Exercises: Chapter 7

SHORT-ANSWER QUESTIONS, EXERCISES, AND PROBLEMS

Questions ➢  What is the main distinction between inventory and a plant asset?

➢  Which of the following items are properly classifiable as plant assets on the balance sheet?

➢  Advertising that will appear in the future to inform the public about new energy-saving programs at a manufacturing plant.

➢  A truck acquired by a manufacturing company to be used to deliver the company’s products to wholesalers.

➢  An automobile acquired by an insurance company to be used by one of its salespersons.

➢  Adding machines acquired by an office supply company to be sold to customers.

➢  The cost of constructing and paving a driveway that has an estimated useful life of 10 years.

➢  In general terms, what does the cost of a plant asset include?

➢  In what way does the purchase of a plant asset resemble the prepayment of an expense?

➢  Brown Company purchased an old farm with a vacant building as a factory site for $ 1,040,000. Brown decided to use the building in its operations. How should Brown allocate the purchase price between the land and the building? How should this purchase be handled if the building is to be torn down?

➢  Describe how a company may determine the cost of a self-constructed asset.

➢  In any exchange of noncash assets, the accountant’s task is to find the most appropriate valuation for the asset received. What is the general rule for determining the most appropriate valuation in such a situation?

➢  Why should periodic depreciation be recorded on all plant assets except land?

➢  Define the terms inadequacy and obsolescence as used in accounting for depreciable plant assets.

➢  What four factors must be known to compute depreciation on a plant asset? How objective is the calculation of depreciation?

➢  A friend, Mindy Jacobs, tells you her car depreciated $ 5,000 last year. Explain whether her concept of depreciation is the same as the accountant’s concept.

➢  What does the term accelerated depreciation mean? Give an example showing how depreciation is accelerated.

➢  Provide a theoretical reason to support using an accelerated depreciation method.

➢  Nancy Company purchased a machine that originally had an estimated eight years of useful life. At the end of the third year, Nancy determined that the machine would last only three more years. Does this revision affect past depreciation taken?

➢  What does the balance in the accumulated depreciation account represent? Does this balance represent cash that can be used to replace the related plant asset when it is completely depreciated?

➢  What is the justification for reporting plant assets on the balance sheet at undepreciated cost (book value) rather than market value?

➢  Distinguish between capital expenditures and revenue expenditures.

➢  For each of the following, state whether the expenditure made should be charged to an expense, an asset, or an accumulated depreciation account:

➢  Cost of installing air-conditioning equipment in a building that was not air-conditioned.

➢  Painting of an owned factory building every other year.

➢  Cost of replacing the roof on a 10-year-old building that was purchased new and has an estimated total life of 40 years. The expenditure did not extend the life of the asset beyond the original estimate.

➢  Cost of repairing an electric motor. The expenditure extended the estimated useful life beyond the original estimate.

➢  Indicate which type of account (asset, accumulated depreciation, or expense) would be debited for each of the following expenditures:

➢  Painting an office building at a cost of $ 1,000. The building is painted every year.

➢  Adding on a new plant wing at a cost of $ 24,000,000.

➢  Expanding a paved parking lot at a cost of $ 144,000.

➢  Replacing a stairway with an escalator at a cost of $ 20,000.

➢  Replacing the transmission in an automobile at a cost of $ 1,600, thus extending its useful life two years beyond the original estimate.

➢  Replacing a broken fan belt at a cost of $ 600.

➢  How do subsidiary records provide control over a company’s plant assets?

➢  What advantages can accrue to a company that maintains plant asset subsidiary records?

➢  Real world question Based on the financial statements and the notes to those statements of The Limited, Inc., contained in the Annual report appendix, what was the 2000 ending net property and equipment balance? Did the company acquire any of these assets in 2000? What depreciation method did the company use?

Exercises Exercise A Stephon Company paid $ 640,000 cash for a tract of land on which it plans to erect a new warehouse, and paid $ 8,000 in legal fees related to the purchase. Stephon also agreed to assume responsibility for $ 25,600 of unpaid taxes on the property. The company incurred a cost of $ 28,800 to remove an old apartment building from the land. Prepare a schedule showing the cost of the land acquired.

