in 2014. Since it is company
policy not to amortize intangible assets in the year of acquisition, the company would report the
entire $50,000 as an asset as of December 31, 2014.

(2) Since Southern Robotics successfully defended its patent, the patent is still expected to provide a
future benefit to the company. Hence, the company should continue to carry the patent on its books
as an asset. The amount it should report for the patent as of December 31, 2015 should be the cost
of acquiring and defending the patent less the portion of these costs that have been amortized.
Therefore, Southern Robotics should report $200,000 on its balance sheet (i.e., $50,000 in legal and
filing fees incurred in 2014 + $200,000 in legal fees incurred in 2015 to defend the patent – $50,000
in amortization).

(3) Amortization Expense (E, –SE)........................................................... 50,000

Patent (–A).................................................................................... 50,000
Amortized patent.
b.
(1) Since the lawsuit did not take place until 2015, the patent still had value to Southern Robotics as of
December 31, 2014. Therefore, the company should still report the patent at $50,000 on its books as
of December 31, 2014. However, if Southern Robotics was aware of the lawsuit as of December
31, 2014, it might want to disclose the lawsuit and the potential effect on the company's financial
statements in a footnote as a contingency.

(2) Since Southern Robotics was unsuccessful in defending its patent, the company no longer has the
exclusive right to use or market its robotics arm. Therefore, the patent no longer provides the
company with any future benefits. Since the patent no longer provides any future benefits, it should
be written off in 2015.

(3) Loss on Patent (Lo, –SE)..................................................................... 50,000

Legal Expenses (E, –SE)..................................................................... 200,000
Patent (–A).................................................................................... 50,000
Cash (–A)...................................................................................... 200,000
Incurred legal fees for patent defense and wrote off patent.
E9–21
a. The journal entry for the acquisition can be derived from the information provided and appears
below:
 Assets (+A) (at fair market value).........................................................5.1
Goodwill (+A)........................................................................................3.8
Liabilities (+L)..................................................................................... 1.1
Cash (-A).............................................................................................. 7.8

Goodwill represents the excess of the purchase price above the fair market value of the assets
purchased.

b. Assets increased by a net $1.1 billion ($5.1 + 3.8 – 7.8) and liabilities increased by $1.1 billion.

E9–22
a. Under US GAAP, long-lived assets must be carried at original cost less accumulated depreciation
(amortization); if the market value of the asset permanently falls below the balance sheet carrying
value, an impairment charge must be recorded, and cannot be reversed in later periods if the value
of the asset recovers. Under IFRS, companies can either follow the US GAAP method, or they can
periodically revalue their long-lived assets to fair market value – recognizing not only impairments,
but also increases and recoveries of asset values.
b. EADS has accounted for this asset according to U.S. GAAP methods.
c. If EADS were to carry the asset at its Fair Market Value (using the IFRS approach), the company
would increase the value of the asset by 7 million euros and would record a gain on its income
statement of the same amount.

PROBLEMS
P9–1
a. Stonebrecker should capitalize all costs that it incurred that were necessary and reasonable to get the
equipment in a serviceable condition and location. The capitalizable costs are (1) the $1,000,000
purchase price, (2) the $40,000 transportation costs actually incurred by Stonebrecker, (3) the $8,000
insurance coverage, (4) the $20,000 installation fees, (5) the $15,000 to reinforce the floor, and (6) the
$10,000 of employee downtime. Some accountants may disagree with capitalizing the last two items as
 part of the equipment. However, theoretically, these costs are necessary to get the equipment in a usable
condition. Therefore, the total dollar amount that should be capitalized for the equipment is $1,093,000.

b. Equipment (+A).......................................................................................... 1,093,000

Cash (–A)............................................................................................. 1,093,000
Purchased equipment.

c. The depreciation base represents the capitalized cost of a fixed asset that the company does not expect
to recover over the asset's estimated useful life. Since the capitalized cost of the equipment is
$1,093,000 and the company expects to sell the equipment for $100,000 after ten years, the company
does not expect to recover $993,000 of the capitalized cost. Therefore, the depreciation base of the
equipment is $993,000.

d. As discussed in part [c], the depreciation base represents the dollar amount of a fixed asset that the
company does not expect to recover from the asset at the end of the asset's estimated useful life. This
implies that the depreciation base represents the dollar amount of a fixed asset that the company expects
to consume over the asset's estimated useful life. Since the consumption of an asset is an outflow of that
asset and since, by definition, outflows of assets are expenses, the depreciation base represents the
amount that should be expensed over a fixed asset's useful life. This is true whether the company uses
the straight-line method or the double-declining-balance method. Thus, every depreciation method will
result in the same total amount being depreciated over a fixed asset's useful life. Although each method
gives rise to the same total amount of depreciation, the timing of depreciation charges varies across
depreciation methods. The straight-line method allocates depreciation evenly across time, while the
double-declining-balance method allocates the depreciation base more rapidly to the early years of the
asset's useful life and more slowly to the later years of the asset's useful life. Thus, Stonebrecker will
depreciate a total of $993,000 under both depreciation methods.
P9–2
a.
1/1/14 Relative Purchase Cost
Asset FMV FMV  Price = Allocation
Building $ 300,000 300/1,200 $1,000,000 $ 250,000
Office equip. 150,000 150/1,200 1,000,000 125,000
Crane 1 75,000 75/1,200 1,000,000 62,500
Crane 2 75,000 75/1,200 1,000,000 62,500
Land 600,000 600/1,200 1,000,000 500,000
Total $ 1,200,000 1,200/1,200 $ 1,000,000

