Principles of Accounting 12th Edition Needles Solutions Manual

Principles of Accounting 12th Edition
Needles Solutions Manual

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CHAPTER 10—Solutions
LONG-TERM ASSETS
Discussion Questions
1. On the date of acquisition, the carrying value equals the current market value. After
that, it would be a coincidence if the carrying value equaled the market value.
2. A higher land valuation has the effect of increasing income because a smaller build-
ing valuation results in a lower amount to depreciate over the building's useful life.
3. An accelerated depreciation method is best for companies facing rapid technological

change. Companies use it to minimize the risk of obsolescence.
4. If cash received for the asset equals its carrying value, then no gain or loss occurs.
Also, if an asset has zero carrying value and is discarded, then no gain or loss occurs.
5. Annual depletion refers to units extracted, but depletion expense includes only units
sold. So annual depletion does not equal depletion expense when units extracted do
not equal units sold.
6. A company would amortize a patent over fewer years than the patent will last be-
cause the company would intend to sell the product over fewer years than the life of
the patent.
7. A company would spend millions of dollars on goodwill because the company anti-
cipates superior earnings and believes it will more than recoup the goodwill it
purchased.
8. The major advantage for a company that has positive free cash flow is that it has
extra funds to invest and expand.
10-1
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Short Exercises
SE1. Classifying Cost of Long-Term Assets
1. b 5. c
2. c 6. b
3. a 7. c
4. a 8. c
SE2. Group Purchase
Asset Appraisal Percentage Apportionment*

Land $ 400,000 25.0% $ 375,000
Land improvements 200,000 12.5% 187,500
Building 1,000,000 62.5% 937,500
Total $1,600,000 100.0% $1,500,000
* Land $1,500,000 × 25.0% = $ 375,000

Land improvements $1,500,000 × 12.5% = 187,500
Building $1,500,000 × 62.5% = 937,500
$1,500,000
SE3. Straight-Line Method
Depreciation for each year:

( $8,250 – $750 ) / 4 years = $1,875
SE4. Production Method
Depreciation for
2,400
Year 1: ( $8,250 – $750 ) × = $2,250
8,000
2,000
Year 2: ( $8,250 – $750 ) × = $1,875
8,000
2,200
Year 3: ( $8,250 – $750 ) × = $2,063 *
8,000
1,400
Year 4: ( $8,250 – $750 ) × = $1,313 *
8,000
*Rounded
10-2
SE5. Double-Declining-Balance Method
Depreciation for
Year 1: $8,250.00 × 50% = $4,125.00
Year 2: ( $8,250.00 – $4,125.00 ) × 50% = $2,062.50
Year 3: ( $4,125.00 – $2,062.50 ) × 50% = $1,031.25
Year 4: $7,500.00 – $7,218.75 * = $ 281.25 **
+ +
* $4,125.00 + $2,062.50 + $1,031.25 = $7,218.75
** Remaining amount to reduce to residual value:

$1,031.25 – $750.00 = $281.25
SE6. Disposal of Plant Assets: No Trade-In
1. Carrying Value = Equipment – Accumulated Depreciation—Equipment

= $32,400 – $18,000
= $14,400
2. a. Asset discarded as having no value

Gain (Loss) on Disposal of Equipment = Cash Received – Carrying Value
= $0 – $14,400
= $(14,400)
b. Asset sold for $6,000 cash

Gain (Loss) on Sale of Equipment = Cash Received – Carrying Value
= $6,000 – $14,400
= $(8,400)
c. Asset sold for $16,000 cash

= $16,000 – $14,400
= $1,600
10-3
SE7. Natural Resources
Depletion charge per ton:

( $16,000,000 – $2,400,000 ) / 4,000,000 tons = $3.40 per ton
Depletion expense for the first year:

600,000 tons × $3.40 = $2,040,000
Depreciation expense for the first year:

