Accounting Chapter 11

Q 11.32: The depletion base includes both intangible development costs and restoration costs. A True B False

A True

Q 11.14: On January 1, 2007, Menzel Industries purchased a machine for $120,000. At that time, Menzel estimated that the machine had a 20-year useful life and a $12,000 salvage value. On July 1, 2017, Menzel reviewed the machine's potential, determining that its undiscounted future net cash flows totaled $60,000 and its discounted future net cash flows totaled $45,000. Menzel has no plans to dispose of the machine, in part because no active market exists for it. Assuming that Menzel uses straight-line depreciation, Menzel should record an impairment loss of $_______ related to the machine on July 1, 2017. A $18,300 B $6,700 C $8,300 D $3,300

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

Q 11.8: Huckle Corporation owns just one piece of manufacturing machinery. Each year, the firm sets aside an amount of cash equal to the depreciation expense on that machine. When the machine is completely depreciated, Huckle plans to use the money in the cash fund to buy a new machine. What must happen in order for Huckle to carry out this plan? A Equipment prices must remain reasonably constant during the life of Huckle's current machine. B Equipment prices must rise throughout the life of Huckle's current machine. C Huckle must use the retirement depreciation method. D Huckle must use an accelerated depreciation method.

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

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

A I, III, and IV.

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

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

Q 11.24: Estimating future net cash flows expected from the use of an asset and its eventual disposal is the first step in determining whether an asset is impaired. A True B False

A True

Q 11.9: Which of the following statements accurately describes composite or group depreciation? A With composite or group depreciation, a straight-line rate is computed by dividing the total of the annual depreciation expense for all assets in the group by the total cost of the assets. B With composite or group depreciation, 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 With composite or group depreciation, the years of useful life of the various assets in the group are added together, then the total is divided by the number of items. D With composite or group depreciation, the cost of the individual units within an asset group is charged to expense in the year a unit is retired from service.

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

Q 11.4: When using the activity method, depreciation is treated as A a function of productivity but not the passage of time. B a function of the passage of time but not productivity. C a function of both productivity and the passage of time. D a function of neither the passage of time nor productivity.

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

Q 11.22: If you divide a firm's net sales by its average total assets, you have calculated the firm's A asset turnover ratio. B return on investment. C rate of return on assets. D profit margin on sales.

A asset turnover ratio.

Q 11.25: What are intangible development costs? A costs that are needed for the production of a natural resource, such as drilling costs, that do not result in a physical asset such as equipment B costs that are associated with but not required for the production of a natural resource, such as restoration costs C costs associated with exploring a property to find a natural resource D costs, such as royalty payments, that are required for developing a natural resource in certain situations

A costs that are needed for the production of a natural resource, such as drilling costs, that do not result in a physical asset such as equipment

Q 11.17: Daylight Corporation recently bought a tract of land that contains large amounts of an extractable natural resource. Per its purchase contract, Daylight must restore the land to a condition suitable for recreational use once it is done extracting the resource. Daylight estimates that the land contains 4 million tons of recoverable reserves. It also estimates that, after restoration, the land will have a value of $700,000. Other cost information is as follows: Land $6,800,000 Restoration 1,100,000 Geological surveys 1,000,000 Daylight maintains no inventory of extracted material. Given this information, the firm should charge _______ to depletion expense per ton of material extracted. A $1.80 B $2.05 C $2.23 D $1.78

B $2.05 Depletion cost per unit equals the difference between total cost and salvage value divided by total units available. Here, the total cost means the cost of the land purchase ($6,800,000) plus the restoration cost ($1,100,000) plus the survey cost ($1,000,000). Thus, we arrive at total costs of $8,900,000. After subtracting the $700,000 salvage cost, we get a result of $8,200,000. Dividing this by 4 million tons gives a result of $2.05 per ton.

Q 11.18: On May 1, 2008, Thayer Corporation bought a new machine for $39,000. At that time, the company estimated that the machine had a 10-year useful life and an estimated salvage value of $3,000. Thayer later sold the machine on March 1, 2017, for $1,800. If Thayer recorded monthly depreciation on the machine using the straight-line method, it should recognize a loss of ______ on the sale. A $2,750 B $5,400 C $8,400 D $4,800

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

Q 11.2: In what way does an asset's service life differ from its physical life? A Calculation of an asset's service life includes consideration of the asset's salvage value, while calculation of its physical life does not. B An asset's service life is the time an asset will be used by a company, while its physical life is how long the asset will last. C An asset's service life is the length of time an asset is of use to its original owner, while its physical life is how long the asset will be used by its all owners. D An asset's service life is always longer than its physical life.