Building (+A).............................................................................................. 250,000

Office Equipment (+A)............................................................................... 125,000
Cranes (+A) ............................................................................................... 125,000
Land (+A) ................................................................................................ 500,000
Cash (–A)............................................................................................. 1,000,000
Purchased basket of assets.

b. Depreciation Expense—Building (E, –SE)................................................ 8,750a

Depreciation Expense—Office Equipment (E, –SE)................................. 30,000b
Depreciation Expense—Cranes (E, –SE)................................................... 19,000c
Accumulated Depreciation—Building (–A)....................................... 8,750
Accumulated Depreciation—Office Equipment (–A)........................ 30,000
Accumulated Depreciation—Cranes (–A).......................................... 19,000
Depreciated fixed assets.
_____________
a $8,750 = ($250,000 – $75,000) ÷ 20 years
b $30,000 = ($125,000 – $35,000) ÷ 3 years
c $19,000 = [$125,000 – ($15,000 + $15,000)] ÷ 5 years

c. Property, plant, and equipment:

Land............................................................................................................. $500,000
Building....................................................................................................... 250,000
Office equipment........................................................................................ 125,000
Cranes.......................................................................................................... 125,000
Less: Accumulated depreciation................................................................. (201,000)*
Total property, plant, and equipment......................................................... $799,000
_____________
* $201,000 = ($8,750  4 years) + ($30,000  3 years) + ($19,000  4 years)
P9–3
a. Cost = Purchase Price + Transportation + Installation
= $950,000 + $100,000 + $130,000 = $1,180,000

b. (1) Double-declining-balance method:

Depreciation Expense—Equipment (E, –SE).................................. 590,000*
Accumulated Depreciation—Equipment (–A)......................... 590,000
Depreciated fixed asset.
______________
*$590,000 = $1,180,000  50%

(2) Straight-line method:

Depreciation Expense—Equipment (E, –SE).................................. 282,500*
Accumulated Depreciation—Equipment (–A)......................... 282,500
Depreciated fixed asset.
______________
*$282,500 = ($1,180,000 – $50,000) ÷ 4 years

c. (1) Double-declining-balance method:

Cash (+A).......................................................................................... 250,000
Accumulated Depreciation: Equipment (+A).................................. 590,000
Loss on Sale of Equipment (Lo, –SE).............................................. 340,000
Equipment (–A)......................................................................... 1,180,000
Sold equipment.
(2) Straight-line method:
Cash (+A).......................................................................................... 250,000
Accumulated Depreciation: Equipment (+A).................................. 282,500
Loss on Sale of Equipment (Lo, –SE).............................................. 647,500
Equipment (–A)......................................................................... 1,180,000
Sold equipment.
P9–4
a. Truck (+A)................................................................................................. 48,000
Cash (–A)............................................................................................. 48,000
Purchased a truck.

b.
Depreciation Correct
Per Books Depreciation Difference
2012 $48,000 $ 0 $48,000
2013 0 12,000* 12,000
______________
*$12,000 = ($48,000 – $12,000) ÷ 3 years

Therefore, in 2012 expenses were overstated by $48,000, so net income was understated by $48,000. In
2013 expenses were understated by $12,000, so net income was overstated by $12,000.

c.
Depreciation Correct
Per Books Depreciation Difference
2012 $48,000 $ 0 $48,000
2013 0 32,000* 32,000
______________
*$32,000 = $48,000  2/3

Therefore, in 2012 expenses were overstated by $48,000, so net income was understated by $48,000. In
2013 expenses were understated by $32,000, so net income was overstated by $32,000.
P9–5
a. Dryer (+A)................................................................................................... 100,000
Cash (–A)............................................................................................. 100,000
Purchased a dryer.

b. In deciding how to account for service and repair costs, one must consider the effect of the cost on (1)
the useful life of the asset, (2) the quality of units produced by the asset, (3) the quantity of units
produced by the asset, or (4) the cost of operating the asset. If the costs increase one of the first three
items or reduce the last item, they provide a future benefit to the company. Consequently, the costs
should be capitalized and amortized over the asset's useful life. If the costs do not increase one of the
above items, they do not provide a future benefit, and they should be expensed immediately. In this
particular case, the $160,000 overhaul increased both the dryer's efficiency and useful life.
Consequently, the $160,000 should be capitalized as follows:

Dryer (+A)................................................................................................... 160,000

Cash (–A)............................................................................................. 160,000
Overhauled dryer.

