CH 10 SM 13 BB Post - SOLUTIONS TO CODIFICATION EXERCISES...

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Unformatted text preview: SOLUTIONS TO CODIFICATION EXERCISES CE10-1 Master Glossary (a) Capitalize is used to indicate that the cost would be recorded as the cost of an asset. That procedure is often referred to as deferring a cost, and the resulting asset is sometimes described as a deferred cost. Nonmonetary assets are assets other than monetary ones. Examples are inventories; investments in common stocks; and property, plant, and equipment. A nonreciprocal transfer is a transfer of assets or services in one direction, either from an entity to its owners (whether or not in exchange for their ownership interests) or to another entity, or from owners or another entity to the entity. An entity’s reacquisition of its outstanding stock is an example of a nonreciprocal transfer. A contribution is an unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Those characteristics distinguish contributions from exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately equal value; from investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners; and from other nonreciprocal transfers, such as impositions of taxes or fines and thefts, which are not voluntary transfers. In a contribution transaction, the value, if any, returned to the resource provider is incidental to potential public benefits. In an exchange transaction, the potential public benefits are secondary to the potential proprietary benefits to the resource provider. The term contribution revenue is used to apply to transactions that are part of the entity’s ongoing major or central activities (revenues), or are peripheral or incidental to the entity (gains). (b) (c) (d) CE10-2 According to FASB ASC 835-20-15-8 (Capitalization of Land Expenditures), it depends: . . . Land that is not undergoing activities necessary to get it ready for its intended use is not a qualifying asset. If activities are undertaken for the purpose of developing land for a particular use, the expendi tures to acquire the land qualify for interest capitalization while those activities are in progress. The interest cost capitalized on those expenditures is a cost of acquiring the asset that results from those activities. If the resulting asset is a structure, such as a plant or a shopping center, interest capitalized on the land expenditures is part of the acquisition cost of the structure. If the resulting asset is developed land, such as land that is to be sold as developed lots, interest capitalized on the land expenditures is part of the acquisition cost of the developed land. CE10-3 According to FASB ASC 360-10-25-5, (Planned Major Maintenance Activities) . . . The use of the accrue-in-advance (accrual) method of accounting for planned major maintenance activities is prohibited in annual and interim financial reporting periods. CE10-4 According to FASB ASC 845-10-15-5 (Purchases and Sales of Inventory with the Same Counterparty), the accounting for these exchanges is similar to other nonmonetary exchanges: The Purchases and Sales of Inventory with the Same Counterparty Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Subtopic, see paragraph 845-10-15-1, with specific transaction exceptions noted below. With respect to recognition, FASB ASC 845-10-30 Initial Measurement 30-15 A nonmonetary exchange whereby an entity transfers finished goods inventory in exchange for the receipt of raw materials or work-in-process inventory within the same line of business is not an exchange transaction to facilitate sales to customers for the entity transferring the finished goods, as described in paragraph 845-10-30-3(b), and, therefore, shall be recognized by that entity at fair value if both of the following conditions are met: a. Fair value is determinable within reasonable limits. b. The transaction has commercial substance (see paragraph 845-10-30-4). All other nonmonetary exchanges of inventory within the same line of business shall be recognized at the carrying amount of the inventory transferred. That is, a nonmonetary exchange within the same line of business involving either of the following shall not be recognized at fair value: a. The transfer of raw materials or work-in-process inventory in exchange for the receipt of raw materials, work-in-process, or finished goods inventory b. The transfer of finished goods inventory for the receipt of finished goods inventory. 30-16 ANSWERS TO QUESTIONS 1. The major characteristics of plant assets are (1) that they are acquired for use in operations and not for resale, (2) that they are long-term in nature and usually subject to depreciation, and (3) that they have physical substance. 2. The company should report the asset at its historical cost of $450,000, not its current value. The main reasons for this position are (1) at the date of acquisition, cost reflects fair value; (2) historical cost involves actual, not hypothetical transactions, and as a result is extremely reliable; and (3) gains and losses should not be anticipated but should be recognized when the asset is sold. 3. (a) The acquisition costs of land may include the purchase or contract price, the broker’s commission, title search and recording fees, assumed taxes or other liabilities, and surveying, demolition (less salvage), and landscaping costs. (b)Machinery and equipment costs may properly include freight and handling, taxes on purchase, insurance in transit, installation, and expenses of testing and breaking-in. (c) If a building is purchased, all repair charges, alterations, and improvements necessary to ready the building for its intended use should be included as a part of the acquisition cost. Building costs in addition to the amount paid to a contractor may include excavation, permits and licenses, architect’s fees, interest accrued on funds obtained for construction purposes (during construction period only) called avoidable interest, insurance premiums applicable to the construction period, temporary buildings and structures, and property taxes levied on the building during the construction period. 4. (a)Land. (b) Land. (c) Land. (d) Machinery. The only controversy centers on whether fixed overhead should be allocated as a cost to the machinery. (e) Land Improvements, may be depreciated. (f) Building. (g) Building, provided the benefits in terms of information justify the additional cost involved in providing the information. (h) Land. (i) Land. 5. (a)The position that no fixed overhead should be capitalized assumes that the construction of plant (fixed) assets will be timed so as not to interfere with normal operations. If this were not the case, the savings anticipated by constructing instead of purchasing plant assets would be nullified by reduced profits on the product that could have been manufactured and sold. Thus, construction of plant assets during periods of low activity will have a minimal effect on the total amount of overhead costs. To capitalize a portion of fixed overhead as an element of the cost of constructed assets would, under these circumstances, reduce the amount assignable to operations and therefore overstate net income in the construction period and understate net income in subsequent periods because of increased depreciation charges. (b)Capitalizing overhead at the same rate as is charged to normal operations is defended by those who believe that all manufacturing overhead serves a dual purpose during plant asset construction periods. Any attempt to assign construction activities less overhead than the normal rate implies costing favors and results in the misstatement of the cost of both plant assets and finished goods. Questions Chapter 10 (Continued) 6. (a) Disagree. Organization and promotion expenses should be expensed. (b) Agree. Architect’s fees for plans actually used in construction of the building should be charged to the building account as part of the cost. (c) Agree. GAAP recommends that avoidable interest or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition or location necessary for its intended use. Interest costs are capitalized starting with the first expenditure related to the asset and capitalization would continue until the asset is substantially completed and ready for its intended use. Property taxes during construction should also be charged to the building account. (d) Disagree. Interest revenue is not considered part of the acquisition cost of the building. 7. Since the land for the plant site will be used in the operations of the firm, it is classified as property, plant, and equipment. The other tract is being held for speculation. It is classified as an investment. 8. A common accounting justification is that all costs associated with the construction of an asset, including interest, should be capitalized in order that the costs can be matched to the revenues which the new asset will help generate. 9. Assets that do not qualify for interest capitalization are (1) assets that are in use or ready for their intended use, and (2) assets that are not being used in the earnings activities of the firm. 10. The avoidable interest is determined by multiplying (an) interest rate(s) by the weighted-average amount of accumulated expenditures on qualifying assets. For the portion of weighted-average accumulated expenditures which is less than or equal to any amounts borrowed specifically to finance construction of the assets, the capitalization rate is the specific interest rate incurred. For the portion of weighted-average accumulated expenditures which is greater than specific debt incurred, the interest rate is a weighted average of all other interest rates incurred. The amount of interest to be capitalized is the avoidable interest, or the actual interest incurred, whichever is lower. As indicated in the chapter, an alternative to the specific rate is to use an average borrowing rate. 11. The total interest cost incurred during the period should be disclosed, indicating the portion capitalized and the portion charged to expense. Interest revenue from temporarily invested excess funds should not be offset against interest cost when determining the amount of interest to be capitalized. The interest revenue would be reported in the same manner customarily used to report any other interest revenue. 