Chapter 11 HW Solutions

CHAPTER 11
Investing Activities
THINKING BEYOND THE QUESTION How do we account for investing activities? Investing is necessary for a company to grow. Good investments provide resources that a company can use to produce and sell additional products. These sales lead to higher revenues. Good investments produce profits because the company produces and sells products that are demanded by customers and produces the products efficiently. Higher profits result in higher value for a company and its stockholders. Bad investments result when a company acquires assets that it does not need or is not capable of managing effectively. A company can expand into new product or customer markets that it does not understand, or it can grow more rapidly than demand for its products. Assets acquired from these investments may not result in additional revenues or may result in additional expenses that are higher than additional revenues. QUESTIONS Q11-1 The primary types of assets Archer would include in its accounting system are: a. Current assets: those assets management expects to convert to cash or consume during the next fiscal year. i. Cash and short-term marketable securities: highly liquid resources that are ready sources of cash and that management expects to convert to cash during the next year. ii. Accounts and notes receivable: amounts due from customers that the company expects to collect in the next year. iii. Inventories: materials used in production and goods the company expects to sell in the next year. iv. Prepaid expenses: amounts paid for insurance, taxes, and other items that will be consumed during the coming year. b. Long-term assets: those assets that management does not expect to convert to cash or consume during the next fiscal year. i. Property, plant, and equipment: physical assets used by the company in the production, distribution, and sale of goods and in the general management of the company. (continued)
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ii. Long-term investments: bonds, stocks, and other securities of other companies that management does not plan to sell during the next year. iii. Intangible assets: legal rights and other nonphysical assets acquired by a company that are assumed to have long-term benefits. Q11-2 The gross amount of property, plant, and equipment is the original cost paid to acquire those assets. The net amount of property, plant, and equipment is the amount remaining after accumulated depreciation has been subtracted from original cost. Another term for net property, plant, and equipment is book value. Q11-3 Student responses will vary. Some students will note that interest is the cost of renting money. It is a period cost that is traceable to a given period and should be expensed on the income statement during that period. Others will observe that if interest isnt always part of the cost of obtaining an asset, it shouldnt ever be. To do so would be inconsistent. Many students, however, will observe that the cost of a self-constructed asset includes the cost of all resources consumed in building it. This includes labor, materials, and financing. If the services of financing are consumed in building an asset, the cost of the asset should include the cost of financing. Q11-4 This statement is not true. Sometimes the units-of-production method will lead to faster depreciation than straight-line and sometimes it will lead to slower depreciation. It all depends on the usage of the asset. If usage of the asset is greater than average early in its life, the depreciation will be greater in the early years than it would be under the straight-line method. On the other hand, if usage is less than average in the early years, the depreciation will be less than under the straight-line method. Q11-5 A capital expenditure is one in which new plant assets are acquired or in which the expected useful life or value of a plant asset is enhanced. Capital expenditures are recorded as assets because they create future economic benefits. An operating expenditure is a cost to repair or maintain a plant asset; one that does not enhance either the expected useful life or value of the asset. Operating expenditures are recorded as expenses because they are associated with the use or consumption of an asset. Q11-6 In a way the friend is correct. The terms depletion and depreciation both describe the process of allocating a portion of an assets cost to expense each period of the assets useful life. In this way, both terms describe the same process. What differentiates the terms, however, is that they are used to describe this process for different classes of assets. Depletion is
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the term used to describe the consumption (or using up) of natural resource assets. Depreciation is the term used to describe the consumption (or using up) of plant assets. Q11-7 Depletion arises when a natural resource is consumed or used up. In most cases, it arises when the natural resource is harvested. For example, ore is taken from a mine, oil is pumped from a well, or gravel is taken from a gravel pit. In all of these cases, the cost of depletion becomes part of the cost of the product. In effect, the cost of depletion becomes part of the cost of inventory: be it ore, oil, or gravel. The cost of depletion is stored on the balance sheet as part of the cost of inventory until the inventory is sold. At that point, the depletion cost (and all other costs of production) are released to the income statement and reported under the category of Cost of Goods Sold. Q11-8 The problem with using market value (for most classes of assets) is obtaining a reasonable estimate of market value at each balance sheet date. For example, what is the market value on a given balance sheet date for the Empire State Building? Or for a patent, or machinery in the factory? At best, the estimates of market value would have to be educated guesses: either because the asset is one of a kind, or because there is no active market for assets of that type. Its not that these assets couldnt be sold. Its that the price they would sell for is anybodys guess. The case of marketable securities is very different. These securities trade every day on U.S. and foreign exchanges. The items are homogeneous (every share is exactly the same as every other share) and there are many buyers and many sellers. Therefore, the price at which securities sell on a given day is a reasonable and reliable estimate of what they are worth. There is an active market for these assets. For other assets this is not always the case. Q11-9 Investments in the securities of other firms (e.g., stocks, bonds, certificates of deposit, notes) are classified on a balance sheet according to managements intention for holding the item. If the investment was made to earn a return on a temporary surplus of cash, the investment is reported as a current asset. This is because management expects to turn the investment back into cash as soon as the cash is needed. If the investment was made for a long-term purpose, such as to establish a long-term relationship with the other firm, the investment is reported as a long-term asset. In this case, management intends to hold the investment indefinitely. Using this classification approach helps users of financial statements better understand which resources are available for immediate conversion to cash and which are not.
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Q11-10 When marketable securities are held as trading securities it means that the company routinely sells securities as part of its primary business. In fact, they are more like inventory than investments. The securities are a current asset and expected to be sold soon. Therefore, it is appropriate that the unrealized gain or loss be reported as part of net income because it is a useful estimate of what will occur when the securities are actually sold. In this way, users of the financial statements are given early notification of likely future events. When marketable securities are held as available-for-sale securities, there is no specific plan of disposal. The securities might be sold soon or it might be years before sale. In this case, it is appropriate that the unrealized gain or loss not flow through the income statement. This avoids having net income bounce up and down in reaction to stock market swings during the period that availablefor-sale securities are held. Instead, holding gains or losses are stored on the balance sheet as part of stockholders equity until the securities are sold. At the date of sale, the net unrealized holding gain or loss is canceled and the actual realized gain or loss is reported. Q11-11 Marketable securities and intangible assets have very different characteristics. It is these differences that cause them to be reported using different valuation methods. First, marketable securities are homogeneous in that every share of XYZ Corp.s common stock is an exact duplicate of every other share of XYZ common stock. By their very nature, intangible assets are heterogeneous or unique. For example, patents, copyrights, and trademarks are all unique. Each has a different value from all other patents or copyrights or trademarks. Clearly goodwill (and its value) is an asset that is unique to the company reporting it. Second, there is an active market for the sale of marketable securities that is much broader and deeper than any such market for intangible assets. For some intangibles, such as goodwill, there is no market at all. For these reasons, any attempt to use market value as the reporting basis for intangible assets would have to rely on estimates, assumptions, and guesses rather than actual market transactions. This would make the numbers unreliable. Q11-12 Goodwill arises when one company buys another at a price in excess of the market value of the second companys identifiable net assets. The amount of goodwill recorded is equal to the difference between the price paid and fair value of identifiable net assets acquired. Goodwill represents the extra value or extra earning power that is acquired over and above the value of the net assets. Payment for goodwill presumes that the acquired company is worth more than the mere sum of its net assets. It presumes that the company name, reputation, employees, loyal customers, etc., will allow the acquiring firm to earn a greater return than if it simply went out and reproduced the individual assets it is acquiring. It is the extra value obtained by acquiring an intact, operating firm. One
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caution: sometimes companies get into bidding wars for a given target company and the winner ends up paying more than is reasonable. The entire premium paid by the buyer gets recorded as goodwill. Q11-13 The effects of this transaction will show up in two places on the next statement of cash flows. First, the gain on sale ($25,800) will be reported in the operating activities section as a deduction from net income. The $25,800 gain was included as part of net income but was not the result of an operating activity. Instead, the $25,800 gain is related to an investing activity, the disposal of the land. Therefore, all cash received from the disposal of land (recovery of $40,000 cost + $25,800 gain = $65,800) must be reported in the investing activities section. If the gain is not deducted from net income in the operating activities section, it will be double counted. Q11-14 Accounting information identifies the amounts of assets that a company has recorded. These amounts and other records about a companys assets provide a benchmark against which actual assets can be compared. For example, if accounting records indicate a cash balance of $30,000, an actual count of cash should result in $30,000. Inspection of other assets, such as inventory, investments, and plant assets, should reveal those items for which accounting records exist. Inspections and comparisons with accounting information can reveal whether a company has control over its assets. Theft and mismanagement are common problems for many assets, especially those that are easily stolen or lost, such as cash, securities, inventories, and small tools and equipment. Having good records and comparing these with actual assets on a regular basis can reveal security problems and help identify those responsible for these problems. Accounting controls should be used along with physical controls to safeguard assets.
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EXERCISES E11-1 Definitions of all terms are listed in the glossary. E11-2 Long-Term Deep Drillers, Assets Section of Balance At Year-End $ 195,600 Inc. Sheet
Investments: Investment in Susanna Company Property, Plant, and Equipment: Building $160,000 Drilling Equipment 230,000 Storage Tanks 90,000 Accumulated Depreciation (40,000) Oil Wells Accumulated Depletion Construction in Process Land Intangible Assets: Trademark Goodwill Total Long-Term Assets E11-3 a. $500,500 (15,000)
440,000 485,500 56,300 120,000 4,000 10,000 $1,311,400
Intangible assets: A long-term asset category including items such as patents, copyrights, trademarks, and goodwill These assets are reported at their original cost less the cumulative amount of amortization to date, except goodwill, which is reported at cost or lower if impaired. Inventories: A current asset composed of items that are being held for sale to customers The inventory of a grocery store would include bread and cheese. The inventory of a car manufacturer would include tires, radiators, and seats. Inventories are reported at their cost.* *In Chapter 13 there is coverage of valuing inventory at lower of cost or market.
b.
c.
Investment in marketable securities: a current or long-term asset, depending on the holding period intended by management This classification includes holdings of preferred stock, common stock, bonds, or notes of other corporations. In general, such investments are reported at fair market value. Special reporting rules apply when debt securities are expected to be held to their maturity or if a large portion of a companys common stock is held.
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d.
Property, plant, and equipment: A long-term asset including such items as trucks, buildings, machinery, and equipment These items are reported at cost minus accumulated depreciation. This amount is called book value. Accounts receivable: A current asset comprised of the amount owed to the firm by all customers Accounts receivable is reported at the amount expected to be collected, which recognizes that some customers will refuse, or be unable, to pay. (h) Common stock of Flower Corporation (l) Investment in bonds of Beech Brothers, Inc. (a) (c) (e) (j) (d) (k) (f) (g)
e.
E11-4
Long-term investments: Property, plant, and equipment:
Machinery, net Land Processing plant, net Standby equipment, net Intangible assets: Patents Goodwill Other long-term assets: Obsolete equipment awaiting sale, net Prepaid insurance (the portion not expiring within the next year) Note: (b) Office supplies and (i) Cash are not part of long-term assets. E11-5 Depreciation Method Straight-line Double-declining balance Units-of-production Depreciation Expense $42,857 $85,714 $96,000 Computations ($300,000 7 years = $42,857) ($300,000 2/7 = $85,714) ($300,000 [80,000 units 250,000 units] = $96,000)
The choice of one depreciation method over another can have a significant effect on the financial statements, particularly the income statement. Net income is computed below under each of the three depreciation methods that might have been used. Units-ofStraightDDB Production Line Method Method Method $ 376,300 $ 376,300 $376,300 (225,492) (225,492) (225,492) (96,000) (42,857) (85,714) $ 54,808 $ 107,951 $ 65,094 (continued)
Income Statements Revenues All expenses (except for depreciation) Depreciation expense Net income
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Depending on the depreciation method chosen, the net income reported for the period would vary widely. E11-6 Financial Reporting Purposes $4,186,000 2,478,000 Tax Purposes $4,186,000 3,500,000 $ 686,000 $7,200,000 686,000 $6,514,000
Calculation of Gain on Sale Original cost Less: Straight-line depreciation to date ($10,500 @ 236 months) Accelerated depreciation to date Book value at date of sale Selling price Less: Book value Gain on sale of building (a, b)
$1,708,000 $7,200,000 1,708,000 $5,492,000
Companies typically use straight-line depreciation for financial reporting purposes to minimize the effect of depreciation on net income. Accelerated methods result in larger amounts of depreciation expense for tax purposes in the early years of asset lives. Therefore, cash outflow for taxes is reduced because of the lower amount of taxable income than if straight-line depreciation were used. In later years, a company incurs higher cash outflows for taxes because accelerated methods produce lower depreciation expense than the straight-line method. If an asset is sold, a larger amount of taxable profit will be reported than the profit reported for financial reporting purposes. If tax rates remain constant, the effect on cash outflow for taxes over the life of an asset will be the same regardless of which method is used. The timing of the cash flows is affected, however. By delaying the outflows, a company can invest the cash it saves in other productive assets and earn a return on this investment until the cash is needed to pay taxes. Thus, a company is better off if it can delay tax payments by recording higher amounts of depreciation in the early years of an assets life. E11-7 a. Cost of equipment $ 480,000 Less: Depreciation per year [($480,000 $30,000) 8 years = $56,250] Accumulated depreciation total over 5 years 281,250 Book value on year 5 balance sheet $ 198,750 Remaining undepreciated cost Less: New estimated residual value New depreciable amount Divide by number of years remaining Depreciation expense per remaining year $ 198,750 20,000 $ 178,750 2 $ 89,375
b.
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c.
The nature of estimates is that they are not expected to be realized exactly. Even high-quality estimates made by highly qualified people usually will not turn out exactly. Some revision is to be expected. Over time, circumstances change. Therefore, we cannot conclude that a poor job was done initially. The total construction costs, $1,228,000, would be recorded as an asset, construction work-in-process. Special tools and equipment necessary for the construction and interest for financing the construction would be included as part of the asset. The cost would be transferred to the buildings account once the construction was completed and would be depreciated over the useful life of the asset. The cost of an addition to a building would be recorded as an asset and would be depreciated over the useful life of the asset. The cost of ordinary repairs would be recorded as an expense because the cost does not result in future benefits to the company.
E11-8
a.
b. c.
Cash payments for (a) and (b) would be included under the investing activities section of the statement of cash flows. The cash payment for (c) would be included as part of net income in the operating section (indirect method) of the statement of cash flows. E11-9 a. 2004 = $9,000 2005 = $9,000 2006 = $9,000 2007 = $5,250 $10,750 loss ($48,000 $3,000) 5 years = $9,000 ($9,000 7/12 of a year = $5,250) Original cost $ 48,000 Less: depreciation (3 years @ $9,000) 27,000 depreciation (part year) 5,250 Book value at date of sale $ 15,750 Less: disposal price 5,000 Loss on disposal $ 10,750 2005 $9,000 2006 $9,000 2007 $ 5,250 10,750 5,000 0 $21,000 (continued)
b.
c.
2004 Operating activities: Depreciation expense $ 9,000 Loss on sale Investing activities: Sale (Purchase) of machine (48,000) Financing activities: 0 Totals $(39,000)
0 0 $9,000
0 0 $9,000
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d.
For the income statement, depreciation expense of $9,000 would be subtracted for each of the years 20042007. For the year 2007, the amount of $5,250 would be subtracted as depreciation expense. In 2007, a loss on disposal of the machine, $10,750, would be subtracted. $16.8 million $39.2 million ($140 million 6 50) ($140 million $100.8 million*)
E11-10 Depletion expense: Book value of reserves:
* Accumulated depletion = $140 million 36 50 = $100.8 million Depletion expense does not have a direct effect on cash flows. Cash is paid out when depletable assets are acquired, not when depletion is recorded. Like depreciation and most other expenses, depletion affects cash flow indirectly through taxes. Depletion expense reduces taxable income and cash outflow for tax payments. E11-11 a. $1,650,000 The cost of the land ($4,500,000) should be recorded in an account separate from the cost of the trees growing on the land. The cost to be depleted includes the cost of planting the trees and the cost of thinning and monitoring the timber growth ($1,200,000 + $450,000). $165,000 10% $1,650,000 The cost of the land should be reported at $4,500,000 as a long-term asset. The timber should be reported at $1,485,000 ($1,650,000 $165,000) as a long-term asset. The current value of the uncut timber, which is apparently at least $30 million, will not be reported on any financial statement. Because this can be very important information, an estimate of the current value of a natural resource asset is frequently disclosed in the notes to the financial statements. Another key piece of information that is not reported is the fair value of the land on which the timber sits. Its value in 1975 ($4,500,000) probably bears little resemblance to its value in 2007.
b. c.
d.
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E11-12 Journal
Accounts a. b. c. Long-Term Investment Cash Long-Term Investment Unrealized Holding Gain* Cash Unrealized Holding Gain* Long-Term Investment Gain on Sale of Stock Debits 30,000 30,000 3,500 3,500 35,000 3,500 33,500 5,000 +35,000 3,500* 33,500 +5,000 Credits
Effect on Accounting Equation