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

Q 11.36: Depletion is normally calculated on a straight-line basis. A True B False

B False

Q 11.37: Under what circumstances does the IFRS allow restoration of an impairment loss on a tangible asset? A If the asset is being held for use or disposal. B If the asset is being held for disposal. C If the asset is being held for use. D If the asset has already been disposed of.

B If the asset is being held for disposal.

Q 11.33: Under which of the following circumstances has impairment of property, plant, or equipment occurred? A If the revised estimated useful life is less than the original estimated useful life. B If the expected future net cash flows are less than the asset's carrying value. C If the estimated salvage value is less than the actual proceeds received on disposal. D If the expected future cash outflows exceeds the asset's carrying value.

B If the expected future net cash flows are less than the asset's carrying value.

Q 11.35: Which of the following is true of depletion expense? A It includes tangible equipment costs in the depletion base. B It is usually part of cost of goods sold. C It excludes restoration costs from the depletion base. D It excludes intangible development costs from the depletion base.

B It is usually part of cost of goods sold.

Q 11.3: Which of the following is an economic factor related to an asset's service life? A Decay B Wear and tear C Obsolescence D Unexpected casualties

C Obsolescence

Q 11.26: Which of the following is not included in the total cost of natural resources? A Exploration costs. B Intangible development costs. C Tangible equipment costs D Restoration costs.

C Tangible equipment costs

Q 11.11: Every year, Hercules Inc. has invested an increasing amount in manufacturing equipment. Given that there are a large number of relatively inexpensive machines and all the machines have relatively similar useful lives, Hercules has depreciated the machinery as a group at a uniform rate using the straight-line method. Over time, the ratio of the group's total accumulated depreciation to the total cost of the machinery has increased steadily. Currently, the ratio stands at 0.75 to 1. What is the most likely reason for this increasing ratio? A Hercules has been retiring fully depreciated machinery that should have remained in service. B The estimated average useful life of Hercules' machinery is less than its actual average useful life. C The estimated average useful life of Hercules' machinery is greater than its actual average useful life. D The estimated average useful life of Hercules' machinery is equal to its actual average useful life.

B The estimated average useful life of Hercules' machinery is less than its actual average useful life. Even though the firm is spending slightly more on equipment each year, its ratio of accumulated depreciation to total cost should remain constant, because the increase in total cost should lead to a proportional increase in accumulated depreciation. This, of course, assumes that the firm is accurately estimating the useful life of its machinery. An increase in the accumulated-depreciation-to-total cost ratio suggests that the firm is accumulating depreciation faster than it spends money on new machinery. This in turn suggests that the firm is able to use the machines for a period longer than their estimated average useful lives.

Q 11.30: Which of the following is the most common method of recording depletion for accounting purposes? A The decreasing charge method B The units-of-production method C The percentage depletion method D The straight-line method

B The units-of-production method

Q 11.21: If you want to know how many dollars of sales were produced by each dollar that a firm has invested in assets, you should calculate the firm's A profit margin on assets. B asset turnover ratio. C return on assets ratio. D profit margin on sales.

B asset turnover ratio.

Q 11.28: The recoverability test is used to determine A if an asset's market value has increased. B if asset impairment has occurred. C the salvage value of an asset. D if an asset's useful life has changed.

B if asset impairment has occurred.

Q 11.23: The undiscounted future net cash flows should be used in the A calculation of loss on impairment. B recoverability test for impairment. C fair value test for impairment. D calculation of gain from asset use.

B recoverability test for impairment.

Q 11.10: In 2007, Norbert Incorporated bought a new tooling machine for $45,000. Norbert estimated that the machine had a useful life of 15 years with no salvage value, and it decided to depreciate the machine using the straight-line method. In January 2017, after the machine had been in use for 10 years, Norbert paid $12,000 to completely overhaul the machine. It did so with the expectation that the overhaul would extend the machine's useful life by an additional 5 years. Given this information, Norbert should record a 2017 depreciation expense of _______ for the machine. A $2,500 B $2,850 C $2,700 D $3,000

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

Q 11.19: In January 2017, Expo Mining Company paid $4,400,000 to buy a new mine. Expo estimates it will be able to remove 4,000,000 tons of ore from the mine. It also estimates that the property will be worth $300,000 after the ore has been extracted. Expo incurred a total of $900,000 in development costs when preparing the mine for production. In the mine's first year of operation (2017), Expo removed 500,000 tons of ore and was able to sell 475,000 tons. Given this information, Expo should record total 2017 depletion cost of A $662,500 B $629,375 C $625,000 D $593,750

