 CHAPTER 12 

Investments in Noncurrent
Operating Assets—Acquisition
MULTIPLE CHOICE QUESTIONS
Theory/Definitional Questions

1 Items included as part of land costs

2 Definition of intangible asset
3 Goodwill--no characteristic of exchangeability
4 Definition of goodwill in business combination
5 When goodwill should be recorded
6 Treatment of donated equipment
7 Treatment of a donated asset
8 Valuation of plant assets under deferred payment contract
9 Capitalization of interest
10 Capitalization of ordinary repairs--effect on balance sheet accounts
11 Items deducted from land costs
12 Items added to land cost
13 Treatment of donated asset
14 SFAS No. 34--capitalization of interest
15 Capitalization of interest
16 Capitalization of research and development costs
17 Treatment of research and development costs--immediate expense
18 Inclusion of lab building costs as research and development to be
capitalized
19 Example of betterment expenditure
20 Treatment of machine improvement--increases capacity 25 percent
21 Treatment of reinstallation costs
22 Capitalization of betterment and rearrangement expenditures
23 Recording noncurrent operating assets at fair value
24 Recording noncurrent operating assets at fair value

Computational Questions
25 Computation of recorded costs of factory building
26 Computation of costs assigned to land, buildings, and equipment
27 Computation of costs of three machines

201
202 Chapter 12  Investments in Noncurrent Operating
Assets

* 28 Computation of purchase price under deferred payment contract

29 Computation of carrying value of land
30 Computation of acquisition cost of machine
31 Computation of total intangible assets to be recorded on balance sheet
32 Computation of goodwill amount
33 Computation of goodwill amount
34 Computation of amount of capitalized interest
35 Computation of amount of capitalized interest
36 Computation of cost of assets not acquired for cash
37 Computation of cost of assets not acquired for cash
38 Computation of capitalized interest
39 Computation of capitalized interest
40 Computation of accumulated expenditures to capitalize interest
41 Computation of research and development expense
42 Computation of research and development expense
43 Computation of repair/maintenance expense
44 Computation of amount of improvements to be capitalized
45 Computation of goodwill amount
46 Computation of fixed asset turnover ratio

PROBLEMS
1 Determine cost of land and buildings
2 Determine appropriate amounts for land, warehouse, and office building
3 Record exchange of stock for machine
* 4 Determine acquisition costs of assets
5 Determine amount of capitalized interest
6 Record transactions for research and development, patents, etc.
7 Determine amount of goodwill to be reported
8 Record purchase of company--negative goodwill
9 Compute transaction effects on indirect cash flow statement
10 Record expenditures under successful efforts, full cost method
11 Interest capitalization--avoidable interest method
12 Interest capitalization--average accumulated expenditure method
13 Interest capitalization--avoidable interest method
14 Evaluating interest capitalization standards
15 Assets acquired by issuing stock to a related party
16 Comparing current assets and property accounts

*These questions and problems require the use of present value tables to solve.
MULTIPLE CHOICE QUESTIONS
a 1. Kramer Service Corporation bought a building lot to construct a new
corporate
LO1 office building. An older home on the building lot was razed immediately so
that the office building could be constructed. The cost of purchasing the
older home should be
a. recorded as part of the cost of the land.
b. written off as a loss in the year of purchase.
c. written off as an extraordinary item in the year of purchase.
d. recorded as part of the cost of the new building.

c 2. The term “intangible assets” is used in accounting to denote

LO1 a. current or noncurrent property items without physical characteristics.
b. assets with lesser economic significance because of the nature of such
assets.
c. properties without physical characteristics that have long-term effects on
a business enterprise.
d. such items as patents, copyrights, and claims against customers which
can be valued on a monetary basis.

c 3. Which of the following intangible assets does not have the characteristic of
LO1 exchangeability?
a. Patent
b. Copyright
c. Goodwill
d. Franchise

b 4. In a business combination, goodwill is defined as the excess of cost over

the
LO1 a. fair value of assets acquired.
b. fair value of assets acquired less the liabilities assumed.
c. book value of assets acquired less the liabilities assumed.
d. net book value of assets acquired.

c 5. Goodwill should be recorded in the accounting records only when

LO1 a. it is purchased from another company.
b. it can be established that a definite benefit or advantage has resulted to
a firm from some item such as a good name, capable staff, or reputation.
c. it is acquired through the purchase of another business entity.
d. a firm reports above normal earnings for five or more consecutive years.

203
 d 6. Donated equipment for which the fair value has been determined should be
LO2 recorded as a debit to the appropriate equipment account and a credit to
a. Other Income.
b. Retained Earnings.
c. Capital Stock.
d. Revenue or gain.

b 7. Lakepoint Company recently accepted a donation of land with a fair value

of
LO2 $200,000 from the city of Dale in return for a promise to build a plant in
Dale.
The entry that Lakepoint should use to record this land is:
a. Land............................................................................200,000
Gain from Receipt of
Donated Land.....................................................
200,000

b. Land............................................................................200,000
Gain from Receipt of
Donated Land.....................................................
200,000

c. Land............................................................................200,000
Unrealized Gain from Receipt
of Donated Land.................................................
200,000

d. Land............................................................................200,000
Retained Earnings..............................................
200,000

c 8. Nimbus Inc. purchased certain plant assets under a deferred payment

contract.
LO2 The agreement was to pay $30,000 per year for ten years. The plant
assets should be valued at
a. $300,000.
b. $300,000 plus imputed interest.
c. present value of $30,000 annuity for ten years at an imputed interest
rate.
d. future value of $30,000 annuity for ten years at an imputed interest rate.

a 9. An asset is being constructed for an enterprise’s own use. The asset has
been
LO2 financed with a specific new borrowing. The interest cost incurred during
the construction period as a result of expenditures for the asset is
 a. a part of the historical cost of acquiring the asset to be written off over
the estimated useful life of the asset.
b. interest expense in the construction period.
c. recorded as a deferred charge and amortized over the term of the
borrowing.
d. a part of the historical cost of acquiring the asset to be written off over
the term of the borrowing used to finance the construction of the asset.
d 10. If the cost of ordinary repairs is capitalized as an addition to the building
LO3 account during the current year,
a. net income for the current year will be understated.
b. stockholders’ equity at the end of the current year will be understated.
c. total assets at the end of the current year will not be affected.
d. total liabilities at the end of the current year will not be affected.