A +30,000 30,000 +3,500 +3,500* = L+ OE CC + RE
* This is included as Other Comprehensive Income in the stockholders equity section of the balance sheet.
E11-13 Journal
Accounts a. S-Term Investment in Duncan Cash b. S-Term Investment in Macduff Cash c. S-Term Investment in Duncan Unrealized Holding Gain* Unrealized Holding Loss* S-Term Investment in Macduff Debits 330,000 330,000 440,000 440,000 20,000 20,000 80,000 80,000 80,000 Credits

A +330,000 330,000 +440,000 440,000 +20,000 +20,000* 80,000* = L+ OE CC + RE
*This is included as Other Comprehensive Income in the stockholders equity section of the balance sheet.
At year-end, the two investments should be combined and reported in the asset section as short-term investments, $710,000 ($330,000 + $440,000 + $20,000 $80,000). In addition, the net holding loss of $60,000 ($20,000 $80,000) will be reported as a deduction in the stockholders equity section. If the Macduff investment was a trading security, the $20,000 gain would be an addition to stockholders equity, and the $80,000 loss would be reported on the income statement.
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E11-14 Journal
Accounts a. Long-Term Investment in Othello Cash b. Long-Term Investment in Ferdinand Cash c. Long-Term Investment in Othello Unrealized Holding Gain* Unrealized Holding Loss* Long-Term Investment in Ferdinand Debits 314,000 314,000 418,000 418,000 36,000 36,000 23,000 23,000 23,000 Credits

A +314,000 314,000 +418,000 418,000 +36,000 +36,000* 23,000* = L+ OE CC + RE
At year-end, the two investments should be combined and reported in the asset section as noncurrent available-for-sale investments, $745,000 ($314,000 + 418,000 + $36,000 $23,000). In addition, the net holding gain of $13,000 ($36,000 $23,000) will be reported as an addition in the stockholders equity section. E11-15 a. Journal
Accounts Investment in Bonds Cash Cash Interest Income Debits 800,000 800,000 32,000 32,000 Credits

