Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

Chapter 9
Reporting and Interpreting Long-Lived Tangible and Intangible Assets
ANSWERS TO MINI-EXERCISES M92 1. 2. 3. 4. 5. 6. C C E C E E

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

ANSWERS TO EXERCISES E91 Req. 1 HASBRO, INC. Excerpts from Balance Sheet December 28, 2008 (in millions) ASSETS Current Assets Cash and Cash Equivalents Accounts Receivable Less: Allowance for Doubtful Accounts Inventories Prepaids and Other Current Assets Total Current Assets Property, Plant, and Equipment Land and Improvements Buildings and Improvements Machinery and Equipment Property, Plant, and Equipment (at cost) Less: Accumulated Depreciation Total Property, Plant, and Equipment (net) Other Assets Goodwill Other Intangibles Other Noncurrent Assets Total Other Assets Total Assets Req. 2
Net Sales (Beginning Net Fixed Asset Balance + Ending Net Fixed Asset Balance) 2 $4,022 = ($212 + $188)/2 = 20.11

$630 $644 32 612 301 171 1,714

7 195 413 615 403 212

475 568 200 1,243 $3,169

In 2008, Hasbro generated slightly less revenue from each dollar of net fixed assets (20.11) than in 2007 (20.75).

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

E92 Req.1 The renovation costs should be capitalized because they are necessary costs of preparing the building for use. Req. 2 dr Land (+A)................................................ dr Buildings (+A)......................................... cr Cash (-A)......................................... 127,4001 76,6002 204,000

1 2

Land = $182,000 x 70% = $127,400 Building = ($182,000 x 30%) + $22,000 = $76,600

Req. 3 The depreciation expense on the building for the first year is $6,000 based on the following calculation: Cost of building: Straight-line Depreciation: Initial Payment $54,600 ($76,600 cost - $4,600 residual value) x Renovation prior to use 22,000 1/12 years = $6,000 Acquisition cost: $76,600 Land is presumed to have an unlimited life, so it is not depreciated. Req. 4 Computation of the book value of the property at the end of year 2: Building $ 76,600 Less: Accumulated Depreciation ($6,000 x 2 years) (12,000) Land Book Value:

$ 64,600 127,400 $192,000

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

E913 Req. 1 At the time of purchase, the switch plate patent will appear on the balance sheet as an intangible asset worth $1,000,000. At the end of the year, $100,000 of this patent will be amortized, leaving the book value at $900,000. The $100,000 of amortization expense will appear on the income statement and will decrease income before taxes by $100,000. Req. 2 dr Patent (switch plate) (+A)................................................ cr Cash ( .................................................................. A) dr Amortization Expense (+E, SE)...................................... cr Patent ( A)................................................................. ($1,000,000 x 1/10 = $100,000) Req. 3 The impairment appears on the income statement in the form of the $900,000 loss at the end of 2010. This loss would be included with operating expenses before the Income from Operations subtotal. The patent would no longer appear on the balance sheet. The journal entry is as follows: dr Impairment Loss (+E, SE)............................................ cr Patent ( A)............................................................... 900,000 900,000 1,000,000 1,000,000 100,000 100,000

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

ANSWERS TO GROUP A PROBLEMS PA94 2009 Jan 2 Jan 3 April 1 May 13 July 1 Dec. 31 dr Building (+A)....................................................... cr Cash ( A)..................................................... dr Building (+A)....................................................... cr Cash ( A)..................................................... dr Truck (+A)........................................................... cr Cash ( A)..................................................... dr Repairs and Maintenance Expense (+E, SE)... cr Cash ( A)..................................................... dr Patent (+A)......................................................... cr Cash ( A)..................................................... 95,000 95,000 5,000 5,000 38,000 38,000 250 250 20,000 20,000

dr Depreciation Expense (+E, SE)........................ 24,500 dr Amortization Expense (+E, SE)........................ 2,000 cr Accumulated DepreciationBldg. (+xA, A).... cr Accumulated DepreciationTruck (+xA, A). cr Patent ( A).......................................................

