Chapter 13—Investments in Noncurrent Operating Assets-Utilization & Re-

tirement

MULTIPLE CHOICE

1. Depreciation of noncurrent operating assets is an accounting process for the purpose of

a. reporting declining asset values on the balance sheet.
b. allocating asset costs over the periods benefited by use of the assets.
c. accounting for costs to reflect the change in general price levels.
d. setting aside funds to replace assets when their economic usefulness expires.
ANS: B OBJ: LO 1

2. Which of the following principles best describes the conceptual rationale for the methods of
matching depreciation expense with revenues?
a. Partial recognition
b. Immediate recognition
c. Systematic and rational allocation
d. Associating cause and effect
ANS: C OBJ: LO 1

3. Information needed to compute a depletion charge per unit includes the

a. estimated total amount of resources available for removal.
b. amount of resources removed during the period.
c. cumulative amount of resources removed.
d. amount of resources sold during the period.
ANS: A OBJ: LO 2

4. The composite depreciation method

a. is applied to a group of homogeneous assets.
b. is an accelerated method of depreciation.
c. does not recognize gain or loss on the retirement of specific assets in the group.
d. excludes salvage value from the base of the depreciation calculation.
ANS: C OBJ: LO 1

5. The sum-of-the-years'-digits method of depreciation is being used for a machine with a five-year
estimated useful life. What would be the fraction applied to the cost to be depreciated in the
fourth year?
a. 4/5
b. 2/5
c. 4/15
d. 2/15
ANS: D OBJ: LO 1

6. In order to calculate the third year's depreciation on an asset using the sum-of- the-years'-digits
method, which of the following must be known about the asset?
a. Its acquisition cost
b. Its estimated salvage value
c. Its estimated useful life
d. All the above must be known.
ANS: D OBJ: LO 1

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 7. Which of the following statements is the assumption on which straight-line depreciation is based?
a. The operating efficiency of the asset decreases in later years.
b. Service value declines as a function of time rather than use.
c. Service value declines as a function of obsolescence rather than time.
d. Physical wear and tear are more important than economic obsolescence.
ANS: B OBJ: LO 1

8. A method that ignores salvage value in calculating periodic depreciation expense is the
a. productive-output method.
b. group composite method.
c. sum-of-the-years'-digits method.
d. double-declining-balance method.
ANS: D OBJ: LO 1

9. Which of the following is not required to be reported in the financial statements or disclosed in
the accompanying notes?
a. Balances of major classes of noncurrent operating assets at the balance sheet date
b. Gross historical cost and accumulated amortization for intangible assets at the balance
sheet date
c. Gross historical cost and accumulated depreciation for tangible noncurrent operating as-
sets at the balance sheet date
d. A general description of the cost allocation methods used with respect to major classes of
noncurrent operating assets
ANS: B OBJ: LO 1

10. Which of the following depreciation methods most closely approximates the method used to de-
plete the cost of natural resources?
a. Straight-line method
b. Double-declining-balance method
c. Sum-of-the-years'-digits method
d. Units-of-production method
ANS: D OBJ: LO 2

11. In accordance with generally accepted accounting principles, which of the following methods of
amortization is normally recommended for intangible assets?
a. Sum-of-the-years'-digits
b. Straight-line
c. Group composite
d. Double-declining-balance
ANS: B OBJ: LO 5

12. Which of the following depreciation methods applies a uniform depreciation rate each period to
an asset's book value?
a. Straight-line
b. Units-of-production
c. Declining-balance
d. Sum-of-the-years'-digits
ANS: C OBJ: LO 1

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13. Which of the following reasons provides the best theoretical support for accelerated depreciation?
a. Assets are more efficient in early years and initially generate more revenue.
b. Expenses should be allocated in a manner that "smooths" earnings.
c. Repairs and maintenance costs will probably increase in later periods, so depreciation
should decline.
d. Accelerated depreciation provides easier replacement because of the time value of money.
ANS: A OBJ: LO 1

14. When the estimate of an asset's useful life is changed,

a. depreciation expense for all past periods must be recalculated.
b. there is no change in the amount of depreciation expense recorded for future years.
c. only the depreciation expense in the remaining years is changed.
d. None of the above are true.
ANS: C OBJ: LO 3

15. Which of the following depreciation methods is computed in the same way as depletion?
a. Straight-line
b. Sum-of-the-years'-digits
c. Double-declining-balance
d. Productive-output
ANS: D OBJ: LO 2

16. The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were
a. less than current market value.
b. greater than cost.
c. greater than book value.
d. less than book value.
ANS: D OBJ: LO 6

17. When an exchange of similar assets involves a gain,

a. the recorded amount of the new asset is the cost of the old asset plus any cash paid.
b. the recorded amount of the new asset is its fair market value less any cash paid.
c. the recorded amount of the new asset is the net book value of the old asset plus any cash
paid.
d. None of the above are true.
ANS: C OBJ: LO 6

18. On January 1 Stockton Company acquired a machine with a four-year useful life. Stockton estim-
ates the salvage value of the machine will be equal to ten percent of the acquisition cost. The
company is debating between using either the double-declining-balance method or the sum-of-
the-years'-digits method of depreciation. Comparing the depreciation expense for the first two
years computed using these methods, the depreciation expense for the double-declining-balance
method (compared to the sum-of-the-years'-digits method) will match which of the following pat-
terns?

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 First Second
Year Year

a. Lower Lower
b. Lower Higher
c. Higher Lower
d. Higher Higher

ANS: C OBJ: LO 1

19. Legal fees incurred in successfully defending a patent suit should be capitalized when the patent
has been

Internally Purchased from

Developed an Inventor

a. Yes No
b. Yes Yes
c. No Yes
d. No No

ANS: B OBJ: LO 5

20. Which of the following utilizes the straight-line depreciation method?

Composite Group
Depreciation Depreciation

a. Yes Yes
b. Yes No
c. No Yes
d. No No

ANS: A OBJ: LO 1

21. A depreciable asset has an estimated 15 percent salvage value. At the end of its estimated useful
life, the accumulated depreciation would equal the original cost of the asset under which of the
following depreciation methods?

