Ch.10 Orion

JT Engineering originally paid $10,000 for a machine and recorded depreciation at a rate of $1,000 per year for five years. They sold the machine in the middle of the sixth year for $6,000. What is JT's amount of loss or gain on the sale?

$1500 gain The book value at the time of sale was equal to the original cost - depreciation, or ($10,000 - [$5,000 + $500]) = $4,500. The machine sold for $6,000 while the book value was only $4,500, so the disposal resulted in a $1,500 gain ($6,000 - $4,500 = $1,500).

On January 1, 2009, McCarthy Converting purchased equipment for $608,000. At that time, the machine had an estimated 10-year useful life and $32,000 salvage value. McCarthy has recorded monthly straight-line depreciation on the equipment. McCarthy sold the equipment on December 31, 2017 for $112,000. How much gain should McCarthy recognize on the sale?

$22,400 Monthly depreciation on the machine is ([purchase price - salvage value]/useful life in months), or ([$608,000 - $32,000]/120) = $4,800. McCarthy has had the machine for 108 months, therefore it has recorded 108 * $4,800 = $518,400 in depreciation. This makes the book value $608,000 - $518,400 = $89,600. If McCarthy received $112,000 in the sale, we should subtract the book value from that amount to determine that McCarthy has a $22,400 gain ($112,000 - $89,600 = $22,400).

On January 1, 2017, Wells Tech signed a $950,000 two-year construction contract. Wells secured $950,000 financing at 7%. In 2017, Wells paid out $650,000; average accumulated expenditures was $375,000. Excess borrowed funds were invested, yielding $120,000 income. What should Wells report as capitalized interest at December 31, 2017?

$26,250 Capitalized interest is the lesser of avoidable or actual interest. To determine avoidable interest, accumulated expenditures are multiplied by the interest rate, or $375,000 * .07 = $26,250. To determine actual interest, amount borrowed is multiplied by the interest rate, or $950,000 * .07 = $66,500. Avoidable interest is the lower of the two amounts, so capitalized interest is $26,250.

Michael Company traded machinery with a book value of $760,000 and a fair value of $720,000. It received in exchange from Mayer Company a machine with a fair value of $800,000. Michael also paid cash of $80,000 in the exchange. Mayer's machine has a book value of $760,000. Assuming a lack of commercial substance, how much gain or loss should Michael recognize on the exchange?

$40,000 loss Because Michael traded equipment with a book value of $760,000 and a fair value of $720,000, it will recognize a loss of $40,000 ($720,000 - $760,000), regardless of whether there is commercial substance or not.

Ben's Delivery buys a van with a list price of $60,000. The dealer grants a 15% reduction in list price and an additional 2% cash discount on the net price if payment is made in 30 days. Sales taxes are $800 and Ben's paid an extra $600 to have a GPS device installed. What amount should Ben's record as the cost of the van?

$51,380 First, net price of the van must be determined ($60,000 - [0.15 * $60,000]) = $51,000. Then, the additional discount must be applied ($51,000 - [0.02 * $51,000]) = $49,980. Finally, taxes and cost of GPS must be added ($49,980 + $800 + $600 = $51,380).

Andrew Lighting purchases a factory and all of the equipment, computers, and vehicles within it. Andrew begins production of lamps at the factory using the equipment and delivers them to clients using the vehicles. However, the company sells the computers because it has no use for them. Which of the items included in Andrew's purchase is a fixed asset? 1. Equipment 2. Computers 3. Vehicles

1 & 3 only

On August 1, 2017, Liggett Enterprises purchased a new truck on a deferred payment basis. A $12,000 down payment was made and 4 monthly installments of $10,000 each are to be made starting September 1, 2017. The cash equivalent price of the truck was $48,000. Liggett incurred and paid delivery costs of $2,000. What is the amount to be capitalized as the cost of the truck?

Amount to be capitalized is equal to the cash purchase amount, which was the price + the delivery charge ($48,000 + $2,000 = $50,000).

Why does a gain or loss develop when plant assets are retired?

Assets must be depreciated; depreciation reflects asset cost allocation rather than value, and the gain or loss corrects net income over the life of the asset.

Which of the following best describes the GAAP-required approach to handling interest incurred in financing the construction of property, plant, and equipment?

Capitalize only the actual interest costs incurred during construction.

Charles is the CFO of a toy factory. The factory's management has decided to rearrange and reinstall all of the facility's manufacturing equipment in order to promote a faster, more efficient workflow. Charles knows the original cost for installing all of the facility's machinery as well as the total cost for the rearrangement and reinstallation. If Charles wants to handle the rearrangement and reinstallation cost as a replacement, which of the following statements is accurate?

