Financial Accounting Theory and Analysis Text and Cases 11th Edition Schroeder Solutions Manual

Financial Accounting Theory and
Analysis Text and Cases 11th Edition

Schroeder Solutions Manual
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Accounting Theory and Analysis
11th Edition
Solutions Manual
By
Richard G. Schroeder
University of North Carolina at Charlotte
Myrtle W. Clark
University of Kentucky
Jack M. Cathey
University of North Carolina at Charlotte
Financial Accounting Theory & Analysis: Text and Cases

Solutions Manual, Chapter 9 Page 1
CHAPTER 9
Case 9-1
a. Under FASB ASC 958-605, the land would be recorded at fair value. The inflow is
considered revenue. The land would be reported in the balance sheet at $100,000. A
corresponding amount of revenue would appear in the income statement.
b .i. FASB ASC 958-605 defines a donation as a nonreciprocal transfer. Recording the
land at fair value is consistent with the full disclosure principle. It is also consistent
with the Conceptual Framework's qualitative criterion, relevance. If users wish to
value the firm, fair value of firm assets is relevant to their decision models.
The primary defense of recording a donated asset at fair value is that fair value
represents the cash equivalent value of the asset. If cash had been received,
instead, the dollars would have been recorded. Then the dollars received could have
been used to purchase the asset at fair value.
Recording the inflow as revenue is consistent with the Conceptual Framework's

definition of earnings, as the change in net assets from nonowner sources. The
asset was received from a third party, not an owner. Its inflow adds value to the firm.
ii. Recording the donated asset at fair value is inconsistent with the cost principle.
According to the cost principle, the recorded cost of an asset is equivalent to the
consideration given in return. Because a donation is a nonreciprocal transfer,
nothing was given in return, hence, no cost can be recorded.
A second, though less convincing argument, would be that fair value may be too
subjective to be reliable.
It can also be argued that if fair value is the appropriate and relevant measurement
for a donated asset, then the credit should be considered a gain, not a revenue. The
Conceptual Framework defines revenues as inflows from the production or delivery
of goods and services. A donated asset does not result from the production or

delivery of goods or services. Rather it is more like a gain - resulting from peripheral
or incidental transactions.
c. Under previous practice, the credit for fair value of the donated asset would have been
to donated capital. Because the credit to revenue required under FASB ASC 958-605 is
closed to retained earnings, the composition of stockholders' equity would differ but total
stockholders' equity is unaffected by the SFAS No. 116 requirements. Comparative
balance sheets containing summary information would appear the same as before, as
follows:
ASSETS LIABILITIES $350,000
(800,000 + 100,000) $900,000 S/E 550,000
Hence, balance sheet ratios such as debt/equity are not affected.
Placing the inflow of fair value on the income statement would increase income from
continuing operations, net income and EPS.
Case 9-2
a. Postponing the purchase of the equipment until the next year will have the following
financial statement impacts assuming that the equipment will be placed into use when it
is purchased:
Balance Sheet:
Plant assets will be less by
Cost $400,000
Less Accumulated Depr 20,000 $380,000
((400,000/10) x 1/2)

Notes Payable will be less by $400,000
Interest Payable will be less by 10,000
((400,000/10) x 1/4)
Deferred Tax Liability will be less by
Accumulated Depr - tax $57,143
(400,000 x 2/7 x 1/2)
Accumulated Depr - books 20,000
Temporary difference $ 37,143x tax rate
Income Statement:
Interest Expense will be less by $10,000
Depreciation Expense will be less by $20,000
Income Tax Expense will be more by the tax rate times lost interest and depreciation tax
shield (tax rate x ($10,000 + 57,143)) and less by the change in the deferred tax liability
(tax rate x $37,143).
Statement of Cash Flows:
The inflow from Operating Activities will be affected by the tax savings on the interest
and depreciation taken on the tax return.
The supplemental schedule disclosing financing and investing activities not affecting
cash will include the purchase of the machine with the note.
According to the efficient market theory, the only impact that postponing the purchase
would have on stock price would result from cash flow impacts. These are described in
part b.

Finance theory on capital structure would suggest that the lower debt to equity ratio that
would result from the postponement would imply less risk, because the debt to equity
ratio is thought to be correlated with the firm's beta. If the debt to equity ratio is
significantly affected, the market could perceive the increased risk in a negative manner.
b. The cash flow impacts of postponing the purchase of the equipment comprise the time
value of the tax effects of the interest and depreciation tax shields which total $77,143
($20,000 + $57,143). Although the purchase would only be delayed three months, the
first year depreciation is taken one year earlier and one fourth of the first year's interest
is taken earlier. On the downside, the interest payments and the payment of principal
are both shifted three months earlier. However, this shift is unlikely to have a material
impact.
c. Purchasing before year-end would be more favorable to stockholders. The market

assesses the value of the firm in terms of the present value of future cash flows. The
depreciation and interest tax shields that would occur during the current year would
accelerate the tax benefits of these deductions for one year. The timing of the interest
and loan principal payment would occur three months earlier. But, the tax timing
difference would produce a more significant effect.
Case 9-3
a. The conventional concept of depreciation accounting usually is defined as a system of