$19,200,000 × 600,000 tons / 4,000,000 tons ) = $2,880,000
SE8. Intangible Assets: Computer Software
The research and development costs are expensed as incurred. The costs after the work-
ing program was developed should be capitalized and amortized over the software's use-
ful life. After one year, the software would appear on the balance sheet as follows:
Intangible assets
Software $280,000 *
* $350,000 – ($350,000 / 5 years ) = $280,000
SE9. Management Issues
1. b 4. b
2. a 5. c
3. c 6. b
SE10. Free Cash Flow
Free Net Cash Flows from Purchases of Sales of

= – Dividends – +
Cash Flow Operating Activities Plant Assets Plant Assets
$23,000 = $194,000 – $25,000 – $158,000 + $12,000
This amount of free cash is the amount of cash that Maki Corporation has available for
other purposes, such as expansion or investment, after it deducts the funds it has com-
mitted to continue operations at the planned level.
10-4
Exercises: Set A
E1A. Recognition and Classification of Capital Expenditures
1. RE, OR
2. CE, B
3. CE, A
4. CE, N
5. CE, ER
6. RE, N
E2A. Recognizing and Classifying the Cost of Long-Term Assets
Cost of land:
Purchase price $300,000
Broker's fees 24,000
Title search and other fees 2,200
Demolition 8,000
Grading 4,200
Total cost of land $338,400
Cost of land improvements:

Paving parking lots $ 40,000
Lighting for parking lots 32,000
Signs for parking lots 6,400
Total cost of land improvements $ 78,400
A total of $338,400 should be debited to the Land account, and $78,400 should be debited
to the Land Improvements account.
E3A. Group Purchase
Asset Appraisal Percentage Apportionment*

Land $ 60,000 20% $ 48,000
Building 135,000 45% 108,000
Equipment 105,000 35% 84,000
$300,000 100% $240,000
* Land $240,000 × 20% = $ 48,000

Building $240,000 × 45% = 108,000
Equipment $240,000 × 35% = 84,000
$240,000
10-5
E4A. Cost of Long-Term Asset and Depreciation
Cost and depreciable cost of tractor:

Purchase price $17,500
New tires 1,100
Overhaul 1,400
Total cost $20,000
Less residual value 2,000
Depreciable cost $18,000
First year's depreciation:

$18,000 / 6 = $3,000
E5A. Depreciation Methods
Cost $90,000
Less estimated residual value 15,000
1. Depreciation computed by straight-line method:

$75,000 / 5 = $15,000
2. Depreciation computed by production method:

$75,000 × 48,000 / 200,000 = $18,000
3. Depreciation computed by double-declining-balance method:

2013 40%* × $90,000 = $36,000
2014 40% × ( $90,000 – $36,000 )
= 40% × $54,000 = $21,600
* 100% / 5 = 20%; 20% × 2 = 40%
Adjusting entry:
Depreciation Expense—Drilling Truck 21,600
Accumulated Depreciation—Drilling Truck 21,600
To record depreciation for 2014 using the
double-declining-balance method
Balance sheet presentation:

Property, plant, and equipment
Drilling truck $90,000
Less accumulated depreciation 57,600 *
$32,400
* $36,000 + $21,600 = $57,600
10-6
E6A. Double-Declining-Balance Method
Year 1 50%* × $1,120 = $560

Year 2 50% × ( $1,120 – $560 ) = 50%* × $560 = $280
Year 3 50% × ( $ 560 – $280 ) = 50% × $280 = $140
Year 4 $140 – estimated residual value = $140 – $120 = $ 20
* 100% / 4 = 25%; 25% × 2 = 50%
E7A. Revision of Depreciation Rates
Cost $623,120
Residual value 63,120
First-year depreciation:
$560,000 / 10 = $ 56,000
Second-year depreciation:
$560,000 / 10 = 56,000
Depreciation to date: $112,000
Remaining depreciable cost:

$560,000 – $112,000 = $448,000
Remaining useful life:

