CHAPTER 10 Capital Assets

Transcription

1 CHAPTER 10 Capital Assets ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises Problems Set A Problems Set B 1. Distinguish between tangible and intangible capital assets. 2. Demonstrate the application of the cost principle to property, plant, and equipment specifically, and to capital assets in general. 3. Explain the concept of, and be able to calculate, amortization , 3, 4, 5, 6 2, 3, 4 1, 2, 7 1, 9 1, 2, 3, 9 7, 8 4. Calculate periodic amortization using different methods. 9, 10 5, 6, 7 3, 4, 7, 9, 11, 12 2, 3, 6, 7, 8, 12 2, 3, 6, 8, Describe and demonstrate the procedure for revising periodic amortization. 6. Distinguish between operating and capital expenditures, and prepare the entries for these expenditures. 7. Explain and demonstrate how to account for the disposal of property, plant, and equipment. 8. Calculate the periodic amortization of natural resources , 6, 7 4, 6 4, , 6, 9 5, 6, 9 13, 14 10, 11 8, 9 7, 8, 12 7, 8, 12 15, Contrast the accounting for intangible assets with the accounting for tangible assets. 17, 18, 19, , 12 9, 10, 11 9, 10, Illustrate how capital assets are reported on the balance sheet. 11. Demonstrate how to assess the profitability of total assets , 12 9, 11,

2 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Determine acquisition costs of land and buildings. Simple A Calculate amortization under different methods. Simple A Calculate amortization under different methods, and consider effects. Moderate A Calculate revisions to amortization expense. Moderate A Account for various operating and capital expenditures. Simple A 7A Record operating and capital expenditures. Calculate revision to amortization expense. Calculate amortization under straight-line and declining-balance methods. Calculate gain or loss on disposal and total expense over life of asset and comment. Moderate Moderate A Journalize alternatives related to disposals of capital assets. Moderate A Classify operating and capital expenditures. Simple A 11A 12A Prepare entries to correct for errors made in recording and amortizing intangible assets. Record transactions related to acquisition and amortization of intangibles. Prepare capital assets section of balance sheet. Journalize a series of equipment transactions related to purchase, sales, retirement, and amortization. Prepare capital assets section of balance sheet. Moderate Moderate Moderate A Calculate and comment on asset turnover and return on asset ratios. Moderate B Record acquisition costs of land and building. Simple B 3B Record capital asset acquisition. Calculate amortization under different methods. Determine acquisition cost. Calculate amortization under different methods, and consider effects. Simple Moderate B Calculate revisions to amortization expense. Moderate B Account for various operating and capital expenditures. Simple B 7B Record operating and capital expenditures. Calculate revision to amortization expense. Calculate gain or loss on disposal and total expense over life of asset and comment Moderate Moderate 30-40

3 Problem Number Description Difficulty Level Time Allotted (min.) 8B Journalize alternatives related to disposals of capital assets. Moderate B 10B 11B 12B Classify operating and capital expenditures. Prepare capital assets section of balance sheet. Prepare entries to correct for errors made in recording and amortizing intangible assets. Record transactions related to acquisition and amortization of intangibles. Prepare the capital assets section of balance sheet. Journalize a series of equipment transactions related to purchase, sales, retirement, and amortization. Prepare capital assets section of balance sheet. Simple Moderate Moderate Moderate B Calculate and comment on asset turnover and return on asset ratios. Moderate

4 BLOOM S TAXONOMY TABLE Correlation Chart between Bloom's Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation 1. Distinguish between tangible and intangible capital assets. BE10-1 Q Demonstrate the application of the cost principle to property, plant, and equipment specifically, and to capital assets in general. Q10-2 Q10-3 Q10-4 Q10-5 Q10-6 BE10-2 BE10-3 BE10-4 E10-2 E10-7 P10-1A P10-9A P10-2B P10-9B P10-1B P10-3B E Explain the concept of, Q10-7 Q10-8 and be able to calculate, amortization. 4. Calculate periodic amortization using different methods. 5. Describe and demonstrate the procedure for revising periodic amortization. Q10-9 Q10-10 BE10-5 BE10-6 BE10-7 E10-3 E10-4 E10-7 E10-11 E10-12 Q10-11 BE10-8 E10-5 E10-7 P10-4A P10-2A P10-6A P10-8A P10-12A P10-2B P10-6B P10-8B P10-12B P10-6A P10-4B P10-6B E10-9 P10-3A P10-7A P10-3B E Distinguish between operating and capital expenditures, and prepare the entries for these expenditures. BE10-9 Q10-12 E10-7 P10-5A P10-6A P10-9A P10-5B P10-6B P10-9B 7. Explain and demonstrate how to account for the disposal of property, plant, and equipment. Q10-13 Q10-14 BE10-10 BE10-11 E10-8 P10-8A P10-12A P10-8B P10-12B E10-9 P10-7A P10-7B 8. Calculate the periodic amortization of natural resources. Q10-15 Q10-16 BE10-12 E Contrast the accounting for intangible assets with the accounting for tangible assets Q10-17 Q10-18 Q10-19 Q10-20 BE10-13 E10-11 E10-12 P10-9A P10-11A P10-9B P10-10A P10-10B P10-11B E

5 Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation 10. Illustrate how capital assets are reported on the balance sheet. Q10-21 BE10-14 E10-13 P10-11A P10-12A P10-9B P1-12B P10-11B 11. Demonstrate how to assess the profitability of total assets. Broadening Your Perspective Q10-22 BE10-15 Cumulative Coverage E10-14 P10-13A P10-13B BYP10-1 BYP10-2 BYP10-3 BYP10-4 BYP10-5 BYP

