ACCT FINAL EXAM CH 8-9-10-11

24. Target in 2020 reported net income of $3,281 million, net sales of $77,130 million, and average total assets of $42,035 million. What is Target's asset turnover? What is Target's return on assets?

Asset turnover: $77,130 = 1.83 times $42,035 Return on assets: $3,281 = 7.81% $42,035

4. In some instances, accounting principles require a departure from valuing inventories at cost alone. Determine the proper unit inventory price in the following cases using LCNRV.

(1) $12.80 ($14.80 - $1.50 - $0.50) NRV. (2) $16.10 Cost. (3) $13.00 ($15.20 - $1.65 - $0.55) NRV. (4) $9.20 ($10.40 - $0.80 - $0.40) NRV. (5) $15.90 Cost.

7. In some instances, accounting principles require a departure from valuing inventories at cost alone. Determine the proper unit inventory price in the following cases, under the lower-of-cost-or-market rule.

(1) $14.50 NRV. (2) $16.10 Cost. (3) $13.75 NRV - Normal profit margin. (4) $9.70 Replacement cost. (5) $15.90 Cost.

20. What accounting treatment is normally given to the following items in accounting for plant assets? Additions. Major repairs. Improvements and replacements.

(a) Additions. Additions represent entirely new units or extensions and enlargements of old units. Expenditures for additions are capitalized by charging either old or new asset accounts depending on the nature of the addition. (b) Major Repairs. Expenditures to replace parts or otherwise to restore assets to their previously efficient operating condition are regarded as repairs. To be considered a major repair, several periods must benefit from the expenditure. The cost should be handled as an addition, improvement or replacement depending on the type of major repair made. (c) Improvements. An improvement does not add to existing plant assets. Expenditures for such betterments represent increases in the quality of existing plant assets by rearrangements in plant layout or the substitution of improved components for old components so that the facilities have increased productivity, greater capacity, or longer life. The cost of improvements is accounted for by charges to the appropriate property accounts, the elimination of the cost, and accumulated depreciation associated with the replaced components, if any. Replacements. Replacements involve an "in kind" substitution of a new asset or part for an old asset or part. Accounting for major replacements requires entries to retire the old asset or part and to record the cost of the new asset or part. Minor replacements are treated as period costs.

13. Discuss the basic accounting problem that arises in handling each of the following situations. Assets purchased by issuance of common stock. Acquisition of plant assets by gift or donation. Purchase of a plant asset subject to a cash discount. Assets purchased on a long-term credit basis. A group of assets acquired for a lump sum. An asset traded in or exchanged for another asset.

(a) Assets acquired by issuance of capital stock—when property is acquired by issuance of common stock, the cost of the property is not measured by par or stated value of such stock. If the stock is actively traded on the market, then the market value of the stock is a fair indication of the cost of the property because the market value of the stock is a good measure of the current cash equivalent price. If the market value of the common stock is not determinable, then the market value of the property should be established and used as the basis for recording the asset and issuance of common stock. (b) Assets acquired by gift or donation—when assets are acquired in this manner a strict cost concept would dictate that the valuation of the asset be zero. However, in this situation, accountants record the asset at its fair value. The credit should be made to Contribution Revenue. Contributions received should be credited to revenue unless the contribution is from a governmental unit. Even in that case, we believe that the credit should be to Contribution Revenue. (c) Cash discount—when assets are purchased subject to a cash discount, the question of how the discount should be handled occurs. If the discount is taken, it should be considered a reduction in the asset cost. Different viewpoints exist, however, if the discount is not taken. One approach is that the discount must be considered a reduction in the cost of the asset. The rationale for this approach is that the terms of these discounts are so attractive that failure to take the discount must be considered a loss because management is inefficient. The other view is that failure to take the discount should not be considered a loss, because the terms may be unfavorable, or the company might not be prudent to take the discount. Presently both methods are employ

21. List (a) the similarities and (b) the differences in the accounting treatments of depreciation and depletion.

(a) Depreciation and depletion are similar accounting concepts in that: 1. The cost of the asset is the starting point from which computation of the amount of the periodic charge to operations is made. 2. The estimated life is based on the asset's economic or productive life. 3. The accumulated total of past charges to operations is deducted from the original cost of the asset on the balance sheet. 4. When output methods of computing depreciation charges are used, the formulas are essentially the same as those used in computing depletion charges. 5. Both represent an apportionment of the cost under the process of matching costs with revenue. 6. Assets subject to either are reported in the same classification on the balance sheet. 7. Salvage value is properly recognized in computing the charge to operations. 8. Depreciation and depletion may be included in inventory if the related asset contributed to the production of the inventory. 9. The rates may be changed upon revision of the estimated productive life used in the original rate computations. (b) Depreciation and cost depletion are dissimilar accounting concepts in that: 1. Depletion is almost always based on output while depreciation is usually based on time. 2. Many formulas are used in computing depreciation but only one is used to any extent in computing depletion. 3. Depletion applies to natural resources while depreciation applies to plant and equipment. 4. Depletion refers to the physical exhaustion or consumption of the asset while depreciation refers to the wear, tear, and obsolescence of the asset. 5. The computation of the depletion rate is usually much less precise than the computation of depreciation rates because of the greater uncertainty in estimating the productive life.

13. Under what circumstances is it appropriate to record goodwill in the accounts? How should goodwill, properly recorded on the books, be written off in order to conform with generally accepted accounting principles?

13. Goodwill is recorded only when it is acquired by purchase of an entire business. Goodwill acquired in a business combination is considered to have an indefinite life and therefore should not be amortized, but should be tested for impairment on at least an annual basis.

17. Determine the ending inventory under the conventional retail method for the furniture department of Mayron Department Stores from the following data. If the results of a physical inventory indicated an inventory at retail of $295,000, what inferences would you draw?

(a) Ending inventory: Cost Retail Beginning inventory............................................................. $ 149,000 $ 283,500 Purchases............................................................................ 1,400,000 2,160,000 Freight-in.............................................................................. 70,000 Totals........................................................................... 1,619,000 2,443,500 Add net markups................................................................. _________ 92,000 $1,619,000 2,535,500 Deduct net markdowns........................................................ 48,000 2,487,500 Deduct sales revenue.......................................................... 2,175,000 Ending inventory, at retail.................................................... $ 312,500 Ratio of cost to selling price $1,619,000 = 63.85%. $2,535,500 Ending inventory estimated at cost = 63.85% × $312,500 = $199,531. (b) The retail method, above, showed an ending inventory at retail of $312,500; therefore, merchandise not accounted for amounts to $17,500 ($312,500 - $295,000) at retail and $11,174 ($17,500 × 63.85%) at cost.

21. Which of the following activities should be expensed currently as R&D costs? Testing in search for or evaluation of product or process alternatives. Engineering follow-through in an early phase of commercial production. Legal work in connection with patent applications or litigation, and the sale or licensing of patents.

(a) Expense as R&D. (b) Expense as R&D. (c) Capitalize as patent and/or license and amortize.

