Chapter 11—Investments in Noncurrent Operating Assets-Utilization and Retire-

ment

MULTIPLE CHOICE

1. The sum-of-the-years'-digits method of depreciation is being used for a machine with a five-year esti-
mated useful life. What would be the fraction applied to the cost to be depreciated in the fourth year?
a. 2/5
b. 4/5
c. 2/15
d. 4/15
ANS: C PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

2. Depreciation of noncurrent operating assets is an accounting process for the purpose of

a. reporting declining asset values on the balance sheet.
b. allocating asset costs over the periods benefited by use of the assets.
c. accounting for costs to reflect the change in general price levels.
d. setting aside funds to replace assets when their economic usefulness expires.
ANS: B PTS: 1 DIF: Easy OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

3. Which of the following principles best describes the conceptual rationale for the methods of matching
depreciation expense with revenues?
a. Partial recognition
b. Immediate recognition
c. Systematic and rational allocation
d. Associating cause and effect
ANS: C PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

4. Information needed to compute a depletion charge per unit includes the

a. estimated total amount of resources available for removal.
b. amount of resources removed during the period.
c. cumulative amount of resources removed.
d. amount of resources sold during the period.
ANS: A PTS: 1 DIF: Medium OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic

5. The composite depreciation method

a. is applied to a group of homogeneous assets.
b. is an accelerated method of depreciation.
c. does not recognize gain or loss on the retirement of specific assets in the group.
d. excludes salvage value from the base of the depreciation calculation.
ANS: C PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

6. In order to calculate the third year's depreciation on an asset using the sum-of- the-years'-digits
method, which of the following must be known about the asset?
 a. Its acquisition cost
b. Its estimated salvage value
c. Its estimated useful life
d. All of these must be known.
ANS: D PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

7. Which of the following statements is the assumption on which straight-line depreciation is based?
a. The operating efficiency of the asset decreases in later years.
b. Service value declines as a function of obsolescence rather than time.
c. Service value declines as a function of time rather than use.
d. Physical wear and tear are more important than economic obsolescence.
ANS: C PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

8. A method that ignores salvage value in the early years of the asset’s life in calculating periodic depre-
ciation expense is the
a. productive-output method.
b. group composite method.
c. sum-of-the-years'-digits method.
d. double-declining-balance method.
ANS: D PTS: 1 DIF: Easy OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

9. Which of the following is NOT required to be reported in the financial statements or disclosed in the
accompanying notes?
a. Balances of major classes of noncurrent operating assets at the balance sheet date
b. Gross historical cost and accumulated amortization for intangible assets at the balance
sheet date
c. Gross historical cost and accumulated depreciation for tangible noncurrent operating as-
sets at the balance sheet date
d. A general description of the cost allocation methods used with respect to major classes of
noncurrent operating assets
ANS: B PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Reporting MSC: AACSB Reflective Thinking

10. Which of the following depreciation methods most closely approximates the method used to deplete
the cost of natural resources?
a. Straight-line method
b. Double-declining-balance method
c. Sum-of-the-years'-digits method
d. Units-of-production method
ANS: D PTS: 1 DIF: Easy OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic

11. Which of the following depreciation methods applies a uniform depreciation rate each period to an as-
set's book value?
a. Straight-line
b. Declining-balance
c. Units-of-production
 d. Sum-of-the-years'-digits
ANS: B PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

12. Which of the following reasons provides the best theoretical support for accelerated depreciation?
a. Assets are more efficient in early years and initially generate more revenue.
b. Expenses should be allocated in a manner that "smoothes" earnings.
c. Repairs and maintenance costs will probably increase in later periods, so depreciation
should decline.
d. Accelerated depreciation provides easier replacement because of the time value of money.
ANS: A PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

13. When the estimate of an asset's useful life is changed,

a. depreciation expense for all past periods must be recalculated.
b. there is no change in the amount of depreciation expense recorded for future years.
c. only the depreciation expense in the remaining years is changed.
d. None of these are true.
ANS: C PTS: 1 DIF: Medium OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

14. Which of the following depreciation methods is computed in the same way as depletion?
a. Straight-line
b. Sum-of-the-years'-digits
c. Double-declining-balance
d. Productive-output
ANS: D PTS: 1 DIF: Easy OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic

15. In accordance with generally accepted accounting principles, which of the following methods of amor-
tization is normally recommended for intangible assets?
a. Sum-of-the-years'-digits
b. Straight-line
c. Group composite
d. Double-declining-balance
ANS: B PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic

16. The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were
a. less than current market value.
b. greater than cost.
c. greater than book value.
d. less than book value.
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

17. When an exchange of similar assets involves a gain,

a. the recorded amount of the new asset is the cost of the old asset plus any cash paid.
b. the recorded amount of the new asset is the net book value of the old asset plus any cash
paid.
 c. the recorded amount of the new asset is its fair market value less any cash paid.
d. None of these are true.
ANS: B PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

18. On January 1 Murphy Company acquired a machine with a four-year useful life. Murphy estimates the
salvage value of the machine will be equal to ten percent of the acquisition cost. The company is de-
bating between using either the double-declining-balance method or the sum-of-the-years'-digits
method of depreciation. Comparing the depreciation expense for the first two years computed using
these methods, the depreciation expense for the double-declining-balance method (compared to the
sum-of-the-years'-digits method) will match which of the patterns shown below?

First Second
Year Year
a. Lower Lower
b. Lower Higher
c. Higher Lower
d. Higher Higher

ANS: C PTS: 1 DIF: Challenging OBJ: LO 1

TOP: AICPA FN-Measurement MSC: AACSB Analytic

19. Legal fees incurred in successfully defending a patent suit should be capitalized when the patent has
been

Internally Purchased from

Developed an Inventor
a. Yes No
b. Yes Yes
c. No Yes
d. No No

ANS: B PTS: 1 DIF: Medium OBJ: LO 5

TOP: AICPA FN-Measurement MSC: AACSB Analytic

20. Which of the following utilizes the straight-line depreciation method?

Composite Group
Depreciation Depreciation
a. Yes Yes
b. Yes No
c. No Yes
d. No No

ANS: A PTS: 1 DIF: Medium OBJ: LO 1

TOP: AICPA FN-Measurement MSC: AACSB Analytic

21. When assets are exchanged at a loss in an exchange lacking commercial substance, the basis of the
new asset is usually
a. the list price of the new asset.
b. the book value of the old asset plus any cash paid on the trade-in.
c. the fair market value of the new asset.
d. either the book value of the old asset plus any cash paid on the trade-in or the fair market
value of the new asset.
 ANS: C PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

22. A depreciable asset has an estimated 15 percent salvage value. At the end of its estimated useful life,
the accumulated depreciation would equal the original cost of the asset under which of the following
depreciation methods?