6 ANSWERS TO QUESTIONS 1. Tangible and intangible capital assets both are long-lived assets that are used by a business to produce revenue. The difference between them is that tangible capital assets have physical substance but intangible assets do not. 2. For capital assets, the cost principle means that cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. It also means that the assets are carried at cost, and not at market (unless fair market value is lower than cost). 3. (a) In a cash transaction, cost is equal to the cash paid. (b) In a noncash transaction, cost is equal to the cash equivalent price paid which is the fair market value of the asset given up or, if this is not clearly determinable, the fair market value of the asset received. 4. The cost principle has survived because it provides information that is objective and verifiable. 5. The purchase cost must be split between the land and building because the building is amortized and the land is not. In addition, the cost of each item will be necessary if the land, or the building, is later sold to determine any gain or loss on disposal. 6. The cost is allocated between the building and equipment based on the relative proportion each is of the appraised value. Building $350,000 $750,000 X $500,000 = $233,333 Equipment $400,000 $750,000 X $500,000 = $266, Amortization is a process of allocating the cost of a capital asset to expense over its service (useful) life in a rational and systematic manner. There is no cash involved in the entry to record amortization (Dr. Amortization Expense; Cr. Accumulated Amortization). Recognition of amortization is not intended to result in the accumulation of cash for replacement of the asset. 10-6

7 Questions Chapter 10 (Continued) 8. (a) Residual value is the expected cash value of the asset at the end of its useful life. It is sometimes called salvage value. (b) Residual value is used in determining amortizable cost in each of the amortization methods except the declining-balance method. 9. (a) Useful life is expressed in years under the straight-line and declining-balance methods and in units-of-activity under the unitsof-activity method. (b) The pattern of periodic amortization expense is constant under the straight-line method, decreases under the declining-balance method, and is variable depending on production levels under the units-of-activity method. 10. Balance sheet: Net book value is cost less accumulated amortization of a capital asset. Cost is the same under each method of amortization. The accumulated amortization is affected as follows: Straight-line constant amount each period; units-of-activity varying amount depending on production levels each period; declining-balance decreasing amount each period. Consequently, the net book value will decline on the balance sheet as the asset ages. It will decline faster under the declining-balance method than the straight-line method in the early years and slower in the later years. The units-of-activity method is unpredictable. All three methods will result in the same net book value at the end of the asset s useful life. Income statement: The amortization expense is constant under the straight-line method, varies according to production under the unitsof-activity method and declines over time with the declining-balance method. Consequently, net income is constant under the straight-line method, varies according to production under the units-of-activity method, and increases over time with the declining-balance method. 11. A revision of amortization is made in current and future years but not retroactively. Amortization is based on the information available at the time. It is an estimate. Continual restatement of prior periods would adversely affect the reader's confidence in the financial statements. 10-7

8 Questions Chapter 10 (Continued) 12. Operating expenditures are ordinary repairs made to maintain the operating efficiency and expected productive life of the asset. Because they are recurring expenditures and normally benefit only the current period, they are expensed when incurred. Capital expenditures are additions and improvements made to increase efficiency, productivity, or expected useful life of the asset. Because they benefit future periods, capital expenditures are debited to the capital asset affected. 13. In a sale of capital assets, the net book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the net book value of the asset, a gain on disposal occurs. If the proceeds of the sale are less than the net book value of the asset sold, a loss on disposal occurs. 14. The capital asset and related accumulated amortization should continue to be reported on the balance sheet, without further amortization or adjustment, until the asset is retired. Reporting the asset and related accumulated amortization on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully amortized, no additional amortization should be taken on this asset, even if it is still being used. In no situation can the amortization on the capital asset exceed the cost of the asset. 15. Restoration costs, which are incurred at the end of a capital asset s useful life, affect the amortizable cost of a natural resource. These costs relate to the life of the natural resource, and not just to the ending period in which they are incurred. They are amortized over the life of the asset to properly match them with the resulting revenue. 16. The amortizable cost of a natural resource includes cost less residual value plus any estimated removal and site restoration costs. In calculating the amortization expense for natural resources, the amortizable cost is expressed on a per unit basis, divided by the total production or activity anticipated. The amortizable cost per unit is then multiplied by the actual production output or activity sold for the period. 10-8

9 Questions Chapter 10 (Continued) 17. The intern is not correct. The cost of an intangible asset should be amortized over the shorter of that asset's useful life (the period of time when operations are benefited by use of the asset) or its legal life. If the intangible asset has an indefinite useful life, it is not amortized. It is tested frequently for impairment, however. 18. The favourable attributes which could result in goodwill include exceptional management, desirable location, good customer relations, skilled employees, high quality products, fair pricing policies, and harmonious relations with labour unions. 19. Goodwill is the value of many favourable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold. 20. Research and development costs present several accounting problems. It is sometimes difficult to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, the CICA requires that all research and some development costs be recorded as an expense. Only certain development costs with reasonably assured future benefits can be capitalized. This is intended to maintain the objectivity and reliability of the financial statements. 21. The notes to financial statements should disclose the balance of the major classes of amortizable assets and the amortization method(s) and rates used. The balance of the major classes of unamortized assets should also be disclosed, in addition to any impairment information. 22. Salter Street Film s asset turnover is calculated as follows: Net sales = Average total assets $48,766,938 $78,811,768 = 0.62 times 10-9

10 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) (b) (c) (d) (e) (f) (g) (h) I PPE PPE NA (current asset) I PPE NA (current asset) NR (i) (j) (k) (l) (m) (n) (o) (p) NA (inventory) I I NA (investment) NR NR NR I BRIEF EXERCISE 10-2 All of the expenditures should be included in the cost of the land. The cost of the land is $63,000 ($54,000 + $3,000 + $2,500 + $3,500). BRIEF EXERCISE 10-3 The cost of the truck is $25,400 (cash price $25,000 + painting and lettering $400). The expenditures for the insurance and the motor vehicle licence are recurring and only benefit the current period. They should be expensed and not be added to the cost of the truck. BRIEF EXERCISE 10-4 Jan. 1 Land ($280,000 X $100,000 $300,000)... 93,333 Building ($280,000 X $200,000 $300,000) ,667 Cash... 80,000 Mortgage Payable ,

11 BRIEF EXERCISE 10-5 Amortizable cost is $30,000 ($32,000 $2,000). With a 4-year useful life, annual amortization is $7,500 ($30,000 4). Under the straight-line method, amortization is the same each year. Thus, amortization expense is $7,500 for both the first and second years. BRIEF EXERCISE 10-6 The declining-balance rate is 50% (25% X 2) and this rate is applied to net book value at the beginning of the year. The calculations are: Year 1 Year 2 Net Book Value X Rate = Amortization $32,000 16,000* 50% 50% $16,000 8,000 * $32,000 $16,000 = $16,000 BRIEF EXERCISE 10-7 Amortizable cost = ($36,500 $500) 100,000 = $0.36 Year 1 30,000 kms. X $0.36 = $10,800 Year 2 20,000 kms. X $0.36 = $7,