4. Indicate where the following items would be shown on a balance sheet. A lien that was attached to the land when purchased. Landscaping costs. Attorney's fees and recording fees related to purchasing land. Variable overhead related to construction of machinery. A parking lot servicing employees in the building. Cost of temporary building for workers during construction of building. Interest expense on bonds payable incurred during construction of a building. Assessments for sidewalks that are maintained by the city. The cost of demolishing an old building that was on the land when purchased.

(a) Land. (b) Land Improvements. (c) Land. (d) Machinery. The only controversy centers on whether fixed overhead should be allocated as a cost to the machinery. (e) Land Improvements, should be depreciated. (f) Buildings. (g) Buildings, provided the benefits in terms of information justify the additional cost involved in providing the information. (h) Land. (i) Land.

22. To what extent do you consider the following items to be proper costs of the fixed asset? Give reasons for your opinions. Overhead of a business that builds its own equipment. Cash discounts on purchases of equipment. Interest paid during construction of a building. Cost of a safety device installed on a machine. Freight on equipment returned before installation, for replacement by other equipment of greater capacity. Cost of moving machinery to a new location. Cost of plywood partitions erected as part of the remodeling of the office. Replastering of a section of the building. Cost of a new motor for one of the trucks. Cost to restore land after extracting ore.

(a) Overhead of a business that builds its own equipment. Some accountants have maintained that the equipment account should be charged only with the additional overhead caused by such construction. However, a more realistic figure for the cost of equipment results if the plant asset account is charged for overhead applied on the same basis and at the same rate as used for production. (b) Cash discounts on purchases of equipment. Some accountants treat all cash discounts as financial or other revenue, regardless of whether they arise from the payment of invoices for merchandise or plant assets. Others take the position that only the net amount paid for plant assets should be capitalized on the basis that the discount represents a reduction of price and is not income. The latter position seems more logical in light of the fact that plant assets are purchased for use and not for sale and that they are written off to expense over a long period of time. (c) Interest paid during construction of a building. GAAP requires that avoidable or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition and location necessary for its intended use. (d) Cost of a safety device installed on a machine. This is an addition to the machine and should be capitalized in the machinery account if material. (e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity. If ordering the first equipment was an error, whether due to judgment or otherwise, the freight should be regarded as a loss. However, if information became available after the order was placed which indicated purchase of the new equipment was more advantageous, the cost of the return freight may be viewed as a

20. Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and (c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs?

(a) Personnel (labor) type costs incurred in R&D activities should be expensed as incurred. (b) Materials and equipment costs should be expensed immediately unless the items have alternative future uses. If the items have alternative future uses, the materials should be recorded as inventories and allocated as consumed and the equipment should be capitalized and depreciated as used. (c) Indirect costs of R&D activities should be reasonably allocated to R&D (except for general and administrative costs, which must be clearly related to be included) and expensed.

3. Name the items, in addition to the amount paid to the former owner or contractor, that may properly be included as part of the acquisition cost of the following plant assets. Land. Machinery and equipment. Buildings.

(a) The acquisition costs of land may include the purchase or contract price, the broker's commission, title search and recording fees, assumed taxes or other liabilities, surveying, demolition (less salvage), and landscaping costs that are permanent in nature. (b) Machinery and equipment costs may properly include freight and handling, taxes on the purchase, insurance in transit, installation, and expenses of testing and breaking-in. (c) If a building is purchased, all repair charges, alterations, and improvements necessary to ready the building for its intended use should be included as a part of the acquisition cost. Building costs in addition to the amount paid to a contractor may include excavation, permits and licenses, architect's fees, interest accrued on funds obtained for construction purposes (during construction period only) called avoidable interest, insurance premiums applicable to the construction period, temporary buildings and structures, and property taxes levied on the building during the construction period.

14. In examining financial statements, financial analysts often write off goodwill immediately. Comment on this procedure.

14. Many analysts believe that the value of goodwill is so subjective that it should not be given the same status as other types of assets such as cash, receivables, inventory, etc. The analysts are simply stating that they believe that presentation of goodwill on the balance sheet does not provide any useful information to the users of financial statements. Whether this is true or not is a difficult point to prove, but it should be noted that it appears contradictory to pay for the goodwill and then immediately write it off, denying that it has any value.

5. Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use:

(a) The position that no fixed overhead should be capitalized assumes that the construction of plant (fixed) assets will be timed so as not to interfere with normal operations. If this were not the case, the savings anticipated by constructing instead of purchasing plant assets would be nullified by reduced profits on the product that could have been manufactured and sold. Thus, construction of plant assets during periods of low activity will have a minimal effect on the total amount of overhead costs. To capitalize a portion of fixed overhead as an element of the cost of constructed assets would, under these circumstances, reduce the amount assignable to operations and therefore overstate net income in the construction period and understate net income in subsequent periods because of increased depreciation charges. (b) Capitalizing overhead at the same rate as is charged to normal operations is defended by those who believe that all manufacturing overhead serves a dual-purpose during plant asset construction periods. Any attempt to assign construction activities less overhead than the normal rate implies costing favors and results in the misstatement of the cost of both plant assets and finished goods.

*20. What modifications to the conventional retail method are necessary to approximate a LIFO retail flow?

*20. Two major modifications are necessary. First, the beginning inventory should be excluded from the numerator and denominator of the cost-to-retail percentage and second, markdowns should be included in the denominator of the cost-to-retail percentage.

*25. What is a modified accelerated cost recovery system (MACRS)? Speculate as to why this system is now required for tax purposes.

*25. The modified accelerated cost recovery system (MACRS) has been adopted by the Internal Revenue Service. It applies to depreciable assets acquired in 1987 and later. MACRS eliminates the need to determine each asset's useful life. The selection of a depreciation method and a salvage value is also unnecessary under MACRS. The taxpayer determines the recovery deduction for an asset by applying a statutory percentage to the historical cost of the property. MACRS was adopted to permit a faster write-off of tangible assets to provide additional tax incentives and to simplify the depreciation process. The simplification should end disputes related to estimated useful life and salvage value.

*26. Why is the distinction between a conditional and unconditional contribution important for accounting purposes?

*26. The distinction between a conditional and unconditional contribution is important from an accounting point of view because it affects when expense and revenue are reported. In an unconditional contribution revenue is recognized immediately whereas in a conditional contribution, revenue is deferred.

gross profit method of estimating inventory

1) the beginning inventory plus purchases equal total goods to be accounted for 2) goods not sold must be on hand 3) the sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal ending inventory

1. What are the major characteristics of plant assets?

1. The major characteristics of plant assets are (1) that they are acquired for use in operations and not for resale, (2) that they are long-term in nature and usually subject to depreciation, and (3) that they have physical substance.

1. Distinguish among depreciation, depletion, and amortization.

1. The terms depreciation, depletion, and amortization all imply a cost allocation of different types of assets. Depreciation is employed to indicate that tangible plant assets have decreased in carrying value. Where natural resources (wasting assets) such as timber, oil, coal, and lead are involved, the term depletion is used. The expiration of intangible assets such as patents or copyrights is referred to as amortization.

