CHAPTER 11 INTERMEDIATE ACCOUNTING 105

Q 11.25: On December 31, 2017, Heart Industries had total assets of $8.4 million. If Heart's net sales for 2017 were $5.6 million and its asset turnover ratio was 0.7, then what were Heart's total assets as of January 1, 2017?

A firm's asset turnover ratio is equal to its net sales divided by its average total assets. Thus, we can divide the firm's net sales of $5.6 million by the asset turnover ratio of 0.7 to arrive at average total assets of $8 million. Because a firm's average total assets is equal to the sum of its assets on the first and last day of the year divided by two, we can multiply $8 million by two and then subtract $8.4 million to arrive at total assets of $7.6 million as of January 1.

Q 11.26: For the fiscal year that just ended, Oliver Industries had a 15% ROA, net income of $2.1 million, and an asset turnover ratio of 0.4. Given these values, what were the firm's net sales?

A firm's return on assets (ROA) is equal to its net income divided by its average total assets. Thus, we know that the firm's average total assets must be $2,100,000/15% = $14 million. We can then multiply this amount times the firm's asset turnover ratio to arrive at net sales of $5.6 million. 15%=Y*0.4 SO Y=15%/0.4 =0.375 2.1/0.375=5.6

Q 11.30: Last year, Pinnacle Industries had an asset turnover ratio of 0.38. This means that for every dollar Pinnacle had invested in assets, it generated $0.38 of

SALES PG575

Q 11.31: Over the past year, a firm's net income has decreased while its average total assets have remained constant. This means that the firm's

return on assets has decreased. PG575

Q 11.22: A firm's asset turnover ratio reveals how many dollars of

sales were produced by each dollar invested in assets. PG575

Q 11.16: A firm has several costs related to the development of natural resources. Of these costs, all of the following should be considered a part of depletion cost except

tangible equipment costs associated with machinery used to extract the natural resource. PG569

Q 11.1: In the field of accounting, the term "depreciation" refers to

the process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset. PG554

Q 11.17: Daylight Corporation recently bought a tract of land that contains large amounts of an extractable natural resource. Per its purchase contract, Daylight must restore the land to a condition suitable for recreational use once it is done extracting the resource. Daylight estimates that the land contains 4 million tons of recoverable reserves. It also estimates that, after restoration, the land will have a value of $700,000. Other cost information is as follows: Land $6,800,000 Restoration $1,100,000 Geological surveys $1,000,000 Daylight maintains no inventory of extracted material. Given this information, the firm should charge _______ to depletion expense per ton of material extracted.

ADD 6800000+1100000+1000000=8900000 SUBTRACT 700000=8200000 DIVIDE BY 4000000 = 2.05

Q 11.7: Alpha Corporation and Beta Corporation have just purchased identical pieces of equipment. Each firm estimates that the equipment will have a 5-year service life and no salvage value. Alpha depreciates all of its assets using the straight-line method, whereas Beta depreciates its assets using the sum-of-the-years'-digits method; otherwise, the two firms are identical in every way. Given this information, which of the following statements is accurate?

Alpha's net income will be lower that Beta's during the fourth year of the equipment's service life. PG558

Q 11.2: In what way does an asset's service life differ from its physical life?

An asset's service life is the time an asset will be used by a company, while its physical life is how long the asset will last. PG555

Q 11.23: If a company's asset turnover remained constant but its ROA decreased, then the firm's profit margin on sales must have

DECREASED PG576

Q 11.8: Huckle Corporation owns just one piece of manufacturing machinery. Each year, the firm sets aside an amount of cash equal to the depreciation expense on that machine. When the machine is completely depreciated, Huckle plans to use the money in the cash fund to buy a new machine. What must happen in order for Huckle to carry out this plan?