12 BRIEF EXERCISE 10-8 Net book value, 1/1/2002 ($32,000 $12,000)... $ 20,000 Less: Residual value ,000 Amortizable cost... 18,000 Remaining useful life... 2 years Revised annual amortization expense... $ 9,000 Note: Previously, amortization expense was $6,000 [($32,000 - $2,000) 5]. 2000: $ 6, : 6, : 9, : 9,000 Total $30,000 BRIEF EXERCISE 10-9 (a) O (b) C (c) C (d) O (e) C (f) O (g) O (h) C (i) C (j) O BRIEF EXERCISE (a) Aug. 2 (b) Aug. 2 Accumulated Amortization Delivery Equipment... 41,000 Delivery Equipment... 41,000 Accumulated Amortization Delivery Equipment... 39,000 Loss on Disposal... 2,000 Delivery Equipment... 41,000 Cost of delivery equipment $41,000 Less: Accumulated amortization 39,000 Net book value at date of disposal 2,000 Proceeds from sale 000, Loss on disposal $ 2,

13 BRIEF EXERCISE (a) Sept. 30 Amortization Expense... 6,000 Accumulated Amortization Office Equipment... 6,000 (b) Sept. 30 Cash... 26,000 Accumulated Amortization Office Equipment ($42,000 + $6,000)... 48,000 Gain on Disposal... 2,000 Office Equipment... 72,000 Cost of office equipment $72,000 Less accumulated amortization 048,000 ($42,000 + $6,000) Net book value at date of disposal 24,000 Proceeds from sale 026,000 Gain on disposal $ 2,

14 BRIEF EXERCISE (a) Amortizable cost = $7,000,000 $500,000 + $1,000,000 = $7,500,000 Amortizable cost per unit = $7,500,000 28,000,000 tonnes = $ per tonne Restoration portion = $1,000,000 28,000,000 tonnes = $ Amortization expense Year 1 $ X 6,000,000 tonnes = $1,607,400 Restoration portion Year 1 $ X 6,000,000 tonnes = $214,200 Aug. 31 Amortization Expense... 1,607,400 Accumulated Amortization... 1,393,200 Liability for Restoration Costs ,200 (b) CUONO MINING CO. (Partial) Balance Sheet August 31, 2003 Assets Capital assets Ore mine... $7,000,000 Less: Accumulated amortization... 1,393,200 $5,606,800 Liabilities Long-term liabilities Liability for restoration costs... $ 214,

15 BRIEF EXERCISE (a) Jan. 2 Patents ,000 Cash ,000 (b) Dec. 31 Amortization Expense ($160,000 10)... 16,000 Patents... 16,000 (c) SURKIS COMPANY (Partial) Balance Sheet December 31, 2002 Assets Capital assets Patents (net of $16,000 accumulated amortization)... $144,000 BRIEF EXERCISE JOKER COMPANY (Partial) Balance Sheet December 31, 2002 Assets Capital assets Buildings... $800,000 Less: Accumulated amortization ,000 0$$150,000 Coal mine... $200,000 Less: Accumulated amortization , ,000 Goodwill ,000 Total capital assets... $652,000 BRIEF EXERCISE Asset turnover = $11,635.4 [($3, $5,188.8) 2] = 2.54 times Return on assets = $1,127.1 [($3, $5,188.8) 2] = 24.6% 10-15

16 SOLUTIONS TO EXERCISES EXERCISE 10-1 (a) Dear : The following information is provided in response to your question on the application of the cost principle to capital assets. Under the cost principle, the acquisition cost of a capital asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. This includes not only the cost of acquisition, but any freight, installation, testing, and similar costs to get the asset ready for use. For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and installation costs. Costs such as these benefit the life of the factory machinery and not just the current period. Consequently, they should be capitalized and amortized over the machinery s useful life. Cost is measured by the cash paid in a cash transaction, or by the cash equivalent price paid when noncash assets are used in payment. The cash equivalent price is equal to the fair market value of the asset given up. If that value is not clearly determinable, the fair market value of the asset received is used instead. If you require any further information please contact me. Sincerely, (b) 1. Delivery Equipment (or Vehicles) 5. Factory Machinery 2. Licence Expense 6. Prepaid Insurance 3. Land Improvements 7. Factory Machinery 4. Land 10-16

17 EXERCISE 10-2 (a) Cost of Land Cash paid... $90,000 Net cost of removing warehouse ($6,600 $1,700)... 4,900 Legal fee... 1,100 Total... $96,000 (b) The architect's fee ($7,800) should be debited to the Building account. The cost of the driveways and parking lot ($14,000) should be debited to Land Improvements. EXERCISE 10-3 (a) Amortizable cost per unit is $1.20 per kilometre [($128,000 $8,000) 100,000]. (b) Calculation End of Year Year Units of Activity X Amortization Cost/Unit = Amortization Expense Accumulated Amortization Net Book Value ,000 30,000 25,000 17,000 $ $33, , , ,400 $033, , , ,000 $94,400 58,400 28,400 8,

18 EXERCISE 10-4 (a) Year Straight-Line Units-of- Activity Double Declining-Balance 2002 $12,833 $13,090 $29, ,833 11,550 19,775 (1) Straight-line method: $89,000 - $12,000 = $12,833 per year 6 years 2002 and 2003 amortization expense = $12,833 (2) Units-of-activity method: $89,000 - $12,000 = $7.70 per hour 10,000 hours 2002 amortization expense = 1,700 hours X $7.70 = $13, amortization expense = 1,500 hours X $7.70 = $11,550 (3) Declining-balance method: The declining-balance rate is 1/6 X 2 = 33⅓% 2002 amortization expense = $89,000 X 33⅓% = $29,667 Net book value January 1, 2003 = $89,000 $29,667 = $59, amortization expense = $59,333 X 33⅓% = $19,775 (b) Straight line method (c) Cash flow is the same under all three methods. Amortization is an allocation of the cost of a capital asset and not a cash expenditure

