Prin. of Fin. Acc. Ch. 8 Practice Questions

Define deferred taxes. Where does the account Deferred Taxes appear in the financial statements?

- Deferred income taxes are taxes that will be paid in future years that result from different accounting methods being used for financial statement reporting and income tax reporting. - Deferred income taxes are generally shown as a liability on the balance sheet.

List several common intangible assets. How is the life determined that is to be used to compute authorization?

- Some of the most common intangible assets include patents, copyrights, and goodwill. - Amortization is generally based on the legal life of the asset, the useful life of the asset, or, in the case of goodwill, the amount of any impairment. ->The asset is generally amortized over the shortest of these possible lives. The period over which an intangible asset can be amortized for tax purposes is generally determined according to terms specified by tax law. Goodwill is not amortized for financial statement purposes but is amortizable for income tax reporting purposes. These terms are generally different from those used for financial accounting.

When a long-term operational asset is sold at a gain, how is the balance sheet affected? Is the statement of cash flows affected? If so, how?

- Total assets and equity increase by the amount of the gain. - The total amount of cash received is shown as a cash inflow in the investing section of the statement of cash flows.

Why may it be necessary to revise the estimated life of a plant asset? When the estimated life is revised, does it affect the amount of depreciation per year? Why or why not?

- When an asset is purchased and put into service, an estimate is made of the expected useful life of the asset. - However, as the asset is used, it may become apparent that the estimate was incorrect or circumstances may have changed (e.g., the asset is used more than expected) to cause the estimate to be incorrect. - The revised estimated useful life will affect the amount of depreciation per year. If the estimated life is longer than originally expected, the amount of depreciation per year will decrease; if the estimated useful life is shorter than originally expected, the amount of depreciation per year will be larger.

Assume that a piece of equipment costs $5,000 and has accumulated depreciation recorded of $3,000. What is the book value of the equipment? Is the book value equal to the fair market value of the equipment? Explain.

-Book value is computed as the: cost of an asset - the accumulated depreciation of that equipment, $5,000 -$3,000 = $2,000. -This does not represent the fair market value of the equipment because the accumulated depreciation is only an allocation of the cost based on estimates.

Define depletion. What is the most commonly used method of computing depletion?

-Depletion is the process of systematically allocating the cost of natural resources to expense based on estimated production of the asset. -Units-of-Production

The prescribed method of MACRS uses, in most cases, the __________ switching to _________ in the later years.

-Double-declining balance method -Straight-line

List some differences between the U.S. GAAP and IFRS for long-term operational assets.

-In Britain, any purchased goodwill is charged to retained earnings in the year of the purchase, while in the U.S., goodwill is set up as an asset. -Japanese accounting principles report research and development expenses differently from the U.S. GAAP. In Japan, R&D is set up as an asset and expensed over a period of time, whereas, in the US, R&D is expensed in the year incurred

Is land a depreciable asset? Why or why not?

-Land is not a depreciable asset because land has an infinite life. -Land is not destroyed by its use. Natural resources can be removed but the land will remain. When land and natural resources are purchased together, the cost of each must be accounted for separately.

Explain MACRS depreciation. When is its use appropriate?

-MACRS, Modified Accelerated Cost Recovery System, is the prescribed method to be used for tax purposes.

What different kinds of expenditures might be included in the recorded cost of a building?

-The cost of a building includes the amount paid for the building plus any amounts that are paid to put it to its intended use. -Some common costs include the purchase price, title search fee, legal fees, sales commissions, remodeling, and improvements.

Explain the historical cost concept as it applies to long-term operational assets.

-The historical cost concept requires that long-term operational assets be recorded at the amount paid for them. -This is the amount that will be shown on the balance sheet as long as the asset is owned.

Does the method of depreciation required to be used for tax purposes reflect the use of a piece of equipment? Can you use double-declining-balance depreciation for tax purposes?

-The method required for tax purposes, MACRS, does not necessarily reflect the use of the asset. -For most properties, MACRS is based on the double-declining balance method, switching to a straight line later on. Generally, other methods may not be used for tax purposes.

Does the recognition of depreciation expenses affect cash flows? Why or why not?

-The recognition of depreciation expense does not affect cash flows. ->Depreciation recognition is simply the allocation of part of a previously acquired asset to expense.

MalMax purchased a depreciable asset. What would be the difference in total assets at the end of the first year if MalMax chooses straight-line depreciation vs. double-declining-balance depreciation?

-Total assets will be lower at the end of the first year of the asset's life if MalMax chooses the double-declining-balance method of computing depreciation rather than straight-line. ->This results because more expense is recognized in the early years of an asset's life, total assets will be the same regardless of the method chosen because the amount of total depreciation recognized over the asset's life is the same regardless of the depreciation method chosen.

When a basket purchase is made, how is cost assigned to individual assets?

-When a group of assets are purchased together, the purchase price must be allocated among the different assets. -One of the more common methods of making the allocation is the relative fair market value method. The fair market value of each asset is determined and then its ratio to the total fair market value of all assets is applied to the total purchase price.