d 11. A company purchased land to be used as the site for the construction of a
LO1 plant. Timber was cut from the building site so that construction of the plant
could begin. The proceeds from the sale of the timber should be
a. classified as other income.
b. netted against the costs to clear the land and expensed as incurred.
c. deducted from the cost of the plant.
d. deducted from the cost of the land.

d 12. When a company purchases land with a building on it and immediately

tears
LO1 down the building so that the land can be used for the construction of a
plant, the costs incurred to tear down the building should be
a. amortized over the estimated time period between the tearing down of
the building and the completion of the plant.
b. expensed as incurred.
c. added to the cost of the plant.
d. added to the cost of the land.

b 13. A donated plant asset for which the fair value has been determined, and for
LO2 which incidental costs were incurred in acceptance of the asset, should be
recorded at an amount equal to its
a. incidental costs incurred.
b. fair value and incidental costs incurred.
c. book value on books of donor and incidental costs incurred.
d. book value on books of donor.

b 14. According to SFAS No. 34, “Capitalization of Interest Cost,” interest should
be
LO2 capitalized for assets that are
a. in use or ready for their intended use in the earnings activities of the
enterprise.
 b. being constructed or otherwise being produced as discrete projects for
an enterprise’s own use.
c. not being used in the earnings activities of the enterprise and that are
not undergoing the activities necessary to get them ready for use.
d. routinely produced but require an extended period of time and are used
in the earnings activities of the enterprise.

b 15. A company is constructing an asset for its own use. Construction began in
LO2 2001. The asset is being financed entirely with a specific new borrowing.
Construction expenditures were made in 2001 and 2002 at the end of each
quarter. The total amount of interest cost capitalized in 2002 should be
determined by applying the interest rate on the specific new borrowing to
the
a. total accumulated expenditures for the asset in 2002.
b. average accumulated expenditures for the asset in 2002.
c. average expenditures for the asset in 2002.
d. total expenditures for the asset in 2002.

b 16. Which of the following research and development related costs should be
LO3 capitalized and amortized over current and future periods?
a. Labor and material costs incurred in building a prototype model.
b. Cost of testing equipment that will also be used in another separate
research and development project scheduled to begin next year.
c. Administrative salaries allocated to research and development.
d. Research findings purchased from another company to aid a particular
research project currently in process.

d 17. Which of the following principles best describes the current method of
LO3 accounting for research and development costs?
a. Associating cause and effect
b. Systematic and rational allocation
c. Income tax minimization
d. Immediate recognition as an expense

b 18. If a company constructs a laboratory building to be used as a research and

LO3 development facility, the cost of the laboratory building is matched against
earnings as
a. research and development expense in the period(s) of construction.
b. depreciation deducted as part of research and development costs.
c. depreciation or immediate write-off depending on company policy.
d. an expense at such time as productive research and development has
been obtained from the facility.

d 19. When a company replaces an old asphalt roof on its plant with a new
LO3 fiberglass insulated roof, which of the following types of expenditure has
occurred?
 a. Ordinary repairs and maintenance
b. Addition
c. Rearrangement
d. Betterment

c 20. An improvement made to a machine increased its fair market value and its
LO3 production capacity by 25 percent without extending the machine’s useful
life. The cost of the improvement should be
a. expensed.
b. debited to Accumulated Depreciation.
c. capitalized in the machine account.
d. allocated between Accumulated Depreciation and the machine account.

d 21. A machine with an original estimated useful life of ten years is moved to
LO3 another location in the factory after it had been in service for three years.
The efficiency of the machine is increased for its remaining useful life. The
reinstallation costs should be capitalized if the remaining useful life of the
machine is
Five Years Ten Years
a. No No
b. No Yes
c. Yes No
d. Yes Yes

a 22. An expenditure subsequent to acquisition of assembly-line manufacturing

LO3 equipment benefits future periods. The expenditure should be capitalized if
it is a
Betterment Rearrangement
a. Yes Yes
b. Yes No
c. No Yes
d. No No

b 23. Which of the following concepts is often given as justification not to value
LO4 noncurrent operating assets at their current values?
a. The revenue principle
b. Verifiability
c. Relevance
d. Predictive value
 d 24. Which of the following is true?
LO4 a. The Financial Accounting Standards Board has never permitted the
disclosure of the fair values of noncurrent operating assets in the notes
to financial statements.
b. The SEC currently requires the disclosure of the fair values of
noncurrent operating assets in the notes to financial statements of
companies that are registered with the SEC.
c. The Financial Accounting Standards Board currently requires the
disclosure of the fair values of noncurrent operating assets in the notes
to the financial statements.
d. Disclosure of the fair values of noncurrent operating assets in the notes
to the financial statements is currently encouraged but not required by
the Financial Accounting Standards Board.

b 25. On February 12, Laker Company purchased a tract of land as a factory site
for
LO1 $175,000. An existing building on the property was razed and construction
was begun on a new factory building in March of the same year. Additional
data are available as follows:
Cost of razing old building..................................................... $ 35,000
Title insurance and legal fees to purchase land................... 12,500
Architect’s fees...................................................................... 42,500
New building construction cost............................................. 875,000

The recorded cost of the completed factory building should be

a. $910,000.
b. $917,500.
c. $930,000.
d. $952,500.

c 26. The Oscar Corporation acquired land, buildings, and equipment from a
LO2 bankrupt company at a lump-sum price of $180,000. At the time of
acquisition, Oscar paid $12,000 to have the assets appraised. The
appraisal disclosed the following values:
Land....................................................................................... $120,000
Buildings................................................................................ 80,000
Equipment.............................................................................. 40,000