Productive- Sum-of-the- Double-

Output Years'-Digits Declining-Balance
a. Yes No No
b. No No No
c. No Yes No
d. Yes Yes Yes

ANS: B PTS: 1 DIF: Medium OBJ: LO 1

TOP: AICPA FN-Measurement MSC: AACSB Analytic

23. A company using the group depreciation method for its delivery trucks retired one of the trucks after
the average service life of the group was reached. Cash proceeds were received from a salvage com-
pany. The net carrying amount of these group asset accounts would be decreased by the
a. original cost of the truck.
b. original cost of the truck less the cash proceeds.
c. cash proceeds received.
d. cash proceeds received and original cost of the truck.
ANS: C PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

24. In recording the trade of one asset for another, which of the following accounts is usually debited?
a. Cash
b. Accumulated Depreciation-Old Asset
c. Gain on Exchange of Asset
d. None of these
ANS: B PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

25. Stanley Company purchased a machine that was installed and placed in service on January 2, 2013, at
a total cost of $680,000. Residual value was estimated at $70,000. The machine is being depreciated
over ten years by the double-declining-balance method. For the year 2014, Stanley should record de-
preciation expense of
a. $108,800
b. $97,600
c. $68,000
d. $61,000
ANS: A PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

26. Lex Soaps purchased a machine on January 1, 2013, for $18,000 cash. The machine has an estimated
useful life of four years and a salvage value of $4,700. Lex uses the double-declining-balance method
of depreciation for all its assets. What will be the machine's book value as of December 31, 2014?
a. $5,100
b. $4,700
 c. $4,500
d. $4,300
ANS: B PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

27. Hyde Company traded in an old machine with a book value of $15,000 on a new machine. The ex-
change did not have commercial substance. The new machine, which had a cash price of $75,000, was
purchased for $64,000 cash plus the old machine. Hyde should record the cost of the new machine as
a. $64,000.
b. $71,000.
c. $75,000.
d. $79,000.
ANS: C PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

28. Underwood Company purchased a machine on January 2, 2013, for $1,000,000. The machine has an
estimated useful life of five years and a salvage value of $100,000. Depreciation was computed by the
150% declining-balance method. The accumulated depreciation balance at December 31, 2014, should
be
a. $360,000.
b. $459,000.
c. $490,000.
d. $510,000.
ANS: D PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

29. Mantle Company exchanged a used autograph-signing machine with Maris Company for a similar ma-
chine with less use. Mantle's old machine originally cost $50,000 and had accumulated depreciation of
$40,000, as well as a market value of $40,000, at the time of the exchange. Maris' old machine origi-
nally cost $60,000 and at the time of the exchange had a book value of $30,000 and a market value of
$32,000. Maris gave Mantle $8,000 cash as part of the exchange. The exchange lacked commercial
substance. Mantle should record the cost of the new machine at
a. $8,000.
b. $10,000.
c. $16,000.
d. $32,000.
ANS: D PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

30. Zenith Corporation bought a machine on January 1, 2014. In purchasing the machine, the company
paid $40,000 cash and signed an interest-bearing note for $105,000. The estimated useful life of the
machine is five years, after which time the salvage value is expected to be $10,000. Given this infor-
mation, how much depreciation expense would be recorded for the year ending December 31, 2015, if
the company uses the sum-of-the-years'-digits depreciation method?
a. $45,000
b. $36,000
c. $40,000
d. $34,000
ANS: B PTS: 1 DIF: Challenging OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic
31. On January 1, 2014, Jameson Company purchased equipment at a cost of $420,000. The equipment
was estimated to have a useful life of five years and a salvage value of $60,000. Jameson uses the sum-
of-the-years'-digits method of depreciation. What should the accumulated depreciation be at December
31, 2017?
a. $240,000
b. $288,000
c. $336,000
d. $360,000
ANS: C PTS: 1 DIF: Challenging OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

32. On June 30, 2014, a fire in Walnut Company's plant caused the total loss of a production machine. The
machine was being depreciated at $20,000 annually and had a carrying amount of $160,000 at Decem-
ber 31, 2013. On the date of the fire, the fair value of the machine was $220,000, and Walnut received
insurance proceeds of $200,000 in October 2014. In its income statement for the year ended December
31, 2014, what amount should Walnut recognize as a gain or loss on disposition?
a. $0
b. $20,000 loss
c. $40,000 gain
d. $50,000 gain
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

33. On January 1, 2012, Costas Co. purchased a new machine for $1,250,000. The new machine has an es-
timated useful life of five years and the salvage value was estimated to be $250,000. Costas uses the
sum-of-the-years'-digits method of depreciation. The amount of depreciation expense for 2014 is
a. $200,000.
b. $250,000.
c. $300,000
d. $416,667
ANS: A PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

34. On December 2, 2014, Loofa Company, which operates a furniture rental business, traded in a used de-
livery truck with a carrying amount of $5,400 for a new delivery truck having a list price of $16,000
and paid a cash difference of $7,500 to the dealer. The used truck had a fair value of $6,000 on the date
of the exchange. The exchange has commercial substance. At what amount should the new truck be
recorded on Loofa's books?
a. $10,600
b. $12,900
c. $13,500
d. $16,000
ANS: C PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

35. On January 1, 2014, Ashton Company purchased equipment at a cost of $570,000. The equipment was
estimated to have a useful life of five years and a salvage value of $60,000. Ashton uses the sum-of-
the-years'-digits method of depreciation. What should the accumulated depreciation be at December
31, 2016?
a. $340,000
 b. $408,000
c. $456,000
d. $510,000
ANS: B PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

36. In January, Fanning Corporation entered into a contract to acquire a new machine for its factory. The
machine, which had a cash price of $400,000, was paid for as follows:

Down payment .......................................... $ 30,000

Note payable in 10 equal monthly installments ......... 240,000
1,000 shares of Hunter common stock with an agreed 50,000
value of $50 per share ..............................
Total ................................................. $320,000

Prior to the machine's use, installation costs of $10,000 were incurred. The machine has an estimated
useful life of ten years and an estimated salvage value of $10,000. What should Hunter record as de-
preciation expense for the first year under the straight-line method?
a. $38,100
b. $39,100
c. $40,000
d. $41,000
ANS: C PTS: 1 DIF: Challenging OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

37. Meteor Motor Sales exchanged a car from its inventory for a computer to be used as a noncurrent oper-
ating asset. The following information relates to this exchange that took place on July 31, 2014:

Carrying amount of the car ............................ $30,000

Listed selling price of the car ....................... 45,000
Fair value of the computer ............................ 43,000
Cash difference paid by Meteor ........................ 5,000

The exchange has commercial substance.

On July 31, 2014, how much profit should Meteor recognize on this exchange?
a. $0
b. $8,000
c. $10,000
d. $13,000
ANS: B PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

38. The Bromley Company purchased a tooling machine in 2004 for $120,000. The machine was being
depreciated on the straight-line method over an estimated useful life of 20 years, with no salvage
value. At the beginning of 2014, when the machine had been in use for ten years, the company paid
$20,000 to overhaul the machine. As a result of this improvement, the company estimated that the use-
ful life of the machine would be extended an additional five years. What would be the depreciation ex-
pense recorded for the machine in 2014?
a. $4,000
b. $5,333
c. $6,000
 d. $7,333
ANS: B PTS: 1 DIF: Challenging OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

39. Stiller Company owns a machine that was bought on January 2, 2011, for $376,000. The machine was
estimated to have a useful life of five years and a salvage value of $24,000. Stiller uses the sum-of-the-
years'-digits method of depreciation. At the beginning of 2014, Stiller determined that the useful life of
the machine should have been four years and the salvage value $35,200. For the year 2014, Stiller
should record depreciation expense on this machine of
a. $19,200.
b. $44,400.
c. $59,200.
d. $70,400.
ANS: C PTS: 1 DIF: Medium OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

40. Winwood Construction purchased a crane on January 1, 2013, for $102,750. At the time of purchase,
the crane was estimated to have a life of six years and a residual value of $6,750. In 2015, Winwood
determined that the crane had a total useful life of seven years and a residual value of $4,500. If Win-
wood uses the straight-line method of depreciation, what will be the depreciation expense for the crane
in 2015?
a. $16,000
b. $13,250
c. $9,464
d. $8,000
ANS: B PTS: 1 DIF: Medium OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

41. At the start of its business, Londres Corp. decided to use the composite method of depreciation and
prepared the following schedule of machinery owned.