accounting that aims to distribute the cost or other basic value of tangible capital assets,
less salvage (if any), over the estimated useful life of the unit (which may be a group of
assets) in a systematic and rational manner. It is a process of allocation, not of valuation.
Depreciation for the year is the portion of the total charge under such a system that is
allocated to the year.
b. i. This is a static concept of depreciation in which the initial cost or other value is not
changed during the life of the asset; thus total depreciation charges over the life of
the asset are equal to the initial cost or value of the asset less any salvage value.
This concept is based upon the cost, realization and matching concept of
conventional financial accounting. Cost represents the amount that is recorded as
the value of the asset to the entity at the date of acquisition. In subsequent periods
cost less accumulated depreciation is considered to represent the minimum value to
the entity of the services to be received from the plant asset during the remainder of

its life. The realization concept requires that during the life of an asset its valuation
should not be greater than cost or cost less accumulated depreciation; if a higher
valuation were recorded, the entity would recognize unrealized income.
ii. The matching concept requires that the portion of the cost (or value basis) of the
asset to be allocated to each accounting period should be matched with the
expected revenue or net revenue contribution of the period. Matching can take the
form of (1) adjusting depreciation charges for the effects of interest during the entire
life of the asset, (2) associating depreciation allocations with net revenue
contributions of the asset so that they are proportional to the net revenue
contributions of each period, (3) associating depreciation allocations with
nonmonetary, physical service units (e.g., input or output measures, such as
machine-hours or miles of operation or number of units produced) so that they are
proportional to the units of service provided each period or (4) associating
depreciation allocations with units of time (e.g., months or years) so that they are
equal for periods of equal length.
iii. Since this concept merely requires that the allocation be systematic and rational,
much discretion is left to management in the selection of a depreciation method. But
the requirement that the allocation be rational probably means that it should be
related to the expected benefits to be received from the asset.
c. Since the conventional accounting concept of depreciation is a process of cost

allocation, not valuation, the concern here is with determining what portion of the cost of
the computer system should be assigned to expense in a given accounting period. The
estimate of periodic depreciation is dependent upon three separate variables:
i. Establishing the depreciation base. Since an asset may be sold before its service
value is completely consumed, the depreciation base is the cost of asset services
that will be used by the firm and charged to expense during its service life; this
usually is less than the original cost of the asset. The depreciation base of an asset
is its acquisition cost plus removal costs at time of retirement and minus gross
salvage value.
ii. Estimating the service life. This involves selecting the unit in which the service life of
the asset is to be measured and then estimating the total number of units of service
embodied in the asset.

Although service life usually is measured in units of time, it may be more appropriate
to use units of output or activity which usually are expressed in physical units such
as tons, gallons, miles or machine-hours.
In selecting the appropriate unit of service for each asset, consideration should be
given to the factors that decrease the service life of an asset. These factors may be
divided into two classes: (1) physical causes including casualties and (2) economic
and functional causes.
The physical causes are the physical deterioration and impaired utility of the asset
that result (1) from wear and tear that is due to operating use and (2) from other
forms of decay that are due to the action of the elements. Damage resulting from
unusual events such as accidents, earthquakes, floods, hurricanes, and tornadoes
also may reduce or end asset usefulness.
An asset that is in good physical condition may lose its economic usefulness as a
result of technological obsolescence and inadequacy (or economic obsolescence).
Technological obsolescence results from innovations and improvements that make
the existing plant obsolete. Inadequacy usually results from the effects of growth and
change in the scale of a firm's operations that reduce or terminate the service life of
assets.
iii. Choosing the method of cost apportionment. The problem here is to determine
the relative portion of services that has expired in each accounting period. This might
be approached by estimating whether all units of service are equally valuable (and
have an equal cost) or whether some service units have a higher value and cost than
others.
The two major variables to be considered in reaching the rational and systematic
solution to this problem are: (1) whether the quantity of services withdrawn from the
bundle will be equal or will vary during the periods of service life and (2) whether the
value or cost of various units of service will be equal or will vary during the periods of
service life.
d. There are a number of systematic depreciation methods that recognize these factors in
varying degrees and could be used for the computer system; these may be classified as
follows:

i. On the basis of time--
(1) A constant charge per period, i.e., the straight-line method.
(2) A decreasing charge per period, i.e., a declining- balance or the sum-of-the
years digits method.
(3) An interest (increasing charge) method in which the depreciation charges are
adjusted using the entity's average internal rate of return.
ii. On an output measure basis--
(1) A charge based upon a ratio of a constant cost to net revenue contribution;
i.e., the cost allocation for each period would be a constant proportion of the
net revenue contribution of the computer system.
(2) A charge based upon the expected physical services from the computer
system; i.e., the cost allocation would be in terms of hours, days or months of
operation or some other measure of input or output related to the computer
services.
Case 9-4
a. A firm may wish to construct its own fixed assets rather than acquire them from outsiders
to utilize idle facilities and/or personnel. In some cases fixed assets may be self-
constructed to effect an expected cost savings. In other cases the requirements for the
asset demand special knowledge, skills, and talents not readily available outside the
firm. Also, the firm may want to keep the manufacturing process for a particular product
as a trade secret.
b. Costs which should be capitalized for a self-constructed fixed asset include all direct and
indirect material and labor costs identifiable with the construction. All direct overhead
costs identifiable with the asset being constructed should also be capitalized. Examples
of costs elements which should be capitalized during the construction period include
charges for licenses, permits and fees, depreciation of equipment used in the
construction, taxes, insurance, and similar charges related to the assets being
constructed.
c. .i. The increase in overhead caused by the self-construction of fixed assets should be
capitalized. These costs would not have been incurred if the assets had not been
constructed. This proposition holds regardless of whether or not the plant is