19 EXERCISE 10-5 (a) Old amortization rates used Not required Building: ($800,000 $40,000) 40 yrs = $19,000 per year Warehouse: ($100,000 $5,000) 25 yrs = $3,800 per year Current ages (years amortized) Building: $114,000 $19,000 per year = 6 years (equals the period from 1/1/96 to 1/1/02) Warehouse: $9,500 $3,800 per year = 2.5 years (equals the period from 1/7/99 to 1/1/02) Type of Asset Building Warehouse Net book value, 1/1/02 Less: Residual value Revised amortizable cost Divide by revised remaining useful life, in years $686, , ,000 (45 6) 39 yrs $90, ,600 86,900 0 (20 2.5) 17.5 yrs Revised annual amortization expense $15,795 0$4,966 (b) Dec. 31 Amortization Expense... 15,795 Accumulated Amortization Building... 15, Amortization Expense... 4,966 Accumulated Amortization Warehouse 4,

20 EXERCISE 10-6 MEMO To: From: Date: Client Financial Advisor Today The change in the amortization policy will increase the amortization period in cases where the contracted exhibition period is greater than two years. This will have the effect of spreading the cost over a longer period and, in the short term, increasing net income. It will be more difficult to compare the current year s results with previous years because of the change in estimated useful life. In evaluating Alliance s performance, you would want to make an adjustment for this change in estimated life. If the contracted exhibition period is a good measure of the useful life of the broadcast rights and the revenue potential is consistent over this period, then the policy is reasonable

21 EXERCISE 10-7 (a) July 1/01 Equipment... 25,000 Cash... 25,000 (b) June 30/02 Amortization Expense... 5,625 Accumulated Amortization Equipment... 5,625 [($25,000 - $2,500) 4 years] (c) July 1/02 Equipment... 5,500 Cash... 5,500 (d) June 30/03 Amortization Expense... 4,969 Accumulated Amortization Equipment... 4,969 Net book value, July 1, 2002 ($25,000 - $5,625)... $19,375 Add: New part... 5,500 24,875 Less: Residual value... 5,000 Amortizable cost... 19,875 Remaining useful life (5 1)... 4 years Revised annual amortization expense... $ 4,

22 EXERCISE 10-8 Jan. 1 Accumulated Amortization Machinery... 62,000 Machinery... 62,000 June 30 Amortization Expense Accumulated Amortization Computer ($5,000 3 years X 6/12 mos.) 30 Cash Accumulated Amortization Computer... 4,166 ($5,000 3 years x 2.5 years) Loss on Disposal [$500 ($5,000 $4,166)] Computer... 5,000 Dec. 31 Amortization Expense... 4,500 Accumulated Amortization Truck... 4,500 [($30,000 $3,000) 6 years] 31 Loss on Disposal [$0 ($30,000 - $22,500)]... 7,500 Accumulated Amortization Truck... 22,500 [($30,000 $3,000) 6 years x 5 years] Delivery Truck... 30,

23 EXERCISE 10-9 (a) (1) Straight-line method ($10,000 - $1,000) 4 years = $2,250 per year (2) Double-declining-balance method DDB Rate: ¼ x 2 = 50% Year 1: $10,000 x 50% = $5,000 Year 2: $10,000 - $5,000 = $5,000 x 50% = $2,500 Year 3: $5,000 - $2,500 = $2,500 x 50% = $1,250 Year 4: $2,500 - $1,250 = $1,250 x 50% = $625 but amount limited to $250 by salvage value Straight-Line Double Declining Balance Amortization Expense Net Book Value Amortization Expense Net Book Value Year 1 $2,250 $7,750 $5,000 $5,000 Year 2 2,250 5,500 2,500 2,500 Year 3 2,250 3,250 1,250 1,250 Year 4 2,250 1, * 1,000 Total $9,000 $9,000 * Do not amortize below salvage value. (b) (1) Straight-line method Proceeds - Net book value = Gain (loss) $1,500 - $3,250 = ($1,750) (2) Double declining-balance method Proceeds - Net book value = Gain (loss) $1,500 - $1,250 = $

24 EXERCISE 10-9 (Continued) (c) (1) Straight- Line (2) Double Declining- Balance Year 1 Amortization expense $2,250 $5,000 Year 2 Amortization expense 2,250 2,500 Year 3 Amortization expense 2,250 1,250 Year 3 Loss (gain) 1,750 ( 250) Total expense over 3 year period $8,500 $8,500 The total expense over the three year period is the same under each method, $8,500. The gain or loss simply adjusts for over amortization, or under amortization. The $8,500 total cost equals the original cost of $10,000 less proceeds from sale of $1,

25 EXERCISE (a) Dec. 31 Amortization Expense ($0.675 x 100,000 t)... 67,500 Accumulated Amortization Mine... 48,750 Liability for Restoration... 18,750 ($150, ,000 t x 100,000 t) Amortizable cost $480,000 + $150,000 $90,000 = $540,000 Units estimated Amortizable cost per unit 800,000 tonnes (t) $540, ,000 t = $0.675 per tonne Portion applicable to restoration $150, ,000 t x 100,000 t = $18,750 Portion applicable to mine $480,000 - $90,000) 800,000 t x 100,000 t = $48,750 (b) $54,000 of this amount (80,000 X $0.675) is expensed (as part of the cost of goods sold). The remaining $13,500 (20,000 X $0.675) is included in the ending inventory. The costs pertaining to the unsold tonnes are reported in current assets as part of inventory. EXERCISE Dec. 31 Amortization Expense... 30,000 Trademark ($150,000 5)... 30, Amortization Expense... 6,000 Patents ($45,000 5 x 8/12)... 6,

26 EXERCISE (a) Jan. 1 Patents ,000 Cash ,000 April 1 Goodwill ,000 Cash ,000 Note: This would be part of the entry to record the purchase of another company. July 1 Franchise ,000 Cash ,000 Sept. 1 Research Expense ,000 Cash , Development Expense... 50,000 Cash... 50,000 (b) Dec. 31 Amortization Expense ($60,000 + $22,500)... 82,500 Patents ($420,000 7)... 60,000 Franchise [($450,000 10) X 1/2]... 22,500 Note: Because goodwill has an indefinite life, it is not amortized. Rather, it is tested annually for impairment