Exercise B Laural Company paid $ 840,000 cash for real property consisting of a tract of land and a building. The company intended to remodel and use the old building. To allocate the cost of the property acquired, Laural had the property appraised. The appraised values were as follows: land, $ 576,000, and office building, $ 384,000. The cost of clearing the land was $ 18,000. The building was remodeled at a cost of $ 76,800. The cost of a new identical office building was estimated to be $ 432,000. Prepare a schedule showing the cost of the assets acquired.

Exercise C Fine Company purchased a heavy machine to be used in its factory for $ 720,000, less a 2 per cent cash discount. The company paid a fine of $ 3,600 because an employee hauled the machine over city streets without securing the required permits. The machine was installed at a cost of $ 21,600, and testing costs of $ 7,200 were incurred to place the machine in operation. Prepare a schedule showing the recorded cost of the machine.

Exercise D A machine is acquired in exchange for 50 shares of Marley Corporation capital stock. The stock recently traded at $ 400 per share. The machine cost $ 30,000 three years ago. At what amount should the machine be recorded?

Exercise E Keely Company purchased some office furniture for $ 29,760 cash on 2009 March 1. It also paid $ 480 cash for freight costs incurred. The furniture is being depreciated over four years under the straight-line method, assuming a salvage value of $ 1,440. The company employs a calendar-year accounting period. On 2010 July 1, it spent $ 192 to refinish the furniture. Prepare journal entries for the Keely Company to record all of the data, including the annual depreciation adjustments through 2010.

Exercise F On 2009 January 2, a new machine was acquired for $ 900,000. The machine has an estimated salvage value of $ 100,000 and an estimated useful life of 10 years. The machine is expected to produce a total of 500,000 units of product throughout its useful life. Compute depreciation for 2009 and 2010 using each of the following methods:

  1. Straight line.
  2. Units of production (assume 30,000 and 60,000 units were produced in 2009 and 2010, respectively).
  3. Double-declining balance.


Exercise G Terrill Company finds its records are incomplete concerning a piece of machinery used in its plant. According to the company records, the machinery has an estimated useful life of 10 years and an estimated salvage value of $ 24,000. It has recorded $ 12,000 in depreciation each year using the straight-line method. If the accumulated depreciation account shows a balance of $ 72,000, what is the original cost of the machinery and how many years remain to be depreciated?

Exercise H Katherine Company purchased a machine on 2009 April 1, for $ 72,000. The machine has an estimated useful life of five years with no expected salvage value. The company’s accounting year ends on December 31.

Compute the depreciation expense for 2009 and 2010 under the double-declining-balance method.

Exercise I Australia Company purchased a machine for $ 3,200 and incurred installation costs of $ 800. The estimated salvage value of the machine is $ 200. The machine has an estimated useful life of four years. Compute the annual depreciation charges for this machine under the double-declining-balance method.

Exercise J Regal Company acquired a delivery truck on 2009 January 2, for $ 107,200. The truck had an estimated salvage value of $ 4,800 and an estimated useful life of eight years. At the beginning of 2009, a revised estimate shows that the truck has a remaining useful life of six years. The estimated salvage value changed to $ 1,600.

Compute the depreciation charge for 2009 and the revised depreciation charge for 2009 using the straight-line method.

Exercise K Assume that the truck described in the previous exercise was used 40 per cent of the time in 2010 to haul materials used in the construction of a building by Regal Company for its own use. (Remember that 2010 is before the revision was made on estimated life.) During the remaining time, Regal used the truck to deliver merchandise to its customers.

Prepare the journal entry to record straight-line depreciation on the truck for 2010.

Exercise L Vineland Company purchased a computer for $ 60,000 and placed it in operation on 2008 January 2. Depreciation was recorded for 2008 and 2009 using the straight-line method, a six-year life, and an expected salvage value of $ 2,400. The introduction of a new model of this computer in 2010 caused the company to revise its estimate of useful life to a total of four years and to reduce the estimated salvage value to zero.