operating at full capacity. It is improper to increase the cost of finished goods with
costs which were not incurred in their manufacture and which would not have been
incurred if fixed assets had not been produced. However, if the total construction
costs on self-constructed fixed assets were substantially in excess of their business
and economic usefulness, the excess cost should not be capitalized but should
instead be recorded as a loss.
ii. It is clear that the capitalized costs of self-constructed assets should include a
proportionate share of overhead on the same basis as that applied to goods
manufactured for sale when the plant is operating at full capacity at the time the
fixed asset in constructed. Under these circumstances costs of finished goods
produced should not be increased for overhead for goods for which production was
foregone. The activity replacing the production of goods for sale should be charged
with the related overhead.
When idle plant capacity is used for the construction of a fixed asset, opinion varies
as to the propriety of capitalizing a share of general factory overhead allocated on
the same basis as that applied to goods manufactured for sale. The arguments to
allocate overhead maintain that constructed fixed assets should be accorded the
same treatment as inventory, new products, or joint products. It is maintained that
this procedure is necessary, or special favors or exemptions from undercosting of
fixed assets will cause a consequent overcosting of inventory assets.
Those arguing against allocating overhead to fixed assets where the assets are
constructed when idle capacity exists maintain that since normal production will not
be affected or overhead increased, capitalization will result in increased reported
income for the period resulting from construction rather than production of goods for
sale. It is also sometimes maintained that the full cost of the constructed asset
should not include overhead that would be incurred in the absence of such
construction.
d. The $90,000 cost by which initial machines exceeded the cost of the subsequent
machines should be capitalized. Without question there are substantial future benefits
expected from the use of this machine. Because future periods will benefit from the extra
outlays required to develop the initial machine, all development costs should be
capitalized and subsequently associated with the related revenue produced by the sale
of products manufactured. If, however, it can be determined that the excess cost of
producing the first machine was the result of inefficiencies or failures which did not
contribute to the machine's successful development, these costs should be recognized

as an extraordinary loss. Subsequent periods should not be burdened with charges
arising from costs which are not expected to yield future benefits.
Capitalizing the excess costs as a cost of the initial machine can be justified under the
general rules of asset valuation. That is, an asset acquired should be charged with all
costs incurred in obtaining the asset and placing it in productive use. A case could also
be made for prorating the excess cost of developing the first machine equally to all four
machines on the grounds that these costs were necessary in order to obtain the four
machines. In this case, the acquisition of the four machines is analogous to a "basket"
purchase where proration is acceptable.
Although less supportable, another alternative treatment of the excess costs of

developing the initial machine is to treat the costs as research and development. Under
current GAAP costs of research and development are expensed as incurred.
Case 9-5
a. The fair market value of the acquired site, as evidenced by the contract price, is
$60,000. It is the amount that represents the actual bargained price of the land in a cash
transaction. To charge any portion of the option costs to the land account is to disregard
the bargained price of the acquired site and, further, implies that the land is more
valuable because of the options.
The purchase of the options enabled the client to delay his/her selection of a site until
the advantages and disadvantages of each were carefully weighted. The benefits to be
derived from the net advantage of the selected site over the rejected sites will accrue to
the operations of the contemplated plant facility. The cost of the options should therefore
be separately capitalized and allocated to the periods benefited.
It may also be argued that the cost of the options represents management's failure to
plan for the acquisition of a site. Such a contention leads to the conclusion that the cost
of the option is a loss and should be expensed immediately, and it supports the
recording of the cost of the acquired site at $60.000.

b. The actual cost of the selected site is the sum of the contract price plus the cost of the
option which was exercised to purchase the land. All costs incurred to secure title to the
land are properly includable as part of its cost. However, to capitalize the cost of the
options that were allowed to lapse would be inappropriate. They have no bearing on the
acquisition of effective title to the selected site and should be treated as a loss.
c. The options were purchased with full knowledge that, after the relative advantages of
the three locations were investigated, only one of the options would be exercised.
Because the intent was to purchase only one of the three sites, the options should be
viewed as an integrated plan for acquiring the site which was ultimately selected. Thus,
the cost of all three options should be capitalized as a part of the cost of acquiring the
selected site.
Case 9-6
a. Relative to plant assets, a cost incurred or an expenditure made, that is assumed to

