Why do I Need Accounting? and Sarbanes-Oxley Act of 2002

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9

Reporting and Analyzing Long-Lived Assets

 CHAPTER PREVIEW 

For airlines and many other companies, making the right decisions regarding long-lived assets is critical because these assets represent huge investments. The discussion in this chapter is in two parts: plant assets and intangible assets. Plant assets are the property, plant, and equipment (physical assets) that commonly come to mind when we think of what a company owns. intangible assets. These assets, such as copyrights and patents, lack physical substance but can be extremely valuable and vital to a company's success.

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A Tale of Two Airlines

So, you're interested in starting a new business. Have you thought about the airline industry? Today, the most pro�itable airlines in the industry are not well-known majors like American Airlines and United. In fact, most giant, older airlines seem to be either bankrupt or on the verge of bankruptcy. In a recent year, �ive major airlines representing 24% of total U.S. capacity were operating under bankruptcy protection.

Not all airlines are hurting. The growth and pro�itability in the airline industry today is found at relative newcomers like Southwest Airlines and JetBlue Airways. These and other new airlines compete primarily on ticket prices. During a recent �ive-year period, the low-fare airline market share increased by 47%, reaching 22% of U.S. airline capacity.

Southwest was the �irst upstart to make it big. It did so by taking a different approach. It bought small, new, fuel-ef�icient planes. Also, instead of the “hub-and-spoke” approach used by the majors, it opted for direct, short hop, no frills �lights. It was all about controlling costs—getting the most out of its ef�icient new planes.

JetBlue, founded by former employees of Southwest, was recently ranked as the number 1 airline in the United States by the airline rating company SkyTrax. Management initially attempted to differentiate JetBlue by offering amenities not found on other airlines, such as seatback entertainment systems, while adopting Southwest's low-fare model. This approach was successful during JetBlue's early years, as it enjoyed both pro�itability and rapid growth. However, more recently the company has had to take aggressive steps to rein in costs in order to return to pro�itability.

In the past, upstarts such as Valujet chose a different approach. The company bought planes that were 20 to 30 years old (known in the industry as zombies), which allowed it to quickly add planes to its �leet. Valujet started with a $3.4 million investment and grew to be worth $630 million in its �irst three years.

But with high fuel costs, airlines are no longer in the market for old planes which generally can't be operated ef�iciently. Today, success in the airline business comes from owning the newest and most ef�icient equipment, and knowing how to get the most out of it.

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LEARNING OBJECTIVE 1

Explain the accounting for plant asset expenditures. 

Plant assets are resources that have physical substance (a de�inite size and shape), are used in the operations of a business, and are not intended for sale to customers. They are called various names— property, plant, and equipment; plant and equipment; and �ixed assets. By whatever name, these assets are expected to be of provide service to the company for a number of years. Except for land, plant assets decline in service potential (ability to produce revenue) over their useful lives.

Plant assets are critical to a company's success because they determine the company's capacity and therefore its ability to satisfy customers. With too few planes, for example, JetBlue Airways and Southwest Airlines would lose customers to their competitors. But with too many planes, they would be �lying with empty seats. Management must constantly monitor its needs and acquire assets accordingly. Failure to do so results in lost business opportunities or inef�icient use of existing assets and poor �inancial results.

It is important for a company to (1) keep assets in good operating condition, (2) replace worn-out or outdated assets, and (3) expand its productive assets as needed. The decline of rail travel in the United States can be traced in part to the failure of railroad companies to maintain and update their assets. Conversely, the growth of air travel in this country can be attributed in part to the general willingness of airline companies to follow these essential guidelines.

For many companies, investments in plant assets are substantial. Illustration 9-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo1#c09-�ig-0001) shows the percentages of plant assets in relation to total assets in various companies in a recent year.

ILLUSTRATION 9-1 Percentages of plant assets in relation to total assets

DETERMINING THE COST OF PLANT ASSETS The historical cost principle requires that companies record plant assets at cost. Thus, JetBlue Airways and Southwest Airlines record their planes at cost. Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use. For example, when Boeing buys equipment,

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the purchase price, freight costs paid by Boeing, and installation costs are all part of the cost of the equipment.

Determining which costs to include in a plant asset account and which costs not to include is very important. If a cost is not included in a plant asset account, then it must be expensed immediately. Such costs are referred to as revenue expenditures. On the other hand, costs that are not expensed immediately but are instead included in a plant asset account are referred to as capital expenditures. JetBlue reported capital expenditures of $730 million during 2014.

This distinction is important; it has immediate, and often material, implications for the income statement. Some companies, in order to boost current income, have improperly capitalized expenditures that they should have expensed. For example, suppose that a company improperly capitalizes to a building account $1,000 of maintenance costs incurred at the end of the year. (That is, the costs are included in the asset account Buildings rather than being expensed immediately as Maintenance and Repairs Expense.) If the company is allocating the cost of the building as an expense (depreciating it) over a 40-year life, then the maintenance cost of $1,000 will be incorrectly spread across 40 years instead of being expensed in the current year. As a result, the company will understate current-year expenses by approximately $1,000 and will overstate current-year income by approximately $1,000. Thus, determining which costs to capitalize and which to expense is very important.

Cost is measured by the cash paid in a cash transaction or by the cash equivalent price paid when companies use noncash assets in payment. The cash equivalent price is equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable. Once cost is established, it becomes the basis of accounting for the plant asset over its useful life. Current fair value is not used to increase the recorded cost after acquisition. We explain the application of the historical cost principle to each of the major classes of plant assets in the following sections.

INTERNATIONAL NOTE IFRS is more �lexible regarding asset valuation. Companies revalue to fair value when they believe this information is more relevant.

Land

Companies often use land as a building site for a manufacturing plant or of�ice site. The cost of land includes (1) the cash purchase price, (2) closing costs such as title and attorney's fees, (3) real estate brokers' commissions, and (4) accrued property taxes and other liens on the land assumed by the purchaser. For example, if the cash price is $50,000 and the purchaser agrees to pay accrued taxes of $5,000, the cost of the land is $55,000.

All necessary costs incurred in making land ready for its intended use increase (debit) the Land account. When a company acquires vacant land, its cost includes expenditures for clearing, draining, �illing, and grading. If the land has a building on it that must be removed to make the site suitable for construction of a new building, the company includes all demolition and removal costs, less any proceeds from salvaged materials, in the Land account.

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To illustrate, assume that Hayes Company acquires real estate at a cash cost of $100,000. The property contains an old warehouse that is removed at a net cost of $6,000 ($7,500 in costs less $1,500 proceeds from salvaged materials). Additional expenditures are for the attorney's fee $1,000 and the real estate broker's commission $8,000. Given these factors, the cost of the land is $115,000, computed as shown in Illustration 9-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo1#c09-�ig-0002) .

ILLUSTRATION 9-2 Computation of cost of land

When Hayes records the acquisition, it debits Land and credits Cash for $115,000.

Land Improvements

Land improvements are structural additions with limited lives that are made to land, such as driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use. For example, the cost of a new company parking lot includes the amount paid for paving, fencing, and lighting. Thus, the company would debit the total of all of these costs to Land Improvements.

Land improvements have limited useful lives. Even when well-maintained, they will eventually need to be replaced. As a result, companies expense (depreciate) the cost of land improvements over their useful lives.

Buildings

Buildings are facilities used in operations, such as stores, of�ices, factories, warehouses, and airplane hangars. Companies charge to the Buildings account all necessary expenditures relating to the purchase or construction of a building. When a building is purchased, such costs include the purchase price, closing costs (attorney's fees, title insurance, etc.), and real estate broker's commission. Costs to make the building ready for its intended use consist of expenditures for remodeling rooms and of�ices and replacing or repairing the roof, �loors, electrical wiring, and plumbing. When a new building is constructed, its cost consists of the contract price plus payments made by the owner for architects' fees, building permits, and excavation costs.

In addition, companies add certain interest costs to the cost of a building. Interest costs incurred to �inance a construction project are included in the cost of the asset when a signi�icant period of time is required to get the asset ready for use. In these circumstances, interest costs are considered as necessary as materials and labor. However, the inclusion of interest costs in the cost of a constructed building is limited to interest costs incurred during the construction period. When construction has been completed, subsequent interest payments on funds borrowed to �inance the construction are recorded as increases (debits) to Interest Expense.

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Equipment

Equipment includes assets used in operations, such as store check-out counters, of�ice furniture, factory machinery, and delivery trucks. JetBlue Airways' equipment includes aircraft, in-�light entertainment systems, and trucks for ground operations. The cost of equipment consists of the cash purchase price, sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit. However, companies treat as expenses the costs of motor vehicle licenses and accident insurance on company trucks and cars. Such items are annual recurring expenditures and do not bene�it future periods. Two criteria apply in determining the cost of equipment: (1) the frequency of the cost—one time or recurring, and (2) the bene�it period—the life of the asset or one year.

To illustrate, assume that Lenard Company purchases a delivery truck on January 1 at a cash price of $22,000. Related expenditures are sales taxes $1,320, painting and lettering $500, motor vehicle license $80, and a three-year accident insurance policy $1,600. The cost of the delivery truck is $23,820, computed as shown in Illustration 9-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo1#c09-�ig-0003) .

ILLUSTRATION 9-3 Computation of cost of delivery truck

Lenard treats the cost of a motor vehicle license as an expense and the cost of an insurance policy as a prepaid asset. Thus, the company records the purchase of the truck and related expenditures as follows.

For another example, assume Merten Company purchases factory machinery at a cash price of $50,000. Related expenditures are sales taxes $3,000, insurance during shipping $500, and installation and testing $1,000. The cost of the factory machinery is $54,500, computed as shown in Illustration 9-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo1#c09-�ig-0004) .

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ILLUSTRATION 9-4 Computation of cost of factory machinery

Thus, Merten records the purchase and related expenditures as follows.

EXPENDITURES DURING USEFUL LIFE During the useful life of a plant asset, a company may incur costs for ordinary repairs, additions, and improvements. Ordinary repairs are expenditures to maintain the operating ef�iciency and expected productive life of the unit. They usually are fairly small amounts that occur frequently throughout the service life. Examples are motor tune-ups and oil changes, the painting of buildings, and the replacing of worn-out gears on factory machinery. Ordinary repairs are debited to Maintenance and Repairs Expense as incurred.

In contrast, additions and improvements are costs incurred to increase the operating ef�iciency, productive capacity, or expected useful life of the plant asset. These expenditures are usually material in amount and occur infrequently during the period of ownership. Expenditures for additions and improvements increase the company's investment in productive facilities and are generally debited to the plant asset affected. Thus, they are capital expenditures. The accounting for capital expenditures varies depending on the nature of the expenditure.

Northwest Airlines at one time spent $120 million to spruce up 40 jets. The improvements were designed to extend the lives of the planes, meet stricter government noise limits, and save money. The capital expenditure was expected to extend the life of the jets by 10 to 15 years and save about $560 million compared to the cost of buying new planes. The jets were, on average, 24 years old.

ANATOMY OF A FRAUD

Bernie Ebbers was the founder and CEO of the phone company WorldCom. The company engaged in a series of increasingly large, debt-�inanced acquisitions of other companies. These acquisitions made the company grow quickly, which made the stock price increase dramatically. However, because the acquired companies all had different accounting systems, WorldCom's �inancial records were a mess. When WorldCom's performance started to �latten out, Bernie coerced WorldCom's accountants to engage in a number of fraudulent activities to make net income look better than it really was and thus prop up the stock price. One of these frauds involved treating $7 billion of line costs as capital expenditures. The line costs, which were rental fees paid to other phone companies to use their phone lines, had always been properly expensed in previous years. Capitalization delayed expense recognition to future periods and thus boosted current-period pro�its.

Total take: $7 billion

THE MISSING CONTROLS

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Documentation procedures. The company's accounting system was a disorganized collection of non- integrated systems, which resulted from a series of corporate acquisitions. Top management took advantage of this disorganization to conceal its fraudulent activities.

Independent internal veri�ication. A fraud of this size should have been detected by a routine comparison of the actual physical assets with the list of physical assets shown in the accounting records.

TO BUY OR LEASE? In this chapter, we focus on purchased assets, but we want to expose you brie�ly to an alternative—leasing. A lease is a contractual agreement in which the owner of an asset (the lessor) allows another party (the lessee) to use the asset for a period of time at an agreed price. In many industries, leasing is quite common. For example, one-third of heavy-duty commercial trucks are leased.

Some advantages of leasing an asset versus purchasing it are:

1. Reduced risk of obsolescence. Frequently, lease terms allow the party using the asset (the lessee) to exchange the asset for a more modern one if it becomes outdated. This is much easier than trying to sell an obsolete asset.

2. Little or no down payment. To purchase an asset, most companies must borrow money, which usually requires a down payment of at least 20%. Leasing an asset requires little or no down payment.

3. Shared tax advantages. Startup companies typically earn little or no pro�it in their early years, and so they have little need for the tax deductions available from owning an asset. In a lease, the lessor gets the tax advantage because it owns the asset. It often will pass these tax savings on to the lessee in the form of lower lease payments.

4. Assets and liabilities not reported. Many companies prefer to keep assets and especially liabilities off their books. Reporting lower assets improves the return on assets (discussed later in this chapter). Reporting fewer liabilities makes the company look less risky. Certain types of leases, called operating leases, allow the lessee to account for the transaction as a rental, with neither an asset nor a liability recorded.

Airlines often choose to lease many of their airplanes in long-term lease agreements. In recent �inancial statements, JetBlue Airways stated that it leased 60 of its 169 planes under operating leases. Because operating leases are accounted for as rentals, these 60 planes were not presented on its balance sheet.

Under another type of lease, a capital lease, lessees show both the asset and the liability on the balance sheet. The lessee accounts for capital lease agreements in a way that is very similar to debt-�inanced purchases: The lessee shows the leased item as an asset on its balance sheet, and the obligation owed to the lessor as a liability. The lessee depreciates the leased asset in a manner similar to purchased assets. Only four of JetBlue's aircraft were held under capital leases. We discuss leasing further in Chapter 10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch10#ch10) .1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09ifrs#c09-note-0015)

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 ACCOUNTING ACROSS THE ORGANIZATION 

Many U.S. Firms Use Leases

Leasing is big business for U.S. companies. For example, in a recent year leasing accounted for about 33% of all business investment ($264 billion).

Who does the most leasing? Interestingly, major banks such as Continental Bank, J.P. Morgan Leasing, and US Bancorp Equipment Finance are the major lessors. Also, many companies have established separate leasing companies, such as Boeing Capital Corporation, Dell Financial Services, and John Deere Capital Corporation. As an example of the magnitude of leasing, leased planes account for nearly 40% of the U.S. �leet of commercial airlines. Lease Finance Corporation in Los Angeles owns more planes than any airline in the world.

Leasing is also becoming increasingly common in the hotel industry. Marriott, Hilton, and InterContinental are increasingly choosing to lease hotels that are owned by someone else.

Why might airline managers choose to lease rather than purchase their planes? (Go to WileyPLUS for this answer and additional questions.)

DO IT! 1

Cost of Plant Assets

Assume that Drummond Corp. purchases a delivery truck for $15,000 cash plus sales taxes of $900 and delivery costs of $500. The buyer also pays $200 for painting and lettering, $600 for an annual insurance policy, and $80 for a motor vehicle license. Explain how the company should account for each of these costs.

Action Plan ✓ Identify expenditures made in order to get delivery equipment

ready for its intended use.

✓ Expense operating costs incurred during the useful life of the equipment.

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SOLUTION

The �irst four payments ($15,000 purchase price, $900 sales taxes, $500 delivery, and $200 painting and lettering) are expenditures necessary to make the truck ready for its intended use. Thus, the cost of the truck is $16,600. The payments for insurance and the license are operating expenses incurred annually during the useful life of the asset.

Related exercise material: BE9-1, BE9-2, BE9-3, DO IT! 9-1, E9-1, E9-2, and E9-3.

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LEARNING OBJECTIVE 2

Apply depreciation methods to plant assets. 

As explained in Chapter 4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04#ch04) , depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Such cost allocation is designed to properly match expenses with revenues (see Illustration 9-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0005) .)

ILLUSTRATION 9-5 Depreciation as a cost allocation concept

Depreciation affects the balance sheet through accumulated depreciation, which companies report as a deduction from plant assets. It affects the income statement through depreciation expense.

It is important to understand that depreciation is a cost allocation process, not an asset valuation process. No attempt is made to measure the change in an asset's fair value during ownership. Thus, the book value—cost less accumulated depreciation—of a plant asset may differ signi�icantly from its fair value. In fact, if an asset is fully depreciated, it can have zero book value but still have a signi�icant fair value.