15. Andrea Kremer purchased a computer for $8,000 on July 1, 2025. She intends to depreciate it over 4 years using the double-declining-balance method. Salvage value is $1,000. Compute depreciation for 2026.

1.0 ÷ 4 years = 25% straight-line rate x 2 = 50%* double-declining rate $8,000 x 50%* = $4,000 depreciation for first full year. $4,000 x 6/12 = $2,000 depreciation for half a year (first year), 2025. $6,000 ($8,000-$2,000) x 50%* = $3,000 depreciation for 2026.

10. Provide examples of assets that do not qualify for interest capitalization.

10. Assets that do not qualify for interest capitalization are (1) assets that are in use or ready for their intended use, and (2) assets that are not being used in the earnings activities of the firm.

10. What are the major factors considered in determining what depreciation method to use?

10. From a conceptual point of view, the method which best matches revenue and expenses should be used; in other words, the answer depends on how the service potential of the asset declines. If the service potential decline is faster in the earlier years, an accelerated method is more desirable. On the other hand, if the decline is more uniform with the passage of time, a straight-line approach should be used. If the service potential declines as a function of use, the activity method should be used. Some companies use accelerated methods for tax purposes but straight-line for book purposes because a higher net income figure is shown on the books in the earlier years, but a lower tax is paid to the government. Others attempt to use the same method for tax and accounting purposes because it eliminates some recordkeeping costs. Tax policy sometimes also plays a role.

11. Explain the difference between artistic-related intangible assets and contract-related intangible assets.

11. Artistic-related intangible assets involve ownership rights to plays, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights. Contract-related intangible assets represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts.

11. What are the major uses of the gross profit method?

11. The major uses of the gross profit method are: (1) it provides an approximation of the ending inventory which the auditor might use for testing validity of physical inventory count; (2) it means that a physical count need not be taken every month or quarter; and (3) it helps in determining damages caused by casualty when inventory cannot be counted.

14. Charlie Parker, president of Spinners Company, has recently noted that depreciation increases cash provided by operations and therefore depreciation is a good source of funds. Do you agree? Discuss.

14. No, depreciation does not provide cash; revenues do. The funds for the replacement of the assets come from the revenues; without the revenues, no income materializes, and no cash inflow results. A separate decision must be made by management to set aside cash to accumulate asset replacement funds. Depreciation is added to net income on the statement of cash flows (indirect method) because it is a noncash expense, not because it is a cash inflow.

15. Schwartzkopf Co. purchased for $2,200,000 property that included both land and a building to be used in operations. The seller's book value was $300,000 for the land and $900,000 for the building. By appraisal, the fair value was estimated to be $500,000 for the land and $2,000,000 for the building. At what amount should Schwartzkopf report the land and the building at the end of the year?

15. Fair value of land x Cost = Cost allocated to land Fair value of building and land $500,000 x $2,200,000 = $440,000 (Cost allocated to land) $2,500,000 Fair value of building Fair value of building and land x Cost = Cost allocated to building $2,000,000 x $2,200,000 = $1,760,000 (Cost allocated to building) $2,500,000

15. Braxton Inc. is considering the write-off of a limited-life intangible because of its lack of profitability. Explain to the management of Braxton how to determine whether a write-off is permitted.

15. Accounting standards require that if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, then the carrying amount of the asset should be assessed. The assessment or review takes the form of a recoverability test that compares the sum of the expected future cash flows from the asset (undiscounted) to the carrying amount. If the cash flows are less than the carrying amount, the asset has been impaired. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset. The fair value of assets is measured by their fair value if an active market for them exists. If no market price is available, the present value of the expected future net cash flows from the asset may be used.

16. Pueblo Co. acquires machinery by paying $10,000 cash and signing a $5,000, 2-year, zero-interest-bearing note payable. The note has a present value of $4,208, and Pueblo purchased a similar machine last month for $13,500. At what cost should the new equipment be recorded?

16. $10,000 (cash payment) + $4,208 (present value of note) = $14,208

16. Last year, Zeno Company recorded an impairment on an intangible asset held for use. Recent appraisals indicate that the asset has increased in value. Should Zeno record this recovery in value?16.

16. No. Under GAAP, impairment losses on intangible assets may not be restored.

16. Walkin Inc. is considering the write-down of its long-term plant because of a lack of profitability. Explain to the management of Walkin how to determine whether a write-down is permitted.

16. The accounting standards require that if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, then the carrying amount of the asset should be assessed. The assessment or review takes the form of a recoverability test that compares the sum of the expected future cash flows from the asset (undiscounted) to the carrying amount. If the cash flows are less than the carrying amount, the asset has been impaired. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset. The fair value of assets is measured by their market value if an active market for them exists. If no market price is available, the present value of the expected future net cash flows from the asset may be used.

17. Explain how losses on impaired intangible assets should be reported in income.

17. Impairment losses are reported as part of income from continuing operations, generally in the "Other expenses and losses" section. Impairment losses (and recovery of losses for assets to be disposed of) are similar to other costs that would flow through operations. Thus, gains (recoveries of losses) on assets to be disposed of should be reported as part of income from continuing operations.

17. Last year, Wyeth Company recorded an impairment on an asset held for use. Recent appraisals indicate that the asset has increased in value. Should Wyeth record this recovery in value under GAAP?

17. No. Under U.S. GAAP, impairment losses on assets held for use may not be restored.

17. Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for these two situations.

17. Ordinarily accounting for the exchange of nonmonetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Thus, any gains and losses on the exchange should be recognized immediately. If the fair value of either asset is not reasonably determinable, the book value of the asset given up is usually used as the basis for recording the nonmonetary exchange. This approach is always employed when the exchange has commercial substance. The general rule is modified when exchanges lack commercial substance. In this case, the enterprise is not considered to have completed the earnings process and therefore a gain should not be recognized. However, a loss should be recognized immediately. In certain situations, gains on an exchange that lacks commercial substance may be recorded whenmonetary consideration is received. When monetary consideration is received, it is assumed that a portion of the earnings process is completed, and therefore, a partial gain is recognized.

18. Toro Co. has equipment with a carrying amount of $700,000. The expected future net cash flows from the equipment are $705,000, and its fair value is $590,000. The equipment is expected to be used in operations in the future. What amount (if any) should Toro report as an impairment to its equipment?

18. An impairment is deemed to have occurred if, in applying the recoverability test, the carrying amount of the asset exceeds the expected future net cash flows from the asset. In this case, the expected future net cash flows of $705,000 exceed the carrying amount of the equipment of $700,000, so no impairment is assumed to have occurred; thus, no measurement of the loss is made or recognized even though the fair value is $590,000.

18. Deere and Company reported inventory in its balance sheet as follows. Inventories $1,999,100,000 What additional disclosures might be necessary to present the inventory fairly?