12. (a) Assets acquired by issuance of capital stock—when property is acquired by issuance of securities such as common stock, the cost of the property is not measured by par or stated value of such stock. If the stock is actively traded on the market, then the market value of the stock is a fair indication of the cost of the property because the market value of the stock is a good measure of the current cash equivalent price. If the market value of the common stock is not determinable, then the market value of the property should be established and used as the basis for recording the asset and issuance of common stock. Questions Chapter 10 (Continued) (b) Assets acquired by gift or donation—when assets are acquired in this manner a strict cost concept would dictate that the valuation of the asset be zero. However, in this situation, accountants record the asset at its fair market value. The credit should be made to Contribution Revenue. Contributions received should be credited to revenue unless the contribution is from a governmental unit. Even in that case, we believe that the credit should be to Contribution Revenue. (c) Cash discount—when assets are purchased subject to a cash discount, the question of how the discount should be handled occurs. If the discount is taken, it should be considered a reduction in the asset cost. Different viewpoints exist, however, if the discount is not taken. One approach is that the discount must be considered a reduction in the cost of the asset. The rationale for this approach is that the terms of these discounts are so attractive that failure to take the discount must be considered a loss because management is inefficient. The other view is that failure to take the discount should not be considered a loss, because the terms may be unfavorable or the company might not be prudent to take the discount. Presently both methods are employed in practice. The former approach is conceptually correct. (d) Deferred payments—assets should be recorded at the present value of the consideration exchanged between contracting parties at the date of the transaction. In a deferred payment situation, there is an implicit (or explicit) interest cost involved, and the accountant should be careful not to include this amount in the cost of the asset. (e) Lump sum or basket purchase—sometimes a group of assets are acquired for a single lump sum. When a situation such as this exists, the accountant must allocate the total cost among the various assets on the basis of their relative fair market value. (f) Trade or exchange of assets—when one asset is exchanged for another asset, the accountant is faced with several issues in determining the value of the new asset. The basic principle involved is to record the new asset at the fair market value of the new asset or the fair market value of what is given up to acquire the new asset, whichever is more clearly evident. However, the accountant must also be concerned with whether the exchange has commercial substance and whether monetary consideration is involved in the transaction. The commercial substance issue rests on whether the expected cash flows on the assets involved are significantly different . In addition, monetary consideration may affect the amount of gain recognized on the exchange under consideration. 13. The cost of such assets includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembly and installation costs, and costs of conducting trial runs. Costs thus include all expenditures incurred in acquiring the equipment and preparing it for use. When plant assets are purchased subject to cash discounts for prompt payment, the question of how the discount should be handled arises. The appropriate view is that the discount, whether taken or not, is considered a reduction in the cost of the asset. The rationale for this approach is that the real cost of the asset is the cash or cash equivalent price of the asset. Similarly, assets purchased on long-term payment plans should be accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction. 14. Fair market value of land Fair market value of building and land $500,000 X $2,200,000 = $440,000 $2,500,000 X Cost = Cost allocated to land (Cost allocated to land) $2,000,000 X $2,200,000 = $1,760,000 (Cost allocated to building) $2,500,000 Questions Chapter 10 (Continued) 15. $10,000 + $4,208 = $14,208 16. Ordinarily accounting for the exchange of nonmonetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Thus any gains and losses on the exchange should be recognized immediately. If the fair value of either asset is not reasonably determinable, the book value of the asset given up is usually used as the basis for recording the nonmonetary exchange. This approach is always employed when the exchange has commercial substance. The general rule is modified when exchanges lack commer-cial substance. In this case, the enterprise is not considered to have completed the earnings process and therefore a gain should not be recognized. However, a loss should be recognized immediately . In certain situations, gains on an exchange that lacks commercial substance may be recorded when monetary consideration is received. When monetary consideration is received, it is assumed that a portion of the earnings process is completed, and therefore, a partial gain is recognized. 17. In accordance with GAAP which requires losses to be recognized immediately, the entry should be: Heavy Duty Truck (new)....................................................................... Accumulated Depreciation.................................................................... Loss on Disposal of Heavy Duty Truck................................................. Heavy Duty Truck (old)................................................................... Cash............................................................................................... *[($30,000 – $6,000) X 49 months/120 months = $9,800] **(Book value $20,200 – $16,000 trade-in = $4,200 loss) 18. Ordinarily such expenditures include (1) the recurring costs of servicing necessary to keep property in good operating condition, (2) cost of renewing structural parts of major plant units, and (3) costs of major overhauling operations which may or may not extend the life beyond original expectation. The first class of expenditures represents the day-to-day service and in general is chargeable to operations as incurred. These expenditures should not be charged to the asset accounts. The second class of expenditures may or may not affect the recorded cost of property. If the asset is rigidly defined as a distinct unit, the renewal of parts does not usually disturb the asset accounts; however, these costs may be capitalized and apportioned over several fiscal periods on some equitable basis. If the property is conceived in terms of structural elements subject to separate replacement, such expenditures should be charged to the plant asset accounts. The third class of expenditures, major overhauls, is usually entered through the asset accounts because replacement of important structural elements is usually involved. Other than maintenance charges mentioned above are those expenditures which add some physical aspect not a part of the asset at the time of its original acquisition. These expenditures may be capitalized in the asset account. An expenditure which extends the life but not the usefulness of the asset is often charged to the Accumulated Depreciation account. A more appropriate treatment requires retiring from the asset and accumulated depreciation accounts the appropriate amounts (original cost from the asset account ) and to capitalize in the asset account the new cost. Often it is difficult to determine the original cost of the item being replaced. For this reason the replacement or renewal is charged to the Accumulated Depreciation account. 19. (a) Additions. Additions represent entirely new units or extensions and enlargements of old units. Expenditures for additions are capitalized by charging either old or new asset accounts depending on the nature of the addition. 42,000 9,800* 4,200** 30,000 26,000 Questions Chapter 10 (Continued) (b) Major Repairs. Expenditures to replace parts or otherwise to restore assets to their previously efficient operating condition are regarded as repairs. To be considered a major repair, several periods must benefit from the expenditure. The cost should be handled as an addition, improvement or replacement depending on the type of major repair made. (c) Improvements. An improvement does not add to existing plant assets. Expenditures for such betterments represent increases in the quality of existing plant assets by rearrangements in plant layout or the substitution of improved components for old components so that the facilities have increased productivity, greater capacity, or longer life. The cost of improvements is accounted for by charges to the appropriate property accounts and the elimination of the cost and accumulated depreciation associated with the replaced components, if any. Replacements. Replacements involve an “in kind” substitution of a new asset or part for an old asset or part. Accounting for major replacements requires entries to retire the old asset or part and to record the cost of the new asset or part. Minor replacements are treated as period costs. 20. The cost of installing the machinery should be capitalized, but the extra month’s wages paid to the dismissed employees should not, as this payment did not add any value to the machinery. The extra wages should be charged off immediately as an expense; the wages could be shown as a separate item in the income statement for disclosure purposes. 21. (a) Overhead of a business that builds its own equipment. Some accountants have maintained that the equipment account should be charged only with the additional overhead caused by such construction. However, a more realistic figure for cost of equipment results if the plant asset account is charged for overhead applied on the same basis and at the same rate as used for production (see Question 5). (b) Cash discounts on purchases of equipment. Some accountants treat all cash discounts as financial or other revenue, regardless of whether they arise from the payment of invoices for merchandise or plant assets. Others take the position that only the net amount paid for plant assets should be capitalized on the basis that the discount represents a reduction of price and is not income. The latter position seems more logical in light of the fact that plant assets are purchased for use and not for sale and that they are written off to expense over a long period of time. (c) Interest paid during construction of a building. GAAP recommends that avoidable or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition and location necessary for its intended use. (d) Cost of a safety device installed on a machine. This is an addition to the machine and should be capitalized in the machinery account if material. (e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity. If ordering the first equipment was an error, whether due to judgment or otherwise, the freight should be regarded as a loss. However, if information became available after the order was placed which indicated purchase of the new equipment was more advantageous, the cost of the return freight may be viewed as a necessary cost of the new equipment. Questions Chapter 10 (Continued) (f) Cost of moving machinery to a new location. Normally, only the cost of one installation should be capitalized for any piece of equipment. Thus the original installation and any accumulated depreciation relating thereto should be removed from the accounts and the new installation costs (i.e., cost of moving) should be capitalized. In cases where this is not possible and the cost of moving is substantial, it is capitalized and depreciated appropriately over the period during which it makes a contribution to operations. (g) Cost of plywood partitions erected in the remodeling of the office. This is a part of the remodeling cost and may be capitalized as part of the remodeling itself is of such a nature that it is an addition to the building and not merely a replacement or repair. (h) Replastering of a section of the building. This seems more in the nature of a repair than anything else and as such should be treated as an expense. (i) Cost of a new motor for one of the trucks. This probably extends the useful life of the truck. As such it may be viewed as an extraordinary repair and charged against the accumulated depreciation on the truck. The remaining service life of the truck should be estimated and the depreciation adjusted to write off the new book value, less salvage, over the remaining useful life. A more appropriate treatment is to remove the cost of the old motor and related depreciation and add the cost of the new motor if possible. 