7 years – 2 years = 5 years
Third-year depreciation:
$448,000 / 5 = $89,600
10-7
E8A. Disposal of Plant Assets
Carrying Value = Equipment – Accumulated Depreciation—Equipment

= $64,800 – $36,000
= $28,800
1. Asset discarded as having no value

Gain (Loss) on Disposal of Equipment = Cash Received – Carrying Value
= $0 – $28,800
= $(28,800)
2. Asset sold for $12,000 cash

= $12,000 – $28,800
= $(16,800)
3. Asset sold for $36,000 cash

= $36,000 – $28,800
= $7,200
10-8
E9A. Disposal of Plant Assets
2015
July 1 Depreciation Expense—Computer 225
Accumulated Depreciation—Computer 225
To record one-half year's depreciation
on computer
( $2,500 – $250 ) / 5 years
× 6 / 12 = $225
1. 2015
July 1 Accumulated Depreciation—Computer 1,575
Loss on Disposal of Computer 925
Computer 2,500
Computer discarded after 3 1/2 years
3.5 years × $450 * = $1,575
2. 2015
July 1 Cash 400
Accumulated Depreciation—Computer 1,575
Loss on Sale of Computer 525
Computer 2,500
Computer sold for $400; loss recognized
3. 2015
July 1 Cash 1,100
Accumulated Depreciation—Computer 1,575
Gain on Sale of Computer 175
Computer 2,500
Computer sold for $1,100; gain recognized
*($2,500 – $250) / 5 years = $450/year
E10A. Natural Resource Depletion and Depreciation of Related Plant Assets
Depletion charge per ton:

( $8,800,000 – $500,000 ) / 5,000,000 tons = $1.66 per ton
Depletion expense for the first year:

750,000 tons × $1.66 = $1,245,000
10-9
E11A. Amortization of Copyrights and Trademarks
1. Cost of copyright $40,000

Estimated useful life ÷ 4 years
Annual amortization $10,000
2. Since the trademark's life is indefinite, it should be carried at cost and evaluated
annually for impairment.
Note that the copyright is limited by the period over which it will produce revenue,
whereas the trademark falls under the maximum life allowed.
E12A. Accounting for a Patent
a. Patent 1,030,000
Cash 1,030,000
To record purchase of patent on computer
b. Patent 450,000
Cash 450,000
Successful defense of patent
c. Amortization Expense 148,000
Patent 148,000
Annual amortization of patent
$1,480,000 / 10 years = $148,000
d. Loss on Write-off of Patent 1,184,000
Patent 1,184,000
Write-off of worthless patent
$1,480,000 – ( $148,000 × 2 )
= $1,184,000
E13A. Management Issues
1. a 5. b
2. c 6. a
3. c 7. b
4. c
E14A. Free Cash Flow
Free Net Cash Flows from Purchases of Sale of Plant

Cash Flow Operating Activities Plant Assets Assets
$(484,000) = $432,000 – $100,000 – $924,000 + $108,000
These results tell us that this company has a liquidity problem and needs to raise more
cash through financing activities to finance its purchases of plant assets.
Note to Instructor: Solutions for Exercises: Set B are provided separately on the Instructor's
Resource CD and website.
10-10
Problems
P1. Identification of Long-Term Assets Terminology
1. 1. i 6. c
2. d 7. j
3. a 8. b
4. e 9. h
5. g 10. f
2. The items that would be seen on an income statement are (g) depreciation, (h) de-
pletion, (i) amortization, and (j) revenue expenditures. Of these, only revenue ex-
penditures would result in an outlay of cash. Items (a)–(f) are assets or affect asset
accounts.
10-11
P2. Determining Cost of Assets
1. Cergo Computers
Schedule of Proper Charges for Training Center
December 31, 2014
Land
Land Improvements Building Equipment
Attorney's fee $ 34,900
Cost of land 598,000
Architect's fee, building design $ 102,000
Building 1,020,000
Parking lot and sidewalk $135,600
Electrical wiring, building 164,000
Landscaping 55,000
Survey cost 9,200
Training equipment $136,400
Equipment installation 68,000
Cost of grading the land 14,000
Soundproofing 59,200
Administrative salary* 12,800 6,400 38,400 6,400
Total cost $723,900 $142,000 $1,383,600 $210,800
* (2 months / 10 months) × $64,000 = $12,800;