18. Information relative to the composition of the inventory (i.e., raw material, work-in-process, and finished goods); the inventory financing where significant or unusual (transactions with related parties, product financing arrangements, firm purchase commitments, involuntary liquidations of LIFO inventories, pledging inventories as collateral); and the inventory costing methods employed (lower-of-cost-or-market, FIFO, LIFO, average cost) should be disclosed. If Deere and Company uses LIFO, it should also report the LIFO reserve.

19. Explain how gains or losses on impaired assets should be reported in income.

19. Impairment losses are reported as part of income from continuing operations, generally in the "Other expenses and losses" section. Impairment losses (and recovery of losses for assets to be disposed of) are similar to other costs that would flow through operations. Thus, gains (recoveries of losses) on assets to be disposed of should be reported as part of income from continuing operations in the "Other revenues and gains" section.

19. Of what significance is inventory turnover to a retail store?

19. Inventory turnover measures how quickly inventory is sold. Generally, the higher the inventory turnover, the better the enterprise is performing. The more times the inventory turns over, the smaller the net margin can be to earn an appropriate total profit and return on assets. For example, a company can price its goods lower if it has a high inventory turnover. A company with a low profit margin, such as 2%, can earn as much as a company with a high net profit margin, such as 40% if its inventory turnover is often enough. To illustrate, a grocery store with a 2% profit margin can earn as much as a jewelry store with a 40% profit margin and an inventory turnover of 1 if its turnover is more than 20 times.

2. If intangibles are acquired for stock, how is the cost of the intangible determined?

2. If intangibles are acquired for stock, the cost of the intangible is the fair value of the consideration given or the fair value of the consideration received, whichever is more clearly evident.

20. It has been suggested that plant and equipment could be replaced more quickly if depreciation rates for income tax and accounting purposes were substantially increased. As a result, business operations would receive the benefit of more modern and more efficient plant facilities. Discuss the merits of this proposition.

20. In a decision to replace or not to replace an asset, the undepreciated cost of the old asset is not a factor to be considered. Therefore, the decision to replace plant assets should not be affected by the amount of depreciation that has been recorded. The relative efficiency of new equipment as compared with that presently in use, the cost of the new facilities, the availability of capital for the new asset, etc., are the factors entering into the decision. Normally, the fact that the asset had been fully depreciated through the use of some accelerated depreciation method, although the asset was still in use, should not cause management to decide to replace the asset. If the new asset under consideration for replacement was not any more efficient than the old, or if it cost a good deal more in relation to its efficiency, it is illogical for management to replace it merely because all or the major portion of the cost had been charged off for tax and accounting purposes.

22. Indicate the proper accounting for the following items. Organization costs. Advertising costs. Operating losses.

22. Each of these items should be charged to current operations. Advertising costs have some minor exceptions to this general rule. Any tangible assets used in Advertising, such as billboards or blimps, are recorded as assets.

22. In the extractive industries, businesses may pay dividends in excess of net income. How can this practice be justified?

22. This practice can be justified for companies that expect to extract natural resources and not purchase additional properties. In effect, such companies are distributing gradually to stockholders their original investments by paying a liquidating dividend.

23. In 2024, Austin Powers Corporation developed a new product that will be marketed in 2025. In connection with the development of this product, the following costs were incurred in 2024: research and development costs $400,000, materials and supplies consumed $60,000, and compensation paid to research consultants $125,000. It is anticipated that these costs will be recovered in 2027. What is the amount of research and development costs that Austin Powers should record in 2024 as a charge to expense?

23. $585,000 ($400,000 + $60,000 + $125,000).

23. Neville Enterprises has a number of fully depreciated assets that are still being used in the main operations of the business. Because the assets are fully depreciated, the president of the company decides not to show them on the balance sheet or disclose this information in the notes. Evaluate this procedure.

23. This approach is not correct since at the very minimum the investor should be aware that certain assets are used in the business, which are not reflected in the main body of the financial statements. Either the company should keep these assets on the balance sheet or they should be recorded at salvage value and the resulting gain recognized. In either case, there should be a clear indication that these assets are fully depreciated but are still being used in the business.

23. Shumway Oil uses successful-efforts accounting and also provides full-cost results as well. Under full-cost, Shumway Oil would have reported retained earnings of $42 million and net income of $4 million. Under successful-efforts, retained earnings were $29 million, and net income was $3 million. Explain the difference between full-costing and successful-efforts accounting.

23. Using full-cost accounting, the cost of unsuccessful ventures, as well as those that are successful, is capitalized, because the cost of drilling a dry hole is a cost that is needed to find the commercially profitable wells. Successful efforts accounting capitalizes only those costs related to successful projects. They contend that to measure cost and effort accurately for a single property unit, the only measure is in terms of the cost directly related to that unit. In addition, it is argued that full-cost is misleading because capitalizing all costs will make an unsuccessful company over a short period of time show no less income than does a successful one.

24. What are the general rules for how gains or losses on retirement of plant assets should be reported in income?

24. Gains or losses on plant asset retirements should be shown in the income statement along with other items that arise from customary business activities-usually as other revenues and gains or other expenses and losses.

24. Recently, a group of college students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?

24. These costs are referred to as start-up costs, or more specifically organizational costs in this case. The accounting for start-up costs is straightforward—expense these costs as incurred. The profession recognizes that these costs are incurred with the expectation that future revenues will occur or increased efficiencies will result. However, to determine the amount and timing of future benefits is so difficult that a conservative approach—expensing these costs as incurred—is required.

3. Some believe that accounting depreciation measures the decline in the value of fixed assets. Do you agree? Explain.

3. Disagree. Accounting depreciation is defined as the accounting process of allocating the cost of a tangible asset to expense in a systematic and rational manner to the periods expected to benefit from the use of the asset. Thus, depreciation is not a matter of valuation but a means of cost allocation.

3. Intangibles have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized?

3. Limited-life intangibles should be amortized by systematic charges to expense over their useful life. An intangible asset with an indefinite life is not amortized.

4. Explain how estimation of service lives can result in unrealistically high carrying values for fixed assets.

4. The carrying value of a fixed asset is its cost less accumulated depreciation. If the company estimates that the asset will have an unrealistically long life, the result will be to lower periodic depreciation charges and hence accumulated depreciation. As a result, the carrying value of the asset will be higher.

4. Why does the accounting profession make a distinction between internally created intangibles and purchased intangibles?

4. When intangibles are created internally, it is often difficult to determine the validity of any future service potential. To permit deferral of these types of costs would lead to a great deal of subject-tivity because management could argue that almost any expense could be capitalized on the basis that it will increase future benefits. The cost of purchased intangibles, however, is capitalized because its cost can be objectively verified and reflects its fair value at the date of acquisition.

5. In 2025, Ghostbusters Corp. spent $420,000 for "goodwill" visits by sales personnel to key customers. The purpose of these visits was to build a solid, friendly relationship for the future and to gain insight into the problems and needs of the companies served. How should this expenditure be reported?

5. Companies cannot capitalize self-developed, self-maintained, or self-created goodwill. These expenditures would most likely be reported as selling expenses.