Depreciation applies to three classes of plant assets: land improvements, buildings, and equipment. Each of these classes is considered to be a depreciable asset because the usefulness to the company and the revenue-producing ability of each class decline over the asset's useful life. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact as long as the land is owned. In fact, in many cases, the usefulness of land increases over time because of the scarcity of good sites. Thus, land is not a depreciable asset.

During a depreciable asset's useful life, its revenue-producing ability declines because of wear and tear. A delivery truck that has been driven 100,000 miles will be less useful to a company than one driven only 800 miles.

A decline in revenue-producing ability may also occur because of obsolescence. Obsolescence is the process by which an asset becomes out of date before it physically wears out. The rerouting of major airlines from Chicago's Midway Airport to Chicago-O'Hare International Airport because Midway's runways were too short for giant jets is an example. Similarly, many companies replace their computers

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long before they originally planned to do so because technological improvements make their old hardware obsolete.

Recognizing depreciation for an asset does not result in the accumulation of cash for replacement of the asset. The balance in Accumulated Depreciation represents the total amount of the asset's cost that the company has charged to expense to date; it is not a cash fund.

▼ HELPFUL HINT

Remember that depreciation is the process of allocating cost over the useful life of an asset. It is not a measure of value.

▼ HELPFUL HINT

Land does not depreciate because it does not wear out.

ETHICS NOTE

When a business is acquired, proper allocation of the purchase price to various asset classes is important since different depreciation treatment can materially affect income. For example, buildings are depreciated, but land is not.

FACTORS IN COMPUTING DEPRECIATION Three factors affect the computation of depreciation, as shown in Illustration 9-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0006) .

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ILLUSTRATION 9-6 Three factors in computing depreciation

1. Cost. Earlier in the chapter, we explained the considerations that affect the cost of a depreciable asset. Remember that companies record plant assets at cost, in accordance with the historical cost principle.

2. Useful life. Useful life is an estimate of the expected productive life, also called service life, of the asset for its owner. Useful life may be expressed in terms of time, units of activity (such as machine hours), or units of output. Useful life is an estimate. In making the estimate, management considers such factors as the intended use of the asset, repair and maintenance policies, and vulnerability of the asset to obsolescence. The company's past experience with similar assets is often helpful in deciding on expected useful life.

3. Salvage value. Salvage value is an estimate of the asset's value at the end of its useful life for its owner. Companies may base the value on the asset's worth as scrap or on its expected trade-in value. Like useful life, salvage value is an estimate. In making the estimate, management considers how it plans to dispose of the asset and its experience with similar assets.

▼ HELPFUL HINT

Depreciation expense is reported on the income statement. Accumulated depreciation is reported on the balance sheet as a deduction from plant assets.

DEPRECIATION METHODS Although a number of methods exist, depreciation is generally computed using one of three methods:

1. Straight-line

2. Declining-balance

3. Units-of-activity

Like the alternative inventory methods discussed in Chapter 6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06#ch06) , each of these depreciation methods is acceptable under generally accepted accounting principles. Management selects the method it believes best measures an asset's contribution to revenue over its useful life. Once a company chooses a method, it should apply that method consistently over the useful life of the asset. Consistency enhances the ability to analyze �inancial statements over multiple years.

Our illustration of depreciation methods, both here and in the chapter appendix, is based on the following data relating to a small delivery truck purchased by Bill's Pizzas on January 1, 2017.

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Cost $13,000 Expected salvage value $1,000 Estimated useful life (in years) 5 Estimated useful life (in miles) 100,000

Illustration 9-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0007) shows the distribution of the primary depreciation methods in a sample of the largest U.S. companies. Clearly, straight-line depreciation is the most widely used approach. In fact, because some companies use more than one method, straight-line depreciation is used for some or all of the depreciation taken by more than 95% of U.S. companies. For this reason, we illustrate procedures for straight-line depreciation and discuss the alternative depreciation approaches only at a conceptual level. This coverage introduces you to the basic idea of depreciation as an allocation concept without entangling you in too much procedural detail. (Also, note that many calculators are preprogrammed to perform the basic depreciation methods.) Details on the alternative approaches are presented in Appendix 9A (pages 449– 451).

No matter what method is used, the total amount depreciated over the useful life of the asset is its depreciable cost. Depreciable cost is equal to the cost of the asset less its salvage value.

ILLUSTRATION 9-7 Use of depreciation methods in major U.S. companies

Straight-Line Method

Under the straight-line method, companies expense an equal amount of depreciation each year of the asset's useful life. Management must choose the useful life of an asset based on its own expectations and experience.

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To compute the annual depreciation expense, we divide depreciable cost by the estimated useful life. As indicated above, depreciable cost represents the total amount subject to depreciation; it is calculated as the cost of the plant asset less its salvage value. Illustration 9-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0008) shows the computation of depreciation expense in the �irst year for Bill's Pizzas' delivery truck.

ILLUSTRATION 9-8 Formula for straight-line method

Alternatively, we can compute an annual rate at which the company depreciates the delivery truck. In this case, the rate is 20% (100%÷5 years). When an annual rate is used under the straight-line method, the company applies the percentage rate to the depreciable cost of the asset, as shown in the depreciation schedule in Illustration 9-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0009) (page 432).

ILLUSTRATION 9-9 Straight-line depreciation schedule

Note that the depreciation expense of $2,400 is the same each year. The book value at the end of the useful life is equal to the estimated $1,000 salvage value.

What happens when an asset is purchased during the year, rather than on January 1 as in our example? In that case, it is necessary to prorate the annual depreciation for the portion of a year used. If Bill's Pizzas had purchased the delivery truck on April 1, 2017, the company would use the truck for 9 months in 2017. The depreciation for 2017 would be $1,800 ($12,000×20%×912 of a year).

As indicated earlier, the straight-line method predominates in practice. For example, such large companies as Campbell Soup, Marriott, and General Mills use the straight-line method. It is simple to apply, and it matches expenses with revenues appropriately when the use of the asset is reasonably uniform throughout the service life. The types of assets that give equal bene�its over useful life generally are those

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for which daily use does not affect productivity. Examples are of�ice furniture and �ixtures, buildings, warehouses, and garages for motor vehicles.

DO IT! 2a

Straight-Line Depreciation

On January 1, 2017, Iron Mountain Ski Corporation purchased a new snow- grooming machine for $50,000. The machine is estimated to have a 10-year life with a $2,000 salvage value. What journal entry would Iron Mountain Ski Corporation make at December 31, 2017, if it uses the straight-line method of depreciation?

Action Plan ✓ Calculate depreciable cost (Cost − Salvage value).

✓ Divide the depreciable cost by the asset's estimated useful life.

Related exercise material: BE9-4, DO IT! 9-2a, E9-4, and E9-5.

Declining-Balance Method

The declining-balance method computes depreciation expense using a constant rate applied to a declining book value. This method is called an accelerated-depreciation method because it results in higher depreciation in the early years of an asset's life than does the straight-line approach. However, because the total amount of depreciation (the depreciable cost) taken over an asset's life is the same no matter what approach is used, the declining-balance method produces a decreasing annual depreciation expense over the asset's useful life. In early years, declining-balance depreciation expense will exceed straight-line. In later years, it will be less than straight-line. Managers might choose an accelerated approach if they think that an asset's utility will decline quickly.

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Companies can apply the declining-balance approach at different rates, which result in varying speeds of depreciation. A common declining-balance rate is double the straight-line rate. Using that rate, the method is referred to as the double-declining-balance method.

If we apply the double-declining-balance method to Bill's Pizzas' delivery truck, assuming a �ive-year life, we get the pattern of depreciation shown in Illustration 9-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0010) . Illustration 9A- 2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0025) (page 450) presents the computations behind these numbers. Again, note that total depreciation over the life of the truck is $12,000, the depreciable cost.

ILLUSTRATION 9-10 Declining-balance depreciation schedule

Units-of-Activity Method

As indicated earlier, useful life can be expressed in ways other than a time period. Under the units-of- activity method, useful life is expressed in terms of the total units of production or the use expected from the asset. The units-of-activity method is ideally suited to factory machinery: Companies can measure production in terms of units of output or in terms of machine hours used in operating the machinery. It is also possible to use the method for such items as delivery equipment (miles driven) and airplanes (hours in use). The units-of-activity method is generally not suitable for such assets as buildings or furniture because activity levels are dif�icult to measure for these assets.

Applying the units-of-activity method to the delivery truck owned by Bill's Pizzas, we �irst must know some basic information. Bill's expects to be able to drive the truck a total of 100,000 miles. Illustration 9- 11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0011) shows depreciation over the �ive-year life based on an assumed mileage pattern. Illustration 09-0027 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0027) , page 478, presents the computations used to arrive at these results.

ILLUSTRATION 9-11 Units-of-activity depreciation schedule

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As the name implies, under units-of-activity depreciation, the amount of depreciation is proportional to the activity that took place during that period. For example, the delivery truck was driven twice as many miles in 2018 as in 2017, and depreciation was exactly twice as much in 2018 as it was in 2017.

Management's Choice: Comparison of Methods

Illustration 9-12 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0012) compares annual and total depreciation expense for Bill's Pizzas under the three methods.

ILLUSTRATION 9-12 Comparison of depreciation methods

Annual depreciation expense varies considerably among the methods, but total depreciation expense is the same ($12,000) for the �ive-year period. Each method is acceptable in accounting because each recognizes the decline in service potential of the asset in a rational and systematic manner. Illustration 9- 13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0013) graphs the depreciation expense pattern under each method.

ILLUSTRATION 9-13 Patterns of depreciation

Depreciation and Income Taxes

The Internal Revenue Service (IRS) allows corporate taxpayers to deduct depreciation expense when computing taxable income. However, the tax regulations of the IRS do not require the taxpayer to use the same depreciation method on the tax return that it uses in preparing �inancial statements.

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Consequently, many large corporations use straight-line depreciation in their �inancial statements in order to maximize net income; at the same time, they use a special accelerated-depreciation method on their tax returns in order to minimize their income taxes. For tax purposes, taxpayers must use on their tax returns either the straight-line method or a special accelerated-depreciation method called the Modi�ied Accelerated Cost Recovery System (MACRS).

▼ HELPFUL HINT

Depreciation per �inancial statements is usually different from depreciation per tax returns.

Depreciation Disclosure in the Notes

Companies must disclose the choice of depreciation method in their �inancial statements or in related notes that accompany the statements. Illustration 9-14 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo2#c09-�ig-0014) shows excerpts from the “Property and equipment” notes from the �inancial statements of Southwest Airlines.

ILLUSTRATION 9-14 Disclosure of depreciation policies

From this note, we learn that Southwest Airlines uses the straight-line method to depreciate its planes over periods of 23 to 25 years.

REVISING PERIODIC DEPRECIATION Management should periodically review annual depreciation expense. If wear and tear or obsolescence indicates that annual depreciation is either inadequate or excessive, the company should change the depreciation expense amount.

When a change in an estimate is required, the company makes the change in current and future years but not to prior periods. Thus, when making the change, the company (1) does not change previously recorded depreciation expense, but (2) revises depreciation expense for current and future years. The rationale for this treatment is that continual restatement of prior periods would adversely affect users' con�idence in �inancial statements.

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To determine the new annual depreciation expense, the company �irst computes the asset's depreciable cost at the time of the revision. It then allocates the revised depreciable cost to the remaining useful life.

To illustrate, assume that Bill's Pizzas decides at the end of 2020 (prior to the year-end adjusting entries) to extend the estimated useful life of the truck one year (a total life of six years) and increase its salvage value to $2,200. The company has used the straight-line method to depreciate the asset to date. Depreciation per year was $2,400 [($13,000−$1,000)÷5]. Accumulated depreciation after three years (2017–2019) is $7,200 ($2,400×3), and book value is $5,800 ($13,000−$7,200). The new annual depreciation is $1,200, computed on December 31, 2020, as follows.

ILLUSTRATION 9-15 Revised depreciation computation

Bill's Pizzas does not make a special entry for the change in estimate. On December 31, 2020, during the preparation of adjusting entries, it records depreciation expense of $1,200 instead of the amount recorded in previous years.

Companies must disclose in the �inancial statements signi�icant changes in estimates. Although a company may have a legitimate reason for changing an estimated life, �inancial statement users should be aware that some companies might change an estimate simply to achieve �inancial statement goals. For example, extending an asset's estimated life reduces depreciation expense and increases current period income.

In a recent year, AirTran Airways (now owned by Southwest Airlines) increased the estimated useful lives of some of its planes from 25 to 30 years and increased the estimated lives of related aircraft parts from 5 years to 30 years. It disclosed that the change in estimate decreased its net loss for the year by approximately $0.6 million, or about $0.01 per share. Whether these changes were appropriate depends on how reasonable it is to assume that planes will continue to be used for a long time. Our Feature Story suggests that although in the past many planes lasted a long time, it is also clear that because of high fuel costs, airlines are now scrapping many of their old, inef�icient planes.

▼ HELPFUL HINT

Use a step-by-step approach: (1) determine new depreciable cost; (2) divide by remaining useful life.

IMPAIRMENTS

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As noted earlier, the book value of plant assets is rarely the same as the fair value. In instances where the value of a plant asset declines substantially, its fair value might fall materially below book value. This may happen because a machine has become obsolete, or the market for the product made by the machine has dried up or has become very competitive. A permanent decline in the fair value of an asset is referred to as an impairment. So as not to overstate the asset on the books, the company records a write-down, whereby the asset's cost is reduced to its new fair value during the year in which the decline in value occurs. Recently, Disney recorded a $200 million write-down on its action movie John Carter. Disney spent more than $300 million producing the �ilm.

In the past, some companies improperly delayed recording losses on impairments until a year when it was “convenient” to do so—when the impact on the company's reported results was minimized. For example, in a year when a company has record pro�its, it can afford to write down some of its bad assets without hurting its reported results too much. As discussed in Chapter 4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04#ch04) , the practice of timing the recognition of gains and losses to achieve certain income results is known as earnings management. Earnings management reduces earnings quality. To minimize earnings management, accounting standards now require immediate loss recognition on impaired assets.

Write-downs can create problems for users of �inancial statements. Critics of write-downs note that after a company writes down assets, its depreciation expense will be lower in all subsequent periods. Some companies improperly in�late asset write-downs in bad years, when they are going to report poor results anyway. (This practice is referred to as “taking a big bath.”) Then in subsequent years, when the company recovers, its results will look even better because of lower depreciation expense.

DO IT! 2b

Revised Depreciation

Chambers Corporation purchased a piece of equipment for $36,000. It estimated a 6-year life and $6,000 salvage value. Thus, straight-line depreciation was $5,000 per year [($36,000−$6,000)÷6]. At the end of year three (before the depreciation adjustment), it estimated the new total life to be 10 years and the new salvage value to be $2,000. Compute the revised depreciation.

Action Plan ✓ Calculate depreciable cost.

✓ Divide remaining depreciable cost by new remaining life.

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SOLUTION

Original depreciation expense=[($36,000−$6,000÷6)]=$5,000

Accumulated depreciation after 2 years=2×$5,000=$10,000

Book value=$36,000−$10,000=$26,000

Book value after 2 years of depreciation $26,000 Less: New salvage value 2,000

Depreciable cost $24,000

Remaining useful life 8 years

Revised annual depreciation ($24,000÷8) $ 3,000

Related exercise material: BE9-6, DO IT! 9-2b, and E9-6.

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LEARNING OBJECTIVE 3

Explain how to account for the disposal of plant assets. 

Companies dispose of plant assets that are no longer useful to them. Illustration 9-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo3#c09-�ig-0016) shows the three ways in which companies make plant asset disposals.

ILLUSTRATION 9-16 Methods of plant asset disposal

Whatever the disposal method, the company must determine the book value of the plant asset at the time of disposal in order to determine the gain or loss. Recall that the book value is the difference between the cost of the plant asset and the accumulated depreciation to date. If the disposal does not occur on the �irst day of the year, the company must record depreciation for the fraction of the year to the date of disposal. The company then eliminates the book value by reducing (debiting) Accumulated Depreciation for the total depreciation associated with that asset to the date of disposal and reducing (crediting) the asset account for the cost of the asset. A gain or loss on disposal may be needed to balance this entry, as discussed next.

SALE OF PLANT ASSETS In a disposal by sale, the company compares the book value of the asset with the proceeds received from the sale. If the proceeds from the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds from the sale are less than the book value of the plant asset sold, a loss on disposal occurs.

Only by coincidence will the book value and the fair value of the asset be the same at the time the asset is sold. Gains and losses on sales of plant assets are therefore quite common. As an example, Delta Air Lines at one time reported a $94 million gain on the sale of �ive Boeing B-727-200 aircraft and �ive Lockheed L- 1011-1 aircraft.