Charles can handle the rearrangement and reinstallation cost as a replacement only if he is able to estimate the accumulated depreciation on the original installation costs to date. In order to handle the rearrangement and reinstallation cost as a replacement, Charles must know both the original installation cost and the accumulated depreciation to date. If he is unable to obtain this information, he must either capitalize the cost over future periods expected to benefit (if the cost is material in amount) or immediately expense the cost (if the cost is immaterial in amount).

JT Engineering paid $520,000 for land. It paid $65,000 to tear down a building on the site and made $15,400 in salvage. Titles fees and insurance cost JT $4,320. Architect's fees were $28,200. Construction liability insurance cost $1,600 and the contractor was paid $1,520,000. A $4,620 assessment made by the city for pavement. What is JT's cost of the building?

Cost of building includes materials, labor, and overhead costs incurred during construction and professional fees and building permits. So, JT's cost of building is $28,200 + $1,600 + $1,520,000 = $1,549,800.

JT Engineering paid $520,000 for land. It paid $65,000 to tear down a building on the site and made $15,400 in salvage. Title fees cost JT $4,320. Architect's fees were $28,200. Construction liability insurance cost $1,600 and the contractor was paid $1,520,000. A $4,620 assessment made by the city for pavement. What is JT's cost of land?

Cost of land includes purchase price, closing costs, costs incurred to prepare the land for its intended use, assumption of encumbrances, and land improvements with additional lives. It also includes special assessments. In addition, any salvage value for material removed from the property is credited to the cost of land. So, JT's cost of land is $520,000 + $65,000 - $15,400 + $4,320 +$4620 = $578,540.

Wells Corporation traded in a manual drill press for an automated drill press and gave $24,000 cash. The old press cost $279,000 and had a net book value of $213,000. It also had a fair value of $180,000. How should this transaction be journalized?

Dr. Equipment $204,000 Dr. Loss on disposal $33,000 Dr. accumulated depreciation $66,000 Cr. Equipment $279,000 Cr. cash $24,000 The exchange has commercial substance and represents a loss situation. In the debits column, equipment is the sum of the old machine's fair value and the cash paid ($180,000 + $24,000 = $204,000); loss on disposal is the difference of book value and fair value ($213,000 - $180,000 = $33,000); and depreciation is the difference of cost and book value ($279,000 - $213,000 = $66,000). In the credits column, equipment is the cost of the old press ($279,000) and cash is the amount paid on the new press ($24,000).

Violet Industries has a machine with a book value of $360,000 and a fair value of $600,000. It exchanges this machine for a machine from Maple Corporation with a fair value of $540,000 and cash of $60,000. Maple's machine has a book value of $570,000. Assuming a lack of commercial substance, how much gain should Violet recognize on the exchange?

Gain is found using the formula for gain recognition with some cash received: cash value is divided by the sum of cash and assets received multiplied by the total gain, or ($60,000 /[$60,000 + $540,000]) * $240,000 = $24,000

Glendale Industries has a 10-year-old milling machine that has fully depreciated. In spite of this depreciation, the machine is still functional and Glendale still uses it on a daily basis. How should Glendale report the milling machine in the balance sheet?

Glendale should report its historical cost less depreciation as the machine's value.

A firm recently replaced an existing piece of machinery with a newer model that produces 10% more product per hour. The firm has determined that the carrying amount of the old machine was $50. How should the firm handle the related accounting?

It should capitalize the cost of the new machine and remove the carrying amount of the old machine from the books.

Ahrens Enterprises recently purchased Brady Tech and the land on which it is located. Ahrens plans to demolish the building and build a new factory on the site. How should Ahrens treat the demolition costs?

It should capitalize the demolition as part of the cost of land.

JT Engineering designs and constructs a new widget-making machine for use in its factory. JT allocates overhead to the construction process, just as it does with normal production. Unfortunately, this causes the cost of the machine to exceed that of a similar machine available through an independent producer. How should JT record the excess overhead? Why?

JT should record it as a period loss to avoid capitalizing the asset at more than its probable fair value. If overhead allocated to a self-constructed asset results in recording construction costs in excess of the costs that an outside independent producer would charge for that asset, the company should record the excess overhead as a period loss rather than capitalize it. This avoids capitalizing the asset at more than its probable fair value.

What costs must be capitalized when assets are self-constructed under full costing approach?

Materials, labor, and overhead

John dies and leaves property to his sons Bob, Tom, Ron, and Joe. Bob farms the land he inherits. Tom builds a new factory for the company he owns on his land. Ron subdivides and develops his property. Joe's property abuts the store he owns, and he turns it into a parking lot. Which son should classify his land as inventory rather than as a fixed asset?