Compute the depreciation expense on the computer for 2010.

Exercise M On 2009 January 2, a company purchased and placed in operation a new machine at a total cost of $ 60,000. Depreciation was recorded on the machine for 2009 and 2010 under the straight-line method using an estimated useful life of five years and no expected salvage value. Early in 2011, the machine was overhauled at a cost of $ 20,000. The estimated useful life of the machine was revised upward to a total of seven years.

Compute the depreciation expense on the machine for 2011.

Exercise N Lasky Company purchased a machine on 2009 January 3, at a cost of $ 50,000. It debited freight and installation charges of $ 10,000 to Repairs Expense. It recorded straight-line depreciation on the machine in 2009 and 2010 using an estimated life of 10 years and no expected salvage value.

Compute the amount of the error in net income for 2009 and 2010, and state whether net income is understated or overstated.

Exercise O Bragg Company owns a plant asset that originally cost $ 240,000 in 2006 The asset has been depreciated for three years assuming an eight-year useful life and no salvage value. During 2009, Bragg incorrectly capitalized $ 120,000 in repairs on the plant asset rather than expensing them. Describe the impact of this error on the asset’s cost and Bragg’s net income over the next five years.

Problems Problem A Bolt Company purchased a machine for use in its operations that had an invoice price of $ 80,000 excluding sales tax. A 4 per cent sales tax was levied on the sale. Terms were net 30. The company estimated the total cost of hauling the machine from the dealer’s warehouse to the company’s plant at $ 5,600, which did not include a fine of $ 1,600 for failure to secure the necessary permits to use city streets in transporting the machine. In delivering the machine to its plant, a Bolt employee damaged the truck used; repairs cost $ 3,600. The machine was also slightly damaged with repair costs amounting to $ 1,600.

Bolt incurred installation costs of $ 32,000 that included the $ 4,000 cost of shoring up the floor under the machine. Testing costs amounted to $ 2,400. Safety guards were installed on the machine at a cost of $ 640, and the machine was placed in operation.

Prepare a schedule showing the amount at which the machine should be recorded in Bolt’s accounts.

Problem B Pressler Company planned to erect a new factory building and a new office building in Atlanta, Georgia, USA. A report on a suitable site showed an appraised value of $ 180,000 for land and orchard and $ 120,000 for a building.

After considerable negotiation, the company and the owner reached the following agreement: Pressler Company was to pay $ 216,000 in cash, assume a $ 90,000 mortgage note on the property, assume the interest of $ 1,920 accrued on the mortgage note, and assume unpaid property taxes of $ 13,200. Pressler Company paid $ 18,000 cash for brokerage and legal services in acquiring the property.

Shortly after acquisition of the property, Pressler Company sold the fruit on the trees for $ 2,640, remodeled the building into an office building at a cost of $ 38,400, and removed the trees from the land at a cost of $ 9,000. Construction of the factory building was to begin in a week.

Prepare schedules showing the proper valuation of the assets acquired by Pressler Company.

Problem C Timothy Company acquired and placed into use a heavy factory machine on 2009 October 1. The machine had an invoice price of $ 360,000, but the company received a 3 per cent cash discount by paying the bill on the date of acquisition. An employee of Timothy Company hauled the machine down a city street without a permit. As a result, the company had to pay a $ 1,500 fine. Installation and testing costs totaled $ 35,800. The machine is estimated to have a $ 35,000 salvage value and a seven-year useful life. (A fraction should be used for the DDB calculation rather than a percentage.)

  1. Prepare the journal entry to record the acquisition of the machine.
  2. Prepare the journal entry to record depreciation for 2009 under the double-declining balance method.
  3. Assume Timothy Company used the straight-line depreciation method. At the beginning of 2009, it estimated the machine will last another six years. Prepare the journal entry to record depreciation for 2009. The estimated salvage value would not change.