benefit only the current accounting period is called a revenue expenditure and is
charged to expense in the period believed to benefit. A capital expenditure is similarly a
cost incurred or an expenditure made but is expected to yield benefits either in all future
accounting periods (acquisition of land) or in a limited number of accounting periods.
Capital expenditures (if material in amount) are capitalized, that is, recorded as assets,
and, if related to assets of limited life, amortized over the periods believed to benefit.
The distinction between capital and revenue expenditures is of significance because it

involves the timing of the recognition of expense and, consequently, the determination of
periodic earnings. It also affects the amounts reported as assets whose costs generally
have to be recouped from future periods' revenues.
If a revenue expenditure is improperly capitalized, current earnings are overstated,

assets are overstated, and future earnings are understated for all the periods to which
the improperly capitalized cost is amortized. If the cost is not amortized, future earnings
will not be affected but assets and retained earnings will continue to be overstated for as
long as the cost remains on the books. If a nonamortizable capital expenditure is
improperly expensed, current earnings are understated and assets and retained
earnings are understated for all periods for which unamortized cost should have
remained in the accounting records. If an amortizable capital expenditure is improperly
expensed, current earnings are understated, assets and retained earnings are
understated, and future earnings are overstated for all periods to which the cost should
have been amortized.

b. Depreciation is the accounting process of allocating an asset's historical cost (recorded
amount) to the accounting periods benefited by the use of the asset. It is a process of
cost allocation, not valuation. Depreciation is not intended to provide funds for an asset's
replacement; it is merely an application of the matching concept.
c. The factors relevant in determining the annual depreciation for a depreciable asset are
the initial recorded amount (cost), estimated salvage value, estimated useful life, and
depreciation method.
Assets are typically recorded at their acquisition cost, which is in most cases objectively
determinable. But cost assignments in other cases --"basket purchases" and the
selection of an implicit interest rate in asset acquisition under deferred-payment plans--
may be quite subjective involving considerable judgement.
The salvage value is an estimate of an potentially realizable when the asset is retired
from service. It is initially a judgment factor and is affected by the length of its useful life
to the enterprise.
The useful life is also a judgment factor. It involves selecting the "unit" of measure of
service life and estimating the number of such units embodied in the asset. Such units
may be measured in terms of time periods or in terms of activity (for example, years or
machine hours). When selecting the life, one should select the lower (shorter) of the
physical life or the economic life to this user. Physical life involves wear and tear and
casualties; economic life involves such things as technological obsolescence and
inadequacy.
Selecting the depreciation method is generally a judgment decision; but, a method may
be inherent in the definition adopted for the units of service life, as discussed earlier. For
example, if such units are machine hours, the method is a function of the number of
machine hours used during each period. A method should be selected that will best
measure the portion of services expiring each period. Once a method is selected, it may
be objectively applied by using a predetermined, objectively derived formula.
d. Because revenue usually represents an inflow of funds, and expense usually represents
an outflow of funds, net earnings represent a net inflow of funds. However, the revenues
and expenses reported in the income statements are accrual-based, not cash-based

measures. Hence, net income must be adjusted to measure the net cash flows from
operations. Depreciation reduces reported net earnings but does not involve an outflow
of cash. Therefore, it is added back to reported net earnings to calculate cash provided
by operations. On a statement of cashflows, depreciation should be clearly shown as an
adjustment to net earnings not requiring a use of cash rather than be shown as a source
of cash. Depreciation is not a direct source of cash. It can be considered an indirect
source only through income tax savings.
Case 9-7
The following costs, if applicable, should be capitalized as a cost of land:
a. (a) Negotiated purchase price
(b) Brokers' commission
(c) Legal fees
(d) Title fees
(e) Recording fee
(f) Escrow fees
(g) Surveying fees
(h) Existing unpaid taxes, interest, or liens assumed by the buyer
(i) Clearing, grading, landscaping and subdividing
(j) Cost of removing old building (less salvage)
(k) Special assessments such as lighting or sewers if they are permanent in nature.
b. A plant asset acquire on a deferred-payment plan should be recorded at an equivalent

cash price excluding interest. If interest is not stated in the sales contract, an imputed
interest should be determined. The asset should then be recorded at its present value,
which is computed by discounting the payments at the stated or imputed interest rate.
The interest portion (stated or imputed) of the contract price should be charged to
interest expense over the life of the contract.

a. In general, plant assets should be recorded at the fair value of the consideration given or
the fair value of the asset received, whichever is more clearly evident. Specifically,
under the criteria contained at FASB ASC 845, when exchanging an old machine and
paying cash for a new machine, the new machine should be recorded at the amount of
monetary consideration (cash paid plus the undepreciated cost of the nonmonetary
asset (old machine) surrendered if there is no indicated loss. No indicated gain should
be recognized by the party paying monetary consideration.
If cash is received, gains are not recognized; however, a loss should be recognized if the
fair value of the asset exchanged is less than its book value (i.e., an impairment is
evident). The resulting amount initially recorded for the acquired asset is equal to the
book value of the exchanged asset (adjusted to its fair value, when there is an apparent
impairment) plus or minus any cash (boot) paid or received.
Case 9-8
a. Expenditures should be capitalized when they benefit future periods. The cost to acquire
the land should be capitalized and classified as land, a nondepreciable asset. Since
tearing down the small factory is readying the land for its intended use, its cost is part of
the cost of the land and should be capitalized and classified as land. As a result, this
cost will not be depreciated as it would if. it were classified with the capitalizable cost of
the building.
Since rock blasting and removal is required for the specific purpose of erecting the
building, its cost is part of the cost of the building and should be capitalized and
classified with the capitalizable cost of the building. This cost should be depreciated over
the estimated useful life of the building.
The road is a land improvement, and its cost should be capitalized and classified
separately as a land improvement. This cost should be depreciated over its estimated
useful life.
The added four stories is an addition, and its cost should be capitalized and classified
with the capitalizable cost of the building. This cost should be depreciated over the
remaining life of the original office building because that life is shorter than the estimated
life of the addition.