6. For what reasons are plant assets retired? What are physical and economic factors?

6. Assets are retired for one of two reasons: physical factors or economic factors—or a combination of both. Physical factors are the wear and tear, decay, and casualty factors that hinder the asset from performing indefinitely. Economic factors can be interpreted to mean any other constraint that develops to hinder the service life of an asset.

7. Burke Company has purchased two tracts of land. One tract will be the site of its new manufacturing plant, while the other is being purchased with the hope that it will be sold in the next year at a profit. How should these two tracts of land be reported in the balance sheet?

7. Since the land for the plant site will be used in the operations of the firm, it is classified as property, plant, and equipment. The other tract is being held for speculation. It is classified as an investment.

7. What should be the pattern of amortization for a limited-life intangible?

7. The amount of amortization expensed for a limited-life intangible asset should reflect the pattern in which the asset is consumed or used up, if that pattern can be reliably determined. If the pattern of production or consumption cannot be determined, the straight-line method of amortization should be used.

8. Workman Company purchased a machine on January 2, 2025, for $800,000. The machine has an estimated useful life of 5 years and a salvage value of $100,000. Depreciation was computed by the 150% declining-balance method. What is the amount of accumulated depreciation at the end of December 31, 2026?

8. Cost $800,000 Cost $800,000 Depreciation rate x .30* Depreciation for 2025 (240,000) Depreciation for 2025 $240,000 Undepreciated cost in 2026 560,000 Depreciation rate x .30* 2025 Depreciation $240,000 Depreciation for 2026 $168,000 2026 Depreciation 168,000 Accumulated depreciation at December 31, 2026 $408,000 *[(1 ÷ 5 years) x 150%]

8. When must a company recognize an asset retirement obligation?

8. An asset retirement obligation must be recognized when a company has an existing legal obligation associated with the retirement of a long-lived asset and when the amount can be reasonably estimated.

8. Columbia Sportswear Company acquired a trademark that is helpful in distinguishing one of its new products. The trademark is renewable every 10 years at minimal cost. All evidence indicates that this trademarked product will generate cash flows for an indefinite period of time. How should this trademark be amortized?

8. This trademark is an indefinite life intangible and, therefore, should not be amortized.

9. Silverman Company purchased machinery for $162,000 on January 1, 2025. It is estimated that the machinery will have a useful life of 20 years, salvage value of $15,000, production of 84,000 units, and working hours of 42,000. During 2025, the company uses the machinery for 14,300 hours, and the machinery produces 20,000 units. Compute depreciation under the straight-line, units-of-output, working hours, sum-of-the-years'-digits, and double-declining-balance methods.

9. Depreciation base: Cost $162,000 Straight-line, $147,000 ÷ 20 = $ 7,350 Salvage (15,000) $147,000 Units-of-output, $147,000 x 20,000 = $35,000 84,000 Working hours, $147,000 x 14,300 = $50,050 42,000 Sum-of-the-years-digits, $147,000 x 20/210* = $14,000 Double-declining-balance, $162,000 x .10** = $16,200 **[(1 ÷ 20) x 2]

9. One financial accounting issue encountered when a company constructs its own plant is whether the interest cost on funds borrowed to finance construction should be capitalized and then amortized over the life of the assets constructed. What is the justification for capitalizing such interest?

9. A common accounting justification is that all costs associated with the construction of an asset, including interest, should be capitalized in order that the costs can be matched to the revenues, which the new asset will help generate.

9. Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?

9. Relative sales value is an appropriate basis for pricing inventory when a group of varying units is purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory.

9. Romo Company spent $190,000 developing a new process, $45,000 in legal fees to obtain a patent, and $91,000 to market the process that was patented, all in the year 2025. How should these costs be accounted for in 2025?

9. The $190,000 should be expensed as research and development expense in 2025. The $91,000 is expensed as selling and promotion expense in 2025. The $45,000 of costs to legally obtain the patent should be capitalized and amortized over the useful or legal life of the patent, whichever is shorter.

5. The plant manager of a manufacturing firm suggested in a conference of the company's executives that accountants should speed up depreciation on the machinery in the finishing department because improvements were rapidly making those machines obsolete, and a depreciation fund big enough to cover their replacement is needed. Discuss the accounting concept of depreciation and the effect on a business concern of the depreciation recorded for plant assets, paying particular attention to the issues raised by the plant manager.

A change in the amount of annual depreciation recorded does not change the facts about the decline in economic usefulness. It merely changes reported figures. Depreciation in accounting consists of allocating the cost of an asset over its useful life in a systematic and rational manner. Abnormal obsolescence, as suggested by the plant manager, would justify more rapid depreciation, but increasing the depreciation charge would not necessarily result in funds for replacement. It would not increase revenue but simply make reported income lower than it would have been, thus preventing the overstatement of net income. Recording depreciation on the books does not set aside any assets for the eventual replacement of the depreciated assets. Fund segregation can be accomplished but it requires additional managerial action. Unless an increase in depreciation is accompanied by an increase in the sales price of the product, or unless it affects management's decision on dividend policy, it does not affect funds. Ordinarily higher depreciation will not lead to higher sales prices and thus to more rapid "recovery" of the cost of the asset, and the economic factors present would have permitted this higher price regardless of the excuse given or the particular rationalization used. The price could have been increased without a higher depreciation charge. The funds of a firm operating profitably do increase. The measure of the increase in cash from operations is not merely net income, but that figure plus non-cash expenses such as depreciation. The fact that net income alone does not measure the increase in funds from profitable operations leads some non-accountants to the erroneous conclusion that a fund is being created and that the amount of depreciation recorded affects the fund accumulation. Acceleration of depreciation for

13. Adriana Co., with annual net sales of $5 million, maintains a markup of 25% based on cost. Adriana's expenses average 15% of net sales. What is Adriana's gross profit and net profit in dollars?

A markup of 25% on cost equals a 20% markup on selling price; therefore, gross profit equals $1,000,000 ($5 million × .20) and net income equals $250,000 [$1,000,000 - (.15. × $5 million)]. The following formula was used to compute the 20% markup on selling price: Gross profit on selling price = Percentage markup on cost = .25 = 20% 100% + Percentage markup on cost 1 + .25

10. Izzy Inc. purchased a patent for $350,000 which has an estimated useful life of 10 years. Its pattern of use or consumption cannot be reliably determined. Prepare the entry to record the amortization of the patent in its first year of use.

Amortization Expense ($350,000 ÷ 10)................................................................. 35,000 Patents (or Accumulated Amortization).............................................................. 35,000 Straight-line amortization is used because the pattern of use cannot be reliably determined.

8. What factors might call for inventory valuation at sales prices (net realizable value or market price)?

An exception to the normal recognition rule occurs where (1) there is a controlled market with a quoted price applicable to specific commodities and (2) no significant costs of disposal are involved. Certain agricultural products and precious metals which are immediately marketable at quoted prices are often valued at net realizable value (market price).