27 EXERCISE (a) Account Statement Classification Accumulated amortization leasehold improvements Balance sheet Capital assets (PPE contra account) Accumulated amortization equipment Balance sheet Capital assets (PPE contra account) Accumulated amortization hockey franchise and rights to players Balance sheet Capital assets (intangible contra account) Amortization expense Income Operating expenses statement Equipment Balance sheet Capital assets (PPE) Investments Balance sheet Long-term investments Hockey franchise and rights to players Balance sheet Capital assets (intangible) Leasehold improvements Balance sheet Capital assets (PPE) PPE property, plant, and equipment (b) NORTHWEST SPORTS ENTERPRISES (Partial) Balance Sheet June 30, 2000 Assets Capital assets Leasehold improvements... $1,124,248 Less: Accumulated amortization ,697 $ 893,551 Equipment... $1,081,364 Less: Accumulated amortization , ,290 Hockey franchise and rights to players.. $7,528,235 Less: Accumulated amortization... 1,693,850 5,834,385 Total capital assets... $6,949,

28 EXERCISE (a) Asset turnover ratio $208,569,000 = $525,710,500 = 0.40 times Return on assets ratio $23,219,000 = = 4.42% $525,710,500 (b) IMAX s asset turnover of 0.40 times, and its return on assets of 4.42%, are slightly below the industry averages of 0.5 times and 5.7%. This indicates that the company is not on par with the industry in terms of its management of capital assets

29 SOLUTIONS TO PROBLEMS PROBLEM 10-1A Item Land Building Other Accounts $145,000 2,000 13,000 4,000 (2,500) $161,500 20,000 10, , $630,000 5,000 3, ,000,00 $23,000 Property Tax Expense Land Improvements Land Improvements 10-29

30 PROBLEM 10-2A (a) Year Calculation MACHINE 1 $90,000* X 10%** = $9,000 $90,000 X 10% = $9,000 $90,000 X 10% = $9,000 $90,000 X 10% = $9,000 *$96,000 - $6,000 = $90,000 ** 1/10 years = 10% Accumulated Amortization 12/31 $09, , , , MACHINE 2 $60,000 X 25%* = $15,000 $45,000 X 25% = $11,250 $33,750 X 25% = $ 8,438 * 1/8 years = 12.5% x 2 = 25% $15, , , MACHINE 3 1,000 X ($60,000* 24,000) = $ 2,500 4,500 X ($60,000 24,000) = $11,250 * $66,000 - $6,000 = $60,000 $ 2,500 13,

31 PROBLEM 10-2A (Continued) (b) Year Calculation Amortization Expense MACHINE 2 (1) 2000 $60,000 X 25% X 9/12 = $11,250 $11,250 (2) 2001 $48,750* X 25% = $12,188 $12,188 (3) 2002 $36,562 x 25% = $9,140 $ 9,140 * $60,000 - $11,250 = $48,750 ** $48,750 - $12,188 = $36,

32 PROBLEM 10-3A (a) Year Amortizable Cost $90,000* 090, ,000 Calculation X STRAIGHT-LINE AMORTIZATION Amortization Rate = 33⅓%** 33⅓% 33⅓% Amortization Expense $30, , ,000 End of Year Accumulated Amortization $30, , ,000 Net Book Value $70,000 40,000 10,000 * $100,000 - $10,000 = $90,000 ** 1/3 years = 33⅓% Year Net Book Value Beginning of Year $100, ,333 11,110 DOUBLE DECLINING-BALANCE AMORTIZATION Calculation X Amortization Rate = 66⅔%* 66⅔% 66⅔% Amortization Expense $66, ,223 01,110** End of Year Accumulated Amortization $66, , ,000 Net Book Value $33,333 11,110 10,000 * 1/3 years = 33⅓% x 2 = 66⅔% ** Adjusted so ending net book value will equal residual value. (b) Straight-line amortization provides the lower amount for 2002 amortization expense ($30,000) and, therefore, the higher 2002 income. Over the three-year period, both methods result in the same total amortization expense ($90,000) and, therefore, the same total income. (c) Both methods will result in the same cash flow from operations in 2002 and over the three-year period. Recording amortization expense does not affect cash flow. It is only an allocation of the capital cost to expense over its useful life

33 PROBLEM 10-4A Year Amortization Expense Accumulated Amortization 2000 $7,200* $ 7, ,200 14, ,400** 19, ,400 25, ,400 30, ,900*** 37,500 Years 2000 and 2001: * $40,000 $4,000 = $7,200 5 years Years 2002, 2003, and 2004: ** $40,000 $14,400 $4,000 = $5, years Year 2005: ***$40,000 $30,600 - $2,500 = $6,900 1 year Proof: Accumulated amortization equals $37,500. Net book value is equal to $40,000 $37,500 = $2,500 which is equal to the estimated residual value of $2,

34 PROBLEM 10-5A Account Debited Explanation 1. Equipment Cost to prepare the equipment for use. 2. Land improvements Non-permanent land expenditure. 3. Building Improvement or betterment expenditure, which makes the factory office more productive. 4. Repair expense Does not benefit future periods. If the loss was considered to be significant, it would be recorded separately as a loss due to labour dispute, rather than as repair expense. 5. Equipment Cost to prepare the equipment for use. 6. Repair expense Does not benefit future periods. If the damage was covered by insurance, a receivable (from the insurance company) account would be debited. If the loss was considered to be significant, it would be recorded separately as a loss due to damages, rather than as repair expense

35 PROBLEM 10-6A (a) Jan. 7 Equipment... 14,000 Cash... 14,000 Feb. 7 Repair Expense... 1,000 Cash... 1,000 Mar. 19 Repair Expense... 2,500 Cash... 2,500 (b) (1) Years 1 and 2: ($100,000 $10,000) 5 = $18,000 (2) Years 3 7: Net book value, Jan. 7, Year 3 ($100,000 - $18,000 - $18,000) $64,000 Add: Addition... 14,000 78,000 Less: Revised residual value... 12,000 Revised amortizable cost... 66,000 Remaining useful life (7 2 years)... 5 years Revised annual amortization expense... $13,200 (3) $13,200 [as per calculation in part (2) above] 10-35