Problem D Peach Company has the following entries in its Building account:

Debits
2009
May   5 Cost of land and building purchased $200,000
          5 Broker fees incident to purchase of land and building 12,000
2010
Jan.  3 Contract price of new wing added to south end 84,000
        15 Cost of new machinery, estimated life 10 years 160,000
June 10 Real estate taxes for six months ended 2010/6/30 3,600
Aug. 10 Cost of building parking lot for employees in back of building 4,960
Sept. 6 Replacement of windows broken in August 160
Oct. 10 Repairs due to regular usage 2,240
Credits
2009
May 24 Transfer to Land account, per allocation of purchase cost
authorized in minutes of board of directors 32,000
2010
Jan. 5 Proceeds from leases of second floor for six months ended
2009/12/31 8,000
Peach acquired the original property on 2009 May 5. Orange immediately engaged a contractor to construct a new wing on the south end of the building. While the new wing was being constructed, the company leased the second floor as temporary warehouse space to Kellett Company. During this period (July 1 to 2009 December 31), the company installed new machinery costing $ 160,000 on the first floor of the building. Regular operations began on 2010 January 2.

  1. Compute the correct balance for the Buildings account as of 2010 December 31. The company employs a calendar-year accounting period.
  2. Prepare the necessary journal entries to correct the records of Peach Company at 2010 December 31. No depreciation entries are required.


Problem E Cardine Company acquired and placed into use equipment on 2009 January 2, at a cash cost of $ 935,000. Transportation charges amounted to $ 7,500, and installation and testing costs totaled $ 55,000.

The equipment was estimated to have a useful life of nine years and a salvage value of $ 37,500 at the end of its life. It was further estimated that the equipment would be used in the production of 1,920,000 units of product during its life. During 2009, 426,000 units of product were produced.

Compute the depreciation to the nearest dollar for the year ended December 31, using:

  1. Straight-line method.
  2. Units-of-production method.
  3. Double-declining-balance method (use a fraction rather than a percentage).


Problem F Goodrich Company purchased a machine on 2009 October 1 for $ 100,000. The machine has an estimated salvage value of $ 30,000 and an estimated useful life of eight years.

Compute to the nearest dollar the amount of depreciation Goodrich should record on the machine for the years ending 2009 December 31, and 2010, under each of the following methods:

  1. Straight-line.
  2. Double-declining-balance.


Alternate problems Alternate problem A Brite Company purchased a machine that had an invoice price of $ 400,000 excluding sales tax. Terms were net 30. A 4 per cent sales tax was levied on the sale. The company incurred and paid freight costs of $ 10,000. Special electrical connections were run to the machine at a cost of $ 14,000 and a special reinforced base for the machine was built at a cost of $ 18,000. The machine was dropped and damaged while being mounted on this base. Repairs cost $ 4,000. Raw materials with a cost of $ 1,000 were consumed in testing the machine. Safety guards were installed on the machine at a cost of $ 1,400, and the machine was placed in operation. In addition, $ 500 of costs were incurred in removing an old machine.

Prepare a schedule showing the amount at which the machine should be recorded in Brite Company’s account.

Alternate problem B Maxwell Company purchased 2 square miles of farmland under the following terms: $ 968,000 cash; and liability assumed on mortgage note of $ 320,000 and interest accrued on mortgage note assumed, $ 12,800. The company paid $ 67,200 of legal and brokerage fees and also paid $ 3,200 for a title search on the property.

The company planned to use the land as a site for a new office building and a new factory. Maxwell paid clearing and leveling costs of $ 28,800. It sold crops on the land for $ 7,360 and sold one of the houses on the property for $ 19,200. The other buildings were torn down at a cost of $ 14,400; sale of salvaged materials yielded cash proceeds of $ 13,600. Approximately 1 per cent of the land acquired was deeded to the county for roads. The cost of excavating a basement for the office building amounted to $ 9,120.

Prepare a schedule showing the amount at which the land should be carried on Maxwell Company’s books.

Alternate problem C Dawson Towing Company purchased a used panel truck for $ 28,800 cash. The next day the company’s name and business were painted on the truck at a total cost of $ 1,488. The truck was then given a minor overhaul at a cost of $ 192, and new “super” tires were mounted on the truck at a cost of $ 1,920, less a trade-in allowance of $ 240 for the old tires. The truck was placed in service on 2009 April 1, at which time it had an estimated useful life of five years and a salvage value of $ 3,360.