Total Estimated Estimated Life

Cost Salvage Value in Years
Machine A $350,000 $25,000 20
Machine B 130,000 10,000 15
Machine C 25,000 -- 5

Londres computes depreciation on the straight-line method. Based on the information presented, the
composite life of these assets (in years) should be
a. 13.4
b. 14.4
c. 15.9
d. 17.1
ANS: C PTS: 1 DIF: Medium OBJ: LO 1
TOP: AICPA FN-Measurement MSC: AACSB Analytic

42. A truck that cost $12,000 was originally being depreciated over four years using the straight-line
method with no salvage value. If after one year, it was decided that the truck would last an additional
four years (or a total of five years), the second year's depreciation would be
a. $1,500
b. $2,250
 c. $2,400
d. $3,000
ANS: B PTS: 1 DIF: Easy OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

43. On January 1, 2013, Canal Locks Corporation purchased drilling equipment for $11,500. The equip-
ment has an estimated useful life of four years and a salvage value of $200. Given this information, if
Canal uses the sum-of-the-years'-digits method of depreciation and then trades the equipment for new
equipment with a fair market value of $16,000 on December 31, 2014, and pays $8,000 cash in the ex-
change, assuming the exchange has commercial substance, the new equipment should be recorded at
a. $16,000.
b. $12,475.
c. $11,590.
d. $8,110.
ANS: A PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

44. On January 1, 2013, Pastel Colors Corporation purchased drilling equipment for $11,500. The equip-
ment has an estimated useful life of four years and a salvage value of $200. Assuming that Pastel Col-
ors uses the straight-line method of depreciation, if it trades the equipment for new equipment with a
list price of $15,500 on December 31, 2014, and pays $4,050 in the exchange, assuming the exchange
lacks commercial substance, the new equipment should be recorded at
a. $15,500.
b. $11,450.
c. $9,850.
d. $9,900.
ANS: D PTS: 1 DIF: Challenging OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

45. Lovejoy Co. purchased a patent on January 1, 2011, for $714,000. The patent was being amortized
over its remaining legal life of 15 years expiring on January 1, 2026. During 2014, Lovejoy deter-
mined that the economic benefits of the patent would not last longer than 10 years from the date of ac-
quisition. What amount should be charged to patent amortization expense for the year ended December
31, 2014?
a. $47,600
b. $71,400
c. $81,600
d. $142,800
ANS: C PTS: 1 DIF: Medium OBJ: LO 3
TOP: AICPA FN-Measurement MSC: AACSB Analytic

46. Morgan Trucking traded a used truck with a book value of $1,700 and a fair market value of $2,300 for
a new truck with a list price of $17,800. Morgan agreed to pay $13,000 in cash for the exchange in ad-
dition to giving up the used truck. Assuming the exchange has commercial substance, at what amount
should the new truck be recorded?
a. $17,800
b. $15,300
c. $14,700
d. None of these
ANS: B PTS: 1 DIF: Medium OBJ: LO 6
 TOP: AICPA FN-Measurement MSC: AACSB Analytic

47. Ibarra Carpet traded cleaning equipment with a cost of $27,000 and accumulated depreciation of
$5,250 for new equipment with a fair market value of $14,500. Assuming the exchange lacks commer-
cial substance, Ibarra should record the new equipment at
a. $14,750.
b. $13,750.
c. $14,500.
d. $7,500.
ANS: C PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

48. During 2009, Cabot Machine Company spent $352,000 on research and development costs for an in-
vention. This invention was patented on January 2, 2010, at a nominal cost that was expensed in 2010.
The patent has a legal life of 17 years and an estimated useful life of 8 years. In January 2014, Cabot
paid $32,000 for legal fees in a successful defense of the patent. Amortization for 2014 should be
a. $2,462.
b. $8,000.
c. $32,000.
d. $52,000.
ANS: B PTS: 1 DIF: Medium OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic

49. On January 1, 2010, Elaine Company purchased for $600,000, a trademark with an estimated useful
life of 16 years. In January 2014, Elaine paid $90,000 for legal fees in a successful defense of the
trademark. Trademark amortization expense for the year ended December 31, 2014, should be
a. $37,500.
b. $43,125.
c. $45,000.
d. $90,000.
ANS: C PTS: 1 DIF: Medium OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic

50. Cavallo Company acquired a tract of land containing an extractable natural resource. Cavallo is re-
quired by the purchase contract to restore the land to a condition suitable for recreational use after it
has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be
2,500,000 tons and that the extraction will be completed in five years. Relevant cost information fol-
lows:

Land ................................................. $9,000,000

Exploration and development costs .................... $1,000,000
Expected cash flows for restoration costs ............ $1,500,000
Credit-adjusted risk free interest rate .............. 10%

What should be the depletion charge per ton of extracted material?

a. $4.00
b. $4.37
c. $3.97
d. $3.60
ANS: B PTS: 1 DIF: Challenging OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic
51. Backhoe Construction Company recently exchanged an old truck, which cost $118,000 and was one-
third depreciated, and paid $80,000 cash for a used crane having a current fair value of $140,000. As-
suming the exchange has commercial substance, at what amount should the crane be recorded on the
books of Backhoe?
a. $80,000
b. $118,000
c. $140,000
d. $152,000
ANS: C PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

52. In January 2014, Router Mining Corporation purchased a mineral mine for $7,200,000 with removable
ore estimated by geological surveys at 4,320,000 tons. The property has an estimated value of
$720,000 after the ore has been extracted. Router incurred $2,160,000 of development costs preparing
the property for the extraction of ore. During 2014, 540,000 tons were removed and 480,000 tons were
sold. For the year ended December 31, 2014, Router should include what amount of depletion in its
cost of goods sold?
a. $720,000
b. $810,000
c. $960,000
d. $1,080,000
ANS: C PTS: 1 DIF: Challenging OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic

53. In 2013, Pauley Company paid $1,000,000 to purchase land containing a total estimated 160,000 tons
of extractable mineral deposits. The estimated value of the property after the mineral has been re-
moved is $200,000. Extraction activities began in 2014, and by the end of the year, 20,000 tons had
been recovered and sold. In 2015, geological studies indicated that the total amount of mineral deposits
had been underestimated by 25,000 tons. During 2015, 30,000 tons were extracted, and 28,000 tons
were sold. What is the depletion rate per ton (rounded to the nearest cent) in 2015?
a. $4.24
b. $4.32
c. $4.85
d. $5.19
ANS: A PTS: 1 DIF: Challenging OBJ: LO 2
TOP: AICPA FN-Measurement MSC: AACSB Analytic

54. In January 2014, Bevis Company exchanged an old machine, with a book value of $256,000 and a fair
value of $260,000, and paid $40,000 cash for a similar used machine having a fair value of $300,000.
The exchange lacked commercial substance. At what amount should the machine acquired in the ex-
change be recorded on Bevis' books?
a. $256,000
b. $296,000
c. $300,000
d. $304,000
ANS: B PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic
55. Nielsen Cargo Company recently exchanged an old truck, which cost $108,000 and was one-third de-
preciated, and paid $70,000 cash for a similar truck having a current fair value of $130,000. The ex-
change lacked commercial substance. At what amount should the truck be recorded on the books of
Nielsen?
a. $70,000
b. $108,000
c. $130,000
d. $142,000
ANS: C PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

56. On July 1, Toucan Corporation, a calendar-year company, received a condemnation award of $150,000
as compensation for the forced sale of a plant located on company property that stood in the path of a
new highway. On this date, the plant building had a depreciated cost of $75,000 and the land cost was
$25,000. On October 1, Toucan purchased a parcel of land for a new plant site at a cost of $62,500. Ig-
noring income taxes, Toucan should report in its income statement for the year ended December 31 a
gain of
a. $0.
b. $12,500.
c. $37,500.
d. $50,000.
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