20,000 4,500 2,000

Building (double declining balance): ($95,000 + $5,000 $0) x 2/10 = $20,000 Truck (straight line; partial year): ($38,000 $8,000) x 1/5 x 9/12 = $4,500 Patent (straight line; partial year): $20,000 x 1/5 x 6/12 = $2,000 2010 June 30 dr Depreciation Expense (+E, SE) ...................... cr Accumulated DepreciationTruck (+xA, A). $3,000 = ($38,000 $8,000) x 1/5 x 6/12 June 30 dr Cash (+A) .......................................................... dr Accumulated DepreciationTruck ( +A)....... xA, cr Truck ( ..................................................... A) cr Gain on Disposal (+R, +SE)......................... dr Depreciation Expense (+E, SE) ...................... dr Impairment Loss (+E, SE) ............................... cr Accumulated DepreciationBldg. (+xA, A) cr Patent ( A).................................................... 33,000 7,500 38,000 2,500 16,000 18,000 16,000 18,000 3,000 3,000

Dec 31

Building: ($95,000 + $5,000 $20,000) x 2/10 = $16,000; Patent Book Value (prior to write-down): $20,000 $2,000 = $18,000

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

ANSWERS TO SKILLS DEVELOPMENT CASES S95 Req.1 Method Straight-line Computation

(Cost Residual Value) x (1/ Useful Life)

Depreciation Expense

Book Value

($35,000 - $7,000) x 1/4

(Cost Res. Value) x Estimated Total Production Actual Production

$7,000

$28,000

Units-ofProduction

{($35,000 - $7,000) 28,000} x 4,000

$4,000

31,000

Doubledecliningbalance

(Cost Accumulated Depreciation) x (2/ Useful Life)

($35,000 0) x 2/4

$17,500

17,500

The units-of-production method would meet the owners objective of keeping the total assets above $250,000. Under this method, the depreciation expense would be $4,000 leaving a book value for the new equipment of $31,000, which would keep the total assets at $251,000. The straight-line and double-declining-balance methods would produce book values that would cause total assets to fall below $250,000. Req. 2 One could justifiably argue that it is unethical to choose a particular method if the sole purpose of the choice is to mislead others or if existing rules are knowingly violated. This isnt the case in this situation however. The choice of the units-of-production method is supported by a valid business reason. By using this method, the company is able to match the cost of using the new equipment to the periods in which the output from the equipment is sold to generate revenue. Arguably, this provides more useful financial information than the other two alternative methods, which assume asset usage patterns that differ from actual usage. The two parties most directly affected by this decisionthe owner and the bankcan both benefit from this decision. The owner gets a more appropriate measure of his companys net income for the year and its net assets at the end of the year. The bank similarly receives more useful information that will enable the bank to avoid incurring

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Chapter 09 - Reporting and Interpreting Long-Lived Tangible and Intangible Assets

S95 (continued) Req. 2 (continued) unnecessary costs associated with renegotiating the terms of its loan to the company renegotiations that could ultimately reveal that the company is generating sufficient cash flows to repay the loan (despite what net income suggests under the alternative depreciation methods). The primary drawback of this decision for the owner is that it is somewhat more costly to track information about the equipments output (although this information already seems to be readily available). The primary drawback of this decision for the bank is that the bank gives up the opportunity to renegotiate the loan at terms more favorable to the bank (although, as we discussed above, theres no guarantee the bank would succeed in obtaining more favorable terms through renegotiations). The recommendation to use the units-of-production method does not violate any laws or rules. Companies are allowed to use different methods of depreciation for different types of assets, so the use of the double-declining-balance method for existing equipment is not a constraint. Units-of-production has long been recognized as an alternative depreciation method under GAAP. The only other relevant factor in reaching a decision is the owners advice to work with the numbers to make sure everything is onside with the bank. This seems to be an inappropriate and potentially unethical basis for making a decision. The owner needs to be informed of the benefits of honestly reporting the companys financial condition and results of operationsfor both internal and external decision-making purposes. By itself, the owners remark shouldnt necessarily cause you to change your recommendation. But, it is one of those little red flags that should lead you to be watchful for other potentially unethical requests in the future.

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