6. What are factors to be considered in estimating the useful life of an intangible asset?

Factors to be considered in determining useful life are: (a) The expected use of the asset by the entity. (b) The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. (c) Any legal, regulatory, or contractual provisions that may limit useful life. (d) Any legal, regulatory or contractual provisions that enable renewal or extension of the asset's legal or contractual life without substantial cost. (e) The effects of obsolescence, demand, competition, and other economic factors. (f) The level of maintenance expenditure required to obtain the expected future cash flows from the asset.

7. What basic questions must be answered before the amount of the depreciation charge can be computed?

Before the amount of the depreciation charge can be computed, three basic questions must be answered: (1) What is the depreciation base to be used for the asset? (2) What is the asset's useful life? (3) What method of cost apportionment is best for this asset?

13. A building that was purchased on December 31, 2011, for $2,500,000 was originally estimated to have a life of 50 years with no salvage value at the end of that time. Depreciation has been recorded through 2025. During 2026, an examination of the building by an engineering firm discloses that its estimated useful life is 15 years after 2025. What should be the amount of depreciation for 2026?

Original estimate: $2,500,000 ÷ 50 = $50,000 per year Depreciation to January 1, 2026: $50,000 x 14 = $700,000 Depreciation in 2026 ($2,500,000 - $700,000) ÷ 15 = $120,000

12. If Remmers, Inc. uses the composite method and its composite rate is 7.5% per year, what entry should it make when plant assets that originally cost $50,000 and have been used for 10 years are sold for $14,000?

Cash.............................................................................................................. 14,000 Accumulated Depreciation—Plant Assets............................................ 36,000 Plant Assets......................................................................... 50,000 No gain or loss is recognized under the composite method.

12. Distinguish between gross profit as a percentage of cost and gross profit as a percentage of sales price. Convert the following gross profit percentages based on cost to gross profit percentages based on sales price: 25% and 33⅓%. Convert the following gross profit percentages based on sales price to gross profit percentages based on cost: 33⅓% and 60%.

Gross profit as a percentage of sales indicates that the markup is based on selling price rather than cost; for this reason the gross profit as a percentage of selling price will always be lower than if based on cost. Conversions are as follows: 25% on cost = .25 ÷ ( 1 + .25) = 20% on selling price 33 1/3% on cost = .333 ÷ (1 + .333) = 25% on selling price 33 1/3% on selling price = .333 ÷ (1 - .333) = 50% on cost 60% on selling price = .60 ÷ (1 - .60) = 150% on cost

18. Crowe Company purchased a heavy-duty truck on July 1, 2021, for $30,000. It was estimated that it would have a useful life of 10 years and then would have a trade-in value of $6,000. The company uses the straight-line method. It was traded on August 1, 2026, for a similar truck costing $42,000; $16,000 was allowed as trade-in value (also fair value) on the old truck and $26,000 was paid in cash. A comparison of expected cash flows for the trucks indicates the exchange lacks commercial substance. What is the entry to record the trade-in?

In accordance with GAAP which requires losses to be recognized immediately, the entry should be: Trucks (new).......................................................................................... 42,000 Accumulated Depreciation.................................................................... 12,200* Loss on Disposal of Trucks................................................................... 1,800** Trucks (old)...................................................................................... 30,000 Cash................................................................................................. 26,000 *[($30,000 - $6,000) x (61 months/120 months) = $12,200] **(Book value $30,000 - $12,200) - $16,000 trade-in = $1,800 loss)

14. A fire destroys all of the merchandise of Assante Company on February 10, 2025. Presented below is information compiled up to the date of the fire. What is the approximate inventory on February 10, 2025?

Inventory, January 1, 2025....................................................................... $ 400,000 Purchases to February 10, 2025.............................................................. $1,140,000 Freight-in to February 10, 2025................................................................ 60,000 1,200,000 Merchandise available...................................................................... 1,600,000 Sales revenue to February 10, 2025........................................................ 1,950,000 Less gross profit at 40% ($1,950,000 × .40).................................... 780,000 Estimated cost of goods sold....................................................... 1,170,000 Inventory (approximately) at February 10, 2025.......................... $ 430,000

5. What method(s) might be used in the accounts to record a loss due to a price decline in the inventories? Discuss.

One approach is to reduce inventory from cost to net realizable value by debiting a loss account and crediting Inventory. This method reports a loss in the period in which the decline in value takes place (often referred to as the loss method). The loss would then be shown as a separate item in the income statement and the cost of goods sold for the year would not be distorted by its inclusion. An objection to this method of valuation is that an inconsistency is created between the income statement and the statement of financial position. Another approach is to increase Cost of Goods Sold by the amount of the loss and decrease the Inventory account. Because this method fails to reflect this loss separately, objections can be raised against this procedure because the loss is buried in Cost of Goods Sold and is not easy to separately identify

19. Once equipment has been installed and placed in operation, subsequent expenditures relating to this equipment are frequently thought of as repairs or general maintenance and, hence, chargeable to operations in the period in which the expenditure is made. Actually, determination of whether such an expenditure should be charged to operations or capitalized involves a much more careful analysis of the character of the expenditure. What are the factors that should be considered in making such a decision? Discuss fully.

Ordinarily such expenditures include (1) the recurring costs of servicing necessary to keep property in good operating condition, (2) cost of renewing structural parts of major plant units, and (3) costs of major overhauling operations which may or may not extend the life beyond original expectation. The first class of expenditures represents the day-to-day service and in general is chargeable to operations as incurred. These expenditures should not be charged to the asset accounts. The second class of expenditures may or may not affect the recorded cost of property. If the asset is rigidly defined as a distinct unit, the renewal of parts does not usually disturb the asset accounts; however, these costs may be capitalized and apportioned over several fiscal periods on some equitable basis. If the property is conceived in terms of structural elements subject to separate replacement, such expenditures should be charged to the plant asset accounts. The third class of expenditures, major overhauls, is usually entered through the asset accounts because replacement of important structural elements is usually involved. Other than maintenance charges mentioned above are those expenditures which add some physical aspect not a part of the asset at the time of its original acquisition. These expenditures may be capitalized in the asset account. An expenditure which extends the life but not the usefulness of the asset is often charged to the Accumulated Depreciation account. A more appropriate treatment requires retiring from the asset and accumulated depreciation accounts the appropriate amounts (original cost from the asset account) and to capitalize in the asset account the new cost. Often it is difficult to determine the original cost of the item being replaced. For this reason, the replacement or renewal is charged to the

19. What is the nature of research and development costs?

Research and development costs are incurred to develop new products or processes, to improve present products, or to discover new knowledge. R&D expenditures present problems of (1) identifying the costs associated with particular activities, projects, or achievements, and (2) determining the magnitude of the future benefits and the length of time over which such benefits may be realized. R&D activities may incur costs classified as follows: (a) materials, equipment, and facilities, (b) personnel, (c) purchased intangibles, (d) contract services, and (e) indirect costs.

18. Simon Company determines that its goodwill is impaired. It finds that the book value of its reporting unit is $1,490,000, including recorded goodwill of $400,000. The fair value of the identifiable assets of the reporting unit is $1,450,000. What is the amount of goodwill impaired?