Gain on Sale

To illustrate a gain on sale of plant assets, assume that on July 1, 2017, Wright Company sells of�ice furniture for $16,000 cash. The of�ice furniture originally cost $60,000 and as of January 1, 2017, had accumulated depreciation of $41,000. Depreciation for the �irst six months of 2017 is $8,000. Wright records depreciation expense and updates accumulated depreciation to July 1 as follows.

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After the accumulated depreciation balance is updated, the company computes the gain or loss as the difference between the proceeds from sale and the book value at the date of disposal. Wright Company has a gain on disposal of $5,000, as computed in Illustration 9-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo3#c09-�ig-0017) (page 438).

ILLUSTRATION 9-17 Computation of gain on disposal

Wright records the sale and the gain on sale of the plant asset as follows.

Companies report a gain on disposal of plant assets in the “Other revenues and gains” section of the income statement. Recently, the shares of Sears Holdings Corporation rose 19% when the company announced its intention to sell 1,200 stores to raise cash.

Loss on Sale

Assume that instead of selling the of�ice furniture for $16,000, Wright sells it for $9,000. In this case, Wright experiences a loss of $2,000, as computed in Illustration 9-18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo3#c09-�ig-0018) .

ILLUSTRATION 9-18 Computation of loss on disposal

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Wright records the sale and the loss on sale of the plant asset as follows.

Companies report a loss on disposal of the plant asset in the “Other expenses and losses” section of the income statement.

RETIREMENT OF PLANT ASSETS Companies simply retire, rather than sell, some assets at the end of their useful lives. For example, some productive assets used in manufacturing may have very speci�ic uses, and they consequently have no ready market when the company no longer needs them. In such a case, the asset is simply retired.

Companies record retirement of an asset as a special case of a disposal where no cash is received. They decrease (debit) Accumulated Depreciation for the full amount of depreciation taken over the life of the asset and decrease (credit) the asset account for the original cost of the asset. The loss (a gain is not possible on a retirement) is equal to the asset's book value on the date of retirement.1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09ifrs#c09-note-0016)

DO IT! 3

Plant Asset Disposals

Overland Trucking has an old truck that cost $30,000 and has accumulated depreciation of $16,000. Assume two different situations:

1. The company sells the old truck for $17,000 cash.

2. The truck is worthless, so the company simply retires it.

What entry should Overland use to record each scenario?

Action Plan ✓ Compare the asset's book value and its fair value to determine

whether a gain or loss has occurred.

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✓ Make sure that both the Equipment account and Accumulated Depreciation—Equipment are reduced upon disposal.

Related exercise material: BE9-7, BE9-8, DO IT! 9-3, E9-7, E9-8, and E9-9.

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LEARNING OBJECTIVE 4

Identify the basic issues related to reporting intangible assets. 

Intangible assets are rights, privileges, and competitive advantages that result from ownership of long- lived assets that do not possess physical substance. Many companies' most valuable assets are intangible. Some widely known intangibles are Microsoft's patents, McDonalds's franchises, the trade name iPod, and Nike's trademark “swoosh.”

As you will learn in this section, �inancial statements report numerous intangibles. Yet, many other �inancially signi�icant intangibles are not reported. To give an example, according to its �inancial statements in a recent year, Google had total stockholders' equity of $22.7 billion. But its market value— the total market price of all its shares on that same date—was roughly $178.5 billion. Thus, its actual market value was about $155.8 billion greater than the amount reported for stockholders' equity on the balance sheet. It is not uncommon for a company's reported book value to differ from its market value because balance sheets are reported at historical cost. But such an extreme difference seriously diminishes the usefulness of the balance sheet to decision-makers. In the case of Google, the difference is due to unrecorded intangibles. For many high-tech or so-called intellectual-property companies, most of their value is from intangibles, many of which are not reported under current accounting rules.

Intangibles may be evidenced by contracts, licenses, and other documents. Intangibles may arise from the following sources:

1. Government grants, such as patents, copyrights, licenses, trademarks, and trade names.

2. Acquisition of another business in which the purchase price includes a payment for goodwill.

3. Private monopolistic arrangements arising from contractual agreements, such as franchises and leases.

ACCOUNTING FOR INTANGIBLE ASSETS Companies record intangible assets at cost. Cost is comprised of all expenditures necessary for the company to acquire the right, privilege, or competitive advantage. Intangibles are categorized as having either a limited life or an inde�inite life. If an intangible has a limited life, the company allocates its cost over the asset's useful life using a process similar to depreciation. The process of allocating to expense the cost of intangibles is referred to as amortization. The cost of intangible assets with inde�inite lives should not be amortized.

To record amortization of an intangible asset, a company increases (debits) Amortization Expense and decreases (credits) the speci�ic intangible asset. (Alternatively, some companies choose to credit a contra account, such as Accumulated Amortization. For homework, you should directly credit the speci�ic intangible asset.)

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Intangible assets are typically amortized on a straight-line basis. For example, the legal life of a patent is 20 years. Companies amortize the cost of a patent over its 20-year life or its useful life, whichever is shorter. To illustrate the computation of patent amortization, assume that National Labs purchases a patent at a cost of $60,000 on June 30. If National estimates the useful life of the patent to be eight years, the annual amortization expense is $7,500 ($60,000÷8) per year. National records $3,750 ($7,500×612) of amortization for the six-month period ended December 31 as follows.

When a company has signi�icant intangibles, analysts should evaluate the reasonableness of the useful life estimates that the company discloses in the notes to its �inancial statements. In determining useful life, the company should consider obsolescence, inadequacy, and other factors. These may cause a patent or other intangible to become economically ineffective before the end of its legal life.

For example, suppose Intel obtained a patent on a new computer chip it had developed. The legal life of the patent is 20 years. From experience, however, we know that the useful life of a computer chip patent is rarely more than �ive years. Because new superior chips are developed so rapidly, existing chips become obsolete. Consequently, we would question the amortization expense of Intel if it amortized its patent on a computer chip for a life signi�icantly longer than a �ive-year period. Amortizing an intangible over a period that is too long will understate amortization expense, overstate Intel's net income, and overstate its assets.

DECISION TOOLS

Evaluating a company's amortization of intangibles helps users determine if net income is overstated.

TYPES OF INTANGIBLE ASSETS

Patents

A patent is an exclusive right issued by the U.S. Patent Of�ice that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant. The initial cost of a patent is the cash or cash equivalent price paid to acquire the patent.

The saying “A patent is only as good as the money you're prepared to spend defending it” is very true. Most patents are subject to some type of litigation by competitors. A well-known example is the patent infringement suit brought by Amazon.com against Barnes & Noble.com regarding its online shopping software. If the owner incurs legal costs in successfully defending the patent in an infringement suit, such costs are considered necessary to establish the validity of the patent. Thus, the owner adds those costs to the Patents account and amortizes them over the remaining life of the patent.

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Research and Development Costs

Research and development costs are expenditures that may lead to patents, copyrights, new processes, and new products. Many companies spend considerable sums of money on research and development (R&D) in an ongoing effort to develop new products or processes. For example, in a recent year Google spent over $9.8 billion on research and development. There are uncertainties in identifying the extent and timing of the future bene�its of these expenditures. As a result, companies usually record research and development costs as an expense when incurred, whether the R&D is successful or not.

To illustrate, assume that Laser Scanner Company spent $3 million on research and development that resulted in two highly successful patents. It spent $20,000 on legal fees for the patents. It can include the legal fees in the cost of the patents but cannot include the R&D costs in the cost of the patents. Instead, Laser Scanner records the R&D costs as an expense when incurred.

Many disagree with this accounting approach. They argue that to expense these costs leads to understated assets and net income. Others argue that capitalizing these costs would lead to highly speculative assets on the balance sheet. Who is right is dif�icult to determine.

▼ HELPFUL HINT

Research and development costs are not intangible costs, but because these expenditures may lead to patents and copyrights, we discuss them in this section.

INTERNATIONAL NOTE IFRS allows capitalization of some development costs. This may contribute to differences in R&D expenditures across nations.

Copyrights

The federal government grants copyrights, which give the owner the exclusive right to reproduce and sell an artistic or published work. Copyrights last for the life of the creator plus 70 years. The cost of the copyright consists of the cost of acquiring and defending it. The cost may be only the small fee paid to the U.S. Copyright Of�ice, or it may amount to a great deal more if a copyright is acquired from another party. The useful life of a copyright generally is signi�icantly shorter than its legal life.

Trademarks and Trade Names

A trademark or trade name is a word, phrase, jingle, or symbol that distinguishes or identi�ies a particular enterprise or product. Trade names like Wheaties, Monopoly, Sunkist, Kleenex, Coca-Cola, Big

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Mac, and Jeep create immediate product identi�ication and generally enhance the sale of the product. The creator or original user may obtain the exclusive legal right to the trademark or trade name by registering it with the U.S. Patent Of�ice. Such registration provides 20 years' protection and may be renewed inde�initely as long as the trademark or trade name is in use.

If a company purchases the trademark or trade name, the cost is the purchase price. If the company develops the trademark or trade name itself, the cost includes attorney's fees, registration fees, design costs, successful legal defense costs, and other expenditures directly related to securing it. Because trademarks and trade names have inde�inite lives, they are not amortized.

 ACCOUNTING ACROSS THE ORGANIZATION 

Google

We Want to Own Glass

Google, which has trademarked the term “Google Glass,” now wants to trademark the term “Glass.” Why? Because the simple word Glass has marketing advantages over the term Google Glass. It is easy to remember and is more universal. Regulators, however, are balking at Google's request. They say that the possible trademark is too similar to other existing or pending software trademarks that contain the word “glass.” Also, regulators suggest that the term Glass is merely descriptive and therefore lacks trademark protection. For example, regulators note that a company that makes salsa could not trademark the term “Spicy Salsa.”

BorderStylo LLC, which developed a Web-browser extension called Write on Glass, has �iled a notice of opposition to Google's request. Google is �ighting back and has sent the trademark examiner a 1,928-page application defense.

Source: Jacob Gershman, “Google Wants to Own ‘Glass’,” Wall Street Journal (April 4, 2014), p. B5.

If Google is successful in registering the term Glass, where will this trademark be reported on its �inancial statements? (Go to WileyPLUS for this answer and additional questions.)

Franchises

When you purchase a RAV4 from a Toyota dealer, �ill up your tank at the corner Shell station, eat lunch at Subway, or make reservations at a Marriott hotel, you are dealing with franchises. A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products, to perform speci�ic services, or to use certain trademarks or trade names, usually within a designated geographic area.

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Another type of franchise is a license. Licenses granted by a governmental body permit a business to use public property in performing its services. Examples are the use of city streets for a bus line or taxi service; the use of public land for telephone, electric, and cable television lines; and the use of airwaves for radio or TV broadcasting. In a recent license agreement, Fox, CBS, and NBC agreed to pay $27.9 billion for the right to broadcast NFL football games over an eight-year period.

Franchises and licenses may be granted for a de�inite period of time, or the time period may be inde�inite or perpetual. When a company incurs costs in connection with the acquisition of the franchise or license, it should recognize an intangible asset. Companies record as operating expenses annual payments made under a franchise agreement in the period in which they are incurred. In the case of a limited life, a company amortizes the cost of a franchise (or license) as operating expense over the useful life. If the life is inde�inite or perpetual, the cost is not amortized.

Goodwill

Usually, the largest intangible asset that appears on a company's balance sheet is goodwill. Goodwill represents the value of all favorable attributes that relate to a company that are not attributable to any other speci�ic asset. These include exceptional management, desirable location, good customer relations, skilled employees, high-quality products, fair pricing policies, and harmonious relations with labor unions. Goodwill is unique because unlike other assets such as investments, plant assets, and even other intangibles, which can be sold individually in the marketplace, goodwill can be identi�ied only with the business as a whole.

If goodwill can be identi�ied only with the business as a whole, how can it be determined? Certainly, many business enterprises have many of the factors cited above (exceptional management, desirable location, and so on). However, to determine the amount of goodwill in these situations would be dif�icult and very subjective. In other words, to recognize goodwill without an exchange transaction that puts a value on the goodwill would lead to subjective valuations that do not contribute to the reliability of �inancial statements. Therefore, companies record goodwill only when there is an exchange transaction that involves the purchase of an entire business. When an entire business is purchased, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.

In recording the purchase of a business, a company debits the identi�iable acquired assets and credits liabilities at their fair values, credits cash for the purchase price, and records the difference as the cost of goodwill. Goodwill is not amortized because it is considered to have an inde�inite life. However, it must be written down if a company determines the value of goodwill has been permanently impaired.

DO IT! 4

Classi�ication Concepts

Match the statement with the term most directly associated with it.

Copyright

Intangible assets

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Research and development costs

Amortization

Franchise

1. _______ The allocation to expense of the cost of an intangible asset over the asset's useful life.

2. _______ Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.

3. _______ An exclusive right granted by the federal government to reproduce and sell an artistic or published work.

4. _______ A right to sell certain products or services or to use certain trademarks or trade names within a designated geographic area.

5. _______ Costs incurred by a company that often lead to patents or new products. These costs must be expensed as incurred.

Action Plan ✓ Know that the accounting for intangibles often depends on

whether the item has a �inite or inde�inite life.

✓ Recognize the many similarities and differences between the accounting for plant assets and intangible assets.

SOLUTION

1. Amortization

2. Intangible assets

3. Copyright

4. Franchise

5. Research and development costs

Related exercise material: BE9-9, DO IT! 9-4, E9-11, E9-12, and E9-13.

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LEARNING OBJECTIVE 5

Discuss how long-lived assets are reported and analyzed. 

PRESENTATION Usually, companies show plant assets in the �inancial statements under “Property, plant, and equipment,” and they show intangibles separately under “Intangible assets.” Illustration 9-19 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0019) shows a typical balance sheet presentation of long-lived assets, adapted from a recent The Coca-Cola Company balance sheet.

ILLUSTRATION 9-19 Presentation of property, plant, and equipment and intangible assets

When a plant asset is fully depreciated, the plant asset and related accumulated depreciation should continue to be reported on the balance sheet without further depreciation or adjustment until the asset is retired. Intangibles do not usually use a contra asset account like the contra asset account Accumulated Depreciation used for plant assets. Instead, companies record amortization of intangibles as a direct decrease (credit) to the asset account.

Either within the balance sheet or in the notes, companies should disclose the balances of the major classes of assets, such as land, buildings, and equipment, and of accumulated depreciation by major classes or in total. In addition, they should describe the depreciation and amortization methods used and disclose the amount of depreciation and amortization expense for the period.

PEOPLE, PLANET, AND PROFIT INSIGHT

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BHP Billiton

Sustainability Report Please

Sustainability reports identify how the company is meeting its corporate social responsibilities. Many companies, both large and small, are now issuing these reports. For example, companies such as Disney, Best Buy, Microsoft, Ford, and ConocoPhilips issue these reports. Presented below is an adapted section of a recent BHP Billiton (a global mining, oil, and gas company) sustainability report on its environmental policies. These policies are to (1) take action to address the challenges of climate change, (2) set and achieve targets that reduce pollution, and (3) enhance biodiversity by assessing and considering ecological values and land-use aspects. Here is how BHP Billiton measures the success or failure of some of these policies:

Environment Commentary Target Date

We will maintain total greenhouse gas emissions below FY2006 levels.

FY2013 greenhouse gas emissions were lower than the FY2006 baseline.

30 June 2017

All operations to offset impacts to biodiversity and the related bene�its derived from ecosystems.

Land and Biodiversity Management Plans were developed at all our operations.

Annual

We will �inance the conservation and continuing management of areas of high biodiversity and ecosystem value.

Two projects of international conservation signi�icance were established—the Five Rivers Conservation Project, in Australia, and the Valdivian Coastal Reserve Conservation Project, in Chile.

30 June 2017

In addition to the environment, BHP Billiton has sections in its sustainability report that discuss people, safety, health, and community.

Why do you believe companies issue sustainability reports? (Go to WileyPLUS for this answer and additional questions.)

ANALYSIS The presentation of �inancial statement information about plant assets enables decision makers to analyze the company's use of its plant assets. We will use two measures to analyze plant assets: return on assets and asset turnover. We also show how pro�it margin relates to both.

Return on Assets

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An overall measure of pro�itability is the return on assets. This ratio is computed by dividing net income by average total assets. (Average assets are commonly calculated by adding the beginning and ending values of assets and dividing by 2.) Return on assets indicates the amount of net income generated by each dollar of assets. Thus, the higher the return on assets, the more pro�itable the company.

Information is provided below related to JetBlue Airways.

DECISION TOOLS

Return on assets helps users determine if a company is using its assets effectively.