Productive- Sum-of-the- Double-

Output Years'-Digits Declining-Balance

a. Yes No No
b. No No No
c. No Yes No
d. Yes Yes Yes

ANS: B OBJ: LO 1

22. When similar assets are exchanged at a loss, the basis of the new asset is usually
a. the list price of the new asset.
b. the book value of the old asset plus any cash paid on the trade-in.
c. the fair market value of the new asset.
d. Either b or c.
ANS: C OBJ: LO 6

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23. A company using the group depreciation method for its delivery trucks retired one of the trucks
after the average service life of the group was reached. Cash proceeds were received from a sal-
vage company. The net carrying amount of these group asset accounts would be decreased by the
a. original cost of the truck.
b. original cost of the truck less the cash proceeds.
c. cash proceeds received.
d. cash proceeds received and original cost of the truck.
ANS: C OBJ: LO 6

24. In recording the trade of one asset for another, which of the following accounts is usually deb-
ited?
a. Accumulated Depreciation-Old Asset
b. Cash
c. Gain on Exchange of Asset
d. None of the above
ANS: A OBJ: LO 6

25. Dewey Company purchased a machine that was installed and placed in service on January 2,
2004, at a total cost of $480,000. Residual value was estimated at $80,000. The machine is being
depreciated over ten years by the double-declining-balance method. For the year 2005, Dewey
should record depreciation expense of
a. $64,000.
b. $76,800.
c. $80,000.
d. $96,000.
ANS: B OBJ: LO 1

26. Luther Soaps purchased a machine on January 1, 2004, for $18,000 cash. The machine has an es-
timated useful life of four years and a salvage value of $4,700. Luther uses the double-declining-
balance method of depreciation for all its assets. What will be the machine's book value as of
December 31, 2005?
a. $5,100
b. $4,700
c. $4,500
d. $4,300
ANS: B OBJ: LO 1

27. Malone Company traded in an old machine with a book value of $15,000 on a new similar ma-
chine. The new machine, which had a cash price of $75,000, was purchased for $64,000 cash plus
the old machine. Malone should record the cost of the new machine as
a. $64,000.
b. $71,000.
c. $75,000.
d. $79,000.
ANS: C OBJ: LO 6

28. Overberg Company purchased a machine on January 2, 2004, for $1,000,000. The machine has
an estimated useful life of five years and a salvage value of $100,000. Depreciation was com-
puted by the 150% declining-balance method. The accumulated depreciation balance at Decem-
ber 31, 2005, should be

315
 a. $360,000.
b. $459,000.
c. $490,000.
d. $510,000.
ANS: D OBJ: LO 1

29. Jordan Company exchanged a used autograph-signing machine with Rodman Company for a
similar machine with less use. Jordan's old machine originally cost $50,000 and had accumulated
depreciation of $40,000, as well as a market value of $40,000, at the time of the exchange. Rod-
man's old machine originally cost $60,000 and at the time of the exchange had a book value of
$30,000 and a market value of $32,000. Rodman gave Jordan $8,000 cash as part of the ex-
change. Jordan should record the cost of the new machine at
a. $8,000.
b. $10,000.
c. $16,000.
d. $32,000.
ANS: A OBJ: LO 6

30. XYZ Corporation bought a machine on January 1, 2005. In purchasing the machine, the company
paid $50,000 cash and signed an interest-bearing note for $100,000. The estimated useful life of
the machine is five years, after which time the salvage value is expected to be $15,000. Given
this information, how much depreciation expense would be recorded for the year ending Decem-
ber 31, 2006, if the company uses the sum-of-the-years'-digits depreciation method?
a. $45,000
b. $40,000
c. $36,000
d. $34,000
ANS: C OBJ: LO 1

31. On January 1, 2005, Carson Company purchased equipment at a cost of $420,000. The equip-
ment was estimated to have a useful life of five years and a salvage value of $60,000. Carson
uses the sum-of-the-years'-digits method of depreciation. What should the accumulated depreci-
ation be at December 31, 2008?
a. $240,000
b. $288,000
c. $336,000
d. $360,000
ANS: C OBJ: LO 1

32. On June 30, 2005, a fire in Oak Company's plant caused the total loss of a production machine.
The machine was being depreciated at $20,000 annually and had a carrying amount of $160,000
at December 31, 2004. On the date of the fire, the fair value of the machine was $220,000, and
Pine received insurance proceeds of $200,000 in October 2005. In its income statement for the
year ended December 31, 2005, what amount should Oak recognize as a gain or loss on disposi-
tion?
a. $0
b. $20,000 loss
c. $40,000 gain
d. $50,000 gain
ANS: D OBJ: LO 6

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33. On January 1, 2003, Kalos Co. purchased a new machine for $2,500,000. The new machine has
an estimated useful life of five years and the salvage value was estimated to be $250,000. Kalos
uses the sum-of-the-years'-digits method of depreciation. The amount of depreciation expense for
2005 is
a. $450,000.
b. $600,000.
c. $666,667.
d. $750,000.
ANS: A OBJ: LO 1

34. On December 2, 2005, Part Company, which operates a furniture rental business, traded in a used
delivery truck with a carrying amount of $5,400 for a new delivery truck having a list price of
$16,000 and paid a cash difference of $7,500 to the dealer. The used truck had a fair value of
$6,000 on the date of the exchange. At what amount should the new truck be recorded on Part's
books?
a. $10,600
b. $12,900
c. $13,500
d. $16,000
ANS: C OBJ: LO 6

35. On January 1, 2005, Carson Company purchased equipment at a cost of $570,000. The equip-
ment was estimated to have a useful life of five years and a salvage value of $60,000. Carson
uses the sum-of-the-years'-digits method of depreciation. What should the accumulated depreci-
ation be at December 31, 2007?
a. $340,000
b. $408,000
c. $456,000
d. $510,000
ANS: B OBJ: LO 1