A +800,000 800,000 +32,000 +32,000 = L+ OE CC + RE
b.
Assets: Long-term investments: Investment in bonds (at cost) 800,000 Assets: Long-term investments: Investment in bonds (at market) 786,000 Stockholders equity: Unrealized holding loss 14,000
c.
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E11-16 1. Journal
Date May 15, 2005 Sept. 12, 2005 Dec. 31, 2005 Accounts Long-Term Investment Cash Cash Investment Income Long-Term Investment Unrealized Holding Gain* Cash Investment Income Unrealized Holding Loss* Long-Term Investment Cash Unrealized Holding Loss* Long-Term Investment Realized Gain on Sale Debits 380,000 380,000 12,000 12,000 100,000 100,000 14,400 14,400 40,000 40,000 400,000 60,000 440,000 20,000 440,000 +20,000 40,000 +400,000 60,000* 40,000* +14,400 +14,400 +100,000 +100,000 * Credits

A +380,000 380,000 +12,000 +12,000 = L+ OE CC + RE
Sept. 12, 2006
Dec. 31, 2006
Apr. 6, 2007
Explanations: May 15, 2005: Investment recorded at cost. September 12, 2005: Dividends reported as realized income; reported in the income statement in computing net income for the year. December 31, 2005: Increase in the market value of the investment; not included as part of net income because it is an unrealized holding gain; added to owners' equity. September 12, 2006: Dividends reported as realized income; reported in the income statement in computing net income for the year. December 31, 2006: Decrease in the market value of the investment; not included as part of net income because it is an unrealized holding loss; subtracted from owners' equity. April 6, 2007: Recognized a gain on sale of the investment; reported as part of net income because the investment was sold. Realized gains and losses are recorded when investments are sold. (continued)
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2.
Cost of investment Holding gain Holding loss Market value of investment $480,000 E11-17 a.
2005 $380,000 100,000
2006 $380,000 100,000 (40,000) $440,000
b.
c.
d.
e.
Goodwill arises when one firm buys another. It is the difference between the purchase price and the fair market value of the purchased companys identifiable net assets. It represents the intangible value of a company that exceeds the value of its identifiable assets and liabilities. The key to understanding goodwill is that certain valuable aspects of a company cannot be recorded on its balance sheet. The value of highly trained employees, high employee morale, high customer loyalty, or supplier loyalty is not captured and reported in the financial statements. Goodwill is the amount paid to acquire these nonrecorded assets. Goodwill is reported as an intangible asset on the balance sheet of a company that has purchased another company. If management successfully maintains (or enhances) the value of goodwill, it stays on the balance sheet at original cost. If the value of goodwill decreases (is impaired), it is written down on the balance sheet and a loss is recorded in the income statement. $30 million. The fair market value of the acquired companys net assets was $170 million ($350 million fair value of assets $180 million fair value of liabilities). In exchange for $170 million of net assets, the buying firm paid $200 million. The difference is recorded as goodwill. Sometimes, management of the acquiring firm simply makes a mistake by offering more for a company than it is worth. The estimated value of a companys identifiable assets (trucks, buildings, etc.) is difficult enough to estimate. The estimated value of unrecorded assets (employee morale, loyal customers, etc.) is even more difficult. Sometimes, poor estimates are made, higher prices than appropriate are offered, and management later wishes it had not acquired the second company after all. Amount paid to acquire 100% of Metrodomes net assets Fair market value of Metrodomes net assets Goodwill $845,000 783,000 $ 62,000
E11-18 a.
b.
In general, goodwill becomes impaired when the activities that created it cease. For instance, in this case the goodwill was generated by activities that created very loyal retail customers. Perhaps these activities included convenient hours or after-hour
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services, an extensive product line, special discounts for long-time customers, personal first-name service, or visible community support activities. If those activities were to cease under the new owners it is understandable that the customers might become less loyal and the goodwill would dissipate. In this specific case, there is another probable reason that goodwill could become impaired. It exists because of loyal customers who have been so for more than 30 years. These folks cant last much longer. Unless new loyal customers can be created, the existing goodwill is likely to die off eventually. E11-19 a. 1. $23,017 1st year depreciation: SLN(314221,15000,13) Invoice price of machinery Add: 6.15% sales tax Cost of machinery 2. $23,017 (same amount for each year) 3. $38,017 Cost of machinery Less: 12 year @ $23,017 Book value b. $314,221 276,204 $ 38,017 $296,016 18,205 $314,221
1. $47,387 1st year depreciation: DDB(118468,5000,5,1) Invoice price of equipment $112,316 Add: remodeling cost/installation 6,152 Cost of equipment $118,468 2. $10,236 4th year depreciation: DDB(118468,5000,5,4)
c.
1. $216,667 All years are the same: SLN(1300000,0,6) 2. zero $1.3 million cost $1.3 million amortization
E11-20 Investing activities are those that involve acquisition, use, and disposal of long-term assets. Short-term investments in marketable securities are also part of investing activities. Balance sheet: 1. Most noncurrent asset accounts involve investing activities. Increases or decreases in long-term investments; property, plant, and equipment; and intangible assets are all the result of investing activities. 2. Short-term investments in marketable securities are reported in the current asset section. 3. Holding gains or losses are reported in the stockholders equity section. Income statement: 1. Depreciation, amortization, and depletion are reported as part of operating expenses.
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(continued)
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2. Dividends and interest earned from investments are reported after operating expenses as nonoperating revenue. 3. Gains or losses from disposing of long-term assets are reported as nonoperating items after operating expenses. Statement of cash flows: 1. Depreciation, amortization, and depletion expense are added to net income (under the indirect method) in the operating activities section. 2. Gains (losses) are subtracted (added) in the operating activities section of an indirect method statement. 3. Every item listed under the investing activities section involves investing activities (under both the direct and indirect methods). These include all cash purchases and cash sales of property, plant, and equipment; intangibles; and long-term investments. Interest and dividends received from investments in securities are part of net income. Thus, they are part of the operating activities section, not the investing activities section. E11-21 Zirconium Graphics Partial Statement of For the Year Ended December 31 Cash Flow from Operating Activities Net income Adjustments for noncash items: Depreciation and amortization expense $ 7,500 Loss on sale of plant assets 8,000 Gain on sale of investments (2,000) Net cash flow from operating activities Cash Flow from Investing Activities Capital expenditures $(50,000) Sale of plant assets 22,000 Purchase of investment (16,000) Sales of investment* 28,000 Net cash flow for investing activities Cash Company Flows
$ 60,000
$ 73,500
$(16,000)
Interest and dividend income is part of net income. Since cash was received for the interest and dividends, no adjustment is necessary. *Note: While the assignment says nothing about these securities being trading securities, if they were, the impact of the cash sale would be shown in the operating section, since trading securities are part of the primary operations.
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E11-22 a. b.
Equity method.
This investment was large enough to acquire significant influence over the investee firm (4,800 of the firms 16,000 shares). Effect on Accounting Equation
Debits Credits 43,200 43,200 9,000 9,000 2,400 2,400 +2,400 2,400 A +43,200 43,200 +9,000 9,000 = L+ OE CC + RE
Journal
Date Jan. 1 Dec. 31 Dec. 31 Accounts Long-Term Investment Cash Long-Term Investment Investment Income Cash Long-Term Investment
c.
$49,800
Original cost Add: 30% of Biltmores net income Less: dividends received Ending balance of investment account
$43,200 9,000 (2,400) $49,800
PROBLEMS P11-1 A. Depreciation Schedule

