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Solutions chapter11

# Solutions chapter11 - CHAPTER 11 QUESTIONS 1 Depreciation...

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CHAPTER 11 QUESTIONS 1. Depreciation refers to the cost allocation of tangible long-term assets; depletion refers to the cost allocation of natural resources; and amortization refers to the cost alloca- tion of intangible assets. All three terms have similar underlying principles governing their use. 2. Four separate factors must be considered in determining the periodic depreciation charges that should be made for a com- pany’s assets. They are (1) asset cost, (2) residual or salvage value, (3) useful life, and (4) pattern of use. These factors, when considered together, help determine which of the common methods is most appropri- ate for the circumstances. 3. Residual or salvage value is included in the formulas for all time-factor depreciation methods except for the declining-balance methods. In practice, residual value is often ignored if it is the practice of a company to retain assets for most of their useful lives. In the case of declining-balance methods, although residual value is not included in the formulas, it is considered when an as- set is near the end of its useful life. Gener- ally, the book value should not be reduced below its expected residual value. 4. Functional factors include inadequacy and obsolescence that reduce the usefulness of the asset. Physical factors include wear and tear, deterioration and decay, and damage or destruction reducing the useful- ness of the asset. 5. Time-factor methods of depreciation base cost allocation on time according to either straight-line or accelerated depreciation. In theory, the pattern selected should be related to the pattern of benefits expected from the asset. Because the pattern of be- nefits is very subjective, the selection of a specific time-factor method is usually an ar- bitrary decision. Use-factor methods of depreciation base cost allocation on some measure that relates more directly to the use of the as- set. Most commonly, the allocation is based on productive output or service hours. In theory, the use-factor methods provide a much better matching of costs against revenues than do time-factor meth- ods. However, because use-factor methods require more extensive accounting records, they are not as common as the time-factor methods. 6. With group depreciation , periodic depreci- ation expense is computed on a whole group of assets as if the group were one single asset. The weighted-average life of the group is used to determine how much of the aggregate asset cost should be de- preciated each year. No gains or losses are recognized at the time of the retirement of individual assets; accumulated depreciation is reduced for the difference between the asset cost and the cash retirement pro- ceeds. 7. The amount of an asset retirement obliga- tion is added to the cost of the associated asset. Accordingly, the asset retirement ob- ligation increases periodic depreciation. In addition, the amount of the asset retirement obligation itself increases each year as the time until the obligation must be satisfied decreases. However, this increase, which

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