36 PROBLEM 10-7A (a) (1) Straight-Line (2) Declining-Balance Amortization Net Book Amortization Net Book Years Expense Value Expense Value 1 $ 5,000 $16,000 $ 5,250 $15, ,000 11,000 3,938 11, ,000 6,000 2,953 8, ,000 1,000 2,215 6,644 Total $20,000 $14,356 (1) STRAIGHT-LINE AMORTIZATION Calculation End of Year Net Amortizable Amortization Amortization Accumulated Book Year Cost X Rate = Expense Amortization Value 1 $20,000* 25%** $ 5,000 $ 5,000 $16, ,000 25% 5,000 10,000 11, ,000 25% 5,000 15,000 6, ,000 25% 5,000 20,000 1,000 * $21,000 - $1,000 = $20,000 ** ¼ years = 25% (2) SINGLE DECLINING-BALANCE AMORTIZATION Calculation End of Year Net Book Value Net Beginning Amortization Amortization Accumulated Book Year of Year X Rate = Expense Amortization Value 1 $21,000 25%* $5,250 $ 5,250 $15, ,750 25% 3,938 9,188 11, ,812 25% 2,953 12,141 8, ,859 25% 7,859** 20,000 1,000 * ¼ years = 25% ** Adjusted so ending net book value will equal salvage value

37 PROBLEM 10-7A (Continued) (b) 1. (i) Straight (ii) Declining Line Balance 2. Cost... $21,000 $21,000 Accum. amortization ,000 12,141 Net book value... 6,000 8,859 Cash proceeds... 7,000 7,000 Gain (loss) on disposal... $ 1,000 ($ 1,859) Amortization expense... $15,000 $12,141 Add: Loss on disposal... 1,859 Less: Gain on disposal... 1, Net expense... $14,000 $14,000 In total the effect on net income is the same under both methods. This is because the method of amortization selected only affects the timing of the expense recognition. In total over the life of the asset, the expense recognized is the same

38 PROBLEM 10-8A (a) June 30 Accumulated Amortization Delivery Equipment... 24,000 Loss on Disposal... 21,000 Delivery Equipment... 45,000 Accumulated Amortization ($45,000 - $5,000) X 3/5 years = $24,000 (b) June 30 Cash... 25,000 Accumulated Amortization Delivery Equipment... 24,000 Gain on Disposal... 4,000 Delivery Equipment... 45,000 (c) June 30 Cash... 18,000 Accumulated Amortization Delivery Equipment... 24,000 Loss on Disposal... 3,000 Delivery Equipment... 45,

39 PROBLEM 10-9A Expenditure Architect fees Account Title Building Cost to demolish an old building that is on a piece of land intended for a new building Land: it is a cost of getting the land ready for its intended use Lawyer s fees associated with a successful patent application Patent Lawyer s fees associated with an unsuccessful patent application Legal Fees Expense (Operating Expense): if the application was unsuccessful, then there is no asset Cost of a grease and oil change on the company s truck Repairs and Maintenance Expense Cost of installing a new roof on the company s building Building (it would be rare to find a separate capital asset set up for a roof account as distinct from the building) Cost of painting the president s office Repairs and Maintenance Expense (Operating Expense) Cost of CD s and toner for the office computer and printer Office Supplies Expense (Operating Expense) 10-39

40 Expenditure Payment to a celebrity for endorsement of a product Account Title Advertising Expense (Operating Expense): Some companies would allocate the cost according to the number of times that the advertisements are to be aired. A current asset, such as prepaid advertising, would be established for those costs related to future advertisements. However, in the real world, all such costs are generally charged to advertising expense Cost of four new tires for the company delivery van Repairs and Maintenance Expense (Operating Expense): Depending on the vehicle usage during a year, an argument could be made for capitalizing this expenditure. Again, in the real world, this expenditure is usually charged to expenses Cost to rebuild the engine on the company delivery van Delivery Van: The benefit should extend beyond one year; therefore, the amount would be capitalized as part of the cost of the delivery van Cost to pave the company parking lot Cost of painting the corporate logo on the sides of the company delivery van Land Improvements Repairs and Maintenance Expense (Operating Expense): Does not make the delivery van any more productive. This is also likely a recurring expense 10-40

41 PROBLEM 10-10A 1. Research Expense... 72,000 Patents ($120,000 X 60%)... 72,000 To correct patent cost. Patents ($120, years)... 6,000 Amortization Expense... 6,000 To reverse recorded amortization expense. Amortization Expense... 2,400 Patents [($120,000 - $72,000) 20 years]... 2,400 To record correct amortization expense. 2. Gain on Patent Appreciation... 94,400 Patents... 94,400 To correct overvaluation of patent. Patents ($139, years)... 6,970 Amortization Expense... 6,970 To reverse recorded amortization expense. Amortization Expense... 2,250 Patents ($45, years)... 2,250 To record correct amortization expense. 3. Amortization Expense... 1,500 Goodwill... 1,500 To reverse recorded amortization expense. Note: Goodwill is not amortized. 4. Charitable Donations Expense... 5,000 Goodwill... 5,

42 PROBLEM 10-11A (a) Jan. 2 Patent # ,000 Cash... 12,000 June 30 Patent # ,000 Cash ,000 Sept. 1 Advertising Expense... 80,000 Cash... 80,000 Oct. 1 Copyright # ,000 Cash ,000 (b) Dec. 31 Amortization Expense... 8,333 Patent #1... 8,333 ($70, years) + ($12,000 9 years) 31 Amortization Expense... 3,125 Patent #2... 3,125 ($125, years X 6/12 mos.) 31 Amortization Expense... 4,800 Copyright #1... 4,800 ($48, years) 31 Amortization Expense... 5,000 Copyright #2... 5,000 ($120,000 6 years X 3/12 mos.) 10-42

43 PROBLEM 10-11A (Continued) (c) TAR COMPANY (Partial) Balance Sheet December 31, 2002 Assets Capital assets Patents (net of $18,458 amortization) (1)... $188,542 Copyrights (net of $29,000 amortization) (2) ,000 Total capital assets... $327,542 (1) Patent cost = $70,000 + $12,000 + $125,000 = $207,000 Patent amortization = $7,000 + $8,333 + $3,125 = $18,458 (2) Copyright cost = $48,000 + $120,000 = $168,000 Copyright amortization = $19,200 + $4,800 + $5,000 = $29,