Straight-Line Method Depreciation Expense Book Value $125,000 95,000 65,000 35,000 5,000 Declining-Balance Method Depreciation Expense Book Value $125,000 62,500 31,250 15,625 5,000 Units-of-Production Method Depreciation Expense Book Value $125,000 93,800 67,400 29,840 5,000
Year 0 1 2 3 4 Totals
$ 30,000 30,000 30,000 30,000 $120,000
$ 62,500 31,250 15,625 10,625* $120,000
$ 31,200 26,400 37,560 24,840 $120,000
Double-declining-balance: Year 1 = $125,000 (2/4) = $62,500 Year 2 = $62,500 (2/4) = $31,250 Year 3 = $31,250 (2/4) = $15,625 *Year 4 = $15,625 $5,00 = $10,625 (amount needed to reduce book value to estimated residual value of $5,000) Units-of-production (unit depreciation rate is $120,000 1,000 hours = $120 per hour): Year 1 = $120 per hour 260 hours = $31,200 Year 2 = $120 per hour 220 hours = $26,400 Year 3 = $120 per hour 313 hours = $37,560
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Year 4 = $120 per hour 207 hours = $24,840 B.
C.
(continued) The straight-line method generally has the advantage of creating the smallest amount of depreciation expense in the early years of the assets life. Therefore, it would usually result in higher reported net income in years 1 and 2 than other methods. This is not the case, however, if the units-of-production method is used and less-thanaverage use is made of the asset. In that case, a small amount of usage results in a small amount of depreciation expense and correspondingly higher net income. The double-declining-balance method generally creates the largest amount of depreciation expense in years 1 and 2, as it did for this asset. Therefore, the method generally results in lower reported net income than the other methods. Because most managers want to report high net incomes for financial reporting purposes but low net incomes for tax purposes, they generally use straight-line depreciation for financial reporting and an accelerated method for tax purposes. Depreciation expense reduces the book value of an asset but does not require cash outflow. Cash flow is affected indirectly by depreciation expense through income tax. A higher amount of expense results in a lower amount of taxable income and in lower tax payments. Therefore, the depreciation method that produces the highest depreciation expense each year produces the highest net cash inflow (lowest cash outflow). For the asset in this problem, double-declining-balance would result in the lowest tax payment in years 1 and 2, units-of-production in year 3, and straight-line in year 4. B. Book Value at Beginning of Year $2,100,000 1,400,000 933,333 622,222 414,815 276,543
P11-2
A.
Usual DoubleDeclining-BalModified ance Method Book Value Double-Declin(2/6 Book Valat Beginning ing-Balance Year ue) of Year Method 2007 $ 700,000 $2,100,000 $ 700,000 2008 466,667 1,400,000 466,667 2009 311,111 933,333 311,111 2010 207,407 622,222 207,407 2011 138,272 414,815 207,407 2012 276,543 207,408 207,408* Total $2,100,000 $2,100,000 *$1 rounding adjustment Under the modified approach, depreciation for tax purposes in 2007, 2008, and 2009 uses the standard double-declining-balance method (2/6 book value at beginning of period). In 2010, the straight-line method is applied to the remaining book value ($2,100,000 $700,000 $466,667 $311,111 =
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Chapter 11
$622,222). This results in the same amount of depreciation ($207,407) for each of the last three years. In 2011 and 2012, the straight-line depreciation of $207,407 is higher than double-declining-balance depreciation. Note: Under the tax code version of double-declining balance, residual values are not recognized and book value never reaches zero. In effect, part of the assets cost is never deductible as depreciation expense. The modified double-declining-balance method is designed to allow 100% of the assets cost to be recovered via depreciation expense. C. 3 4 1 2 Difference Difference Modified DoubleStraight-Line in Income in Taxes Declining-BalDepreciation (Column 1 (Column 3 Year ance Method (Cost 6 years) Column 2) 35%) 2007 $ 700,000 $ 350,000 $ 350,000 $122,500 2008 466,667 350,000 116,667 40,833 2009 311,111 350,000 (38,889) (13,611) 2010 207,407 350,000 (142,593) (49,908) 2011 207,407 350,000 (142,593) (49,908) 2012 207,408 350,000 (142,592) (49,906)* Total $2,100,000 $2,100,000 $ 0 *$1 rounding adjustment D. The higher the depreciation, the lower is taxable income and the lower is the amount of cash paid out for taxes. Choosing an accelerated depreciation method raises depreciation in the earlier years of the assets life, which reduces taxable income and decreases cash paid out for taxes. This benefit is reversed, however, in the later years when depreciation is lower, income is higher, and higher taxes must be paid. The company saves taxes in the first years of the assets life but pays higher taxes in the remaining years. On a present value basis, the company is better off by deferring taxes during the early years until the later years. P11-3 A. Cost of diagnostic equipment = $107,191 (The cost of an asset includes all expenditures necessary and reasonable to get the asset to the location needed in the condition needed.) Amount Include? Reason $93,000 Yes Necessary and reasonable 8,091 Yes Necessary and reasonable 2,650 Yes Necessary and reasonable 425 No Not necessary to incur this cost 750 Yes Necessary and reasonable 300 No Carelessness not an asset
1. 2. 3. 4. 5. 6.
Item Invoice cost Sales tax Transportation cost Special permit fine Right-side wall cost Left-side wall cost
67
7. Setup and testing
2,700
Yes
Necessary and reasonable (continued)
Cost of manufacturing equipment = $318,258 The cost of the equipment is the present value of the cash sary to acquire it. Present value of down payment Present value of installment payments ($85,000 2.57710) Total purchase price before sales tax Sales tax (@ 7.5%) Cost of the manufacturing equipment B. DDB Depreciation for the First Year $35,730 ($107,191 2/6) $106,086 ($318,258 2/6) $141,816 SL Depreciation for the First Year $17,865 ($107,191 6 yrs) $53,043 ($318,258 6 yrs) $70,908 Difference in FirstYear Depreciation Expense and Net Income $17,865 $53,043 $70,908 flows neces$ 77,000 219,054 $ 296,054 22,204 $ 318,258
Asset Diagnostic Equipment Manufacturing Equipment Totals
First-year net income would be $70,908 higher if straight-line were used instead of double-declining-balance. P11-4 A. Equal annual payment = $727,781 PV of an annuity = Amount IF (Table 4) $6,000,000 = Amount 8.24424 $727,781 = $6,000,000 8.24424 ($6,000,000 0.08 = $480,000) Cost ($5,500,000 + $500,000 $100,000) $5,900,000 Life 20 years Depreciation per year $ 295,000
First year interest = $480,000 B. Existing building = $295,000 per year
New building = $229,600 per year For the new building, the total cost must be determined. It is the sum of the costs given in the problem plus interest on the oneyear construction loan: Architect's plans Materials Labor costs Other fees and permits $ 120,000 1,700,000 3,500,000 150,000
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Chapter 11
Interest on loan Total cost Useful life Depreciation per year C.
270,000 $5,740,000 25 years $ 229,600
($4,500,000 6%)
If the firm purchases the existing building and land, there would be an outflow in the investing section for the cost of the building and land, $6,000,000. Also, assuming the indirect method is used to prepare the statement of cash flows, depreciation expense of $295,000 would be added to net income in the operating section. There also would be an inflow of $6,000,000 in the financing section. If the firm constructs its own building, there would be an outflow in the investing section for the cost of the building, $5,740,000. Again, assuming the indirect method, depreciation expense of $229,600 would be added to net income in the operating section. There would be an inflow and an outflow (when repaid) of $4,500,000 in the financing section. The difference that the controller wishes to recognize as a Gain on Construction is $160,000. It would not be appropriate to include such an item on the income statement because the gain itself did not arise from an exchange with an external party. Only the actual cost of acquiring either of the two assets should be included in the longterm asset section of the balance sheet.
D.
P11-5 A. Straight-Line Depreciation Depreciation Accumulated Year Expense Depreciation 1 $ 24,000* $ 24,000 2 24,000 48,000 3 24,000 72,000 4 24,000 96,000 5 24,000 120,000 Total $120,000 *($124,000 $4,000) 5 years Beginning Book Value $124,000 100,000 76,000 52,000 28,000 Double-Declining-Balance Depreciation Beginning Depreciation Book Value Expense Accumulated Year (BBV) (BBV 0.4) Depreciation 1 $124,000 $ 49,600 $ 49,600 2 74,400 29,760 79,360 3 44,640 17,856 97,216 4 26,784 10,714* 107,930 5 16,070 12,070** 120,000 Total $120,000 * Rounded to nearest whole number. Ending Book Value $100,000 76,000 52,000 28,000 4,000
Ending Book Value $74,400 44,640 26,784 16,070 4,000
69
** Note that in year 5, an additional amount of depreciation expense isrecorded so that the ending book value is the salvage amount of $4,000. (continued) B. Units-of-Production Depreciation Beginning Depreciation Accumulated Ending Year Book Value Expense* Depreciation Book Value 1 $124,000 $ 24,000 $ 24,000 $100,000 2 100,000 24,000 48,000 76,000 3 76,000 24,000 72,000 52,000 4 52,000 24,000 96,000 28,000 5 28,000 24,000 120,000 4,000 Total $120,000 *Based on $4 per hour ($124,000 $4,000) 30,000 hours. If used evenly, the annual usage is 6,000 hours (30,000 hours 5 years). 6,000 hours $4 = $24,000 per year. It is probably not reasonable to expect that actual usage would be even. Variations in usage could be the result of shutdowns for maintenance, employee vacations, layoffs, strikes, changing economic conditions (changes in customer orders), or shortage of raw materials, to mention a few possibilities. C. Using the answers from parts A and B, the book value at the time of the sale must be calculated for each depreciation method. For the straight-line and double-declining-balance methods, one-half of the depreciation expense from year 5 is added to the amount of accumulated depreciation for year 4. StraightLine $124,000 (24,000) (24,000) (24,000) (12,000) $ 40,000 $ 25,000 40,000 $(15,000) DoubleDecliningBalance $124,000 (49,600) (29,760) (17,856) (5,357)* $ 21,427 $ 25,000 21,427 $ 3,573 Units-ofProduction $124,000 (24,000) (28,000) (32,000) (16,000) $ 24,000 $ 25,000 24,000 $ 1,000
Original cost Year 1 depreciation Year 2 depreciation Year 3 depreciation Year 4 partial depreciation Book value at date of sale Selling price Book value at date of sale Gain (loss) on sale * $10,714 2 = $5,357
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Chapter 11
The straight-line method yields a loss on sale, while the double-declining-balance and units-of-production methods show a gain on sale. This results from the rapidity of depreciation; straight-line is slower (less depreciation per year) than the other two. The accelerated depreciation methods drove the book value down below what the asset could sell for. Therefore, there was a gain on sale. In essence, the accelerated depreciation methods depreciated the asset too rapidly and some of that depreciation expense was recovered when sold. Straight-line depreciation had the opposite effect. Book value was not driven down fast enough and a loss was incurred at the date of sale. D. Straightline Income statement: Depreciation expense $12,000 Effect of sale $15,000 loss Statement of cash flows: Operating activities Add: depreciation expense $12,000 Add (deduct) loss or gain on sale 15,000 Investing activities: Add: Sale of machine $25,000 P11-6 A. $468,975 DoubleDecliningBalance $5,357 $3,573 gain $5,357 (3,573) $25,000 Units-ofProduction $16,000 $1,000 gain $16,000 (1,000) $25,000
Invoice $450,000 Delivery 7,540 Installation and testing 11,435 Total cost $468,975 The annual insurance cost is not part of the cost of equipment. Straight-Line Method Depreciation End-of-Year Year Expense Book Value 0 468,975 1 71,496 397,479 2 71,496 325,983 3 71,496 254,487 4 71,496 182,991 5 71,496 111,495 6 71,496 40,000* * Ignore $1 rounding error. ** Amount necessary to reduce ending book value to residual value. (continued) Double-Declining-Balance Method Depreciation End-of-Year Expense Book Value 468,975 156,325 312,650 104,217 208,433 69,478 138,955 46,319 92,636 30,879 61,757 21,757** 40,000
B.
C. Income statements: All years are
71
Straight-line depreciation Income before depreciation and taxes Depreciation Income before taxes Income taxes (35%) Net income D.
the same $160,000 71,496 88,504 30,976 57,528
Income statements: Double-decliningbalance Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Income before depreciation and taxes $160,000 $160,000 $160,000 $160,000 $160,000 $160,000 Depreciation 156,325 104,217 69,478 46,319 30,879 21,757 Income before taxes 3,675 55,783 90,522 113,681 129,121 138,243 Income taxes (35%) 1,286 19,524 31,683 39,788 45,192 48,385 Net income 2,389 36,259 58,839 73,893 83,929 89,858 E. A very different pattern of net income is reported over the six years depending on which depreciation method is used. Because doubledeclining-balance depreciation front-loads the depreciation expense into the early years, net income is smaller in the early years and larger in the latter years as compared to use of the straight-line method. The depreciation method being used is not reported on the face of the income statement or balance sheet. Instead, the reader of the financial statements must consult the notes to the financial statements to determine this. With knowledge of the depreciation method in use, the reader is better able to interpret the significance of the reported numbers. This is especially true when companies in similar businesses use different accounting methods. Straight-Line Depreciation Depreciation Accumulated Ending Year Expense Depreciation Book Value $112,000 $112,000 488,000 1 112,000 224,000 376,000 2 112,000 336,000 264,000 3 112,000 448,000 152,000 4 112,000 560,000 40,000 5 $560,000 Total The straight-line depreciation schedule is based on $112,000 depreciation expense per year. ($600,000 cost $40,000 residual value) 5 years = $112,000 per year Beginning Book Value $600,000 488,000 376,000 264,000 152,000
P11-7 A.
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Chapter 11
Year 1 2 3 4 5 Total
Double-Declining-Balance Depreciation Beginning Depreciation Accumulated Ending Book Value Expense Depreciation Book Value $600,000 $240,000 $240,000 $360,000 360,000 144,000 384,000 216,000 216,000 86,400 470,400 129,600 129,600 51,840 522,240 77,760 77,760 37,760 560,000 40,000 $560,000
The double-declining-balance depreciation schedule is based on these computations: ($600,000 2/5 = $240,000) ($360,000 2/5 = $144,000) ($216,000 2/5 = $86,400) ($129,600 2/5 = $51,840) ($77,760 2/5 = $31,104*) *Note that in year 5, an additional amount of depreciation expense is recorded so that the ending book value is reduced to the salvage amount of $40,000. B. $168,000 Units-of-production rate = ($600,000 $40,000) 4,000,000 units = $0.14 per yard. Depreciation expense = 1,200,000 million yards $0.14 = $168,000. C. Double-declining-balance method StraightLine Net income before depreciation and taxes Depreciation expense Income before tax Income tax (30%) Net income D. E. $3,600,000 112,000 $3,488,000 1,046,400 $2,441,600 DoubleDecliningBalance $3,600,000 240,000 $3,360,000 1,008,000 $2,352,000 Units-ofProduction $3,600,000 168,000 $3,432,000 1,029,600 $2,402,400
Straight-line method (see schedule above) This is an example of moral hazard. The CEO must make a decision on behalf of the stockholders, but the interests of the CEO and the interests of the stockholders are different. The CEOs interest is to maximize net income because that maximizes the CEOs bonus. Under this guideline, the straight-line method would be chosen. The stockholders interest is to minimize the cash outflow for taxes. (continued)
73
(When given the choice of paying taxes now or paying taxes later, stockholders would prefer to pay later given the time value of money.) Under this guideline, the double-declining-balance method would be chosen. Would you be willing to put the interests of the stockholders (for whom you work) before your own? P11-8 A. Year 1 2 3 4 Total Beginning Book Value $1,200,000 920,000 640,000 360,000 Straight-Line Depreciation Depreciation Accumulated Expense Depreciation $ 280,000 $ 280,000 280,000 560,000 280,000 840,000 280,000 1,120,000 $1,120,000 Ending Book Value $920,000 640,000 360,000 80,000
Straight-line depreciation schedule based on $280,000 depreciation expense per year. ($1,200,000 cost $80,000 residual value) 4 years = $280,000 per year Double-Declining-Balance Depreciation Beginning Depreciation Accumulated Ending Book Value Expense Depreciation Book Value $1,200,000 $ 600,000 $ 600,000 $600,000 600,000 300,000 900,000 300,000 300,000 150,000 1,050,000 150,000 150,000 70,000* 1,120,000 80,000 $1,120,000
Year 1 2 3 4 Total
Double-declining-balance depreciation schedule is based on these computations: ($1,200,000 2/4 = $600,000) ($600,000 2/4 = $300,000) ($300,000 2/4 = $150,000) ($150,000 2/4 = $75,000) *Since recording $75,000 of depreciation expense would decrease book value below salvage value, only $70,000 of depreciation expense is recorded in the last period. B. $224,000 Units-of-production rate = ($1,200,000 $80,000) 2,000,000 units = $0.56 per unit. Depreciation expense = 400,000 units $0.56 = $224,000.
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Chapter 11
C.
Double-declining-balance method StraightLine Income before depreciation and taxes Depreciation expense Income before tax Income tax (35%) Net income $7,200,000 280,000 $6,920,000 2,422,000 $4,498,000 DoubleDecliningBalance $7,200,000 600,000 $6,600,000 2,310,000 $4,290,000 Units-ofProduction $7,200,000 224,000 $6,976,000 2,441,600 $4,534,400
D. P11-9 A.
Units-of-production method (see part C solution) First year depletion = $2,400,000 Cost of mine Estimated tons of ore Depletion per ton Tons produced 1st year First year depletion $40,000,000 500,000 $ 80 30,000 $ 2,400,000
First year depreciation = $400,000 Cost of machinery $ 4,800,000 Expected life in years 12 Depreciation per year $ 400,000 B. First year depletion = $2,400,000 First year depreciation = $288,000* *Student responses will vary. One reasonable approach is as follows. If the machinery can be used only for this mine, it is reasonable to base depreciation on the output of the mine; that is, use units-of-production depreciation, rather than straight-line based on the estimated life of the machinery. Cost of machinery Expected life (tons of ore) Depreciation per ton Tons produced first year Depreciation expense C. Profit under part A = $800,000 Profit under part B = $912,000 Part A Revenue ($120 30,000 tons) $3,600,000 Less: Depletion (cost of goods sold) 2,400,000 Depreciation 400,000 Profit $ 800,000 Part B $3,600,000 2,400,000 288,000 $ 912,000 (continued) $4,800,000 500,000 $ 9.60 30,000 $ 288,000 No change from part A
75
The profit differs only because of the choices made regarding accounting for depreciation. The difference between depreciation expense is $112,000, which is the entire difference in profit. D. Second year depletion = $1,649,000 Cost of mine $40,000,000 First year depletion 2,400,000 Remaining cost $37,600,000 Remaining tons of ore 570,000 Cost per remaining ton $ 65.96 Tons in second year 25,000 Second year depletion $ 1,649,000 Second year depreciation = $400,000 Same amount every year. E. Book value of mine = $35,951,000 Cost Year 1 depletion Year 2 depletion Ending book value $40,000,000 2,400,000 1,649,000 $35,951,000
Book value of machinery = $4,000,000
Cost $4,800,000 Year 1 depreciation 400,000 Year 2 depreciation 400,000 Ending book value $4,000,000
P11-10 A.
Available-for-sale: Because these are investments in equity securities, they cannot qualify for held-to-maturity treatment. They could only be trading securities if they were held for resale in the normal course of business. Nothing in this problem suggests that is the purpose of these investments. In fact, the problem expressly notes the long-term nature of its occasional investments. Accordingly, the proper classification is available-for-sale. 2006 Year-end market value Historical cost Net unrealized holding loss Milton $3,100,000 3,500,000 Holmes $2,800,000 2,690,000 Total $5,900,000 6,190,000 $ (290,000)
B.
For year-end 2006, Keelson would report $5,900,000 in long-term investments and $290,000 in net unrealized holding loss. 2007 Year-end market value Historical cost Net unrealized holding loss Milton $3,350,000 3,500,000 Balthasar $1,940,000 1,930,000 Total $5,290,000 5,430,000 $ (140,000)
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Chapter 11
For year-end 2007, Keelson would report $5,290,000 in long-term investments and $140,000 in net unrealized holding loss. In both years, the net unrealized holding loss would be reported as a deduction from stockholders equity. C. Effect on income in 2006: Dividends received from Milton Effect on income in 2007: Dividends received from Milton Realized gain on sale of Holmes stock Net effect on income *$2,900,000 $2,690,000 historical cost = $210,000 P11-11 A. 1. Short-term investments (at market value): Harbor Company $ 41,000 Paxton 32,540 Total $ 73,540 2. Long-term investments (at market value): Regency $ 25,000 Hilton 34,200 Total $ 59,200 3. Stockholders equity: Net unrealized holding gain Proof: Market Harbor $41,000 Regency 25,000 Hilton 34,200 Paxton 32,540 Net unrealized holding gain B. C. Cost $37,500 22,880 36,400 33,750 Gain (Loss) $ 3,500 2,120 (2,200) (1,210) $ 2,210 $2,210 $500,000 $500,000 210,000* $710,000
Dividend revenue (or investment revenue) $5,600 [Harbor dividends ($3,900) + Hilton dividends ($1,700)] Companies hold assets because of the future economic benefits that can be derived from them. In the case of buildings and equipment, for example, future benefits are obtained by using the assets in the production of goods and services. In the case of small investments in common stock, however, future economic benefits are derived from their sale. That is, this class of asset is not used in the business to produce goods and services. The benefits of this asset come only from receipt of periodic dividends and eventual sale. The current market value of an investment is likely to be a better estimate of the future economic benefit to be obtained upon sale than is the price originally paid to acquire it.
77
P11-12 A.
$101,815. The price of the bonds would be computed as the present value of four semiannual payments of $4,500 each ($100,000 9% 1/2 year) discounted at 4% plus the present value of a single payment of $100,000 at the end of four periods discounted at 4%: ($4,500 3.62990) + ($100,000 0.85480) = $16,335 + $85,480 = $101,815. 2 3 Interest Revenue (Column 2 4%) 4,073 4,056 4,038 4,018* 4 Cash Interest Received 4,500 4,500 4,500 4,500 5 Amort. of Premium (Column 4 Column 3) 427 444 462 482 6
B. 1
Present Value at Beginning Period of Period 1 101,815 2 101,388 3 100,944 4 100,482 C. Journal
Date 2007 Apr. 1 Sept. 30
Value at End of Period 101,388 100,944 100,482 100,000
*$1 adjustment for rounding