b. The gain should be recognized on the sale of the land and building because income is
realized whenever the earning process has been completed and the sale has taken
place.
The net book value at the date of sale would be composed of the capitalized cost of the
land, the land improvement, and the building, as determined above, less the
accumulated depreciation on the land improvement and the building. The excess of the
proceeds received from the sale over the net book value at the date of the sale would be
accounted for as a gain and included in income from continuing operations in the income
statement.
Case 9-9
a. The expenditures that should be capitalized when equipment is acquired for cash
should include the invoice price of the equipment (net of discounts) plus all incidental
outlays relating to its purchase or preparation for use, such as insurance during transit,
freight, duties, ownership search, ownership registration, installation, and breaking-in
costs. Any available discounts, whether taken or not, should be deducted from the
capitalizable cost of the equipment.
b . i. When the market value of the equipment is not determinable by reference to a

similar cash purchase, the capitalizable cost of equipment purchased with bonds
having an established market price should be the market value of the bonds.
ii. When the market value of the equipment is not determinable by reference to a
similar cash purchase, and the common stock used in the exchange does not have
an established market price, the capitalizable cost of equipment should be the
equipment's estimated fair value if that is more clearly evident than the fair value of
the common stock. Independent appraisals may be used to determine the fair values
of the assets involved.
iii. When the market value of equipment acquired is not determinable by reference to a
similar cash purchase, the capitalizable cost of equipment purchased by exchanging
similar equipment having a determinable market value should be the lower of the
recorded amount of the equipment relinquished or the market value of the equipment
exchanged.

c. The factors that determine whether expenditures relating to property, plant, and
equipment already in use should be capitalized are as follows:
. Expenditures are relatively large in amount.
. They are nonrecurring in nature.
. They extend the useful life of the property, plant, and equipment.
. They increase the usefulness of the property, plant, and equipment.
d. The net book value at the date of the sale (cost of the property, plant, and equipment
less the accumulated depreciation) should be removed from the accounts. The excess of
cash from the sale over the net book value removed is accounted for as a gain on the
sale and reported on the income statement, while the excess of net book value removed
over cash from the sale is accounted for as a loss on the sale and reported on the
income statement.
Case 9-10
a. Historical cost is the amount of cash, or its equivalent, paid to acquire an asset. It
includes the purchase price and all cost necessary to acquire the asset and get it ready
for its intended use. Use of historical cost presents the economic facts as they actually
occurred. Thus, it is relevant and reliable. It is relevant because accountants are
stewards to owners. The stewardship role implies that accountants must report how
moneys invested are spent. This information is disclosed by historical prices paid to
acquire assets. Historical cost is reliable because it is objective and verifiable. Historical
exchange prices are objectively determinable and verifiable because they are based on
evidence that an exchange has taken place and amounts are typically supported by a
paper trail, e.g., invoices. Hence, they these measurements represent what they purport
to represent and as such are represenationally faithful and neutral.
An asset is defined as an economic resource that has future benefit to the entity and
results from prior transactions and events. The prior transaction resulting in its existence
is the exchange that occurred when the asset was acquired. Those moneys were
invested in the asset to provide economic benefit to the company. So long as the asset
is in use, cost provides benefit. Hence, cost is a relevant attribute to report to investors,
creditors, and other users.

b. Under the present accounting model, the cost of cleanup would be considered cost of
land. The cost of land includes its acquisition price and all costs incurred to get it ready
for its intended use. In this example the intended use to have a building built on it.
Since, the cleanup is necessary before building can begin, the cost of cleanup is a cost
to get the land ready for its intended use and should be capitalized as land. Under this
scenario the presumption is that the cleanup cost was necessary to acquire the asset,
hence it provides future benefit. The cleanup itself provides value because without it the
land is not usable as a building site, and would presumable be worth less. Hence, this
expenditure fits the definition of an asset.
Case 9-11
a. The stewardship role of accounting implies that accountants should report on how
moneys were invested in assets and the performance resulting from making those
investments. This notion is consistent with reporting assets at historical cost. Long-term
assets provide benefits for a number of time periods. Investments are made in fixed
assets so that over the long-run revenues will be generated. Fixed asset investments
thus generate revenues over multiple accounting periods. The matching principle
implies that these revenues should be matched with the cost of generating them.
Because an element of this cost is the cost of long-term fixed assets these costs should
be matched with the revenues they generate, implying that the cost should be allocated
to those periods in which the revenues (benefits) are expected to occur.
b. Accountants believe that cost allocation provides relevant information because it