The annual service cost of $1,000 and the major repair cost of $5,000 are incurred simply to maintain
the dryer's existing service potential and, therefore, do not provide expected future benefits.
Consequently, these costs should be expensed as incurred.

c. 2011 through 2014:

Depreciation Expense = (Cost – Salvage Value) ÷ Useful Life
= ($100,000 – $10,000) ÷ 5 Years = $18,000 per Year

2015 through 2018:

Depreciation Expense = {[(Cost – Accumulated Depreciation) + Betterments] – Salvage
Value} ÷ Remaining Useful Life.
= {[($100,000 – $72,000) + $160,000] – $10,000} ÷ 4 Years
= $44,500 per Year

P9–6
a. Building (+A).............................................................................................. 1,500,000
Cash (–A)............................................................................................. 1,500,000
Purchased a building.

b. Building (+A).............................................................................................. 200,000

Cash (–A)............................................................................................. 200,000
Installed a new roof on building.

c. Depreciation Expense (E, –SE).................................................................. 50,500*

Accumulated Depreciation (–A).......................................................... 50,500
Depreciated building.
________________
*$50,500 = {[($1,500,000 – $540,000 Accumulated Depreciation) + $200,000] –
$150,000 Salvage Value} ÷ Remaining Life of 20 Years.
P9–6 Concluded
d. Cash (+A).................................................................................................... 1,200,000
Accumulated Depreciation (+A)................................................................ 843,000*
Building (–A)....................................................................................... 1,700,000
Gain on Sale of Building (Ga, +SE).................................................... 343,000
Sold building.
________________
*$843,000 = ($54,000  10 years for 2010 through 2019) + ($50,500  6 years
for 2020 through 2025)

Note: The above entry assumes that the adjusting entry to record depreciation expense for 2025 had
already been recorded. If this entry had not yet been made, the appropriate entry to record the sale
would have been as follows:

Cash (+A).................................................................................................... 1,200,000

Accumulated Depreciation (+A)................................................................ 792,500
Depreciation Expense (E, –SE).................................................................. 50,500
Building (–A)....................................................................................... 1,700,000
Gain on Sale of Building (Ga, +SE).................................................... 343,000
Sold building.

P9–7
a. Depreciation Expense per Year = ($180,000 – $30,000) ÷ 10 Years
= $15,000 per Year

1/1/14 Accumulated Depreciation = $15,000 Depreciation Expense per Year  5 Years

= $75,000

1/1/14 Book Value = Cost – 1/1/14 Accumulated Depreciation

= $180,000 – $75,000
= $105,000

b. Depreciation Expense (E, –SE).................................................................. 9,375

Accumulated Depreciation (–A).......................................................... 9,375
Depreciated fixed assets.
________________
*$9,375 = (Book Value of $105,000 – Salvage Value of $30,000) ÷ Remaining Useful
Life of 8 Years

P9–8
When the hand-held instruments were capitalized as a prepaid expense, they were carried as Current
Assets and converted to an expense as used. After the accounting change, the asset was carried as a
long-lived asset and converted to an expense through a depreciation charge that spread the cost over a
five-year period, lowering the amount charged against earnings when compared to the previous method.
The asset will remain on the books for a longer period of time (assets and equity are higher) and income
will also be higher due to the lower expense. The current ratio is lowered, because the assets are moved
to the noncurrent section of the balance sheet. Finally, the fixed asset turnover ratio, which measures
sales to fixed assets, will be lower as the dollar amount assigned to fixed assets is now greater.
P9–9
a. Every depreciation method depreciates the same amount over the useful life of a fixed asset.
Depreciation methods only vary the timing of depreciation charges. Therefore, both the straight-line
method and the double-declining-balance method will give rise to the same total amount of
depreciation over the four-year useful life of this equipment. The following table shows that the
total depreciation under the two methods is the same.

Method Year 1 Year 2 Year 3 Year 4 Total

Straight-linea $15,000 $15,000 $15,000 $15,000 $60,000
Double-declining-balance b 40,000 20,000 0 0 60,000
________________
a $15,000 = ($80,000 – $20,000) ÷ 4 years
b Depreciation Depreciation Historical Accumulated Book
Date Factor Expense Cost Depreciation Value
1/1/14 $80,000 $ 0 $80,000
12/31/14 50% $40,000 80,000 40,000 40,000
12/31/15 50% 20,000 80,000 60,000 20,000
12/31/16 50% 0 80,000 60,000 20,000
12/31/17 50% 0 80,000 60,000 20,000

b. Since, as demonstrated in part (a), both depreciation methods give rise to the same total amount of
depreciation over the fixed asset’s life, the total amount of net income over the asset’s life must also
be the same. Therefore, the total amount of taxes will be the same regardless of which depreciation
method a company selects. The following shows that the total amount of net income and taxes are
the same under the two methods.