Debits Credits 101,815 101,815 4,500 4,073 427 4,500 4,056 444 4,500 4,038 462 4,500 4,018 482 100,000 100,000 A +101,815 101,815 +4,500 +4,073 427 +4,500 +4,056 444 +4,500 +4,038 462 +4,500 +4,018 482 +100,000 100,000 = L+ OE CC + RE
Accounts Investment in Bonds Cash Cash Interest Revenue Investment in Bonds Cash Interest Revenue Investment in Bonds Cash Interest Revenue Investment in Bonds Cash Interest Revenue Investment in Bonds Cash Investment in Bonds
2008 Mar. 31
Sept. 30
2009 Mar. 31
Mar. 31
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Chapter 11
D. Year 2007 2008 2009
Interest Revenue $ 4,073 8,094 4,018 $ 16,185
Cash Flows $ 101,815 4,500 9,000 4,500 +100,000 $ 16,185
The total interest revenue reported on the three year-end income statements (2007 = $4,073; 2008 = $8,094; 2009 = $4,018) is $16,185. This is exactly equal to the net cash inflow over the same years from the investment in bonds. E. When considering a completed transformation cycle, accrual basis and cash basis measures yield the same results. Here the entire transformation has taken place. The bonds were purchased, cash interest payments were received, and the principal recovered. It is only when a transformation cycle is incomplete that accrual and cash-based measures yield different results. This is seen in the solution to part D where the information at each of the five important dates is very different between the two measures. Overall, however, they both report that the firm earned $16,185 from the investment in bonds.
79
P11-13 Journal
Accounts A. B. C. D. E. F. Debits Credits 10,000 500 +400 400 10,445 82 418 +10,445 10,445 +500 82 +418 +37 37 +37* +400*