attempts to match cost with revenue and thus provides measures of performance. On
the other hand, all allocation schemes are by their very nature arbitrary. As such, they
are not objective. Also, one could argue that cash flow is all that matters with regard to
fixed assets. In other words, purchasing a fixed asset is an investing activity, a cash
outflows. It is not an operating activity. It provides physical assets to generate revenue,
but it is a sunk cost and does not recur on an annual basis.
c. If the purpose of the balance sheet is to disclose resources and claims to resources,
historical cost once the asset has been purchased may no longer be relevant. Historical
cost does not provide a measure of the current value of the asset in use. Each period
the company in effect makes a conscious decision to keep the asset. These decisions
imply that the company is, in effect, reinvesting in the asset. Reinvestment decisions are
made based on replacement cost. Hence, replacement cost would provide relevant
measures of fixed assets.

d. Yes, a current value approach to the valuation of fixed assets would be consistent with
the physical capital maintenance concept. The concept of physical capital maintenance
is concerned with maintaining productive capacity, the operating assets of the entity.
Assets must eventually be replaced in order to maintain the current level of productive
capacity. Hence, measurement of assets at their replacement cost, a current cost
measure, is consistent with the physical capital maintenance concept.
e. The major problems associated with use of replacement cost relate to determining the
amount of replacement cost. Once purchased, the replacement cost of fixed assets may
be difficult if not practically impossible to determine. Replacement cost is the cost to
replace the assets with similar assets in similar condition. But, there may be no ready
market for the assets. In these cases it may be necessary to obtain appraisal values in
order to approximate replacement cost. In some cases specific price indexes may be
used, but these measures provide reasonably approximations only when the price of the
asset being measured moves in the same way as the movement of the price index.
Moreover, relevance of replacement cost may be questionable. It can be argued that

entry values are relevant only when purchase is contemplated. For owned assets
replacement cost may be irrelevant because these assets will either be used or sold.
Hence, a better measure of current value may be net realizable value.
FASB ASC 9-1 Depreciation
FASB ASC 360-10-35 Found by searching “depreciation and property, plant and
equipment” or by accessing the Assets link and selecting Property, plant and equipment,
overall. Specifically, the definition of depreciation is contained in FASB ASC 350-10-35-
4. The pronouncements dealing with depreciation can be found by accessing the Printer
Friendly with sources link.
FASB ASC 9-2 Asset Impairment
A search of “asset impairments” resulted in over 130 entries. The EITF issues can be
found by searching asset impairment and EITF.

FASB ASC 9-3 Asset Retirement Obligations
The discussion of asset retirement obligations is contained at FASB ASC 410 Found by
searching “asset retirement obligations” or through the cross reference section using the
original pronouncement number FAS 143. The EITF issues can be found by accessing
the Printer Friendly with sources link at topic 410.
FASB ASC 9-4 Disclosure of Depreciation
Found by accessing the Assets link, selecting Property, plant and equipment and
selecting disclosure.
Topic 360-10-50
FASB ASC 9-5 Overhaul Costs in the Airline Industry
Select the industry link and then choose airlines. Select Property and Equipment and
then Initial Measurement.
Topic 908-360
FASB ASC 9-6 Accounting for the Mining Extractive Industry
Select the industry link and then choose extractive industry-mining.
Topic 930-330
FASB ASC 9-7 Franchise Prematurity Period
Select the industry link and then choose franchises.

Topic 952.
Debate 9-1
Team 1 Argue for the capitalization of interest
The FASB considers interest incurred during construction of the asset as an element of
historical cost. Historical cost is the amount of cash, or its equivalent, paid to acquire an
asset. It includes the purchase price and all cost necessary to acquire the asset and get
it ready for its intended use. Use of historical cost presents the economic facts as they
actually occurred. Thus, it is relevant and reliable. It is relevant because accountants
are stewards to owners. The stewardship role implies that accountants must report how
moneys invested are spent. This information is disclosed by historical prices paid to
acquire assets. Historical cost is reliable because it is objective and verifiable. Historical
exchange prices are objectively determinable and verifiable because they are based on
evidence that an exchange has taken place and amounts are typically supported by a
paper trail, e.g., invoices. Hence, they these measurements represent what they purport
to represent and as such are represenationally faithful and neutral.
An asset is defined as an economic resource that has future benefit to the entity and
results from prior transactions and events. The prior transaction resulting in its existence
is the exchange that occurred when the asset was acquired. Those moneys were
invested in the asset to provide economic benefit to the company. So long as the asset
is in use, cost provides benefit. Hence, cost is a relevant attribute to report to investors,
creditors, and other users.
According to SFAS No. 34, (See FASB ASC 835-20) interest during construction is a
cost of getting the asset ready for its intended use. Moneys were spent to construct the
asset. Debt existed so that the moneys could be available to spend on construction
costs. If the moneys had not been spent on constructing the asset, the moneys could
have been used to extinguish the debt. Hence, the interest on the debt was avoidable.
Because the interest was avoidable, its incurrence during the construction period implies
that it was directly attributable to the construction itself. As such, it is properly classified
as a construction cost, i.e., costs attach. It is a cost of getting the asset ready for its
intended use and should be capitalized along with other construction costs.
Team 2 Argue against the capitalization of interest

