Tutorial 6

Chapter 10
Plant Assets, Natural Resources, and Intangibles

Review Questions
1. How does depreciation relate to a plant asset?
Business need to allocate the cost of plant assets over the years that the asset is expected to be used.
This allocation of a plant asset’s cost over its useful life is called depreciation and follows the
matching principle. The matching principle ensures that all expenses are matched against the
revenues of the period. Because plant assets are used over several years, a business will spread the
cost of the asset over several years. All plant assets except land are depreciated. We record no
depreciation for land because its value typically does not decline with use.
2. Define the cost principle.
The cost principle is a principle that states that acquired assets and services should be recorded at
their actual cost.
3. List three amounts included in the cost of land paid by the purchaser.
The cost of land paid by the purchaser includes the purchase price, brokerage commission, and
survey and legal fees among others.
4. Explain the relative-market-value method.
The relative-market-value method is a method of allocating the total cost (100%) of multiple assets
purchased at one time. Total cost is divided among the assets according to their relative market
values.
5. Explain two categories of spending on plant assets after acquisition.
Accountants divide spending on plant assets after the acquisition into Capital expenditures and
Revenue expenditures. Capital Expenditure is an expenditure that increases the capacity or
efficiency of a plant asset or extends its useful life. Capital expenditures are debited to an asset
account. Revenue Expenditure is an expenditure that does not increase the capacity or efficiency of
an asset or extend its useful life. Revenue expenditures are debited to an expense account.
6. When is an asset considered obsolete?
An asset is considered obsolete when a newer asset can perform the job more efficiently than the old.
© 2016 Pearson Education, Ltd. 10-1

7. Depreciation of a plant asset is based on three main factors. List and briefly explain all of them?
Depreciation of a plant asset is based on capitalized cost, estimated useful life, and estimated
residual value. Capitalized cost is a known cost and includes all items spent for the asset to perform
its intended function. The other two factors are estimates. Estimated useful life is how long the
company expects it will use the asset. Estimated residual value—also called salvage value—is the
asset’s expected value at the end of its useful life. When a company decides to dispose of an asset,
the company will sell or scrap it. The residual value is the amount the company expects to receive
when the company disposes of the asset.
8. Define the straight-line method and give a simple example of how to calculate depreciation value
using the straight-line method.
Straight-Line Method is a depreciation method that allocates an equal amount of depreciation each
year. Therefore, it can be calculated as (Cost − Residual Value) / Useful Life. If a company
purchases an asset worth $40,000, with no residual value, and an estimated useful life of 8 years,
then its depreciation value using straight-line depreciation will be ($40,000 – 0)/8 = $5,000 per year.
9. Name and explain the depreciation method used for tax purposes.
The depreciation method specified for tax purposes is the Modified Accelerated Cost Recovery
System (MACRS). Under MACRS, assets are divided into specific classes, such as 3-year, 5-year, 7-
year, and 39-year property. Businesses do not get to choose the useful life of the asset. Instead, the
revenue service specifies the useful life based on the specific classes. For example, office furniture
has a 7-year life for tax purposes but might only be depreciated for five years for book purposes. In
addition, the MACRS method ignores residual value. For tax purposes, an asset is fully depreciated
to a book value of zero. MACRS is not acceptable for financial reporting under GAAP. This requires
that businesses record depreciation for plant assets under two methods—book method (straight-line,
units-of-production, or double-declining-balance) and tax method (MACRS).
10. What is the depreciation method that is used for tax accounting purposes? How is it different than
the methods that are used for financial accounting purposes?
Modified Accelerated Cost Recovery System (MACRS) is a method used for tax purposes. Under
MACRS, assets are divided into specific classes, such as 3-year, 5-year, 7-year, and 39-year
property. Businesses do not get to choose the useful life of the asset. In addition, the MACRS
method ignores residual value.
11. Differentiate between trademarks and copyright.
A copyright is an exclusive right to reproduce and sell a book, musical composition, film, or other
works of art, or intellectual property while a trademark is an asset that represents distinctive
identifications of a product or service.
12. What does a patent mean?
A patent is an intangible asset that is a federal government grant conveying an exclusive 20-year
right to produce and sell a process, product, or formula.
13. How is discarding of a plant asset different from selling a plant asset?
Discarding of plant assets involves disposing of the asset for no cash. Selling an asset involves
receiving cash in exchange for the asset.
14. How is gain or loss determined when disposing of plant assets? What situation constitutes a gain?
What situation constitutes a loss?
Gain or loss is determined by comparing the cash received and the market value of any other assets
received with the book value of the plant asset disposed of. A gain occurs when the cash received
and the market value of any other assets received is greater than the book value of the disposed plant
asset. A loss occurs when the cash received and the market value of any other assets received is less
than the book value of the disposed plant asset.
15. What is a natural resource? What is the process by which businesses spread the allocation of a
natural resource’s cost over its usage?
Natural resources are assets that come from the earth that are extracted or cut down. Examples
include iron ore, oil, natural gas, diamonds, coal, and timber. Depletion is the process by which
businesses spread the allocation of a natural resource’s cost over its usage.
16. What is an intangible asset? Provide some examples.
Intangible assets are assets that have no physical form. Instead, these assets convey special rights
from patents, copyrights, trademarks, and other creative works.
17. What is the process by which businesses spread the allocation of an intangible asset’s cost over its
useful life?
Amortization is the process by which businesses spread the allocation of an intangible asset’s cost
over its useful life.
18. What is goodwill? Is goodwill amortized? What happens if the value of goodwill has decreased at
the end of the year?
Goodwill is the excess of the cost of an acquired company over the sum of the market values of its
net assets (assets minus liabilities). Goodwill is the value paid above the net worth of the company’s
assets and liabilities. Goodwill is not amortized. Instead, the acquiring company measures the fair
value of its goodwill each year. If the goodwill has increased in value, there is nothing to record. But
if goodwill’s value has decreased, then the company records an impairment loss and writes the
goodwill down.
19. What does the asset turnover ratio measure, and how is it calculated?
The asset turnover ratio measures how efficiently a business uses its average total assets to generate
sales. Net sales / Average total assets.

20A. What does it mean if an exchange of plant assets has commercial substance? Are gains and losses
recorded on the books because of the exchange?
An exchange has commercial substance if the future cash flows change as a result of the
transaction. In other words, if in the future cash flows (receipts of revenue or payment of expenses)
of the business will change because of the exchange. Exchanges that have commercial substance
require any gain or loss on the transaction to be recognized. The old asset will be removed from
the books and the new asset will be recorded at its market value. Exchanges that lack commercial
substance ignore any gain or loss on the transaction, except in a few limited situations. The new
asset is recorded at the old asset’s book value plus cash paid minus cash received instead of at
market value.
Short Exercises
S10-1 Determining the cost of an asset
Learning Objective 1
Alton Clothing purchased land, paying $88,000 cash plus a $250,000 note payable. In addition, Alton
paid delinquent property tax of $1,900, title insurance costing $500, and $4,200 to level the land and
remove an unwanted building. Record the journal entry for purchase of the land.
SOLUTION
Purchase price of land $ 338,000

Add related costs:
Property taxes in arrears $ 1,900
Title insurance 500
Removal of building 4,200 6,600
Total cost of land $ 344,600
Date Accounts and Explanation Debit Credit

Land 344,600
Notes Payable 250,000
Cash 94,600
To record purchase of land with cash
and note payable.

S10-2 Making a lump-sum asset purchase
Foley Distribution Service paid $130,000 for a group purchase of land, building, and equipment. At the
time of the acquisition, the land had a market value of $70,000, the building $42,000, and the equipment
$28,000. Journalize the lump-sum purchase of the three assets for a total cost of $130,000, the amount
for which the business signed a note payable.
SOLUTION
× Total = Assigned
Market Purchase Cost of
Asset Value Percentage of Total Value Price Each Asset
Land $ 70,000 $70,000 / $140,000 = 50% × $130,000 = $ 65,000
Building 42,000 $42,000 / $140,000 = 30% × $130,000 = 39,000
Equipment 28,000 $28,000 / $140,000 = 20% × $130,000 = 26,000
Total $ 140,000 100% $ 130,000

Land 65,000
Building 39,000
Equipment 26,000
Notes Payable 130,000
To record purchase of land, building,
and equipment in exchange for note
payable.
S10-3 Computing first-year depreciation and book value

At the beginning of the year, Austin Airlines purchased a used airplane for $33,500,000. Austin Airlines
expects the plane to remain useful for five years (4,000,000 miles) and to have a residual value of
$5,500,000. The company expects the plane to be flown 1,100,000 miles during the first year.
Requirements
1. Compute Austin Airlines’s first-year depreciation expense on the plane using the following methods:
a. Straight-line
b. Units-of-production
c. Double-declining-balance
2. Show the airplane’s book value at the end of the first year for all three methods.

