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Chapter 9 - Solution Manual

C the options were purchased with full knowledge that

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c. The options were purchased with full knowledge that, after the relative advantages of the three locations were investigated, only one of the options would be exercised. Because the intent was to purchase only one of the three sites, the options should be viewed as an integrated plan for acquiring the site which was ultimately selected. Thus, the cost of all three options should be capitalized as a part of the cost of acquiring the selected site.
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174 Case 9-6 a. Relative to plant assets, a cost incurred or an expenditure made, that is assumed to benefit only the current accounting period is called a revenue expenditure and is charged to expense in the period believed to benefit. A capital expenditure is similarly a cost incurred or an expenditure made but is expected to yield benefits either in all future accounting periods (acquisition of land) or in a limited number of accounting periods. Capital expenditures (if material in amount) are capitalized, that is, recorded as assets, and, if related to assets of limited life, amortized over the periods believed to benefit. The distinction between capital and revenue expenditures is of significance because it involves the timing of the recognition of expense and, consequently, the determination of periodic earnings. It also affects the amounts reported as assets whose costs generally have to be recouped from future periods' revenues. If a revenue expenditure is improperly capitalized, current earnings are overstated, assets are overstated, and future earnings are understated for all the periods to which the improperly capitalized cost is amortized. If the cost is not amortized, future earnings will not be affected but assets and retained earnings will continue to be overstated for as long as the cost remains on the books. If a nonamortizable capital expenditure is improperly expensed, current earnings are understated and assets and retained earnings are understated for all periods for which unamortized cost should have remained in the accounting records. If an amortizable capital expenditure is improperly expensed, current earnings are understated, assets and retained earnings are understated, and future earnings are overstated for all periods to which the cost should have been amortized. b. Depreciation is the accounting process of allocating an asset's historical cost (recorded amount) to the accounting periods benefited by the use of the asset. It is a process of cost allocation, not valuation. Depreciation is not intended to provide funds for an asset's replacement; it is merely an application of the matching concept. c. The factors relevant in determining the annual depreciation for a depreciable asset are the initial recorded amount (cost), estimated salvage value, estimated useful life, and depreciation method.
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