Chapter 11
(L.O. 6) Which of the following is not one of the differences between the computation of depreciation under GAAP and the computation under the Modified Accelerated Cost Recovery System (MACRS)? A. The recording of depreciation expense is taken directly to retained earnings under the MACRS method. B. A mandated tax life is used which is generally shorter than the economic life of the asset. C. Cost recovery is on an accelerated basis under the MACRS. D. An assigned salvage value of zero is used under the MACRS.
(A) Depreciation is still an expense which is shown as a reduction in net income under the MACRS. The data in alternatives B, C, and D represent the basic differences in the depreciation computation under MACRS.
(L.O. 3) On December 31, 2019, Aquinas Company had equipment that had a carrying amount of $300,000 which the company wrote down to its $250,000 fair value. At the end of 2020 it was determined that the fair value of the equipment had risen to $320,000. At December 31, 2020, assuming Aquinas does not intend to dispose of the equipment, how should Aquinas record the change in fair value of the equipment? A. The carrying amount of the equipment should not change except for the depreciation taken in 2020. B. The equipment should reflect the new cost basis of $300,000. C. The equipment should reflect the new cost basis of $320,000. D. The equipment should reflect the new cost basis of $270,000.
(A) Once an impairment loss is recorded, the reduced carrying amount of an asset held for use becomes its new cost basis. As a result, the new cost basis is not changed except for depreciation in future periods or for additional impairments
(L.O. 1) The major difference between the service life of an asset and its physical life is that: A. service life refers to the time an asset will be used by a company and physical life refers to how long the asset will last. B. physical life is the life of an asset without consideration of salvage value and service life requires the use of salvage value. C. physical life is always longer than service life. D. service life refers to the length of time an asset is of use to its original owner, while physical life refers to how long the asset will be used by all owners.
(A) Service life is the period of time an asset will provide productive service to a company. Physical life indicates how long an asset may be physically capable of producing a product or being used. The major difference is that an asset with physical life may not be economical to use and, as such, would not be of service to an entity. Salvage value is not a relevant issue in this distinction. Also, while physical life may be longer than service life, it is not necessarily always longer. The distinction of original owner vs. future owners is not a major element of the difference.
L.O. 1) The economic factors related to an asset's service life include: A. obsolescence. B. wear and tear. C. decay. D. unexpected casualties.
(A) The economic factors related to an asset's service life include: inadequacy, supersession, and obsolescence. The items listed in alternatives (B), (C), and (D) refer to the physical factors related to an asset's physical life.
(L.O. 2) The Archer Company purchased a tooling machine in 2010 for $30,000. The machine was being depreciated on the straight-line method over an estimated useful life of 20 years, with no salvage value. At the beginning of 2020, when the machine had been in use for 10 years, the company paid $5,000 to overhaul the machine. As a result of this improvement, the company estimated that the useful life of the machine would be extended an additional 5 years. What should be the depreciation expense recorded for this machine in 2020? A. $1,000. B. $1,333. C. $1,500. D. $1,833.
(B) Asset cost ...................................................................... $30,000 Depreciation at 1/1/20.................................................... 15,000 Book value ..................................................................... 15,000 Overhaul addition........................................................... 5,000 Depreciable base........................................................... $20,000 Remaining useful life 10 + 5 = 15 Depreciation in 2020: $20,000 ÷ 15 = $1,333
(L.O. 3) An impairment in the value of property, plant, and equipment is recorded by recognizing a: Loss Reduction in Asset Book Value A. Yes No B. Yes Yes C. No Yes D. No No
(B) A permanent impairment in the value of property, plant, and equipment is recorded by recognizing a loss and reducing the book value of the asset through a credit to accumulated depreciation. If the asset is to continue in use, estimates of the remaining useful life and the salvage value may be revised as well
(L.O. 1) When depreciation is computed for partial periods under a decreasing charge depreciation method, it is necessary to: A. charge a full year's depreciation to the year of acquisition. B. determine depreciation expense for the full year and then prorate the expense between the two periods involved. C. use the straight-line method for the year in which the asset is sold or otherwise disposed of. D. use a salvage value equal to the first year's partial depreciation charge.