SOLUTION
Requirement 1
a. Straight-line = (Cost − Residual value) / Useful life

= ($33,500,000 ̶ $5,500,000) / 5 years
= $5,600,000 per year
b. Depreciation per unit = (Cost – Residual value) / Useful life in units

= ($33,500,000 ̶ $5,500,000) / 4,000,000 miles
= $7 per mile
Units-of-production = Depreciation per unit × Current year usage

= $7 per mile × 1,100,000 miles
= $7,700,000 for year 1
c. Double-declining-balance = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($33,500,000 ̶ $0) × 2 × (1/ 5 years)
= $13,400,000 for year 1
Requirement 2
Double-declining-
Straight-line Units-of-production balance
Cost $ 33,500,000 $ 33,500,000 $ 33,500,000
Less: Accumulated Depreciation 5,600,000 7,700,000 13,400,000
Book value $ 27,900,000 $ 25,800,000 $ 20,100,000
S10-4 Computing second-year depreciation and accumulated depreciation

At the beginning of 2016, Air Asia purchased a used airplane at a cost of $40,000,000. Air Asia expects
the plane to remain useful for eight years (5,000,000 miles) and to have a residual value of $5,000,000.
Air Asia expects the plane to be flown 1,200,000 miles the first year and 1,400,000 miles the second
year.
Requirements
1. Compute second-year (2017) depreciation expense on the plane using the following methods:
a. Straight-line
b. Units-of-production
c. Double-declining-balance
2. Calculate the balance in Accumulated Depreciation at the end of the second year for all three
methods.

SOLUTION
Requirement 1
a. Straight-line = (Cost − Residual value) / Useful life

= ($40,000,000 ̶ $5,000,000) / 8 years
= $4,375,000 per year
b. Depreciation per unit = (Cost – Residual value) / Useful life in units

= ($40,000,000 ̶ $5,000,000) / 5,000,000 miles
= $7 per mile

= $7 per mile × 1,200,000 miles
= $8,400,000 in year 1
= Depreciation per unit × Current year usage

= $7 per mile × 1,400,000 miles
= $9,800,000 in year 2
c. Double-declining-balance = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($40,000,000 ̶ $0) × 2 × (1/ 8 years)
= $10,000,000 in year 1
= (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($40,000,000 ̶ $10,000,000) × 2 × (1/ 8 years)
= $7,500,000 in year 2
Requirement 2
Units-of- Double-declining-
Straight-line production balance
Depreciation Expense – year 1 $ 4,375,000 $ 8,400,000 $ 10,000,000
Depreciation Expense – year 2 4,375,000 9,800,000 7,500,000
Total Accumulated Depreciation $ 8,750,000 $ 18,200,000 $ 17,500,000

S10-5 Calculating partial-year depreciation
On September 30, 2015, Meggie Services purchased a copy machine for $38,000. Meggie Services
expects the machine to last for four years and have a residual value of $2,000. Compute depreciation
expense on the machine for the year ended December 31, 2015, using the straight-line method.
SOLUTION
Straight-line = (Cost − Residual value) / Useful life × (Number of Months / 12)

= ($38,000 ̶ $2,000) / 4 years × (3/12)
= $2,250
S10-6 Changing the estimated life of an asset

Assume that ABC Catering Services paid $20,000 for equipment with a 10-year life and zero expected
residual value. After using the equipment for four years, the company determines that the asset will
remain useful for only three more years.
Requirements
1. Record depreciation expense on the equipment for year 5 by the straight-line method.
2. What is accumulated depreciation at the end of year 5?

SOLUTION
Requirement 1
Straight-line = (Cost − Residual value) / Useful life

= ($20,000 ̶ $0) / 10 years
= $2,000 per year
Accumulated depreciation after 4 years = $2,000 per year × 4 years

= $8,000
Book value after 4 years = (Cost – Accumulated Depreciation)

= $20,000 ̶ $8,000
= $12,000
Revised depreciation = (Book value − Revised residual value) / Revised useful life remaining
= ($12,000 ̶ $0) / 3 years
= $4,000 per year

End of Depreciation Expense—Equipment 4,000
Year 5 Accumulated Depreciation—Equip. 4,000
To record depreciation on equipment.
Requirement 2
Straight-line
Depreciation Expense – years 1– 4 $ 8,000
Depreciation Expense – year 5 4,000
Total Accumulated Depreciation $ 12,000

S10-7 Discarding of a fully depreciated asset
On June 15, 2015, Perfect Furniture discarded equipment that had a cost of $12,000, a residual value of
$0, and was fully depreciated. Journalize the disposal of the equipment.
SOLUTION

June 15 Accumulated Depreciation—Equipment 12,000
Equipment 12,000
Discarded fully depreciated equipment.
S10-8 Discarding an asset

On May 31, 2016, Choice Landscapes discarded equipment that had a cost of $29,400. Accumulated
Depreciation as of December 31, 2015, was $27,000. Assume annual depreciation on the equipment is
$2,400. Journalize the partial-year depreciation expense and disposal of the equipment.
SOLUTION
Partial year depreciation = $2,400 × 5/12 = $1,000
Market value of assets received $ 0

Less: Book value of asset disposed of
Cost $ 29,400
Less: Accumulated Depreciation ($27,000 + $1,000) (28,000) 1,400
Gain or (Loss) $ (1,400)

May 31 Depreciation Expense—Equipment 1,000
Accumulated Depreciation—Equipment 1,000
To record depreciation on equipment.
31 Accumulated Depreciation—Equipment 28,000

Loss on Disposal 1,400
Equipment 29,400
Discarded equipment with a book value of
$1,400.

S10-9 Selling an asset at gain or loss
Mill Creek Golf Club purchased equipment on January 1, 2016, for $31,500. Suppose Mill Creek Golf
Club sold the equipment for $22,000 on December 31, 2018. Accumulated Depreciation as of December
31, 2018, was $21,000. Journalize the sale of the equipment, assuming straight-line depreciation was
used.
SOLUTION
Market value of assets received $ 22,000

Cost $ 31,500
Less: Accumulated Depreciation (21,000) 10,500
Gain or (Loss) $ 11,500

Dec. 31 Cash 22,000
Equipment 31,500
Gain on Disposal 11,500
Sold equipment for cash.

S10-10 Selling an asset at gain or loss
Pelman Company purchased equipment on January 1, 2016, for $32,000. Suppose Pelman sold the
equipment for $5,000 on December 31, 2017. Accumulated Depreciation as of December 31, 2017, was
$22,000. Journalize the sale of the equipment, assuming straight-line depreciation was used.
SOLUTION

Cost $ 32,000
Less: Accumulated Depreciation (22,000) 10,000

Dec. 31 Cash 5,000
Equipment 32,000
Sold equipment for cash.

S10-11 Accounting for depletion of natural resources
North Coast Petroleum holds huge reserves of oil assets. Assume that at the end of 2016, North Coast
Petroleum’s cost of oil reserves totaled $60,000,000,000, representing 5,000,000,000 barrels of oil.
Requirements
1. Which method does North Coast Petroleum use to compute depletion?
2. Suppose North Coast Petroleum removed and sold 900,000,000 barrels of oil during 2017.
Journalize depletion expense for 2017.
SOLUTION
Requirement 1
Units-of-production is the method used to compute depletion.
Requirement 2
Depletion per unit = (Cost – Residual value) / Estimated total units

= ($60,000,000,000 ̶ $0) / 5,000,000,000 barrels
= $12 per barrel
Depletion expense = Depletion per unit × Number of units extracted

= $12 per barrel × 900,000,000 barrels
= $10,800,000,000

Dec. 31 Depletion Expense—Oil Reserves 10,800,000,000
Accumulated Depletion—Oil 10,800,000,000
Reserves
To record depletion.

