Chapter 11

Hi-Tech Corp. spent $300,000 on research and development to generate new product lines. Only one of the five product lines resulted in a patented item, while the remaining four were considered unsuccessful. Under U.S. GAAP, how much of the $300,000 should be recognized as an expense?

$300,000

What is included in an asset's acquisition cost?

An asset's acquisition cost includes those expenditures that are reasonable and necessary to bring it to the location and condition for its intended use. The company has to pay sales tax on the asset to purchase it.

Do assets under construction for a company's own use qualify for interest cost capitalization? Explain.

Firms should capitalize the interest charges related to assets constructed or otherwise produced for the firm's own use and assets intended for sale or lease that are constructed or otherwise produced as discrete projects.

What is goodwill and how is it recorded?

Goodwill is an intangible asset representing the value paid for a business in excess of the fair values of the net assets acquired. Its value is created by several factors that are typically difficult to identify and measure, such as product quality, reputation, ability to generate earnings above the industry average, superior management, preferred location, and company training programs. As a result, goodwill is recorded on the consolidated balance sheet only if purchased in a business combination.

How can intangible assets pose some significant valuation problems? Does the determination of useful life for an intangible asset pose a valuation problem? Explain.

How can intangible assets pose some significant valuation problems? Intangible assets are defined as assets without physical substance that have economic value because of the rights they confer upon the holder. A characteristic of an intangible asset is the significant degree of uncertainty regarding its future economic benefit. Does the determination of useful life for an intangible asset pose a valuation problem? No. Useful lives can be estimated for definite or finite life intangible assets.

Under IFS, if borrowed funds are idle and invested in income-generating investments, can firms reduce interest to be capitalized by the amount of interest earned?

If a firm invests idle funds from specific debt in interest-earning assets on a temporary basis, IRS indicates that the firm should offset interest income against the interest capitalized.

Do firms initially record internally created intangibles at cost?

Intangible assets can only be recorded if purchased. However, there are some industry-specific exceptions. For example, there is an exception to the general rule that all R&D must be expensed as incurred in the case of development costs associated with firms that sell or lease software to entities outside the firm.

Is an asset required to have a finite life to be classified as a long-term operating asset?

Intangible assets do not have to have a finite life to be classified as a long-term operating asset. However, tangible fixed assets and definite life intangible assets must have finite lives to be classified as long-term operating assets.

Why is the leasehold account an intangible asset?

Leasehold is the right to use a specific piece of property for a fixed period of time in exchange for a certain payment. The cash payment is viewed as a prepayment of rent. The leasehold payment does not transfer ownership, but it is a requisite payment to complete a lease contract. The amortization of the leasehold is the equivalent of recognizing additional rent expense each period. Therefore, the leasehold has asset value, not because it will provide economic benefit in the typical sense, but because it will not require the use of assets in the future to utilize the asset or the facility.

For a long-lived operating asset acquired by issuing a note payable, do firms measure the initial carrying value of the asset by the face value of the note? Explain.

No. If the face amount of a note does not reasonably represent the present value of the consideration given or received in the exchange, the accountant must determine the proper valuation of the asset.

Do managers capitalize expenditures that they believe have future economic benefits? Why or why not?

One characteristic of an asset is that is represents probable future economic benefits. Because of its uncertainty, some expenditures that are generally believed to have future economic benefits are expensed, like advertising or research. They do not meet the characteristic of an asset in that the future economic benefit is not probable.

Haply, Inc. incurred the following expenditures when acquiring a new assembly machine: Additionally, Haply sold its old assembly machine for $500. What is the acquisition cost of the new assembly machine?

The acquisition cost of the assembly machine is $189.000

How does a company record natural resources?

The cost of a natural resource consists of acquisition cost, development costs, exploration costs and restoration costs. Some of these assets can be moved and used in alternate locations. If "movable", the asset can be accounted for independently of the natural resource.

Rachel Corporation is constructing a new wind power-generating facility. Construction began on January 2 and was completed on December 31 of the current year. Rachel made the following expenditures during the year: To specifically finance the project, Rachel issued $3,100,000 of 2-year, 9% notes payable on January 2. Interest is payable annually on December 31 each year. It earned interest income of $3,500 from investing the proceeds of the note during the year. What amount of interest can Rachel capitalize during the year assuming that Rachel Corporation reports under IRS?

The interest to be capitalized is $275,500

Under IFS, when depreciating an asset, do managers have to estimate the useful life and salvage value for all components of the asset? Explain.

Yes. IRS requires the use of component depreciation for each component that is significant in relation to the asset's total cost. U.S. GAP allows component depreciation, but it is seldom used.

Does a firm acquiring a long-lived operating asset by issuing a note payable record the finance charges and asset value separately? Explain.

Yes. When a note is exchanged for a plant asset, the asset's value and finance charges must be reported and accounted for separately. Separating the asset value from the finance charges is critical for proper expense classification on the income statement. In addition, if the finance charge is not separated from the acquisition cost, it could result in overstating the asset's carrying value on the balance sheet.