57. The Chisholm Company purchased a machine on November 1, 2005, for $148,000. At the time of ac-
quisition, the machine was estimated to have a useful life of ten years and an estimated salvage value
of $4,000. Chisholm has recorded monthly depreciation using the straight-line method. On July 1,
2014, the machine was sold for $13,000. What should be the loss recognized from the sale of the ma-
chine?
a. $4,000
b. $5,000
c. $10,200
d. $13,000
ANS: C PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

58. In January 2014, Shone Company exchanged an old machine, with a book value of $156,000 and a fair
value of $140,000, and paid $40,000 cash for a similar used machine having a list price of $200,000.
The exchange had commercial substance. At what amount should the machine acquired in the ex-
change be recorded on Shone's books?
a. $200,000
b. $196,000
c. $184,000
d. $180,000
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic
59. Raptor Company owns a tract of land that it purchased in 2008 for $200,000. The land is held as a fu-
ture plant site and has a fair market value of $280,000 on July 1, 2014. Talon Company also owns a
tract of land held as a future plant site. Talon paid $360,000 for the land in 2013 and the land has a fair
market value of $380,000 on July 1, 2014. On this date, Raptor exchanged its land and paid $100,000
cash for the land owned by Talon. The exchange had commercial substance. At what amount should
Raptor record the land acquired in the exchange?
a. $280,000
b. $300,000
c. $320,000
d. $380,000
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

60. A company owns a piece of land that originally cost $10,000 and has a fair market value of $8,000. It
is exchanged along with $5,000 cash for another piece of land having a fair value of $13,000. The ex-
change had commercial substance. The proper journal entry to record this transaction is
a. Land (new)........................ 15,000
Land (old)...................... 10,000
Cash ........................... 5,000
b. Land (new) ....................... 13,000
Loss on Exchange ................. 2,000
Land ........................... 10,000
Cash ........................... 5,000
c. Land (new)........................ 18,000
Land (old) ..................... 10,000
Cash ........................... 5,000
Gain on Exchange ............... 3,000
d. Land (new)........................ 13,000
Retained Earnings ................ 2,000
Land (old)...................... 10,000
Cash ........................... 5,000

ANS: B PTS: 1 DIF: Medium OBJ: LO 6

TOP: AICPA FN-Measurement MSC: AACSB Analytic

61. In October 2014, Pollock Company exchanged a used packaging machine having a book value of
$240,000 for a new machine and paid a cash difference of $30,000. The market value of the used pack-
aging machine was determined to be $280,000. The exchange had commercial substance. In its income
statement for the year ended December 31, 2014, how much gain should Pollock recognize on this ex-
change?
a. $0
b. $10,000
c. $30,000
d. $40,000
ANS: D PTS: 1 DIF: Medium OBJ: LO 6
TOP: AICPA FN-Measurement MSC: AACSB Analytic

62. Which of the following assets generally is required to be tested at least annually for impairment?
a. Machinery
b. Patent
c. Renewable broadcast license
d. Copyright
ANS: C PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic
63. Which of the following represents the maximum amortization period mandated by current generally
accepted accounting principles for amortizable intangible asset?
a. 10 years
b. 20 years
c. 40 years
d. No arbitrary cap on the useful life of amortizable intangible assets has been established.
ANS: D PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic

64. The impairment test for an intangible asset with an indefinite life compares the
a. fair value of the asset to its book value.
b. sum of the undiscounted cash flows expected to be generated by the asset to its book
value.
c. sum of the discounted cash flows expected to be generated by the asset to its fair value.
d. sum of the undiscounted cash flows expected to be generated by the asset to its fair value.
ANS: A PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Reflective Thinking

65. The impairment test for an intangible asset with a definite life compares the
a. fair value of the asset to its book value.
b. sum of the undiscounted cash flows expected to be generated by the asset to its book
value.
c. sum of the discounted cash flows expected to be generated by the asset to its fair value.
d. sum of the undiscounted cash flows expected to be generated by the asset to its fair value.
ANS: B PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Reflective Thinking

66. Which of the following assets generally is required to be tested at least annually for impairment?
a. Machinery
b. Patent
c. Goodwill
d. Copyright
ANS: C PTS: 1 DIF: Easy OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Reflective Thinking

67. Five years ago, Monroe, Inc., purchased a patent for $110,000. Lower demand for the product pro-
duced under this patent necessitates that an impairment test be made. On the date of purchase, the
patent had an estimated useful life of eleven years. It currently has a remaining useful life of four
years. The current fair value of the patent is $43,000. Company management estimates that the patent
will generate future cash flows of $12,000 per year for the next four years.

The amount of the impairment loss to be recognized is

a. $50,000.
b. $60,000.
c. $12,000.
d. $17,000.
ANS: D PTS: 1 DIF: Medium OBJ: LO 5
TOP: AICPA FN-Measurement MSC: AACSB Analytic
 PROBLEM

1. The following is a schedule of machinery owned by Stanton Manufacturing Company.

Estimated Estimated
Total Salvage Life in
Cost Value Years
Machine A $ 600,000 $110,000 20
Machine B 315,000 30,000 10
Machine C 84,000 0 15
Machine D 107,000 7,000 5
$1,106,000

Stanton computes depreciation on the straight-line basis. Based on the information presented, compute
the:

(1) Composite life of these assets (in years).

(2) Composite depreciation rate.

ANS:

Salvage Depreciable Estimated Annual

Asset Cost Value Cost Life Depreciation
A $ 600,000 $110,000 $490,000 20 $24,500
B 315,000 30,000 285,000 10 28,500
C 84,000 0 84,000 15 5,600
D 107,000 7,000 100,000 5 20,000
$1,106,000 $147,000 $959,000 $78,600

(1) $959,000/$78,600 = 12.20 years

(2) $78,600/$1,106,000 = 7.11%

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

2. Irvington Manufacturing Inc. purchased a new machine on January 2, 2014, that was built to perform
one function on its assembly line. Data pertaining to this machine are:

Acquisition cost $330,000

Residual value $30,000
Estimated service life:
Years 5
Service hours 250,000
Production output 300,000

Using each of the following methods, compute the annual depreciation rate and charge for the years
ended December 31, 2014, and 2015:

(1) Straight-line
(2) Service hours (assume 32,000 hours for 2014 and 36,000 hours for 2015).
(3) Productive-output (assume 31,000 units for 2014 and 37,000 units for 2015).

ANS:
 (1)
Straight-line:
2014: ($330,000 - $30,000)/5 = $60,000
2015: $60,000

(2)
Service hours: ($330,000 - $30,000)/250,000 = $1.20 per hour
depreciation rate
2014: $1.20  32,000 = $38,400
2015: $1.20  36,000 = $43,200

(3)
Productive-output: ($330,000 - $30,000)/300,000 = $1.00 per unit
depreciation rate
2014: $1.00  31,000 = $31,000
2015: $1.00  37,000 = $37,000

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

3. The Fanfare Company applied for and received numerous patents at a total cost of $286,500 at the be-
ginning of 2011. It is assumed the patents will be useful evenly during their full legal lives. At the be-
ginning of 2013, the company paid $48,600 in legal fees for successful defense in a patent infringe-
ment suit. At the beginning of 2014, information became available that caused the company to reduce
the remaining life of the patents to five years.

Calculate the amortization expense for the years 2011, 2012, 2013, and 2014. Round to the nearest dol-
lar.