36. In January, Hunter Corporation entered into a contract to acquire a new machine for its factory.
The machine, which had a cash price of $300,000, was paid for as follows:
Down payment .......................................... $ 30,000
Note payable in 10 equal monthly installments ......... 240,000
1,000 shares of Hunter common stock with an agreed 50,000
value of $50 per share ..............................
Total ................................................. $320,000

Prior to the machine's use, installation costs of $8,000 were incurred. The machine has an estim-
ated useful life of ten years and an estimated salvage value of $10,000. What should Hunter re-
cord as depreciation expense for the first year under the straight-line method?
a. $29,800
b. $30,000
c. $31,000
d. $31,800
ANS: A OBJ: LO 1
37. Melvin Motor Sales exchanged a car from its inventory for a computer to be used as a noncurrent
operating asset. The following information relates to this exchange that took place on July 31,
2005:

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 Carrying amount of the car ............................ $30,000
Listed selling price of the car ....................... 45,000
Fair value of the computer ............................ 43,000
Cash difference paid by Melvin ........................ 5,000

On July 31, 2005, how much profit should Melvin recognize on this exchange?
a. $0
b. $8,000
c. $10,000
d. $13,000
ANS: B OBJ: LO 6

38. The Bucol Company purchased a tooling machine in 1995 for $120,000. The machine was being
depreciated on the straight-line method over an estimated useful life of 20 years, with no salvage
value. At the beginning of 2005, when the machine had been in use for ten years, the company
paid $20,000 to overhaul the machine. As a result of this improvement, the company estimated
that the useful life of the machine would be extended an additional five years. What would be the
depreciation expense recorded for the above machine in 2005?
a. $4,000
b. $5,333
c. $6,000
d. $7,333
ANS: B OBJ: LO 3

39. Tillman Company owns a machine that was bought on January 2, 2002, for $376,000. The ma-
chine was estimated to have a useful life of five years and a salvage value of $24,000. Tillman
uses the sum-of-the-years'-digits method of depreciation. At the beginning of 2005, Tillman de-
termined that the useful life of the machine should have been four years and the salvage value
$35,200. For the year 2005, Tillman should record depreciation expense on this machine of
a. $19,200.
b. $44,400.
c. $59,200.
d. $70,400.
ANS: C OBJ: LO 3

40. Hendricks Construction purchased a crane on January 1, 2004, for $102,750. At the time of pur-
chase, the crane was estimated to have a life of six years and a residual value of $6,750. In 2006,
Hendricks determined that the crane had a total useful life of seven years and a residual value of
$4,500. If Hendricks uses the straight-line method of depreciation, what will be the depreciation
expense for the crane in 2006?
a. $16,000
b. $13,250
c. $9,464
d. $8,000
ANS: B OBJ: LO 3

41. At the start of its business, Snell Corp. decided to use the composite method of depreciation and
prepared the following schedule of machinery owned.

Total Estimated Estimated Life

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 Cost Salvage Value in Years
Machine A $275,000 $25,000 20
Machine B 100,000 10,000 15
Machine C 20,000 -- 5

Snell computes depreciation on the straight-line method. Based on the information presented, the
composite life of these assets (in years) should be
a. 13.3.
b. 16.0.
c. 18.0.
d. 19.8.
ANS: B OBJ: LO 1

42. A truck that cost $8,000 was originally being depreciated over four years using the straight-line
method with no salvage value. If after one year, it was decided that the truck would last an addi-
tional four years (or a total of five years), the second year's depreciation would be
a. $2,000.
b. $1,000.
c. $1,500.
d. $2,500.
ANS: C OBJ: LO 3

43. On January 1, 2004, Herschel Locks Corporation purchased drilling equipment for $11,500. The
equipment has an estimated useful life of four years and a salvage value of $200. Given this in-
formation, if Herschel uses the sum-of-the-years'-digits method of depreciation and then trades
the equipment for new, dissimilar equipment with a fair market value of $16,000 on December
31, 2005, and pays $8,000 cash in the exchange, the new equipment should be recorded at
a. $16,000.
b. $12,475.
c. $11,590.
d. $8,110.
ANS: A OBJ: LO 6

44. On January 1, 2004, Herschel Locks Corporation purchased drilling equipment for $11,500. The
equipment has an estimated useful life of four years and a salvage value of $200. Assuming that
Herschel uses the straight-line method of depreciation, if it trades the equipment for new similar
equipment with a list price of $15,500 on December 31, 2005, and pays $4,050 in the exchange,
the new equipment should be recorded at
a. $15,500.
b. $11,450.
c. $9,850.
d. $9,900.
ANS: D OBJ: LO 6

45. Pastel Co. purchased a patent on January 1, 2002, for $714,000. The patent was being amortized
over its remaining legal life of 15 years expiring on January 1, 2017. During 2005, Pastel determ-
ined that the economic benefits of the patent would not last longer than 10 years from the date of
acquisition. What amount should be charged to patent amortization expense for the year ended
December 31, 2005?
a. $47,600
b. $71,400

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 c. $81,600
d. $142,800
ANS: C OBJ: LO 3

46. Hartwell Trucking traded a used truck with a book value of $1,700 and a fair market value of
$2,300 for a new similar truck with a list price of $17,800. Hartwell agreed to pay $13,000 in
cash for the exchange in addition to giving up the used truck. At what amount should the new
truck be recorded?
a. $17,800
b. $15,300
c. $14,700
d. None of the above
ANS: B OBJ: LO 6

47. Monier Carpet traded cleaning equipment with a cost of $17,000 and accumulated depreciation of
$3,250 for new similar equipment with a fair market value of $11,500. Monier should record the
new equipment at
a. $14,750.
b. $13,750.
c. $11,500.
d. $7,500.
ANS: C OBJ: LO 6

48. During 2000, Volvo Machine Company spent $352,000 on research and development costs for an
invention. This invention was patented on January 2, 2001, at a nominal cost that was expensed
in 2001. The patent has a legal life of 17 years and an estimated useful life of 8 years. In January
2005, Volvo paid $32,000 for legal fees in a successful defense of the patent. Amortization for
2005 should be
a. $2,462.
b. $8,000.
c. $32,000.
d. $52,000.
ANS: B OBJ: LO 5