What cost should be assigned to the land, buildings, and equipment,

respectively?
a. $64,000, $64,000, and $64,000
b. $90,000, $60,000, and $30,000
c. $96,000, $64,000, and $32,000
d. $120,000, $80,000, and $40,000
 d 27. Carter Company acquired three machines for $200,000 in a package deal.
LO2 The three assets together had a book value of $160,000 on the seller’s
books. An appraisal costing the purchaser $2,000 indicated that the three
machines had the following market values (book values are given in
parentheses):
Machine 1: $60,000 ($40,000)
Machine 2: $80,000 ($50,000)
Machine 3: $100,000 ($70,000)

The three assets should be individually recorded at a cost of (rounded to

the nearest dollar)
Machine 1 Machine 2 Machine 3
a. $40,000 $53,333 $66,667
b. $50,000 $62,500 $87,500
c. $40,000 $50,000 $70,000
d. $50,500 $67,333 $84,167

d 28. Peterson, Inc. purchased a machine under a deferred payment contract on

LO2 December 31, 2001. Under the terms of the contract, Peterson is required
to make eight annual payments of $140,000 each beginning December 31,
2002. The appropriate interest rate is 8 percent. The purchase price of the
machine is
a. $1,389,190.
b. $1,120,000.
c. $868,900.
d. $804,520.

c 29. On October 1, Takei, Inc. exchanged 8,000 shares of its $25 par value
LO2 common stock for a parcel of land to be held for a future plant site. Takei’s
common stock had a fair market value of $80 per share on the exchange
date. Takei received $36,000 from the sale of scrap when an existing
building on the site was razed. The land should be carried at
a. $200,000.
b. $236,000.
c. $604,000.
d. $640,000.
 a 30. Marburg Manufacturing Company purchased a machine on January 2,
2002.
LO1 The invoice price of the machine was $40,000, and the vendor offered a 2
percent discount for payment within ten days. The following additional costs
were incurred in connection with the machine:
Transportation-in................................................................... $1,200
Installation cost...................................................................... 700
Testing costs prior to regular operation................................ 550

If the invoice is paid within the discount period, Marburg should record the
acquisition cost of the machine at
a. $41,650.
b. $41,100.
c. $40,400.
d. $39,200.

b 31. The general ledger of the Flayle Corporation as of December 31 includes

the
LO1 following accounts:
Organization costs................................................................. $ 20,000
Deposits with advertising agency (will be used to promote
goodwill)................................................................................ 32,000
Discount on bonds payable................................................... 60,000
Excess of cost over book value of net assets of acquired
subsidiary.............................................................................. 280,000
Trademarks............................................................................ 48,000

In the preparation of Flayle’s balance sheet as of December 31, what

should be reported as total intangible assets?
a. $68,000
b. $328,000
c. $368,000
d. $380,000

b 32. On June 30, 2002, Hi-Tech Inc. purchased for cash at $50 per share all
LO1 150,000 shares of outstanding common stock of Skicraft Company.
Skicraft’s balance sheet at June 30, 2002, showed net assets with a book
value of $6,000,000. The fair value of Skicraft’s property, plant, and
equipment on June 30, 2002, was $800,000 in excess of its book value.
What amount, if any, will be recorded by Hi-Tech as goodwill on the date of
purchase?
a. $0
b. $700,000
c. $800,000
d. $1,500,000
 a 33. On July 31, 2002, Cleveland Company purchased for $4,000,000 cash all
of
LO1 the outstanding common stock of Gem Company when Gem’s balance
sheet showed net assets of $3,200,000. Gem’s assets and liabilities had
fair values different from the book values as follows:
Book Value Fair Value
Property, plant, and equipment, net................ $5,000,000 $5,750,000
Other assets.................................................... 500,000 0
Long-term debt................................................ 3,000,000 2,800,000

As a result of the transaction, what amount will be shown as goodwill in the

July 31, 2002, consolidated balance sheet of Cleveland Company and its
wholly owned subsidiary, Gem Company?
a. $350,000
b. $250,000
c. $750,000
d. $800,000

d 34. Peyton Company started construction of a new office building on January 1,

LO2 2001, and moved into the finished building on July 1, 2002. Of the
building’s
$5,000,000 total cost, $4,000,000 was incurred in 2001 evenly throughout
the year. Peyton’s incremental borrowing rate was 12 percent throughout
2001, and the total amount of interest incurred by Peyton during 2001 was
$204,000. What amount should Peyton report as capitalized interest at
December 31, 2001?
a. $480,000
b. $300,000
c. $240,000
d. $204,000

c 35. Mozely Company borrowed $400,000 on a 10 percent note payable to

finance
LO2 a new warehouse Mozely is constructing for its own use. The only other
debt on Mozely’s books is a $600,000, 12 percent mortgage payable on an
office building. At the end of the current year, average accumulated
expenditures on the new warehouse totaled $475,000. Mozely should
capitalize interest for the current year in the amount of
a. $40,000.
b. $47,500.
c. $49,000.
d. $52,250.
 c 36. Jazz Company acquired land and paid for it in full by issuing $600,000 of its
LO2 10 percent bonds payable and 40,000 shares of its common stock, par $10.
The stock was selling at $19 per share and the bonds were trading at 102.
What amount should Jazz record as the cost of the land?
a. $988,000
b. $1,000,000
c. $1,372,000
d. $1,387,200

c 37. Jazz Company purchased land with a current market value of $240,000. Its
LO2 book value in the accounts of the seller was $130,500. In exchange for the
land, Jazz issued 20,000 shares of its common stock, par $10, with an
estimated market value of $14 per share. Jazz stock is not traded on an
established stock exchange. What amount should Jazz record as the cost
of the land?
a. $130,500
b. $200,000
c. $240,000
d. $280,000

b 38. The third year of a construction project began with a $30,000 balance in
LO2 Construction in Progress. Included in that figure is $6,000 of interest
capitalized in the first two years. Construction expenditures during the third
year were $80,000 which were incurred evenly throughout the entire year.
The company has had over $300,000 in interest-bearing debt outstanding
the third year, at a weighted average rate of 9 percent. How much interest
for the third year is capitalized?
a. $3,600
b. $6,300
c. $9,360
d. $9,900

b 39. Jazz company started construction on a building on January 1 of this year

and
LO2 completed construction on December 31 of the same year. Jazz had only
two interest notes outstanding during the year, and both of these notes
were outstanding for all 12 months of the year. The following information is
available:
Average accumulated expenditures................................ $250,000
Ending balance in construction in progress
before capitalization of interest........................................ 360,000
6 percent note incurred specifically for the project.......... 150,000
9 percent long-term note.................................................. 500,000
 What amount of interest should Jazz capitalize for the current year?
a. $15,000
b. $18,000
c. $22,500
d. $27,900

b 40. A company made the following cash expenditures on a self-constructed

LO2 building begun January 1 of the current year:
January 1......................................................................... $50,000
June 1............................................................................... 60,000
December 1...................................................................... 90,000

