DC ACCOUNTING CHAPTER 7

What is the service life of an asset? How do we determine service life under the straight-line and the activity-based depreciation methods?

Service life of an asset: How long the company expects to receive benefits from the asset BEFORE disposing of it. Basically its expected life. Straight line: Cost-Residual value / service life Activity based: Cost- residual value / estimate or expected miles(hours) The service life tells how long the company expects to obtain benefits from the asset before disposing of it. Under the straight-line method we determine service life in units of time. Under the activity-based method we determine service life in units of activity. For example, the estimated service life of a delivery truck might be either five years or 100,000 miles.

Contrast the effects of the straight-line, double declining-balance, and activity-based methods on annual depreciation expense.

Straight-line: How to maximize net income by minimizing depreciation expense in the first year of the asset's life? Long service life, high residual value, and straight-line depreciation. About 92% of companies use straight-line because it is the most easily understood Keeps the same amount (depreciation expense) being taken away per year Both straight line and double declining will result in the same total depreciation over the asset's service life Measures depreciation over time A company may use the straight-line method for an asset it uses consistently each accounting period, such as a building. Straight line creates an equal amount of depreciation each year. Double declining: Both straight line and double declining will result in the same total depreciation over the asset's service life Uses double the amount of percent to calculate straight line Double declining depreciation rate = 2 / estimated service life Measures depreciation over time Double-declining balance may be appropriate for an asset that generates a higher quality/amount of production in its earlier years than in its later years. Double declining creates more depreciation in earlier years and less depreciation in later years. Activity Based: Allocate (distribute) an asset's cost based on its use Activity based depreciation varies depending on the miles/hours/WHATEVER each year.

What is book value? How do we compute the gain or loss on the sale of long-term assets?

The book value of an asset is equal to the assets cost less accumulated depreciation. (Original cost - Accumulated Depreciation= Book value) Gain is found if book value is less than sale or trade after subtracting the liabilities out then it is a gain. Loss is found if book value is greater than sale or trade after subtracting the liabilities out.

Why don't we depreciate land? What are land improvements? Why do we record land and land improvements separately?

We do not depreciate land because land is assumed to have an unlimited useful life. Improvements to land such as paving, lighting, and landscaping that are subject to depreciation because they have a limited use of life.

Which of the following will maximize net income by minimizing depreciation expense in the first year of the asset's life? (LO7-4) a. Short service life, high residual value, and straight-line depreciation. b. Long service life, high residual value, and straight-line depreciation. c. Short service life, low residual value, and double-declining-balance depreciation. d. Long service life, high residual value, and double-declining-balance depreciation.

b

The return on assets is equal to the: (LO7-7) a. Profit margin plus asset turnover. b. Profit margin minus asset turnover. c. Profit margin times asset turnover. d. Profit margin divided by asset turnover.

c

Which of the following statements is true regarding the amortization of intangible assets? (LO7-5) a. Intangible assets with a limited useful life are not amortized. b. The service life of an intangible asset is always equal to its legal life. c. The expected residual value of most intangible assets is zero. d. In recording amortization, Accumulated Amortization is always credited.

c

Research and development costs generated internally: (LO7-2) a. Are recorded as research and development assets. b. Are capitalized and then amortized. c. Should be included in the cost of the patent they relate to. d. Should be expensed.

d

Sandwich Express incurred the following costs related to its purchase of a bread machine. (LO7-1) Cost of the equipment $20,000 Sales tax (8%) 1,600 Shipping 2,200 Installation 1,400 Total costs $25,200 At what amount should Sandwich Express record the bread machine? a.$20,000. b.$21,600. c.$23,800. d.$25,200.

d

The balance in the Accumulated Depreciation account represents: (LO7-4) a. The amount charged to expense in the current period. b. A contra expense account. c. A cash fund to be used to replace plant assets. d. The amount charged to depreciation expense since the acquisition of the plant asset.

d

Explain how the accounting treatment differs between purchased and internally developed intangible assets.

Purchased:: Record its original cost plus all other costs, such as legal fees, necessary to get the asset ready for use Developing/Creator: We expense the income statement most of the costs for internally developed intangible assets in the period we incur (becomes subject to) those costs

Explain how we initially record a long-term asset.

Record asset at its cost plus all expenditures (expenses) necessary to get the asset ready for use

WorldCom committed the largest fraud in U.S. history. What was the primary method WorldCom's management used to carry out the fraud?

Recorded things as long term asset that should have been current expenses. This is inaccurate to the net income since investors/creditors are thinking that the net income is higher than what it really is. Net income inflation (BAD)

What is residual value? How do we use residual value in calculating depreciation under the straight-line method?

Residual value- The amount a company expects to receive from selling the asset at the end of its service life We use residual value by subtracting that from the cost and dividing by the service life.

Which of the following expenditures should be recorded as an expense? (LO7-3) a. Repairs and maintenance that maintain current benefits. b. Adding a major new component to an existing asset. c. Replacing a major component of an existing asset. d. Successful legal defense of an intangible asset.

a

1.We normally record a long-term asset at the: (LO7-1) a.Cost of the asset only. b.Cost of the asset plus all costs necessary to get the asset ready for use. c.Appraised value. d.Cost of the asset, but subsequently adjust it up or down to appraised value

b

The book value of an asset is equal to the: (LO7-4) a. Replacement cost. b. Asset's cost less accumulated depreciation. c. Asset's fair value less its historical cost. d. Historical cost plus accumulated depreciation.

b

Equipment originally costing $95,000 has accumulated depreciation of $30,000. If it sells the equipment for $55,000, the company should record: (LO7-6) a. No gain or loss. b. A gain of $10,000. c. A loss of $10,000. d. A loss of $40,000

c