Illustration 9-20 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0020) presents the 2014 and 2013 return on assets of JetBlue Airways, Southwest Airlines, and the industry average.

ILLUSTRATION 9-20 Return on assets for JetBlue and Southwest

JetBlue's return on assets was better than that of Southwest's and higher than the airline industry. At one time, the airline industry experienced �inancial dif�iculties as it attempted to cover high labor, fuel, and security costs while offering fares low enough to attract customers. Such dif�iculties were re�lected in a low industry average for return on assets. In response, Southwest announced that it would not add additional planes beyond the 700 it already had until it met its investment-return targets. Instead, the company added seats to existing planes and replaced some smaller planes with larger ones.

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ACCOUNTING ACROSS THE ORGANIZATION Marketing ROI as Pro�it Indicator

Marketing executives use the basic �inance concept underlying return on assets to determine “marketing return on investment (ROI).” They calculate marketing ROI as the pro�it generated by a marketing initiative divided by the investment in that initiative.

It can be tricky to determine what to include in the “investment” amount and how to attribute pro�it to a particular marketing initiative. However, many �irms feel that measuring marketing ROI is worth the effort because it allows managers to evaluate the relative effectiveness of various programs. In addition, it helps quantify the bene�its that marketing provides to the organization. In periods of tight budgets, the marketing ROI number can provide particularly valuable evidence to help a marketing manager avoid budget cuts.

Source: James O. Mitchel, “Marketing ROI,” LIMRA's MarketFacts Quarterly (Summer 2004), p. 15.

How does measuring marketing ROI support the overall efforts of the organization? (Go to WileyPLUS for this answer and additional questions.)

Asset Turnover

Asset turnover indicates how ef�iciently a company uses its assets to generate sales—that is, how many dollars of sales a company generates for each dollar invested in assets. It is calculated by dividing net sales by average total assets. When we compare two companies in the same industry, the one with the higher asset turnover is operating more ef�iciently. It is generating more sales per dollar invested in assets. Illustration 9-21 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0021) (page 446) presents the asset turnovers for JetBlue Airways and Southwest Airlines.

ILLUSTRATION 9-21 Asset turnovers for JetBlue and Southwest

These asset turnover values tell us that for each dollar of assets, JetBlue generates sales of $0.77 and Southwest $0.94. Southwest is more successful in generating sales per dollar invested in assets. The average asset turnover for the airline industry is 0.80 times. In recent years, airlines have reduced both

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the number of planes used and routes �lown to try to pack more customers on a plane. This would increase the asset turnover.

Asset turnovers vary considerably across industries. During a recent year, the average asset turnover for electric utility companies was 0.34. The grocery industry had an average asset turnover of 2.89. Asset turnover values, therefore, are only comparable within—not between—industries.

DECISION TOOLS

The asset turnover helps users determine how effectively a company is generating sales from its assets.

Pro�it Margin Revisited

In Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , you learned about pro�it margin. That ratio is calculated by dividing net income by net sales. It tells how effective a company is in turning its sales into income—that is, how much income each dollar of sales provides. Illustration 9-22 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0022) shows that return on assets can be computed as the product of pro�it margin and asset turnover.

ILLUSTRATION 9-22 Composition of return on assets

This relationship has very important strategic implications for management. From Illustration 9-22 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0022) , we can see that if a company wants to increase its return on assets, it can do so in two ways: (1) by increasing the margin it generates from each dollar of goods that it sells (the pro�it margin), or (2) by increasing the volume of goods that it sells (the asset turnover). For example, most grocery stores have very low pro�it margins, often in the range of 1 or 2 cents for every dollar of goods sold. Grocery stores, therefore, focus on asset turnover: They rely on high turnover to increase their return on assets. Alternatively, a store selling luxury goods, such as expensive jewelry, does not generally have a high turnover. Consequently, a seller of luxury goods focuses on having a high pro�it margin. Recently, Apple decided to offer a less expensive version of its popular iPod. This new product would provide a lower margin but higher volume than Apple's more expensive version.

Let's evaluate the return on assets of JetBlue Airways for 2014 by evaluating its components—pro�it margin and asset turnover. See Illustration 9-23 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig-0023) .

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ILLUSTRATION 9-23 Components of rate of return for JetBlue and Southwest

JetBlue's return on asset of 6.8% versus Southwest's 5.7% means that JetBlue generates 6.8 cents per each dollar invested in assets, while Southwest generates 5.7 cents. Illustration 9-23 reveals that although these two airlines have similar return on asset values, they achieve this return in a slightly different fashion. First, JetBlue's pro�it margin of 8.8% versus Southwest's 6.1% means that for every dollar of sales, JetBlue generates approximately 8.8 cents of net income, while Southwest generates approximately 6.1 cents. Second, JetBlue's asset turnover of 0.77 means that it generates 77 cents of sales per each dollar invested in assets, while Southwest generates 94 cents. Therefore, in 2014, Southwest was more effective at generating sales from its assets, while JetBlue was better at deriving pro�it from its sales.

KEEPING AN EYE ON CASH

Depreciation and amortization expense are among the biggest causes of differences between accrual- accounting net income and net cash provided by operating activities. Depreciation and amortization reduce net income, but they do not use up any cash. Therefore, to determine net cash provided by operating activities under a common approach referred to as the indirect method, companies add depreciation and amortization back to net income. For example, if a company reported net income of $175,000 during the year and had depreciation expense of $40,000, net cash provided by operating activities would be $215,000 (assuming no other accrual-accounting differences). The operating activities section of Coca-Cola's statement of cash �lows reports the following adjustment for depreciation and amortization.

The adjustment for depreciation and amortization was more than twice as big as any other adjustment required to convert net income to net cash provided by operating activities.

It is also interesting to examine the statement of cash �lows to determine the amount of property, plant, and equipment a company purchased and the cash it received from property, plant, and equipment sold in a given year. For example, the investing activities section of Coca-Cola reports the following.

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As indicated, Coca-Cola made signi�icant purchases and sales of property, plant, and equipment. The level of purchases suggests that Coca-Cola believes that it can earn a reasonable rate of return on these assets.

DO IT! 5

Asset Turnover

Paramour Company reported net income of $180,000, net sales of $420,000, and had total assets of $460,000 on January 1, 2017, and total assets on December 31, 2017, of $540,000. Determine Paramour's asset turnover for 2017.

Action Plan ✓ Recognize that the asset turnover analyzes the productivity of

a company's assets.

✓ Know the formula Net sales ÷ Average total assets equals Asset turnover.

Related exercise material: BE9-10, DO IT! 9-5, E9-15, E9-16, and E9-17.

USING DECISION TOOLS—DELTA AIR LINES

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Delta Air Lines, Inc., headquartered in Atlanta, Georgia, is one of the largest airlines in the world. It serves 342 destinations in 61 countries.

INSTRUCTIONS

Review the excerpts from the company's 2014 annual report presented on page 449 and then answer the following questions.

What method does the company use to depreciate its aircraft? Over what period is the company depreciating these aircraft?

Compute the company's return on assets ratio, asset turnover ratio, and pro�it margin ratio for 2014 and 2013. Comment on your results.

(in millions) 2014 2013 Net income (loss) $  659 $10,540 Net sales 40,362 37,773 Beginning total assets 52,252 44,550 Ending total assets 54,121 52,252

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SOLUTION

1. The company depreciates property and equipment using the straight-line approach. It depreciates aircraft over a 21–30-year life.

Delta's pro�it margin and return on assets decreased signi�icantly from 2013 to 2014. (This huge drop occurred because the company had a massive, one-time tax bene�it in 2013.) Its asset turnover decreased slightly.

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LEARNING OBJECTIVE *6

APPENDIX 9A: Compute periodic depreciation using the declining- balance method and the units-of-activity method.

In this appendix, we show the calculations of the depreciation expense amounts that we used in the chapter for the declining-balance and units-of-activity methods.

DECLINING-BALANCE METHOD The declining-balance method produces a decreasing annual depreciation expense over the useful life of the asset. The method is so named because the computation of periodic depreciation is based on a declining book value (cost less accumulated depreciation) of the asset. Annual depreciation expense is computed by multiplying the book value at the beginning of the year by the declining-balance depreciation rate. The depreciation rate remains constant from year to year, but the book value to which the rate is applied declines each year.

Book value for the �irst year is the cost of the asset because the balance in accumulated depreciation at the beginning of the asset's useful life is zero. In subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year. Unlike other depreciation methods, the declining-balance method ignores salvage value in determining the amount to which the declining- balance rate is applied. Salvage value, however, does limit the total depreciation that can be taken. Depreciation stops when the asset's book value equals its expected salvage value.

Depreciation must be completed by the end of the asset's useful life. Therefore, in the last year of the asset's useful life, it is sometimes necessary to adjust the amount of depreciation expense so that the book value equals the expected salvage value. For example, note the adjustment to the �inal year in Illustration 9A-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0025) .

As noted in the chapter, a common declining-balance rate is double the straight-line rate—the double- declining-balance method. If Bill's Pizzas uses the double-declining-balance method, the depreciation rate is 40% (2 × the straight-line rate of 20%). Illustration 9A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0024) presents the formula and computation of depreciation for the �irst year on the delivery truck.

ILLUSTRATION 9A-1 Formula for declining-balance method

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Illustration 9A-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0025) presents the depreciation schedule under this method.

ILLUSTRATION 9A-2 Double-declining-balance depreciation schedule

The delivery equipment is 69% depreciated ($8,320÷$12,000) at the end of the second year. Under the straight-line method, it would be depreciated 40% ($4,800÷$12,000) at that time. Because the declining- balance method produces higher depreciation expense in the early years than in the later years, it is considered an accelerated-depreciation method.

The declining-balance method is compatible with the expense recognition principle. It matches the higher depreciation expense in early years with the higher bene�its received in these years. Conversely, it recognizes lower depreciation expense in later years when the asset's contribution to revenue is likely to be lower. Also, some assets lose their usefulness rapidly because of obsolescence. In these cases, the declining-balance method provides a more appropriate depreciation amount.

When an asset is purchased during the year, it is necessary to prorate the declining-balance depreciation in the �irst year on a time basis. For example, if Bill's Pizzas had purchased the delivery equipment on April 1, 2017, depreciation for 2017 would be $3,900 ($13,000×40%×912). The book value for computing depreciation in 2018 then becomes $9,100 ($13,000−$3,900), and the 2018 depreciation is $3,640 ($9,100×40%).

▼ HELPFUL HINT

The straight-line rate is approximated as 1÷Estimated life. In this case, it is 1÷5=20%.

▼ HELPFUL HINT

Depreciation stops when the asset's book value equals its expected salvage value.

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UNITS-OF-ACTIVITY METHOD Under the units-of-activity method, useful life is expressed in terms of the total units of production or use expected from the asset. The units-of-activity method is ideally suited to equipment whose activity can be measured in units of output, miles driven, or hours in use. The units-of-activity method is generally not suitable for assets for which depreciation is a function more of time than of use.

To use this method, a company estimates the total units of activity for the entire useful life and divides that amount into the depreciable cost to determine the depreciation cost per unit. It then multiplies the depreciation cost per unit by the units of activity during the year to �ind the annual depreciation for that year.

To illustrate, assume that Bill's Pizzas estimates it will drive its new delivery truck 15,000 miles in the �irst year. Illustration 9A-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig- 0026) presents the formula and computation of depreciation expense in the �irst year.

ILLUSTRATION 9A-3 Formula for units-of-activity method

Illustration 9A-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo6#c09-�ig-0027) shows the depreciation schedule, using assumed mileage data.

ILLUSTRATION 9A-4 Units-of-activity depreciation schedule

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The units-of-activity method is not nearly as popular as the straight-line method, primarily because it is often dif�icult to make a reasonable estimate of total activity. However, this method is used by some very large companies, such as Standard Oil Company of California and Boise Cascade Corporation. When the productivity of the asset varies signi�icantly from one period to another, the units-of-activity method results in the best matching of expenses with revenues.

This method is easy to apply when assets are purchased during the year. In such a case, companies use the productivity of the asset for the partial year in computing the depreciation.

ALTERNATIVE TERMINOLOGY

Another term often used is the units-of-production method.

▼ HELPFUL HINT

Depreciation stops when the asset's book value equals its expected salvage value.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW 1 Explain the accounting for plant asset expenditures. The cost of plant assets includes all expenditures necessary to acquire the asset and make it ready for its intended use. Once cost is established, a company uses that amount as the basis of accounting for the plant asset over its useful life.

2 Apply depreciation methods to plant assets. Depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Depreciation is not a process of valuation, and it is not a process that results in an accumulation of cash. Depreciation re�lects an asset's decreasing usefulness and revenue- producing ability, resulting from wear and tear and from obsolescence.

The formula for straight-line depreciation is:

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The expense patterns of the three depreciation methods are as follows.

Method Annual Depreciation Pattern Straight-line Constant amount Declining-balance Decreasing amount Units-of-activity Varying amount

Companies make revisions of periodic depreciation in present and future periods, not retroactively.

3 Explain how to account for the disposal of plant assets. The procedure for accounting for the disposal of a plant asset through sale or retirement is (a) eliminate the book value of the plant asset at the date of disposal; (b) record cash proceeds, if any; and (c) account for the difference between the book value and the cash proceeds as a gain or a loss on disposal.

4 Identify the basic issues related to reporting intangible assets. Companies report intangible assets at their cost less any amounts amortized. If an intangible asset has a limited life, its cost should be allocated (amortized) over its useful life. Intangible assets with inde�inite lives should not be amortized.

5 Discuss how long-lived assets are reported and analyzed. Companies usually show plant assets under “Property, plant, and equipment”; they show intangibles separately under “Intangible assets.” Either within the balance sheet or in the notes, companies disclose the balances of the major classes of assets, such as land, buildings, and equipment, and accumulated depreciation by major classes or in total. They describe the depreciation and amortization methods used, and disclose the amount of depreciation and amortization expense for the period. In the statement of cash �lows, under the indirect method, depreciation and amortization expense are added back to net income to determine net cash provided by operating activities. The investing section reports cash paid or received to purchase or sell property, plant, and equipment.

Plant assets may be analyzed using return on assets and asset turnover. Return on assets consists of two components: asset turnover and pro�it margin.

*6 Compute periodic depreciation using the declining-balance method and the units-of-activity method. The depreciation expense calculation for each of these methods is:

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DECISION TOOLS REVIEW

GLOSSARY REVIEW Accelerated-depreciation method A depreciation method that produces higher

depreciation expense in the early years than the straight-line approach.

Additions and improvements Costs incurred to increase the operating ef�iciency, productive capacity, or expected useful life of a plant asset.

Amortization The process of allocating to expense the cost of an intangible asset.

Asset turnover Indicates how ef�iciently a company uses its assets to generate sales; calculated as net sales divided by average total assets.

Capital expenditures Expenditures that increase the company's investment in plant assets.

Capital lease A contractual agreement allowing one party (the lessee) to use another party's asset (the lessor); accounted for like a debt-�inanced purchase by the lessee.

Cash equivalent price An amount equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.

Copyrights An exclusive right granted by the federal government allowing the owner to reproduce and sell an artistic or published work.

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Declining-balance method A depreciation method that applies a constant rate to the declining book value of the asset and produces a decreasing annual depreciation expense over the asset's useful life.

Depreciable cost The cost of a plant asset less its salvage value.

Depreciation The process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner.

Franchise A contractual arrangement under which the franchisor grants the franchisee the right to sell certain products, to perform speci�ic services, or to use certain trademarks or trade names, usually within a designated geographic area.

Goodwill The value of all favorable attributes that relate to a company that are not attributable to any other speci�ic asset.

Impairment A permanent decline in the fair value of an asset.

Intangible assets Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.

Lessee A party that has made contractual arrangements to use another party's asset for a period at an agreed price.

Lessor A party that has agreed contractually to let another party use its asset for a period at an agreed price.

Operating leases A contractual agreement allowing one party (the lessee) to use the asset of another party (the lessor); accounted for as a rental by the lessee.

Ordinary repairs Expenditures to maintain the operating ef�iciency and expected productive life of the asset.

Patent An exclusive right issued by the U.S. Patent Of�ice that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant.

Plant assets Resources that have physical substance, are used in the operations of the business, and are not intended for sale to customers.

Research and development costs Expenditures that may lead to patents, copyrights, new processes, and new products; must be expensed as incurred.

Return on assets A pro�itability measure that indicates the amount of net income generated by each dollar of assets; computed as net income divided by average total assets.

Revenue expenditures Expenditures that are immediately charged against revenues as an expense.

Straight-line method A method in which companies expense an equal amount of depreciation for each year of the asset's useful life.

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Trademark A word, phrase, jingle, or symbol that distinguishes or identi�ies a particular enterprise or product.