22. This approach is not correct since at the very minimum the investor should be aware that certain assets are used in the business which are not reflected in the main body of the financial statements . Either the company should keep these assets on the balance sheet or they should be recorded at salvage value and the resulting gain recognized. In either case, there should be a clear indication that these assets are fully depreciated, but are still being used in the business. 23. Gains or losses on plant asset retirements should be shown in the income statement along with other items that arise from customary business activities. SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 $27,000 + $1,400 + $10,200 = $38,600 BRIEF EXERCISE 10-2 Expenditures Date 3/1 6/1 12/31 Amount $1,800,000 1,200,000 3,000,000 $6,000,000 Capitalization Period 10/12 7/12 0 Weighted-Average Accumulated Expenditures $1,500,000 700,000 0 $2,200,000 BRIEF EXERCISE 10-3 Principal 10%, 5-year note 11%, 4-year note $2,000,000 3,500,000 $5,500,000 Interest $200,000 385,000 $585,000 $585,000 $5,500,000 = 10.64% Weighted-average interest rate = BRIEF EXERCISE 10-4 Weighted-Average Accumulated Expenditures $1,000,000 1,200,000 $2,200,000 X Interest Rate 12% 10.64% = Avoidable Interest $120,000 127,680 $247,680 BRIEF EXERCISE 10-5 Truck ($80,000 X .68301)....................................... Discount on Notes Payable.................................. Notes Payable............................................... 54,641 25,359 80,000 BRIEF EXERCISE 10-6 Recorded Amount $ 52,500 192,500 70,000 $315,000 Fair Value Land Building Equipment $ 60,000 220,000 80,000 $360,000 % of Total 60/360 220/360 80/360 X X X Cost $315,000 $315,000 $315,000 BRIEF EXERCISE 10-7 Land (2,000 X $40)................................................. Common Stock (2,000 X $10)...................... Paid-in Capital in Excess of Par................. 80,000 20,000 60,000 BRIEF EXERCISE 10-8 Computer................................................................ Accumulated Depreciation................................... Truck.............................................................. Cash............................................................... Gain on Disposal of Truck........................... 3,300 18,000 20,000 500 800 BRIEF EXERCISE 10-9 Computer ($3,300 – $800)..................................... Accumulated Depreciation................................... Truck.............................................................. Cash............................................................... 2,500 18,000 20,000 500 BRIEF EXERCISE 10-10 Office Equipment................................................... Accumulated Depreciation................................... Loss on Disposal of Machine............................... Machine......................................................... Cash............................................................... 5,000 3,000 4,000 9,000 3,000 BRIEF EXERCISE 10-11 Truck....................................................................... Accumulated Depreciation................................... Loss on Disposal of Truck.................................... Truck.............................................................. Cash............................................................... 37,000 27,000 2,000 30,000 36,000 BRIEF EXERCISE 10-12 Truck....................................................................... Accumulated Depreciation................................... Loss on Disposal of Truck.................................... Truck.............................................................. Cash............................................................... 35,000 17,000 1,000 20,000 33,000 BRIEF EXERCISE 10-13 Only cost (c) is expensed when incurred. BRIEF EXERCISE 10-14 (a) Depreciation Expense ($2,400 X 8/12).................... Accumulated Depreciation............................. Cash........................................................................... .................................................................................... Accumulated Depreciation ($8,400 + $1,600)......... Machinery......................................................... Gain on Disposal of Machinery...................... 1,600 1,600 10,500 10,000 20,000 500 (b) BRIEF EXERCISE 10-15 (a) Depreciation Expense ($2,400 X 8/12).................... Accumulated Depreciation............................. Cash........................................................................... .................................................................................... Loss on Disposal of Machinery............................... Accumulated Depreciation ($8,400 + $1,600)......... Machinery......................................................... 1,600 1,600 5,200 4,800 10,000 20,000 (b) SOLUTIONS TO EXERCISES EXERCISE 10-1 (15–20 minutes) Land Improvements Item (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) Land Building $275,000 Other Accounts ($275,000) Notes Payable $ 10,000 7,000 6,000 (1,000) 25,000 250,000 9,000 $ 4,000 11,000 (5,000) 13,000 19,000 14,000 3,000 EXERCISE 10-2 (10–15 minutes) The allocation of costs would be as follows: Land.................................................................... ............................................................................ Razing costs Salvage Legal fees Survey Plans Title insurance Liability insurance Construction Interest Land $450,000 42,000 (6,300) 1,850 $ 1,500 900 2,740,000 170,000 2,200 65,000 Building $489,050 $2,978,100 EXERCISE 10-3 (10–15 minutes) 1. Truck #1................................................................ Cash............................................................ Truck #2................................................................ Discount on Notes Payable................................ Cash............................................................ Notes Payable............................................ *PV of $18,000 @ 10% for 1 year = $18,000 X .90909 = $16,364 $16,364 + $2,000 = $18,364 Truck #3................................................................ Cost of Goods Sold............................................. Inventory..................................................... Sales............................................................ 13,900 13,900 18,364* 1,636 2,000 18,000 2. 3. 15,200 12,000 12,000 15,200 [Note to instructor: The selling (retail) price of the computer system appears to be a better gauge of the fair value of the consideration given than is the list price of the truck as a gauge of the fair value of the consideration received (truck). Vehicles are very often sold at a price below the list price.] 4. Truck #4................................................................ Common Stock........................................... Paid-in Capital in Excess of Par (1,000 shares X $13 = $13,000; $13,000 less $10,000 par value)............ 13,000 10,000 3,000 EXERCISE 10-4 (20–25 minutes) Purchase Cash paid for equipment, including sales tax of $5,000..... Freight and insurance while in transit.................................. Cost of moving equipment into place at factory................. Wage cost for technicians to test equipment...................... Special plumbing fixtures required for new equipment..... Total cost................................................................................. $105,000 2,000 3,100 6,000 8,000 $124,100 The insurance premium paid during the first year of operation on this equipment should be reported as insurance expense, and not be capitalized. Repair cost incurred in the first year of operations related to this equipment should be reported as repair and maintenance expense, and not be capitalized. Both these costs relate to periods subsequent to purchase. Construction Material and purchased parts ($200,000 X .99).................... Labor costs.............................................................................. Overhead costs....................................................................... Cost of installing equipment.................................................. Total cost................................................................................. $198,000 190,000 50,000 4,400 $442,400 Note that the cost of material and purchased parts is reduced by the amount of cash discount not taken because the equipment should be reported at its cash equivalent price. The imputed interest on funds used during construction related to stock financing should not be capitalized or expensed. This item is an opportunity cost that is not reported. Profit on self-construction should not be reported. Profit should only be reported when the asset is sold. EXERCISE 10-5 (30–40 minutes) Land Abstract fees $ 520 Architect’s fees Cash paid for land and old building 92,000 Removal of old building ($20,000 – $5,500) 14,500 Interest on loans during construction Excavation before construction Machinery purchased Freight on machinery Storage charges caused by noncompletion of building New building Assessment by city Hauling charges—machinery Installation—machinery Landscaping 485,000 1,600 620 2,000 5,400 $114,020 $514,570 $67,040 $4,100 —Misc. expense (Loss) Buildings $ 3,170 M&E Other 7,400 19,000 $63,700 1,340 2,180 —Misc. expense (Loss) $1,300 —Misc. expense (Discount Lost) EXERCISE 10-6 (15–20 minutes) 1. Land...................................................................... ............................................................................... Buildings.............................................................. Equipment............................................................ Cash............................................................ $680,000 X $150,000 $800,000 $350,000 $800,000 $300,000 $800,000 = $127,500 Land 127,500 297,500 255,000 680,000 $680,000 X = $297,500 Buildings $680,000 X = $255,000 Equipment EXERCISE 10-6 (Continued) 2. Store Equipment................................................. Cash............................................................ Note Payable.............................................. Office Equipment................................................ Accounts Payable ($20,000 X .98)............ Land...................................................................... ............................................................................... Contribution Revenue............................... Warehouse........................................................... Cash............................................................ 25,000 2,000 23,000 19,600 19,600 27,000 27,000 600,000 600,000 3. 4. 5. EXERCISE 10-7 (20–25 minutes) (a) Avoidable Interest Weighted-Average Accumulated Expenditures $2,000,000 1,800,000 $3,800,000 X Interest Rate = Avoidable Interest 12% 10.38% $240,000 186,840 $426,840 Principal $1,600,000 1,000,000 $2,600,000 Interest $160,000 110,000 $270,000 Weighted-average interest rate computation 10% short-term loan 11% long-term loan Total Interest Total Principal = $270,000 = 10.38% $2,600,000 EXERCISE 10-7 (Continued) (b) Construction loan Short-term loan Long-term loan Actual Interest $2,000,000 X 12% = $1,600,000 X 10% = $1,000,000 X 11% = Total $240,000 160,000 110,000 $510,000 Because avoidable interest is lower than actual interest, use avoidable interest. Cost $5,200,000 Interest capitalized 426,840 Total cost $5,626,840 Depreciation Expense = $5,626,840 – $300,000 = $177,561 30 years EXERCISE 10-8 (20–25 minutes) (a) Computation of Weighted-Average Accumulated Expenditures Expenditures Date March 1 June 1 July 1 December 1 Amount $ 360,000 600,000 1,500,000 1,200,000 $3,660,000 X Capitalization Period 10/12 7/12 6/12 1/12 = Weighted-Average Accumulated Expenditures $ 300,000 350,000 750,000 100,000 $1,500,000 Computation of Avoidable Interest Weighted-Average Accumulated Expenditures X $1,500,000 Interest Rate 12% (Construction loan) = Avoidable Interest $180,000 Computation of Actual Interest Actual interest $3,000,000 X 12% $4,000,000 X 11% $1,600,000 X 10% $360,000 440,000 160,000 $960,000 Note: Use avoidable interest for capitalization purposes because it is lower than actual interest. EXERCISE 10-8 (Continued) (b) Building................................................................ Interest Expense*................................................ Cash ($360,000 + $440,000 + $160,000)... *Actual interest for year Less: Amount capitalized Interest expense debit $ 960,000 (180,000) $ 780,000 180,000 780,000 960,000 EXERCISE 10-9 (20–25 minutes) (a) Computation of Weighted-Average Accumulated Expenditures Expenditures Date July 31 November 1 Amount $300,000 100,000 X Capitalization Period 3/12 0 = Weighted-Average Accumulated Expenditures $75,000 0 $75,000 Interest revenue Avoidable interest $100,000 X 10% X 3/12 = $2,500 Weighted-Average Accumulated Expenditures X $75,000 Actual Interest $400,000 X 12% X 5/12 = $30,000 X 8% = Interest Rate 12% = Avoidable Interest $9,000 $20,000 2,400 $22,400 $ 9,000 Interest capitalized EXERCISE 10-9 (Continued) (b) (1) 7/31 Cash.................................................. ........................................................... Note Payable.......................... Machine............................................ Trading Securities........................... Cash........................................ (2) 11/1 Cash.................................................. ........................................................... Interest Revenue ($100,000 X 10% X 3/12)..... Trading Securities.................. Machine............................................ Cash........................................ (3) 12/31 Machine............................................ Interest Expense ($22,400 – $9,000)......................... Cash ($30,000 X 8%).............. Interest Payable ($400,000 X 12% X 5/12)..... 400,000 400,000 300,000 100,000 400,000 102,500 2,500 100,000 100,000 100,000 9,000 13,400 2,400 20,000 EXERCISE 10-10 (20–25 minutes) Situation I. $90,000—The requirement is the amount Columbia should report as capitalized interest at 12/31/10. The amount of interest eligible for capitalization is Weighted-Average Accumulated Expenditures X Interest Rate = Avoidable Interest Since Columbia has outstanding debt incurred specifically for the construction project, in an amount greater than the weighted-average accumulated expenditures of $900,000, the interest rate of 10% is used for capitalization purposes. Therefore, the avoidable interest is $90,000, which is less than the actual interest. $900,000 X .10 = $90,000 EXERCISE 10-10 (Continued) Finally, per GAAP (FASB ASC 835-20-30-10), the interest earned of $250,000 is irrelevant to the question addressed in this problem because such interest earned on the unexpended portion of the loan is not to be offset against the amount eligible for capitalization. Situation II. $39,000—The requirement is total interest costs to be capitalized. GAAP identifies assets which qualify for interest capitalization: assets constructed for an enterprise’s own use and assets intended for sale or lease that are produced as discrete projects. Inventories that are routinely produced in large quantities on a repetitive basis do not qualify for interest capitalization. Therefore, only $30,000 and $9,000 are capitalized. Situation III. $330,000—The requirement is to determine the amount of interest to be capitalized on the financial statements at April 30, 2011. The GAAP requirements are met: (1) expenditures for the asset have been made, (2) activities that are necessary to get the asset ready for its intended use are in progress, and (3) interest cost is being incurred. The amount to be capitalized is determined by applying an interest rate to the weighted-average amount of accumulated expenditures for the asset during the period. Because the $6,000,000 of expenditures incurred for the year ended April 30, 2011, were incurred evenly throughout the year, the weighted-average amount of expenditures for the year is $3,000,000, ($6,000,000 ÷ 2). Therefore, the amount of interest to be capitalized is $330,000 ($3,000,000 X 11%). In any period the total amount of interest cost to be capitalized shall not exceed the total amount of interest cost incurred by the enterprise. (Total interest is $1,100,000). Finally, the interest earned of $650,000 is irrelevant to the question addressed in this problem because such interest earned on the unexpended portion of the loan is not to be offset against the amount eligible for capitalization. EXERCISE 10-11 (10–15 minutes) (a) Equipment............................................................ Accounts Payable...................................... Accounts Payable............................................... Equipment ($15,000 X .02)........................ Cash............................................................ (b) Equipment (new)................................................. Loss on Disposal of Equipment........................ Accumulated Depreciation ($8,000 – $6,000)... Accounts Payable...................................... Equipment (old)......................................... **Cost Accumulated depreciation Book value Fair market value Loss *Cost ($14,200 + $400) $ 8,000 6,000 2,000 400 $ 1,600 $14,600 14,200 14,200 14,862 1,338 16,200 1,338 16,200 1,338 16,200 15,000 15,000 15,000 300 14,700 14,600* 1,600** 6,000 14,200 8,000 Accounts Payable............................................... Cash............................................................ (c) Equipment ($16,200 X .91743)............................ Discount on Notes Payable ($16,200 – $14,862)........................................... Notes Payable............................................ Interest Expense................................................. Notes Payable...................................................... Discount on Notes Payable...................... Cash............................................................ EXERCISE 10-12 (15–20 minutes) (a) Land...................................................................... ............................................................................... Contribution Revenue............................... Land...................................................................... ............................................................................... Buildings.............................................................. Common Stock ($50 X 14,000)................. Paid-in Capital in Excess of Par*............. 81,000 81,000 180,000 630,000 700,000 110,000 (b) *Since the market value of the stock is not determinable, the market value of the property is used as the basis for recording the asset and issuance of the stock. (c) Machinery............................................................. Materials..................................................... Direct Labor................................................ Factory Overhead...................................... *Fixed overhead applied Additional overhead Factory supplies used (60% X $16,000) 41,700 12,500 16,000 13,200* $ 9,600 2,700 900 $13,200 EXERCISE 10-13 (20–25 minutes) 1. Land...................................................................... ............................................................................... Building................................................................ Machinery and Equipment................................. Common Stock (12,500 X $100)............... Paid-in Capital in Excess of Par............... ($2,250,000 – $1,250,000) 375,000 1,125,000 750,000 1,250,000 1,000,000 The cost of the property, plant and equipment is $2,250,000 (12,500 X $180). This cost is allocated based on appraised values as follows: Land Building $400,000 X $2,250,000 = $375,000 $2,400,000 $1,200,000 X $2,250,000 = $1,125,000 $2,400,000 Machinery & Equipment $800,000 X $2,250,000 = $750,000 $2,400,000 EXERCISE 10-13 (Continued) 2. Buildings ($105,000 plus $161,000)................... Machinery and Equipment................................. Land Improvements............................................ Land...................................................................... ............................................................................... Cash............................................................ Machinery and Equipment................................. Cash............................................................ ($10,500 plus $274,400, which is 98% of $280,000.) 266,000 135,000 122,000 18,000 541,000 284,900 284,900 3. EXERCISE 10-14 (15–20 minutes) (a) Equipment............................................................ Discount on Notes Payable................................ Notes Payable............................................ *PV of $180,000 annuity @ 12% for 5 years ($180,000 X 3.60478) = $648,860 Interest Expense................................................. Notes Payable...................................................... Discount on Notes Payable...................... Cash............................................................ *(12% X $648,860) 648,860* 251,140 900,000 (b) 77,863* 180,000 77,863 180,000 Year 1/2/10 12/31/10 12/31/11 Note Payment $180,000 180,000 12% Interest $77,863 65,607 Reduction of Principal $102,137 114,393 Balance $648,860 546,723 432,330 EXERCISE 10-14 (Continued) (c) Interest Expense................................................. Notes Payable...................................................... Discount on Notes Payable...................... Cash............................................................ Depreciation Expense......................................... Accumulated Depreciation....................... *($648,860 ÷ 10) 65,607 180,000 65,607 180,000 64,886* 64,886 (d) EXERCISE 10-15 (15–20 minutes) (a) Equipment............................................................ 105,815.80* Discount on Notes Payable................................ 24,184.20 Cash............................................................ 30,000.00 Notes Payable............................................ 100,000.00 *PV of $20,000 annuity @ 10% for 5 years ($20,000 X 3.79079) $ 75,815.80 Down payment 30,000.00 Capitalized value of equipment $105,815.80 Notes Payable...................................................... Interest Expense (see schedule)....................... Cash............................................................ Discount on Notes Payable...................... 20,000.00 7,581.58 20,000.00 7,581.58 (b) Year 12/31/09 12/31/10 12/31/11 Note Payment $20,000.00 20,000.00 10% Interest $7,581.58 6,339.74 Reduction of Principal $12,418.42 13,660.26 Balance $75,815.80 63,397.38 49,737.12 EXERCISE 10-15 (Continued) (c) Notes Payable...................................................... Interest Expense................................................. Cash............................................................ Discount on Notes Payable...................... 