49. On January 1, 2001, Barry Company purchased for $600,000, a trademark with an estimated use-
ful life of 16 years. In January 2005, Barry paid $90,000 for legal fees in a successful defense of
the trademark. Trademark amortization expense for the year ended December 31, 2005, should be
a. $37,500.
b. $43,125.
c. $45,000.
d. $90,000.
ANS: C OBJ: LO 5
50. Joseph Company acquired a tract of land containing an extractable natural resource. Joseph is re-
quired by the purchase contract to restore the land to a condition suitable for recreational use after
it has extracted the natural resource. Geological surveys estimate that the recoverable reserves
will be 2,500,000 tons and that the land will have a value of $1,000,000 after restoration. Relev-
ant cost information follows:

Land ................................................. $9,000,000

Estimated restoration costs .......................... 1,500,000

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 What should be the depletion charge per ton of extracted material?
a. $4.00
b. $3.80
c. $3.60
d. $3.20
ANS: B OBJ: LO 2

51. Bunker Construction Company recently exchanged an old truck, which cost $108,000 and was
one-third depreciated, and paid $70,000 cash for a used crane having a current fair value of
$130,000. At what amount should the crane be recorded on the books of Bunker?
a. $70,000
b. $108,000
c. $130,000
d. $142,000
ANS: C OBJ: LO 6

52. In January 2005, Vance Mining Corporation purchased a mineral mine for $7,200,000 with re-
movable ore estimated by geological surveys at 4,320,000 tons. The property has an estimated
value of $720,000 after the ore has been extracted. Vance incurred $2,160,000 of development
costs preparing the property for the extraction of ore. During 2005, 540,000 tons were removed
and 480,000 tons were sold. For the year ended December 31, 2005, Vance should include what
amount of depletion in its cost of goods sold?
a. $720,000
b. $810,000
c. $960,000
d. $1,080,000
ANS: C OBJ: LO 2

53. In 2004, Newman Company paid $1,000,000 to purchase land containing a total estimated
160,000 tons of extractable mineral deposits. The estimated value of the property after the miner-
al has been removed is $200,000. Extraction activities began in 2005, and by the end of the year,
20,000 tons had been recovered and sold. In 2006, geological studies indicated that the total
amount of mineral deposits had been underestimated by 25,000 tons. During 2006, 30,000 tons
were extracted, and 28,000 tons were sold. What is the depletion rate per ton (rounded to the
nearest cent) in 2006?
a. $4.24
b. $4.32
c. $4.85
d. $5.19
ANS: A OBJ: LO 2

54. In January 2005, Bevis Company exchanged an old machine, with a book value of $156,000 and
a fair value of $160,000, and paid $40,000 cash for a similar used machine having a fair value of
$200,000. At what amount should the machine acquired in the exchange be recorded on Bevis'
books?
a. $156,000
b. $196,000
c. $200,000
d. $204,000
ANS: B OBJ: LO 6

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55. Ellis Construction Company recently exchanged an old truck, which cost $108,000 and was one-
third depreciated, and paid $70,000 cash for a similar truck having a current fair value of
$130,000. At what amount should the truck be recorded on the books of Ellis?
a. $70,000
b. $108,000
c. $130,000
d. $142,000
ANS: C OBJ: LO 6

56. On July 1, Phoenix Corporation, a calendar-year company, received a condemnation award of

$150,000 as compensation for the forced sale of a plant located on company property that stood
in the path of a new highway. On this date, the plant building had a depreciated cost of $75,000
and the land cost was $25,000. On October 1, Phoenix purchased a parcel of land for a new plant
site at a cost of $62,500. Ignoring income taxes, Phoenix should report in its income statement for
the year ended December 31 a gain of
a. $0.
b. $12,500.
c. $37,500.
d. $50,000.
ANS: D OBJ: LO 6

57. The John Company purchased a machine on November 1, 1996, for $148,000. At the time of ac-
quisition, the machine was estimated to have a useful life of ten years and an estimated salvage
value of $4,000. John has recorded monthly depreciation using the straight-line method. On July
1, 2005, the machine was sold for $13,000. What should be the loss recognized from the sale of
the machine?
a. $4,000
b. $5,000
c. $10,200
d. $13,000
ANS: C OBJ: LO 6

58. In January 2005, Butz Company exchanged an old machine, with a book value of $156,000 and a
fair value of $140,000, and paid $40,000 cash for a similar used machine having a list price of
$200,000. At what amount should the machine acquired in the exchange be recorded on Butz's
books?
a. $200,000
b. $196,000
c. $184,000
d. $180,000
ANS: D OBJ: LO 6
59. Eagle Company owns a tract of land that it purchased in 2002 for $200,000. The land is held as a
future plant site and has a fair market value of $280,000 on July 1, 2005. Hall Company also
owns a tract of land held as a future plant site. Hall paid $360,000 for the land in 2004 and the
land has a fair market value of $380,000 on July 1, 2005. On this date, Eagle exchanged its land
and paid $100,000 cash for the land owned by Hall. At what amount should Eagle record the land
acquired in the exchange?
a. $280,000
b. $300,000
c. $320,000

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 d. $380,000
ANS: D OBJ: LO 6

60. A company owns a piece of land that originally cost $10,000 and has a fair market value of
$8,000. It is exchanged along with $5,000 cash for another piece of land having a fair value of
$13,000. The proper journal entry to record this transaction is
a. Land (new)........................ 15,000
Land (old)...................... 10,000
Cash ........................... 5,000
b. Land (new) ....................... 13,000
Loss on Exchange ................. 2,000
Land ........................... 10,000
Cash ........................... 5,000
c. Land (new)........................ 18,000
Land (old) ..................... 10,000
Cash ........................... 5,000
Gain on Exchange ............... 3,000
d. Land (new)........................ 13,000
Retained Earnings ................ 2,000
Land (old)...................... 10,000
Cash ........................... 5,000