(1 month / 10 months) × $64,000 = $6,400;
(6 months / 10 months) × $64,000 = $38,400;
(1 month / 10 months) × $64,000 = $6,400
2. The classification of the above items among several accounts will affect profitability
because each of the items has a different useful life. Land, for instance, is presumed
to have an unlimited life and is not depreciated. Expenses have an immediate impact
on earnings. The other accounts will be depreciated over different useful lives. All
of this is in the interest of achieving a proper application of accrual accounting.
10-12
P3. Comparison of Depreciation Methods
1. Depreciation Table
Depreciation Carrying
Method Year Computation Depreciation Value
a. Straight-line 1 $660,000 * / 4 $165,000 $555,000
2 660,000 / 4 165,000 390,000
3 660,000 / 4 165,000 225,000
4 660,000 / 4 165,000 60,000
6,000
b. Production 1 $660,000 × $198,000 $522,000
20,000
8,000
2 660,000 × 264,000 258,000
20,000
4,000
3 660,000 × 132,000 126,000
20,000
2,000
4 660,000 × 66,000 60,000
20,000
c. Double- 1 $720,000 × 50%† $360,000 $360,000
declining- 2 360,000 × 50% 180,000 180,000
balance 3 180,000 × 50% 90,000 90,000
4 90,000 – $60,000 ** 30,000 60,000
* $720,000 – $60,000 = $660,000

†
100% / 4 = 25%; 25% × 2 = 50%
** To reduce to estimated residual value.
2. If the robot was sold for $750,000 after year 2, the gain or loss under each method
follows:
a. A gain of $360,000 ( $750,000 – $390,000 )
b. A gain of $492,000 ( $750,000 – $258,000 )
c. A gain of $570,000 ( $750,000 – $180,000 )
3. Straight-line results in equal amounts of annual depreciation over the five years. The
production method results in variable amounts of depreciation and is unpredictable
from year to year. The accelerated method results in more depreciation in the earlier
years and less in the later years. The method of depreciation thus affects the reported
profitability of the company, but has no effect on cash flows. The entry to record de-
preciation expense does not involve the Cash account. Cash was expended as an in-
vesting activity when the asset was purchased.
10-13
a. Straight-line 1 $325,500 * / 6 $54,250 $306,250
2 325,500 / 6 54,250 252,000
3 325,500 / 6 54,250 197,750
4 325,500 / 6 54,250 143,500
5 325,500 / 6 54,250 89,250
6 325,500 / 6 54,250 35,000
1,800
b. Production 1 $325,500 × $58,590 $301,910
10,000
2,000
2 325,500 × 65,100 236,810
10,000
2,500
3 325,500 × 81,375 155,435
10,000
1,500
4 325,500 × 48,825 106,610
10,000
1,200
5 325,500 × 39,060 67,550
10,000
1,000
6 325,500 × 32,550 35,000
10,000
c. Double- 1 $360,500 × 33.33%† $120,155 $240,345
declining- 2 240,345 × 33.33% 80,107 160,238
balance 3 160,238 × 33.33% 53,407 106,831
4 106,831 × 33.33% 35,607 71,224
5 71,224 × 33.33% 23,739 47,485
6 47,485 – $35,000 ** 12,485 35,000
* $360,500 – $35,000 = $325,500