Interest is the cost of debt, not the cost of an asset. Interest is a function of time. As
such it is a period cost, i.e., an expense of the accounting period. Debt is incurred to
acquire assets which will be employed to generate future cash inflows, or revenues. The
assets generate the revenue, not the debt. Hence, the assets constitute the physical
plant, the operating assets of the business enterprise. When operating assets are used
up their cost expiration is considered an expense of operations. Alternatively, because
debt is not a part of the physical plant, the cost of debt (interest) is not considered an
operating expense. Rather, it is a nonoperating cost, or expense, of doing business.
According to SFAC No. 6, expenses are outflows or other using up of assets or

incurrences of liabilities from delivering or producing goods, rendering services, or
carrying out other activities that constitute the entity’s ongoing major or central
operations. Debt provides moneys to acquire assets. The assets are used to deliver or
produce goods, etc. Interest is incurred to provide debt. Thus, indirectly, the interest is
an outflow of assets, incurred in the process of delivering or producing goods, rendering
services, or carrying out other activities that constitute the entity’s ongoing major or
central operations. It is incurred during the accounting period in which those activities
take place and is a cost, or expense, of the period. It should not be capitalized as a part
of the historical cost of the constructed asset.
Finance theory is consistent with the argument that interest incurred during construction
should not be capitalized. Modern capital structure theory views creditors as capital
providers. The corporation determines how much debt versus common stock it wants in
its capital structure. In other words, moneys can be supplied to acquire assets with debt
or by issuing common stock. According to finance theory, the interest on the debt, like
dividends to common stockholders, is a payment to capital providers, a return on their
investment in the business. As such it represents a distribution of income, not a cost
incurred to acquire an asset. Under this theory, interest would not only not be a part of
the historical cost of the asset, it would not even be considered an expense.
Debate 9-2 Donated Assets
Team 1.
Donated assets should not be reported in a company’s balance sheet. Firstly, a

donation is a non-reciprocal transfer. The company did not give up anything to acquire
donated assets. Therefore, there is no cost. According to the historical cost principle,
the cost of an asset includes all costs that were necessary to acquire an asset and get it
ready for its intended use. Since, nothing was expended to acquire the asset or get it
ready for its intended use, the historical cost principle would be consistent with reporting
no value on the company’s balance sheet.

Secondly, non-reporting of donated assets is consistent with financial capital
maintenance, noted by the FASB in the Conceptual Framework as appropriate for
financial reporting. Accordingly, financial accounting would report what was done with
the dollars invested by owners. Since no investor dollars were spent to acquire a
donated asset, there is nothing to report.
Finally, not reporting a value for donated assets is objective. Reporting fair value would
require subjective estimates that may not be unbiased, or if unbiased may not reflect the
fair value of the donated assets. If so, the reported values may not be relevant to users.
Team 2.
Donated assets should be reported in a company’s balance sheet at fair value. They
represent an inflow of assets to the company from non-owner sources. They meet the
definition of assets. They are probable future benefits owned or controlled by the
company that resulted from a prior transaction or event (the donation). Thus,
representational faithfulness would require that they be reported in the balance sheet
until used up as an expense.
Reporting fair value of donated assets would provide relevant information to users
regarding the financial position of the company. The company would not have a hidden
asset and the principle of full disclosure would be met.
WWW
Case 9-12
a. Under current GAAP an asset is considered impaired when the total expected future
cash inflows are less than the book value (carrying value) of the asset. That is, the
carrying value of the asset if not recoverable.
b. Under current GAAP, an impairment loss is equal to the difference between the book
value of the asset and its fair market value.
c. Less conservative. The recoverable amount is equal to the gross (total) expected cash
flows. This amount would be greater than fair value. Fair value is typically presumed to
be the present value of expected future cash flows. Hence, the loss measured using the
recoverable amount would be smaller, and income would be higher (not conservative).
Conservatism implies that when choosing between two alternatives, the one resulting in
the lower net income would be selected.
d. Current GAAP measurement of the loss would be more consistent with the economic
concept of income. The economic concept views income as the change in wealth (the
value of the company) from one period to the next, excluding investments by and
distributions to owners. Fair value is a current value measure of wealth, gross future
cash flows would not measure current value.