S10-12 Accounting for an intangible asset
On March 1, 2016, Twist Company purchased a patent for $168,000 cash. Although the patent gives
legal protection for 20 years, the patent is expected to be used for only five years.
Requirements
1. Journalize the purchase of the patent.
2. Journalize the amortization expense for the year ended December 31, 2016. Assume straight-line
amortization.
SOLUTION
Requirement 1

Mar. 1 Patent 168,000
Cash 168,000
To record purchase of patent.
Requirement 2
Amortization expense = (Cost – Residual value) / Useful life

= ($168,000 ̶ $0) / 5 years × 10/12
= $28,000

Dec. 31 Amortization Expense—Patent 28,000
Patent 28,000
To record amortization of patent.

S10-13 Accounting for goodwill
TXL Advertising paid $250,000 to acquire Seacoast Report, a weekly advertising paper. At the time of
the acquisition, Seacoast Report’s balance sheet reported total assets of $140,000 and liabilities of
$80,000. The fair market value of Seacoast Report’s assets was $110,000. The fair market value of
Seacoast Report’s liabilities was $80,000.
Requirements
1. How much goodwill did TXL Advertising purchase as part of the acquisition of Seacoast Report?
2. Journalize TXL Advertising’s acquisition of Seacoast Report.
SOLUTION
Requirement 1
Purchase price to acquire Seacoast Report $ 250,000

Market value of Seacoast Report’s assets $ 110,000
Less: Seacoast Report’s liabilities (80,000)
Market value of Seacoast Report’s net assets 30,000
Goodwill $ 220,000
Requirement 2

Assets 110,000
Goodwill 220,000
Liabilities 80,000
Cash 250,000
To record purchase of Seacoast Report.

S10-14 Computing the asset turnover ratio
Balani, Inc. had net sales of $52,000,000 for the year ended May 31, 2016. Its beginning and ending
total assets were $53,200,000 and $98,400,000, respectively. Determine Balani’s asset turnover ratio for
year ended May 31, 2016.
SOLUTION
Asset turnover ratio = Net sales / Average total assets

= $52,000,000 / [($53,200,000 + $98,400,000) / 2]
= $52,000,000 / $75,800,000
= 0.69 times (rounded)
S10A-15 Exchanging plant assets

Appendix 10A
Alpha Communications, Inc. purchased a computer for $2,600, debiting Computer Equipment. During
2014 and 2015, Alpha Communications, Inc. recorded total depreciation of $1,800 on the computer. On
January 1, 2016, Alpha Communications, Inc. traded in the computer for a new one, paying $2,400 cash.
The fair market value of the new computer is $4,300. Journalize Alpha Communications, Inc.’s
exchange of computers. Assume the exchange had commercial substance.
SOLUTION

Less:
Book value of asset exchanged
Cost $ 2,600
Less: Accumulated depreciation (1,800) $ 800
Cash paid 2,400 3,200

Jan. 1 Computer Equipment (new) 4,300
Accumulated Depreciation—Computer 1,800
Equipment
Computer Equipment (old) 2,600
Cash 2,400
Exchanged old computer equipment and cash
for new computer equipment.

S10A-16 Exchanging plant assets
Appendix 10A
Orange Corporation purchased equipment for $30,000. Orange recorded total depreciation of $24,000 on
the equipment. On January 1, 2016, Orange traded in the equipment for new equipment, paying $23,500
cash. The fair market value of the new equipment is $28,500. Journalize Orange Corporation’s exchange
of equipment. Assume the exchange had commercial substance.
SOLUTION

Less:
Cost $ 30,000
Less: Accumulated depreciation (24,000) $ 6,000
Cash paid 23,500 29,500

Jan. 1 Equipment (new) 28,500
Equipment (old) 30,000
Cash 23,500
Exchanged old equipment and cash for new
equipment.

Exercises
E10-17 Determining the cost of assets
1. Land $365,000
Lavallee Furniture purchased land, paying $95,000 cash plus a $260,000 note payable. In addition,
Lavallee paid delinquent property tax of $3,000, title insurance costing $2,000, and $5,000 to level the
land and remove an unwanted building. The company then constructed an office building at a cost of
$450,000. It also paid $55,000 for a fence around the property, $16,000 for a sign near the entrance, and
$7,000 for special lighting of the grounds.
Requirements
1. Determine the cost of the land, land improvements, and building.
2. Which of these assets will Lavallee depreciate?
SOLUTION
Requirement 1
Land
Land Improvements Building
Purchase price $ 95,000
Note payable 260,000
Property tax 3,000
Title insurance 2,000
Remove building 5,000
Construct building $ 450,000
Fence $ 55,000
Sign 16,000
Lighting 7,000
Totals $ 365,000 $ 78,000 $ 450,000
Requirement 2
Lavallee will depreciate Land Improvements and Building.

E10-18 Making a lump-sum purchase of assets
Lot 3 $108,750
Dearwood Properties bought three lots in a subdivision for a lump-sum price. An independent appraiser
valued the lots as follows:
Dearwood paid $435,000 in cash. Record the purchase in the journal, identifying each lot’s cost in a
separate Land account. Round decimals to two places, and use the computed percentages throughout.
SOLUTION
× Total = Assigned
Lot 1 $ 45,000 $45,000 / $450,000 = 10% × $435,000 = $ 43,500
Lot 2 292,500 $292,500 / $450,000 = 65% × $435,000 = 282,750
Lot 3 112,500 $112,500 / $450,000 = 25% × $435,000 = 108,750
Total $ 450,000 100% $ 435,000

Land—Lot 1 43,500
Land—Lot 2 282,750
Land—Lot 3 108,750
Cash 435,000
To record purchase of lots for cash.

E10-19 Distinguishing capital expenditures from revenue expenditures
Consider the following expenditures:
Classify each of the expenditures as a capital expenditure or a revenue expenditure related to machinery.
SOLUTION
a. Capital expenditure
b. Revenue expenditure
c. Capital expenditure
d. Revenue expenditure
e. Capital expenditure
f. Capital expenditure
g. Capital expenditure
h. Capital expenditure
i. Capital expenditure

E10-20 Computing depreciation—three methods
1. Double-declining-balance, 12/31/17, Exp. $5,250
(Requirement 1 only)
Crackling Fried Chicken bought equipment on January 2, 2016, for $21,000. The equipment was
expected to remain in service for four years and to perform 3,600 fry jobs. At the end of the equipment’s
useful life, Crackling’s estimates that its residual value will be $3,000. The equipment performed 360
jobs the first year, 1,080 the second year, 1,440 the third, and 720 the fourth year.
Requirements
1. Prepare a schedule of depreciation expense, accumulated depreciation, and book value per year for
the equipment under the three depreciation methods. Show your computations. Note: Three
depreciation schedules must be prepared.
2. Which method tracks the wear and tear on the equipment most closely?
SOLUTION
Requirement 1
Depreciable cost = Cost − Residual value = $21,000 − $3,000 = $18,000
Straight-Line Depreciation Schedule

Depreciation for the Year
Asset Depreciable Depreciation Depreciation Accumulated Book
Date Cost Cost Rate Expense Depreciation Value
1/01/16 $ 21,000 $ 21,000
12/31/16 $ 18,000 1/4 $ 4,500 $ 4,500 16,500
12/31/17 18,000 1/4 4,500 9,000 12,000
12/31/18 18,000 1/4 4,500 13,500 7,500
12/31/19 18,000 1/4 4,500 18,000 3,000
Depreciation per unit = (Cost – Residual value) / Useful life in units

= ($21,000 ̶ $3,000) / 3,600 fry jobs
= $5 per fry job
Units-of-Production Depreciation Schedule

Asset Depreciation Number Depreciation Accumulated Book
Date Cost per Unit of Units Expense Depreciation Value
1/01/16 $ 21,000 $ 21,000
12/31/16 $5 360 $ 1,800 $ 1,800 19,200
12/31/17 5 1,080 5,400 7,200 13,800
12/31/18 5 1,440 7,200 14,400 6,600
12/31/19 5 720 3,600 18,000 3,000

E10-20, cont.
Requirement 1, cont.
Double-Declining-Balance Depreciation Schedule

Asset Book DDB Depreciation Accumulated Book
Date Cost Value Rate Expense Depreciation Value
1/01/16 $ 21,000 $ 21,000
12/31/16 $ 21,000 2 × (1 / 4) $ 10,500 $ 10,500 10,500
12/31/17 10,500 2 × (1 / 4) 5,250 15,750 5,250
12/31/18 5,250 2,250* 18,000 3,000
12/31/19 0 18,000 3,000
*3rd year depreciation is the “plug figure” needed to reduce book value to residual value ($5,250 - $3,000)
Requirement 2
The units-of-production method tracks the wear and tear on the equipment most closely.
E10-21 Changing an asset’s useful life and residual value

Yr. 16 $42,400
Budget Hardware Consultants purchased a building for $452,000 and depreciated it on a straight-line
basis over a 35-year period. The estimated residual value is $102,000. After using the building for 15
years, Budget realized that wear and tear on the building would wear it out before 35 years and that the
estimated residual value should be $90,000. Starting with the 16th year, Budget began depreciating the
building over a revised total life of 20 years using the new residual value. Journalize depreciation
expense on the building for years 15 and 16.