Straight-line method:
Method Year 1 Year 2 Year 3 Year 4 Total
Revenues $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 400,000
Depreciation exp. 15,000 15,000 15,000 15,000 60,000
Other expenses 60,000 60,000 60,000 60,000 240,000
Pretax income $ 25,000 $ 25,000 $ 25,000 $ 25,000 $ 100,000
Income taxes 8,750 8,750 8,750 8,750 35,000
Net income $ 16,250 $ 16,250 $ 16,250 $ 16,250 $ 65,000

Double-declining-balance:
Method Year 1 Year 2 Year 3 Year 4 Total
Revenues $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 400,000
Depreciation exp. 40,000 20,000 0 0 60,000
Other expenses 60,000 60,000 60,000 60,000 240,000
Pretax income $ 0 $ 20,000 $ 40,000 $ 40,000 $ 100,000
Income taxes 0 7,000 14,000 14,000 35,000
Net income $ 0 $ 13,000 $ 26,000 $ 26,000 $ 65,000

c. The double-declining-balance method is preferred for tax purposes because this method defers tax
payments. Under this depreciation method, more depreciation is taken in the early years of an
asset’s life than in later years. Increasing depreciation in an asset’s early life reduces taxable
income which, in turn, reduces income taxes in the early years of the asset’s life [see part b]. The
reduction in income taxes in the early years of the asset’s life is offset by higher taxes in the later
years of an asset’s life. However, due to the time value of money, deferring taxes is beneficial.
d. Straight-line method:
 Present Value = $8,750 from part (b)  Present Value of an Ordinary Annuity Factor
for i = 10% and n = 4
= $8,750  3.16987 (from Table 5)
= $27,736.36

Double-declining-balance method:
Present Value = ($7,000  Present Value Factor for i = 10% and n = 2) + ($14,000 
Present Value Factor for i = 10% and n = 3) + ($14,000  Present Value
Factor for i = 10% and n = 4)
= ($7,000  0.82645) + ($14,000  0.75131) + ($14,000  0.68301)
= $5,785.15 + $10,518.34 + $9,562.14
= $25,865.63

In present value terms, Kimberly Sisters would save $1,870.73 ($27,736.36 – $25,865.63) in taxes on
this one asset by selecting the double-declining-balance method over the straight-line method.

P9–10
(a) (b) (c)
S-L Depreciation DDB S-L Depreciation
(10-year life) Depreciation (5-year life)
Tax Payments:
Revenues $ 250,000 $ 250,000 $ 250,000
Depreciation expense (40,000)a (80,000)b (80,000)c
Other expenses (140,000) (140,000) (140,000)
Net income before taxes $ 70,000 $ 30,000 $ 30,000
Income taxes (22,400) (9,600) (9,600)
Net income $ 47,600 $ 20,400 $ 20,400
_________________
a $40,000 = ($400,000 – 0) ÷ 10 years
b $80,000 = ($400,000  20%)
c $80,000 = ($400,000 – 0) ÷ 5 years

Bonus Payment:
Net income $ 47,600 $ 20,400 $ 20,400
Bonus percentage 8% 8% 8%
Bonus amount $ 3,808 $ 1,632 $ 1,632

Dividend Payment
Net income $ 47,600 $ 20,400 $ 20,400
Dividend percentage 75% 75% 75%
Dividend amount $ 35,700 $ 15,300 $ 15,300
P9–11
a. Drilling Equipment (+A)............................................................................ 800,000
Mobile Home (+A)..................................................................................... 54,000
Cash (–A)............................................................................................. 854,000
Purchased assets for drilling fields.
b.
2014:
Depletion (E, –SE)...................................................................................... 240,000*
Drilling Equipment (or Accumulated Depletion) (–A)....................... 240,000
Depleted drilling equipment.
_____________
*$240,000 = ($800,000 ÷ 2,000,000 barrels)  600,000 barrels

2015:
Depletion (E, –SE)...................................................................................... 300,000*
Drilling Equipment (or Accumulated Depletion) (–A)....................... 300,000
Depleted drilling equipment.
_____________
*$300,000 = ($800,000 ÷ 2,000,000 barrels)  750,000 barrels

2016:
Depletion (E, –SE)...................................................................................... 260,000*
Drilling Equipment (or Accumulated Depletion) (–A)....................... 260,000
Depleted drilling equipment.
_____________
*$260,000 = ($800,000 ÷ 2,000,000 barrels)  650,000 barrels

c.
2014:
Depreciation Expense (E, –SE).................................................................. 7,000*
Accumulated Depreciation (–A).......................................................... 7,000
Depreciated mobile home.

2015:
Depreciation Expense (E, –SE).................................................................. 7,000*
Accumulated Depreciation (–A).......................................................... 7,000
Depreciated mobile home.