Units-of-activity method A depreciation method in which useful life is expressed in terms of the total units of production or use expected from the asset.

PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)

1. Corrieten Company purchased equipment and incurred these costs:

Cash price $24,000 Sales taxes 1,200 Insurance during transit 200 Installation and testing 400

Total costs $25,800

What amount should be recorded as the cost of the equipment?

(a) $24,000.

(b) $25,200.

(c) $25,400.

(d) $25,800.

(LO 1)

2. Harrington Corporation recently leased a number of trucks from Andre Corporation. In inspecting the books of Harrington Corporation, you notice that the trucks have not been recorded as assets on its balance sheet. From this, you can conclude that Harrington is accounting for this transaction as a/an:

(a) operating lease.

(b) capital lease.

(c) purchase.

(d) None of the above.

(LO 1)

3. Additions to plant assets are:

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(a) revenue expenditures.

(b) debited to the Repairs and Maintenance Expense account.

(c) debited to the Purchases account.

(d) capital expenditures.

(LO 2)

4. Depreciation is a process of:

(a) valuation.

(b) cost allocation.

(c) cash accumulation.

(d) appraisal.

(LO 2)

5. Cuso Company purchased equipment on January 1, 2016, at a total invoice cost of $400,000. The equipment has an estimated salvage value of $10,000 and an estimated useful life of 5 years. What is the amount of accumulated depreciation at December 31, 2017, if the straight-line method of depreciation is used?

(a) $80,000.

(b) $160,000.

(c) $78,000.

(d) $156,000.

(LO 2)

6. A company would minimize its depreciation expense in the �irst year of owning an asset if it used:

(a) a high estimated life, a high salvage value, and declining-balance depreciation.

(b) a low estimated life, a high salvage value, and straight-line depreciation.

(c) a high estimated life, a high salvage value, and straight-line depreciation.

(d) a low estimated life, a low salvage value, and declining-balance depreciation.

(LO 2)

7. When there is a change in estimated depreciation:

(a) previous depreciation should be corrected.

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(b) current and future years' depreciation should be revised.

(c) only future years' depreciation should be revised.

(d) None of the above.

(LO 2)

8. Able Towing Company purchased a tow truck for $60,000 on January 1, 2017. It was originally depreciated on a straight-line basis over 10 years with an assumed salvage value of $12,000. On December 31, 2019, before adjusting entries had been made, the company decided to change the remaining estimated life to 4 years (including 2019) and the salvage value to $2,000. What was the depreciation expense for 2019?

(a) $6,000.

(b) $4,800.

(c) $15,000.

(d) $12,100.

(LO 3)

9. Bennie Razor Company has decided to sell one of its old manufacturing machines on June 30, 2017. The machine was purchased for $80,000 on January 1, 2013, and was depreciated on a straight-line basis for 10 years assuming no salvage value. If the machine was sold for $26,000, what was the amount of the gain or loss recorded at the time of the sale?

(a) $18,000 loss.

(b) $54,000 loss.

(c) $22,000 gain.

(d) $46,000 gain.

(LO 4)

10. Pierce Company incurred $150,000 of research and development costs in its laboratory to develop a new product. It spent $20,000 in legal fees for a patent granted on January 2, 2017. On July 31, 2017, Pierce paid $15,000 for legal fees in a successful defense of the patent. What is the total amount that should be debited to Patents through July 31, 2017?

(a) $150,000.

(b) $35,000.

(c) $185,000.

(d) $170,000.

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(LO 4)

11. Indicate which one of these statements is true.

(a) Since intangible assets lack physical substance, they need to be disclosed only in the notes to the �inancial statements.

(b) Goodwill should be reported as a contra account in the stockholders' equity section.

(c) Totals of major classes of assets can be shown in the balance sheet, with asset details disclosed in the notes to the �inancial statements.

(d) Intangible assets are typically combined with plant assets and inventory and then shown in the property, plant, and equipment section.

(LO 4)

12. If a company reports goodwill as an intangible asset on its books, what is the one thing you know with certainty?

(a) The company is a valuable company worth investing in.

(b) The company has a well-established brand name.

(c) The company purchased another company.

(d) The goodwill will generate a lot of positive business for the company for many years to come.

(LO 4)

13. Which of the following statements is false?

(a) If an intangible asset has a �inite life, it should be amortized.

(b) The amortization period of an intangible asset can exceed 20 years.

(c) Goodwill is recorded only when a business is purchased.

(d) Research and development costs are expensed when incurred, except when the research and development expenditures result in a successful patent.

(LO 5)

14. Which of the following measures provides an indication of how ef�icient a company is in employing its assets?

(a) Current ratio.

(b) Pro�it margin.

(c) Debt to assets ratio.

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(d) Asset turnover.

(LO 5)

15. Lake Coffee Company reported net sales of $180,000, net income of $54,000, beginning total assets of $200,000, and ending total assets of $300,000. What was the company's asset turnover?

(a) 0.90

(b) 0.20

(c) 0.72

(d) 1.39

(LO 6)

16. Kant Enterprises purchased a truck for $11,000 on January 1, 2016. The truck will have an estimated salvage value of $1,000 at the end of 5 years. If you use the units-of- activity method, the balance in accumulated depreciation at December 31, 2017, can be computed by the following formula:

(a) ($11,000÷Total estimated activity)×Units of activity for 2017.

(b) ($10,000÷Total estimated activity)×Units of activity for 2017.

(c) ($11,000÷Total estimated activity)×Units of activity for 2016 and 2017.

(d) ($10,000÷Total estimated activity)×Units of activity for 2016 and 2017.

(LO 6)

*17. Jefferson Company purchased a piece of equipment on January 1, 2017. The equipment cost $60,000 and has an estimated life of 8 years and a salvage value of $8,000. What was the depreciation expense for the asset for 2018 under the double-declining- balance method?

(a) $6,500.

(b) $11,250.

(c) $15,000.

(d) $6,562.

SOLUTION 1. (d) All of the costs ($1,200+$200+$400) in addition to the cash price

($24,000) should be included in the cost of the equipment because they

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were necessary expenditures to acquire the asset and make it ready for its intended use. The other choices are therefore incorrect.

2. (a) Operating leases are accounted for as rentals and are not recorded on the balance sheet. The other choices are incorrect because (b) if the leased assets were accounted for as a capital lease or (c) if the assets were purchased, they would be reported on the balance sheet. Choice (d) is wrong as there is a correct answer.

3. (d) When an addition is made to plant assets, it is intended to increase productive capacity, increase the assets' useful life, or increase the ef�iciency of the assets. This is called a capital expenditure. The other choices are incorrect because (a) additions to plant assets are not revenue expenditures because the additions will have a long-term useful life whereas revenue expenditures are minor repairs and maintenance that do not prolong the life of the assets; (b) additions to plant assets are debited to Plant Assets, not Maintenance and Repairs Expense, because the Maintenance and Repairs Expense account is used to record expenditures not intended to increase the life of the assets; and (c) additions to plant assets are debited to Plant Assets, not Purchases, because the Purchases account is used to record assets intended for resale (inventory).

4. (b) Depreciation is a process of allocating the cost of an asset over its useful life, not a process of (a) valuation, (c) cash accumulation, or (d) appraisal.

5. (d) Accumulated depreciation will be the sum of 2 years of depreciation expense. Annual depreciation for this asset is ($400,000− $10,000)/5=$78,000. The sum of 2 years' depreciation is therefore $156,000 ($78,000+$78,000), not (a) $80,000, (b) $160,000, or (c) $78,000.

6. (c) A high estimated life spreads the cost over a longer period of time, resulting in a smaller expense each year. The high salvage value limits the cost to be allocated. Straight-line depreciation yields a smaller depreciation charge in the �irst year than the declining-balance method. The other choices are therefore incorrect.

7. (b) When there is a change in estimated depreciation, the current and future years' depreciation computation should re�lect the new estimates. The other choices are incorrect because (a) previous years' depreciation should not be adjusted when new estimates are made for depreciation, and (c) when there is a change in estimated depreciation, the current and future years' depreciation computation should re�lect the new estimates. Choice (d) is wrong because there is a correct answer.

8. (d) First, calculate accumulated depreciation from January 1, 2017, through December 31, 2018, which is $9,600 {[($60,000− $12,000)/10 years]×2 years}. Next, calculate the revised depreciable

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cost, which is $48,400 ($60,000−$9,600−$2,000). Thus, the depreciation expense for 2019 is $12,100 ($48,400/4), not (a) $6,000, (b) $4,800, or (c) $15,000.

9. (a) First, the book value needs to be determined. The accumulated depreciation as of June 30, 2017, is $36,000 [($80,000/10)×4.5 years]. Thus, the cost of the machine less accumulated depreciation equals $ 44,000 ($80,000−$36,000). The loss recorded at the time of sale is $18,000 ($26,000−$44,000), not (b) $54,000, (c) $22,000, or (d) $46,000.

10. (b) Because the $150,000 was spent developing the patent rather than buying it from another �irm, it is debited to Research and Development Expense. Only the $35,000 spent on legal fees ($20,000 for granting patent and $15,000 for defense) can be debited to Patents, not (a) $150,000, (c) $185,000, or (d) $170,000.

11. (c) Reporting only totals of major classes of assets in the balance sheet is appropriate. Additional details can be shown in the notes to the �inancial statements. The other choices are false statements.

12. (c) In order to report goodwill, a company must have entered into an exchange transaction that involves the purchase of another business. Choices (a) the company is a valuable company worth investing in, (b) the company has a well-established brand name, and (d) the goodwill will generate a lot of positive business for the company for many years to come are not necessarily valid assumptions.

13. (d) Research and development (R&D) costs are expensed when incurred, regardless of whether the research and development expenditures result in a successful patent or not. The other choices are true statements.

14. (d) The asset turnover indicates how ef�iciently a company is employing its assets. The other choices are incorrect because (a) the current ratio is an indicator of liquidity and the company's ability to pay its obligations when they come due, (b) the pro�it margin is an indicator of how pro�itable a company is, and (c) the debt to assets ratio indicates the proportion of assets that are �inanced by debt rather than by equity.

15. (c) Asset turnover=Net sales ($180,000)/Average total assets [($200,000+$300,000)/2]=0.72 times, not (a) 0.90, (b) 0.20, or (d) 1.39 times.

*16. (d) The units-of-activity method takes salvage value into consideration; therefore, the depreciable cost is $10,000. This amount is divided by total estimated activity. The resulting number is multiplied by the units of activity used in 2016 and 2017 to compute the accumulated depreciation at the end of 2017, the second year of the asset's use. The other choices are therefore incorrect.

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*17. (b) For the double-declining method, the depreciation rate would be 25% or (1/8×2). For 2017, annual depreciation expense is $15,000 ($60,000 book value×25%); for 2018, annual depreciation expense is $11,250 [($60,000−$15,000)×25%], not (a) $6,500, (c) $15,000, or (d) $6,562.

PRACTICE EXERCISES

Compute revised annual depreciation.

(LO 2)

1. Will Smith, the new controller of Alexandria Company, has reviewed the expected useful lives and salvage values of selected depreciable assets at the beginning of 2017. Here are his �indings:

All assets are depreciated by the straight-line method. Alexandria Company uses a calendar year in preparing annual �inancial statements. After discussion, management has agreed to accept Will's proposed changes. (The “Proposed” useful life is total life, not remaining life.)

INSTRUCTIONS

(a) Compute the revised annual depreciation on each asset in 2017. (Show computations.)

(b) Prepare the entry (or entries) to record depreciation on the building in 2017.

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SOLUTION

Prepare entries to set up appropriate accounts for different intangibles; amortize intangible assets.

(LO 4)

2. Lake Company, organized in 2017, has the following transactions related to intangible assets.

1/2/17 Purchased patent (8-year life) $560,000 4/1/17 Goodwill purchased (inde�inite life) 360,000 7/1/17 10-year franchise; expiration date 7/1/2027 440,000 9/1/17 Research and development costs 185,000

INSTRUCTIONS

3. Prepare the necessary entries to record these intangibles. All costs incurred were for cash. Make the adjusting entries as of December 31, 2017, recording any necessary amortization and re�lecting all balances accurately as of that date.

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PRACTICE PROBLEMS

Compute depreciation under different methods.

(LO 2, 6)

1. DuPage Company purchases a factory machine at a cost of $18,000 on January 1, 2017. DuPage expects the machine to have a salvage value of $2,000 at the end of its 4-year useful life.

During its useful life, the machine is expected to be used 160,000 hours. Actual annual hourly use was 2017, 40,000; 2018, 60,000; 2019, 35,000; and 2020, 25,000.

INSTRUCTIONS

Prepare depreciation schedules for the following methods: (a) straight-line, (b) units-of- activity, and (c) declining-balance using double the straight-line rate. (Parts (b) and (c) are discussed in the chapter appendix.)

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Record disposal of plant asset.

(LO 3)

2. On January 1, 2014, Skyline Limousine Co. purchased a limousine at an acquisition cost of $28,000. Skyline depreciated the vehicle by the straight-line method using a 4-year service life and a $4,000 salvage value. The company's �iscal year ends on December 31.

INSTRUCTIONS

Prepare the journal entry or entries to record the disposal of the limousine, assuming that it was:

(a) Retired and scrapped with no salvage value on January 1, 2018.

(a) Sold for $5,000 on July 1, 2017.

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WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

QUESTIONS 1. Mrs. Harcross is uncertain about how the historical cost principle applies to plant assets. Explain

the principle to Mrs. Harcross.

2. How is the cost for a plant asset measured in a cash transaction? In a noncash transaction?

3. Barrister Company acquires the land and building owned by Ansel Company. What types of costs may be incurred to make the asset ready for its intended use if Barrister Company wants to use only the land? If it wants to use both the land and the building?

4. Distinguish between ordinary repairs and capital expenditures during an asset's useful life.

5. Breton Inc. needs to upgrade its diagnostic equipment. At the time of purchase, Breton had expected the equipment to last 8 years. Unfortunately, it was obsolete after only 4 years. Nolan Rush, CFO of Breton Inc., is considering leasing new equipment rather than buying it. What are the potential bene�its of leasing?

6. In a recent newspaper release, the president of Magnusson Company asserted that something has to be done about depreciation. The president said, “Depreciation does not come close to accumulating the cash needed to replace the asset at the end of its useful life.” What is your response to the president?

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7. Melanie is studying for the next accounting examination. She asks your help on two questions: (a) What is salvage value? (b) How is salvage value used in determining depreciable cost under the straight-line method? Answer Melanie's questions.

8. Contrast the straight-line method and the units-of-activity method in relation to (a) useful life and (b) the pattern of periodic depreciation over useful life.

9. Contrast the effects of the three depreciation methods on annual depreciation expense.

10. In the fourth year of an asset's 5-year useful life, the company decides that the asset will have a 6- year service life. How should the revision of depreciation be recorded? Why?

11. How is a gain or a loss on the sale of a plant asset computed?

12. Marsh Corporation owns a machine that is fully depreciated but is still being used. How should Marsh account for this asset and report it in the �inancial statements?

13. What does Apple use as the estimated useful life on its buildings? On its machinery and equipment? (Hint: You will need to �ind the notes to Apple's �inancial statements online. See the directions for �inding the notes in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) at the end of the textbook.)

14. What are the similarities and differences between depreciation and amortization?

15. During a recent management meeting, Bruce Dunn, director of marketing, proposed that the company begin capitalizing its marketing expenditures as goodwill. In his words, “Marketing expenditures create goodwill for the company which bene�its the company for multiple periods. Therefore it doesn't make good sense to have to expense it as it is incurred. Besides, if we capitalize it as goodwill, we won't have to amortize it, and this will boost reported income.” Discuss the merits of Bruce's proposal.

16. Warwick Company hires an accounting intern who says that intangible assets should always be amortized over their legal lives. Is the intern correct? Explain.

17. Goodwill has been de�ined as the value of all favorable attributes that relate to a business enterprise. What types of attributes could result in goodwill?

18. Kathy Malone, a business major, is working on a case problem for one of her classes. In this case problem, the company needs to raise cash to market a new product it developed. Doug Price, an engineering major, takes one look at the company's balance sheet and says, “This company has an awful lot of goodwill. Why don't you recommend that they sell some of it to raise cash?” How should Kathy respond to Doug?

19. Under what conditions is goodwill recorded? What is the proper accounting treatment for amortizing goodwill?

20. Often research and development costs provide companies with bene�its that last a number of years. (For example, these costs can lead to the development of a patent that will increase the company's income for many years.) However, generally accepted accounting principles require that such costs be recorded as an expense when incurred. Why?