SOLUTION
Straight-line depreciation = (Cost − Residual value) / Useful life

= ($452,000 ̶ $102,000) / 35 years
= $10,000 per year
Accumulated depreciation after 15 years = $10,000 per year × 15 years

= $150,000
Book value after 15 years = (Cost – Accumulated Depreciation)

= $452,000 ̶ $150,000
= $302,000
Revised depreciation = (Book value − Revised residual value) / Revised useful life remaining
= ($302,000 − $90,000) / (20 total years – 15 previous years)
= $42,400 per year

Year 15 Depreciation Expense—Building 10,000
Accumulated Depreciation—Building 10,000
To record depreciation on building.
Year 16 Depreciation Expense—Building 42,400


E10-22 Recording partial-year depreciation and sale of an asset
Learning Objectives 2, 3
Depr. Exp. $2,400
On January 2, 2015, Ditto Clothing Consignments purchased showroom fixtures for $12,000 cash,
expecting the fixtures to remain in service for five years. Ditto has depreciated the fixtures on a double-
declining-balance basis, with zero residual value. On October 31, 2016, Ditto sold the fixtures for
$5,900 cash. Record both depreciation expense for 2016 and sale of the fixtures on October 31, 2016.
SOLUTION
Double-declining-balance = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($12,000 ̶ $0) × 2 × (1/5 years)
= $4,800 in year 1
= (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($12,000 ̶ $4,800) × 2 × (1/ 5 years) × 10/12
= $2,400 in year 2

Cost $ 12,000

Oct. 31 Depreciation Expense—Fixtures 2,400
Accumulated Depreciation—Fixtures 2,400
To record depreciation on fixtures.
31 Cash 5,900
Fixtures 12,000
Sold fixtures for cash.

E10-23 Recording partial-year depreciation and sale of an asset
Loss $(6,000)
On January 2, 2014, Pet Salon purchased fixtures for $48,200 cash, expecting the fixtures to remain in
service for nine years. Pet Salon has depreciated the fixtures on a straight-line basis, with $5,000
residual value. On May 31, 2016, Pet Salon sold the fixtures for $30,600 cash. Record both depreciation
expense for 2016 and sale of the fixtures on May 31, 2016.
SOLUTION

= ($48,200 ̶ $5,000) / 9 years
= $4,800 per year (2014 and 2015)
= (Cost − Residual value) / Useful life

= ($48,200 ̶ $5,000) / 9 years × 5/12
= $2,000 per partial year (2016)

Cost $ 48,200
Less: Accumulated Depreciation ($4,800 + $4,800 + $2,000) (11,600) 36,600

May 31 Depreciation Expense—Fixtures 2,000
To record depreciation on fixtures.
31 Cash 30,600
Fixtures 48,200
Sold fixtures for cash.

E10-24 Journalizing natural resource depletion
$1.20 per ton
Colorado Mountain Mining paid $507,700 for the right to extract mineral assets from a 500,000-ton
deposit. In addition to the purchase price, Colorado also paid a $600 filing fee, a $1,700 license fee to
the state of Nevada, and $90,000 for a geological survey of the property. Because Colorado purchased
the rights to the minerals only, it expects the asset to have zero residual value. During the first year,
Colorado removed and sold 60,000 tons of the minerals. Make journal entries to record (a) purchase of
the minerals (debit Minerals), (b) payment of fees and other costs, and (c) depletion for the first year.
SOLUTION
Purchase price of minerals $ 507,700

Add related costs:
Filing fee $ 600
License 1,700
Geological survey 90,000 92,300
Total cost of minerals $ 600,000

= ($600,000 ̶ $0) / 500,000 tons
= $1.20 per ton

= $1.20 per ton × 60,000 tons
= $72,000

a. Minerals 507,700
Cash 507,700
To record purchase of mineral rights.
b. Minerals 92,300
Cash 92,300
To record payment of costs associated with
purchase of minerals.
c. Depletion Expense—Minerals 72,000

Accumulated Depletion—Minerals 72,000

E10-25 Handling acquisition of patent, amortization, and change in useful life
2. Amort. Exp. $225,000
Medway Printers (MP) manufactures printers. Assume that MP recently paid $900,000 for a patent on a
new laser printer. Although it gives legal protection for 20 years, the patent is expected to provide a
competitive advantage for only eight years.
Requirements
1. Assuming the straight-line method of amortization, make journal entries to record (a) the purchase of
the patent and (b) amortization for the first full year.
2. After using the patent for four years, MP learns at an industry trade show that another company is
designing a more efficient printer. On the basis of this new information, MP decides, starting with
year 5, to amortize the remaining cost of the patent over two remaining years, giving the patent a
total useful life of six years. Record amortization for year 5.
SOLUTION
Requirement 1
Amortization expense = (Cost – Residual value) / Useful life
= ($900,000 ̶ $0) / 8 years
= $112,500

Patent 900,000
Cash 900,000
To record purchase of patent.
Amortization Expense—Patent 112,500

Patent 112,500
To record amortization.
Requirement 2
Accumulated amortization after 4 years = $112,500 per year × 4 years
= $450,000
Book value after 4 years = (Cost – Accumulated Amortization)

= $900,000 ̶ $450,000
= $450,000
Revised amortization = (Book value − Revised residual value) / Revised useful life remaining
= ($450,000 ̶ $0) / 2 years
= $225,000 per year
Accounts and Explanation Debit Credit

Date
Amortization Expense—Patent 225,000
Patent 225,000
To record amortization.
E10-26 Measuring and recording goodwill
2. Goodwill $7,000,000
Princess has acquired several other companies. Assume that Princess purchased Kettle for $11,000,000
cash. The book value of Kettle’s assets is $12,000,000 (market value,
$16,000,000), and it has liabilities of $12,000,000 (market value, $12,000,000).
Requirements
1. Compute the cost of the goodwill purchased by Princess.
2. Record the purchase of Kettle by Princess.
SOLUTION
Requirement 1
Purchase price to acquire Kettle $ 11,000,000

Market value of Kettle’s assets $ 16,000,000
Less: Kettle’s liabilities (12,000,000)
Market value of Kettle’s net assets 4,000,000
Goodwill $ 7,000,000
Requirement 2

Assets 16,000,000
Goodwill 7,000,000
Liabilities 12,000,000
Cash 11,000,000
To record purchase of Kettle.

E10-27 Computing asset turnover ratio
Snap Dragon Photo reported the following figures on its December 31, 2016, income statement and
balance sheet:
Compute the asset turnover ratio for 2016.
SOLUTION
Dec. 31, 2016 Dec. 31, 2015

Cash $ 26,000 $ 28,000
Accounts Receivable 56,000 58,000
Merchandise Inventory 79,000 76,000
Prepaid Expenses 8,000 14,000
Property, plant, and equipment, net 180,000 11,000
Total Assets $ 349,000 $ 187,000

= $440,000 / [($349,000 + $187,000) / 2]
= $440,000 / $268,000

E10A-28 Exchanging assets—two situations
Appendix 10A
2. Loss $(7,000)
Commerce Bank recently traded in office fixtures. Here are the facts:
Requirements
1. Record Commerce Bank’s trade-in of old fixtures for new ones. Assume the exchange had
commercial substance.
2. Now let’s change one fact. Commerce Bank feels compelled to do business with Shoreside
Furniture, a bank customer, even though the bank can get the fixtures elsewhere at a better price.
Commerce Bank is aware that the new fixtures’ market value is only $135,000. Record the trade-in.
Assume the exchange had commercial substance.