ANS:
2011: $286,500/17 = ............................. $ 16,853

2012: $286,500/17 = ............................. $ 16,853

2013: Acquisition cost .......................... $286,500

Less: amortization to date ................ 33,706
Carrying value ............................ $252,794
Successful defense ........................ 48,600
New carrying value ........................ $301,394
Remaining life = 15 years
$301,394/15 = ............................. $ 20,093

2014: Carrying value, Jan. 1, 2013 .............. $301,394

Amortization for 2013 ..................... 20,093
Carrying value, Jan. 1, 2014 .............. $281,301

Remaining life = 5 years

$281,301/5 = .............................. $ 56,260

PTS: 1 DIF: Medium OBJ: LO 5 TOP: AICPA FN-Measurement

MSC: AACSB Analytic
4. In 2013, Bootcamp Mining Inc. purchased land for $5,600,000 that had a natural resource supply esti-
mated at 4,000,000 tons. When the natural resources are removed, the land will have an estimated
value of $640,000. The present value of the expected cash outflows for the required restoration cost for
the property is estimated to be $800,000.

Development and road construction costs on the land were $560,000, and a building was constructed at
a cost of $88,000 with an estimated $8,000 salvage value when all the natural resources have been ex-
tracted.

During 2014, additional development costs of $272,000 were incurred, but additional resources were
not discovered. Production for 2013 and 2014 was 700,000 tons and 900,000 tons, respectively.

Compute the depletion charge for 2013 and 2014. (Include depreciation on the building, if any, as a de-
pletion charge.) Round depletion charge to the nearest cent.

ANS:
Acquisition costs ....................................
Restoration costs ....................................
Residual value--land .................................
Development costs ....................................
Building .............................................
Salvage value--building ..............................

$6,400,000/4,000,000 tons = $1.60 per ton

2013:

2014:

$5,552,000/3,300,000 tons = $1.68 per ton (rounded)

900,000 tons  $1.68 = .............................. $1,512,000

PTS: 1 DIF: Medium OBJ: LO 2 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

5. Information concerning Santori Corporation's intangible assets is as follows:

Santori incurred $352,000 of experimental and development costs in its laboratory to develop a patent
that was granted on January 2, 2014. Legal fees and other costs associated with registration of the
patent totaled $65,600. Thomas estimates that the useful life of the patent will be eight years.

A second patent was purchased from Lowman Company for $160,000 on July 1, 2011. Expenditures
for successful litigation in defense of this patent totaling $40,000 were paid on July 1, 2014. Thomas
estimates that the useful life of the patent will be 20 years from the date of acquisition.

Prepare a schedule showing the intangible assets section of Santori's balance sheet at December 31,
2014.

ANS:

Santori Corporation
Balance Sheet (partial)
December 31, 2014

Patent, net of accu-

mulated amortization $ 57,400*
of $8,200 ......
Patent, net of accu-
mulated amortization 170,824**
of $29,176 ..
$ 228,224

* Patent
Capitalized cost of patent at January 2, 2014 ........ $ 65,600
Amortization ($65,600/8 years) ....................... (8,200)
Balance: December 31, 2014 ........................... $ 57,400

Accumulated
** Patent Cost Amortization
Cost of Patent ............................ $160,000
Amortization
(July 1, 2011 - Dec. 31, 2013)
$
($160,00 2
0
0/20  2 ,
1/2) ... 0
........ 0
....... 0

Amortization
(Jan. 1, 2011 - June 30, 2013)
($8,000

1/2) ...
........
........
......
Cost of successful defense ................. 40,000 ________
$200,000
Amortization
(July 1, 2014 - Dec. 31, 2014)
[($200,0
00 -
 $24,000)
/17] 
1/2 ....
....
$200,000
Deduct accumulated amortization ........... 29,176
Patent balance ............................ $170,824

PTS: 1 DIF: Challenging OBJ: LO 2 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

6. Algon Company owns a machine that cost $560,000, has a book value of $240,000, and an estimated
fair value of $480,000. Nogal Company has a machine that cost $720,000, has accumulated deprecia-
tion of $400,000, and an estimated fair value of $640,000. Algon pays Nogal cash of $160,000. As-
sume the trade has commercial substance.

(1) Record the exchange on Algon Company's books.

(2) Record the exchange on Nogal Company's books.

ANS:
(1)
Algon Company's books
Machinery ................................. 640,000
Accumulated Depreciation .................. 320,000
Machinery ............................... 560,000
Cash .................................... 160,000
Gain on Exchange of Asset ............... 240,000

(2)
Nogal Company's books
Cash ...................................... 160,000
Machinery ................................. 480,000
Accumulated Depreciation .................. 400,000
Machinery ............................... 720,000
Gain on Exchange of Asset ............... 320,000*

* Cost .................................... $720,000

Accumulated depreciation ................ 400,000
Book value .............................. $320,000
Fair value .............................. 640,000
Gain .................................... $320,000

PTS: 1 DIF: Medium OBJ: LO 6 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

7. The Corey Company exchanged equipment costing $190,000 with accumulated depreciation of
$45,000 for equipment owned by Salvo Corporation. The Salvo equipment cost $305,000 with accu-
mulated depreciation of $105,000. The fair value of both pieces of equipment was $275,000.

Provide the necessary entries to record the transaction on both companies' books assuming:

(1) The exchange lacks commercial substance.

(2) The exchange has commercial substance.

ANS:
(1)
 Corey: Equipment ....................... 145,000
Accumulated Depreciation ........ 45,000
Equipment ..................... 190,000

Salvo: Equipment ....................... 200,000

Accumulated Depreciation ........ 105,000
Equipment ..................... 305,000

(2)
Corey: Equipment ....................... 275,000
Accumulated Depreciation ........ 45,000
Equipment ..................... 190,000
Gain on Exchange of Equipment . 120,000

Salvo: Equipment ....................... 275,000

Accumulated Depreciation ........ 105,000
Equipment ..................... 305,000
Gain on Exchange of Equipment . 75,000

PTS: 1 DIF: Medium OBJ: LO 6 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

8. Pepitone Inc. exchanged a machine costing $400,000 with accumulated depreciation of $280,000 for a
machine from the Berra Company. Berra paid $20,800 cash in addition to its machine (which cost
$200,000 with accumulated depreciation of $68,000) for the Pepitone machine. The Berra machine has
a fair value of $160,000.

Provide the necessary entries to record the transactions on both companies' books assuming the ma-
chine lacks commercial substance.

ANS:
Berra: Machinery .........................
Accumulated Depreciation ..........
Machinery..........................
Cash...............................

Pepitone: Machinery .........................

Accumulated Depreciation ..........
Cash .........................
Machinery.....................
Gain on Exchange of Machinery.
*[$20,800/($20,800 + $160,000)]  ($180,800 - $120,000) =
$6,995

PTS: 1 DIF: Medium OBJ: LO 6 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

9. Mueller Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreci-
ated using the straight-line method with a 20-year useful life and 10% residual value. Mueller's opera-
tions have experienced significant losses for the past 2 years and, as a result, the company has decided
that the equipment should be evaluated for possible impairment. The management of Mueller Com-
pany estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the
equipment will be $80,000 per year. The fair value of the equipment is $240,000.

(1) Determine if an impairment loss should be recognized.

 (2) Determine the amount of the loss and prepare the journal entry to record the loss.
(3) How would your answer to (1) change if the fair value of the equipment was
$500,000?

ANS:
(1)
Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Current
book value of the equipment is:

Original cost ........................................ $1,000,000

Accumulated depreciation ($45,000  8 years) ......... 360,000
Book value ........................................... $ 640,000

The book value of $640,000 is compared to the undiscounted sum of the future cash flows to deter-
mine whether the equipment is impaired. The sum of the future cash flows is less, so an impairment
loss should be recognized.

