ch10 - CHAPTER 10 DISCUSSION QUESTIONS 1 The major...

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CHAPTER 10 DISCUSSION QUESTIONS 1. The major characteristics of property, plant, and equipment are as follows: a. They are physical objects that can be seen and touched. b. They are used in operations to produce goods or provide services. c. They usually have a useful life of two or more years. 2. Money has a time value because money today can be invested and earn interest in the future. Because of this time value, pay- ments made in the future must be discoun- ted to their present values. For example, as- sume that a company that has $200 today has to pay that money for loan payments, $100 today and $100 in two years. The $100 that doesn’t have to be paid for two years can be invested to earn interest for two years. The amount it accumulates to, say, $120, is greater than the $100 that must be paid. Since the present value of the $120 is $100 today, the present value of the $100 to be paid in two years must be less than $100. 3. Any expenditure incurred in the process of bringing an asset to operating condition is considered to benefit the company over the asset’s useful life and therefore is treated as part of the asset’s cost. In addition to the purchase price, the cost of a capitalized as- set, such as a machine, might include sales tax, delivery charges, and setup costs. 4. When a leasing transaction has characterist- ics of a purchase, it will be treated in the same manner as the purchase of an asset if it meets criteria established by the account- ing profession for a capital lease. If the lease does not meet the criteria, it will be treated as a simple rental agreement (an op- erating lease). Under a capital lease, the leased assets are recorded and reported on the lessee’s balance sheet along with the re- lated liability to the lessor (owner of the property). The substance of a transaction, not its form, should determine the account- ing treatment. 5. Interest expense is included in the cost of the building (capitalized) because it is as much a cost of the building as is the cost of the materials. If the company had pur- chased the building from someone else, the price of the building would include interest paid by the company that constructed the building. Without borrowing the money and incurring interest expense, the building couldn’t be built. 6. The fair market values of the assets ac- quired are considered the best relative measure of future service potentials of the assets. Therefore, the cost of the assets purchased as a group is apportioned among them based on their relative fair values in or- der to recover the total cost over the eco- nomically useful lives of the assets acquired as a group. 7. Depreciation is an allocation of the cost of a building over its estimated useful life, not an estimate of the decline in value. Depreci- ation expense is recognized even though assets increase in value because the cost of assets must be expensed on the income statement. 8. An ordinary expenditure is one that benefits only the current period and does not in- crease an asset’s productive capacity or life. A capital expenditure is usually significant in amount and one that benefits future periods and increases the productive capacity or lengthens the life of the asset. 9. When in doubt, firms usually classify ex- penditures as ordinary rather than as capital expenditures. This is the conservative ap- proach and does not allow assets to be recorded at amounts that exceed their future economic benefits. 10. Assets should not be recorded on the finan- cial statements at amounts that exceed their market values. Therefore, impairments of asset value must be recognized as losses in the current period. 11. U.S. accountants do not write up asset amounts when their values increase for sev- eral reasons including the following: 91
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92 Chapter 10 a. In the United States, property, plant, and equipment assets are carried at cost , less accumulated depreciation. b. Not recognizing increases in value is the conservative approach, which is usually preferred in the United States. c. The amount of an increase in value can- not be known with certainty until the as- set is finally sold.
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