Case 9-13
Three approaches have been suggested to account for actual interest incurred in
financing the construction or acquisition of property, plant, and equipment.
1. Capitalize no interest during construction. Under this approach interest is considered

a cost of financing and not a cost of construction. It is contended that if the company
had used stock financing rather than debt financing, this expense would not have
developed. The major arguments against this approach are that an implicit interest
cost is associated with the use of cash regardless of the source.
2. Capitalize the actual interest costs. This approach relies on the historical cost
concept that only actual transactions are recorded. It is argued that interest incurred
is as much a cost of acquiring the asset as the cost of the materials, labor, and other
resources used. As a result, a company that uses debt financing will have an asset
of higher cost than an enterprise that uses stock financing. The results achieved by
this approach are held to be unsatisfactory by some because the cost of an asset
should be the same whether cash, debt financing, or stock financing is employed.
3. Charge construction with all costs of funds employed, whether identifiable or not.
This approach is an economic cost approach that maintains that one part of the cost
of construction is the cost of financing whether by debt, cash, or stock financing. An
asset should be charged with all costs necessary to get it ready for its intended use.
Interest, whether actual or imputed, is a cost of building, just as labor, materials, and
overhead are costs. A major criticism of this approach is that imputation of a cost of
equity capital is subjective and outside the framework of a historical cost system.
Current GAAP requires that the lower of actual or avoidable interest cost be capitalized
as part of the cost of acquiring an asset if a significant period of time is required to bring
the asset to a condition or location necessary for its intended use. Interest costs would
be capitalized (provided interest costs are being incurred) starting with the first
expenditure related to the asset and would continue until the asset is substantially
completed and ready for its intended use. Capitalization should occur only if the benefits
exceed the costs.
Case 9-14
a. The issues discussed in IAS No. 16 are the timing of recognition of assets, the
determination of their carrying amounts, and the associated depreciation charges to be
recognized. The revised IAS No. 16 did not change the fundamental approach to
accounting for property, plant and equipment. The Board’s purpose in revising the
standard was to provide additional guidance on selected matters.

b. IAS No. 16 indicates that items of property, plant, and equipment should be recognized
as assets when it is probable that the future economic benefit associated with these
assets will flow to the enterprise and that their cost can be reliably measured.
Case 9-15
The solution to this case is dependent upon the companies selected by the students. A
recommended method to check their solutions is to require the downloaded company
information to be turned in along with the solution.
Financial Analysis Case
Answers will vary depending on company selected


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Financial Accounting Theory and

Analysis Text and Cases 11th Edition

Financial Accounting Theory & Analysis: Text and Cases

Recording the inflow as revenue is consistent with the Conceptual Framework's

Financial Accounting Theory & Analysis: Text and Cases

ASSETS LIABILITIES $350,000

(800,000 + 100,000) $900,000 S/E 550,000

Hence, balance sheet ratios such as debt/equity are not affected.

Plant assets will be less by

Less Accumulated Depr 20,000 $380,000

Financial Accounting Theory & Analysis: Text and Cases

Interest Payable will be less by 10,000

Deferred Tax Liability will be less by

Accumulated Depr - tax $57,143

(400,000 x 2/7 x 1/2)

Accumulated Depr - books 20,000

Temporary difference $ 37,143x tax rate

Interest Expense will be less by $10,000

Depreciation Expense will be less by $20,000

Statement of Cash Flows:

Financial Accounting Theory & Analysis: Text and Cases

c. Purchasing before year-end would be more favorable to stockholders. The market

a. The conventional concept of depreciation accounting usually is defined as a system of

Financial Accounting Theory & Analysis: Text and Cases

c. Since the conventional accounting concept of depreciation is a process of cost

Financial Accounting Theory & Analysis: Text and Cases

Financial Accounting Theory & Analysis: Text and Cases

(1) A constant charge per period, i.e., the straight-line method.

ii. On an output measure basis--

Financial Accounting Theory & Analysis: Text and Cases

Financial Accounting Theory & Analysis: Text and Cases

Although less supportable, another alternative treatment of the excess costs of

Financial Accounting Theory & Analysis: Text and Cases

a. Relative to plant assets, a cost incurred or an expenditure made, that is assumed to

The distinction between capital and revenue expenditures is of significance because it

If a revenue expenditure is improperly capitalized, current earnings are overstated,

Financial Accounting Theory & Analysis: Text and Cases

Financial Accounting Theory & Analysis: Text and Cases

The following costs, if applicable, should be capitalized as a cost of land:

a. (a) Negotiated purchase price

(b) Brokers' commission

(c) Legal fees

(d) Title fees

(e) Recording fee

(f) Escrow fees

(g) Surveying fees

(h) Existing unpaid taxes, interest, or liens assumed by the buyer

(i) Clearing, grading, landscaping and subdividing

(j) Cost of removing old building (less salvage)

b. A plant asset acquire on a deferred-payment plan should be recorded at an equivalent

Financial Accounting Theory & Analysis: Text and Cases

Financial Accounting Theory & Analysis: Text and Cases

b . i. When the market value of the equipment is not determinable by reference to a

Financial Accounting Theory & Analysis: Text and Cases

. Expenditures are relatively large in amount.

. They are nonrecurring in nature.

. They increase the usefulness of the property, plant, and equipment.

Financial Accounting Theory & Analysis: Text and Cases

b. Accountants believe that cost allocation provides relevant information because it

Financial Accounting Theory & Analysis: Text and Cases

Moreover, relevance of replacement cost may be questionable. It can be argued that

FASB ASC 9-1 Depreciation

FASB ASC 9-2 Asset Impairment

Financial Accounting Theory & Analysis: Text and Cases