Ron

What amount is recorded for a nonmonetary asset acquired in exchange for another nonmonetary asset when the exchange has commercial substance?

The fair value of the asset given up, with a gain or loss recognized

Which of the following provides the justification for the capitalization of interest costs?

The historical cost principle

In accordance with the historical cost principle, how should overhead costs incurred for self-constructed assets be treated?

They should be allocated on a pro rata basis between the asset and normal operations

Which of the following situations would be considered a major repair? a) A firm replaces the motor in a large piece of manufacturing equipment. b) A firm cleans and repaints the outside of a large piece of manufacturing equipment. c) A firm replaces the on/off switch in a large piece of manufacturing equipment. d) A firm conducts its annual tune-up of a large piece of manufacturing equipment.

a) A firm replaces the motor in a large piece of manufacturing equipment.

When a plant asset is disposed of, a gain or loss may result. Under which of the following circumstances would the gain or loss be classified under Discontinued Operations, as an extraordinary item, on the income statement? a) If it resulted from an involuntary conversion and the conditions of the disposition are unusual and infrequent in nature in the sale of a component of a business. b) If it resulted from an abandonment of the asset. c) If it resulted from a sale prior to the completion of the estimated useful life of the asset. d) If it resulted from the sale of a fully depreciated asset.

a) If it resulted from an involuntary conversion and the conditions of the disposition are unusual and infrequent in nature in the sale of a component of a business.

Pablo is manager of a small manufacturing firm that has decided to replace its current heating system. Pablo knows the cost of purchasing and installing the new system, as well as the original cost and the current scrap value of the old system. If Pablo wants to capitalize the cost of the replacement using the substitution approach, which of the following statements is accurate? a) Pablo must determine accumulated depreciation on the old system before proceeding with the substitution approach. b) Pablo cannot use the substitution approach because the replacement does not extend the heating system's useful life. c) Pablo currently has all the information he needs to proceed with the substitution approach. d) Pablo is ready to proceed with the substitution approach, but only if he is confident that the old system has depreciated such that its carrying cost is almost zero.

a) Pablo must determine accumulated depreciation on the old system before proceeding with the substitution approach.

A firm recently had its manufacturing machinery rearranged and reinstalled to better facilitate future production. Because the cost of the rearrangement and reinstallation was material, and because the firm was able to estimate the original installation cost but not the accumulated depreciation to date, it should a) capitalize the new cost as an asset to be amortized over future periods expected to benefit. b) immediately expense the new cost. c) expense the new cost over future periods expected to benefit. d) handle the rearrangement and reinstallation cost as a replacement.

a) capitalize the new cost as an asset to be amortized over future periods expected to benefit.

If assets are purchased on long-term credit contracts, they should be accounted for using the a) present value of the consideration exchanged between the contracting parties at the date of the transaction. b) present value of the estimated valuation of the assets on the scheduled date of complete payment. c) net realizable value, less an allowance for any potential increase in interest rates prior to the date of final payment. d) present value of the consideration exchanged between the contracting parties or the future value of the asset when final payment is made, whichever is more readily determinable.

a) present value of the consideration exchanged between the contracting parties at the date of the transaction.

In which of the following circumstances would a parcel of land be least likely to experience depreciation? a) subdivision of a large tract of land by a developer who plans to build a housing addition b) failure by members of a waterfront community to install structures to prevent soil erosion c) natural disasters such as fires or droughts that damage or destroy the land or its natural resources d) land management decisions by a farmer that result in inadequate crop rotation and fertilization

a) subdivision of a large tract of land by a developer who plans to build a housing addition In general, land is only depreciated if a material decrease in value occurs. Such decreases are often the result of poor crop rotation, drought, erosion, or natural disasters. Subdividing land for resale as a housing addition is not typically an act that results in depreciation.

JT Engineering purchased a piece of property for construction of a new factory. There was an existing building on the property, which JT has demolished. How should JT record the cost of this demolition?

as a land cost

Branson Industries constructs its own widget-making machine. After construction is complete and costs and expenses have been allocated, Branson determines that the initial cost of the asset has been understated, which will result in inaccurate future allocations. Which of the following is a likely assumption based on this information? a) Branson assigned a portion of all overhead to the construction process. You got it correct : b) Branson assigned no fixed overhead to the cost of the constructed asset. c) Branson used the value an outside independent producer would have charged them to construct the asset. d) Branson assigned historical overhead to the construction process.

b) Branson assigned no fixed overhead to the cost of the constructed asset.

Which of the following is a reason why companies should not write up property, plant, and equipment to reflect fair value when it is above cost? a) At any time after the date of acquisition, historical cost is the best reflection of fair value. b) Gains and losses should not be anticipated but should be recognized when the asset is sold. c) Historical cost involves hypothetical transactions. d) Costs are not added to the asset after the date of acquisition.

b) Gains and losses should not be anticipated but should be recognized when the asset is sold.