The building is still under construction at year-end. What is the average

accumulated expenditures for the purpose of capitalizing interest?
a. $87,500
b. $92,500
c. $100,000
d. $200,000

a 41. During 2002, Krieger, Inc. incurred the following costs:

LO3 Research and development services performed by Dell
Company for Krieger............................................................. $125,000
Testing for evaluation of new products................................. 150,000
Laboratory research aimed at discovery of new knowledge 187,500

In its income statement for the year ended December 31, 2002, Krieger
should report research and development expense of
a. $462,500.
b. $312,500.
c. $150,000.
d. $125,000.

c 42. Richard Co. incurred research and development costs in 2002 as follows:
LO3 Equipment acquired for use in various research and
development projects............................................................ $500,000
Depreciation on the above equipment.................................. 67,500
Materials used....................................................................... 100,000
Compensation costs of personnel......................................... 250,000
Outside consulting fees......................................................... 75,000
Indirect costs appropriately allocated................................... 125,000
 The total research and development costs charged in Richard’s 2002
income statement should be
a. $425,000.
b. $542,500.
c. $617,500.
d. $925,000.

c 43. During the year just ended, Morton Company made the following
expenditures
LO3 relating to its plant building:
Continuing and frequent repairs........................................... $160,000
Repainted the plant building................................................. 40,000
Major improvements to the electrical wiring system............. 128,000
Partial replacement of roof tiles............................................ 56,000

How much should be charged to repair and maintenance expense during

the year just ended?
a. $160,000
b. $216,000
c. $256,000
d. $328,000

a 44. On September 10, Sandy Company incurred the following costs for one of
its
LO3 printing presses:
Purchase of stapling attachment........................................... $90,000
Installation of attachment...................................................... 20,000
Replacement parts for renovation of press........................... 60,000
Labor and overhead in connection with renovation of press 28,000

Neither the attachment nor the renovation increased the estimated useful
life of the press. However, the renovation resulted in significantly increased
productivity. What amount of the costs should be capitalized?
a. $198,000
b. $110,000
c. $90,000
d. $88,000
 c 45. On April 30, 2002, Sistar, Inc. purchased for $30 per share all 200,000 of
Wren
LO2 Corp.’s outstanding common stock. On this date Wren’s balance sheet
showed net assets of $5,000,000. Additionally, the fair value of Wren’s
identifiable assets on this date was $400,000 in excess of their carrying
amount. On Sistar’s April 30, 2002, consolidated balance sheet, what
amount should be reported as goodwill?
a. $350,000
b. $400,000
c. $600,000
d. $1,000,000

b 46. Selected information from the 2002 and 2001 financial statements of Bowen
LO5 Corporation is presented below.
(in
thousands)
As of Dec.31
2002
2001
Cash......................................................................................$ 21 $ 35
Marketable Securities............................................................ 27 22
Accounts Receivable (net).................................................... 60 98
Inventory................................................................................ 105 142
Prepaid Expenses................................................................. 5 3
Land and Building (net)......................................................... 247 315
Accounts Payable.................................................................. 57 75
Accrued Expenses................................................................. 10 14
Notes Payable (short-term)................................................... 8 4
Bond Payable........................................................................ 52 66

Bowen had cash sales of $750 and credit sales of $615 during 2002. Cost
of
goods sold for 2002 was $819. Bowen’s fixed asset turnover for 2002 is
a. 2.97.
b. 4.86.
c. 2.53.
d. 5.53.
PROBLEMS
Problem 1
On February 1, 2001, Reardon Corporation purchased a parcel of land as a factory
site for $320,000. An old building on the property was demolished and
construction begun on a new warehouse that was completed April 15, 2002. Costs
incurred on the construction project are listed below.

Demolition of old building......................................................... $ 21,000

Architect’s fees......................................................................... 31,700
Legal fees--title investigation................................................... 4,100
Construction costs.................................................................... 950,000
Imputed interest based on stock financing.............................. 14,000
Landfill for building site............................................................ 19,300
Clearing of trees from building site.......................................... 9,600
Temporary buildings used for construction activities............... 29,000
Land survey.............................................................................. 4,000
Excavation for basement.......................................................... 13,200
(Salvage materials from demolition sold for $1,800)
(Timber sold for $3,300)

Determine the cost of the land and new building.

Solution 1
LO1
Land
Cost .......................................................................................... $ 320,000
Demolition................................................................................ 21,000
Legal fees--title investigation................................................... 4,100
Landfill...................................................................................... 19,300
Clearing of trees....................................................................... 9,600
Land survey.............................................................................. 4,000
Salvage.................................................................................... (1,800)
Sale of timber........................................................................... (3,300)
Total.................................................................................. $ 372,900

Building
Construction costs.................................................................... $ 950,000
Architect’s fees......................................................................... 31,700
Temporary buildings................................................................. 29,000
Excavation................................................................................ 13,200
Total.................................................................................. $1,023,900

Note: Interest charges would not be recorded. Under FASB Statement No. 34,
only interest charges incurred may be recognized.
Problem 2
On May 1, 2001, Lenny Corporation purchased for $690,000 a tract of land on
which a warehouse and office building were located. The following data were
collected concerning the property:

Current Assessed Vendor’s

Valuation Original Cost
Land...............................................$280,000 $180,000
Warehouse.................................................... 320,000 315,000
Office Building............................................... 200,000 129,000
$800,000 $624,000

Determine the appropriate amounts that Lenny should record for the land,
warehouse, and office building.