SOLUTION
Requirement 1

Less:
Cost $ 99,000
Cash paid 108,000 (142,000)
Gain or (Loss) $ 0

Fixtures (new) 142,000
Fixtures (old) 99,000
Cash 108,000
Exchanged old fixtures and cash for new
fixtures.
Requirement 2

Less:
Cost $ 99,000
Cash paid 108,000 (142,000)

Fixtures (new) 135,000
Fixtures (old) 99,000
Cash 108,000
Exchanged old fixtures and cash for new
fixtures.

E10A-29 Measuring asset cost, units-of-production depreciation, and asset trade
Learning Objectives 1, 2, 7
Appendix 10A
1. $12,870
Pact Trucking Corporation uses the units-of-production depreciation method because units-of-
production best measures wear and tear on the trucks. Consider these facts about one Mack truck in the
company’s fleet.
When acquired in 2013, the rig cost $450,000 and was expected to remain in service for 10 years or
1,000,000 miles. Estimated residual value was $120,000. The truck was driven 82,000 miles in 2013,
122,000 miles in 2014, and 162,000 miles in 2015. After 39,000 miles, on March 15, 2016, the company
traded in the Mack truck for a less expensive Freightliner. Pact also paid cash of $27,000. Fair market
value of the Mack truck was equal to its net book value on the date of the trade.
Requirements
1. Record the journal entry for depreciation expense in 2016.
2. Determine Pact’s cost of the new truck.
3. Record the journal entry for the exchange of assets on March 15, 2016. Assume the exchange had
commercial substance.

SOLUTION
Requirement 1

= ($450,000 ̶ $120,000) / 1,000,000 miles
= $0.33 per mile

= $0.33 per mile × 82,000 miles
= $27,060 in 2013

= $0.33 per mile × 122,000 miles
= $40,260 in 2014

= $0.33 per mile × 162,000 miles
= $53,460 in 2015

= $0.33 per mile × 39,000 miles
= $12,870 in 2016
Total accumulated depreciation = $27,060 + $40,260 + $53,460 + $12,870

= $133,650

Mar. 15 Depreciation Expense—Truck 12,870
Accumulated Depreciation—Truck 12,870
To record depreciation on truck.

E10A-29, cont.
Requirement 2

Less:
Cost $ 450,000
Less: Accumulated depreciation (133,650)* $ 316,350
Cash paid 27,000 343,350
Gain or (Loss) $ 0
*from Requirement 1
If the fair market value of the old truck is equal to its net book value, then the “trade-in” value of the old
truck is equal to the book value and there is no gain or loss on the exchange. Therefore, the cost of the
new truck is $343,350—the book value of the old truck plus the cash paid.
Requirement 3

Mar. 15 Truck (new) 343,350
Accumulated Depreciation—Truck 133,650
Truck (old) 450,000
Cash 27,000
Exchanged old truck and cash for new truck.

Problems (Group A)
P10-30A Determining asset cost and recording partial-year depreciation
1. Bldg. $446,100
Park and Fly, near an airport, incurred the following costs to acquire land, make land improvements, and
construct and furnish a small building:
Park and Fly depreciates land improvements over 20 years, buildings over 40 years, and furniture over
eight years, all on a straight-line basis with zero residual value.
Requirements
1. Set up columns for Land, Land Improvements, Building, and Furniture. Show how to account for
each cost by listing the cost under the correct account. Determine the total cost of each asset.
2. All construction was complete and the assets were placed in service on October 1. Record partial-
year depreciation expense for the year ended December 31.

SOLUTION
Requirement 1
Land
Land Improvements Building Furniture
Real estate taxes 5,500
Dirt and earthmoving 8,300
Fence $ 9,400
Building permit $ 1,200
Architect’s fee 20,600
Signs 9,700
Building materials 211,000
Building labor 172,000
Interest on construction loan 9,300
Parking lots 28,800
Lights for parking lots 10,600
Salary of construction supervisor 8,000 32,000
Furniture $ 11,600
Transportation of furniture 2,000
Additional fencing 6,000
Totals $102,200 $ 72,500 $ 446,100 $ 13,600
Requirement 2
Land Improvements = ($72,500 ̶ $0) / 20 years × (3/12)

= $906 (rounded)
Building = ($446,100 ̶ $0) / 40 years × (3/12)

= $2,788 (rounded)
Furniture = ($13,600 ̶ $0) / 8 years × (3/12)

= $425

P10-30A, cont.

Dec. 31 Depreciation Expense—Land Improvements 906
Accumulated Depreciation—Land Improvements 906
To record depreciation on land improvements.
31 Depreciation Expense—Building 2,788

31 Depreciation Expense—Furniture 425

Accumulated Depreciation—Furniture 425
To record depreciation on furniture.
P10-31A Determining asset cost, recording first-year depreciation, and identifying depreciation
results that meet management objectives
1. Units-of-production, 12/31/16, Dep. Exp. $14,000
On January 3, 2016, Fast Delivery Service purchased a truck at a cost of $62,000. Before placing the
truck in service, Fast spent $3,000 painting it, $1,500 replacing tires, and $3,500 overhauling the engine.
The truck should remain in service for five years and have a residual value of $5,000. The truck’s annual
mileage is expected to be 28,000 miles in each of the first four years and 18,000 miles in the fifth year—
130,000 miles in total. In deciding which depreciation method to use, Steven Kittridge, the general
manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-
production, and double- declining-balance).
Requirements
1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation
expense, accumulated depreciation, and asset book value.
2. Fast prepares financial statements using the depreciation method that reports the highest net income
in the early years of asset use. Consider the first year that Fast uses the truck. Identify the
depreciation method that meets the company’s objectives.

SOLUTION
Requirement 1
Purchase price of truck $ 62,000

Add related costs:
Painting $ 3,000
Tires 1,500
Engine overhaul 3,500 8,000
Total cost of truck $ 70,000

1/03/16 $ 70,000 $ 70,000
12/31/16 $ 65,000 1/5 $ 13,000 $ 13,000 57,000
12/31/17 65,000 1/5 13,000 26,000 44,000
12/31/18 65,000 1/5 13,000 39,000 31,000
12/31/19 65,000 1/5 13,000 52,000 18,000
12/31/20 65,000 1/5 13,000 65,000 5,000

P10-31A, cont.

= ($70,000 ̶ $5,000) / 130,000 miles
= $0.50 per mile

1/03/16 $ 70,000 $ 70,000
12/31/16 $ 0.50 28,000 $ 14,000 $ 14,000 56,000
12/31/17 0.50 28,000 14,000 28,000 42,000
12/31/18 0.50 28,000 14,000 42,000 28,000
12/31/19 0.50 28,000 14,000 56,000 14,000
12/31/20 0.50 18,000 9,000 65,000 5,000

1/03/16 $ 70,000 $ 70,000
12/31/16 $ 70,000 2 × (1 / 5) $ 28,000 $ 28,000 42,000
12/31/17 42,000 2 × (1 / 5) 16,800 44,800 25,200
12/31/18 25,200 2 × (1 / 5) 10,080 54,880 15,120
12/31/19 15,120 2 × (1 / 5) 6,048 60,928 9,072
12/31/20 9,072 4,072* 65,000 5,000
*5th year depreciation is the “plug figure” needed to reduce book value to residual value ($9,072 − $5,000)
Requirement 2
The depreciation method that reports the highest net income in the first year is the straight-line method.
It produces the lowest depreciation expense ($13,000) and therefore the highest net income.

P10-32A Recording lump-sum asset purchases, depreciation, and disposals
Sep. 1 Gain $88,000
Grace Carol Associates surveys American eating habits. The company’s accounts include Land,
Buildings, Office Equipment, and Communication Equipment, with a separate Accumulated
Depreciation account for each asset. During 2016, Grace Carol completed the following transactions:
Record the transactions in the journal of Grace Carol Associates.