(B) Under decreasing charge depreciation methods, depreciation expense is computed for each complete year of an asset's life. If the asset being depreciated under the decreasing charge method is purchased during a year, the depreciation for the entire year is computed and then a portion is allocated to depreciation expense based on the percentage of the year that the asset was used.
(L.O. 1) Which of the following statements is the assumption on which straight-line depreciation is based? A. The operating efficiency of the asset decreases in later years. B. Service value declines as a function of time rather than use. C. Service value declines as a function of obsolescence rather than time. D. Physical wear and tear are more important than economic obsolescence.
(B) When the service value of an asset declines as a function of time rather than use, it is rational to allocate the asset's cost using the straight-line method. Answer (A) is incorrect because an accelerated-depreciation method gives a better allocation of an asset's cost when the operating efficiency of the asset decreases in later years. Answer (D) is incorrect because an activity depreciation method gives a better allocation of an asset's cost when physical wear and tear are more important than economic obsolescence. Answer (C) is incorrect because, although straight-line depreciation is commonly used in practice to depreciate assets when their service value declines as a function of obsolescence rather than time, this is done as a practical expedient. This practice does not provide the assumption on which straightline depreciation is based.
(L.O. 2) The estimated life of a building that has been depreciated for 30 of its originally estimated life of 50 years has been revised to a remaining life of 10 years. On the basis of this information the accountant should: A. continue to depreciate the building over the original 50-year life. B. depreciate the remaining book value over the remaining life of the asset. C. adjust accumulated depreciation to its appropriate balance, through net income, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years. D. adjust accumulated depreciation to its appropriate balance, through retained earnings, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years
(B) Whenever the estimated useful life of an asset is changed, the undepreciated book value of the asset should be depreciated over the new estimated useful life. This change is merely a change in an estimate and does not require any special accounting treatment
(L.O. 3) Thucydides Company purchased a new machine on May 1, 2010, for $25,000. At the time of acquisition, the machine was estimated to have a useful life of 10 years and an estimated salvage value of $1,000. The company has recorded monthly depreciation using the straight-line method. On March 1, 2019, the machine was sold for $800. What should be the loss recognized from the sale of the machine? A. $ 0. B. $2,000. C. $3,000. D. $3,400.
(C) Asset cost .......................................................................... $25,000 Depreciation 5/1/10 to 3/1/19 ($200/mo.)........................... 21,200 Book value at 3/1/19 .......................................................... $ 3,800 Sales price ......................................................................... 800 Loss on sale....................................................................... $ 3,000
(L.O. 2) Composite or group depreciation is a depreciation system whereby: A. the years of useful life of the various assets in the group are added together and the total divided by the number of items. B. the cost of individual units within an asset group is charged to expense in the year a unit is retired from service. C. 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. D. the original cost of all items in a given group or class of assets is retained in the asset account and the cost of replacements is charged to expense when they are acquired.
(C) Composite or group depreciation is defined as a system whereby 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.
(L.O. 1) The activity method of depreciation (often called the variable charge approach) assumes that depreciation is a function of: Productivity___ Passage of Time A. Yes Yes B. No No C. Yes No D. No Yes
(C) The activity method assumes that depreciation is a function of productivity rather than the passage of time. The life of the asset is considered in terms of either the output it provides (units of production) or an input measure such as number of hours it works.
(L.O. 1) Which of the following depreciation methods does not consider salvage value in computing the total depreciation to be taken? A. Straight-line. B. Sum-of-years'-digits. C. Declining-balance. D. Activity or production.
(C) The declining-balance method does not deduct salvage value in the computation of total deprecation to be taken. The declining-balance rate is multiplied by the book value (cost less accumulated depreciation) at the beginning of each period. By applying the declining-balance rate to the book value each year, a decreasing charge is recorded each year. Depreciation on the asset continues until the asset's book value is equal to its salvage value.
(L.O. 1) Each year Abner Corporation sets aside an amount of cash equal to depreciation expense on its only machine. When the asset is completely depreciated, the cash fund will allow the corporation to buy a new machine if: A. prices rise throughout the life of the property. B. an accelerated depreciation method was used. C. prices remain reasonably constant during the life of the property. D. the straight-line depreciation method is used.