A firm makes an improvement to a machine that increases the machine's fair value and boosts its production capacity by 30%. If this improvement does not extend the machine's useful life, then how should the firm treat the related cost? a) It should expense the cost. b) It should capitalize the cost in the machine account. c) It should allocate the cost between accumulated depreciation and the machine account. d) It should debit the cost to accumulated depreciation.

b) It should capitalize the cost in the machine account.

Which of the following is one of the major characteristics of property, plant, and equipment? a) The asset is acquired for resale. You got it correct : b) The asset is long-term in nature and usually depreciated. c) The asset can be used in operations for at least 5 years. d) The asset lacks physical substance.

b) The asset is long-term in nature and usually depreciated.

Since depreciation is an estimate of cost allocation and not a valuation process a) a sale prior to the end of the estimated useful life of the asset is considered an abandonment of the asset. b) any gain or loss recorded at disposal is a correction of net income. c) any gain or loss recorded at disposal is included in cost of goods sold for the period. d) a sale prior to the end of the estimated useful life of the asset is considered a discontinued operation.

b) any gain or loss recorded at disposal is a correction of net income.

An expenditure made in connection with a machine being used by an enterprise should not be capitalized a) if it merely extends the useful life but does not improve the quality of units produced. b) if it maintains the machine in normal operating condition. c) if it merely improves the quality of units produced but does not extend the useful life. d) if it increases the quantity of units produced by the machine.

b) if it maintains the machine in normal operating condition.

For self-constructed assets, why is it less problematic to allocate costs for materials and direct labor than to allocate costs for overhead?

because materials and direct labor used in construction can be easily traced using work and material orders, while overhead cannot

Which of the following describes one of the conditions that must be satisfied before interest capitalization on a qualifying asset can begin? a) Activities that are necessary to get the asset ready for its intended use are due to commence in the next fiscal period. b) The interest rate is equal to or greater than the company's cost of capital. c) Expenditures for the assets have been made. d) The company is using equity, rather than debt, financing.

c) Expenditures for the assets have been made.

Which of the following best describes the major argument for using a full-costing approach with constructed assets? a) Failure to allocate overhead costs overstates the initial cost of the asset and results in an inaccurate future allocation. b) Failure to allocate overhead costs understates income of the current period. c) Failure to allocate overhead costs understates the initial cost of the asset and results in an inaccurate future allocation. d) Failure to allocate overhead costs overstates current expenses.

c) Failure to allocate overhead costs understates the initial cost of the asset and results in an inaccurate future allocation.

In which of the following instances should the firm's expenditure be categorized as an addition? a) A firm opts to replace an existing piece of machinery with a new model that is 25% more efficient. b) A firm opts to replace an existing piece of machinery with a similar piece of machinery made by a different manufacturer. c) A firm opts to move a piece of machinery to a different part of the factory floor and reinstall it there. d) A firm opts to buy a new piece of machinery that will automate a process previously carried out by hand.

d) A firm opts to buy a new piece of machinery that will automate a process previously carried out by hand.

In which of the following circumstances should the cost involved be expensed rather than capitalized? a) An $800,000 addition that doubles production capabilities is built on to a factory. b) A factory's outdated tool grinding machine is replaced with a $40,000 new machine. c) A factory pays $8,500 to rearrange its machines and improve its workflow. d) A production machine on a factory floor breaks down and requires $12,600 in repairs.

d) A production machine on a factory floor breaks down and requires $12,600 in repairs.

RL enterprises designs and constructs a new gadget-making machine for use in its factory. The overhead for the construction project is recorded as a period loss rather than being capitalized for fear that doing so would cause the machine to be capitalized at more than its probable fair value. Based on this, which of the following assumptions can you make? a) The allocated overhead caused the cost of the machine to fall below the cost of similar machines available for purchase on the market. b) The allocated overhead caused the cost of the machine to exceed the amount budgeted for construction of the machine. c) The allocated overhead caused the cost of the machine to fall below the amount budgeted for construction of the machine. d) The allocated overhead caused the cost of the machine to exceed the cost of similar machines available for purchase on the market.

d) The allocated overhead caused the cost of the machine to exceed the cost of similar machines available for purchase on the market. If overhead allocated to a self-constructed asset results in recording construction costs in excess of the costs that an outside independent producer would charge for that asset, the company should record the excess overhead as a period loss rather than capitalize it. This avoids capitalizing the asset at more than its probable fair value.

A nonmonetary exchange of assets has commercial substance when

there is a difference in future cash flows.