SOLUTION

Jan. 1 Office Equipment 112,000
Cash 74,000
Note Payable 38,000
To record purchase of office equipment.
Apr. 1 Land 255,000

Communication Equipment 85,000
Cash 340,000
To record purchase of land and comm. equipment.
Sep. 1 Depreciation Expense—Building 8,000

Cash 380,000
Building 540,000
To record sale of building.
Dec. 31 Depreciation Expense—Communication Equipment 12,750

Accumulated Depreciation—Comm. Equipment 12,750
To record depreciation on communication equipment.
31 Depreciation Expense—Office Equipment 44,800

Accumulated Depreciation—Office Equipment 44,800
To record depreciation on office equipment.
Calculations:
Apr. 1 – Acquisition of land and communication equipment:
× Total = Assigned
Land $ 267,750 $267,750 / $357,000 = 75% × $340,000 = $ 255,000
Comm. Equip. 89,250 $89,250 / $357,000 = 25% × $340,000 = 85,000
Total $ 357,000 100% $ 340,000

P10-32A, cont.
Sep. 1 – Sale of building
Straight-line depreciation = (Cost − Residual value) / Useful life × (Number of Months / 12)
= ($540,000 ̶ $60,000) / 40 years × 8/12

Cost $ 540,000
Dec. 31 – Depreciation on communication equipment
= ($85,000 ̶ $0) / 5 years × 9/12
Dec. 31 – Depreciation on office equipment
Double-declining-balance depreciation = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= ($112,000 ̶ $0) × 2 × (1/5 years)
= $44,800 in 2016

P10-33A Accounting for natural resources
Dep. Exp. $1,186,250
Chapman Oil, Inc. has an account titled Oil and Gas Properties. Chapman paid $6,300,000 for oil
reserves holding an estimated 400,000 barrels of oil. Assume the company paid $560,000 for additional
geological tests of the property and $440,000 to prepare for drilling. During the first year, Chapman
removed and sold 65,000 barrels of oil. Record all of Chapman’s transactions, including depletion for
the first year.
SOLUTION
Purchase price of oil reserves $ 6,300,000

Add related costs:
Geological tests $ 560,000
Drilling preparation 440,000 1,000,000
Total cost of oil reserves $ 7,300,000

= ($7,300,000 ̶ $0) / 400,000 barrels
= $18.25 per barrel

= $18.25 per barrel × 65,000 barrels
= $1,186,250

Oil and Gas Properties 6,300,000
Cash 6,300,000
To record purchase of oil reserves.

Cash 1,000,000
To record payment of costs associated with purchase
of oil reserves.
Depletion Expense—Oil and Gas Properties 1,186,250

Accumulated Depletion—Oil and Gas Properties 1,186,250

P10-34A Accounting for intangibles
1. Goodwill $650,000
Middle Telecom provides communication services in Iowa, Nebraska, the Dakotas, and Montana.
Middle purchased goodwill as part of the acquisition of Shipley Wireless Enterprises, which had the
following figures:
Requirements
1. Journalize the entry to record Middle’s purchase of Shipley Wireless for $400,000 cash plus a
$600,000 note payable.
2. What special asset does Middle’s acquisition of Shipley Wireless identify? How should Middle
Telecom account for this asset after acquiring Shipley Wireless? Explain in detail.
SOLUTION
Requirement 1
Purchase price to acquire Shipley Wireless ($400,000 + $600,000) $1,000,000

Market value of Shipley Wireless’s assets $ 900,000
Less: Shipley Wireless’s liabilities (550,000)
Market value of Shipley Wireless’s net assets 350,000
Goodwill $ 650,000

Assets 900,000
Goodwill 650,000
Liabilities 550,000
Cash 400,000
Note Payable 600,000
To record purchase of Shipley Wireless.
Requirement 2
The acquisition identifies the asset goodwill.
Middle Telecom should measure the fair value of this asset each year. If this asset has increased in
value, Middle should record nothing. If the value of the asset has decreased, Middle should record an
impairment loss and write down goodwill.

P10A-35A Journalizing partial-year depreciation and asset disposals and exchanges
Appendix 10A
Jan. 1 Gain $7,000
During 2016, Zora Corporation completed the following transactions:
Record the transactions in the journal of Zora Corporation.

SOLUTION

Jan. 1 Office Equipment (new) 142,000
Office Equipment (old) 129,000
Cash 75,000
To record exchange of office equipment.
Apr. 1 Depreciation Expense—Equipment 2,400

To record partial year depreciation on equipment.
1 Cash 6,100
Loss on Disposal 500
Equipment 48,000
To record sale of equipment.
Dec. 31 Depreciation Expense—Office Equipment 71,000

Calculations:
Jan. 1 – Exchange of office equipment

Less:
Cost $ 129,000
Cash paid 75,000 135,000

P10-35A, cont.
Apr. 1 – Sale of equipment
= ($48,000 ̶ $0) / 5 years × 3/12

Cost $ 48,000
Gain or (Loss) $ (500)

= ($142,000 – $0) × 2 × (1/4 years)
= $71,000

Problems (Group B)
P10-36B Determining asset cost and recording partial-year depreciation
1. Bldg. $471,000
Park and Go, near an airport, incurred the following costs to acquire land, make land improvements, and
construct and furnish a small building:
Park and Go depreciates land improvements over 20 years, buildings over 50 years, and furniture over
eight years, all on a straight-line basis with zero residual value.
Requirements
1. Set up columns for Land, Land Improvements, Building, and Furniture. Show how to account for
each cost by listing the cost under the correct account. Determine the total cost of each asset.
2. All construction was complete and the assets were placed in service on July 1. Record partial-year
depreciation expense for the year ended December 31.

SOLUTION
Requirement 1
Land
Land Improvements Building Furniture
Real estate taxes 6,300
Dirt and earthmoving 8,100
Fence $ 9,200
Building permit $ 800
Architect’s fee 20,800
Signs 9,000
Building materials 215,000
Building labor 174,000
Interest on construction loan 9,400
Parking lots 29,500
Lights for parking lots 10,500
Salary of construction supervisor 9,000 51,000
Furniture $ 11,300
Transportation of furniture 2,200
Additional fencing 6,700
Totals $ 105,900 $ 73,900 $ 471,000 $ 13,500
Requirement 2
Land Improvements = ($73,900 ̶ $0) / 20 years × (6/12)

= $1,848 (rounded)
Building = ($471,000 ̶ $0) / 50 years × (6/12)

= $4,710
Furniture = ($13,500 ̶ $0) / 8 years × (6/12)

= $844 (rounded)

P10-36B, cont.

Dec. 31 Depreciation Expense—Land Improvements 1,848
Accumulated Depreciation—Land Improvements 1,848
To record depreciation on land improvements.
31 Depreciation Expense—Building 4,710

31 Depreciation Expense—Furniture 844

Accumulated Depreciation—Furniture 844
To record depreciation on furniture.
P10-37B Determining asset cost, recording first-year depreciation, and identifying depreciation
results that meet management objectives
1. Units-of-production, 12/31/16, Dep. Exp. $18,900
On January 3, 2016, Quick Delivery Service purchased a truck at a cost of $90,000. Before placing the
truck in service, Quick spent $2,500 painting it, $1,800 replacing tires, and $4,700 overhauling the
engine. The truck should remain in service for five years and have a residual value of $9,000. The
truck’s annual mileage is expected to be 21,000 miles in each of the first four years and 16,000 miles in
the fifth year—100,000 miles in total. In deciding which depreciation method to use, Harvey Warner,
the general manager, requests a depreciation schedule for each of the depreciation methods (straight-
line, units-of-production, and double-declining-balance).
Requirements
1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation
expense, accumulated depreciation, and asset book value.
2. Quick prepares financial statements using the depreciation method that reports the highest net
income in the early years of asset use. Consider the first year that Quick uses the truck. Identify the
depreciation method that meets the company’s objectives.

