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Chapter 7 Problem Session Exercise




Problem I: Indicate whether each of the following statements is true (T) or false (F).

a. _F_ The cost of an intangible asset should be capitalized regardless of whether the intangible
asset was purchased or created internally by the company.

b. _T__ When more than one operating asset is purchased at the same time for a single cost, the
cost assigned to each asset should be allocated based on the relative fair market values of
the assets.

c. _T__ Land is not subject to depreciation but land improvements are.

d. _F__ The allocation of cost of a natural resource is called amortization.

e. _F__ All purchased intangible assets are subject to amortization.

f. _F__ The accounting definition of depreciation refers to the decrease in an operating assets
fair market value over its useful life.

g. _T__ The process of recording depreciation is an application of the matching principle.

h. _F__ The balance in the Accumulated Depreciation account should be reported on the income
statement.

i. _T__ As an asset is depreciated, its book value will decrease.

j. _T__ Regardless of the depreciation method used, the book value of a depreciable asset at the
end of its useful life should be equal to its residual (or salvage) value.

k. _T__ Regardless of the depreciation method used, the accumulated depreciation balance at the
end of an assets useful life should be equal to its depreciable cost which is calculated by
taking the difference between its cost and residual value.

l. _T__ The gain or loss on the disposal of a long-term asset can be determined by comparing the
assets book value to the amount it is sold for (ex. cash received).

m. _T__ All else being equal, if Wolfpack Company has a higher return on assets than Tarheel
Inc., Wolfpack is using its operating assets more effectively than Tarheel.

n. _T__ The return on assets ratio can be separated into two components, profit margin and asset
turnover, in order to provide a better analysis of what is driving the return on assets ratio.

o. _T__ A company may use a depreciation method for tax purposes different than what it uses for
financial statement purposes.
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Problem II: A local company purchased an industrial machine on January 1, 20X4. The machine was placed
into service on March 1, 20X4. Below are various costs incurred related to the machine that occurred either
before or after it was placed into service. For each of these costs, indicate by using a checkmark () whether
the cost should be capitalized as part of the assets cost or expensed in the period incurred. The chart
indicates when the costs were incurred.

In addition, in the column to the far right, indicate the name of the account which should be debited. The first
one has been one as an example.
Capitalized Expensed Account name to be debited
Costs Incurred Between January 1, 2014, and March 1, 2014,
Before the Asset was Placed into Service

1. base invoice price of $10,000 Machine
2. sales taxes Machine
3. insurance paid to cover a possible accident
loss while the machinery was in transit
Machine
4. shipping charges Machine
5. installation charges Machine
6. test run charges Machine
Costs Incurred Between March 1, 2014,
and the End of the Assets Useful Life

7. insurance paid to cover accidental loss while
the asset is being used over its useful life
Insurance Expense
8. ordinary repairs and maintenance costs Repairs and Maintenance Expense
9. extraordinary repair cost Machine
10. property taxes paid related to the machine Property Tax Expense

Problem III: On January 1, 20X4, Woodson Distributors Inc. purchased a machine costing $48,000. The
machine is estimated to have a residual value of $2,000 and a four year life.

A. In the following chart, compare how much depreciation expense should be recorded each year of the
assets life if the company uses the straight-line versus the double-declining balance depreciation (DDB)
method.

Straight-line Method DDB Method
Year 1 $11,500 $24,000
Year 2 $11,500 $12,000
Year 3 $11,500 $6,000
Year 4 $11,500 $4,000

Total over all four years $46,000 $46,000

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B. What do you notice about the total amount of depreciation taken over the entire life of the asset under
both methods?
The total depreciation is the same.

C. What do you notice about the pattern of depreciation taken over the entire life of the asset under both
methods?
The straight-line method results in an even pattern of depreciation. The DDB method is an accelerated
pattern resulting in more depreciation being taken in the assets earlier years than in its later years.

D. In 20X4 (year one), all else being equal, which method would yield the highest income before income
tax, highest income tax expense, and highest net income?
Straight-line

E. In 20X4 (year one), all else being equal, which method would yield the lowest income before income tax,
lowest income tax expense, and lowest net income?
DDB

F. If total income tax expense over the entire four years is the same, what is the advantage of having the
most tax savings in year one versus year four?
The advantage of having the tax savings in year one is due to the time value of money. The tax savings in
year one will allow the company to keep more of its cash in year one, which it could turn around and
invest for four years.

G. Assuming a calendar year-end, the journal entry to record depreciation expense at the end of 20X4 using
the straight-line method would be as follows:
Debit Credit
12/31/X4 Depreciation Expense 11,500
Acc. Dep. 11,500

H. If the company uses the straight-line method. What will be the balance in the Accumulated Depreciation
account at the end of 20X7? What will be the book value at the end of 20X7?
Depreciation balance will be $46,000 at the end of year four; therefore, the book value will be $2,000
(cost minus accumulated depreciation).

I. If the company uses the DDB method. What will be the balance in the Accumulated Depreciation
account at the end of 20X7? What will be the book value at the end of 20X7?
Depreciation balance will be $46,000 at the end of year four; therefore, the book value will be $2,000
(cost minus accumulated depreciation).

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J. If the asset had been placed into service on March 1, 20X4 instead, what would be the amount of
depreciation recorded for the year ending 12/31X4 under each of the methods?
We would need to do a partial-allocation of depreciation expense. If the asset were placed into service on
March 1, 20X4, only 10 months worth of depreciation should be taken in 20X4.
Straight-line method: $11,500 x 10/12 = $9,583.33
DDB method: $24,000 x 10/12 = $20,000