2016:
Depreciation Expense (E, –SE).................................................................. 7,000*
Accumulated Depreciation (–A).......................................................... 7,000
Depreciated mobile home.
_____________
*$7,000 = ($54,000 – $5,000) ÷ 7 years
P9–11 Concluded

Different methods are used to allocate the costs of the drilling equipment and the mobile home based
upon the link between the asset and the oil field. The drilling equipment is site-specific. Hence, its
useful life is identical to the productive life of the oil field. Under the matching principle, the activity
method provides the best matching of the costs with the associated benefits. On the other hand, the
mobile home is not site-specific; it has a useful life beyond this oil field. The activity method would not
be appropriate for the mobile home because the productive capabilities of future oil fields on which the
mobile home may be used are not yet known. Consequently, Garmen Oil Company must select either
the straight-line method or an accelerated method to depreciate the mobile home.

d.
Depletion:
2014:
Depletion (E, –SE)...................................................................................... 240,000
Drilling Equipment (or Accumulated Depletion) (–A)....................... 240,000
Depleted drilling equipment.

2015:
Depletion (E, –SE)...................................................................................... 300,000
Loss on Oil Field (Lo, –SE)........................................................................ 260,000*
Drilling Equipment (or Accumulated Depletion) (–A)....................... 560,000
Depleted drilling equipment.
_____________
* Since the well is dry, the drilling equipment will not provide any future benefits; hence, the remaining
cost of $260,000 [($800,000 – ($240,000 + $300,000)] should be written off.
2016:
No journal entries are necessary.
Depreciation:
Since the mobile home is not site-specific, the entries for depreciation would be the same as in part (c).

P9–12
a. Cash (+A).................................................................................................... 325,000
 Accumulated Depreciation (+A)................................................................ 240,000*
Machinery (–A).................................................................................... 500,000
Gain on Sale of Machinery (Ga, +SE)................................................ 65,000
Sold machinery.
_____________
*$240,000 = [($500,000 – $100,000) ÷ 5 years]  3 years used

b. Depreciation Expense (E, –SE).................................................................. 40,000*

Accumulated Depreciation (–A).......................................................... 40,000
Depreciated machinery for January 1 – June 30.
_____________
*$40,000 = [($500,000 – $100,000) ÷ 5 years]  1/2 year

Cash (+A).................................................................................................... 320,000

Accumulated Depreciation (+A)................................................................ 280,000
Machinery (–A).................................................................................... 500,000
Gain on Sale of Machinery (Ga, +SE)................................................ 100,000
Sold machinery.

c. FMV of asset received:

Land (+A).................................................................................................... 210,000
Accumulated Depreciation (+A)................................................................ 240,000
Loss on Trade-in (Lo, –SE)........................................................................ 225,000
Machinery (–A).................................................................................... 500,000
Cash (–A)............................................................................................. 175,000
Exchanged machinery for land.

FMV of assets given up:

Land (+A).................................................................................................... 250,000*
Accumulated Depreciation (+A)................................................................ 240,000
Loss on Trade-in (Lo, –SE)........................................................................ 185,000
Machinery (–A).................................................................................... 500,000
Cash (–A)............................................................................................. 175,000
Exchanged machinery for land.
_____________
*$250,000 = Cash given up + Appraised value of machinery given up

P9–13
a. Most assets are reported on the balance sheet at historical cost or at historical cost less accumulated
depreciation. The historical cost of a particular asset is constant over time. However, the fair market
value of that same asset fluctuates over time. Consequently, the fair market value of assets can be less
than, equal to, or greater than the historical cost of the assets at any point in time.
b. Diversified would pay more for Specialists due to goodwill (i.e., synergy). Specialists' assets considered
as a package are worth more than the sum of their individual values. Goodwill arises because certain
"assets" are not included on a company's balance sheet. Items that cannot be given a value (i.e., cannot
be quantified) are omitted from a balance sheet. Examples include customer loyalty and the company's
name recognition.
c. Assets (+A).................................................................................................. 1,350,000
Goodwill (+A)............................................................................................. 700,000
Liabilities (+L)..................................................................................... 250,000
Cash (–A)............................................................................................. 1,800,000
Purchased Specialists, Inc.
d. Until recently under GAAP, goodwill was capitalized at the time of acquisition and then amortized over
a maximum of 40 years. The school of thought holding the opposite viewpoint espouses that goodwill
should be expensed at the time of acquisition. They maintain that since goodwill is a plug number on the
books of the acquired company and its amortization period is totally arbitrary, it need not be put on the
balance sheet. Further, goodwill should be periodically tested to see if it has been “impaired” (i.e., if
the fair value of the assets acquired has dropped).