Equipment prices must remain reasonably constant during the life of Huckle's current machine. PG563

Q 11.19: In January 2017, Expo Mining Company paid $4,400,000 to buy a new mine. Expo estimates it will be able to remove 4,000,000 tons of ore from the mine. It also estimates that the property will be worth $300,000 after the ore has been extracted. Expo incurred a total of $900,000 in development costs when preparing the mine for production. In the mine's first year of operation (2017), Expo removed 500,000 tons of ore and was able to sell 475,000 tons. Given this information, Expo should record total 2017 depletion cost of

Expo's total cost for opening the mine was $4,400,000 + $900,000 = $5,300,000. Subtracting the $300,000 salvage value and dividing the result by 4,000,000 tons gives a depletion cost of $1.25 per ton. Because Expo removed 500,000 tons of ore, its total depletion cost is $1.25 x 500,000 = $625,000.

Q 11.24: When preparing its financial statements, a firm should include which of the following disclosures? I. The firm's depreciation expense for the period. II. The firm's accumulated depreciation. III. Balances of major classes of depreciable assets. IV. Details demonstrating how depreciation was calculated.

I, II and III.

Q 11.20: Erickson Industries is preparing its yearly financial statements. When preparing these statements, Erickson needs to include: I. The firm's depreciation expense for the period. II. Details demonstrating how the firm's depreciation amounts were calculated. III. Balances of the firm's major classes of depreciable assets, grouped by nature and function. IV. The firm's accumulated depreciation, either by major classes of depreciable assets or in total.

I, III, and IV.

Q 11.27: If a firm's sales increased but its asset turnover ratio remained constant, then the firm's average total assets must have

INCREASED P575

Q 11.13: How should a firm record an impairment in the value of property, plant, or equipment?

It should record both a loss and a reduction in the asset's book value. PG567-568

Q 11.14: On January 1, 2007, Menzel Industries purchased a machine for $120,000. At that time, Menzel estimated that the machine had a 20-year useful life and a $12,000 salvage value. On July 1, 2017, Menzel reviewed the machine's potential, determining that its undiscounted future net cash flows totaled $60,000 and its discounted future net cash flows totaled $45,000. Menzel has no plans to dispose of the machine, in part because no active market exists for it. Assuming that Menzel uses straight-line depreciation, Menzel should record an impairment loss of $_______ related to the machine on July 1, 2017.

Menzel paid $120,000 for the machine and estimated a useful life of 20 x 12 = 240 months and a salvage value of $12,000. Thus, each month, the firm recorded ($120,000 - $12,000)/240 = $450 in depreciation. Menzel bought the machine on January 1, 2007, and reviewed its potential on July 1, 2017, which means it owned the machine for all of 2007-2016 and 6 months in 2017, or a total of (10 x 12) + 6 = 126 months. Over this span, it recorded 126 x $450 = $56,700 in depreciation expense, which means the machine had a carrying amount of $120,000 - $56,700 = $63,300. Because this amount is greater than the estimated undiscounted future net cash flows of $60,000, an impairment has occurred. The amount of the impairment is equal to the difference between the machine's carrying amount and the present value of its expected future net cash flows, or $63,300 - $45,000 = $18,300.

Q 11.10: In 2007, Norbert Incorporated bought a new tooling machine for $45,000. Norbert estimated that the machine had a useful life of 15 years with no salvage value, and it decided to depreciate the machine using the straight-line method. In January 2017, after the machine had been in use for 10 years, Norbert paid $12,000 to completely overhaul the machine. It did so with the expectation that the overhaul would extend the machine's useful life by an additional 5 years. Given this information, Norbert should record a 2017 depreciation expense of _______ for the machine.

Norbert originally bought the machine for $45,000 and planned on depreciating that entire amount over 15 years using the straight-line method. Thus, each year the firm recorded $45,000/15 = $3,000 depreciation on the machine. So, after 10 years of use, the total depreciation expense would be 10 x $3,000 = $30,000, meaning the book value of the machine would be $45,000 - $30,000 = $15,000. To this, Norbert would add the $12,000 cost of the overhaul, bringing the total book value to $27,000. Because the overhaul extends the machine's useful life by 5 years, the remaining life of the machine is now (15 - 10) + 5 = 10 years. Thus, the total depreciation expense for each of those 10 remaining years, including 2017, is $27,000/10 = $2,700.