Solution 2
LO2
Land..............................$280,000/$800,000 = 35%
Warehouse...................................................... $320,000/$800,000 = 40%
Office Building.................................................. $200,000/$800,000 = 25%
$800,000 100%
Allocation:
.35 x $690,000 = $241,500 Land
.40 x $690,000 = 276,000 Warehouse
.25 x $690,000 = 172,500 Office Building
$690,000

Problem 3
The Callister Company exchanged 25,000 shares of its own $50 par value common
stock for a turret lathe from Payne Company. The market value of the Callister
Company stock was $68 per share at the date of exchange. The equipment had a
carrying value of $1,625,000.

Record the exchange on the books of Callister Company in general journal form.

Solution 3
LO2
Machinery................................................................... 1,700,000
Common Stock (25,000 x $50)................................ 1,250,000
Paid-In Capital in Excess of Par........................ 450,000
Problem 4
One of the most critical steps in recording the acquisition of assets is the
determination of the cost assigned to the asset. Data related to assets acquired by
Mentor Manufacturing Company are as follows:
(1) Machine A was purchased at a list price of $92,000; terms 1/10, net 30. The
machine invoice was paid after the discount period. Transportation charges
were $1,270; installation costs were $920; and the cost of a trial run was $960.
Normal repairs and maintenance for the first year were $410.

(2) Machine B could be purchased for five annual payments of $6,332 or $29,400
in cash. Mentor elected to purchase Machine B under the installment plan.
Other related acquisition costs totaled $175.

(3) On May 12, 2001, Alabama Company offered to sell land to Mentor for
$62,000; the offer was rejected. On June 29, 2,125 shares of Mentor common
stock were issued in exchange for the land. The par value of the stock was
$20 per share; the market value of the stock was $32 per share at the time of
purchase. Mentor’s management was confident the land would be worth at
least $64,000 to the company.

(4) The company purchased equipment under a deferred payment contract--

$40,000 down payment and 30 semiannual payments of $5,000. (Assume a
12 percent interest rate.)

Determine the acquisition cost for each of the assets.

Solution 4
LO2
(1) Cost of machine ($92,000 x .99)...................................... $91,080
Transportation costs................................................... 1,270
Installation costs......................................................... 920
Trial run....................................................................... 960
Cost basis for Machine A............................................ $94,230

The $410 for normal repairs and maintenance is a period cost; the $920
($92,000 - $91,080) is recorded as Discounts Lost or Interest Expense.

(2) Cash price of machine................................................ $29,400

Other acquisition costs............................................... 175
Cost basis for Machine B........................................... $29,575

The interest of ($31,660 - $29,400) = $2,260 is not included in the asset cost.
(3) Cost basis for land:
2,125 shares @ $32 (market) = $68,000

(4) Down payment............................................................ $ 40,000

Semiannual payments ($5,000 x 13.7648)*...................... 68,824
$108,824
* n = 30 i = 6% (Table 4--Present value of an ordinary annuity)
Problem 5
During 2002, Grant Industries, Inc. constructed a new manufacturing facility at a
cost of $12,000,000. The weighted average accumulated expenditures for 2002
were calculated to be $5,400,000. The company had the following debt
outstanding at December 31, 2002:
(a) 10 percent, five-year note to finance construction of the manufacturing
facility, dated January 1, 2002, $3,600,000.
(b) 12 percent, 20-year bonds issued at par on April 30, 1998, $8,400,000.
(c) 8 percent, six-year note payable, dated March 1, 2001, $1,800,000.

Determine the amount of interest to be capitalized by Grant Industries for 2002.

Solution 5
LO2
Average Applicable
Accumulated Interest Avoidable
Expenditures Rate Interest
$3,600,000 10% $360,000
1,800,000 11.29% * 203,220
$5,400,000 $563,220

* Calculation of weighted average interest rate:

Principal Interest
12% bonds........................$ 8,400,000 $1,008,000
8% note payable............. 1,800,000 144,000
$10,200,000 $1,152,000

$1,152,000/$10,200,000 = 11.29% (rounded)

 Actual interest cost incurred during 2002:
Construction loan ($3,600,000 x 10%).................................... $ 360,000
12% bonds ($8,400,000 x 12%)............................................... 1,008,000
8% notes ($1,800,000 x 8%)................................................... 144,000
$1,512,000

The interest that should be capitalized for 2002 by Grant Industries, Inc. is
$563,220 (the lesser of the avoidable interest of $563,220 and the actual interest
cost incurred of $1,512,000).

Problem 6
Gooden Enterprises Inc. developed a new machine for manufacturing baseballs.
Because the machine is considered very valuable, the company had it patented.
The following expenditures were incurred in developing and patenting the machine.
(a) Purchases of special equipment to be used solely for
development of the new machine............................................... $182,000
(b) Research salaries and fringe benefits for engineers
and scientists.............................................................................. 17,100
(c) Cost of testing prototype............................................................. 23,600
(d) Legal costs for filing for patent................................................... 12,700
(e) Fees paid to government patent office....................................... 2,500
(f) Drawings required by patent office to be filed with
patent application........................................................................ 4,700

Gooden elected to amortize the patent over its legal life. At the beginning of the
second year, Gooden Enterprises paid $24,000 to successfully defend the patent in
an infringement suit. At the beginning of the fourth year Gooden determined that
the remaining estimated useful life of the patent was five years.