P9–14

a. Goodwill would be calculated by taking the purchase price less the fair value of the net assets. In this
case $3.4 billion was paid and the fair value of the net assets was $1.3 billion ($2.3 less $1.0).
Therefore, Goodwill is $2.1 billion.

b. There may be a number of reasons why Zimmer paid over the fair value of Centerplus. There may be
assets that are not recorded on Centerplus’s books. This usually would be the value of the brand name
or a high quality workforce. Another reason could be that Zimmer foresees that there will be significant
synergy between the two companies. It may be that these additional locations will have a significant
competitive benefit to Zimmer. Another possible reason would be to block another competitor from
buying Centerplus. Other reasons could be that Zimmer management just want to make Zimmer a
bigger company (management compensation is sometimes based on the size of the company), or it
could be that Zimmer overpaid.
 ISSUES FOR DISCUSSION

ID9–1
a. Gains and losses resulting from the disposal of fixed assets are based on the difference between the
proceeds received from the disposal and the asset's book value. Thus, one would have to know the book
value of each individual casino and the land to be able to determine the gain or loss from selling one of
the casinos. Book value equals the original cost of the fixed asset less any accumulated depreciation
associated with the fixed asset. Since MGM Grand, Inc., held the casino it sold for just a short time, the
casino's book value is essentially identical to its cost. Thus, in this case, one would need to know the
individual costs of the two casinos and the land.
When assets are purchased in a group for one purchase price, as they were in this case, a common
method to determine the purchase price for each individual asset acquired is to use the assets' relative
fair market values. The fair market values of the individual assets would often be determined by an
independent appraiser.

b. Cash (+A).................................................................................................... 110,000,000

Casino (–A).......................................................................................... 75,000,000
Land (–A)............................................................................................. 17,000,000
Gain on Sale (Ga, +SE)........................................................................ 18,000,000
Sold casino and land.

c. For the purchasing company, it would be necessary to allocate the total $110 million cost to the casino
and land. This could be done based on an appraised fair market value. The land without the casino
would be appraised first; the difference between the $110 million and the appraisal would be the value
of the casino.

d. Cost of hotel: $110,000,000 – $43,000,000 = $67,000,000

Depreciation per year: $67,000,000 ÷ 25 years = $2,680,000 per year

ID9–2
One of the underlying goals of an accounting system is to properly match revenues with expenses.
There are many marketing costs that will help to produce revenue for the company over multiple
periods. If the company expenses all of these marketing expenses in the first year, then net income for
the first year will be understated and then overstated in future years when the revenue produced is not
matched with the marketing expenses incurred to generate it. At the same time it is very difficult to
determine a rational way to allocate marketing costs to the revenue that it produces.

Management, separate from any desires to influence the stock price, will generally want to match its
marketing expenses with the revenues that these expenses produce. Management wants to be able to
evaluate the impact of its marketing efforts. Shareholders may want to see a system of charging
marketing expenses that will have the best impact on stock performance. In the early years of a
company this may mean capitalizing heavy marketing from the early years and defering the expense
until the company has higher levels of revenue to absorb these expenses. Auditors want to make sure
that marketing expenses are handled consistently and in a manner that fairly represents the true
economic value of these

ID9–2 Concluded
 expenditures. Auditors also tend to be conservative when there is uncertainty as to the future value of
an asset. Will these marketing costs from this year truly have value in future years? Since this is a
subjective estimate, auditors may want to expense all marketing expenses in the year incurred.

ID9–3
a. The main issue to be considered is whether the capital expenditure is a betterment or simply
maintenance. To be considered a betterment, the expenditure must (1) increase the asset's useful
life, (2) increase the quality of the asset's output, (3) increase the quantity of the asset's output, or
(4) reduce the cost associated with operating the asset. If the expenditure meets one of these
criteria, the expenditure should be capitalized. Otherwise, the expenditure should be expensed.

b. The amount may be immaterial.

c. Depreciation per year represents the remaining net cost of an asset allocated over the asset's
estimated remaining useful life. In this particular case, the remaining net cost equals the sum of the
asset's book value at the time of refurbishment and the cost of the refurbishment less the estimated
salvage value of the plant. This amount would be depreciated over the estimated useful life of the
"new" plant.

ID9–4
a. EADS is expensing a portion of its research and development costs, but the company is not
expensing the entire amount. The portion not expensed is capitalized on the balance sheet as an
asset (Capitalized Development Costs) and amortized as an expense in future periods.

b. Under U.S. GAAP, the entire amount would be expensed.

c. The R & D expense under US GAAP would have been 3,142 million euros plus 572 million euros.

d. In a comparison of earnings IFRS vs. U.S. GAAP for EADS, the IFRS net income overstates
earnings by the 572 million euros that were not expensed (but were instead capitalized to the
balance sheet). Had the company used U.S. GAAP, total expenses would have been 572 million
euros higher.