The amount of goodwill impaired is $40,000, computed as follows: Carrying value of net assets.................................. $1,490,000 Fair value of reporting unit..................................... (1,450,000) Impaired goodwill................................................... $ 40,000

11. What interest rates should be used in determining the amount of interest to be capitalized? How should the amount of interest to be capitalized be determined?

The avoidable interest is determined by multiplying (an) interest rate(s) by the weighted-average amount of accumulated expenditures on qualifying assets. For the portion of weighted-average accumulated expenditures which is less than or equal to any amounts borrowed specifically to finance construction of the assets, the capitalization rate is the specific interest rate incurred. For the portion of weighted-average accumulated expenditures, which is greater than specific debt incurred, the interest rate is a weighted-average of all other interest rates incurred. The amount of interest to be capitalized is the avoidable interest, or the actual interest incurred, whichever is lower. As indicated in the chapter, an alternative to the specific rate is to use an average borrowing rate.

2. Mickelson Inc. owns land that it purchased on January 1, 2005, for $450,000. At December 31, 2025, its current value is $770,000 as determined by appraisal. At what amount should Mickelson report this asset on its December 31, 2025, balance sheet? Explain.

The company should report the asset at its historical cost of $450,000, not its current value. The main reasons for this position are (1) at the date of acquisition, cost reflects fair value; (2) historical cost involves actual, not hypothetical transactions, and as a result is extremely reliable; and (3) gains and losses should not be anticipated but should be recognized when the asset is sold.

11. Under what conditions is it appropriate for a business to use the composite method of depreciation for its plant assets? What are the advantages and disadvantages of this method?

The composite method is appropriate for a company that owns a large number of heterogeneous plant assets and which would find it impractical to keep detailed records for them. The principal advantage is that the composite method simplifies the bookkeeping process and tends to average out errors caused by over-or under depreciation. As a result, gains or losses on disposals of assets do not distort periodic income. The principal disadvantage is that after a period of time, the book value of the plant assets may not reflect the proper carrying value of the assets. Since the Accumulated Depreciation account is debited or credited for the difference between the cost of the asset and the cash received from the retirement of the asset (i.e., no gain or loss on disposal is recognized), the account is self-correcting over time.

16. The conventional retail inventory method yields results that are essentially the same as those yielded by the lower-of-cost-or-market method. Explain. Prepare an illustration of how the retail inventory method reduces inventory to market.

The conventional retail method is based on lower-of-average-cost-or-market whereby inventory figures at retail are reduced to an inventory valuation figure by multiplying the retail figures by a percentage which is the complement of the markup percent. To determine the markup percent, original markups and additional net markups are related to the original cost. The complement of the markup percent so determined is then applied to the inventory at retail after the latter has been reduced by net markdowns, thus in effect achieving a lower-of-cost-or-market valuation. An example of reduction to market follows: Assume purchase of 100 items at $1 each, marked to sell at $1.50 each, at which price 80 were sold. The remaining 20 are marked down to $1.15 each. The inventory at $15.33 is $4.67 below original cost and is valued at an amount which will produce the "normal" 33 1/3% gross profit if sold at the present retail price of $23.00. Computation of Inventory Cost Retail Ratio Purchases $100 $150 66 2/3% Sales revenue (120) Markdowns (20 × $.35) (7) Inventory at retail $ 23 Inventory at lower-of-cost-or-market $23 × 66 2/3% = $15.33

21. New machinery, which replaced a number of employees, was installed and put in operation in the last month of the fiscal year. The employees had been dismissed after payment of an extra month's wages, and this amount was added to the cost of the machinery. Discuss the propriety of the charge. If it was improper, describe the proper treatment.

The cost of installing the machinery should be capitalized, but the extra month's wages paid to the dismissed employees should not, as this payment did not add any value to the machinery. The extra wages should be charged off immediately as an expense; the wages could be shown as a separate item in the income statement for disclosure purposes.

14. Magilke Industries acquired equipment this year to be used in its operations. The equipment was delivered by the suppliers, installed by Magilke, and placed into operation. Some of it was purchased for cash with discounts available for prompt payment. Some of it was purchased under long-term payment plans for which the interest charges approximated prevailing rates. What costs should Magilke capitalize for the new equipment purchased this year? Explain.

The cost of such assets includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembly and installation costs, and costs of conducting trial runs. Costs thus include all expenditures incurred in acquiring the equipment and preparing it for use. When plant assets are purchased subject to cash discounts for prompt payment, the question of how the discount should be handled arises. The appropriate view is that the discount, whether taken or not, is considered a reduction in the cost of the asset. The rationale for this approach is that the real cost of the asset is the cash or cash equivalent price of the asset. Similarly, assets purchased on long-term payment plans should be accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction.

*25. What is the difference between a conditional and unconditional contribution?

The criteria for evaluating whether contributions are unconditional (and thus recognized immediately in income) or conditional (for which income recognition is deferred) depend on the terms of the gift or grant agreement. The focus is on whether a gift or grant agreement has the following terms. (1) specifies a "barrier or hurdle" that the recipient must overcome to be entitled to the resources. A barrier is the inclusion of a measurable performance requirement such as the degree of completion or specific output or outcome. (2) releases the donor from its obligation to transfer resources (or if assets are advanced, a right to demand their return) if the barrier or hurdle is not achieved. An agreement that contains both is a conditional contribution. An agreement that omits one or both is unconditional.

10. At December 31, 2025, Ashley Co. has outstanding purchase commitments for 150,000 gallons, at $6.20 per gallon, of a raw material to be used in its manufacturing process. The company prices its raw material inventory at cost or market, whichever is lower. Assuming that the market price as of December 31, 2025, is $5.90, how would you treat this situation in the accounts?

The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made [($6.20 - $5.90) × 150,000] = $45,000: Loss on Purchase Commitments.................................................................. 45,000 Estimated Liability on Purchase Commitments................................ 45,000 The entry is made because a loss in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet with an appropriate note indicating the nature and extent of the commitment. This liability indicates the minimum obligation on the commitment contract at the present time—the amount that would have to be forfeited in case of breach of contract.

2. Identify the factors that are relevant in determining the annual depreciation charge, and explain whether these factors are determined objectively or whether they are based on judgment.