(C) Total depreciation on any asset is limited to the cost of that asset. If an amount of money equal to depreciation expense is set aside, the total accumulation will allow for the purchase of a new machine only if prices remain reasonably constant or decrease. The depreciation method employed has no impact on the total amount of depreciation.
(L.O. 2) Each year a company has been investing an increasing amount in machinery. Because there are a large number of small items with relatively similar useful lives, the company has been applying straight-line depreciation method at a uniform rate to the machinery as a group. The ratio of this group's total accumulated depreciation to the total cost of the machinery has been steadily increasing and now stands at .75 to 1. The most likely explanation of this increasing ratio is that: A. the estimated average useful life of the machinery is greater than the actual average useful life. B. the estimated average useful life of the machinery is equal to the actual average useful life. C. the estimated average useful life of the machinery is less than the actual average useful life. D. the company has been retiring fully depreciated machinery that should have remained in service.
(C) With a uniform rate of depreciation being charged, a steadily increasing ratio of total accumulated depreciation to total cost would indicate that the estimated average useful life of the machinery is less than the actual average useful life. If the estimated average useful life of the machinery was equal to the actual average useful life, the ratio would remain constant.
(L.O. 4) The Xenophon Company acquired a tract of land containing an extractable natural resource. Xenophon Company is required by its purchase contract to restore the land to a condition suitable for recreational use after it extracts the natural resource. Geological surveys estimate that recoverable reserves will be 3 million tons and that the land will have a value of $600,000 after restoration. Relevant cost information follows: Land .................................................... $6,000,000 Restoration.......................................... 900,000 Geological surveys.............................. 300,000 If Xenophon Company maintains no inventories of extracted material, what should be the charge to depletion expense per ton of material extracted? A. $1.80. B. $1.90. C. $2.00. D. $2.20.
(D) Land cost ....................................................................... $6,000,000 Restoration..................................................................... 900,000 Geological surveys......................................................... 300,000 Total cost ....................................................................... $7,200,000 Land residual value........................................................ 600,000 Depletion base ............................................................... $6,600,000 Depletion expense per ton $6,600,000 ÷ 3,000,000 = $2.20.
. (L.O. 2) Plato Corporation purchased a machine with a cost of $165,000 and a salvage value of $9,000 on April 1, 2019. The machine will be depreciated over a 12 year useful life using the sum-of-years'-digits method. The amount of depreciation Plato Corporation would record for the year ended 12/31/20 would be: A. $22,000. B. $24,000. C. $16,500. D. $22,500.
(D) SYD Denominator = [12 × (12 + 1)] /2 = 78 Depreciable Base: $165,000 − $9,000 = $156,000 1st Full Year Depreciation: 12/78 × $156,000 = $24,000 2nd Full Year Depreciation: 11/78 × $156,000 = $22,000 2019 Depreciation (April 1 to December 31): $24,000 × 9/12 = $18,000 2020 Depreciation (January 1 to December 31): $24,000 − $18,000 = $ 6,000 $22,000 × 9/12 = 16,500 2020 Depreciation $22,500
(L.O. 1) Which of the following is a realistic assumption of the straight-line method of depreciation? A. The asset's economic usefulness is the same each year. B. The repair and maintenance expense is essentially the same each period. C. The rate of return analysis is enhanced using the straight-line method. D. Depreciation is a function of time rather than a function of usage.
(D) Alternatives A, B, and C reflect problems with use of the straight-line method of depreciation. An asset's economic usefulness is rarely the same each year, and with most assets, repair and maintenance costs increase as the asset gets older. Also, rate of return analysis is distorted under the straight-line method as well as other methods. The one true statement concerns the fact that the straight-line method is a function of time rather than a function of usage.
(L.O. 1) SL and YD Companies purchase identical equipment having an estimated service life of 5 years, with no salvage value. SL Company uses the straight-line depreciation method; YD Company uses the sum-of-the-years' digits method. Assuming that the companies are identical in all other respects: A. if both companies keep the asset for 5 years, YD Company's 5-year total for depreciation expense will be greater than SL Company's 5-year total. B. if the asset is sold after 3 years, SL Company is more likely to report a gain on the transaction than YD Company. C. SL Company's depreciation expense will be higher during the 1st year than YD's. D. SL Company's net income will be lower during the 4th year than YD Company's.