ANS: B OBJ: LO 6

61. In October 2005, Daryl Company exchanged a used packaging machine having a book value of
$240,000 for a dissimilar new machine and paid a cash difference of $30,000. The market value
of the used packaging machine was determined to be $280,000. In its income statement for the
year ended December 31, 2005, how much gain should Daryl recognize on this exchange?
a. $0
b. $10,000
c. $30,000
d. $40,000
ANS: D OBJ: LO 6

62. Which of the following assets generally is required to be tested at least annually for impairment?
a. Machinery
b. Patent
c. Renewable broadcast license
d. Copyright
ANS: C OBJ: LO 5

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63. Which of the following represents the maximum amortization period mandated by current gener-
ally accepted accounting principles for amortizable intangible asset?
a. 10 years
b. 20 years
c. 40 years
d. No arbitrary cap on the useful life of amortizable intangible assets has been established.
ANS: D OBJ: LO 5

64. The impairment test for an intangible asset with an indefinite life compares the
a. fair value of the asset to its book value.
b. sum of the undiscounted cash flows expected to be generated by the asset to its book
value.
c. sum of the discounted cash flows expected to be generated by the asset to its fair value.
d. sum of the undiscounted cash flows expected to be generated by the asset to its fair value.
ANS: A OBJ: LO 5

65. The impairment test for an intangible asset with a definite life compares the
a. fair value of the asset to its book value.
b. sum of the undiscounted cash flows expected to be generated by the asset to its book
value.
c. sum of the discounted cash flows expected to be generated by the asset to its fair value.
d. sum of the undiscounted cash flows expected to be generated by the asset to its fair value.
ANS: B OBJ: LO 5

66. Which of the following assets generally is required to be tested at least annually for impairment?
a. Machinery
b. Patent
c. Goodwill
d. Copyright
ANS: C OBJ: LO 5

67. Five years ago, Goodman, Inc., purchased a patent for $110,000. Lower demand for the product
produced under this patent necessitates that an impairment test be made. On the date of purchase,
the patent had an estimated useful life of eleven years. It currently has a remaining useful life of
four years. The current fair value of the patent is $43,000. Company management estimates that
the patent will generate future cash flows of $12,000 per year for the next four years.

The amount of the impairment loss to be recognized is

a. $50,000.
b. $60,000.
c. $12,000.
d. $17,000.
ANS: D OBJ: LO 5

324
 PROBLEMS

1. The following is a schedule of machinery owned by Martin Manufacturing Company.

Estimated Estimated
Total Salvage Life in
Cost Value Years
Machine A $ 600,000 $110,000 20
Machine B 315,000 30,000 10
Machine C 84,000 0 15
Machine D 107,000 7,000 5
$1,106,000

Martin computes depreciation on the straight-line basis. Based on the information presented,
compute the:

(1) Composite life of these assets (in years).

(2) Composite depreciation rate.

ANS:

Salvage Depreciable Estimated Annual

Asset Cost Value Cost Life Depreciation
A $ 600,000 $110,000 $490,000 20 $24,500
B 315,000 30,000 285,000 10 28,500
C 84,000 0 84,000 15 5,600
D 107,000 7,000 100,000 5 20,000
$1,106,000 $147,000 $959,000 $78,600

(1) $959,000/$78,600 = 12.20 years

(2) $78,600/$1,106,000 = 7.11%

OBJ: LO 1

2. Hearsa Manufacturing Inc. purchased a new machine on January 2, 2005, that was built to per-
form one function on its assembly line. Data pertaining to this machine are:

Acquisition cost $330,000

Residual value $30,000
Estimated service life:
Years 5
Service hours 250,000
Production output 300,000

Using each of the following methods, compute the annual depreciation rate and charge for the
years ended December 31, 2005 and 2006:

(1) Straight-line
(2) Service hours (assume 32,000 hours for 2005 and 36,000 hours for 2006).
(3) Productive-output (assume 31,000 units for 2005 and 37,000 units for 2006).

325
 ANS:

(1)
Straight-line:
2005: ($330,000 - $30,000)/5 = $60,000
2006: $60,000

(2)
Service hours: ($330,000 - $30,000)/250,000 = $1.20 per hour
depreciation rate
2005: $1.20 × 32,000 = $38,400
2006: $1.20 × 36,000 = $43,200

(3)
Productive-output: ($330,000 - $30,000)/300,000 = $1.00 per unit
depreciation rate
2005: $1.00 × 31,000 = $31,000
2006: $1.00 × 37,000 = $37,000

OBJ: LO 1

3. The Fitzsimmons Company applied for and received numerous patents at a total cost of $286,500
at the beginning of 2002. It is assumed the patents will be useful evenly during their full legal
lives. At the beginning of 2004, the company paid $48,600 in legal fees for successful defense in
a patent infringement suit. At the beginning of 2005, information became available that caused
the company to reduce the remaining life of the patents to five years.

Calculate the amortization expense for the years 2002, 2003, 2004, and 2005. Round to the
nearest dollar.

ANS:

2002: $286,500/17 = ............................. $ 16,853

2003: $286,500/17 = ............................. $ 16,853

2004: Acquisition cost .......................... $286,500

Less: amortization to date ................ 33,706
Carrying value ............................ $252,794
Successful defense ........................ 48,600
New carrying value ........................ $301,394
Remaining life = 15 years
$301,394/15 = ............................. $ 20,093

2005: Carrying value, Jan. 1, 2004 .............. $301,394

Amortization for 2004 ..................... 20,093
Carrying value, Jan. 1, 2005 .............. $281,301

Remaining life = 5 years

$281,301/5 = .............................. $ 56,260

OBJ: LO 5

326
4. In 2004, Silverspur Mining Inc. purchased land for $5,600,000 that had a natural resource supply
estimated at 4,000,000 tons. When the natural resources are removed, the land has an estimated
value of $640,000. The required restoration cost for the property is estimated to be $800,000.