The factors relevant in determining the annual depreciation for a depreciable asset are the depreciation base (initial cost less estimated salvage value), estimated useful life, and depreciation method. Assets are typically recorded at their acquisition cost, which is in most cases objectively determinable. But cost assignment in other cases—"basket purchases" and the selection of an implicit interest rate in asset acquisitions under deferred payment plans—may be quite subjective, involving considerable judgment. The salvage value is the estimated amount that a company will receive when the asset is sold or when the asset is retired from service. The estimate is based on judgment and is affected by the length of the useful life of the asset. The useful life is also based on judgment. It involves selecting the "unit" of measure of service life and estimating the number of such units embodied in the asset based on the company's experience with such assets. Such units may be measured in terms of time periods or terms of activity (for example, years or machine hours). When selecting the life, one should select the lower (shorter) of the physical life or the economic life. Physical life involves wear and tear and casualties; economic life involves such things as technological obsolescence and inadequacy. Selecting the depreciation method is generally a judgment decision, but a method may be inherent in the definition adopted for the units of service life, as discussed earlier. For example, if such units are machine hours, the method is a function of the number of machine hours used during each period. A method should be selected that will best measure the portion of services expiring each period. Once a method is selected, it may be objectively applied by using a predetermined, objectively derived formul

What approaches may be employed in applying the LCNRV procedure? Which approach is normally used and why?

The lower-of-cost-or-net realizable value rule may be applied directly to each item, to each category, or to the total of the inventory (or in some cases, to the total of the components of each major category). The method should be the one that most clearly reflects income. The most common practice is to value the inventory on an item-by-item basis. Companies favor the individual item approach because tax requirements in some countries require that an individual item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation on the statement of financial position.

12. How should the amount of interest capitalized be disclosed in the notes to the financial statements? How should interest revenue from temporarily invested excess funds borrowed to finance the construction of assets be accounted for?

The total interest cost incurred during the period should be disclosed, indicating the portion capitalized and the portion charged to expense. Interest revenue from temporarily invested excess funds should not be offset against interest cost when determining the amount of interest to be capitalized. The interest revenue would be reported in the same manner customarily used to report any other interest revenue.

25. An intangible asset with an estimated useful life of 30 years was acquired on January 1, 2015, for $540,000. On January 1, 2025, a review was made of intangible assets and their expected service lives, and it was determined that this asset had an estimated useful life of 30 more years from the date of the review. What is the amount of amortization for this intangible in 2025?

The total life, per revised facts, is 40 years (10 + 30). There are 30 (40 - 10) remaining years for amortization purposes. Original amortization: = $18,000 per year; $18,000 X 10 years expired = $180,000 accumulated amortization. $540,000 original cost -180,000 accumulated amortization $360,000 remaining cost to amortize $360,000 ÷ 30 years = $12,000 amortization for 2025 and years thereafter

1. What are the two main characteristics of intangible assets?

The two main characteristics of intangible assets are: (a) they lack physical existence. (b) they are not a financial instrument.

Explain the rationale for the ceiling and floor in the lower-of-cost-or-market method of valuing inventories.

The upper (ceiling) and lower (floor) limits for the value of the inventory are intended to prevent the inventory from being reported at an amount in excess of the net realizable value or at an amount less than the net realizable value less a normal profit margin. The maximum limitation, not to exceed the net realizable value (ceiling) covers obsolete, damaged, or shopworn material and prevents overstatement of inventories and understatement of the loss in the current period. The minimum limitation deters understatement of inventory and overstatement of the loss in the current period.

Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?

The usual basis for carrying forward the inventory to the next period is cost. Departure from cost is required when the utility of the goods included in the inventory is less than their cost, this loss in utility should be recognized as a loss in the period in which it occurred. Furthermore, the subsequent period should be charged for goods at an amount that measures their expected contribution to that period. In other words, the subsequent period should be charged for inventory at prices no higher than those which would have been paid if the inventory had been obtained at the beginning of that period. In accordance with the foregoing reasoning, the rule of "cost or net realizable value, whichever is lower" may be applied to each item in the inventory, to the total of the components of each major category, or to the total of the inventory, whichever most clearly reflects operations. The rule is usually applied to each item, but if individual inventory items enter into the same category or categories of finished product, alternative procedures are suitable. Mismatch in valuation A company recognizes decreases in the value of the asset and the charge to expense in the period in which the loss in utility occurs—not in the period of sale. On the other hand, it recognizes increases in the value of the asset only at the point of sale. In other words, a company may value the inventory at cost in one year and at market or NRV in the next year. Mismatch in income Net income for the year in which a company takes the loss is lower. Net income of the subsequent period may be higher than normal if the expected reductions in sales price do not materialize. Use of estimates Application of these rules uses "normal profit" or "ordinary" costs to sell or dispose in determining inventory values. Since companies develop t

15. What conditions must exist for the retail inventory method to provide valid results?

The validity of the retail inventory method is dependent upon (1) the composition of the inventory remaining approximately the same at the end of the period as it was during the period, and (2) there being approximately the same rate of markup at the end of the year as was used throughout the period. The retail method, though ordinarily applied on a departmental basis, may be appropriate for the business as a unit if the above conditions are met.

12. What is goodwill? What is a bargain purchase?

Varying approaches are used to define goodwill. They are: (a) Goodwill should be measured initially as the excess of the fair value of the acquisition cost over the fair value of the net assets acquired. This definition is a measurement definition but does not conceptually define goodwill. (b) Goodwill is sometimes defined as one or more unidentified intangible assets and identifiable intangible assets that are not reliably measurable. Examples of elements of goodwill include new channels of distribution, synergies of combining sales forces, and a superior management team. (c) Goodwill may also be defined as the intrinsic value that a business has acquired beyond the mere value of its net assets whether due to the personality of those conducting it, the nature of its location, its reputation, or any other circumstance incidental to the business and tending to make it permanent. Another definition is the capitalized value of the excess of estimated future profits of a business over the rate of return on capital considered normal in the industry. A bargain purchase arises when the fair value of the assets purchased is higher than the cost. This situation may develop from a market imperfection. In this case, the seller would have been better off to sell the assets individually than in total. However, situations do occur (e.g., a forced liquidation or distressed sale due to the death of the company founder), in which the purchase price is less than the value of the identifiable net assets.

Where there is evidence that the utility of inventory goods, as part of their disposal in the ordinary course of business, will be less than cost, what is the proper accounting treatment?

Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current period, and the inventory should be stated at net realizable value in the financial statements.

6. The Buildings account of Postera Inc. includes the following items that were used in determining the basis for depreciating the cost of a building. Organization and promotion expenses. Architect's fees. Interest and taxes during construction. Interest revenue on investments held to fund construction of a building. Do you agree with these charges? If not, how would you deal with each of the items above in the corporation's books and in its annual financial statements?

a) Disagree. Organization and promotion expenses should be expensed. (b) Agree. Architect's fees for plans actually used in the construction of the building should be charged to the building account as part of the cost. (c) Agree. GAAP recommends that avoidable interest or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition or location necessary for its intended use. Interest costs are capitalized starting with the first expenditure related to the asset and capitalization would continue until the asset is substantially completed and ready for its intended use. Property taxes during construction should also be charged to the building account. (d) Disagree. Interest revenue is not considered part of the acquisition cost of the building and should be recorded as revenue.

net realizable value (NRV)

the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation

other valuation approaches

valuation using relative sales value : used when buying varying units in a single lump-sum purchase

Lower of Cost or Market (LCM)

value method works well to measure the decline in value of a company's inventory for most companies the FASB decided to grant an exception to the LCNRV approach for companies that use the LIFO or retail inventory methods.