44 PROBLEM 10-12A (a) April 1 Land... 2,630,000 Cash... 2,630,000 May 1 Amortization Expense... 19,000 Accumulated Amortization Equipment 19,000 ($570, years X 4/12 mos.) 1 Cash ,000 Accumulated Amortization Equipment 247,000 Gain on Disposal... 27,000 Equipment ,000 Cost $570,000 Accumulated amortization [($570, years X 4 years) + $19,000] 247,000 Net book value 323,000 Cash proceeds 0 350,000 Gain on disposal $ 27,000 June 1 Cash... 1,800,000 Land ,000 Gain on Disposal... 1,600,000 July 1 Equipment... 2,000,000 Cash... 2,000,000 Dec. 31 Amortization Expense... 50,000 Accumulated Amortization Equipment 50,000 ($500, years) 10-44

45 PROBLEM 10-12A (Continued) (a) (Continued) Dec. 31 Accumulated Amortization Equipment 500,000 Equipment ,000 Cost $500,000 Accumulated amortization ($500, years X 10 years) 500,000 Gain (loss) on disposal $ 0 (b) Dec. 31 Amortization Expense ,000 Accumulated Amortization Buildings 950,000 ($28,500,000 X 1/30) 31 Amortization Expense... 4,793,000 Accumulated Amortization Equipment 4,793,000 $46,930, years $4,693,000 $2,000, years X 6/12 mos., 100,000 $4,793,000 a $48,000,000 $570,000 $500,000 = $46,930,

46 PROBLEM 10-12A (Continued) (c) DUFOUR COMPANY (Partial) Balance Sheet December 31, 2003 Capital assets* Land... $06,430,000 Buildings... $28,500,000 Less: Accumulated amortization buildings... 13,050,000 15,450,000 Equipment... $48,930,000 Less: Accumulated amortization equipment... 9,115,000 39,815,000 Total capital assets... $61,695,000 *See T accounts which follow (not required)

47 PROBLEM 10-12A (Continued) Jan. 1 Bal. 4,000,000 Apr. 1 2,630,000 Dec. 31 Bal. 6,430,000 Land June 1 200,000 Jan. 1 Bal. 28,500,000 Dec. 31Bal. 28,500,000 Buildings Jan. 1 Bal. 48,000,000 July 1 2,000,000 Dec. 31 Bal. 48,930,000 Equipment May ,000 Dec ,000 Accumulated Amortization Buildings Jan. 1 Bal. 12,100,000 Dec. 31 AJE 950,000 Dec. 31 Bal. 13,050,000 Accumulated Amortization Equipment May ,000 Dec ,000 Jan. 1 Bal. 5,000,000 May 1 19,000 Dec ,000 Dec. 31 AJE 4,793,000 Dec. 31 Bal. 9,115,

48 PROBLEM 10-13A (a) Andrew Company Michael Company Asset turnover $1,400,000 $2,500,000 = 0.56 times $1,300,000 $2,000,000 = 0.65 times Return on assets $700,000 $2,500,000 = 28% $1,000,000 $2,000,000 = 50% (b) Michael Company is more efficient in using its assets to generate sales its assets turnover of 0.65 times is higher than 0.56 times for Andrew Company. It is also more efficient in using assets to produce income with a return on assets of 50% compared to 28% for Andrew Company

49 PROBLEM 10-1B 1. Land ($145,000 X $100,000 $150,000)... 96,667 Building ($145,000 X $50,000 $150,000)... 48,333 Land and Building , Land Improvements... 4,000 Land and Buildings... 4, Land ($2,000 X $100,000 $150,000)... 1,333 Building ($2,000 X $50,000 $150,000) Land and Building... 2, Property Tax Expense... 5,000 Land and Building... 5, Land Improvements... 10,000 Land and Buildings... 10, Repair Expense... 3,000 Land and Buildings... 3,

50 PROBLEM 10-2B (a) 2000 Dec. 2 Equipment... 45,000 Accounts Payable... 45,000 (b) 1. Straight-line 2 Equipment Cash Accounts Payable... 45,000 Cash... 45, Equipment... 3,100 Cash... 3,100 Total cost of equipment: Invoice cost... $45,000 Shipping Testing... 3,100 Total... $48, Dec. 31 Amortization Expense... 8,180 Accumulated Amortization... 8,180 ($48,900 - $8,000) 5 years = $8, Dec. 31 Amortization Expense... 8,180 Accumulated Amortization... 8,180 ($48,900 - $8,000) 5 years = $8,

51 PROBLEM 10-2B (Continued) (b) 2. Units-of-activity 2001 Dec. 31 Amortization Expense... 6,000 Accumulated Amortization... 6,000 ($48,900 - $8,000) 200,000 units = $0.20 per unit $0.20 per unit X 30,000 units = $6, Dec. 31 Amortization Expense... 9,600 Accumulated Amortization... 9,600 ($48,900 - $8,000) 200,000 units = $0.20 per unit $0.20 per unit X 48,000 units = $9, Double declining-balance 2001 Dec. 31 Amortization Expense... 19,560 Accumulated Amortization... 19,560 Rate 1/5 X 2 = 40% $48,900 X 40% = $19, Dec. 31 Amortization Expense... 11,736 Accumulated Amortization... 11,736 ($48,900 - $19,560) X 40% = $11,

52 PROBLEM 10-3B (a) Cost: Cash price $35,000 Shipping costs 175 Insurance during shipping 75 Installation and testing 50 Total cost $35,300 Oil and lubricants are not included as they are operating expenses, benefiting only the current period. (b) 1. STRAIGHT-LINE AMORTIZATION Year Amortizable Cost $30,300* 30,300 30,300 30,300 Calculation X Amortization Rate = 25%** 25% 25% 25% Amortization Expense $7,575 07,575 07,575 7,575 * Amortizable cost = $35,300 - $5,000 = $30,300 ** 1 4 years = 25% End of Year Accumulated Amortization $ 7, , ,725 30,300 Net Book Value $27,725 20,150 12,575 5,