†
(100% / 6) × 2 = 33.33%
** To reduce to estimated residual value.
2. If the crane was sold for $250,000 after year 3, the gain or loss under each method
follows:
a. A gain of $ 52,250 ( $250,000 – $197,750 )
b. A gain of $ 94,565 ( $250,000 – $155,435 )
c. A gain of $143,169 ( $250,000 – $106,831 )
3. Straight-line results in equal amounts of annual depreciation over the six years. The
profitability of the company, but has no effect on operating cash flows. The entry to
record depreciation expense does not involve the Cash account. Cash was expended
as an investing activity when the asset was purchased.
10-14
P5. Natural Resource Depletion and Depreciation of Related Plant Assets
1. Cost of land and ore $3,300,000

Residual value of land (600,000)
Cost of ore $2,700,000
Estimated tons of ore ÷ 10,000,000
Depletion charge per ton $0.27
2. Tons of ore mined and sold 450,000

Depletion charge per ton × $0.27
Depletion expense $121,500
3. Cost of buildings $300,000

Percentage of depletion
( 450,000 / 10,000,000 ) × 0.045
Depreciation expense $ 13,500
4. Cost of equipment $360,000

Percentage of depletion × 0.045
a. Depreciation proportional to depletion $ 16,200
b. Depreciation, straight-line method
( $360,000 / 10 years) $ 36,000
5. If the company sold and mined 250,000 tons of ore instead of 450,000, the amount of
depletion expense and depreciation expense would decrease. The changes in deple-
tion expense and depreciation expense, in and of themselves, will not affect cash
flows, but the decrease in revenues will decrease cash flows. Profitability will also
decrease even though depletion and depreciation expenses decrease due to the
lower sales.
10-15
Alternate Problems
P6. Determining Cost of Assets
1. Krall Company
Schedule of Proper Charges to Asset and Expense Accounts
December 31, 2014
Land
Land Improvements Buildings Machinery Expense
Land $316,600
Surveying costs 4,100
Transfer of title and
other fees 920
Broker's fees 21,144
Attorney's fees 7,048
Timber removal 50,400
Grading land 4,200
Foundation
preparation $ 34,600
Architect's fee $ 12,960* 51,840*
Building construction 710,000
Sidewalks 11,400
Parking lots 54,400
Lighting for grounds 80,300
Landscaping 11,800
Machinery $ 989,000
Shipping cost 55,300
Installation 176,200
Testing 22,100
Safety adjustments 12,540
Damage to building $ 8,900
Injured employee 2,400
Water damage 6,820
Sale of timber (5,000)
Supervisory salaries** 15,000 7,500 37,500 7,500
Totals $426,212 $166,560 $833,940 $1,262,640 $18,120
* 20% × $64,800 = $12,960; 80% × $64,800 = $51,840

** ($48,000 + $42,000) ÷ 12 = $7,500 per month
2. The classification of the above items among several accounts will affect profitability
because each of the items has a different useful life. Land, for instance, is presumed
to have an unlimited life and is not depreciated. Expenses have an immediate im-
pact on earnings. The other accounts will be depreciated over different useful lives.
All of this is in the interest of achieving a proper application of accrual accounting.
10-16
a. Straight-line 1 $20,000 * / 4 $5,000 $17,500
2 20,000 / 4 5,000 12,500
3 20,000 / 4 5,000 7,500
4 20,000 / 4 5,000 2,500
1,200
b. Production 1 $20,000 × $4,000 $18,500
6,000
1,800
2 20,000 × 6,000 12,500
6,000
2,400
3 20,000 × 8,000 4,500
6,000
600
4 20,000 × 2,000 2,500
6,000
c. Double- 1 $22,500 × 50%† $11,250 $11,250
declining- 2 11,250 × 50% 5,625 5,625
balance 3 5,625 × 50% 2,813 ** 2,813
4 2,813 – $2,500 *** 313 2,500
* $22,500 – $2,500 = $20,000

