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Chap8-solutions - 8.26(Alcoa calculations for various...

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Unformatted text preview: 8.26 (Alcoa; calculations for various depreciation methods.) a. Year 1 Year 2 Year 3 Straight-Line Method .................... $14,000 $14,000 $14,000 ($88,800 — $4,800)/6 = $14,000. b. Sum- of- the— Years' -Digits Method... $24,000 $20,000 $16,000 (6 x 7)/2= 21 sum-oil the-m years -digits. c. Declining-Balance Method.............. $29,304 $19,634 $13,154 33 percent rate. d. Production Method... $12,600 $14,000 $15,400 $84, 000/30, 000: $2. 80 per hour. 8.35 (Capitalizing versus expensing; if capitalized, what amortization period?) a. If the firm makes this expenditure to secure future benefits, then there is an argument for capitalizing it. The entries would be: Building (orw Fire Escapes) 28,000 Cash... .... Liabilities + E - uit Class. +2a.ooo I_I—— _I_I—_ To capitalize improvements. Depreciation Expense... .. 4,000 Accumulated Depreciation ....................................... Liabilities + E - uit Class. ——_I_I One year's amortization of improvements based on a seven-year life. A somewhat more logical View is that the firm made the expenditure to maintain the service potential that it had planned previously. It obtains no additional benefits beyond those planned. See the discussion in Part (1. of Problem 8.34 above. The expenditure is a result of new legislation, so this View results in the following entry at the time the law is passed: Loss from New Legislation... 28,000 Building (or Accumulated Depreciation) 28,000 Liabilities + E- uit 43.000 I_I —2a.ooo To recognize loss. 28,000 4,000 C. When the expenditure is made, the entry is: Building (or Fire Escapes) 28,000 Cash............... Mt-lnfll Liabilities + E . uit Class. +2a.ooo I_I—— _I_I—_ 28,000 To capitalize expenditure for fire escapes. This second treatment results in immediate recognition of the loss, and subsequent depreciation of the building improvements and fire escapes is the same as before the law was passed. Investment in General Electric Stock 100,000 Gain on Disposal of Investment.............................. 950,000 Liabilities + E . uit Class _I_I—_ _I_I—_ In the case of widely traded stock, the stock market valuation is probably a better guide than is the appraisal value of a single building. Investment ' Small Timers Stock Gain on Disposal of Investment.............................. Shareholders' Liabilities + E . uit 1.000.000 I_I +900.000 _I_I—_ 100,000 900,000 For thinly traded issues, the appraisal value of the building may be a more reliable guide. Many people think that investors cannot sell large blocks of such stock at once, except at a discount from the quoted price per share. We would not argue with the same answer as Part b. above. d. Garages ............................................................................. 18,000 Cash ................... @[email protected] Liabilities + E-uit —I_I—_ —I_I—_ To capitalize improvements to garages. 18,000 Depreciation Expense... ... 900 Accumulated Depreciation... 900 Liabilities + E-uit Elm-I_Im $18,000/20 years = $900 per year. The useful life of the improvements in this case is likely to be as long as the useful lives of the garages. A case can be made, however, for amortization over five or ten years. e. AdvertisingExpense...................................................... 400,000 Cash .............................................................................. 400,000 Shareholders' Liabilities + E -uit _—_I_I Firms generally immediately expense expenditures on advertising. Theoretically, the firm should capitalize some portion of the expenditures as an asset because the company probably would not spend on advertising unless it expected future benefits. However, firms seldom follow the more theoretically sound procedure in practice due to the difficulty of identifying and measuring the future benefits. f. Research Expensel 500,000 Cash... 1,500,000 Liabilities + Euit —1 500 000 I_I —1 500 000 This is the treatment required by FASB Statement No. 2, although we criticize it. The company has a proven record of success with its research and it would not continue the research expenditures unless it expected future benefits. Capitalization of these benefits on the balance sheet and subsequent amortization is at least a theoretically superior treatment. g. Charitable Contribution—Expense 250,000 Cash... ... 250,000 Liabilities + E-uit —250.000 I_I —250.000 Although some indirect future benefit may come to the company, it is too indefinite to justify recognition of an asset. We wonder, though, if companies give away money without some expectation of future benefit. h. MachineTools..................................................................6,000,000 Cash 6,000,000 Liabilities + E uuit _I_I— _I_I— To set up asset account. Work-in-Process Inventory ........................................... 2,000,000 Accumulated Depreciation ....................................... 2,000,000 Shareh olders' Liabilities + E -uit _I_I— _I_I— Depreciate over 3 years, the life of the automobile model. The tools will be obsolete in three years; their physical life of six years is irrelevant. For some reason, automobile manufacturers do not show accumulated depreciation on special tools in published statements; credits appear to go directly to the asset account. i (Dollar Amounts in Millions) Start of Year Plant Assets (Airplanes) 100 Cash................ . 100 @[email protected] Liabilities + E-uil _I_I—_ _I_I—_ To record purchase of airplanes. Plant Assets (Spare PartS) 20 Cash................ 20 @E-Imw Liabilities + E-uil _I_I—_ _I_I—_ To record spare parts as plant assets, not as inven- tory. This is the point of the question. Because the spare parts are giving up their future benefits as the firm uses the airplanes, we treat their cost as plant assets. At the end of the useful life of the airplanes, the spare parts will be worthless. We think they should be depreciated over the life of the airplanes, not accounted for like an inventory of parts which the firm can use in various alternative ways. Nothing in the chapter alerts the student to this treatment and many, if not most, will set up the asset as inventory. (Dollar Amounts in Millions) End of Year Depreciation Expense... 12 Accumulated Depreciation... 12 Shargholders' Liabilities + E- uit _I_I—IncSRE Depreciation on plant assets for 1f10 of useful life costing $120 (= $100 + $20) in total. This treatment is consistent with that described in the preceding entry. Whether the instructor or students agree with us, the point is worth discussing. Is the cost of spare parts acquired solely for use with a plant asset and, therefore, treated like plant assets or like inventory? (Dollar Amounts in Millions) End of Year Depreciation Expense... 12 Accumulated Depreciation... 12 Shargholders' Liabilities + E- uit _I_I—IncSRE The entry made for the same reason as in the preceding question. We think the following entries, which result from treating the spare parts as inventory, are wrong: Depreciation Expense" ... 10 Accumulated Depreciation... 10 Liabilities + E- uit _I_I—_ Repair Expense... 1 Spare Parts Inventory 1 ShaIlEeh olders' Liabilities + E- uit Class. -I_I—_ 8.41 C. (Recognizing and measuring impairment losses.) a. The loss occurs because of an adverse action by a governmental entity. The undiscounted cash flows of $50 million are less than the book value of the building of $60 million. An impairment loss has therefore occurred. The market value of the building of $32 million is less than the book value of $60 million. Thus, the amount of the impairment loss is $28 million (= $60 million — $32 million). The journal entry to record the impairment loss is (in millions): Loss from Impairment 28 Accumulated Depreciation 20 Building... 48 ShaIlEeh olders' Liabilities + E- uit _I_I—_ _I_I—_RE This entry records the impairment loss, eliminates the accumulated depreciation, and writes down the building to its market value of $32 million (= $80 — $48). b. The undiscounted cash flows of $70 exceed the book value of the building of $60 million. Thus, no impairment loss occurs according to the definition in FASB Statement No. 144. An economic loss occurred but GAAP does not recognize it. The loss arises because the accumulated costs significantly exceed the amount originally anticipated. The book value of the building of $25 million exceeds the undiscounted future cash flows of $22 million. Thus, an impairment loss has occurred. The impairment loss recognized equals $9 million (= $25 million — $16 million). The journal entry is (in millions): Loss from Impairment... 9 Construction' In Process: 9 Liabilities + E - uit nI_I‘-_ The loss occurs because of a significant decline in the market value of the patent. FASB Statement No. 142 requires calculation of the impairment loss on the patent before computing the value loss on goodwill. The undiscounted future cash flows of $18 million are less than the book value of the patent of $20 million. Thus, an impairment loss occurred. The amount of the loss is $8 million (= $20 million — $12 million). The journal entry to record the loss is: Loss from Impairment 8 Patent... 8 Liabilities + E- uit ClassfiE _I_I—_ The second step is to determine if an impairment loss on the goodwill occurred. The market value of the entity is $25 million. The book value after writing down the patent is $27 million (= $12 million for patent and $15 million for goodwill). Thus, a goodwill impairment loss occurred. If the market value of the patent is $12 million, the market value of the goodwill is $13 million. The impairment loss on goodwill is therefore $2 million (= $15 million — $13 million). The journal entry is: Loss from Impairment 2 Goodwill... 2 Liabilities + Eu uit Class. _I_I—_ e. The loss occurs because of a significant change in the business climate for Chicken Franchisees. One might question whether this loss is temporary or permanent. Evidence from previous similar events (for example, Tylenol) suggests that consumers soon forget or at least forgive the ofi‘ending company. The FASB reporting standard discusses but rejects the use of a permanency criterion in identifying impairment losses. Thus, an impairment loss occurs in this case because the future undiscounted cash flows of $6 million from the franchise rights are less than the book value of the franchise rights of $10 million. The amount of the impairment loss is $7 million (= $10 million — $3 million). The journal entry is (in millions): Impairment Loss... 7 Franchise Rights: 7 Shareholders Liabilities + E . uit ClaSSIIQE _I_I—_ This entry assumes that Chicken Franchisees does not use an Accumulated Amortization account. ...
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