Record the above transactions in general journal form for Gooden Enterprises Inc.
for the first five years of the life of the patent. Include any amortization or
depreciation for each period.
 Solution 6
LO3
Year 1 Research and Development Expense [$182,000 +
$17,100 + $23,600 = $222,700]...................................... 222,700
Patents [$12,700 + $2,500 + $4,700 = $19,900]............... 19,900
Cash................................................................. 242,600

Year 1 Amortization of Patents [$19,900/17 = $1,171]............ 1,171

Patents............................................................. 1,171

Year 2 Patents.................................................................. 24,000

Cash................................................................. 24,000

Year 2 Amortization of Patents [($19,900 + $24,000 -

$1,171)/16]................................................................................. 2,671
Patents............................................................. 2,671

Year 3 Amortization of Patents......................................... 2,671

Patents............................................................. 2,671

Year 4 Amortization of Patents [($19,900 + $24,000 -

$1,171 - $2,671 - $2,671)/5]........................................... 7,477
Patents............................................................. 7,477

Year 5 Amortization of Patents......................................... 7,477

Patents............................................................. 7,477

Problem 7
On June 1, 2002, the Otis Company paid $1,200,000 for all the issued and
outstanding stock of Billups Corporation in a transaction properly accounted for as
a purchase. The recorded assets and liabilities of Billups Corporation on June 1,
2002, are as follows:

Cash. ................................................................................................ $ 200,000

Inventory........................................................................................... 540,000
Property and equipment (net of accumulated depreciation of $525,000)....... 630,000
Liabilities...........................................................................................
(420,000)

On June 1, 2002, it was determined that the inventory of Billups had a fair value of
$575,000, and the property and equipment had a fair value of $720,000.

Determine the goodwill resulting from the business combination.

Solution 7
LO2
Cash purchase price............................................................ $1,200,000
Recorded cost of net assets purchased.............................. $950,000
Difference between cost and market value of specific assets:
Inventory........................................................................ 35,000
Property and equipment................................................ 90,000
Fair value of net assets........................................................ 1,075,000
Goodwill purchased............................................................. $ 125,000

Problem 8
On March 1, 2002, the Sefkwak Company paid $400,000 for all the issued and
outstanding stock of Bodo Corporation in a transaction properly accounted for as a
purchase. The market values of the assets and liabilities of Bodo Corporation on
March 1, 2002, are as follows:

Cash. ............................................................................. $ 10,000

Accounts receivable...................................................... 120,000
Inventory........................................................................ 330,000
Property and equipment................................................ 80,000
Liabilities....................................................................... (20,000)

Make the journal entry necessary for Sefkwak to record the purchase.

Solution 8
LO2
Cash. .…........................................................................ 10,000
Accounts Receivable..................................................... 120,000
Inventory........................................................................ 330,000
Liabilities.................................................................. 20,000
Negative Goodwill.................................................... 40,000
Cash......................................................................... 400,000

Cash purchase price............................................................ $400,000

Market value of net assets................................................... 520,000
Excess of market value over purchase price....................... $120,000
Reduction of property and equipment (noncurrent assets). 80,000
Remainder (negative goodwill)............................................ $ 40,000
Problem 9
Lurie Company made the following cash expenditures during the year:

(a) Paid $100,000 for interest capitalized as part of a self-construction

project.

(b) Paid $225,000 for interest that was expensed during the year.

(c) Paid $300,000 for R&D expenditures that were immediately expensed.

(d) Paid $400,000 to acquire new machinery.

Indicate where in the statement of cash flows each of the preceding items would be
reflected. Lurie uses the indirect method of reporting cash flow from operations.

Solution 9
LO2, LO3
(a) $100,000 cash outflow in the investing activities section.

(b) Nowhere. Interest expense would be included in the computation of net

income and would not be shown separately in the operating activities
section of the statement of cash flows. However, the amount of cash paid
for interest must be disclosed separately, as a supplemental part of the
statement of cash flows or in the notes.

(c) Nowhere. Again, research and development expense would be included

in the computation of net income. Net income is the basis for computing
cash from operations when the indirect method is used.

(d) $400,000 cash outflow in the investing activities section.

Problem 10
Delb Company is an oil and gas exploration firm. During 2002, Delb engaged in
five different exploration projects. The costs associated with these projects are as
follows:

Project 1................................................................ $ 325,000

Project 2................................................................ 178,000
Project 3................................................................ 423,000
Project 4................................................................ 240,000
Project 5................................................................ 96,000
Total................................................................. $1,262,000

Only Projects 2 and 5 were successful. As of the end of the year, production had
not yet started at either of these two sites.
Assuming that all exploration costs were paid for in cash, make the journal entry to
record the expenditures for the year using

(1) the successful efforts method.

(2) the full cost method.

Solution 10
LO3
(1) Exploration Expense..................................................... 988,000
Capitalized Exploration Cost......................................... 274,000
Cash...................................................................... 1,262,000

(2) Capitalized Exploration Cost......................................... 1,262,000

Cash...................................................................... 1,262,000

Problem 11
Arrow Construction Company, Inc., is constructing an office building for its own use.
The following expenditures relating to the construction of the office building were
made during the 2002:

Total construction expenditures:

January 2, 2002.............................................................$500,000
May 1, 2002................................................................... 500,000
November 1, 2002......................................................... 400,000

Outstanding company debt:

Bond issue directly related to the new office building; interest rate, 12%;
term, 5 years from beginning of construction............... $800,000
General bond liability:
Bonds issued just prior to construction of building; interest rate, 10%
for 10 years................................................................... $400,000
Bonds issue prior to construction; interest rate 8% for 8 years
$900,000
Estimated cost of equity capital...........................................
13%

Determine the amount of interest to be capitalized during 2002 using the avoidable
interest method.
Solution 11
LO6
Avoidable Interest Method:
Interest Fraction
Capitalization of the Year Capitalized
Expenditure Date Amount Rate Outstanding Interest
January 2, 2002 $500,000 12% 12/12 $ 60,000
May 1, 2002 300,000 12% 8/12 24,000
200,000 9.4% 8/12 12,533
November 1, 2002 400,000 9.4% 2/12 6,267
Total capitalized interest for 2002........................................................$102,800

Problem 12
Arrow Construction Company, Inc., is constructing an office building for its own use.
The following expenditures relating to the construction of the office building were
made during the 2002:

Total construction expenditures:

January 2, 2002.............................................................$500,000
May 1, 2002................................................................... 500,000
November 1, 2002......................................................... 400,000

Outstanding company debt:

Bond issue directly related to the new office building; interest rate, 12%;
term, 5 years from beginning of construction............... $800,000
General bond liability:
Bonds issued just prior to construction of building; interest rate, 10%
for 10 years................................................................... $400,000
Bonds issue prior to construction; interest rate 8% for 8 years
$900,000
Estimated cost of equity capital...........................................
13%