SOLUTION
Requirement 1
Purchase price of truck $ 90,000

Add related costs:
Painting $ 2,500
Tires 1,800
Engine overhaul 4,700 9,000
Total cost of truck $ 99,000

1/03/16 $ 99,000 $ 99,000
12/31/16 $ 90,000 1/5 $ 18,000 $ 18,000 81,000
12/31/17 90,000 1/5 18,000 36,000 63,000
12/31/18 90,000 1/5 18,000 54,000 45,000
12/31/19 90,000 1/5 18,000 72,000 27,000
12/31/20 90,000 1/5 18,000 90,000 9,000

P10-37B, cont.

= ($99,000 ̶ $9,000) / 100,000 miles
= $0.90 per mile

1/03/16 $ 99,000 $ 99,000
12/31/16 $ 0.90 21,000 $ 18,900 $ 18,900 80,100
12/31/17 0.90 21,000 18,900 37,800 61,200
12/31/18 0.90 21,000 18,900 56,700 42,300
12/31/19 0.90 21,000 18,900 75,600 23,400
12/31/20 0.90 16,000 14,400 90,000 9,000

1/03/16 $ 99,000 $ 99,000
12/31/16 $ 99,000 2 × (1 / 5) $ 39,600 $ 39,600 59,400
12/31/17 59,400 2 × (1 / 5) 23,760 63,360 35,640
12/31/18 35,640 2 × (1 / 5) 14,256 77,616 21,384
12/31/19 21,384 2 × (1 / 5) 8,554 86,170 12,830
12/31/20 12,830 3,830* 90,000 9,000
*5th year depreciation is the “plug figure” needed to reduce book value to residual value ($12,830 − $9,000)
Requirement 2
The depreciation method that reports the highest net income in the first year is the straight-line method.
It produces the lowest depreciation expense ($18,000) and therefore the highest net income.

P10-38B Recording lump-sum asset purchases, depreciation, and disposals
Sep. 1 Gain $68,000
Granny Carney Associates surveys American eating habits. The company’s accounts include Land,
Buildings, Office Equipment, and Communication Equipment, with a separate Accumulated
Depreciation account for each asset. During 2016, Granny Carney completed the following transactions:
Record the transactions in the journal of Granny Carney Associates.

SOLUTION

Jan. 1 Office Equipment 112,000
Cash 78,000
Note Payable 34,000
To record purchase of office equipment.
Apr. 1 Land 307,500

Communication Equipment 102,500
Cash 410,000
To record purchase of land and comm. equipment.
Sep. 1 Depreciation Expense—Building 8,000

Cash 360,000
Building 540,000
To record sale of building.
Dec. 31 Depreciation Expense—Communication Equipment 15,375

Accumulated Depreciation—Comm. Equipment 15,375
To record depreciation on communication equipment.
31 Depreciation Expense—Office Equipment 44,800

Calculations:
Apr. 1 – Acquisition of land and communication equipment:
× Total = Assigned
Land $ 322,875 $322,875 / $430,500 = 75% × $410,000 = $ 307,500
Comm. Equip. 107,625 $107,625 / $430,500 = 25% × $410,000 = 102,500
Total $ 430,500 100% $ 410,000

P10-38B, cont.
Sep. 1 – Sale of building
= ($540,000 ̶ $60,000) / 40 years × 8/12

Cost $ 540,000
Dec. 31 – Depreciation on communication equipment
= ($102,500 ̶ $0) / 5 years × 9/12

= ($112,000 ̶ $0) × 2 × (1/5 years)
= $44,800 in 2016

P10-39B Accounting for natural resources
Dep. Exp. $2,261,000
Gandy Oil Incorporated has an account titled Oil and Gas Properties. Gandy paid $6,100,000 for oil
reserves holding an estimated 300,000 barrels of oil. Assume the company paid $560,000 for additional
geological tests of the property and $480,000 to prepare for drilling. During the first year, Gandy
removed and sold 95,000 barrels of oil. Record all of Gandy’s transactions, including depletion for the
first year.
SOLUTION
Purchase price of oil reserves $ 6,100,000

Add related costs:
Geological tests $ 560,000
Drilling preparation 480,000 1,040,000
Total cost of oil reserves $ 7,140,000

= ($7,140,000 ̶ $0) / 300,000 barrels
= $23.80 per barrel

= $23.80 per barrel × 95,000 barrels
= $2,261,000

Cash 6,100,000
To record purchase of oil reserves.

Cash 1,040,000
To record payment of costs associated with purchase
of oil reserves.
Depletion Expense—Oil and Gas Properties 2,261,000

Accumulated Depletion—Oil and Gas Properties 2,261,000

P10-40B Accounting for intangibles
1. Goodwill $460,000
Central States Telecom provides communication services in Iowa, Nebraska, the Dakotas, and Montana.
Central States purchased goodwill as part of the acquisition of Shurburn Wireless Company, which had
the following figures:
Requirements
1. Journalize the entry to record Central States’s purchase of Shurburn Wireless for $360,000 cash plus
a $540,000 note payable.
2. What special asset does Central States’s acquisition of Shurburn Wireless identify? How should
Central States Telecom account for this asset after acquiring Shurburn Wireless? Explain in detail.
SOLUTION
Requirement 1
Purchase price to acquire Shurburn Wireless ($360,000 + $540,000) $ 900,000

Market value of Shurburn Wireless’s assets $1,000,000
Less: Shurburn Wireless’s liabilities (560,000)
Market value of Shurburn Wireless’s net assets 440,000
Goodwill $ 460,000

Assets 1,000,000
Goodwill 460,000
Liabilities 560,000
Cash 360,000
Note Payable 540,000
To record purchase of Shurburn Wireless.
Requirement 2
The acquisition identifies the asset goodwill.
Central States Telecom should measure the fair value of this asset each year. If this asset has increased
in value, Central States should record nothing. If the value of the asset has decreased, Central States
should record an impairment loss and write down goodwill.

P10A-41B Journalizing partial-year depreciation and asset disposals and exchanges
Appendix 10A
Jan. 1 Gain $8,000
During 2016, Dora Company completed the following transactions:
Record the transactions in the journal of Dora Company.

SOLUTION

Jan. 1 Office Equipment (new) 163,000
Office Equipment (old) 124,000
Cash 100,000
To record exchange of office equipment.
Apr. 1 Depreciation Expense—Equipment 2,700

To record partial year depreciation on equipment.
1 Cash 6,300
Equipment 54,000
To record sale of equipment.
Dec. 31 Depreciation Expense—Office Equipment 81,500

Calculations:
Jan. 1 – Exchange of office equipment

Less:
Cost $ 124,000
Cash paid 100,000 155,000

P10-41B, cont.
Apr. 1 – Sale of equipment
= ($54,000 ̶ $0) / 5 years × 3/12

Cost $ 54,000

= ($163,000 – $0) × 2 × (1/4 years)
= $81,500

Continuing Problem
P10-42 Calculating and journalizing partial-year depreciation
This problem continues the Daniels Consulting situation from Problem P8-41 of Chapter 8. Assume
Daniels Consulting had purchased a computer, $3,600, and office furniture, $3,000, on December 3 and
4, 2016, respectively, and that they were expected to last five years. Assume that both assets have a
residual value of $0.
Requirements
1. Calculate the amount of depreciation expense for each asset for the year ended December 31, 2016,
assuming the computer is depreciated using the straight-line method and the office furniture is
depreciated using the double-declining-balance method.
2. Record the entry for the one month’s depreciation.
SOLUTION
Requirement 1
Depreciation on computer
= ($3,600 ̶ $0) / 5 years × 1/12
= $60 per month
Depreciation on office furniture

= ($3,000 ̶ $0) × 2 × (1/5 years) × 1/12
= $100
Requirement 2

Dec. 31 Depreciation Expense—Computer 60
Accumulated Depreciation—Computer 60
To record depreciation on computer.
31 Depreciation Expense—Office Furniture 100

Accumulated Depreciation—Office Furniture 100
To record depreciation on office furniture.