Development and road construction costs on the land were $560,000, and a building was con-
structed at a cost of $88,000 with an estimated $8,000 salvage value when all the natural re-
sources have been extracted.

During 2005, additional development costs of $272,000 were incurred, but additional resources
were not discovered. Production for 2004 and 2005 was 700,000 tons and 900,000 tons, respect-
ively.

Compute the depletion charge for 2004 and 2005. (Include depreciation on the building, if any, as
a depletion charge.) Round depletion charge to the nearest cent.

ANS:

Acquisition costs .................................... $5,600,000

Restoration costs .................................... 800,000
Residual value--land ................................. (640,000)
Development costs .................................... 560,000
Building ............................................. 88,000
Salvage value--building .............................. (8,000)
$6,400,000
$6,400,000/4,000,000 tons = $1.60 per ton

2004: 700,000 tons × $1.60 = ...................... $1,120,000

2005: Original cost ............................... $6,400,000
Additional costs--2005 ...................... 272,000
6,672,000
Estimated depletion--2004 ................... (1,120,000)
Balance subject to depletion ................ $5,552,000

$5,552,000/3,300,000 tons = $1.68 per ton (rounded)

900,000 tons × $1.68 = .............................. $1,512,000

OBJ: LO 2

5. Information concerning Thomas Corporation's intangible assets is as follows:

Thomas incurred $352,000 of experimental and development costs in its laboratory to develop a
patent that was granted on January 2, 2005. Legal fees and other costs associated with registration
of the patent totaled $65,600. Thomas estimates that the useful life of the patent will be eight
years.

A second patent was purchased from Johnson Company for $160,000 on July 1, 2002. Expendit-
ures for successful litigation in defense of this patent totaling $40,000 were paid on July 1, 2005.
Thomas estimates that the useful life of the patent will be 20 years from the date of acquisition.

Prepare a schedule showing the intangible assets section of Thomas' balance sheet at December
31, 2005.

ANS:

327
 Thomas Corporation
Balance Sheet (partial)
December 31, 2005

Patent, net of accumulated amortization of $8,200 ...... $ 57,400*

Patent, net of accumulated amortization of $29,176 .. 170,824**
$ 228,224

* Patent
Capitalized cost of patent at January 2, 2005 ........ $ 65,600
Amortization ($65,600/8 years) ....................... (8,200)
Balance: December 31, 2005 ........................... $ 57,400

Accumulated
** Patent Cost Amortization
Cost of Patent ............................ $160,000
Amortization
(July 1, 2002 - Dec. 31, 2004)
($160,000/20 × 2 1/2) .................. $20,000
Amortization
(Jan. 1, 2002 - June 30, 2005)
($8,000 × 1/2) ......................... 4,000
Cost of successful defense ................. 40,000 ________
$200,000 $24,000
Amortization
(July 1, 2005 - Dec. 31, 2005)
[($200,000 - $24,000)/17] × 1/2 ........ 5,176
$200,000 $29,176
Deduct accumulated amortization ........... 29,176
Patent balance ............................ $170,824

OBJ: LO 2

6. Riley Company owns a machine that cost $560,000, has a book value of $240,000, and an estim-
ated fair value of $480,000. Fizzer Company has a machine that cost $720,000, has accumulated
depreciation of $400,000, and an estimated fair value of $640,000. The machines of both com-
panies are of the same type and perform the same function. Riley and Fizzer, both in the same
line of business, trade assets and Riley pays Fizzer cash of $160,000.

(1) Record the exchange on Riley Company's books.

(2) Record the exchange on Fizzer Company's books.

ANS:

(1)
Riley Company's books
Machinery ................................. 640,000
Accumulated Depreciation .................. 320,000
Machinery ............................... 560,000
Cash .................................... 160,000
Gain on Exchange of Asset ............... 240,000*

* Because cash equals 25% or more of the fair value of the exchange.

(2)

328
 Fizzer Company's books
Cash ...................................... 160,000
Machinery ................................. 480,000
Accumulated Depreciation .................. 400,000
Machinery ............................... 720,000
Gain on Exchange of Asset ............... 320,000*

* Cost .................................... $720,000

Accumulated depreciation ................ 400,000
Book value .............................. $320,000
Fair value .............................. 640,000
Gain .................................... $320,000

OBJ: LO 6

7. The Chase Company exchanged equipment costing $240,000 with accumulated depreciation of
$90,000 for equipment owned by Jones Corporation. The Jones equipment cost $330,000 with
accumulated depreciation of $120,000. The fair value of both pieces of equipment was $300,000.

Provide the necessary entries to record the transaction on both companies' books assuming:

(1) The assets exchanged are similar and Chase and Jones are in the same line of busi-
ness.
(2) The assets exchanged are dissimilar.

ANS:

(1)
Chase: Equipment ....................... 150,000
Accumulated Depreciation ........ 90,000
Equipment ..................... 240,000

Jones: Equipment ....................... 210,000

Accumulated Depreciation ........ 120,000
Equipment ..................... 330,000

(2)
Chase: Equipment ....................... 300,000
Accumulated Depreciation ........ 90,000
Equipment ..................... 240,000
Gain on Exchange of Equipment . 150,000

Jones: Equipment ....................... 300,000

Accumulated Depreciation ........ 120,000
Equipment ..................... 330,000
Gain on Exchange of Equipment . 90,000

OBJ: LO 6

8. Seaver Inc. exchanged a machine costing $400,000 with accumulated depreciation of $280,000
for a machine from the Goodin Company. Goodin paid $20,800 cash in addition to its machine
(which cost $200,000 with accumulated depreciation of $68,000) for the Seaver machine. The
Goodin machine has a fair value of $160,000.

Provide the necessary entries to record the transactions on both companies' books assuming the
machines are similar and Seaver and Goodin are in the same line of business.