ID9–5
One of the underlying goals of an accounting system is to properly match revenues with expenses.
There are many advertising and research & development costs that will help to produce revenue for the
company over multiple periods. If the company expenses all of these expenses in the first year, then net
income for the first year will be understated and then overstated in future years when the revenue
produced is not matched with the expenses incurred to generate it. At the same time it is very difficult
to determine a rational way to allocate these costs to the revenue that it produces. When these costs are
incurred it is extremely difficult to know the revenue, if any, that will be produced in future periods.
The capitalization of software development costs has the opposite effect. Expenses that are incurred in
the current year will not impact the income statement this year but will in future years. The
predictability of the future value of software is higher than for advertising and research and
development costs.

Management, separate from any desires to influence the stock price, will generally want to match its
expenses with the revenues that these expenses produce. Management wants to be able to evaluate the
impact of both its advertising and research & development costs. Shareholders may want to see a
system of charging marketing expenses that will have the best impact on stock performance. In the
early years of a company this may mean capitalizing heavy marketing from the early years and defering
the expense until the company has higher levels of revenue to absorb these expenses. Management may
also have an incentive to report higher net income, which could cause some managers to want to change
accounting policies to work to their benefit. This speaks for the benefit of consistently applying
accounting policies from year to year.
ID9–6
a. The effect on profits from increased capital spending will come from increased depreciation charges.
Capitalized expenditures for fixed assets will eventually hit the income statement as depreciation
expense.

b. The balance sheet will reflect growth in the property, plant and equipment, as well future growth in the
contra asset accumulated depreciation account. The income statement will show increased depreciation
expense. And finally, the statement of cash flow will show greater uses of cash in the investing
activities section.

c. The justification of management for the increased capital expenditures will be to remain competitive in
the marketplace. If businesses do not reinvest in the long-term assets of their operations, they will not
be able to remain competitive. Spending the additional money for fixed assets will affect the financial
statements today, but that spending will also keep the business viable into the future. The stockholders
have to allow funds to be allocated for investing activities if they want to continue to receive a return on
their investment in the company.

ID9–7
a. The most likely scenario causing a restaurant’s value to be impaired is a loss in the desirability of
the location. If a McDonald’s restaurant was located at a certain intersection and traffic patterns in the
city changed (due to a new interstate highway, for example), the restaurant will no longer be as
attractive a location. McDonald’s therefore would have to adjust downward the carrying value for that
restaurant.

b. McDonald’s will record the impairment by first determining the fair value of the asset. Then, the
company will record an impairment expense and reduce the asset from its current carrying value down
to the (new) fair value.

c. As with other expenses that are somewhat at management’s discretion, shareholders are vulnerable if
management decides to take an impairment expense in a year where earnings are otherwise very
healthy, eliminating the need to take the expense in future years when earnings are less robust. A
management team could lower current earnings (and thus future earnings expectations) by taking
impairment charges in current periods.

ID9–8
a. It seems GE is engaging in income-smoothing. Whenever GE has a one-time reporting gain due to any
unusual events, it also tries to book a related expense or a charge to offset that gain. This ensures that
earnings do not rise so high that they cannot be topped the following year.

b. Discretionary restructuring charges are used by GE to offset the one-time gains in order to avoid an
abnormal peak in the company’s earnings for the year. It seems that GE’s management strongly
believes in modest but consistent earnings growth. Therefore, they engage in below-the-line activities
and generate gains for themselves, which they try to offset to a somewhat lesser extent by recording a
restructuring charge. GE wants to pursue this strategy because capital markets reward a net increase in
earnings with a higher stock price. Therefore, GE hopes to increase the price of its stock.

c. Since the proliferation of total quality movement, restructuring is usually perceived by the investors and
the market as a cost-cutting exercise by the company. If the market believes that a company is
becoming leaner and meaner in its operations, it expects the company’s profits to rise in the future.
Therefore, in anticipation it rewards the company by increasing its stock prices.
 FASB is rightfully concerned in limiting such behavior of various companies. The reason is that several
times in practice, restructuring charges have had nothing to do with downsizing or rightsizing. No costs
are reduced in the future and no real benefits may accrue to the company in the coming years. Since
there are no guidelines, all kinds of expenses incurred by the companies are being classified under this
broad category of “restructuring charges,” which the market has come to perceive as a favorable
charge.
ID9–9
a. The problem with using current costs is trying to determine what the current cost is. That is, how does
one determine the current cost of a specialized piece of manufacturing equipment or the current cost of
an office building in a slow-moving real estate market? This difficulty in determining current costs
gives managers leeway to manipulate the amounts reported in the financial statements. If managers are
given the opportunity to manipulate the financial statements through subjective current costs, then
financial statement users will be wary of placing any reliance on the financial statements. Thus, current
costs could potentially lead to the demise of financial statements.