(2)
The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book value
of the equipment and its fair value. The impairment loss would be recorded as follows:

Accumulated Depreciation--Equipment ........ 360,000

Loss on Impairment of Equipment ............ 400,000
Equipment ($1,000,000 - $240,000) ..... 760,000

(3)
The answer to (1) is unaffected by the fair value of the asset. The existence of an impairment loss is
determined solely by using the undiscounted sum of estimated future cash flow, not the fair value of
the asset.

PTS: 1 DIF: Medium OBJ: LO 4 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

10. Harrison Company is located in Taiwan and uses international accounting standards. Harrison Com-
pany purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated using the
straight-line method with a 20-year useful life and 10% residual value. Harrison's operations have ex-
perienced significant losses for the past 2 years and, as a result, the company has decided that the
equipment should be evaluated for possible impairment. The management of Harrison Company esti-
mates that the equipment has a remaining useful life of 7 years. The discounted value of the future net
cash inflows from the use of the equipment is $220,000. The fair value of the equipment is $240,000.
No goodwill was associated with the purchase of the equipment. Harrison Company has chosen to rec-
ognize increases in the value of long-term operating assets in accordance with the allowable alternative
under IAS 36.

(1) Determine if an impairment loss should be recognized.

(2) Determine the amount of the loss and prepare the journal entry to record the loss.
(3) What journal entry should Harrison Company make if the fair value of the equip-
ment was $980,000?

ANS:
(1)
Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Current
book value of the equipment is:
 Original cost ........................................ $1,000,000
Accumulated depreciation ($45,000  8 years) ......... 360,000
Book value ........................................... $ 640,000

According to IAS 36, the existence of impairment is determined by comparing book value of $640,000
to the higher of the fair value or the asset ($240,000) or the discounted future cash flows associated
with the asset’s use ($220,000). Since fair value is higher, it is used to determine if an impairment ex-
ists. The fair value is lower than the book value, so an impairment loss should be recognized. In this
case, the determination of the existence of an impairment loss is based on is based on a comparison of
book value and fair value; under U.S. GAAP, the test is based on a comparison of book value and the
undiscounted sum of future cash flows. IFS 36 completely rejected the undiscounted cash flow thresh-
old adopted by the FASB.

(2)
The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book value
of the equipment and its fair value. The impairment loss would be recorded as follows:

Accumulated Depreciation--Equipment ........ 360,000

Loss on Impairment of Equipment ............ 400,000
Equipment ($1,000,000 - $240,000) ........ 760,000

(3)
Since the fair value of $980,000 is greater than the book value of $640,000, Harrison Company will
recognize $340,000 ($980,000 - $640,000) as an upward asset revaluation. The upward revaluation is
recorded as follows:

Accumulated Depreciation--Equipment ........ 360,000

Revaluation Equity Reserve ............... 340,000
Equipment ($1,000,000 - $980,000) ........ 20,000

PTS: 1 DIF: Challenging OBJ: LO 4 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

11. A recently issued FASB standard requires that an impairment loss be recognized if the sum of the ex-
pected future net cash inflows (undiscounted and without interest charges) is less than the carrying
value of the asset. The amount of the impairment loss recognized is the amount by which the carrying
amount of the asset exceeds the fair value of the asset.

Provide examples of events or changes in circumstances that indicate that the recoverability of the car-
rying amount of an asset may have been impaired.

Evaluate the recognition criterion proposed by the FASB, specifically addressing the issue of using the
undiscounted sum of the future net cash flows.

ANS:
The following are examples of events or changes in circumstances that may indicate that the carrying
amount of an asset may not be recoverable:

a. A significant decrease in the market value of an asset.

b. A significant change in the extent or manner in which an asset is used.

c. A significant adverse change in legal factors or in the business climate that affects
the value of an asset.
 d. An accumulation of costs significantly in excess of the amount originally expected to
acquire or construct an asset.

e. A projection or forecast that demonstrates continuing losses associated with an asset.

The use of the sum of the expected future net cash flows (undiscounted and without interest charges)
as a criterion for impairment appears to contradict modern theories both of accounting and finance.
The time value of money should be considered at a minimum as an element of cost recovery.

The FASB, however, believes that including the time value of money in the test for impairment poses
some significant problems. The first is the difficulty of associating the actual outstanding debt with in-
dividual assets. The only practical application would be the use of an incremental borrowing rate
which may result in a very close approximation of the present values of the cash flows. The second
problem relates to the fact that each entity has a different incremental borrowing rate because different
entities have different debt capacities. The result of these entity-unique borrowing rates is that different
present values would result for similar impaired assets because the assets are owned by different enti-
ties having different debt capacities. The FASB's solution of using the sum of the expected future net
cash flows (undiscounted and without interest charges) avoids not only the problems associated with
the discount rate but also the necessity of projecting the timing of cash flows. This approach uses in-
formation that is generally available to the entity and allows a more expeditious evaluation of an as-
set's compliance with the established recognition criterion.

PTS: 1 DIF: Medium OBJ: LO 4 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

12. Python Mining Company has a copper mine in Nevada operating at a reduced level of production for
the past two years. The market for copper has been adversely affected by weak prices, low demand,
and foreign competition. Management believes that the market likely will improve next year and does
not plan to abandon this facility. Nevertheless, the controller of the company plans to test the plant and
equipment of the operation for impairment due to the decrease in its use. The plant and equipment used
in this operation were acquired five years ago for $1,600,000 and have been depreciated using straight-
line depreciation over a 20-year life with no residual value. The controller estimates that the assets
have a remaining useful life of 15 years and that the following two cash flow scenarios are possible,
with the indicated probabilities:

Future Cash Inflows Probability

Scenario 1 $58,000 per year for 15 years 80%
Scenario 2 $100,000 per year for 15
years 20%

The fair value of the plant and equipment is estimated to be $890,000.

Prepare the entry (if any) required to recognize the impairment loss.

ANS:
Book value of plant and equipment:

Cost $1,600,000
Accumulated depreciation:
($1,600,000/20)  5 years 400,000
Book value $1,200,000
 Calculation of undiscounted cash flows:

Probability-
Undiscounted Future Cash Weighted Future
Flows Probability Cash Flows
$58,000  15 = $870,000
Scenario 1 80% $696,000
Scenario 2 $100,000  15 = $1,500,000 20% 300,000
Total $996,000

A comparison of the undiscounted cash flows ($996,000) with the carrying value of the plant and
equipment ($1,200,000) reveals that an impairment has occurred. The amount of the impairment loss is
the carrying value minus the fair value of the plant and equipment:

Carrying value $1,200,000

Fair value 890,000
Impairment loss $ 310,000

The journal entry to record the impairment loss would be:

Accumulated Depreciation 400,000

Loss on Impairment of Plant & Equipment 310,000
Plant & Equipment 710,000
($1,600,000 – $890,000)

PTS: 1 DIF: Challenging OBJ: LO 4 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

13. Masdirt Mining Company has a copper mine in Tanzania. The company is subject to the pronounce-
ments of the International Accounting Standards Board, and, specifically, IFRS 36.

The plant and equipment used in this operation were acquired five years ago for $1,600,000 and have
been depreciated using straight-line depreciation over a 20-year life. The controller estimates that the
assets have a remaining useful life of 15 years.

The controller of the company is preparing the financial statements for the year just ended and notes
that the fair value of the plant and equipment is estimated to be $1,150,000 at the close of last year.
The controller also determines that the present value of the discounted future cash flows associated
with the asset’s future use equals $1,300,000.

Prepare the entry (if any) the controller should make under IFRS 36 relating to the current fair value of
the plant & equipment. Additionally, assume that the company sold the plant & equipment for
$1,300,000 immediately after the end of last year. Prepare the entry (if any) required under IFRS 36.