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21. Suppose in 2017 that Campbell Soup Company reported average total assets of $6,265 million, net sales of $7,586 million, and net income of $736 million. What was Campbell Soup's return on assets?

22. Cassy Dominic, a marketing executive for Fresh Views Inc., has proposed expanding its product line of framed graphic art by producing a line of lower-quality products. These would require less processing by the company and would provide a lower pro�it margin. Mel Joss, the company's CFO, is concerned that this new product line would reduce the company's return on assets. Discuss the potential effect on return on assets that this product might have.

23. Give an example of an industry that would be characterized by (a) a high asset turnover and a low pro�it margin, and (b) a low asset turnover and a high pro�it margin.

24. Peyton Corporation and Rogers Corporation operate in the same industry. Peyton uses the straight-line method to account for depreciation, whereas Rogers uses an accelerated method. Explain what complications might arise in trying to compare the results of these two companies.

25. Mesa Corporation uses straight-line depreciation for �inancial reporting purposes but an accelerated method for tax purposes. Is it acceptable to use different methods for the two purposes? What is Mesa Corporation's motivation for doing this?

26. You are comparing two companies in the same industry. You have determined that Gore Corp. depreciates its plant assets over a 40-year life, whereas Ross Corp. depreciates its plant assets over a 20-year life. Discuss the implications this has for comparing the results of the two companies.

27. Explain how transactions related to plant assets and intangibles are reported in the statement of cash �lows under the indirect method.

BRIEF EXERCISES

Determine the cost of land.

(LO 1), AP

BE9-1 These expenditures were incurred by Dobbin Company in purchasing land: cash price $60,000, accrued taxes $5,000, attorney's fees $2,100, real estate broker's commission $3,300, and clearing and grading $3,500. What is the cost of the land?

Determine the cost of a truck.

(LO 1), AP

BE9-2 Thoms Company incurs these expenditures in purchasing a truck: cash price $24,000, accident insurance (during use) $2,000, sales taxes $1,080, motor vehicle license $300, and painting and lettering $1,700. What is the cost of the truck?

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Prepare entries for delivery truck costs.

(LO 1), AP

BE9-3 Krieg Company had the following two transactions related to its delivery truck.

1. Paid $38 for an oil change.

2. Paid $400 to install special shelving units, which increase the operating ef�iciency of the truck.

Prepare Krieg's journal entries to record these two transactions.

Compute straight-line depreciation.

(LO 2), AP

BE9-4 Gordon Chemicals Company acquires a delivery truck at a cost of $31,000 on January 1, 2017. The truck is expected to have a salvage value of $4,000 at the end of its 4-year useful life. Compute annual depreciation for the �irst and second years using the straight-line method.

Compute depreciation and evaluate treatment.

(LO 2), AN

BE9-5 Ivy Company purchased land and a building on January 1, 2017. Management's best estimate of the value of the land was $100,000 and of the building $250,000. However, management told the accounting department to record the land at $230,000 and the building at $120,000. The building is being depreciated on a straight-line basis over 20 years with no salvage value. Why do you suppose management requested this accounting treatment? Is it ethical?

Compute revised depreciation.

(LO 2), AP

BE9-6 On January 1, 2017, the Hermann Company ledger shows Equipment $36,000 and Accumulated Depreciation $13,600. The depreciation resulted from using the straight-line method with a useful life of 10 years and a salvage value of $2,000. On this date, the company concludes that the equipment has a remaining useful life of only 2 years with the same salvage value. Compute the revised annual depreciation.

Journalize entries for disposal of plant assets.

(LO 3), AP

BE9-7 Prepare journal entries to record these transactions. (a) Echo Company retires its delivery equipment, which cost $41,000. Accumulated depreciation is also $41,000 on this delivery equipment. No salvage value is received. (b) Assume the same information as in part (a), except that accumulated depreciation for the equipment is $37,200 instead of $41,000.

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Journalize entries for sale of plant assets.

(LO 3), AP

BE9-8 Antone Company sells of�ice equipment on July 31, 2017, for $21,000 cash. The of�ice equipment originally cost $72,000 and as of January 1, 2017, had accumulated depreciation of $42,000. Depreciation for the �irst 7 months of 2017 is $4,600. Prepare the journal entries to (a) update depreciation to July 31, 2017, and (b) record the sale of the equipment.

Account for intangibles—patents.

(LO 4), AP

BE9-9 Abner Company purchases a patent for $156,000 on January 2, 2017. Its estimated useful life is 6 years.

(a) Prepare the journal entry to record amortization expense for the �irst year.

(b) Show how this patent is reported on the balance sheet at the end of the �irst year.

Compute return on assets and asset turnover.

(LO 5), AP

BE9-10 Suppose in its 2017 annual report that McDonald's Corporation reports beginning total assets of $28.46 billion, ending total assets of $30.22 billion, net sales of $22.74 billion, and net income of $4.55 billion.

(a) Compute McDonald's return on assets.

(b) Compute McDonald's asset turnover.

Classi�ication of long-lived assets on balance sheet.

(LO 5), AP

BE9-11 Suppose Nike, Inc. reported the following plant assets and intangible assets for the year ended May 31, 2017 (in millions): other plant assets $965.8, land $221.6, patents and trademarks (at cost) $515.1, machinery and equipment $2,094.3, buildings $974.0, goodwill (at cost) $193.5, accumulated amortization $47.7, and accumulated depreciation $2,298.0. Prepare a partial balance sheet for Nike for these items.

Determine net cash provided by operating activities.

(LO 5), AP

BE9-12 Hunt Company reported net income of $157,000. It reported depreciation expense of $12,000 and accumulated depreciation of $47,000. Amortization expense was $8,000. Hunt purchased new equipment during the year for $50,000. Show how this information would be used to determine net cash provided by operating activities under the indirect method.

Compute declining-balance depreciation.

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(LO 6), AP

*BE9-13 Depreciation information for Gordon Chemicals Company is given in BE9-4. Assuming the declining-balance depreciation rate is double the straight-line rate, compute annual depreciation for the �irst and second years under the declining-balance method.

Compute depreciation using units-of-activity method.

(LO 6), AP

*BE9-14 Kwik Taxi Service uses the units-of-activity method in computing depreciation on its taxicabs. Each cab is expected to be driven 150,000 miles. Taxi 10 cost $27,500 and is expected to have a salvage value of $500. Taxi 10 was driven 32,000 miles in 2016 and 33,000 miles in 2017. Compute the depreciation for each year.

DO IT! EXERCISES

Explain accounting for cost of plant assets

(LO 1), C

DO IT! 9-1 Hummer Company purchased a delivery truck. The total cash payment was $30,020, including the following items.

Negotiated purchase price $24,000 Installation of special shelving 1,100 Painting and lettering 900 Motor vehicle license 180 Annual insurance policy 2,400 Sales tax 1,440

Total paid $30,020

Explain how each of these costs would be accounted for.

Calculate depreciation expense and make journal entry.

(LO 2), AP

DO IT! 9-2a On January 1, 2017, Salt Creek Country Club purchased a new riding mower for $15,000. The mower is expected to have a 10-year life with a $1,000 salvage value. What journal entry would Salt Creek make on December 31, 2017, if it uses straight-line depreciation?

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Calculated revised depreciation

(LO 2), AP

DO IT! 9-2b Fordon Corporation purchased a piece of equipment for $50,000. It estimated an 8-year life and $2,000 salvage value. At the end of year four (before the depreciation adjustment), it estimated the new total life to be 10 years and the new salvage value to be $4,000. Compute the revised depreciation.

Make journal entries to record plant asset disposal.

(LO 3), AP

DO IT! 9-3 Bylie Company has an old factory machine that cost $50,000. The machine has accumulated depreciation of $28,000. Bylie has decided to sell the machine.

(a) What entry would Bylie make to record the sale of the machine for $25,000 cash?

(b) What entry would Bylie make to record the sale of the machine for $15,000 cash?

Match intangible assets with concepts.

(LO 4), C

DO IT! 9-4 Match the statement with the term most directly associated with it.

Goodwill

Intangible assets

Research and development costs

Amortization

Franchise

1. _______ Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.

2. _______ The allocation of the cost of an intangible asset to expense in a rational and systematic manner.

3. _______ A right to sell certain products or services, or use certain trademarks or trade names within a designated geographic area.

4. _______ Costs incurred by a company that often lead to patents or new products. These costs must be expensed as incurred.

5. _______ The excess of the cost of a company over the fair value of the net assets required.

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Calculate asset turnover.

(LO 5), AP

DO IT! 9-5 For 2017, Sale Company reported beginning total assets of $300,000 and ending total assets of $340,000. Its net income for this period was $50,000, and its net sales were $400,000. Compute the company's asset turnover for 2017.

EXERCISES Determine cost of plant acquisitions.

(LO 1), C

E9-1 The following expenditures relating to plant assets were made by Glenn Company during the �irst 2 months of 2017.

1. Paid $7,000 of accrued taxes at the time the plant site was acquired.

2. Paid $200 insurance to cover a possible accident loss on new factory machinery while the machinery was in transit.

3. Paid $850 sales taxes on a new delivery truck.

4. Paid $21,000 for parking lots and driveways on the new plant site.

5. Paid $250 to have the company name and slogan painted on the new delivery truck.

6. Paid $8,000 for installation of new factory machinery.

7. Paid $900 for a 1-year accident insurance policy on the new delivery truck.

8. Paid $75 motor vehicle license fee on the new truck.

Instructions

(a) Explain the application of the historical cost principle in determining the acquisition cost of plant assets.

(b) List the numbers of the transactions, and opposite each indicate the account title to which each expenditure should be debited.

Determine property, plant, and equipment costs.

(LO 1), C

E9-2 Adama Company incurred the following costs.

1. Sales tax on factory machinery purchased $  5,000

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2. Painting of and lettering on truck immediately upon purchase 700 3. Installation and testing of factory machinery 2,000 4. Real estate broker's commission on land purchased 3,500 5. Insurance premium paid for �irst year's insurance on new truck 880 6. Cost of landscaping on property purchased 7,200 7. Cost of paving parking lot for new building constructed 17,900 8. Cost of clearing, draining, and �illing land 13,300 9. Architect's fees on self-constructed building 10,000

Instructions

Indicate to which account Adama would debit each of the costs.

Determine acquisition costs of land.

(LO 1), AP

E9-3 On March 1, 2017, Boyd Company acquired real estate, on which it planned to construct a small of�ice building, by paying $80,000 in cash. An old warehouse on the property was demolished at a cost of $8,200; the salvaged materials were sold for $1,700. Additional expenditures before construction began included $1,900 attorney's fee for work concerning the land purchase, $5,200 real estate broker's fee, $9,100 architect's fee, and $14,000 to put in driveways and a parking lot.

Instructions

(a) Determine the amount to be reported as the cost of the land.

(b) For each cost not used in part (a), indicate the account to be debited.

Understand depreciation concepts.

(LO 2), C

E9-4 Alysha Monet has prepared the following list of statements about depreciation.

1. Depreciation is a process of asset valuation, not cost allocation.

2. Depreciation provides for the proper matching of expenses with revenues.

3. The book value of a plant asset should approximate its fair value.

4. Depreciation applies to three classes of plant assets: land, buildings, and equipment.

5. Depreciation does not apply to a building because its usefulness and revenue-producing ability generally remain intact over time.

6. The revenue-producing ability of a depreciable asset will decline due to wear and tear and to obsolescence.

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7. Recognizing depreciation on an asset results in an accumulation of cash for replacement of the asset.

8. The balance in accumulated depreciation represents the total cost that has been charged to expense since placing the asset in service.

9. Depreciation expense and accumulated depreciation are reported on the income statement.

10. Three factors affect the computation of depreciation: cost, useful life, and salvage value.

Instructions

Identify each statement as true or false. If false, indicate how to correct the statement.

Determine straight-line depreciation for partial period.

(LO 2), AP

E9-5 Gotham Company purchased a new machine on October 1, 2017, at a cost of $90,000. The company estimated that the machine has a salvage value of $8,000. The machine is expected to be used for 70,000 working hours during its 8-year life.

Instructions

Compute the depreciation expense under the straight-line method for 2017 and 2018, assuming a December 31 year-end.

Compute revised annual depreciation.

(LO 2), AN

E9-6 Victor Mineli, the new controller of Santorini Company, has reviewed the expected useful lives and salvage values of selected depreciable assets at the beginning of 2017. Here are his �indings:

All assets are depreciated by the straight-line method. Santorini Company uses a calendar year in preparing annual �inancial statements. After discussion, management has agreed to accept Victor's proposed changes. (The “Proposed” useful life is total life, not remaining life.)

Instructions

(a) Compute the revised annual depreciation on each asset in 2017. (Show computations.)

(b) Prepare the entry (or entries) to record depreciation on the building in 2017.

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Journalize transactions related to disposals of plant assets.

(LO 3), AP

E9-7 Thieu Co. has delivery equipment that cost $50,000 and has been depreciated $24,000.

Instructions

Record entries for the disposal under the following assumptions.

(a) It was scrapped as having no value.

(b) It was sold for $37,000.

(c) It was sold for $20,000.

Record disposal of equipment.

(LO 3), AP

E9-8 Here are selected 2017 transactions of Akron Corporation.

Jan. 1 Retired a piece of machinery that was purchased on January 1, 2007. The machine cost $62,000 and had a useful life of 10 years with no salvage value.

June 30 Sold a computer that was purchased on January 1, 2015. The computer cost $36,000 and had a useful life of 3 years with no salvage value. The computer was sold for $5,000 cash.

Dec. 31 Sold a delivery truck for $9,000 cash. The truck cost $25,000 when it was purchased on January 1, 2014, and was depreciated based on a 5-year useful life with a $4,000 salvage value.

Instructions

Journalize all entries required on the above dates, including entries to update depreciation on assets disposed of, where applicable. Akron Corporation uses straight-line depreciation.

Record equipment transactions and determine missing amounts.

(LO 1, 2, 3), AN

E9-9 Shown below are the T-accounts relating to equipment that was purchased for cash by a company on the �irst day of the current year. The equipment was depreciated on a straight-line basis with an estimated useful life of 10 years and a salvage value of $100. Part of the equipment was sold on the last day of the current year for cash proceeds.

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Instructions

Prepare the journal entries to record the following and derive the missing amounts:

(a) Purchase of equipment on January 1. What was the cash paid?

(b) Depreciation recorded on December 31. What was the depreciation expense?

(c) Sale of part of the equipment on December 31. What was the gain on disposal?

Apply accounting concepts.

(LO 1, 2, 3,4), C

E9-10 The following situations are independent of one another.

1. An accounting student recently employed by a small company doesn't understand why the company is only depreciating its buildings and equipment, but not its land. The student prepared journal entries to depreciate all the company's property, plant, and equipment for the current year-end.

2. The same student also thinks the company's amortization policy on its intangible assets is wrong. The company is currently amortizing its patents but not its goodwill. As a result, the student added goodwill to her adjusting entry for amortization at the end of the current year. She told a fellow employee that she felt she had improved the consistency of the company's accounting policies by making these changes.

3. The same company has a building still in use that has a zero book value but a substantial fair value. The student felt that this practice didn't bene�it the company's users—especially the bank —and wrote the building up to its fair value. After all, she reasoned, you can write down assets if fair values are lower. Writing them up if fair value is higher is yet another example of the improved consistency that she has brought to the company's accounting practices.

Instructions

Explain whether or not the accounting treatment in each of the above situations is in accordance with generally accepted accounting principles. Explain what accounting principle or assumption, if any, has been violated and what the appropriate accounting treatment should be.

Prepare adjusting entries for amortization.

(LO 4), AN

E9-11 These are selected 2017 transactions for Wyle Corporation:

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Jan. 1 Purchased a copyright for $120,000. The copyright has a useful life of 6 years and a remaining legal life of 30 years.

Mar. 1 Purchased a patent with an estimated useful life of 4 years and a legal life of 20 years for $54,000.

Sept. 1 Purchased a small company and recorded goodwill of $150,000. Its useful life is inde�inite.

Instructions

Prepare all adjusting entries at December 31 to record amortization required by the events.

Prepare entries to set up appropriate accounts for different intangibles; calculate amortization.

(LO 4), AN

E9-12 On January 1, 2017, Haley Company had a balance of $360,000 of goodwill on its balance sheet that resulted from the purchase of a small business in a prior year. The goodwill had an inde�inite life. During 2017, the company had the following additional transactions.

Jan. 2 Purchased a patent (5-year life) $280,000. July 1 Acquired a 9-year franchise; expiration date July 1, 2026, $540,000. Sept. 1 Research and development costs $185,000.

Instructions

(a) Prepare the necessary entries to record the transactions related to intangibles. All costs incurred were for cash.

(b) Make the entries as of December 31, 2017, recording any necessary amortization.