†
100% / 4 = 25%; 25% × 2 = 50%
** Rounded
*** To reduce to estimated residual value
2. If the printer was sold for $12,000 after year 2, the gain or loss under each method
follows:
a. A loss of $500 ( $12,000 – $12,500 )
b. A loss of $500 ( $12,000 – $12,500 )
c. A gain of $6,375 ( $12,000 – $ 5,625 )
3. Straight-line results in equal amounts of annual depreciation over the five years. The
profitability of the company, but has no effect on cash flows. The entry to record de-
preciation expense does not involve the Cash account. Cash was expended as an in-
vesting activity when the asset was purchased.
10-17
a. Straight-line 1 $310,000 * / 6 $51,667 $298,333
2 310,000 / 6 51,667 246,666
3 310,000 / 6 51,667 194,999
4 310,000 / 6 51,667 143,332
5 310,000 / 6 51,667 91,665
6 310,000 / 6 51,665*** 40,000
1,800
b. Production 1 $310,000 × $55,800 $294,200
10,000
2,000
2 310,000 × 62,000 232,200
10,000
2,500
3 310,000 × 77,500 154,700
10,000
1,500
4 310,000 × 46,500 108,200
10,000
1,200
5 310,000 × 37,200 71,000
10,000
1,000
6 310,000 × 31,000 40,000
10,000
c. Double- 1 $350,000 × 33.33% † $116,655 $233,345
declining- 2 233,345 × 33.33% 77,774** 155,571
balance 3 155,571 × 33.33% 51,852** 103,719
4 103,719 × 33.33% 34,570** 69,149
5 69,149 × 33.33% 23,047** 46,102
6 46,102 – $40,000 *** 6,102 40,000
* $350,000 – $40,000 = $310,000

†
(100% / 6) × 2 = 33.33%
** Rounded
*** To reduce to estimated residual value
2. If the crane was sold for $500,000 after year 3, the gain or loss under each method
follows:
a. A gain of $305,001 ( $500,000 – $194,999 )
b. A gain of $345,300 ( $500,000 – $154,700 )
c. A gain of $396,281 ( $500,000 – $103,719 )
3. Straight-line results in equal amounts of annual depreciation over the six years. The
profitability of the company, but has no effect on operating cash flows. The entry to
record depreciation expense does not involve the Cash account. Cash was expended
as an investing activity when the asset was purchased.
10-18
P9. Natural Resource Depletion and Depreciation of Related Plant Assets
1. Cost of land and ore $4,400,000

Residual value of land (800,000)
Cost of ore $3,600,000
Estimated tons of ore ÷ 10,000,000
Depletion charge per ton $0.36
2. Tons of ore mined and sold 800,000

Depletion charge per ton × $0.36
Depletion expense $288,000
3. Cost of buildings $400,000

Percentage of depletion
( 800,000 / 10,000,000 ) × 0.08
Depreciation expense $ 32,000
4. Cost of equipment $480,000