ANS:
Book value of plant and equipment:

Cost $1,600,000
Accumulated depreciation:
($1,600,000/20)  5 years 400,000
Book value $1,200,000

The entry required for revaluation of the plant and equipment would be:
 Accumulated Depreciation 400,000
Revaluation Equity Reserve 100,000
($1,300,000 – $1,200,000)
Plant & Equipment 300,000
($1,600,000 – $1,300,000)

The entries required upon the sale of the plant and equipment would be:

Cash 1,300,000
Plant & Equipment 1,300,000

Revaluation Equity Reserve 100,000

Retained Earnings 100,000

PTS: 1 DIF: Challenging OBJ: LO 4 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

14. Carbonite Bottling purchased for $800,000 a trademark for a very successful soft drink it markets un-
der the name BLAST!. The trademark was determined to have an indefinite life. A competitor recently
introduced a product that is in direct competition with the BLAST! product, thus suggesting the need
for an impairment test. Data gathered by Carbonite suggests that the useful life of the trademark is still
indefinite, but the cash flows expected to be generated by the trademark have been reduced either to
$30,000 per year (with a probability of 80%) or to $60,000 per year (with 20% probability). The ap-
propriate risk-free interest rate is 5%. The appropriate risk-adjusted interest rate is 10%.

Prepare the appropriate journal entry (if needed) to record the effect of the events described above.

ANS:
The estimate of the fair value of the intangible is computed as follows:

Present Value of Probability-

Indefinite An- Weighted
Future Cash nual Cash Flows Present Value
Inflows Probability
Scenario 1 $30,000 $ 600,000 80% $480,000
Scenario 2 $60,000 $1,200,000 20% 240,000
Total estimated fair value $720,000

1
The present value of a stream of indefinite, or infinite, annual cash flows is a perpetuity calculated by
dividing the annual cash flow by the discount rate (annual cash flow/discount rate).

Since the estimated fair value of the trademark is less than its book value ($720,000 < $800,000), the
intangible asset is impaired. The impairment loss is recognized with the following journal entry:

Impairment Loss ($800,000 – $720,000) 80,000

Trademark 80,000

PTS: 1 DIF: Challenging OBJ: LO 5 TOP: AICPA FN-Measurement

MSC: AACSB Analytic
15. Roadworthy Company acquired Highway Company on January 1, 2014. As part of the acquisition,
$1,000,000 in goodwill was recognized and assigned to Roadworthy's Transportation reporting unit.
For 2014, earnings from the Transportation reporting unit were $450,000. Separately traded companies
with operations similar to the Transportation reporting unit had market values approximately equal to
five times earnings. As of December 31, 2014, book values and fair values of the Transportation re-
porting unit were:

Book Values Fair Values

Intangible Assets $4,000,000 $4,500,000
Goodwill $1,000,000 -
Liabilities $2,500,000 $2,500,000

Prepare the impairment test of goodwill as well as any entry needed to record an impairment loss.

ANS:
Using the earnings multiple, the fair value of the Transportation reporting unit is estimated to be
$2,250,000 ($450,000  5).

The book value of the net assets of the Transportation reporting unit is:

($4,000,000 + $1,000,000) – $2,500,000 = $2,500,000.

The implied fair value of goodwill is computed as follows:

Estimated fair value of Transportation reporting unit $2,250,000

Fair value of identifiable net assets ($4,500,000 – $2,500,000) 2,000,000
Implied fair value of goodwill $ 250,000

The implied fair value of goodwill is less than the recorded amount of goodwill ($250,000 <
$1,000,000). The journal entry to record the goodwill impairment loss is:

Goodwill Impairment Loss 750,000

Goodwill ($1,000,000 – $250,000) 750,000

PTS: 1 DIF: Challenging OBJ: LO 5 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

16. Use-factor depreciation methods view asset consumption as related primarily to asset use or output.
These methods provide periodic depreciation charges based on the amount of use of the asset in a
given period. The service life of assets under the use-factor methods may be expressed either as hours
of service or units of production.

Required:

Identify the general limitations of the use-factor depreciation methods.

ANS:
The following limitations are associated with the use-factor depreciation methods:

1. Estimation of the performance of an asset in terms of service hours or productive output

may be difficult.
2. Measurement of asset service potential solely in terms of productive hours or service
hours may fail to recognize factors such as increasing maintenance and repair costs as
 the asset ages or the inadequacy or obsolescence of the asset that may occur.
3. The service life of the asset may continue to expire even though the asset is not in use,
but this fact will not be reflected in earnings since depreciation is recorded only when
the asset is used. Reported earnings thus may fail to reflect a consumption of the cost of
the asset. The omission of this charge may have the effect of concealing fluctuations in
earnings and thus result in periodic operating results being smoothed.

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

17. Depreciation is the systematic allocation of historical depreciable cost to periods in which an asset is
used. Depreciation is not a cash outflow but does reduce reported income and thus retained earnings by
the depreciable cost of the asset less the tax savings associated with depreciation.

Required:

1. Explain the effect of depreciation on the dividend policy of an enterprise.

2. Explain the effect of depreciation on capital maintenance for an enterprise.

ANS:
1. Depreciation does in fact reduce income and retained earnings by the depreciable cost of
an asset less the tax savings associated with depreciation. Dividends that can be paid un-
der the laws of many states are limited to the amount of retained earnings. As a result,
depreciation may in some cases reduce the amount of dividends that can be paid. Most
firms, however, do not pay the maximum dividend allowed by law, so the effect of de-
preciation in limiting the amount of dividend paid may be minimal.
2. Deprecation can indirectly conserve resources in an amount equal to the acquisition cost
of depreciable assets, depending on the dividend payout and tax depreciation policies of
an enterprise. Depreciation does not guarantee that sufficient capital will be available to
replace an asset, however. Replacement cost of most plant assets generally is greater
than the original cost, particularly during periods of inflation. Depreciation based on his-
torical cost results in depreciation expense being understated and income overstated.
Companies paying dividends based on the overstated net income may pay out funds that
will be required in the future to replace plant assets. Additionally, the resources con-
served must actually be set aside. A firm earning no revenues could show depreciation
expense but have no funds available for the replacement of assets. The investment of re-
sources set aside likely would not generate a sufficient return to provide principal and
interest adequate to fund the replacement cost of the asset. Depreciation thus does not
conserve resources in the amount of the depreciation recognized or in the amount neces-
sary to replace assets.

PTS: 1 DIF: Challenging OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

18. A portion of the statement of cash flows for Stealth Airlines is show below:

Stealth Airlines
Statement of Cash Flows
For the year ended December 31, 2014
(in millions of dollars)

Operating Activities:
 Net income $14,500
Adjustments to reconcile net income to cash
provided by continuing operations:

Depreciation and amortization 29,330

The business section of a newspaper referred to the $29,330 amount as “cash provided by depreciation
and amortization.”

Required:

Evaluate the newspaper’s description of the amount shown on the statement of cash flows for depreci-
ation and amortization.

ANS:
The amount shown for depreciation and amortization is added to net income to arrive a operating cash
flows does not represent any contribution that depreciation or amortization made to operating cash
flows. The amount is added back to net income because depreciation and amortization do not result in
a cash outflow but were deducted from revenues to arrive at net income. The only actual contribution
made by depreciation and amortization to cash inflows results from the tax deduction allowed for de-
preciation and amortization, which may be different from the amount reported on the financial state-
ments due to differences in financial accounting standards and tax law. No guarantee exists that cash in
the amount of depreciation or amortization expense is available for asset replacement unless manage-
ment takes specific actions to set such funds aside. The newspaper’s description thus is misleading at
best and erroneous at worst.