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

Q 11.7: Alpha Corporation and Beta Corporation have just purchased identical pieces of equipment. Each firm estimates that the equipment will have a 5-year service life and no salvage value. Alpha depreciates all of its assets using the straight-line method, whereas Beta depreciates its assets using the sum-of-the-years'-digits method; otherwise, the two firms are identical in every way. Given this information, which of the following statements is accurate? A Alpha's depreciation expense will be higher than Beta's during the first year of the equipment's service life. B If both firms sell the equipment after 3 years, Alpha is more likely to report a gain on the transaction than Beta. C Alpha's net income will be lower than Beta's during the fourth year of the equipment's service life. D If both firms keep the equipment for 5 years, Alpha's five-year total for depreciation expense will be lower than Beta's.

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

Q 11.40: When preparing its financial statements, a firm should include which of the following disclosures? I. The firm's depreciation expense for the period. II. The firm's accumulated depreciation. III. Balances of major classes of depreciable assets. IV. Details demonstrating how depreciation was calculated. A I, II and IV. B I, III and IV. C I, II and III. D II, III and IV.

C I, II and III.

Q 11.13: How should a firm record an impairment in the value of property, plant, or equipment? A It should record neither a loss nor a reduction in the asset's book value. B It should record a loss but not a reduction in the asset's book value. C It should record both a loss and a reduction in the asset's book value. D It should record a reduction in the asset's book value but not a loss.

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

Q 11.15: On December 31, 2016, Albert Corporation owned a piece of equipment with a carrying amount of $400,000, which the firm wrote down to its $350,000 fair value. As of December 31, 2017, Albert determined the equipment's fair value had risen to $420,000. Albert has no plans to dispose of the equipment. Given this information, which of the following statements is accurate? A The equipment should reflect the new cost basis of $400,000. B The equipment should reflect the new cost basis of $370,000. C The carrying amount of the equipment should decrease by the depreciation expense taken in 2017. D The equipment should reflect the new cost basis of $420,000.

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

Q 11.27: What is a natural resource? A an asset with no tangible value that occurs in nature B an asset whose entire value is determined by its natural surroundings C an asset that is completely consumed or removed and can only be replaced by an act of nature D an asset that is renewable and provides clean energy

C an asset that is completely consumed or removed and can only be replaced by an act of nature

Q 11.31: A firm's asset turnover ratio reveals how many dollars of A income was produced by each dollar invested in assets. B sales were produced by each dollar of income. C sales were produced by each dollar invested in assets. D income was produced by each dollar of sales.

C sales were produced by each dollar invested in assets.

Q 11.1: In the field of accounting, the term "depreciation" refers to A a 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 a method of allocating asset cost to an expense account in a manner which closely matches the physical deterioration of the tangible asset involved. C 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. D the process of charging the decline in value of an economic resource to income in the period in which the benefit occurred.

C 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.

Q 11.12: Baker Industries originally estimated the useful life of one of its buildings to be 50 years. Now, after the building has been depreciated for 30 years, Baker has revised its remaining life to just 10 years. How should Baker's accountant respond to this revision? A The accountant should adjust the building's 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. B The accountant should adjust the building's 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. C The accountant should depreciate the building's remaining book value over 20 years. D The accountant should depreciate the building's remaining book value over 10 years.

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

Q 11.6: If you do not consider salvage value when computing depreciation expense to be taken on an asset, you must be using the A sum-of-years'-digits method of depreciation. B straight-line method of depreciation. C activity or production method of depreciation. D declining-balance method of depreciation.

D declining-balance method of depreciation.

Q 11.34: Taylor uses a depreciation method that has elements of both the straight-line method and the activity approach. What type of depreciation method is Taylor using? A unit method B group method C composite approach D hybrid method

D hybrid method

Q 11.16: A firm has several costs related to the development of natural resources. Of these costs, all of the following should be considered a part of depletion cost except A the acquisition cost of the natural resource deposit. B intangible development costs, such as drilling costs and costs associated with tunnels and shafts. C exploration costs. D tangible equipment costs associated with machinery used to extract the natural resource.

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

Q 11.39: In the recoverability test, the estimated value of future cash flows should be A impaired. B discounted. C unimpaired. D undiscounted.

D undiscounted.