Determine the amount of interest to be capitalized during 2002 using the average
accumulated expenditure method.
Solution 12
LO6
Average accumulated expenditure method:
Fraction
of the Year Capitalized
Expenditure Date Amount Outstanding Interest
January 2, 2002 $500,000 12/12 $500,000
May 1, 2002 500,000 8/12 333,333
November 1, 2002 400,000 2/12 66,667
Total weighted average expenditures
for 2002........................................................$900,000

Weighted Interest
Expenditure Capitalization Capitalized
Amount Rate Interest
$800,000 12% $ 96,000
$100,000 9.4% 9,400
Total capitalized interest for 2002 $105,400

Problem 13
Arrow Construction Company, Inc., is constructing an office building for its own use.
The following expenditures relating to the construction of the office building were
made during the 2002:

Total construction expenditures:

January 2, 2002.............................................................$500,000
May 1, 2002................................................................... 500,000
November 1, 2002......................................................... 400,000

Outstanding company debt:

Bond issue directly related to the new office building; interest rate, 12%;
term, 5 years from July 1, 2002.....................................
$800,000
General bond liability:
Bonds issued just prior to construction of building; interest rate, 10%
for 10 years................................................................... $400,000
Bonds issue prior to construction; interest rate 8% for 8 years
$900,000
Estimated cost of equity capital...........................................
13%

Determine the amount of interest to be capitalized during 2002 using the avoidable
interest method.
 Solution 13
LO6
Interest Fraction
Capitalization of the Year Capitalized
Expenditure Date Amount Rate Outstanding Interest
January 2, 2002:
Jan.--June $500,000 9.4% 6/12 $ 23,500
July--Dec. 500,000 12% 6/12 30,000
May 1, 2002:
May--June 300,000 9.4% 2/12 4,700
July--Dec 300,000 12% 6/12 18,000
May--Dec 200,000 9.4% 8/12 12,533
November 1, 2002 400,000 9.4% 2/12 6,267
Total capitalized interest for 2002……………………………………. $ 95,000

Problem 14
Assets constructed for a firm’s own use present the problem of whether to
capitalize
interest on the funds invested during the time required to prepare the assets for
their intended use. Current generally accepted accounting principles as specified
by the FASB in Statement No. 34 require the capitalization of interest on borrowed
capital, but not to exceed the total interest paid by the firm.

Evaluate the appropriateness of the approach currently required in the

professional pronouncements now in effect.

Solution 14
LO2
Capitalization of interest on borrowed capital (but not in excess of total interest
paid by the enterprise) avoids the difficulty of determining how much of an
investment is financed by debt and how much by equity. The entire investment is
assumed to be financed by debt. Interest capitalized, however, is limited to the
total interest incurred by the enterprise during the period. Interest thus represents
an opportunity cost in the amount that could have been avoided by not borrowing
or by using the funds to reduce outstanding debt. Limiting the amount
capitalized to the total interest cost incurred during the period is consistent with
the historical cost principle since only the
actual interest expense incurred is capitalized.

The current approach is deficient because it fails to recognize the portion of the
investment financed by equity sources. An opportunity cost exists for using funds
obtained from equity sources just as surely as for using funds obtained from debt
sources. Ignoring the opportunity cost associated with equity sources results in
inconsistent and incomparable valuations. The approach does not lead to comparable
results for different firms producing similar assets but with different capital structures.
 Additionally, the limitation on the capitalization of interest associated with debt to
the amount of interest actually incurred by an enterprise fails to recognize the total
cost of using money associated with an investment.

Problem 15
You are the auditor of Don Corporation, a newly organized company that
manufactures plastic cups using an extrusion process. One of the promoters of the
company was formerly involved in an enterprise that used the extrusion process and
has agreed to contribute an extrusion machine to the new company in return for
shares of stock of Don Corporation. What concerns would you have as the auditor of
Don Corporation regarding this transaction?

Solution 15
LO2
This transaction represents a related party transaction. Accordingly, you should be
concerned about the amount recorded on the records of the company. You should
determine what methods were used to establish the value on the books of the
company of the asset contributed as well as the cost of the machine to the
promoter and the length of ownership by the promoter. You should be concerned
not only about the value of the asset for purposes of recording the asset in the
property accounts, but also about attempts by the promoter and management to
defraud investors in the company through attempts to inflate the value of the
shares of stock by overvaluing the asset.

Problem 16
You have just been promoted to the position of senior accountant with the public
accounting firm of Watts and Zimmerman. Your first audit client as senior accountant
is to be the Delta Manufacturing Company. You have had a considerable amount
of experience both in planning and conducting the audit procedures for current
asset
accounts such as cash, receivables, and inventory. This is your first experience,
however, in planning the audit of the property, plant, and equipment accounts.
Compare the nature of current assets with property, plant, and equipment, and
describe how any differences might affect your audit generally.
 Solution 16
LO1
The audit work required to verify the property, plant, and equipment accounts
generally is substantially less than that required for current assets. This is due to
the nature of the assets included in the property accounts.

A typical unit of property or equipment usually has a high dollar value, and
relatively
few transactions may support one large amount on the balance sheet. Current
asset accounts such as cash, receivables, and inventory, on the other hand,
generally have a large volume of transactions, many of which may be of lower
dollar values.

The property accounts typically do not show large changes in the balances of
these accounts from year to year. Current asset accounts often change
dramatically from year to year, again as a result of a large volume of transactions.

The cash, receivables, and inventory accounts of the current asset section all
pose significant problems in terms of ensuring that a proper cut-off of transactions
is made at the end of the accounting period. Errors in recording purchases or
sales can affect net income. The potential for such errors is significant for the
current asset accounts due to the large volume of transactions. An error in
recording the acquisition or retirement of a plant asset at year-end likely
will not affect net income for the period nearly to the extent a cut-off error in the
current asset accounts.
CHAPTER 12 -- QUIZ A
Name _________________________
Section ________________________

T F 1. The acquisition cost of property includes only the original purchase price or
equivalent value.

T F 2. Any taxes, freight, installation, and other expenditures related to the

acquisition of assets should be expensed as incurred.