Percentage of depletion × 0.08
a. Depreciation proportional to depletion $ 38,400
b. Depreciation, straight-line method
( $480,000 / 10 years) $ 48,000
5. If the company sold and mined 1,000,000 tons of ore instead of 800,000, the amount of
depletion expense and depreciation expense would increase. The changes in deple-
tion expense and depreciation expense, in and of themselves, will not affect cash
flows, but the increase in revenues will increase cash flows. Profitability will also
increase even though depletion and depreciation expenses increase because the
sale price exceeds the depletion cost per ton.
10-19
Cases
C1. Conceptual Understanding: Effect of Change in Estimates
The advantage to the airlines of increasing the useful life of aircraft is that the annual de-
preciation charge will decrease. This will serve to increase earnings or reduce losses of
the airlines. However, changing the amount of the annual depreciation expense will not
affect the amount of cash flows. Whatever problems the airlines have with liquidity will
continue. It is true that the useful life of most long-term assets can be extended by good
maintenance and testing, but the assets will eventually have to be replaced simply be-
cause new technology will make them obsolete. The costs of these assets benefit the use-
ful lives of the assets and should be allocated to that life to achieve a proper matching of
revenue and expenses. These depreciable costs are separate and apart from the main-
tenance and testing costs that are expenses in the years in which they occur.
C2. Conceptual Understanding: Impairment Test
Asset impairment occurs when the carrying value of a long-term asset exceeds its fair
value. When an impairment occurs, a loss is recorded and the recorded value of the asset
is reduced. This entry reduces the earnings of the current period but does not affect cash
flows. The concept of impairment is considered a conservative method because it recog-
nizes losses when fair value is below carrying value, but it does not recognize gains when
the fair value exceeds carrying value. This is in line with the convention of conservatism,
which holds that losses should be anticipated but gains should be deferred.
C3. Conceptual Understanding: Accounting Estimates
The two principal estimates that must be made to compute the annual depreciation charge
are the estimated useful life and the residual value. The two most important factors that
must be taken into consideration in making these estimates are the extent of physical de-
terioration that will occur and the rate at which the asset will become obsolete.
C4. Interpreting Financial Reports: Brands
Brands are recorded when purchased from other companies; therefore Starwood's asset
brands resulted from acquisition. However, if brands are internally developed or if a com-
pany only manages a brand for the owner, then no asset would be recorded for brands.
For one or both of these reasons, Marriott has no asset on its balance sheet for brands.
However, if another company wanted to buy Marriott's internally generated brands, the
Marriott brands would certainly have great value. Both Marriott and Starwood benefit from
their brands, but because Marriott has no asset for brands, it has no related amortization
expense and hence its net income and return on assets will be higher. Starwood has both
an asset for brands and related amortization expense that lowers both its net income and
return on assets. Therefore, a comparison of these two companies would result in Marriott
appearing to outperform Starwood.
10-20
C5. Annual Report Case: Long-Term Assets
1. In 2011, property and equipment, net constituted 13.1 percent ($8,467 / $64,543)
of total assets.
The main components of property and equipment were land, building and improve-
ments, fixtures and equipment, leasehold improvements, capitalized software, and
capital leases. Fixtures and equipment at over $7.5 billion of investment is the larg-
est component.
Leasehold improvements are improvements to leased property that become the

property of the lessor at the end of the lease. This is the second largest category
for CVS at over $3.0 billion. The company leases most of its stores, which results
in a demand for these types of improvements. Leasehold improvements are depre-
ciated over the life of the leases and thus reduce income by the amount of the de-
preciation (excluding tax effects).
2. Property, equipment, and improvements to leased premises are depreciated using

the straight-line method. Estimated useful lives generally range from 10 to 40 years
for buildings, building improvements, and leasehold improvements, and 3 to 10
years for fixtures and equipment and internally developed software. CVS will have
to remodel its stores several times over the life of the buildings because the fixtures
and equipment have shorter useful lives than the buildings.
3. When evaluating assets for impairment, CVS first compares the carrying value of the
asset to the asset's estimated future cash flows. If the estimated future cash flows
used in this analysis are less than the carrying amount of the asset, an impairment
loss calculation is prepared.
10-21
C6. Comparison Analysis: Long-Term Assets and Free Cash Flows
1. (in millions)
CVS 2011 2010
Property and equipment expenditures $1,872 $2,005
Net property and equipment $8,467 $8,322
Percentage 22.1%* 24.1%*
Southwest Airlines 2011 2010

Property and equipment expenditures $968 $493
Net property and equipment $12,127 $10,578
Percentage 8.0%* 4.7% *
*Rounded
Southwest is growing its property and equipment more rapidly (from 4.7% to 8.0%
per year).
2. (in millions)
Free Net Cash Flows from Purchases of Sales of
Cash Flow Operating Activities Plant Assets Plant Assets
CVS
2011 = $5,856 – $674 – $1,872 + $4
= $3,314
2010 = $4,779 – $479 – $2,005 + $34

= $2,329
Southwest
2011 = $1,385 – $14 – $968 + $0
= $403
2010 = $1,561 – $13 – $493 + $0