Q 11.3: Which of the following is an economic factor related to an asset's service life?

Obsolescence PG555

Q 11.5: You are comparing two graphs, each of which plots depreciation expense on its vertical axis (y-axis) and time on its horizontal axis (x-axis). Graph A shows an asset that is depreciated using the declining-balance method, while Graph B shows an asset that is depreciated using straight-line method. Assuming both graphs depict linear relationships, which of the following would you expect to observe?

On Graph A, the line plotting depreciation expense will slope down to the right, while on Graph B, the line will be perfectly horizontal. PG558-559

Q 11.18: On May 1, 2008, Thayer Corporation bought a new machine for $39,000. At that time, the company estimated that the machine had a 10-year useful life and an estimated salvage value of $3,000. Thayer later sold the machine on March 1, 2017, for $1,800. If Thayer recorded monthly depreciation on the machine using the straight-line method, it should recognize a loss of ______ on the sale.

Thayer paid $39,000 for the machine and estimated a useful life of 10 x 12 = 120 months and a salvage value of $3,000. Thus, each month, the firm recorded ($39,000 - $3,000)/120 = $300 in depreciation. Thayer bought the machine on May 1, 2008, and sold it on March 1, 2017, which means it owned the machine for 8 months in 2008, 2 months in 2017, and all of 2009-2016, or a total of 8 + (8 x 12) + 2 = 106 months. Over this span, it recorded 106 x $300 = $31,800 in depreciation expense, which meant the machine had a book value of $39,000 - $31,800 = $7,200. Since Thayer sold the machine for only $1,800, it should recognize a loss of $7,200 - $1,800 = $5,400 on the sale.

Q 11.12: Baker Industries originally estimated the useful life of one of its buildings to be 50 years. Now, after the building has been depreciated for 30 years, Baker has revised its remaining life to just 10 years. How should Baker's accountant respond to this revision?

The accountant should depreciate the building's remaining book value over 10 years. PG564

Q 11.15: On December 31, 2016, Albert Corporation owned a piece of equipment with a carrying amount of $400,000, which the firm wrote down to its $350,000 fair value. As of December 31, 2017, Albert determined the equipment's fair value had risen to $420,000. Albert has no plans to dispose of the equipment. Given this information, which of the following statements is accurate?

The carrying amount of the equipment should decrease by the depreciation expense taken in 2017. PG567

Q 11.11: Every year, Hercules Inc. has invested an increasing amount in manufacturing equipment. Given that there are a large number of relatively inexpensive machines and all the machines have relatively similar useful lives, Hercules has depreciated the machinery as a group at a uniform rate using the straight-line method. Over time, the ratio of the group's total accumulated depreciation to the total cost of the machinery has increased steadily. Currently, the ratio stands at 0.75 to 1. What is the most likely reason for this increasing ratio?

The estimated average useful life of Hercules' machinery is less than its actual average useful life. PG560

Q 11.21: If you know only a firm's asset turnover and return on assets, you be able to calculate its profit margin on sales

WILL PG576

Q 11.9: Which of the following statements accurately describes composite or group depreciation?

With composite or group depreciation, a straight-line rate is computed by dividing the total of the annual depreciation expense for all assets in the group by the total cost of the assets. PG560

Q 11.4: When using the activity method, depreciation is treated as

a function of productivity but not the passage of time. PG557

Q 11.32: When preparing disclosures for its balance sheet, a firm should be sure to include

a general description of the depreciation methods applicable to major classes of depreciable assets.

Q 11.29: If a firm's net sales increase but its average total assets remain constant, then the firm's

asset turnover will increase. PG575

Q 11.6: If you do not consider salvage value when computing depreciation expense to be taken on an asset, you must be using the

declining-balance method of depreciation. PG559

Q 11.28: Shawn knows his company's profit margin on sales and its net sales amount. Given these values, Shawn can determine the company's ________ its net sales by its profit margin on sales.

net income by multiplying PG576