T F 3. Brokers’ commissions, legal fees, and escrow fees are included in the
acquisition cost of land.

T F 4. Under current accounting rules, goodwill is recognized only when an entity is

purchased in its entirety.

T F 5. Generally, expenditures to repair, recondition, or improve a used asset before

it is placed in service should be recorded as part of the asset’s acquisition
cost.

T F 6. Land held for future use or speculation should be reported in the property,
plant, and equipment section of the balance sheet.

T F 7. Special assessments by local governments for streets, sidewalks, lighting,

and sewers that will be maintained by the government are included in the
land account.

T F 8. Goodwill is the most frequently reported intangible asset.

T F 9. Goodwill is recorded by companies that have consistently achieved a level of

income that is above average for their respective industries.

T F 10. When property is acquired by issuing securities, the transaction is always

recorded at the fair market value of the asset acquired.

230
CHAPTER 12 -- QUIZ B
Name _________________________
Section ________________________

T F 1. When the cost of self-construction of an asset is less than the cost to acquire
it through purchase or construction by outsiders, the difference is reported
currently as a gain from self-constructed assets.

T F 2. Charges directly related to construction of an asset may be charged in full to

the cost of the asset or allocated in part to normal operations.

T F 3. Property acquired through donation should be recorded at its fair market

value.

T F 4. When the cost of a self-constructed asset is greater than the cost to acquire
it from outside sources, the difference for accounting purposes should be
reported as a loss in the period construction is completed, if there is
evidence indicating the cost is materially excessive because of construction
inefficiencies or failures.

T F 5. The practice of capitalizing construction period interest is supported by the

concept of the proper matching of revenues and expenses.

T F 6. Research activities include the formulation, design, and testing of products,

and the construction of prototypes.

T F 7. In general, research and development expenditures should be expensed in

the period incurred.

T F 8. All costs incurred in the development of computer software, up to the point

where technological feasibility is established, are to be recorded as an
intangible asset.

T F 9. Additions and betterments that add to asset usefulness by either extending

its life or increasing future cash flows are recorded by adding the
expenditures to the cost of the asset.

T F 10. Incorrectly recording an expense as an asset overstates current earnings,

assets, and owners’ equity.

231
CHAPTER 12 -- QUIZ C
Name _________________________
Section ________________________

A. Patent K. Tangible noncurrent operating assets

B. Development activities L. Maintenance and repairs
C. Capital lease M. Land
D. Organization costs N. Franchise
E. Land improvements O. Research activities
F. Copyright P. Nonreciprocal transfer of a
G. Intangible noncurrent operating assets nonmonetary asset
H. Technological feasibility Q. Negative goodwill
I. Capitalized interest R. Additions and betterments
J. Goodwill S. Trademarks and trade names

Select the term that best fits each of the following definitions and descriptions.

_____ 1. The amount of interest included as part of the cost of a self-constructed

asset.
_____ 2. Activity undertaken to discover new knowledge that may be used in
developing new products, services, or processes.
_____ 3. The excess of fair market values of purchased net assets over the price
paid to purchase a business entity.
_____ 4. Economic resources with future benefit that are used in the normal
operating activity of the organization that cannot be physically observed.
_____ 5. Costs incurred in forming a corporation.
_____ 6. Items such as landscaping, paving, and fencing that improve the usefulness
of property.
_____ 7. An asset that is recorded in the financial statements only when a business
entity is acquired by a purchase.
_____ 8. Expenditures that add to the usefulness of an asset by either extending its
life or increasing future cash flows, without component replacement.
_____ 9. The attainment of a detailed program design and working model for
computer software.
_____10. Exclusive right or privilege received by a business or individual to perform
certain functions or use certain products or services.
_____11. Normal costs of keeping property in operating condition.
_____12. Distinctive symbols, labels, and designs.
_____13. Assets used to produce products or provide services.
_____14. A transfer of a nonmonetary asset with no sacrifice incurred by the
organization receiving the asset.
_____15. An exclusive right granted by the government to an inventor enabling the
inventor to control the manufacture, sale, or other use of the invention.

232
CHAPTER 12 -- QUIZ D
Name _________________________
Section ________________________

A. Land
B. Land Improvements
C. Buildings
D. Machinery and Equipment
E. Other Accounts

Select the appropriate account for each of the following expenditures.

_____ 1. Installation charges for machinery purchased

_____ 2. Reconditioning costs of used equipment acquired
_____ 3. Surveying fees
_____ 4. Landscaping--trees and shrubs
_____ 5. Transportation charges on equipment purchased
_____ 6. Special assessment by electrical company to extend lines to property
_____ 7. Building permits and fees
_____ 8. Attorney’s fees for title search for land
_____ 9. Fence around the parking areas
_____10. Cost of removing trees from a building site
_____11. Sidewalks
_____12. Cost of paving parking lots
_____13. Patterns used for a single job
_____14. Construction period interest
_____15. Special foundation for newly acquired equipment
_____16. Architect’s fees
_____17. Delinquent real estate taxes assumed by purchaser on land acquired for a
building site
_____18. Fees paid to the general contractor for construction supervision
_____19. Royalties paid for machine use
_____20. Construction period insurance--building
_____21. Equipment test runs
_____22. Current period real estate taxes
_____23. Proceeds from sale of trees removed from building site
_____24. Real estate commissions paid for land purchase
_____25. Insurance on machinery in transit
234 Chapter 12  Investments in Noncurrent Operating Assets—Acquisition

CHAPTER 12 -- QUIZ SOLUTIONS

Quiz A Quiz B Quiz C Quiz D

1. F 1. F 1. I 1. D
2. F 2. F 2. O 2. D
3. T 3. T 3. Q 3. A
4. T 4. T 4. G 4. B
5. T 5. T 5. D 5. D
6. F 6. F 6. E 6. A
7. T 7. T 7. J 7. C
8. T 8. F 8. R 8. A
9. F 9. T 9. H 9. B
10. F 10. T 10. N 10. A
11. L 11. B
12. S 12. B
13. K 13. E
14. P 14. C
15. A 15. D
16. C
17. A
18. C
19. E
20. C
21. D
22. E
23. A
24. A
25. D