329
 ANS:

Goodin: Machinery ........................... 152,800

Accumulated Depreciation ............ 68,000
Machinery ........................... 200,000
Cash ................................ 20,800

Seaver: Machinery ........................... 106,195

Accumulated Depreciation ............ 280,000
Cash ................................ 20,800
Machinery ........................... 400,000
Gain on Exchange of Machinery ....... 6,995*
*[$20,800/($20,800 + $160,000)] × ($180,800 - $120,000) =
$6,995

OBJ: LO 6

9. Johnson Company purchased equipment 8 years ago for $1,000,000. The equipment has been de-
preciated using the straight-line method with a 20-year useful life and 10% residual value. John-
son's operations have experienced significant losses for the past 2 years and, as a result, the com-
pany has decided that the equipment should be evaluated for possible impairment. The manage-
ment of Johnson Company estimates that the equipment has a remaining useful life of 7 years.
Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is
$240,000.

(1) Determine if an impairment loss should be recognized.

(2) Determine the amount of the loss and prepare the journal entry to record the loss.
(3) How would your answer to (1) change if the fair value of the building was
$500,000?

ANS:
(1)
Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Cur-
rent book value of the equipment is:

Original cost ........................................ $1,000,000

Accumulated depreciation ($45,000 × 8 years) ......... 360,000
Book value ........................................... $ 640,000

The book value of $640,000 is compared to the undiscounted sum of the future cash flows to de-
termine whether the equipment is impaired. The sum of the future cash flows is less, so an
impairment loss should be recognized.

(2)
The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book
value of the equipment and its fair value. The impairment loss would be recorded as follows:

Accumulated Depreciation--Equipment ........ 360,000

Loss on Impairment of Equipment ............ 400,000
Equipment ($1,000,000 - $240,000) .......... 760,000

(3)

330
 The answer to (1) is unaffected by the fair value of the asset. The existence of an impairment loss
is determined solely by using the undiscounted sum of estimated future cash flow, not the fair
value of the asset.

OBJ: LO 4

10. Johnson Company is located in Hong Kong and uses international accounting standards. Johnson
Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated
using the straight-line method with a 20-year useful life and 10% residual value. Johnson's opera-
tions have experienced significant losses for the past 2 years and, as a result, the company has de-
cided that the equipment should be evaluated for possible impairment. The management of John-
son Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow
from the equipment will be $80,000 per year. The fair value of the equipment is $240,000. No
goodwill was associated with the purchase of the equipment. Johnson Company has chosen to re-
cognize increases in the value of long-term operating assets in accordance to the allowable altern-
ative under IAS 16.

(1) Determine if an impairment loss should be recognized.

(2) Determine the amount of the loss and prepare the journal entry to record the loss.
(3) What journal entry should Johnson Company make if the fair value of the building
was $980,000?

ANS:
(1)
Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Cur-
rent book value of the equipment is:
Original cost ........................................ $1,000,000
Accumulated depreciation ($45,000 × 8 years) ......... 360,000
Book value ........................................... $ 640,000

According to IAS 36, the existence of impairment is determined by comparing book value of
$640,000 to the fair value of $240,000. The fair value is lower, so an impairment loss should be
recognized. In this case, the determination of the existence of an impairment loss is based on is
based on a comparison of book value and fair value; under U.S. GAAP, the test is based on a
comparison of book value and the undiscounted sum of future cash flows.

(2)
The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book
value of the equipment and its fair value. The impairment loss would be recorded as follows:
Accumulated Depreciation--Equipment ........ 360,000
Loss on Impairment of Equipment ............ 400,000
Equipment ($1,000,000 - $240,000) ........ 760,000

(3)
Since the fair value of $980,000 is greater than the book value of $640,000, Johnson Company
will recognize $340,000 ($980,000 - $640,000) as an upward asset revaluation. The upward re-
valuation is recorded as follows:
Accumulated Depreciation--Equipment ........ 360,000
Revaluation Equity Reserve ............... 340,000
Equipment ($1,000,000 - $980,000) ........ 20,000

OBJ: LO 4

331
11. A recently issued FASB standard requires that an impairment loss be recognized if the sum of the
expected future net cash inflows (undiscounted and without interest charges) is less than the car-
rying value of the asset. The amount of the impairment loss recognized is the amount by which
the carrying amount of the asset exceeds the fair value of the asset.

Provide examples of events or changes in circumstances that indicate that the recoverability of
the carrying amount of an asset may have been impaired.

Evaluate the recognition criterion proposed by the FASB, specifically addressing the issue of us-
ing the undiscounted sum of the future net cash flows.

ANS:
The following are examples of events or changes in circumstances that may indicate that the car-
rying amount of an asset may not be recoverable:

a. A significant decrease in the market value of an asset.

b. A significant change in the extent or manner in which an asset is used.

c. A significant adverse change in legal factors or in the business climate that affects
the value of an asset.

d. An accumulation of costs significantly in excess of the amount originally expected

to acquire or construct an asset.

e. A projection or forecast that demonstrates continuing losses associated with an as-

set.

The use of the sum of the expected future net cash flows (undiscounted and without interest
charges) as a criterion for impairment appears to contradict modern theories both of accounting
and finance. The time value of money should be considered at a minimum as an element of cost
recovery.

The FASB, however, believes that including the time value of money in the test for impairment
poses some significant problems. The first is the difficulty of associating the actual outstanding
debt with individual assets. The only practical application would be the use of an incremental
borrowing rate which may result in a very close approximation of the present values of the cash
flows. The second problem relates to the fact that each entity has a different incremental borrow-
ing rate because different entities have different debt capacities. The result of these entity-unique
borrowing rates is that different present values would result for similar impaired assets because
the assets are owned by different entities having different debt capacities. The FASB's solution of
using the sum of the expected future net cash flows (undiscounted and without interest charges)
avoids not only the problems associated with the discount rate but also the necessity of projecting
the timing of cash flows. This approach uses information that is generally available to the entity
and allows a more expeditious evaluation of an asset's compliance with the established recogni-
tion criterion.