A +10,000 10,000 +500 +500 = L+ OE CC + RE
G. H.
Long-Term Investments 10,000 Cash Cash 500 Interest Revenue No entry necessary Long-Term Investments 400 Unrealized Holding Gain* Long-Term Investments 10,445 Cash Cash 500 Long-Term Investment1 Interest Revenue No entry necessary Long-Term Investment 37 2 Unrealized Holding Gain *
1
A portion of the premium must be amortized. Cash interest received equals $500 ($10,000 5%) while interest revenue is $418 ($10,445 4%). This yields $82 of premium amortization. 2 Amortization of premium brings the carrying value of the bonds down to $10,363 ($10,445 $82). The market value, however, is $10,400. Therefore, an unrealized holding gain of $37 must be recognized ($10,400 $10,363). * This is included as Other Comprehensive Income in the stockholders equity section of the balance sheet. I. The carrying values to be reported on the balance sheet at the end of year one in parts C, D, G, and H would be: Original Part C D G H Cost $10,000 10,000 10,445 10,445 Amortization of Premium None None $82 $82 Market Value Adjustment None + $400 None + $37 Carrying Value (Book Value) at End of Year 1 $10,000 $10,400 $10,363 $10,400
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Chapter 11
J. 1
Amortization table 2 Present Value at Beginning of Year $10,445 10,363 10,278 10,189 10,097 3 Interest Revenue (Column 2 Interest Rate) $ 418 415 411 408 404 $2,056 4 5 Amortization of Premium (Column 3 Column 4) 82 85 89 92 96 444* 6 Value at End of Year (Column 2 Column 5) $10,363 10,278 10,189 10,097 10,001*
Year 1 2 3 4 5 Totals
Cash Received $ 500 500 500 500 500 $2,500
*Ignore the $1 rounding error. The difference between the interest revenue and the cash received for interest is (ignoring the $1 rounding error) equal to the amount of the premium. P11-14 A. Journal
Date Jan. 1 Dec 31 Accounts Long-Term Investment Cash Cash Long-Term Investment Investment Revenue Debits 283,439 283,439 25,200 3101 25,5102 Credits

A +283,439 283,439 +25,200 +310 +25,510 = L+ OE CC + RE
1 2
Amortization of discount ($25,510 $25,200 = $310) Balance of investment account 9% yield ($283,439 9% = $25,510) (continued)
81
B. If the bonds are? Held-toMaturity Securities Amortized cost none none $3101 $283,7492 Trading Securities Mark to market $(1,749)3 none $310 $282,0004 Availablefor-Sale Securities Mark to market none $(1,749) $310 $282,000
Accounting method to be used Amount of unrealized holding gain (loss) to be reported on income statement Amount of unrealized holding gain (loss) to be reported on balance sheet Amount of discount amortized during first year Balance of investment account on balance sheet at end of first year
1
2 3
Interest earned ($283,439 9% = $25,510) minus interest received ($25,200) Amortized cost ($283,439 + $310) Difference between amortized cost ($283,749) and market value ($282,000) Market value at balance sheet date Journal Effect on Accounting Equation
Debits 160,800* 160,800 Credits A +160,800 160,800 = L+ OE CC + RE
P11-15 A.
Date Accounts
Aug. 22 Long-Term Investment Cash
*Includes commission, fees, and taxes.
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Chapter 11
B. If the total number of Radius common shares outstanding totals 1 million1 80,0002 30,0003 Mark to Consolidation market Equity method method
Accounting method to be used Amount of unrealized holding gain (loss) to be reported on income statement none none none Amount of unrealized holding gain (loss) to be reported on balance sheet $(12,800)4 none none Balance of investment account on not balance sheet $148,0005 determinable none 1 A small investment (2% of outstanding shares) that does not create significant influence or control. 2 An investment comprising 25% of the outstanding shares (20,000 80,000 shares). Large enough to assume significant influence. 3 An investment comprising 2/3 of the outstanding shares. This gives control to the acquiring firm. 4 Cost ($160,800) minus ending market value ($148,000) 5 Ending market value C. Journal
Date Accounts Debits Credits

A +171,400 148,000 +12,8001 +10,6002 = L+ OE CC + RE
Jan. 23 Cash 171,400 Long-Term Investment 148,000 Unrealized Holding Loss 12,800 Realized Holding Gain 10,600
1
This is included as Other Comprehensive Income in the stockholders equity section of the balance sheet. Selling price original purchase price Journal
Accounts Debits 660,000 660,000 660,000 Credits
P11-16 A. Effect on Accounting Equation

A = L+ OE CC + RE 660,000
1.
Cost of Goods Sold Mining Site
(continued)
83
Cost of the mining site less salvage value ($4,900,000 $500,000) divided by estimated output (20 million tons) equals depletion cost per ton of $0.22. Cost per ton ($0.22) times amount produced and sold (3 million tons) equals total depletion amount of $660,000. Journal
Accounts 2. Depreciation Expense Accumulated Depreciation Debits 21,888 21,888 21,888 Credits

A = L+ OE CC + RE 21,888
Proof: Year 1 2 3 Beginning Book Value $152,000 91,200 54,720 Rate 40% 40% 40% Depreciation Expense $60,800 36,480 21,888 Ending Book Value $91,200 54,720 32,832
Journal
Accounts 3. Amortization Expense Patent Debits 7,125 7,125 Credits

A 7,125 = L+ OE CC + RE 7,125
The minimum effect on net income is accomplished by amortizing over the longest period allowed. The maximum period allowed is 40 years, or the economic life, whichever is shorter. In this case, the economic life is 8 years. Therefore, amortization expense is $57,000 8 years = $7,125. B. Straight-line depreciation expense (year 1) = $26,000 [($152,000 $22,000) 5] Straight-line depreciation expense (year 2) = $26,000 [($152,000 $22,000) 5] Revised depreciation expense (years 310) = $12,250 Proof: Cost of assets Depreciation taken in first two years ($26,000 each year) Less: Estimated residual value Remaining amount to be depreciated Divided by 8 years remaining $152,000 52,000 $100,000 2,000 $ 98,000 8 $ 12,250
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Chapter 11
P11-17 A. Journal
Accounts Depreciation Expense Accumulated Depreciation Debits 42,500 42,500 42,500 Credits

A = L+ OE CC + RE 42,500
($475,000 cost $50,000 residual value) 10 years = $42,500 depreciation expense B. Journal
Accounts Cash1 Accumulated Depreciation 2 Loss on Sale3 Machinery4
1 2

Debits 3,000 297,500 174,500 475,000 Credits A +3,000 +297,500 174,500 475,000 = L+ OE CC + RE
Given in the data. $42,500 annual depreciation expense 7 years 3 Book value ($475,000 $297,500 = $177,500) minus cash received ($3,000) = $174,500 4 Original cost of machinery
C. Journal
Accounts Debits Credits