20,000.00 6,339.74 20,000.00 6,339.74 EXERCISE 10-16 (25–35 minutes) LOGAN INDUSTRIES Acquisition of Assets 1 and 2 Use appraised values to break-out the lump-sum purchase Value on Books $78,000 26,000 Description Machinery Office Equipment Appraisal $ 90,000 30,000 $120,000 Percentage 90/120 30/120 Lump-Sum $104,000 104,000 Machinery............................................................... Office Equipment................................................... Cash............................................................... Acquisition of Asset 3 78,000 26,000 104,000 Use the cash price as a basis for recording the asset with a discount recorded on the note. Machinery............................................................... Discount on Notes Payable ($40,000 – $35,900).... Cash............................................................... Notes Payable............................................... 35,900 4,100 10,000 30,000 EXERCISE 10-16 (Continued) Acquisition of Asset 4 Since the exchange lacks commercial substance, a gain will be recognized in the proportion of cash received ($10,000/$80,000) times the $16,000 gain (FMV of $80,000 minus BV of $64,000). The gain recognized will then be $2,000 with $14,000 of it being unrecognized and used to reduce the basis of the asset acquired. Machinery ($70,000 – $14,000)........................... Accumulated Depreciation................................. Cash...................................................................... ............................................................................... Machinery................................................... Gain on Disposal of Machinery................ 56,000 36,000 10,000 100,000 2,000 Acquisition of Asset 5 In this case the Office Equipment should be placed on Logan’s books at the fair market value of the stock. The difference between the stock’s par value and its fair value should be credited to Paid-in Capital in Excess of Par. Office Equipment (100 X $11 per share)........... Common Stock........................................... Paid-in Capital in Excess of Par............... *($11 – $8) X 100 Shares. 1,100 800 300* EXERCISE 10-16 (Continued) Schedule of Weighted-Average Accumulated Expenditures Current Year Capitalization Period 9/12 9/12 5/12 2/12 0/12 Weighted-Average Accumulated Expenditures $135,000 90,000 150,000 80,000 0 $455,000 Date February 1 February 1 June 1 September 1 November 1 Amount $ 180,000 120,000 360,000 480,000 100,000 $1,240,000 Note that the capitalization is only 9 months in this exercise. Avoidable Interest Weighted-Average Accumulated Expenditures $455,000 X Interest Rate 12% = Avoidable Interest $54,600 Since the weighted-average expenditures are less than the amount of specific borrowing, the specific borrowing rate is used. Land Cost Building Cost $ 180,000 $1,114,600 ($1,060,000 + $54,600) 180,000 1,114,600 1,240,000 54,600 Land...................................................................... ............................................................................... Building................................................................ Cash............................................................ Interest Expense........................................ EXERCISE 10-17 (10–15 minutes) Alatorre Corporation Machine ($320 + $85)............................................. Accumulated Depreciation................................... Loss on Disposal of Machine............................... Machine......................................................... Cash............................................................... *Computation of loss: Book value of old machine ($290 – $140) Fair value of old machine Loss on exchange Mills Business Machine Company Cash........................................................................ ................................................................................. Inventory................................................................. Cost of Goods Sold............................................... Sales.............................................................. Inventory....................................................... 405 140 65* 290 320 $150 (85) $ 65 320 85 270 405 270 EXERCISE 10-18 (20–25 minutes) (a) Exchange has commercial substance: Depreciation Expense......................................... Accumulated Depreciation—Melter......... ($12,700 – $700 = $12,000; $12,000 ÷ 5 = $2,400; $2,400 X 4/12 = $800) Melter.................................................................... Accumulated Depreciation—Melter.................. Gain on Disposal of Plant Assets............ Melter.......................................................... Cash............................................................ *Cost of old asset Accumulated depreciation ($7,200 + $800) Book value Fair value of old asset Gain (on disposal of plant asset) **Cash paid Fair value of old melter Cost of new melter $12,700 (8,000) 4,700 (5,200) $ 500 $10,000 5,200 $15,200 800 800 15,200** 8,000 500* 12,700 10,000 EXERCISE 10-18 (Continued) (b) Exchange lacks commercial substance: Depreciation Expense......................................... Accumulated Depreciation—Melter......... Melter.................................................................... Accumulated Depreciation—Melter.................. Gain on Disposal of Plant Assets............ Melter.......................................................... Cash............................................................ **Cash paid Fair value of old asset Cost of new asset $10,000 5,200 $15,200 800 800 15,200** 8,000 500 12,700 10,000 Note that the entries are the same for both (a) and (b). The gain is not deferred because cash boot is greater than 25%, which makes the transaction monetary in nature. EXERCISE 10-19 (15–20 minutes) (a) Exchange lacks commercial substance. Santana Company: Equipment........................................................ Accumulated Depreciation............................. Equipment............................................... Cash......................................................... Valuation of equipment Book value of equipment given Cash paid New equipment OR Fair value received Less: Gain deferred New equipment *Fair value of old equipment Book value of old equipment Gain on disposal $15,500 4,500* $11,000 $13,500 (9,000) $ 4,500 11,000 19,000 28,000 2,000 $ 9,000 2,000 $11,000 Note: Cash paid is less than 25%, the transaction is nonmonetary, so the gain is deferred. Delaware Company: Cash....................................................................... ................................................................................ Equipment............................................................. Accumulated Depreciation—Equipment........... Loss on Disposal of Plant Assets...................... Equipment.................................................... *Computation of loss: Book value of old equipment Fair value of old equipment 2,000 13,500 10,000 2,500* 28,000 $18,000 15,500 Loss on disposal of equipment $ 2,500 EXERCISE 10-19 (Continued) (b) Exchange has commercial substance Santana Company Equipment............................................................ Accumulated Depreciation—Equipment.......... Equipment.................................................. Cash............................................................ Gain on Disposal of Equipment............... *Cost of new equipment: Cash paid Fair value of old equipment Cost of new equipment $ 2,000 13,500 $15,500 15,500* 19,000 28,000 2,000 4,500** **Computation of gain on disposal of equipment: Fair value of old equipment Book value of old equipment ($28,000 – $19,000) Gain on disposal of equipment $13,500 9,000 $ 4,500 Delaware Company Cash...................................................................... ............................................................................... Equipment............................................................ Accumulated Depreciation—Equipment (Old)... Loss on Disposal of Equipment........................ Equipment.................................................. *Cost of new equipment: Fair value of equipment Less: Cash received Cost of new equipment $15,500 2,000 $13,500 2,000 13,500* 10,000 2,500** 28,000 **Computation of loss on disposal of equipment: Book value of old equipment ($28,000 – $10,000) Fair value of equipment (Old) $18,000 15,500 Loss on disposal of equipment $ 2,500 EXERCISE 10-20 (15–20 minutes) (a) Exchange has commercial substance Automatic Equipment......................................... Accumulated Depreciation—Equipment.......... Gain on Disposal of Equipment............... Equipment.................................................. Cash ($7,000 + $1,100).............................. *$62,000 – $42,000. Valuation of equipment Cash Installation cost Market value of used equipment Cost of new equipment Computation of gain Cost of old asset Accumulated depreciation Book value Fair market value of old asset Gain on disposal of equipment (b) Fair value not determinable Automatic Equipment......................................... Accumulated Depreciation—Equipment.......... Equipment.................................................. Cash............................................................ *Basis of new equipment Book value of old equipment Cash paid (including installation costs) Basis of new equipment $42,000 8,100 $50,100 50,100* 20,000 62,000 8,100 $62,000 20,000 42,000 45,800 $ 3,800 $ 7,000 1,100 45,800 $53,900 53,900 20,000* 3,800 62,000 8,100 EXERCISE 10-21 (20–25 minutes) (a) Any addition to plant assets is capitalized because a new asset has been created. This addition increases the service potential of the plant. Expenditures that do not increase the service benefits of the asset are expensed. Painting costs are considered ordinary repairs because they maintain the existing condition of the asset or restore it to normal operating efficiency. The approach to follow is to remove the book value of the old roof and substitute the cost of the new roof. It is assumed that the expen diture increases the future service potential of the asset. Conceptually, the book value of the old electrical system should be removed. However, practically it is often difficult if not impossible to determine this amount. In this case, one of two approaches is followed . One approach is to capitalize the replacement on the theory that sufficient depreciation was taken on the old system to reduce the carrying amount to almost zero. A second approach is to debit Accumulated Depreciation on the theory that the replacement extends the useful life of the asset and thereby recaptures some or all of the past depreciation. In our present situation, the problem specifically states that the useful life is not extended and therefore debiting Accumulated Depreciation is inappropriate. Thus, this expenditure should be added to the cost of the plant facility. See discussion in (d) above. In this case, because the useful life of the asset has increased, a debit to Accumulated Depreciation would appear to be the most appropriate. (b) (c) (d) (e) EXERCISE 10-22 (15–20 minutes) 1/30 Accumulated Depreciation—Buildings........... Loss on Disposal of Plant Assets.................... Buildings................................................... Cash........................................................... *(5% X $112,000 = $5,600; $5,600 X 17 = $95,200) **($112,000 – $95,200) + $5,100 3/10 Cash ($2,900 – $300).......................................... Accumulated Depreciation—Machinery.......... Loss on Disposal of Plant Assets.................... Machinery.................................................. *(70% X $16,000 = $11,200) **($16,000 – $11,200) + $300 – $2,900 3/20 Machinery........................................................... Cash........................................................... Machinery........................................................... Accumulated Depreciation—Machinery.......... Loss on Disposal of Plant Assets.................... Machinery.................................................. Cash........................................................... *(60% X $4,000 = $2,400) **($4,000 – $2,400) Building Maintenance and Repairs Expense. . Cash........................................................... 3,000 3,000 5,500 2,400* 1,600** 4,000 5,500 2,600 11,200* 2,200** 16,000 95,200* 21,900** 112,000 5,100 5/18 6/23 6,900 6,900 EXERCISE 10-23 (10–15 minutes) (a) (b) (c) (d) (e) (f) (g) (h) C E, assuming immaterial C C C E C C EXERCISE 10-24 (20–25 minutes) (a) Depreciation Expense (8/12 X $72,000)........... Accumulated Depreciation—Machine.... Loss on Disposal of Machine ($1,300,000 – $408,000) – $630,000............... Cash.................................................................... ............................................................................. Accumulated Depreciation—Machine ($360,000 + $48,000)....................................... Machine..................................................... (b) Depreciation Expense (3/12 X $72,000)........... Accumulated Depreciation—Machine.... Cash .................................................................... Accumulated Depreciation—Machine ($360,000 + $18,000)....................................... Machine..................................................... Gain on Disposal of Machine [$1,040,000 – ($1,300,000 – $378,000)].... 