  1. Prepare a schedule showing the cost to be recorded for the truck.
  2. Prepare the journal entry to record depreciation at the end of the calendar-year accounting period, 2009 December 31. Use the double-declining-balance method.
  3. Assume that the straight-line depreciation method has been used. At the beginning of 2009 it is estimated the truck will last another four years. The estimated salvage value changed to $ 1,920. Prepare the entry to record depreciation for 2012.


Alternate problem D You are the new controller for Jayson Company, which began operations on 2009 October 1, after a start-up period that ran from the middle of 2008. While reviewing the accounts, you find an account entitled “Fixed Assets”, which contains the following items:

Cash paid to previous owner of land and old buildings $ 192,000
Cash given to construction company as partial payment for the new building 72,000
Legal and title search fees 2,400
Real estate commission 14,400
Cost of demolishing old building 16,800
Cost of leveling and grading 9,600
Architect’s fee (90% of building and 10% improvements) 6,000
Cost of excavating (digging) basement for new building 21,600
Cash paid to construction company for new building 288,000
Repair damage done by vandals 7,200
Sprinkler system for lawn 31,200
Lighting system for parking lot 40,800
Paving of parking lot 60,000
Net invoice price of machinery 1,152,000
Freight cost incurred on machinery 50,400
Installation and testing of machinery 19,200
Medical bill paid for employee injured in installing machinery 3,600
Landscaping (permanent) 38,400
Repair damage to building in installation of machinery 4,800
Special assessment paid to city for water mains and sewer line 45,600
Account balance $2,106,000
In addition, you discover that cash receipts of $ 1,200 from selling materials salvaged from the old building were credited to Miscellaneous Revenues in 2009. Digging deeper, you find that the plant manager spent all of his time for the first nine months of 2009 supervising installation of land improvements (10 per cent), building construction (40 per cent), and installation of machinery (50 per cent). The plant manager’s nine-month salary of $ 108,000 was debited to Officers’ Salaries Expense.

  1. List all items on a form containing columns for Land, Land Improvements, Building, and Machinery. Sort the items into the appropriate columns, omitting those items not properly included as an element of asset cost. Show negative amounts in parentheses. Total your columns.
  2. Prepare one compound journal entry to reclassify and adjust the accounts and to eliminate the Fixed Assets account. Do not attempt to record depreciation for the partial year.


Alternate problem E Land Company acquired and put into use a machine on 2009 January 1, at a cash cost of $ 120,000 and immediately spent $ 5,000 to install it. The machine had an estimated useful life of eight years and an estimated salvage value of $ 15,000 at the end of this time. It was further estimated that the machine would produce 500,000 units of product during its life. In the first year, the machine produced 100,000 units.

Prepare journal entries to record depreciation to the nearest dollar for 2009, using:

  1. Straight-line method.
  2. Units-of-production method.
  3. Double-declining-balance method.


Alternate problem F Crawford Company paid $ 60,000 for a machine on 2009 April 1, and placed it in use on that same date. The machine has an estimated life of 10 years and an estimated salvage value of $ 10,000.

Compute the amount of depreciation to the nearest dollar the company should record on this asset for the years ending 2009 December 31, and 2010, under each of the following methods:

  1. Straight-line.
  2. Double-declining-balance.


Beyond the numbers—Critical thinking

Business decision case A You are a new staff auditor assigned to audit Cray Company’s Buildings account. You determine that Cray Company made the following entries in its Buildings account in 2009:

Debits
2009
Jan.   2 Cost of land and old buildings purchased $ 720,000
          2 Legal fees incident to purchase 9,600
          2 Fee for title search 1,200
         12 Cost of demolishing old buildings on land 19,200
June 16 Cost of insurance during construction of new building 4,800
July   30 Payment to contractor on completion of new building 1,080,000
Aug.  5 Architect’s fees for design of new building 48,000
Sept. 15 City assessment for sewers and sidewalks (considered permanent) 16,800
Oct.   6 Cost of landscaping (considered permanent) 9,600
Nov.  1 Cost of driveways and parking lots 60,000
Credits
Jan. 15 Proceeds received upon sale of salvaged materials from old
buildings 4,800
In addition to the entries in the account, you obtained the following information in your interview with the accountant in charge of the Buildings account:

The company began using the new building on 2009 September 1. The building is estimated to have a 40-year useful life and no salvage value.