(c) Indicate what the intangible asset account balances should be on December 31, 2017.

Discuss implications of amortization period.

(LO 4), C

E9-13 Alliance Atlantis Communications Inc. changed its accounting policy to amortize broadcast rights over the contracted exhibition period, which is based on the estimated useful life of the program. Previously, the company amortized broadcast rights over the lesser of 2 years or the contracted exhibition period.

Instructions

Write a short memo to your client explaining the implications this has for the analysis of Alliance Atlantis's results.

Answer questions on depreciation and intangibles.

(LO 2, 4), C

E9-14 The questions listed below are independent of one another.

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Instructions

Provide a brief answer to each question.

(a) Why should a company depreciate its buildings?

(b) How can a company have a building that has a zero reported book value but substantial fair value?

(c) What are some examples of intangibles that you might �ind on your college campus?

(d) Give some examples of company or product trademarks or trade names. Are trade names and trademarks reported on a company's balance sheet?

Calculate asset turnover and return on assets.

(LO 5), AP

E9-15 Suppose during 2017 that Federal Express reported the following information (in millions): net sales of $35,497 and net income of $98. Its balance sheet also showed total assets at the beginning of the year of $25,633 and total assets at the end of the year of $24,244.

Instructions

Calculate the (a) asset turnover and (b) return on assets.

Calculate and interpret ratios.

(LO 5), AP

E9-16 Lymen International is considering a signi�icant expansion to its product line. The sales force is excited about the opportunities that the new products will bring. The new products are a signi�icant step up in quality above the company's current offerings, but offer a complementary �it to its existing product line. Fred Riddick, senior production department manager, is very excited about the high-tech new equipment that will have to be acquired to produce the new products. Barbara Dyson, the company's CFO, has provided the following projections based on results with and without the new products.

Without New Products With New Products Sales revenue $10,000,000 $16,000,000 Net income   $500,000   $960,000 Average total assets  $5,000,000 $12,000,000

Instructions

(a) Compute the company's return on assets, pro�it margin, and asset turnover, both with and without the new product line.

(b) Discuss the implications that your �indings in part (a) have for the company's decision.

Calculate and interpret ratios.

(LO 5), AP

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E9-17 Linley Company reports the following information (in millions) during a recent year: net sales, $11,408.5; net earnings, $264.8; total assets, ending, $4,312.6; and total assets, beginning, $4,254.3.

Instructions

(a) Calculate the (1) return on assets, (2) asset turnover, and (3) pro�it margin.

(b) Prove mathematically how the pro�it margin and asset turnover work together to explain return on assets, by showing the appropriate calculation.

(c) Linley Company owns Northgate (grocery), Linley Theaters, Oz Drugstores, and Ransome (heavy equipment), and manages commercial real estate, among other activities. Does this diversity of activities affect your ability to interpret the ratios you calculated in (a)? Explain.

Determine net cash provided by operating activities.

(LO 5), AN

E9-18 Mendez Corporation reported net income of $58,000. Depreciation expense for the year was $132,000. The company calculates depreciation expense using the straight-line method, with a useful life of 10 years. Top management would like to switch to a 15-year useful life because depreciation expense would be reduced to $88,000. The CEO says, “Increasing the useful life would increase net income and net cash provided by operating activities.”

Instructions

Provide a comparative analysis showing net income and net cash provided by operating activities (ignoring other accrual adjustments) under the direct method using a 10-year and a 15-year useful life. (Ignore income taxes.) Evaluate the CEO's suggestion.

Compute depreciation under units-of-activity method.

(LO 6), AP

*E9-19 Whippet Bus Lines uses the units-of-activity method in depreciating its buses. One bus was purchased on January 1, 2017, at a cost of $100,000. Over its 4-year useful life, the bus is expected to be driven 160,000 miles. Salvage value is expected to be $8,000.

Instructions

(a) Compute the depreciation cost per unit.

(b) Prepare a depreciation schedule assuming actual mileage was: 2017, 40,000; 2018, 52,000; 2019, 41,000; and 2020, 27,000.

Compute declining-balance and units-of-activity depreciation.

(LO 6), AP

*E9-20 Basic information relating to a new machine purchased by Gotham Company is presented in E9-5.

Instructions

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Using the facts presented in E9-5, compute depreciation using the following methods in the year indicated.

(a) Declining-balance using double the straight-line rate for 2017 and 2018.

(b) Units-of-activity for 2017, assuming machine usage was 480 hours. (Round depreciation per unit to the nearest cent.)

EXERCISES: SET B AND CHALLENGE EXERCISES Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.

PROBLEMS: SET A Determine acquisition costs of land and building.

(LO 1), C

P9-1A Peete Company was organized on January 1. During the �irst year of operations, the following plant asset expenditures and receipts were recorded in random order.

Instructions

Analyze the transactions using the following table column headings. Enter the number of each transaction in the Item column, and enter the amounts in the appropriate columns. For amounts in the Other Accounts column, also indicate the account title.

Item Land Buildings Other Accounts

Land $302,170

Journalize equipment transactions related to purchase, sale, retirement, and depreciation.

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(LO 2, 3, 5), AP

P9-2A At December 31, 2017, Arnold Corporation reported the following plant assets.

During 2018, the following selected cash transactions occurred.

Apr. 1 Purchased land for $2,200,000. May 1 Sold equipment that cost $600,000 when purchased on January 1, 2011. The equipment was

sold for $170,000. June 1 Sold land for $1,600,000. The land cost $1,000,000. July 1 Purchased equipment for $1,100,000. Dec. 31 Retired equipment that cost $700,000 when purchased on December 31, 2008. No salvage value

was received.

Instructions

(a) Journalize the transactions. Arnold uses straight-line depreciation for buildings and equipment. The buildings are estimated to have a 40-year useful life and no salvage value; the equipment is estimated to have a 10-year useful life and no salvage value. Update depreciation on assets disposed of at the time of sale or retirement. (Hint: You may wish to set up T-accounts, post beginning balances, and then post 2018 transactions.)

(b) Record adjusting entries for depreciation for 2018.

(c) Prepare the plant assets section of Arnold's balance sheet at December 31, 2018.

(c) Tot. plant assets $50,037,500

Journalize entries for disposal of plant assets.

(LO 3), AP

P9-3A Pine Company had the following assets on January 1, 2017.

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During 2017, each of the assets was removed from service. The machinery was retired on January 1. The forklift was sold on June 30 for $12,000. The truck was discarded on December 31.

Instructions

Journalize all entries required on the above dates, including entries to update depreciation, where applicable, on disposed assets. The company uses straight-line depreciation. All depreciation was up to date as of December 31, 2016.

Loss on truck disposal $10,600

Record property, plant, and equipment transactions; prepare partial balance sheet.

(LO 1, 2, 3, 5), AP

P9-4A At January 1, 2017, Youngstown Company reported the following property, plant, and equipment accounts:

Accumulated depreciation—buildings $  62,200,000 Accumulated depreciation—equipment 54,000,000 Buildings 97,400,000 Equipment 150,000,000 Land 20,000,000

The company uses straight-line depreciation for buildings and equipment, its year-end is December 31, and it makes adjusting entries annually. The buildings are estimated to have a 40-year useful life and no salvage value; the equipment is estimated to have a 10-year useful life and no salvage value.

During 2017, the following selected transactions occurred:

Apr. 1 Purchased land for $4.4 million. Paid $1.1 million cash and issued a 3-year, 6% note payable for the balance. Interest on the note is payable annually each April 1.

May 1 Sold equipment for $300,000 cash. The equipment cost $2.8 million when originally purchased on January 1, 2009.

June 1 Sold land for $3.6 million. Received $900,000 cash and accepted a 3-year, 5% note for the balance. The land cost $1.4 million when purchased on June 1, 2011. Interest on the note is due annually each June 1.

July 1 Purchased equipment for $2.2 million cash. Dec. 31 Retired equipment that cost $1 million when purchased on December 31, 2007. No proceeds

were received.

Instructions

(a) Record the above transactions.

(b) Record any adjusting entries required at December 31.

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(c) Prepare the property, plant, and equipment section of the company's statement of �inancial position at December 31.

Total PP&E $138,575,000

Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section and note.

(LO 4, 5), AP

P9-5A The intangible assets section of Amato Corporation's balance sheet at December 31, 2017, is presented here.

Patents ($60,000 cost less $6,000 amortization) $54,000 Copyrights ($36,000 cost less $25,200 amortization) 10,800

Total $64,800

The patent was acquired in January 2017 and has a useful life of 10 years. The copyright was acquired in January 2011 and also has a useful life of 10 years. The following cash transactions may have affected intangible assets during 2018.

Jan. 2 Paid $46,800 legal costs to successfully defend the patent against infringement by another company.

Jan.– June

Developed a new product, incurring $230,000 in research and development costs. A patent was granted for the product on July 1, and its useful life is equal to its legal life. Legal and other costs for the patent were $20,000.

Sept. 1 Paid $40,000 to a quarterback to appear in commercials advertising the company's products. The commercials will air in September and October.

Oct. 1 Acquired a copyright for $200,000. The copyright has a useful life and legal life of 50 years.

Instructions

(a) Prepare journal entries to record the transactions.

(b) Prepare journal entries to record the 2018 amortization expense for intangible assets.

(c) Prepare the intangible assets section of the balance sheet at December 31, 2018.

(d) Prepare the note to the �inancial statements on Amato Corporation's intangible assets as of December 31, 2018.

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(c) Tot. intangibles $315,300

Prepare entries to correct errors in recording and amortizing intangible assets.

(LO 4), AP

P9-6A Due to rapid employee turnover in the accounting department, the following transactions involving intangible assets were improperly recorded by Inland Corporation.

1. Inland developed a new manufacturing process, incurring research and development costs of $160,000. The company also purchased a patent for $40,000. In early January, Inland capitalized $200,000 as the cost of the patents. Patent amortization expense of $10,000 was recorded based on a 20-year useful life.

2. On July 1, 2017, Inland purchased a small company and as a result recorded goodwill of $80,000. Inland recorded a half-year's amortization in 2017, based on a 20-year life ($2,000 amortization). The goodwill has an inde�inite life.

Instructions

Prepare all journal entries necessary to correct any errors made during 2017. Assume the books have not yet been closed for 2017.

Calculate and comment on return on assets, pro�it margin, and asset turnover.

(LO 5), AN

P9-7A Blythe Corporation and Jacke Corporation, two companies of roughly the same size, are both involved in the manufacture of shoe-tracing devices. Each company depreciates its plant assets using the straight-line approach. An investigation of their �inancial statements reveals the information shown below.

Blythe Corp. Jacke Corp. Net income $  240,000 $  300,000 Sales revenue 1,150,000 1,200,000 Total assets (average) 3,200,000 3,000,000 Plant assets (average) 2,400,000 1,800,000 Intangible assets (goodwill) 300,000 0

Instructions

(a) For each company, calculate these values:

1. Return on assets.

2. Pro�it margin.

3. Asset turnover.

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(b) Based on your calculations in part (a), comment on the relative effectiveness of the two companies in using their assets to generate sales. What factors complicate your ability to compare the two companies?

Compute depreciation under different methods.

(LO 2, 6), AP

*P9-8A In recent years, Jayme Company has purchased three machines. Because of frequent employee turnover in the accounting department, a different accountant was in charge of selecting the depreciation method for each machine, and various methods have been used. Information concerning the machines is summarized in the table below.

For the declining-balance method, Jayme Company uses the double-declining rate. For the units-of-activity method, total machine hours are expected to be 30,000. Actual hours of use in the �irst 3 years were: 2016, 800; 2017, 4,500; and 2018, 6,000.

Instructions

(a) Compute the amount of accumulated depreciation on each machine at December 31, 2018.

(b) If machine 2 was purchased on April 1 instead of July 1, what would be the depreciation expense for this machine in 2016? In 2017?

(c) Machine 2 $60,520

Compute depreciation under different methods.

(LO 2, 6), AP

*P9-9A Megan Corporation purchased machinery on January 1, 2017, at a cost of $250,000. The estimated useful life of the machinery is 4 years, with an estimated salvage value at the end of that period of $30,000. The company is considering different depreciation methods that could be used for �inancial reporting purposes.

Instructions

(a) Prepare separate depreciation schedules for the machinery using the straight-line method, and the declining-balance method using double the straight-line rate. (Round to the nearest dollar.)

(b) Which method would result in the higher reported 2017 income? In the highest total reported income over the 4-year period?

(c) Which method would result in the lower reported 2017 income? In the lowest total reported income over the 4-year period?

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(a) Double-declining-balance expense 2019 $31,250

PROBLEMS: SET B AND SET C Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEM Cookie Creations

(Note: This is a continuation of the Cookie Creations problem from Chapters 1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01#ch01) through 8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch08#ch08) .)

CC9 Part 1 Now that she is selling mixers and her customers can use credit cards to pay for them, Natalie is thinking of upgrading her website so that she can sell mixers online, to broaden her range of customers. She will need to know how to account for the costs of upgrading the site.

Part 2 Natalie is also thinking of buying a van that will be used only for business. Natalie is concerned about the impact of the van's cost on her income statement and balance sheet. She has come to you for advice on calculating the van's depreciation.

Go to the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , to see the completion of this problem.

COMPREHENSIVE ACCOUNTING CYCLE | REVIEW ACR9-1 Milo Corporation's unadjusted trial balance at December 1, 2017, is presented below.

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The following transactions occurred during December.

Dec. 2 Purchased equipment for $16,000, plus sales taxes of $800 (paid in cash). 2 Milo sold for $3,500 equipment which originally cost $5,000. Accumulated

depreciation on this equipment at January 1, 2017, was $1,800; 2017 depreciation prior to the sale of equipment was $825.

15 Milo sold for $5,000 on account inventory that cost $3,500. 23 Salaries and wages of $6,600 were paid.

Adjustment data:

1. Milo estimates that uncollectible accounts receivable at year-end are $4,000.

2. The note receivable is a 1-year, 8% note dated April 1, 2017. No interest has been recorded.

3. The balance in prepaid insurance represents payment of a $3,600, 6-month premium on September 1, 2017.

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4. The building is being depreciated using the straight-line method over 30 years. The salvage value is $30,000.

5. The equipment owned prior to this year is being depreciated using the straight-line method over 5 years. The salvage value is 10% of cost.

6. The equipment purchased on December 2, 2017, is being depreciated using the straight-line method over 5 years, with a salvage value of $1,800.

7. The patent was acquired on January 1, 2017, and has a useful life of 9 years from that date.

8. Unpaid salaries at December 31, 2017, total $2,200.

9. Both the short-term and long-term notes payable are dated January 1, 2017, and carry a 10% interest rate. All interest is payable in the next 12 months.

10. Income tax expense was $15,000. It was unpaid at December 31.

Instructions

(a) Prepare journal entries for the transactions listed above and adjusting entries.

(b) Prepare an adjusted trial balance at December 31, 2017.

(b) Totals $1,205,775

(c) Prepare a 2017 income statement and a 2017 retained earnings statement.

(c) Net income $50,775

(d) Prepare a December 31, 2017, balance sheet.

(d) Total assets $247,475

ACR9-2 Aberkonkie Corporation prepares quarterly �inancial statements. The post-closing trial balance at December 31, 2016, is presented below.

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During the �irst quarter of 2017, the following transaction occurred:

1. On February 1, Aberkonkie collected fees of $12,000 in advance. The company will perform $1,000 of services each month from February 1, 2017, to January 31, 2018.

2. On February 1, Aberkonkie purchased computer equipment for $9,000 plus sales taxes of $600. $3,000 cash was paid with the rest on account. Check #455 was used.

3. On March 1, Aberkonkie acquired a patent with a 10-year life for $9,600 cash. Check #456 was used.

4. On March 28, Aberkonkie recorded the quarter's sales in a single entry. During this period, Aberkonkie had total sales of $140,000 (not including the sales referred to in item 1 above). All of the sales were on account.

5. On March 29, Aberkonkie collected $133,000 from customers on account.

6. On March 29, Aberkonkie paid $16,370 on accounts payable. Check #457 was used.

7. On March 29, Aberkonkie paid other operating expenses of $97,525. Check #458 was used.

8. On March 31, Aberkonkie wrote off a receivable of $200 for a customer who declared bankruptcy.

9. On March 31, Aberkonkie sold for $1,620 equipment that originally cost $11,000. It had an estimated life of 5 years and salvage of $1,000. Accumulated depreciation as of December 31, 2016, was $8,000 using the straight line method. (Hint: Record depreciation on the equipment sold, then record the sale.)

