Chapter 9 - Solution Manual

Assets are typically recorded at their acquisition

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Assets are typically recorded at their acquisition cost, which is in most cases objectively determinable. But cost assignments in other cases --"basket purchases" and the selection of an implicit interest rate in asset acquisition under deferred-payment plans--may be quite subjective involving considerable judgement. The salvage value is an estimate of an potentially realizable when the asset is retired from service. It is initially a judgment factor and is affected by the length of its useful life to the enterprise. The useful life is also a judgment factor. It involves selecting the "unit" of measure of service life and estimating the number of such units embodied in the asset. Such units may be measured in terms of time periods or in terms of activity (for example, years or machine hours). When selecting the life, one should select the lower (shorter) of the physical life or the economic life to this user. Physical life involves wear and tear and casualties; economic life involves such things as technological obsolescence and inadequacy.
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175 Selecting the depreciation method is generally a judgment decision; but, a method may be inherent in the definition adopted for the units of service life, as discussed earlier. For example, if such units are machine hours, the method is a function of the number of machine hours used during each period. A method should be selected that will best measure the portion of services expiring each period. Once a method is selected, it may be objectively applied by using a predetermined, objectively derived formula. d. Because revenue usually represents an inflow of funds, and expense usually represents an outflow of funds, net earnings represent a net inflow of funds. However, the revenues and expenses reported in the income statements are accrual-based, not cash-based measures. Hence, net income must be adjusted to measure the net cash flows from operations. Depreciation reduces reported net earnings but does not involve an outflow of cash. Therefore, it is added back to reported net earnings to calculate cash provided by operations. On a statement of cashflows, depreciation should be clearly shown as an adjustment to net earnings not requiring a use of cash rather than be shown as a source of cash. Depreciation is not a direct source of cash. It can be considered an indirect source only through income tax savings. Case 9-7 The following costs, if applicable, should be capitalized as a cost of land: a. (a) Negotiated purchase price (b) Brokers' commission (c) Legal fees (d) Title fees (e) Recording fee (f) Escrow fees (g) Surveying fees (h) Existing unpaid taxes, interest, or liens assumed by the buyer (i) Clearing, grading, landscaping and subdividing (j) Cost of removing old building (less salvage) (k) Special assessments such as lighting or sewers if they are permanent in nature.
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