The company began using the driveways and parking lots on 2009 November 1. The driveways and parking lots have an estimated 10-year useful life and no salvage value.

The company uses the straight-line depreciation method to depreciate all of its plant assets.

Using all of this information, do the following:

  1. Prepare a schedule that shows the separate cost of land, buildings, and land improvements.
  2. Compute the amount of depreciation expense for 2009.
  3. Complete the journal entries required to correct the accounts at 2009 December 31. Assume that closing entries have not been made.
  4. Write a brief statement describing to management why depreciation must be recorded and how recording depreciation affects net income.


Business decision case B On 2010 October 1, Besler Company acquired and placed into use new equipment costing $ 504,000. The equipment has an estimated useful life of five years and an estimated salvage value of $ 24,000. Besler estimates that the equipment will produce 2 million units of product during its life. In the last quarter of 2010, the equipment produced 120,000 units of product. As the company’s accountant, management has asked you to do the following:

  1. Compute the depreciation for the last quarter of 2010, using each of the following methods:


Straight-line.

Units-of-production.

Double-declining-balance.

  1. Prepare a written report describing the conditions in which each of these four methods would be most appropriate.


Business decision case C The notes to the financial statements of Wolverine World Wide, Inc., in “A Broader Perspective”, stated that substantially all fixed assets are depreciated using the straight-line method. Explain why the straight-line method of depreciation may be appropriate for this company.

Business decision case D Discuss the meaning of rate of return on operating assets, its elements, and what it means to investors and management.

Calculate the rate of return on operating assets for The Limited in the Annual report appendix for the two most recent years. Assume all assets are operating assets. Comment on the results.

Annual report analysis E The following footnote excerpted from a recent annual report of Kerr-McGee Corporation describes the company’s accounting policies for property, plant, and equipment:

Property, plant, and equipment is depreciated over its estimated life by the unit-of-production or the straight-line-method.

  1. How many different depreciation methods are used by Kerr-McGee Corporation? Does this practice conform with generally accepted accounting principles?
  2. Discuss why management might select each of these methods to depreciate plant assets.


Group project F In a group of two or three students, visit a large company in your community and inquire about the subsidiary records it maintains to establish accounting control over its plant assets. Also inquire about physical controls used to protect its equipment that is movable, such as computers, copy machines, and so on. Write a report to your instructor summarizing your findings and be prepared to give a short report to your class.

Group project G With a team of two or three students, visit two companies in your community to inquire about why they use certain depreciation methods. Try to locate companies that use several depreciation methods in accounting for various depreciable fixed assets. Interview those who made the decision as to methods to use to find out the reasons for their choices. Write a report to your instructor summarizing your findings.

Group project H In a small group of students, visit a large company in your community to determine how it decides to account for expenditures on fixed assets made after the assets have been in use for some time. In other words, how does it decide whether to debit the asset account, the accumulated depreciation account, or an expense account? What role does materiality play in the decision? Evaluate the reasonableness of the decision model used. Write a report to your instructor summarizing your findings and be prepared to make a short presentation to your class.

Using the Internet—A view of the real world Visit the CPA Review site at:

http://www.beckerconviser.com Investigate this site. Identify the major types of employers. Make note of any interesting information at this site. Write a report to your instructor summarizing your findings. Be prepared to make a short presentation to the class.

Visit the Best Software website at:

http://www.bestsoftware.com What types of software does the company sell? Why might a company buy a software package from Best Software? Study any other aspect of the information that looks interesting. Write a report to your instructor summarizing your findings.

 1.     [1]Because depreciation expense is an estimate, calculations may be rounded to the nearest dollar.

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