48,000 48,000 262,000 630,000 408,000 1,300,000 18,000 18,000 1,040,000 378,000 1,300,000 118,000 EXERCISE 10-24 (Continued) (c) Depreciation Expense (7/12 X $72,000)........... Accumulated Depreciation—Machine.... Contribution Expense........................................ Accumulated Depreciation—Machine ($360,000 + $42,000)....................................... Machine..................................................... Gain on Disposal of Machine.................. *$1,100,000 – $1,300,000 + $402,000 42,000 42,000 1,100,000 402,000 1,300,000 202,000* EXERCISE 10-25 (15–20 minutes) April 1 Cash................................................................. .......................................................................... Accumulated Depreciation—Building.......... Land........................................................ Building.................................................. Gain on Disposal of Plant Assets........ *Computation of gain: Book value of land $ 60,000 Book value of building ($280,000 – $160,000) 120,000 Book value of land and building 180,000 Cash received 410,000 Gain on disposal $230,000 Aug. 1 Land................................................................. .......................................................................... Building........................................................... Cash........................................................ 90,000 380,000 470,000 410,000 160,000 60,000 280,000 230,000* TIME AND PURPOSE OF PROBLEMS Problem 10-1 (Time 35–40 minutes) Purpose—to provide a problem involving the proper classification of costs related to property, plant, and equipment. Property, plant, and equipment must be segregated into land, buildings, leasehold improvements, and machinery and equipment for purposes of the analysis. Such costs as demolition costs, real estate commissions, imputed interest, minor and major repair work, and royalty payments are presented. An excellent problem for reviewing the first part of this chapter. Problem 10-2 (Time 40–55 minutes) Purpose—to provide a problem involving the proper classification of costs related to property, plant, and equipment. Such costs as land, freight and unloading, installation, parking lots, sales and use taxes, and machinery costs must be identified and appropriately classified. An excellent problem for reviewing the first part of this chapter. Problem 10-3 (Time 35–45 minutes) Purpose—to provide a problem involving the proper classification of costs related to land and buildings. Typical transactions involve allocation of the cost of removal of a building, legal fees paid, general expenses, cost of organization, special tax assessments, etc. A good problem for providing a broad perspective as to the types of costs expensed and capitalized. Problem 10-4 (Time 35–40 minutes) Purpose—to provide a problem involving the method of handling the disposition of certain properties. The dispositions include a condemnation, demolition, trade-in, contribution and sale to a stockholder. The problem therefore involves a number of situations and provides a good overview of the accounting treatment accorded property dispositions. Problem 10-5 (Time 20–30 minutes) Purpose—to provide the student with a problem in which schedules must be prepared on the costs of acquiring land and the costs of constructing a building. Interest costs are included. Problem 10-6 (Time 25–35 minutes) Purpose—to provide the student with a problem to determine costs to include in the value of land and plant, including interest capitalization. Problem 10-7 (Time 20–30 minutes) Purpose—to provide the student with a problem to compute capitalized interest and to present disclosures related to capitalized interest. Problem 10-8 (Time 35–45 minutes) Purpose—to provide the student with a problem involving the exchange of machinery. Four different exchange transactions are possible, and journal entries are required for each possible transaction. The exchange transactions cover the receipt and disposition of cash as well as the purchase of a machine from a dealer of machinery. Problem 10-9 (Time 30–40 minutes) Purpose—to provide a problem on the accounting treatment for exchanges of assets that have and do not have commercial substance involving gain situations. Problem 10-10 (Time 30–40 minutes) Purpose—to provide the student with another problem involving the exchange of productive assets. This problem is unusual because the size of the boot is greater than 25%. As a result, the entire transaction is monetary in nature and all gains and losses are recognized. Problem 10-11 (Time 35–45 minutes) Purpose—to provide a property, plant, and equipment problem consisting of three transactions that have to be recorded—(1) an asset purchased on a deferred payment contract, (2) a lump-sum purchase , and (3) a nonmonetary exchange. SOLUTIONS TO PROBLEMS PROBLEM 10-1 (a) REAGAN COMPANY Analysis of Land Account for 2010 Balance at January 1, 2010.................. Land site number 621 Acquisition cost.................................... Commission to real estate agent......... Clearing costs........................................ Less: Amounts recovered................... Total land site number 621....... Land site number 622 Land value.............................................. Building value........................................ Demolition cost..................................... Total land site number 622....... Balance at December 31, 2010............. REAGAN COMPANY Analysis of Buildings Account for 2010 Balance at January 1, 2010........................... Cost of new building constructed on land site number 622 Construction costs.............................. Excavation fees.................................... Architectural design fees.................... Building permit fee............................... Balance at December 31, 2010..................... $ 890,000 $ 230,000 $850,000 51,000 $35,000 13,000 22,000 923,000 300,000 120,000 41,000 461,000 $1,614,000 $330,000 38,000 11,000 2,500 381,500 $1,271,500 PROBLEM 10-1 (Continued) REAGAN COMPANY Analysis of Leasehold Improvements Account for 2010 Balance at January 1, 2010................................ Office space......................................................... Balance at December 31, 2010........................... REAGAN COMPANY Analysis of Machinery and Equipment Account for 2010 Balance at January 1, 2010................................ Cost of the new machines acquired Invoice price.............................................. Freight costs............................................. Installation costs...................................... Balance at December 31, 2010........................... (b) $875,000 $ 87,000 3,300 2,400 $660,000 89,000 $749,000 92,700 $967,700 Items in the fact situation which were not used to determine the answer to (a) above are as follows: 1. Interest imputed on common stock financing is not permitted by GAAP and thus does not appear in any financial statement. 2. Land site number 623, which was acquired for $650,000, should be included in Reagan’s balance sheet as land held for resale (investment section). 3. Royalty payments of $17,500 should be included as a normal operating expense in Reagan’s income statement. PROBLEM 10-2 (a) LOBO CORPORATION Analysis of Land Account 2010 Balance at January 1, 2010............................................... Plant facility acquired from Mendota Company— portion of fair value allocated to land (Schedule 1).................................................................... Balance at December 31, 2010......................................... LOBO CORPORATION Analysis of Land Improvements Account 2010 Balance at January 1, 2010............................................. Parking lots, streets, and sidewalks.............................. Balance at December 31, 2010........................................ LOBO CORPORATION Analysis of Buildings Account 2010 Balance at January 1, 2010............................................. Plant facility acquired from Mendota Company— portion of fair value allocated to building (Schedule 1)................................................................... Balance at December 31, 2010........................................ $1,100,000 $140,000 95,000 $235,000 $300,000 185,000 $485,000 555,000 $1,655,000 PROBLEM 10-2 (Continued) LOBO CORPORATION Analysis of Machinery and Equipment Account 2010 Balance at January 1, 2010............................... Cost of new machinery and equipment acquired Invoice price.............................................. Freight and unloading costs................... Sales taxes................................................ Installation costs...................................... $ 960,000 $400,000 13,000 20,000 26,000 459,000 $1,419,000 Deduct cost of machines disposed of Machine scrapped June 30, 2010.......... Machine sold July 1, 2010...................... Balance at December 31, 2010........................ $ 80,000* 44,000* 124,000 $1,295,000 *The accumulated depreciation account can be ignored for this part of the problem. PROBLEM 10-2 (Continued) Schedule 1 Computation of Fair Value of Plant Facility Acquired from Mendota Company and Allocation to Land and Building 20,000 shares of Lobo common stock at $37 quoted market price on date of exchange (20,000 X $37) Allocation to land and building accounts in proportion to appraised values at the exchange date: Percentage of total 25 75 100 $185,000 555,000 $740,000 $740,000 Amount Land Building Total Land Building Total (b) $230,000 690,000 $920,000 ($740,000 X 25%) ($740,000 X 75%) Items in the fact situation that were not used to determine the answer to (a) above, are as follows: 1. The tract of land, which was acquired for $150,000 as a potential future building site, should be included in Lobo’s balance sheet as an investment in land. The $110,000 and $320,000 book values respective to the land and building carried on Mendota’s books at the exchange date are not used by Lobo. The $12,080 loss (Schedule 2) incurred on the scrapping of a machine on June 30, 2010, should be included in the other expenses and losses section in Lobo’s income statement. The $67,920 accumulated depreciation (Schedule 3) should be deducted from the Accumulated Depreciation—Machinery and Equipment account in Lobo’s balance sheet. 