b. Historical costs are sunk costs in that they represent the cost of an asset at the time the asset was
acquired; historical costs do not indicate the magnitude of cash or net assets that an asset will generate
in the future. Since sunk costs are irrelevant for decision-making purposes, historical costs are not
relevant for decision-making purposes. Alternatively, current costs provide a measure of the value of an
asset today. For example, the amount reported for Cost of Goods Sold and Depreciation Expense under
current cost represents the current values of the inventory sold during the period and of the fixed assets
"consumed" during the accounting period, respectively. These values essentially represent what it
would cost the company to replace the inventory it sold and the fixed assets it "consumed." In addition,
the amounts reported on the balance sheet for inventory and fixed assets essentially represent what it
would cost the company to replace its inventory and fixed assets, which is essentially the same value as
what the company would realize if it sold the inventory and fixed assets. Thus, current cost information
would be very relevant for decision-making purposes because it provides information about cash
inflows the company could generate and about cash outflows the company is likely to make. In short,
current cost information is very relevant for decision-making purposes.

c. The argument comes down to reliability versus relevancy. Current cost information is more relevant
than historical cost information, but it is considerably more difficult to objectively determine current
costs than it is to determine historical costs. If individual financial statement users were able to dictate
the valuation basis to be used in preparing financial statements, each individual would be able to
determine his or her personal decision on the tradeoff between reliability and relevancy. However,
financial statements are intended for general use, which means that the same financial statements will
be used by a variety of people. Historically, reliability has been given more importance than relevancy
because (1) relevant information is not very useful if you are not sure you can rely on the information
and (2) managers and auditors are legally liable to financial statement users. That is, they are uneasy
about providing information that might be subjective because it could greatly increase their legal
exposure.

ID9–10
a. Asset write-downs allow Kellogg to manage earnings by reducing depreciation expenses in future
periods. If Kellogg has a good quarter and decides to write down an asset this lowers the book value of
the asset and thereby reduces the amount of depreciation expense that will be incurred in future periods.
b. The accounting profession in general tends to prefer conservative accounting practices. By carrying the
value of assets at a lower value, the auditors reduce their risk that if something goes wrong with the
company that they will be sued. So if management makes estimates that reduce the value of assets, the
auditors will be less likely to object.

c. The FASB has come out against this policy of “taking a bath” by companies when they have had a
really bad quarter to begin with. Some companies will then go ahead and write down assets so that in
future periods the amount of depreciation will be reduced thereby improving reported net income.
While the write down of assets may be conservative, this approach violates the matching principle. The
appropriate costs are not being matched with the related revenues in future periods.

ID9–11
a. The write-off of an outdated technology system would reduce assets and equity; equity is reduced
because of the write-off expense, which reduces Retained Earnings through lower profits.

b. The most likely factor in determining that a system is overvalued is the introduction of new
technology products in the market that better meet the company’s needs. The old system, still
carried on the balance sheet, is no longer as valuable because of the technological updates of the
new systems.

c. Management could decide to take the write-off expense in a year where earnings are otherwise very
healthy, eliminating the need to take the expense in future years when earnings are less robust. A
management team could lower current earnings (and thus future earnings expectations) by taking
the write-off charge in the current period.

ID9–12
According to U.S. GAAP, long-lived assets are recorded at original cost less accumulated depreciation. If
the market value of the asset permanently falls below the balance sheet carrying value, an impairment
charge must be recorded, and cannot be reversed in later periods, even if the value of the asset recovers.
Under IFRS, companies can either follow the U.S. GAAP method, or they can periodically revalue their
long-lived assets to fair market value, recognizing not only impairments but also recoveries of previously
impaired assets and increases in asset values. Effectively, U.S. GAAP follows the more conservative
“lower-of-cost-or market” principle, where asset values may be marked down but may never be marked up.
IFRS, on the other hand, gives companies the option to value assets according to ever-changing market
values, where both market value increases and decreases are recorded.

Under U.S. GAAP, development costs must be expensed, while IFRS gives companies the ability, in certain
circumstances, to capitalized development costs and amortize those costs over future accounting periods.
U.S. GAAP requires immediate expensing, while IFRS can allow costs to be allocated to future periods.

ID9–13

a. Property, plant and equipment make up 12.6% ($11,854/$93,798) of total assets. Other long-lived assets
make up 22.9% ($21,490/$93,798) of total assets.

b. According to Note 5, Information Technology Assets is the largest category within property, plant and
equipment.
c. Depreciation expense (from the Statement of Cash Flow) is 3.96% ($1,988/$50,175) of Net Revenue.
Because depreciation is a non-cash expense, it is added back in the Statement of Cash Flow in the
calculation of cash from operating activities.

d. According to Note 1, Google depreciates its assets using the straight-line method. The company uses 2
to 5 years for most assets, but up to 25 years for buildings.

e. The company’s largest intangible asset is Goodwill.

f. The company evaluates assets for impairment whenever business circumstances or events indicate the
carrying value of assets might not be recoverable. If the evaluation determines impairment, the asset is
written down to its estimated fair value.

g. According to the statement of cash flow, Google spent $3,273 million on PP & E in 2012.