OBJ: LO 4

332
12. Anaconda Mining Company has a copper mine in Nevada operating at a reduced level of produc-
tion for the past two years. The market for copper has been adversely affected by weak prices,
low demand, and foreign competition. Management believes that the market likely will improve
next year and does not plan to abandon this facility. Nevertheless, the contoller of the company
plans to test the plant and equipment of the operation for impairment due to the decrease in its
use. The plant and equipment used in this operation were acquired five years ago for $1,600,000
and have been depreciated using straight-line depreciation over a 20-year life with no residual
value. The controller estimates that the assets have a remaining useful life of 15 years and that
the following two cash flow scenarios are possible, with the indicated probabilites:

Future Cash Inflows Probability

Scenario 1 $58,000 per year for 15 years 80%
Scenario 2 $100,000 per year for 15
years 20%

The fair value of the plant and equipment is estimated to be $890,000.

Prepare the entry (if any) required to recognize the impairment loss.

ANS:
Book value of plant and equipment:

Cost $1,600,000
Accumulated depreciation:
($1,600,000/20) x 5 years 400,000
Book value $1,200,000

Calculation of undiscounted cash flows:

Probability-
Undiscounted Fu- Weighted Future
ture Cash Flows Probability Cash Flows
$58,000 x 15 =
Scenario 1 $870,000 80% $696,000
Scenario 2 $100,000 x 15 =
$1,500,000 20% 300,000
Total $996,000

A comparison of the undiscounted cash flows ($996,000) with the carrying value of the plant and
equipment ($1,200,000) reveals that an impairment has occurred. The amount of the impairment
loss is the carrying value minus the fair value of the plant and equipment:

Carrying value $1,200,000

Fair value 890,000
Impairment loss $ 310,000

The journal entry to record the impairment loss would be:

Accumulated depreciation 400,000

Loss on impairment of plant & equipment 310,000
Plant & Equipment 710,000
($1,600,000 - $890,000)

OBJ: LO 4

333
13. Bingham Mining Company has a copper mine in Australia. The company is subject to the pro-
nouncements of the International Accounting Standards Board, and, specifically, IFRS 16.
The plant and equipment used in this operation were acquired five years ago for $1,600,000 and
have been depreciated using straight-line depreciation over a 20-year life. The controller estim-
ates that the assets have a remaining useful life of 15 years.

The controller of the company is preparing the financial statements for the year just ended and
notes that the fair value of the plant and equipment is estimated to be $1,300,000 at the close of
last year.

Prepare the entry (if any) the controller should make under IFRS 16 relating to the current fair
value of the plant & equipment. Additionally, assume that the company sold the plant & equip-
ment for $1,300,000 immediately after the end of last year. Prepare the entry (if any) required
under IFRS 16.

ANS:
Book value of plant and equipment:

Cost $1,600,000
Accumulated depreciation:
($1,600,000/20) x 5 years 400,000
Book value $1,200,000

The entry required for revaluation of the plant and equipment would be:

Accumulated depreciation 400,000

Revaluation Equity Reserve 100,000
($1,300,000 - $1,200,000)
Plant & Equipment 300,000
($1,600,000 - $1,300,000)

The entries required upon the sale of the plant and equipment would be:

Cash 1,300,000
Plant & Equipment 1,300,000

Revaluation Equity Reserve 100,000

Retained Earnings 100,000

OBJ: LO 4

14. Bellows Bottling purchased for $800,000 a trademark for a very successful soft drink it markets
under the name BLAST!. The trademark was determined to have an indefinite life. A competitor
recently introduced a product that is in direct competition with the BLAST! product, thus sug-
gesting the need for an impairment test. Data gathered by Bellows suggests that the useful life of
the trademark is still indefinite, but the cash flows expected to be generated by the trademark
have been reduced either to $30,000 per year (with a probability of 80%) or to $60,000 per year
(with 20% probability). The appropriate risk-free interest rate is 5%. The appropriate risk-adjus-
ted interest rate is 10%.

Prepare the appropriate journal entry (if needed) to record the effect of the events described
above.

ANS:

334
 The estimate of the fair value of the intangible is computed as follows:

Present Value
of Indefinite Probability-
Future Cash Annual Cash Weighted
Inflows Flows Probability Present Value
Scenario 1 $30,000 $ 600,000 80% $480,000
Scenario 2 $60,000 $1,200,000 20% 240,000
Total estimated
fair value $720,000

1
The present value of a stream of indefinite, or infinite, annual cash flows is a perpetuity calcu-
lated by dividing the annual cash flow by the discount rate (annual cash flow/discount rate).

Since the estimated fair value of the trademark is less than its book value ($720,000 < $800,000),
the intangible asset is impaired. The impairment loss is recognized with the following journal
entry:

Impairment Loss ($800,000 - $720,000) 80,000

Trademark 80,000

OBJ: LO 5

15. Wilbur Company acquired Smith Company on January 1, 2005. As part of the acquisition,
$1,000,000 in goodwill was recognized and assigned to Wilbur's Transportation reporting unit.
For 2005, earnings from the Transportation reporting unit were $450,000. Separately traded
companies with operations similar to the Transprotation reporting unit had market values approx-
imately equal to five times earnings. As of December 31, 2005, book values and fair values of
the Transportation reporting unit were:

Book Values Fair Values

Intangible Assets $4,000,000 $4,500,000
Goodwill $1,000,000 -
Liabilities $2,500,000 $2,500,000

Prepare the impairment test of goodwill as well as any entry needed to record an impairment loss.

ANS:
Using the earnings multiple, the fair value of the Transportation reporting unit is estimated to be
$2,250,000 ($450,000 x 5).

The book value of the net assets of the Transportation reporting unit is:

($4,000,000 + $1,000,000) - $2,500,000 = $2,500,000.

335
The implied fair value of goodwill is computed as follows:

Estimated fair value of Transportation reporting unit $2,250,000

Fair value of identifiable net assets ($4,500,000 - $2,500,000) 2,000,000
Implied fair value of goodwill $ 250,000

The implied fair value of goodwill is less than the recorded amount of goodwill ($250,000 <
$1,000,000). The journal entry to record the goodwill impairment loss is:

Goodwill Impairment Loss 750,000

Goodwill ($1,000,000 - $250,000) 750,000

OBJ: LO 5

336