A = L+ OE CC + RE 1,265,000
Cost of Goods Sold 1,265,000 Mineral Rights 1,265,000* 1,265,000 *(80,500 tons 350,000 tons) $5,500,000 = $1,265,000
D.
Mechanically, goodwill is the amount paid over and above the market value of a companys net assets (assets minus liabilities). Conceptually, it is the amount paid for resources that do not appear on the balance sheet. For example, the acquired company may have extremely loyal customers, highly skilled managers, or unusually high morale among employees. Because these allow the acquired company to earn above-average profits, the buying company is willing to pay extra to obtain the extra profits. Goodwill is the amount paid to obtain the extra profits. Journal Effect on Accounting Equation
Debits Credits A +2,200,000 +800,000 3,000,000 = L+ OE CC + RE
E.
Accounts
Investment in Subsidiary 2,200,000 Goodwill 800,000 Cash 3,000,000
85
P11-18 A. Journal
Date July 1, 2004 Dec. 31, 2004 Accounts Equipment Cash Depreciation Expense Accumulated Depreciation Depreciation Expense Accumulated Depreciation Depreciation Expense Accumulated Depreciation Depreciation Expense Accumulated Depreciation Cash Accumulated Depreciation Loss on Asset Sale Equipment Debits Credits 800,000 800,000 75,000 75,000 150,000 150,000 150,000 150,000 75,000 75,000 311,000 450,000 39,000 800,000 75,000 +311,000 +450,000 39,000 800,000 150,000 75,000 150,000 150,000 75,000 150,000

A +800,000 800,000 75,000 = L+ OE CC + RE
Dec. 31, 2005
Dec. 31, 2006
June 30, 2007
June 30, 2007
B.
A $39,000 loss was recorded at the date of sale because the amount of cash received ($311,000) was less than the book value of the equipment (cost accumulated depreciation = $800,000 $450,000 = $350,000). The loss does not mean the company was negligent when selling the equipment. Instead, the loss indicates that the fair value of the asset had declined further than the amount of depreciation that had been taken to date. In a sense, the asset was underdepreciated during the three years of its use. A gain on sale of the asset does not mean the company was skillful in selling the asset. Instead, it indicates that the asset was overdepreciated during the period it was used. Effect on pretax income for 20042007: Total depreciation expense ($75,000 + $150,000 + $150,000 + $75,000) Loss on sale Cumulative net decrease in pretax income for 2004 through 2007 Effect on cash flows for 20042007: Purchase cost of the equipment (2004) Sale of the equipment (2007) Cumulative net cash outflow
C.
$450,000 39,000 $489,000 $800,000 311,000 $ 489,000
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Chapter 11
Accrual and cash flow measurements usually produce the same results when all effects of a series of related transactions are considered. The life of a plant asset is a good example of these relationships. Cash flow and accrual measurements occur from the time an asset is acquired until it is disposed of. Over the life of the asset, the effects on income and cash flows are the same. The difference between the measurements is not in amount, but in timing. Cash flows are measured when they occur. Accrual accounting allocates asset cost over the life of the asset to match expenses with revenues in the periods that benefit from use of the asset. P11-19 Asset valuation by financial institutions has been a major accounting issue in recent years. Traditional accounting rules permitted banks to report loans and other assets at historical cost. Nonperforming loans were written off. Restructured loans could be reported after adjusting for the lower expected cash receipts, resulting from changes in loan terms. An important question in this problem is whether investors are likely to be misled by the banks financial report. Are investors facing a risk that is not apparent? If so, some disclosure of this risk that is sufficient to permit investors to assess the risk and the effect it has on the value of their investments would appear necessary. Otherwise, an ethical problem arises because management is concealing information that has a bearing on the welfare of the banks investors. This information also may affect decisions of depositors, employees, and government authorities. On the other hand, if the banks valuation of $43 million is a fair representation of the present value of the expected cash flows the bank expects to receive from the loans, the amount may not be misleading. A relevant issue is whether the loan loss reserve is sufficient to cover the losses the bank should expect from nonperforming loans. If the bank writes its loans down to market value, it would recognize a loss of $8 million on the loans ($43 million at cost, adjusted for expected losses $35 million at market). This loss would wipe out its current year profits and most of its equity. The loss could result in problems for the bank with regulatory agencies and depositors. A separate issue is valuation of the property held by the bank. The book value of the property appears to be less than its market value. The property should be reflected on the banks statements at an amount approximating its value to the bank. This value could be approximated by discounting the expected cash flows the bank expects from the property. A criticism of accounting rules is that they do not necessarily require organizations to report information about the current market value of their assets. These values may be useful to decision makers. Managers and auditors often argue against reporting these amounts because they often are subjective and may be difficult to determine.
87
P11-20 A. Journal
Date Jan. 1 Dec. 31 Dec. 31 Accounts Long-Term Investment Cash Long-Term Investment Investment Revenue Cash Long-Term Investment Debits Credits 24,000 24,000 9,120 9,120 1,440 1,440 +1,440 1,440

A +24,000 24,000 +9,120 +9,120 = L+ OE CC + RE
B. 1. Question In which section of the balance sheet will this investment be reported? Be specific. What amount will be reported on the balance sheet for this investment? Show your work. What amount of income will be reported on the income statement related to this investment? Explain. What information will be reported about any unrealized holding gain or loss? Explain. Solution Long-term investment section.
2.
3.
4.
$31,680; Cost of $24,000 plus $9,120 earned on investment minus $1,440 received via dividends. $9,120; 24% of Helio Companys net income. The dividends received are not income but a partial return of Schusters investment in Helio. None. Under the equity method, the market value of the investment is ignored. This is reasonable since there is no expectation that the investment will be sold any time soon.
88
P11-21
Asset Cost Salvage Life (months) Method Month 1 2 3 4 5 6 7 8 9 Total Straight-Line $ 27,222.22 27,222.22 27,222.22 27,222.22 27,222.22 27,222.22 27,222.22 27,222.22 27,222.22 $245,000.00 $ 12,222.22 12,154.32 12,086.80 12,019.65 11,952.87 11,886.47 11,820.43 11,754.76 11,689.46 $107,586.98
Buildings 2,200,000.00 100,000.00 360 Straight-Line Declining-Balance
Total
Accelerated $ 48,888.88 48,376.54 47,679.39 48,351.75 47,725.75 45,578.04 45,018.57 43,824.08 41,993.50 $417,436.50
$ 5,833.33 5,833.33 5,833.33 5,833.33 5,833.33 5,833.33 5,833.33 5,833.33 5,833.33 $52,500.00
The Book Wermz Depreciation Schedule AprilDecember 2008 Store Equipment Transportation Equipment 1,000,000.00 275,000.00 50,000.00 75,000.00 60 36 Straight-Line Declining-Balance Straight-Line Units-of-Production Miles Expense $ 15,833.33 $ 33,333.33 $ 5,555.56 1,500 $ 3,333.33 15,833.33 32,222.22 5,555.56 1,800 4,000.00 15,833.33 31,148.15 5,555.56 2,000 4,444.44 15,833.33 30,109.88 5,555.56 2,800 6,222.22 15,833.33 29,106.21 5,555.56 3,000 6,666.67 15,833.33 28,136.01 5,555.56 2,500 5,555.56 15,833.33 27,198.14 5,555.56 2,700 6,000.00 15,833.33 26,291.54 5,555.56 2,600 5,777.78 15,833.33 25,415.15 5,555.56 2,200 4,888.89 $142,500.00 $262,960.63 $50,000.00 21,100 $46,888.89
Total Accelerated Total Straight-line Difference Tax rate Tax savings
$417,436.50 245,000.00 $ 172,436.50 0.35 $ 60,352.77
Chapter 11
If the life of the buildings was 380 months and the life of the equipment was 72 months:
Store Equipment 1,000,000.00 50,000.00 72 Straight-Line Declining-Balance $ 13,194.44 13,194.44 13,194.44 13,194.44 13,194.44 13,194.44 13,194.44 13,194.44 13,194.44 $118,750.00 $ 27,777.78 27,006.17 26,256.00 25,526.67 24,817.59 24,128.22 23,457.99 22,806.38 22,172.87 $223,949.67 Total
Asset Cost Salvage Life (months) Method Month 1 2 3 4 5 6 7 8 9 Total $ 11,578.95 11,518.01 11,457.38 11,397.08 11,337.10 11,277.43 11,218.07 11,159.03 11,100.30 $102,043.35
Buildings 2,200,000.00 100,000.00 380 Straight-Line Declining-Balance
Straight-Line $ 24,276.32 24,276.32 24,276.32 24,276.32 24,276.32 24,276.32 24,276.32 24,276.32 24,276.32 $218,486.88
Accelerated $ 42,690.06 42,524.18 42,157.82 43,145.97 42,821.36 40,961.21 40,676.06 39,743.19 38,162.06 $372,881.91
$ 5,526.32 5,526.32 5,526.32 5,526.32 5,526.32 5,526.32 5,526.32 5,526.32 5,526.32 $49,736.88
Transportation Equipment 275,000.00 75,000.00 36 Straight-Line Units-of-Production Miles Expense $ 5,555.56 1,500 $ 3,333.33 5,555.56 1,800 4,000.00 5,555.56 2,000 4,444.44 5,555.56 2,800 6,222.22 5,555.56 3,000 6,666.67 5,555.56 2,500 5,555.56 5,555.56 2,700 6,000.00 5,555.56 2,600 5,777.78 5,555.56 2,200 4,888.89 $50,000.00 21,100 $46,888.89
Total Accelerated Total Straight-line Difference Tax rate Tax savings
$372,881.91 218,486.88 $154,395.03 0.35 $54,038.26
89
90
Chapter 11
P11-22 A.
Routine maintenance is an expense that should be recorded in the period incurred. It is not an investing activity similar to those discussed in this chapter. The president is attempting to mislead stakeholders by understating selling, general, and administrative expenses and overstating net income. Investors and creditors depend on relevant and reliable information in order to make decisions. Journal
Accounts Debits 1,000,000 1,000,000 1,000,000 Credits
B. Effect on Accounting Equation