Why is depreciation that has been recognized over the life of an asset shown in a contra account? Why not just reduce the asset account?

-it allows the total cost of the asset and the total amount expensed to be shown in the accounts and on the balance sheet. -This provides more information to the reader of the financial statements, e.g., some judgement can be made about the age and use of the asset. The use of the contra account is also required by GAAP.

What effect does the recognition of depreciation expense have on total assets? On total stockholders' equity?

-reduces total assets -equity is decreased

How are capital expenditures made to improve the quality of a capital asset accounted for? Would the answer change if the expenditure extended the life of the asset but did not improve quality? Explain.

-this improvement is accounted for as if a new asset is purchased; the equipment account is debited. The improvement is depreciated over the remaining life of the original asset since the life of the asset is not extended; only the quality is improved. - This expenditure in effect reduces some of the depreciation already taken on the asset. This is accomplished by reducing the accumulated depreciation account (a debit to accumulated depreciation). ->Depreciation is recalculated by spreading the remaining book value, reduced by salvage value, over the remaining estimated life of the asset.

Define depreciation. What kind of asset depreciates?

1) Depreciation is the systematic allocation of the cost of property, plant and equipment to the accounting periods over which they are to be used. -Some examples of assets that are depreciated include buildings, machinery, and office equipment.

Explain the straight-line, units of production, and double-declining-balance depreciation. When is it appropriate to use each of these depreciation methods?

1) Straight-line: This method allocates an equal amount of depreciation to each period over the useful life of the asset. 2) Units-of-Production: Depreciation is calculated in direct proportion to the number of units produced during the accounting period. 3) Double-Declining-Balance: produces larger amounts of expense in the early years, and smaller expense in the later.

What is the difference between tangible and intangible assets? Give an example of each.

1) Tangible assets are those assets that have a physical existence. Some examples include buildings and equipment. 2) Intangible assets are those assets that represent some rights and privileges associated with owning the asset. Some examples include copyrights, leases, and trademarks.

What is the difference between goodwill and specifically identifiable intangible assets?

1)Specifically identifiable intangible assets are those assets that are purchased for a specific value or have a known value. ->Examples include patents, leases, and copyrights. 2) Intangible assets that are not specifically identifiable are those acquired as part of the acquisition of a whole business or group of assets. The value of these assets is determined by the excess of the purchase price of the group over the value of the specifically identifiable assets acquired. ->The most common assets in this group include goodwill and covenants not to compete.

What is a basket purchase of assets?

A basket purchase of assets is the purchase of a group of assets for a single purchase price.

What type of account (classification) is Accumulated Depreciation?

Accumulated depreciation is a contra asset account.

Define amortization. What kinds of assets are amortized?

Amortization is the systematic allocation of the cost of intangible assets over their estimated useful lives.

Why is the book value of an asset likely to be different from the current fair market value of the asset?

As time passes the asset may increase or decline in value, but this change is not reflected on the books of the company. However, the historical cost of assets may be reduced by depreciation over their lives.

Why is it called the Double-Declining-Balance Method?

It is called double-declining balance because the method applies twice the straight-line rate to the book value of the asset.

What is the difference between the functions of long-term operational assets, and investments?

Long-term operational assets are those assets that are used by a business to generate revenue. In contrast, investments are simply held for the production of interest and dividends and/or for price appreciation.

Why do you think natural resources are called wasting assets?

Natural resources are assets that are produced by nature. -Some examples include oil, coal, minerals, timber, etc. They are called wasting assets because their value "wastes away" as the resources are removed from the earth.

What is salvage value?

Salvage value is the estimated value of a plant asset at the end of its useful life to the business

How do differences in expense recognition and industry characteristics affect financial performance measures?

Some industries are very capital intensive while others are labor intensive. ->When evaluating managerial performance, one must understand the industry that a company is in and compare within the industry.

What is one of the more common methods of making the allocation among different assets in a basket purchase?

The fair market value method The fair market value of each asset is determined and then its ratio to the total fair market value of all assets is applied to the total purchase price.

What are the stages in the life cycle of a long-term operational asset?

The life cycle of a long-term operational asset simply describes the process of acquiring, using, and retiring the asset. This process includes obtaining the funding to acquire the asset, acquiring the asset, using the asset, and disposing of the asset.

Why would a company choose to depreciate one piece of equipment using the double-declining-balance method and another piece of equipment using straight-line depreciation.

The method of depreciation chosen should represent as closely as possible the pattern of usage of that piece of equipment. ->For instance, double-declining balance may be used for an asset that will decline in usefulness more in the early years of the life of the piece of equipment. ->Straight-line depreciation should be used when the asset's usefulness declines at a constant rate.

John Smith mistakenly expensed the cost of a long-term tangible fixed asset. Specifically, he charged the cost of a truck to a delivery expense account. How will this error affect the income statement and the balance sheet in the year the mistake was made?

When the total cost of an asset is expensed in the year acquired, total expense will be overstated and net income will be understated.

How is the book value of an asset determined?

historical cost - any accumulated depreciation.