Critical Thinking
Ethical Issue 10-1
Western Bank & Trust purchased land and a building for the lump sum of $3,000,000. To get the
maximum tax deduction, Western allocated 90% of the purchase price to the building and only 10% to
the land. A more realistic allocation would have been 70% to the building and 30% to the land.
Requirements
1. Explain the tax advantage of allocating too much to the building and too little to the land.
2. Was Western’s allocation ethical? If so, state why. If not, why not? Identify who was harmed.
SOLUTION
Requirement 1
The taxpayer wants to allocate as much of the purchase price as possible to the building because tax law
allows a deduction for depreciation of buildings. The greater the allocation to the building, the greater
the depreciation deduction and the lower the tax. The cost of the land, on the other hand, is not
depreciated, and generates no tax deductible expenses.
Requirement 2
Whether the taxpayer’s choice was ethical or unethical is a difficult call. If the taxpayer is deliberately
misrepresenting the true costs involved, that would be unethical. If the taxpayer is merely taking an
“aggressive position,” and is acting “in good faith,” then it becomes a legal matter for the IRS or tax
courts to decide. If the taxpayer is deliberately taking unfair deductions, then the nation’s taxpayers are
being shortchanged of their rightful tax revenues by dishonest behavior.

Fraud Case 10-1
Jim Reed manages a fleet of utility trucks for a rural county government. He’s been in his job for 30
years, and he knows where the angles are. He makes sure that when new trucks are purchased, the
residual value is set as low as possible. Then, when they become fully depreciated, they are sold off by
the county at residual value. Jim makes sure his buddies in the construction business are first in line for
the bargain sales, and they make sure he gets a little something back. Recently, a new county
commissioner was elected with vows to cut expenses for the taxpayers. Unlike other commissioners, this
man has a business degree, and he is coming to visit Jim tomorrow.
Requirements
1. When a business sells a fully depreciated asset for its residual value, is a gain or loss recognized?
2. How do businesses determine what residual values to use for their various assets? Are there “hard
and fast” rules for residual values?
3. How would an organization prevent the kind of fraud depicted here?
SOLUTION
Requirement 1
No gain or loss is recognized.
Requirement 2
Residual values are determined by judgment and experience. Although the IRS has standards for tax
purposes, businesses are free to set their own values for accounting purposes, as long as they are within
a reasonable range.
Requirement 3
An organization could arrange for public auction of surplus vehicles, which would allow the public to
bid on the assets, and would yield as high a price as possible in the open market. Furthermore, an
organization can employ auditors, either internal or external, who would look into policies related to
residual values and surplus sales. Residual values should be set based on industry standards or blue book
values. Alternatively, an independent person (not Jim Reed) should be in charge of setting the residual
values.

Financial Statement Case 10-1
Visit http://www.pearsonhighered.com/Horngren to view a link to Starbucks Corporation’s Fiscal

2013 annual report. Refer to the Starbucks Corporation financial statements, including Notes 1 and 7.
Answer the following questions.
Requirements
1. Which depreciation method does Starbucks Corporation use for reporting in the financial
statements? What type of depreciation method does the company probably use for income tax
purposes?
2. What was the amount of depreciation and amortization expense for the year ending September 29,
2013? (Hint: Review the Statement of Cash Flows.)
3. The statement of cash flows reports the cash purchases of property, plant, and equipment. How much
were Starbucks’s additions to property, plant, and equipment during the year ending 2013? Did
Starbucks record any proceeds from the sale of property, plant, and equipment?
4. What was the amount of accumulated depreciation at September 29, 2013? What was the net book
value of property, plant, and equipment for Starbucks as of September 29, 2013?
5. Compute Starbucks’s asset turnover ratio for year ending September 29, 2013. How does
Starbucks’s ratio compare with that of Green Mountain Coffee Roasters, Inc.?

SOLUTION
Requirement 1
Depreciation of property, plant, and equipment, which includes assets under capital leases, is provided
on the straight-line method over estimated useful lives, generally ranging from 2 to 15 years for
equipment and 30 to 40 years for buildings. Leasehold improvements are amortized over the shorter of
their estimated useful lives or the related lease life, generally 10 years.
Starbucks probably uses the Modified Accelerated Cost Recovery System (MACRS) for income tax
purposes.
Requirement 2
Depreciation and amortization expenses for the year ended September 29, 2013 were $655.6 million.
Requirement 3
Starbucks’ statement of cash flows for the year ended September 29, 2013 reports a cash outflow of
$1,151.2 million for additions to property, plant, and equipment and $15.3 million cash inflow from
proceeds from sale of property, plant, and equipment.
Requirement 4
As of September 29, 2013, Starbucks reports accumulated depreciation of $4,581.6 million on property,
plant, and equipment of $7,782.1 million, for a net book value of $3,200.5 million.
Requirement 5
(Amounts in millions)
= $14,892.2 / [($11,516.7 + $8,219.2) / 2]
= $14,892.2 / $9,867.95
Green Mountain Coffee Roasters has a ratio of 1.18. Starbucks has a higher ratio which indicates
Starbucks is more efficient at using its assets to generate sales.

Communication Activity 10-1
In 150 words or fewer, explain the different methods that can be used to calculate depreciation. Your
explanation should include how to calculate depreciation expense using each method.
SOLUTION
Student answers will vary, but should include the following points:
The straight-line method allocates an equal amount of depreciation to each year and is calculated as
follows:
The units-of-production method allocates a varying amount of depreciation (by units) to each year
based on an asset’s usage. The calculation is a two-step process.
Step 1: Depreciation per unit = (Cost – Residual value) / Useful life in units
Step 2: Units-of-production depreciation = Depreciation per unit × Current year usage
An accelerated depreciation method, such as the double-declining-balance method, expenses more

depreciation near the start of an asset’s life and less at the end. The double-declining-balance method
multiplies an asset’s decreasing book value by a constant percentage that is twice the straight-line
depreciation rate, 2 × (1 / Useful life). Double-declining-balance amounts can be computed as follows:

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Chapter 10

Plant Assets, Natural Resources, and Intangibles

2. Define the cost principle.

4. Explain the relative-market-value method.

5. Explain two categories of spending on plant assets after acquisition.

6. When is an asset considered obsolete?

© 2016 Pearson Education, Ltd. 10-1

11. Differentiate between trademarks and copyright.

12. What does a patent mean?

16. What is an intangible asset? Provide some examples.

© 2016 Pearson Education, Ltd. 10-3

Purchase price of land $ 338,000

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-4

Date Accounts and Explanation Debit Credit

S10-3 Computing first-year depreciation and book value

© 2016 Pearson Education, Ltd. 10-5

a. Straight-line = (Cost − Residual value) / Useful life

b. Depreciation per unit = (Cost – Residual value) / Useful life in units

Units-of-production = Depreciation per unit × Current year usage

c. Double-declining-balance = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

S10-4 Computing second-year depreciation and accumulated depreciation

© 2016 Pearson Education, Ltd. 10-6

a. Straight-line = (Cost − Residual value) / Useful life

b. Depreciation per unit = (Cost – Residual value) / Useful life in units

Units-of-production = Depreciation per unit × Current year usage

= Depreciation per unit × Current year usage

c. Double-declining-balance = (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

= (Cost – Accumulated depreciation) × 2 × (1 / Useful life)

© 2016 Pearson Education, Ltd. 10-7

Straight-line = (Cost − Residual value) / Useful life × (Number of Months / 12)

S10-6 Changing the estimated life of an asset

© 2016 Pearson Education, Ltd. 10-8

Straight-line = (Cost − Residual value) / Useful life

Accumulated depreciation after 4 years = $2,000 per year × 4 years

Book value after 4 years = (Cost – Accumulated Depreciation)

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-9

Date Accounts and Explanation Debit Credit

S10-8 Discarding an asset

Partial year depreciation = $2,400 × 5/12 = $1,000

Market value of assets received $ 0

Date Accounts and Explanation Debit Credit

31 Accumulated Depreciation—Equipment 28,000

© 2016 Pearson Education, Ltd. 10-10

Market value of assets received $ 22,000

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-11

Market value of assets received $ 5,000

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-12

Depletion per unit = (Cost – Residual value) / Estimated total units

Depletion expense = Depletion per unit × Number of units extracted

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-13

Date Accounts and Explanation Debit Credit

Amortization expense = (Cost – Residual value) / Useful life

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-14

Purchase price to acquire Seacoast Report $ 250,000

Date Accounts and Explanation Debit Credit

© 2016 Pearson Education, Ltd. 10-15

Asset turnover ratio = Net sales / Average total assets

S10A-15 Exchanging plant assets