= $1,055
Both companies have positive free cash flow. This means both companies can fund
part of their expansion through operations.
10-22
C7. Ethical Dilemma: Ethics and Allocation of Acquisition Costs
Depreciation in and of itself does not affect cash flows because it is an allocation of the
cost of purchase and does not require a cash outlay when it is recorded. However, cash
flows are affected by the decision in that depreciation is deductible for tax purposes.
Thus, the decision that results in the higher level of annual depreciation (the controller's
plan) will have a possible effect on cash flows in that it will reduce income taxes by
$32,400 compared to the CFO's plan. This is an ethical dilemma to the extent that one or
the other of the plans is a false representation of the true situation. In cases like this, the
true allocation between land and building is unlikely to be precise and is a matter of
judgment. However, some reasonable allocation can usually be made based on separate
appraisals of the land and the building. The company and therefore the people who have
a stake in it, such as the stockholders and management, would probably benefit from the
approach that would save income taxes. Thus, to the extent that an appraisal of the rela-
tive values of the land and building would support a lower land value, the company would
benefit. The government would not benefit from this approach.
C8. Continuing Case: Annual Report Project
Note to Instructor: Answers will vary depending on the company selected by the students.
10-23

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3. An accelerated depreciation method is best for companies facing rapid technological

SE1. Classifying Cost of Long-Term Assets

SE2. Group Purchase

Asset Appraisal Percentage Apportionment*

* Land $1,500,000 × 25.0% = $ 375,000

SE3. Straight-Line Method

Depreciation for each year:

SE4. Production Method

** Remaining amount to reduce to residual value:

SE6. Disposal of Plant Assets: No Trade-In

1. Carrying Value = Equipment – Accumulated Depreciation—Equipment

2. a. Asset discarded as having no value

b. Asset sold for $6,000 cash

c. Asset sold for $16,000 cash

Depletion charge per ton:

Depletion expense for the first year:

Depreciation expense for the first year:

SE8. Intangible Assets: Computer Software

* $350,000 – ($350,000 / 5 years ) = $280,000

SE9. Management Issues

SE10. Free Cash Flow

Free Net Cash Flows from Purchases of Sales of

E1A. Recognition and Classification of Capital Expenditures

E2A. Recognizing and Classifying the Cost of Long-Term Assets

Cost of land improvements:

E3A. Group Purchase

Asset Appraisal Percentage Apportionment*

* Land $240,000 × 20% = $ 48,000

Cost and depreciable cost of tractor:

First year's depreciation:

E5A. Depreciation Methods

1. Depreciation computed by straight-line method:

2. Depreciation computed by production method:

3. Depreciation computed by double-declining-balance method:

* 100% / 5 = 20%; 20% × 2 = 40%

Balance sheet presentation:

* $36,000 + $21,600 = $57,600

Year 1 50%* × $1,120 = $560

* 100% / 4 = 25%; 25% × 2 = 50%

E7A. Revision of Depreciation Rates

Remaining depreciable cost:

Remaining useful life:

Carrying Value = Equipment – Accumulated Depreciation—Equipment

1. Asset discarded as having no value

2. Asset sold for $12,000 cash

3. Asset sold for $36,000 cash

*($2,500 – $250) / 5 years = $450/year

E10A. Natural Resource Depletion and Depreciation of Related Plant Assets

Depletion charge per ton:

Depletion expense for the first year:

1. Cost of copyright $40,000

E12A. Accounting for a Patent

E13A. Management Issues

E14A. Free Cash Flow

Free Net Cash Flows from Purchases of Sale of Plant

$(484,000) = $432,000 – $100,000 – $924,000 + $108,000

P1. Identification of Long-Term Assets Terminology

* (2 months / 10 months) × $64,000 = $12,800;

* $720,000 – $60,000 = $660,000

* $360,500 – $35,000 = $325,500

1. Cost of land and ore $3,300,000

2. Tons of ore mined and sold 450,000