(D) If both companies are identical in all respects other than depreciation, then the company using the straight-line depreciation method (SL) will have a higher depreciation expense in the 4th year of the asset's life than the company using the sum-of-the-year's-digits method (YD). Thus, SL company's net income will be lower during the 4th year.
(L.O. 3) Maimonides Inc. bought a machine on January 1, 2010 for $100,000. The machine had an expected life of 20 years and was expected to have a salvage value of $10,000. On July 1, 2020, the company reviewed the potential of the machine and determined that its undiscounted future net cash flows totaled $50,000 and its discounted future net cash flows totaled $35,000. If no active market exists for the machine and the company does not plan to dispose of it, what should Maimonides record as an impairment loss on July 1, 2020 assuming the straight-line method is used? A. $ 0 B. $ 2,750 C. $ 5,000 D. $17,750
(D) Under the recoverability test, because the expected future net cash flows (undiscounted) of $50,000 is less than the carrying value of $52,750 [$100,000 − (($100,000 − $10,000)/20) × 10.5] an impairment has occurred. The impairment loss is the amount by which the carrying amount of the asset exceeds its fair value. If no market exists, the present value of expected future net cash flows is used as the fair value. Therefore, the impairment loss is equal to $17,750 ($52,750 − $35,000).
(L.O. 1) Which of the following most accurately reflects the concept of depreciation as used in accounting? A. The process of charging the decline in value of an economic resource to income in the period in which the benefit occurred. B. 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. C. A method of allocating asset cost to an expense account in a manner which closely matches the physical deterioration of the tangible asset involved. 11 - 12 Student Study Guide for Intermediate Accounting, 17th Edition D. An accounting concept that allocates the portion of an asset used up during the year to the contra asset account for the purpose of properly recording the fair market value of tangible assets.
. (B) Depreciation is a process of systematic and rational allocation of an asset's cost to the periods benefitted by the use of that asset. A decline in value is not a part of the depreciation process, and depreciation does not necessarily match the physical deterioration of the asset. Also, depreciation is a concept most concerned with allocating cost to expense rather than a focus on recording fair market value of an asset on the balance sheet.
(L.O. 5) Which of the following disclosures is not required in the financial statements regarding depreciation? A. Accumulated depreciation, either by major classes of depreciable assets or in total. B. Details demonstrating how depreciation was calculated. C. Depreciation expense for the period. D. Balances of major classes of depreciable assets, by nature and function.
. (B) Only a general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets is required in the financial statements regarding depreciation. In addition, answers (A), (C), and (D) are required disclosures in the financial statements.
(L.O. 1) A graph is set up with "depreciation expense" on the vertical axis and "time" on the horizontal axis. Assuming linear relationships, how would the graphs for declining-balance and straight-line, respectively, be drawn? A. Sloping down to the right and vertically. B. Sloping up to the right and vertically. C. Sloping down to the right and horizontally. D. Sloping up to the right and horizontally.
. (C) Declining-balance depreciation results in the highest depreciation expense the first year of an asset's life and then decreases each year of the asset's life thereafter. Thus, the graph of the declining-balance depreciation would be sloping down to the right. Since straight-line depreciation is the same amount each year of an asset's life, the straight-line depreciation graph would be horizontal.
(L.O. 4) Of the following costs related to the development of natural resources, which one is not a part of depletion cost? A. Acquisition cost of the natural resource deposit. B. Exploration costs. C. Tangible equipment costs associated with machinery used to extract the natural resource. D. Intangible development costs such as drilling costs, tunnels, and shafts.
. (C) Tangible equipment costs are normally not considered in the depletion base; instead, separate depreciation charges are employed because the asset can be moved from one drilling or mining site to another. Tangible assets that cannot be moved should be separately depreciated over their useful life or the life of the resource, whichever is shorter.
(L.O. 4) In January 2020, the Lucky Mine Corporation purchased a mineral mine for $3,400,000 with removable ore estimated by geological surveys at 4,000,000 tons. The property has an estimated value of $200,000 after the ore has been extracted. The company incurred $800,000 of development costs preparing the mine for production. During 2020, 400,000 tons were removed and 375,000 tons were sold. What is the amount of depletion cost that Lucky Mine should record for 2020? A. $375,000 B. $393,750 C. $400,000 D. $420,000
C