2. 3. PROBLEM 10-2 (Continued) 4. The $3,000 loss on sale of a machine on July 1, 2010 (Schedule 4) should be included in the other expenses and losses section of Lobo’s income statement. The $21,000 accumulated depreciation (Schedule 4) should be deducted from the Accumulated Depreciation—Machinery and Equipment account in Lobo’s balance sheet. Schedule 2 Loss on Scrapping of Machine June 30, 2010 Cost, January 1, 2002...................................................................... Accumulated depreciation (double-declining-balance method, 10-year life) January 1, 2002, to June 30, 2010 (Schedule 3)................................................................................. Asset book value June 30, 2010 Loss on scrapping of machine....................................................... $80,000 67,920 $12,080 $12,080 PROBLEM 10-2 (Continued) Schedule 3 Accumulated Depreciation Using Double-Declining-Balance Method June 30, 2010 (Double-declining-balance rate is 20%) Book Value at Beginning of Year $80,000 64,000 51,200 40,960 32,768 26,214 20,971 16,777 13,422 Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 (6 months) Depreciation Expense $16,000 12,800 10,240 8,192 6,554 5,243 4,194 3,355 1,342 Accumulated Depreciation $16,000 28,800 39,040 47,232 53,786 59,029 63,223 66,578 67,920 Schedule 4 Loss on Sale of Machine July 1, 2010 Cost, January 1, 2007................................................................. Depreciation (straight-line method, salvage value of $2,000, 7-year life) January 1, 2007, to July 1, 2010 [31/2 years ($44,000 – $2,000) ÷ 7]...................... Asset book value July 1, 2010................................................... Asset book value........................................................................ Proceeds from sale..................................................................... Loss on sale................................................................................ $44,000 (21,000) $23,000 $23,000 (20,000) $ 3,000 PROBLEM 10-3 (a) 1. Land (Schedule A)............................................... Building (Schedule B)......................................... Insurance Expense (6 months X $95)................ Prepaid Insurance (16 months X $95)............... Organization Expense......................................... Retained Earnings............................................... Salary Expense.................................................... Land and Building...................................... Additional Paid-in Capital (800 shares X $17)................................... Schedule A Amount Consists of: Acquisition Cost ($80,000 + [800 X $117]).......................... Removal of Old Building........................... Legal Fees (Examination of title).............. Special Tax Assessment........................... Total....................................................... Schedule B Amount Consists of: Legal Fees (Construction contract)......... Construction Costs (First payment)......... Construction Costs (Second payment). . . Insurance (2 months) ([2,280 ÷ 24] = $95 X 2 = $190)................ Plant Superintendent’s Salary.................. Construction Costs (Final payment)........ Total....................................................... 2. Land and Building............................................... Depreciation Expense................................ Accumulated Depreciation—Building...... 188,700 136,250 570 1,520 610 53,800 32,100 399,950 13,600 $173,600 9,800 1,300 4,000 $188,700 $ 1,860 60,000 40,000 190 4,200 30,000 $136,250 4,000 2,637 1,363 PROBLEM 10-3 (Continued) Schedule C Depreciation taken................................ Depreciation that should be taken (1% X $136,250).................................. Depreciation adjustment...................... (b) Plant, Property, and Equipment: Land................................................................. .......................................................................... Building........................................................... Less: Accumulated depreciation................. Total........................................................ $ 4,000 (1,363) $ 2,637 $188,700 $136,250 1,363 134,887 $323,587 PROBLEM 10-4 The following accounting treatment appears appropriate for these items: Land—The loss on the condemnation of the land of $9,000 ($40,000 – $31,000) should be reported as an extraordinary item on the income statement. If condemnations are either usual or recurring, then an ordinary or unusual classification is more appropriate. The $35,000 land purchase has no income statement effect. Building—There is no recognized gain or loss on the demolition of the building. The entire purchase cost ($15,000), decreased by the demolition proceeds ($3,600), is allocated to land. Warehouse—The gain on the destruction of the warehouse should be reported as an extraordinary item, assuming that it is unusual and infrequent. The gain is computed as follows: Insurance proceeds...................................... Deduct: Cost............................................... Less: Accumulated depreciation......... Realized gain................................................. $74,000 $70,000 16,000 54,000 $20,000 Some contend that a portion of this gain should be deferred because the proceeds are reinvested in similar assets. We do not believe such an approach should be permitted. Deferral of the gain in this situation is not permitted under GAAP. Machine—The recognized gain on the transaction would be computed as follows: Fair market value of old machine................. Deduct: Book value of old machine Cost............................................................ Less: Accumulated depreciation........... Total gain......................................................... Total gain recognized = $2,000 X $7,200 $8,000 2,800 5,200 $2,000 $900 = $250 $900 + $6,300 The gain deferred is $1,750 ($2,000 – $250) PROBLEM 10-4 (Continued) This gain would probably be reported in other revenues and gains. It might be reported as an unusual item if the company believes that such a situa tion occurs infrequently and if material. The cost of the new machine would be capitalized at $4,550. Fair value of new machine.............................................. Less: Gain deferred ($2,000 – $250)............................. Cost of new machine...................................................... $6,300 1,750 $4,550 Furniture—The contribution of the furniture would be reported as a contribution expense of $3,100 with a related gain on disposition of furniture of $950: $3,100 – ($10,000 – $7,850). The contribution expense and the related gain may be netted, if desired. Automobile—The loss on sale of the automobile of $2,580: [$2,960 – ($9,000 – $3,460)] should probably be reported in the other expenses or losses section. It might be reported as an unusual item if the company believes that such a situation occurs infrequently. PROBLEM 10-5 (a) BLAIR CORPORATION Cost of Land (Site #101) As of September 30, 2011 Cost of land and old building...................................... Real estate broker’s commission............................... Legal fees...................................................................... Title insurance.............................................................. Removal of old building............................................... Cost of land.............................................................. $500,000 36,000 6,000 18,000 54,000 $614,000 (b) BLAIR CORPORATION Cost of Building As of September 30, 2011 Fixed construction contract price............................... Plans, specifications, and blueprints......................... Architects’ fees............................................................. Interest capitalized during 2010 (Schedule 1)........... Interest capitalized during 2011 (Schedule 2)........... Cost of building........................................................ $3,000,000 21,000 82,000 130,000 190,000 $3,423,000 Schedule 1 Interest Capitalized During 2010 and 2011 Weighted-average accumulated construction expenditures 2010: 2011: $1,300,000 $1,900,000 X X X Interest rate 10% 10% = = = Interest to be capitalized $130,000 $190,000 PROBLEM 10-6 INTEREST CAPITALIZATION Balance in the Land Account Purchase Price........................................................................ Surveying Costs...................................................................... Title Insurance Policy............................................................. Demolition Costs.................................................................... Salvage..................................................................................... Total Land Cost................................................................. $139,000 2,000 4,000 3,000 (1,000) $147,000 Expenditures (2010) Date 1-Dec 1-Dec 1-Dec Amount $147,000 30,000 3,000 $180,000 Fraction 1/12 1/12 1/12 Weighted—Average Accumulated Expenditures $12,250 2,500 250 $15,000 Interest Capitalized for 2010 Weighted—Average Accumulated Expenditures $15,000 Interest Rate 8% Amount Capitalizable $1,200 Interest charged to Interest Expense [($600,000 X .08 X 1/12) – $1,200] $2,800 PROBLEM 10-6 (Continued) Expenditures (2011) Date Amount 1-Jan 1-Jan 1-Mar 1-May 1-Jul $180,000 1,200 240,000 330,000 60,000 $811,200 Weighted Expenditure $ 90,000 600 80,000 55,000 0 $225,600 Fraction 6/12 6/12 4/12 2/12 0 Interest Capitalized for 2011 WeightedAverage Expenditure $225,600 Interest Rate 8% Amount Capitalizable $18,048 Interest charged to Interest Expense [($600,000 X .08) – $18,048] (a) (b) (c) $29,952 147,000 34,200* 682,248** 2,800 29,952 Balance in Land Account—2010 and 2011........ Balance in Building—2010................................... Balance in Building—2011................................... Balance in Interest Expense—2010.................... Balance in Interest Expense—2011.................... *$30,000 + $3,000 + $1,200 **$34,200 + $240,000 + $330,000 + $60,000 + $18,048 PROBLEM 10-7 (a) Computation of Weighted-Average Accumulated Expenditures Expenditures Date July 30, 2010 January 30, 2011 May 30, 2011 Amount $ 900,000 1,500,000 1,600,000 $4,000,000 Capitalization Weighted-Average X Period = Accumulated Expenditures 10/12 4/12 0 $ 750,000 500,000 0 $1,250,000 (b) Weighted-Average Accumulated Expenditures $1,250,000 Weighted-Average Interest Rate X 11.2%* = Avoidable interest $140,000 Loans Outstanding During Construction Period Principal *10% five-year note 12% ten-year bond $2,000,000 3,000,000 $5,000,000 $560,000 $5,000,000 Actual Interest $200,000 360,000 $560,000 Total interest Total principal (c) (1) and (2) = = 11.2% (weighted-average rate) Total actual interest cost Total interest capitalized Total interest expensed $560,000 $140,000 $420,000 PROBLEM 10-8 1. Holyfield Corporation Cash........................................................................ ................................................................................. Machinery............................................................... Accumulated Depreciation................................... Loss on Disposal of Machinery............................ Machinery....................................................... *Computation of loss: Book value Fair value Loss $100,000 (92,000) $ 8,000 23,000 69,000 60,000 8,000* 160,000 Dorsett Company Machinery............................................................... Accumulated Depreciation................................... Loss on Disposal of Machinery............................ Cash................................................................ Machinery....................................................... *Computation of loss: Book value Fair value Loss 2. $ 75,000 (69,000) $ 6,000 92,000 45,000 6,000* 23,000 120,000 Holyfield Corporation Machinery............................................................... Accumulated Depreciation................................... Loss on Disposal of Machinery............................ Machinery....................................................... Winston Company Machinery ($92,000 – $11,000).............................. Accumulated Depreciation................................... Machinery....................................................... *Computation of gain deferred: Fair value $92,000 Book value (81,000) 92,000 60,000 8,000 160,000 81,000* 71,000 152,000 Gain deferred PROBLEM 10-8 (Continued) 3. $11,000 Holyfield Corporation Machinery.............................................................. Accumulated Depreciation.................................. Loss on Disposal of machinery.......................... Machinery...................................................... Cash............................................................... Liston Company Machinery.............................................................. Accumulated Depreciation.................................. Cash....................................................................... Machinery...................................................... Gain on Disposal of Machinery................... *Fair value Book value Gain $ 95,000 (85,000) $ 10,000 95,000 60,000 8,000 160,000 3,000 92,000 75,000 3,000 160,000 10,000* Because the exchange has commercial substance, the entire gain should be recognized. 4. Holyfield Corporation Machinery.............................................................. Accumulated Depreciation.................................. Loss on Disposal of machinery.......................... Machinery...................................................... Cash............................................................... Greeley Company Cash....................................................................... Used Machine Inventory...................................... Sales.............................................................. Cost of Goods Sold.............................................. Inventory........................................................ 185,000 60,000 8,000 160,000 93,000 93,000 92,000 185,000 130,000 130,000 PROBLEM 10-9 (a) Exchange has commercial substance: Hyde, Inc.’s Books Asset B.................................................................. Accumulated Depreciation—Asset A................. Asset A......................................................... Gain on Disposal of Plant Assets ($60,000 – [$96,000 – $40,000])............... Cash.............................................................. Wiggins, Inc.’s Books Cash....................................................................... ................................................................................ Asset A.................................................................. Accumulated Depreciation—Asset B................. Asset B......................................................... Gain on Disposal of Plant Assets ($75,000 – [$110,000 – $47,000])............. 15,000 60,000 47,000 110,000 12,000 75,000 40,000 96,000 4,000 15,000 (b) Exchange lacks commercial substance: Hyde, Inc.’s Books Asset B ($75,000 – $4,000)................................... Accumulated Depreciation—Asset A................. Asset A......................................................... Cash.............................................................. *Computation of gain deferred: Fair value Book value Gain deferred 71,000* 40,000 96,000 15,000 $60,000 (56,000) $ 4,000 PROBLEM 10-9 (Continued) Wiggins, Inc.’s Books Cash....................................................................... Asset A.................................................................. Accumulated Depreciation—Asset B................. Asset B.......................................................... Gain on Disposal of Plant Assets............... Computation of total gain: Fair value of Asset B Book value of Asset B Total gain 15,000 50,400** 47,000 110,000 2,400* $75,000 (63,000) $12,000 *Gain recognized = $15,000 X $12,000 = $2,400 $15,000 + $60,000 $60,000 9,600 $50,400 **Fair value of asset acquired Less: Gain deferred ($12,000 – $2,400) Basis of Asset A OR Book value of Asset B Portion of book value sold $63,000 (12,600) $50,400 Note to instructor: This illustrates the exception to no gain or loss recognition for exchanges that lack commercial substance. Although it would be rare for an exchange to lack commercial substance when cash is received, a gain can be recognized based on the proportion of cash received to the overall fair value. PROBLEM 10-10 (a) Has Commercial Substance Marshall Construction 1. Equipment ($82,000 + $118,000).................... 200,000 Accumulated Depreciation—Equipment....... 50,000 Loss on Disposal of Plant Assets.................. 8,000* Equipment............................................... Cash......................................................... *Computation of loss: Book value of old crane ($140,000 – $50,000) $90,000 Fair value of old crane 82,000 Loss on disposal of plant assets $ 8,000 2. Brigham Manufacturing Cash.................................................................. ........................................................................... Equipment Inventory....................................... Sales........................................................ Cost of Goods Sold......................................... Equipment Inventory.............................. (b) 118,000 82,000 200,000 165,000 165,000 140,000 118,000 Lacks Commercial Substance 1. Marshall Construction should record the same entry as in part (a) above, since the exchange resulted in a loss. 2. Brigham should record the same entry as in part (a) above. No gain is deferred because we are assuming that Marshall is a customer. In addition, because the cash involved is greater than 25% of the value of the exchange, the entire transaction is considered a monetary transaction and a gain is recognized. Has Commercial Substance Marshall Construction 1. Equipment ($98,000 + $102,000).................... 200,000 Accumulated Depreciation—Equipment....... 50,000 Equipment............................................... Cash......................................................... Gain on Disposal of Plant Assets......... *Computation of gain: Book value of old crane ($140,000 – $50,000) $90,000 (c) 140,000 102,000 8,000* Fair value of old crane Gain on disposal of plant assets 98,000 $ 8,000 PROBLEM 10-10 (Continued) 2. Brigham Manufacturing Cash................................................................ 102,000 ......................................................................... Equipment Inventory..................................... 98,000 Sales...................................................... Cost of Goods Sold....................................... Equipment Inventory........................... (d) 1. Marshall Construction Equipment...................................................... Accumulated Depreciation—Equipment.... Cash....................................................... Equipment............................................. Gain on Disposal of Plant Assets....... 165,000 165,000 200,000 200,000 50,000 103,000 140,000 7,000* *[Fair Value–Old ($97,000) – Book Value–Old ($90,000)] Note: Cash involved is greater than 25% of the value of the exchange, so the gain is not deferred. Brigham Manufacturing Cash................................................................ 103,000 ......................................................................... Equipment Inventory..................................... 97,000 Sales...................................................... Cost of Goods Sold....................................... Equipment Inventory........................... Same reasons as cited in (b) (2) on the previous pages. Note: Even though the exchange lacks commercial substance, cash paid exceeds 25% of total fair value so the transaction is treated as a monetary exchange and recorded at fair value. Note that with this much cash involved, it is unlikely that the exchange would lack commercial substance. 165,000 165,000 2. 200,000 PROBLEM 10-11 (a) The major characteristics of plant assets, such as land, buildings, and equipment, that differentiate them from other types of assets are presented below. 1. Plant assets are acquired for use in the regular operations of the enterprise and are not for resale. 2. Property, plant, and equipment possess physical substance or existence and are thus differentiated from intangible assets such as patents and goodwill. Unlike other assets that possess physical substance (i.e., raw material), property, plant, and equipment do not physically become part of the product held for resale. 3. These assets are durable and long-term in nature and are usually subject to depreciation. Transaction 1. To properly reflect cost, assets purchased on deferred payment contracts should be accounted for at the present value of the consideration exchanged between the contracting parties at the date of the consideration. When no interest rate is stated, interest must be imputed at a rate that approximates the rate that would be negotiated in an arm’s-length transaction. In addition, all costs necessary to ready the asset for its intended use are considered to be costs of the asset. Asset cost = Present value of the note + Freight + Installation = $28,000 X 3.17 + $425 + $500 4 (b) = $22,190 + 925 = $23,115 PROBLEM 10-11 (Continued) Transaction 2. The lump-sum purchase of a group of assets should be accounted for by allocating the total cost among the various assets on the basis of their relative fair market values. The $8,000 of interest expense incurred for financing the purchase is a period cost and is not a factor in determining asset cost. Inventory $220,000 X ($ 50,000/$250,000) = $44,000 Land $220,000 X ($ 80,000/$250,000) = $70,400 Building $220,000 X ($120,000/$250,000) = $105,600 Transaction 3. The cost of a nonmonetary asset acquired in an exchange that has commercial substance should be recorded at the fair value of the asset given up plus any cash paid. Furthermore, any gain on the exchange is also recognized. Fair value of trucks............................................. Cash paid............................................................. Cost of land.......................................................... (c) 1. $46,000 19,000 $65,000 2. 3. A building purchased for speculative purposes is not a plant asset as it is not being used in normal operations. The building is more appropriately classified as an investment. The two-year insurance policy covering plant equipment is not a plant asset as it is not long-term in nature, not subject to depreciation, and has no physical substance. This policy is more appropriately classified as a current asset (prepaid insurance). The rights for the exclusive use of a process used in the manufacture of ballet shoes are not plant assets as they have no physical substance. The rights should be classified as an intangible asset. ...
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This note was uploaded on 03/21/2011 for the course ACCOUNTING 620 taught by Professor Kathy during the Spring '11 term at Southern University at New Orleans .

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