A = L+ OE CC + RE 1,000,000
a.
SGA Expenses Investment in Fixed Assets
C. CMI Com World Statement of Income For the Year Ended 12/31/07 (In thousands) Revenues Cost of revenues Selling, general and administration Net income (loss) Number of shares Earnings per share D. $ 43,000 28,000 15,750 $ (750) 1,000 ($0.75)
The revised income statement results in a loss of $0.75 per share rather than a profit of $0.25 per share as originally shown. The presidents misclassification misleads investors and distorts the financial condition of the company.
P11-23 1 b 2 c 3 d 4 b 5 d 6 d 7 c 8 b 9 b 10 a 11 a 12 c
91
CASES C11-1 Financial statement effects of a purchase: On January 1, Swenson would record an increase in plant assets and long-term liabilities of $2 million. The assets would be depreciated as follows: Year 1 2 3 4 Total Book Value at Beginning of Year $2,000,000 1,500,000 1,000,000 500,000 Depreciation Expense $ 500,000 500,000 500,000 500,000 $2,000,000 Book Value at End of Year $1,500,000 1,000,000 500,000 0
The interest expense would be computed as follows: (a) Year 1 2 3 4 Totals (b) Beginning Principal $2,000,000 1,500,000 1,000,000 500,000 (c) Interest at 10% $200,000 150,000 100,000 50,000 $500,000 (d) (c + d) (b d) Repayment Total Cash End-of-Year of Principal Payment Principal $ 500,000 $ 700,000 $1,500,000 500,000 650,000 1,000,000 500,000 600,000 500,000 500,000 550,000 0 $2,000,000 $2,500,000
Summary of effects on income statement: 1. Depreciation expense each year of $500,000. Total over four years = $2,000,000. 2. Interest expense each year of $200,000, $150,000, $100,000, and $50,000, respectively. Total interest expense over four years = $500,000. Summary of effects on the balance sheet: 1. The assets are reported at book value (cost of $2,000,000 less accumulated depreciation) each year. Book value at the end of each of the four years is $1,500,000, $1,000,000, $500,000, and zero, respectively. 2. The liability for borrowed money is reported at the amount of unpaid principal at the end of each year. Those amounts are $1,500,000, $1,000,000, $500,000, and zero, respectively. Summary of effects on the statement of cash flows: 1. Under the indirect format, the depreciation expense is added to net income as part of computing cash provided by operations. 2. The purchase of the equipment is reported at $2 million as an investing activity.
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Chapter 11
3. The borrowing of $2 million from the bank is reported in the first year as a financing activity cash outflow. 4. The cash repayment of principal each year ($500,000) is reported under financing activities. The cash paid for interest expense ($200,000, $150,000, $100,000, and $50,000, respectively) is reported as part of operating activities. The total cash outflow for four years = $2,500,000. Financial statement effects of a lease: On January 1, Swenson would capitalize the lease at the present value of the required lease payments. $635,000 3.16987 (10% for 4 periods, Table 4) = $2,012,867. This amount would be recorded as a long-term asset and a long-term liability. The assets would be depreciated as follows: Year 1 2 3 4 Total Book Value at Beginning of Year $2,012,867 1,509,650 1,006,433 503,216 Depreciation Expense $ 503,217 503,217 503,217 503,216* $2,012,867 Book Value at End of Year $1,509,650 1,006,433 503,216 0
*$1 rounding difference
The lease payment schedule would be computed as follows: (a) (b) Beginning Lease Principal $2,012,867 1,579,154 1,102,069 577,276 (c) (d) (e) (d c) Reduction of Lease Principal $ 433,713 477,085 524,793 577,276 $2,012,867 (f) (b e) End-of-Year Lease Principal $1,579,154 1,102,069 577,276 0
Year 1 2 3 4 Totals
Effective Lease PayInterest ment (Giv(B 10%) en) $201,287 $ 635,000 157,915 635,000 110,207 635,000 57,724* 635,000 $527,133 $2,540,000
*$4 rounding difference
Summary of effects on income statement: 1. Depreciation expense each year of $503,217. Total over four years = $2,012,867. 2. Interest expense each year of $201,287, $157,915, $110,207, and $57,724, respectively. Total interest expense over four years = $527,133.
93
(continued)
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Chapter 11
Summary of effects on the balance sheet: 1. The assets are reported at book value (capitalized cost of $2,012,867 less accumulated depreciation) each year. Book value at the end of each of the four years is $1,509,650, $1,006,433, $503,216, and zero, respectively. 2. The liability for borrowed money is reported as the amount of unpaid lease principal at the end of each year. Those amounts are $1,579,154, $1,102,069, $577,276, and zero, respectively. Summary of effects on the statement of cash flows: 1. Under the indirect format, the depreciation expense is added to net income as part of computing cash provided by operations. 2. The portion of the lease payment that is repayment of principal is reported each year under financing activities. Those amounts are $433,713, $477,085, $524,793, and $577,276, respectively. The cash paid for interest expense ($201,287, $157,915, $110,207, and $57,724, respectively) is reported each year as part of cash from operations. The total cash outflow for lease payments over four years = $2,540,000. Overall, the lease would result in $40,000 more in cash outflow than the purchase over the four-year period. The present value of this difference is $12,867 at the end of the first year ($2,012,867 $2,000,000 = $12,867). Depreciation expense would also be $12,867 higher under the lease option, and interest expense would be $27,133 higher over four years ($527,133 $500,000). Therefore, the purchase option produces slightly more favorable results. C11-2 A. The primary method for depreciating buildings and equipment is the straight-line method. Accelerated methods are generally used for income tax purposes. Useful lives range from three to 50 years (Note 1-B). Section D (Intangible Assets) explains that on May 28, 2001, the company adopted SFAS no. 142, Goodwill and Intangible Assets. This statement eliminated amortization of goodwill and instead requires that goodwill is tested annually for impairment. Other intangibles are amortized evenly over their estimated useful lives (Note 1-D). All expenditures for research and development are charged against earnings (expensed) in the year incurred (Note 1-J). The production costs of advertising are expensed the first time the advertising takes place (Note 1-K).
95
B.
Cost of plant assets is reported in Note 5 (in millions): Land Buildings Equipment Construction-in-progress Total Less: Accumulated depreciation Net plant assets
53 1,290 3,419 557 $ 5,319 (2,208) $ 3,111
C.
Marketable equity securities are reported in the Other Assets section of the consolidated balance sheet at fair market value. At May 30, 2004, the company reported marketable equity securities valued at $30 million. This represents approximately 0.1% (or 1/10 of 1%) of the companys total assets. Plant assets at end of fiscal year 2003 reported on the balance sheet (in millions) Purchase of plant assets (statement of cash flows) Disposal of plant assets (statement of cash flows) Depreciationincludes amortization (statement of cash flows or income statement) Plant assets at end of fiscal year 2004 (as calculated) Plant assets at end of fiscal year 2004 (as reported) $2,980 628 (36) (399) $3,173 $3,111
D.
The difference between the calculated amount of plant assets and the reported amount is due primarily to the acquisition and disposal of other companies, whose assets are included in the total plant asset account. Also, the depreciation expense amount ($399) used above overstates depreciation because it includes amortization of intangibles.

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CHAPTER 11

440,000 485,500 56,300 120,000 4,000 10,000 $1,311,400

Long-term investments: Property, plant, and equipment:

$1,708,000 $7,200,000 1,708,000 $5,492,000

E11-10 Depletion expense: Book value of reserves:

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Sept. 12, 2006

Dec. 31, 2006

2005 $380,000 100,000

2006 $380,000 100,000 (40,000) $440,000

$43,200 9,000 (2,400) $49,800

PROBLEMS P11-1 A. Depreciation Schedule

$ 30,000 30,000 30,000 30,000 $120,000

$ 62,500 31,250 15,625 10,625* $120,000

$ 31,200 26,400 37,560 24,840 $120,000

Year 4 = $120 per hour 207 hours = $24,840 B.

7. Setup and testing

Necessary and reasonable (continued)

Asset Diagnostic Equipment Manufacturing Equipment Totals

First year interest = $480,000 B. Existing building = $295,000 per year

Interest on loan Total cost Useful life Depreciation per year C.

270,000 $5,740,000 25 years $ 229,600

Ending Book Value $74,400 44,640 26,784 16,070 4,000

C. Income statements: All years are

the same $160,000 71,496 88,504 30,976 57,528

Book value of machinery = $4,000,000

Value at End of Period 101,388 100,944 100,482 100,000

*$1 adjustment for rounding

Effect on Accounting Equation

D. Year 2007 2008 2009

Interest Revenue $ 4,073 8,094 4,018 $ 16,185

Cash Flows $ 101,815 4,500 9,000 4,500 +100,000 $ 16,185

Effect on Accounting Equation

Cash Received $ 500 500 500 500 500 $2,500

Effect on Accounting Equation

Aug. 22 Long-Term Investment Cash

*Includes commission, fees, and taxes.

Effect on Accounting Equation

P11-16 A. Effect on Accounting Equation

Cost of Goods Sold Mining Site

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Effect on Accounting Equation

Investment in Subsidiary 2,200,000 Goodwill 800,000 Cash 3,000,000

Effect on Accounting Equation

Dec. 31, 2005

Dec. 31, 2006

June 30, 2007

June 30, 2007

$450,000 39,000 $489,000 $800,000 311,000 $ 489,000

Effect on Accounting Equation

Buildings 2,200,000.00 100,000.00 360 Straight-Line Declining-Balance

Total Accelerated Total Straight-line Difference Tax rate Tax savings

$417,436.50 245,000.00 $ 172,436.50 0.35 $ 60,352.77

Buildings 2,200,000.00 100,000.00 380 Straight-Line Declining-Balance

Total Accelerated Total Straight-line Difference Tax rate Tax savings

$372,881.91 218,486.88 $154,395.03 0.35 $54,038.26