Bank reconciliation data and adjustment data:

1. The company reconciles its bank statement every quarter. Information from the December 31, 2016, bank reconciliation is:

Deposit in transit: 12/30/2016 $5,000

Outstanding checks #440 3,444

#452 333

#453 865

#454 5,845

The bank statement received for the quarter ended March 31, 2017, is as follows:

Beginning balance per bank $   29,787 

Deposits: 1/2/2017, $5,000; 2/2/2017, $12,000; 3/30/2017, $133,000 150,000 

Checks: #452, $333; #453, $865; #457, $16,370; #458, $97,525 (115,093)

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Debit memo: Bank service charge (record as operating expense)     (100)

Ending bank balance $  64,594 

2. Record revenue earned from item 1 above.

3. $26,000 of accounts receivable at March 31, 2017, are not past due yet. The bad debt percentage for these is 4%. The balance of accounts receivable are past due. The bad debt percentage for these is 23.75%. Record bad debt expense. (Hint: You will need to compute the balance in accounts receivable before calculating this.)

4. Depreciation is recorded on the equipment still owned at March 31, 2017. The new equipment purchased in February is being depreciated on a straight-line basis over 5 years and salvage value was estimated at $1,200. The old equipment still owned is being depreciated over a 10-year life using straight-line with no salvage value.

5. Depreciation is recorded on the building on a straight-line basis based on a 30-year life and a salvage value of $10,000.

6. Amortization is recorded on the patent.

7. The income tax rate is 30%. This amount will be paid when the tax return is due in April. (Hint: Prepare the income statement up to income before taxes and multiply by 30% to compute the amount.)

Instructions

(a) Record journal entries for transactions 1–9.

(b) Enter the December 31, 2016, balances in ledger accounts using T-accounts.

(c) Post the journal entries to the ledger accounts for items 1–9.

(d) Prepare an unadjusted trial balance at March 31.

(d) Trial balance total $320,730

(e) Prepare a bank reconciliation in good form.

(d) Adjusted balance per bank $44,325

(f) Journalize and post entries related to bank reconciliation and all adjusting entries.

(d) Total assets $196,590

(g) Prepare an adjusted trial balance.

(h) Prepare an income statement and a retained earnings statement for the quarter ended March 31, 2017, and a classi�ied balance sheet at March 31, 2017.

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EXPAND YOUR | CRITICAL THINKING

FINANCIAL REPORTING PROBLEM: Apple Inc.

E CT9-1 The �inancial statements of Apple Inc. are presented in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) . Instructions for accessing and using the company's complete annual report, including the notes to the �inancial statements, are also provided in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) .

Instructions

Answer the following questions.

(a) What were the total cost and book value of property, plant, and equipment at September 27, 2014?

(a) Using the notes to the �inancial statements, what method or methods of depreciation are used by Apple for �inancial reporting purposes?

(a) What was the amount of depreciation and amortization expense for each of the 3 years 2012–2014? (Hint: Use the statement of cash �lows.)

(a) Using the statement of cash �lows, what are the amounts of property, plant, and equipment purchased in 2014 and 2013?

(a) Using the notes to the �inancial statements, explain how Apple accounted for its intangible assets in 2014.

COMPARATIVE ANALYSIS PROBLEM: Columbia Sportswear Company vs. VF Corporation

E CT9-2 The �inancial statements of Columbia Sportswear Company are presented in Appendix B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) . Financial statements of VF Corporation are presented in Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) . Instructions for accessing and using the companies' complete annual reports, including the notes to the �inancial statements, are also provided in Appendices B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) and C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) , respectively.

Instructions

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(a) Based on the information in these �inancial statements and the accompanying notes and schedules, compute the following values for each company in 2014.

1. Return on assets.

2. Pro�it margin (use “Total Revenue”).

3. Asset turnover.

(b) What conclusions concerning the management of plant assets can be drawn from these data?

COMPARATIVE ANALYSIS PROBLEM: Amazon.com, Inc. vs. Wal- Mart Stores, Inc.

E CT9-3 The �inancial statements of Amazon.com, Inc. are presented in Appendix D (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) . Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) . Instructions for accessing and using the companies' complete annual reports, including the notes to the �inancial statements, are also provided in Appendices D (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) and E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) , respectively.

Instructions

(a) Based on the information in these �inancial statements and the accompanying notes and schedules, compute the following values for each company for the most recent �iscal year.

1. Return on assets.

2. Pro�it margin (use “Total Revenue”).

3. Asset turnover.

(b) What conclusions concerning the management of plant assets can be drawn from these data?

INTERPRETING FINANCIAL STATEMENTS

E CT9-4 The March 29, 2012, edition of the Wall Street Journal Online contains an article by Miguel Bustillo entitled, “Best Buy Forced to Rethink Big Box.” The article explains how the 1,100 giant stores, which enabled Best Buy to obtain its

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position as the largest retailer of electronics, are now reducing the company's pro�itability and even threatening its survival. The problem is that many customers go to Best Buy stores to see items but then buy them for less from online retailers. As a result, Best Buy recently announced that it would close 50 stores and switch to smaller stores. However, some analysts think that these changes are not big enough.

Suppose the following data were extracted from the 2017 and 2012 annual reports of Best Buy. (All amounts are in millions.)

2017 2016 2012 2011 Total assets at year-end $17,849 $18,302 $11,864 $10,294 Net sales  50,272  30,848 Net income   1,277   1,140

Instructions

Using the data above, answer the following questions.

(a) How might the return on assets and asset turnover of Best Buy differ from an online retailer?

(b) Compute the pro�it margin, asset turnover, and return on assets for 2017 and 2012.

(c) Present the ratios calculated in part (b) in the equation format shown in Illustration 9-22 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo5#c09-�ig- 0022) (page 446).

(d) Discuss the implications of the ratios calculated in parts (b) and (c).

REAL-WORLD FOCUS

AN CT9-5 Purpose: Use an annual report to identify a company's plant assets and the depreciation method used.

Address: www.annualreports.com (http://www.annualreports.com)

Steps

1. Select a particular company.

2. Search by company name.

3. Follow instructions below.

Instructions

Answer the following questions.

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(a) What is the name of the company?

(b) What is the Internet address of the annual report?

(c) At �iscal year-end, what is the net amount of its plant assets?

(d) What is the accumulated depreciation?

(e) Which method of depreciation does the company use?

AN CT9-6 The November 16, 2011, edition of the Wall Street Journal Online contains an article by Maxwell Murphy entitled “The Big Number: 51.”

Instructions

Read the article and answer the following questions.

(a) What do the 51 companies referred to in the title have in common? What implications does this have regarding the fair value of a company's assets?

(b) What signi�icance does the common trait referred to in part (a) have for a company's goodwill?

(c) How does a company get to record goodwill on its books—that is, what must have occurred for goodwill to show up on a company's books?

(d) If these companies write down their goodwill, will this reduce their cash?

DECISION-MAKING ACROSS THE ORGANIZATION

E CT9-7 Brady Furniture Corp. is nationally recognized for making high-quality products. Management is concerned that it is not fully exploiting its brand power. Brady's production managers are also concerned because their plants are not operating at anywhere near full capacity. Management is currently considering a proposal to offer a new line of affordable furniture.

Those in favor of the proposal (including the vice president of production) believe that, by offering these new products, the company could attract a clientele that it is not currently servicing. Also, it could operate its plants at full capacity, thus taking better advantage of its assets.

The vice president of marketing, however, believes that the lower-priced (and lower- margin) product would have a negative impact on the sales of existing products. The vice president believes that $10,000,000 of the sales of the new product will be from customers that would have purchased the more expensive product but switched to the lower-margin product because it was available. (This is often referred to as cannibalization of existing sales.) Top management feels, however, that even with cannibalization, the company's sales will increase and the company will be better off.

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The following data are available.

Instructions

(a) Compute Brady's return on assets, pro�it margin, and asset turnover, both with and without the new product line.

(b) Discuss the implications that your �indings in part (a) have for Brady's decision.

(c) Are there any other options that Brady should consider? What impact would each of these have on the above ratios?

COMMUNICATION ACTIVITY

E CT9-8 The chapter presented some concerns regarding the current accounting standards for research and development expenditures.

Instructions

Assume that you are either (a) the president of a company that is very dependent on ongoing research and development, writing a memo to the FASB complaining about the current accounting standards regarding research and development, or (b) the FASB member defending the current standards regarding research and development. Your memo should address the following questions.

1. By requiring expensing of R&D, do you think companies will spend less on R&D? Why or why not? What are the possible implications for the competitiveness of U.S. companies?

2. If a company makes a commitment to spend money for R&D, it must believe it has future bene�its. Shouldn't these costs therefore be capitalized just like the purchase of any long-lived asset that you believe will have future bene�its?

ETHICS CASE

E CT9-9 Clean Aire Anti-Pollution Company is suffering declining sales of its principal product, nonbiodegradable plastic cartons. The president, Wade Truman, instructs his controller, Kate Rollins, to lengthen asset lives to reduce depreciation expense. A processing line of automated plastic extruding equipment, purchased for $3.5 million in January 2017, was originally estimated to have a useful life of 8 years and a salvage value of $400,000. Depreciation has been recorded for 2 years on that basis. Wade wants the estimated life changed to 12 years total and the straight-line method continued. Kate is hesitant to make the change, believing it is unethical to increase

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net income in this manner. Wade says, “Hey, the life is only an estimate, and I've heard that our competition uses a 12-year life on their production equipment.”

Instructions

(a) Who are the stakeholders in this situation?

(b) Is the proposed change in asset life unethical, or is it simply a good business practice by an astute president?

(c) What is the effect of Wade's proposed change on income before taxes in the year of change?

ALL ABOUT YOU

AN CT9-10 A company's tradename is a very important asset to the company, as it creates immediate product identi�ication. Companies invest substantial sums to ensure that their product is well-known to the consumer. Test your knowledge of who owns some famous brands and their impact on the �inancial statements.

Instructions

(a) Provide an answer to the four multiple-choice questions below.

1. Which company owns both Taco Bell and Pizza Hut? (a) McDonald's.

(b) CKE.

(c) Yum Brands.

(d) Wendy's.

2. Dairy Queen belongs to: (a) Breyer.

(b) Berkshire Hathaway.

(c) GE.

(d) The Coca-Cola Company.

3. Phillip Morris, the cigarette maker, is owned by: (a) Altria.

(b) GE.

(c) Boeing.

(d) ExxonMobil.

4. AOL, a major Internet provider, belongs to:

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(a) Microsoft.

(b) Cisco.

(c) NBC.

(d) Time Warner.

(b) How do you think the value of these brands is reported on the appropriate company's balance sheet?

FASB CODIFICATION ACTIVITY

AP CT9-11 If your school has a subscription to the FASB Codi�ication, go to http://aaahq.org/ascLogin.cfm (http://aaahq.org/ascLogin.cfm) to log in and prepare responses to the following.

(a) What does it mean to capitalize an item?

(b) What is the de�inition provided for an intangible asset?

(c) Your great-uncle, who is a CPA, is impressed that you are taking an accounting class. Based on his experience, he believes that depreciation is something that companies do based on past practice, not on the basis of authoritative guidance. Provide the authoritative literature to support the practice of �ixed-asset depreciation.

CONSIDERING PEOPLE, PLANET, AND PROFIT

E CT9-12 The March 6, 2012, edition of the Wall Street Journal Online contains an article by David Kesmodel entitled “Air War: ‘Winglet’ Versus ‘Sharklet’.” This article demonstrates how a company focused on green technology has also been pro�itable.

Instructions

Read the article and answer the following questions.

(a) Why did Airbus �ile a lawsuit against Aviation Partners?

(b) What are the percentage fuel savings provided by Aviation Partners' Winglets on Boeing jetliners? How much total jet fuel did Aviation Partners say that its Winglets have provided at the time the article was written?

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(c) Describe the history of the relationship between Aviation Partners and Airbus, and the development of the Airbus Sharklet.

(d) What would be the likely accounting implications if Aviation Partners were to lose the lawsuit?

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LEARNING OBJECTIVE 7

Compare the accounting for long-lived assets under GAAP and IFRS. 

IFRS follows most of the same principles as GAAP in the accounting for property, plant, and equipment. There are, however, some signi�icant differences in the implementation. IFRS allows the use of revaluation of property, plant, and equipment, and it also requires the use of component depreciation. In addition, there are some signi�icant differences in the accounting for both intangible assets and impairments.

KEY POINTS

The following are the key similarities and differences between GAAP and IFRS as related to the recording process for long-lived assets.

Similarities

The de�inition for plant assets for both IFRS and GAAP is essentially the same.

Both IFRS and GAAP follow the historical cost principle when accounting for property, plant, and equipment at date of acquisition. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use.

Under both IFRS and GAAP, interest costs incurred during construction are capitalized. Recently, IFRS converged to GAAP requirements in this area.

The accounting for subsequent expenditures (such as ordinary repairs and additions) is essentially the same under IFRS and GAAP.

IFRS also views depreciation as an allocation of cost over an asset's useful life. IFRS permits the same depreciation methods (e.g., straight-line, accelerated, and units-of-activity) as GAAP.

Under both GAAP and IFRS, changes in the depreciation method used and changes in useful life are handled in current and future periods. Prior periods are not affected. GAAP recently conformed to international standards in the accounting for changes in depreciation methods.

The accounting for plant asset disposals is essentially the same under IFRS and GAAP.

The de�inition of intangible assets is essentially the same under IFRS and GAAP.

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The accounting for exchanges of nonmonetary assets has recently converged between IFRS and GAAP. GAAP now requires that gains on exchanges of nonmonetary assets be recognized if the exchange has commercial substance. This is the same framework used in IFRS.

Differences

IFRS uses the term residual value rather than salvage value to refer to an owner's estimate of an asset's value at the end of its useful life for that owner.

IFRS allows companies to revalue plant assets to fair value at the reporting date. Companies that choose to use the revaluation framework must follow revaluation procedures. If revaluation is used, it must be applied to all assets in a class of assets. Assets that are experiencing rapid price changes must be revalued on an annual basis, otherwise less frequent revaluation is acceptable.

IFRS requires component depreciation. Component depreciation speci�ies that any signi�icant parts of a depreciable asset that have different estimated useful lives should be separately depreciated. Component depreciation is allowed under GAAP but is seldom used.

As in GAAP, under IFRS the costs associated with research and development are segregated into the two components. Costs in the research phase are always expensed under both IFRS and GAAP. Under IFRS, however, costs in the development phase are capitalized as Development Costs once technological feasibility is achieved.

IFRS permits revaluation of intangible assets (except for goodwill). GAAP prohibits revaluation of intangible assets.

LOOKING TO THE FUTURE

The IASB and FASB have identi�ied a project that would consider expanded recognition of internally generated intangible assets. IFRS permits more recognition of intangibles compared to GAAP.

IFRS Practice

IFRS SELF-TEST QUESTIONS

1. Which of the following statements is correct? (a) Both IFRS and GAAP permit revaluation of property, plant, and equipment and intangible

assets (except for goodwill).

(b) IFRS permits revaluation of property, plant, and equipment and intangible assets (except for goodwill).

(c) Both IFRS and GAAP permit revaluation of property, plant, and equipment but not intangible assets.

(d) GAAP permits revaluation of property, plant, and equipment but not intangible assets.

2. Research and development costs are: (a) expensed under GAAP.

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(b) expensed under IFRS.

(c) expensed under both GAAP and IFRS.

(d) None of the above.

IFRS EXERCISES

IFRS9-1 What is component depreciation, and when must it be used?

IFRS9-2 What is revaluation of plant assets? When should revaluation be applied?

IFRS9-3 Some product development expenditures are recorded as development expenses and others as development costs. Explain the difference between these accounts and how a company decides which classi�ication is appropriate.

INTERNATIONAL FINANCIAL STATEMENT ANALYSIS: Louis Vuitton

The �inancial statements of Louis Vuitton are presented in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) . Instructions for accessing and using the company's complete annual report, including the notes to its �inancial statements, are also provided in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) .

Instructions

Use the company's annual report to answer the following questions.

(a) According to the notes to the �inancial statements, what method or methods does the company use to depreciate “property, plant, and equipment?” What useful lives does it use to depreciate property, plant, and equipment?

(b) Using the notes to the �inancial statements, explain how the company accounted for its intangible assets with inde�inite lives.

(c) Using the notes to the �inancial statements, determine (1) the balance in Accumulated Amortization and Impairment for intangible assets (other than goodwill), and (2) the balance in Depreciation (and impairment) for property, plant, and equipment.

Answers to IFRS Self-Test Questions

1. b 2. a

1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo1#c09-note-0015a) More advanced courses discuss the accounting for exchanges, the third method of plant asset disposal.

2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch09lo3#c09-note-0016a) More advanced courses discuss the accounting for exchanges, the third method of plant asset disposal.