53 PROBLEM 10-3B (Continued) (b) (Continued) 2. DOUBLE DECLINING-BALANCE AMORTIZATION Year Net Book Value Beginning of Year $35, , ,825 5,000 Calculation X Amortization Rate = 50%** 50% 50% 50% Amortization Expense $17,650 8,825 4,43,825** 0** End of Year Accumulated Amortization $17, , ,300 30,3000 * 1 4 years = 25% x 2 = 50% ** Adjusted so ending net book value will equal residual value Net Book Value $17,650 8,825 5,000 5, UNITS-OF-ACTIVITY AMORTIZATION Year Units-of- Activity 6,500 7,500 6,000 5,000 Calculation X Amortizable Cost per Unit = $1.212* $1.212 $1.212 $1.212 Amortization Expense $7,878 09,090 7,272 6,060 End of Year Accumulated Amortization $ 7, , ,240 30,300 * Amortizable cost per unit: $30,300 25,000 units = $1.212 Net Book Value $27,422 18,332 11,060 5,000 (c) Straight-line amortization provides the lowest amount of amortization expense for The declining-balance method provides the lowest amount for Over the four-year period, all three methods result in the same total amortization expense (equal to the amortizable cost)

54 PROBLEM 10-3B (Continued) (d) The declining-balance method produces the lowest net income in 2002 (highest amortization expense). The straight-line method produces the lowest net income in (e) All three methods will result in the same cash flow from operations in 2002, 2005, and in total over the four-year period. Amortization does not affect cash flow. There is no Cash account involved in the entry to record amortization (Dr. Amortization Expense; Cr. Accumulated Amortization). Amortization simply allocates the cost of the capital asset over the periods it benefits. It does not provide, nor use, cash

55 PROBLEM 10-4B (a) Year Amortization Expense Accumulated Amortization 2000 ($50,000 - $2,000) 6 years = $8,000 $ 8, ($50,000 - $2,000) 6 years = $8,000 16, ($50,000 - $16,000 - $1,400) 3 years = $10,867 26, ($50,000 - $16,000 - $1,400) 3 years = $10,867 37, ($50,000 - $16,000 - $1,400) 3 years = $10,866 48,600 (b) The net book value at the end of the asset s useful life is $1,400 ($50,000 - $48,600). This is equal to its estimated salvage value, which is what it should be

56 PROBLEM 10-5B Account Debited Explanation 1. Equipment Improvement or betterment expenditure, which makes the equipment more productive 2. Repairs and Maintenance Expense Does not make the equipment more productive. Likely benefits only the current period 3. Equipment Improvement or betterment expenditure, which makes the equipment more productive 4. Repairs and Maintenance Expense Does not make the equipment more productive 5. Training Expense Does not increase the productivity of the equipment and current accounting policies do not recognize the cost of human capital 6. Repairs and Maintenance Expense Does not make the equipment more productive. Painting is a recurring expense 10-56

57 PROBLEM 10-6B (a) Jan. 18 Repair Expense... 1,500 Cash... 1,500 Mar. 5 Repair Expense... 2,400 Cash... 2,400 Dec. 31 Equipment... 35,000 Cash... 35,000 (b) (1) Years 1, 2, and 3 ($112,000 $12,000) 5 years = $20,000 (2) Year 4 $20,000 (same as Year 3, since addition to Equipment occurred at year-end) (3) Year 5 Total amortizable cost: Net book value [$112,000 ($20,000 x 4 years)] $ 32,000 Add: Additional cost 35,000 67,000 Less: Revised residual value 5,000 Revised amortizable cost 62,000 Divide by remaining useful life (9 4) 5 years Amortization expense $ 12,

58 PROBLEM 10-7B (a) Double Straight Units-of- Declining- -Line Activity Balance Proceeds $ 4,400 $4,400 $4,400 Less: Net book value 6,000 6,000 2,250 Gain (loss) on disposal ($1,600) ($1,600) $2,150 (b) There really is no best method in this situation. All three methods allocate cost in varying ways over the three year period. The declining-balance method had a gain on disposal, but that just offsets the additional amortization expense this method charged in the early years. The straight-line and units-of-activity methods end up, coincidentally, at the same position at the end of year three. The units-of-activity method likely provided the best matching of the cost of the equipment with the revenue it produced through production. (c) Double Straight- Units-of- Declining- Line Activity Balance Amortization expense $12,000 $12,000 $15,750 Add: Loss (gain) on disposal 1,600 1,600 (2,150) Total effect on net income $13,600 $13,600 $13,600 (d) The results in part (c) show that the total charge to incomes over the life of the assets is the same regardless of the method of amortization chosen. Amortization allocates the cost over the time periods the asset is in use the total charge, including the gain or loss on disposal is the same. The total cost is equal to the original cost less the proceeds on disposal. In this case, $18,000 - $4,400 = $13,

59 PROBLEM 10-8B (a) July 1 Amortization Expense... 7,400 Accumulated Amortization... 7,400 ($75,000 - $1,000) 5 years = $14,800 x 6/12 mos. = $7,400 1 Accumulated Amortization Office Furniture ($14,800 x 4.5 years)... 66,600 Loss on Disposal... 8,400 Office Furniture... 75,000 (b) July 1 Amortization Expense... 7,400 Accumulated Amortization... 7,400 ($75,000 - $1,000) 5 years = $14,800 x 6/12 mos. = $7,400 1 Cash... 1,000 Accumulated Amortization Office Furniture ($14,800 x 4.5 years)... 66,600 Loss on Disposal... 7,400 Office Furniture... 75,000 [The loss on disposal equals amortization for the remaining six months of the original useful life, which makes sense as the only thing that changed was the useful life.] (c) July 1 Amortization Expense... 7,400 Accumulated Amortization... 7,400 ($75,000 - $1,000) 5 years = $14,800 x 6/12 mos. = $7,400 1 Cash... 8,000 Accumulated Amortization Office Furniture ($14,800 x 4.5 years)... 66,600 Loss on Disposal Office Furniture... 75,

60 PROBLEM 10-8B (Continued) (d) July 1 Amortization Expense... 7,400 Accumulated Amortization... 7,400 ($75,000 - $1,000) 5 years = $14,800 x 6/12 mos. = $7,400 1 Cash... 8,500 Accumulated Amortization Office Furniture ($14,800 x 4.5 years)... 66,600 Gain on Disposal Office Furniture... 75,