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

19. Wastenot is a waste disposal company. Explain the effect the following actions of the management of
Wastenot Company might have in managing earnings:

1. Management assigned unsupported and inflated salvage values and extended the useful
lives of company garbage trucks.
2. Management assigned arbitrary salvage values to other assets that previously had no sal-
vage value.
3. Management did not record expenses required to write off the costs of unsuccessful and
abandoned landfill development projects.
4. Management recorded inflated environmental liabilities in connection with acquisitions
of other companies.
5. Management improperly capitalized a variety of expenses.

ANS:
1. Unsupported and inflated salvage values for the garbage trucks (a major category of as-
set for a company in this line of business) would reduce the depreciable base and thus
reduce periodic depreciation expense. The effect would be to increase net income or re-
duce net losses. Extending the useful lives of the trucks would result in a smaller depre-
ciation charge against income each period.
2. Newly-assigned, arbitrary salvage values would result in a smaller depreciable base and
thus lower amounts of depreciation expense and would increase net income or decrease
net losses.
3. Failure to write-off unsuccessful landfill development projects would overstate both net
income and assets.
4. The acquisition of another company often entails assuming environmental liabilities as-
 sociated with the operations of the acquired company. Overstating these liabilities allows
management to subsequently record expenditures (perhaps even those having nothing to
do with environmental liabilities) by reducing these liabilities rather than properly
recording the expenditures as expenses.
5. Improper capitalization of expenses defers these amounts on the balance sheet and al-
lows them to be amortized against revenues over an extended period of time (or not to
be expensed at all).

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

20.
The most recent annual report of the Albondiga Company includes the following information:
(in millions of dollars)
From footnotes:
Depreciation is based on the straight-line method and group methods of deprecia-
tion.
Gross capital expendi- $ 2,176
tures

From statement of
cash flows:
Investing activities 2,120
section: net capital ex-
penditures

From balance sheet:

Increase in accumu- 1,326
lated depreciation

From income state-

ment:
Depreciation expense 2,089

The group method of depreciation treats all assets within a group as having a uniform useful life and
applies a depreciation rate based on the total cost of the group. No gain or loss is recognized on dis-
posal under this method. Accumulated depreciation is reduced by the difference between the cost of
the assets disposed of and cash proceeds.

Required:

1. Assume all plant assets are depreciated on the group basis. Estimate the original cost of
plant assets retired for the year.
2. Assume that the straight-line method is applied individually to all plant assets and that
gains and losses on plant asset disposals were approximately equal in amount during
the year. Estimate the average proportion of useful life remaining at disposal on the
plant assets retired during the year. Identify additional information that would be help-
ful in answering this question.

ANS:
1. Accumulated depreciation increased $1,326, while depreciation expense of $2,089 was
recorded. Accumulated depreciation thus was reduced by $763 ($2,089 – $1,326), as a
result of disposals.
 Net cash applied to capital expenditures was $2,120, while gross capital expenditures
were $2,176. Cash proceeds on plant asset disposals thus were $56 ($2,176 – $2,120).
No gain or loss is recognized on plant asset disposals under the group depreciation
method.

A summary entry for plant asset disposals using the decrease in accumulated deprecia-
tion and cash proceeds indicates that $819 of plant assets were retired during the year
under the assumptions given:

Cash 56
Accumu- 763
lated De-
preciation
Plant Assets 819

2. Using the results obtain in part 1 above, the average proportion of useful life remaining
on plant assets retired during the year is 7% (1 – $763/$819). Information regarding
residual value would be useful here. The remaining book value at disposal may approxi-
mate residual value of the assets retired.

PTS: 1 DIF: Challenging OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

21. The 2014 annual report of Fracking, Inc., provides the following disclosures regarding its oil and gas
operations:

Costs incurred during fiscal year 2014 (in millions of dollars):

Proved $ 38
property
acquisition
Unproved 51
property
acquisition
Explo- 403
ration
Develop- 1,322
ment
Total $ 1,814

During 2014, the company reported exploration expenses totaling $306 million, and depreciation, de-
pletion, and amortization totaling $1,198 million. The amount of capitalized costs for the fiscal years
ending December 31, 2014, and 2013, were:

Capitalized costs for fiscal years ending December 31, 2014, and 2013 (in millions dollars):

2014
Proved properties $ 22,208 $
24,137
Unproven properties 955 1,0
15
Support equipment 1,083 1,081
 and facilities
Gross capitalized costs $ 24,246 $ 26,233
Accumulated depreci- 16,39 16,872
ation, depletion, and 6
amortization
Net capitalized costs $ 7,850 $ 9,361

Fracking uses the successful-efforts method to account for exploration costs.

Required:

1. What amount of the exploration cost incurred by Fracking in 2014 were capitalized?
2. If Fracking were using the full-cost method of accounting for exploration cost, what
amount of exploration cost would be capitalized in 2014. State any assumptions made in
order to answer this question.
3. Use the information above to determine the amount of capitalized costs removed (retired
or otherwise disposed of) from the capitalized cost account, and the amount of accumu-
lated depreciation, depletion, and amortization related to this item.

ANS:
1. Fracking uses the successful efforts method and, as a result, only the exploration costs of
successful wells are capitalized as an asset. Since $403 million in exploration costs were
incurred, and $306 million of such costs were expensed, the difference of $97 million
were associated with successful wells and were capitalized.
2. Under the full-cost method, the full amount of the exploratory costs ($403 million)
would be capitalized in 2014, assuming that the estimated value of the minerals discov-
ered was greater than the exploratory costs incurred. Use of the full-cost method would
increase total assets and decrease exploration expenses by $306 million.
3. Analysis of the gross capitalized costs and the accumulated depreciation, depletion, and
amortization accounts:

Gross capitalized costs:

Beginning balance at 12/31/2013
Amount capitalized during 20141
Less: Ending balance at 12/31/2014
Cost of retirements

1
Determined as total costs incurred ($1,814 million)
less the amount immediately expensed ($306 million).

Accumulated depreciation, depletion, and amortization:

Beginning balance at $ 16,872
12/31/2013
Depreciation, deple- 1,198
tion, and amortization
recorded in 2014
Less: Ending balance (16,396)
at 12/31/2014
Accumulated depreci-
ation, depletion, and
amortization related
to retirements $ 1,674
 Capitalized costs of property totaling $3,495 million and having a net capitalized cost of $1,821 mil-
lion ($3,495 – $1,674) were retired or otherwise disposed of. Determination of the gain or loss is not
feasible due to a lack of information.

PTS: 1 DIF: Challenging OBJ: LO 2 TOP: AICPA FN-Measurement

MSC: AACSB Analytic

22. Image Creators, Inc. owns the following equipment and computes their depreciation on the straight-
line basis:
Estimated Estimated
Total Salvage Life in
Cost Value Years
Equipment A $ 550,000 $110,000 20
Equipment B 300,000 30,000 10
Equipment C 195,000 0 15
Equipment D 157,000 7,000 5
$1,202,000

Required:

(1) Composite life of these assets (in years).

(2) Composite depreciation rate.

ANS:

Salvage Depreciable Estimated Annual

Asset Cost Value Cost Life Depreciation
A $ 550,000 $110,000 $440,000 20 $22,000
B 300,000 30,000 270,000 10 27,000
C 195,000 0 195,000 15 13,000
D 157,000 7,000 150,000 5 30,000
$1,202,000 $147,000 $1,055,000 $92,000

(1) $1,055,000/$92,000 = 11.50 years

(2) $92,000/$1,202,000 = 7.65%

PTS: 1 DIF: Medium OBJ: LO 1 TOP: AICPA FN-Measurement

MSC: AACSB