File: ch09, Chapter 9: Reporting and Analyzing Long-Lived Assets

Multiple Choice

1. Corrieten Company purchased equipment and incurred these costs:

Cash price Sales taxes Insurance during transit Installation and testing Total costs $24,000 1,200 200 400 $25,800

What amount should be recorded as the cost of the equipment? a) $24,000. b) $25,200. c) $25,400. d) $25,800. Ans: d Response A: This answer includes only the cash price of the equipment. All of the costs noted above should be included as part of the cost of the equipment because they are all costs that are necessary to acquire the equipment, safely transport it and prepare it for use. Response B: This answer includes only the cash price and the sales taxes. All of the costs noted above should be included as part of the cost of the equipment because they are all costs that are necessary to acquire the equipment, safely transport it and prepare it for use. Response C: This answer includes only the cash price, sales taxes and insurance during transit. All of the costs noted above should be included as part of the cost of the equipment because they are all costs that are necessary to acquire the equipment, safely transport it and prepare it for use. Response D: Correct!

2. Harrington Corporation recently leased a number of trucks from Andre Corporation. In inspecting the books of Harrington Corporation, you notice that the trucks have not been recorded as assets on its balance sheet. From this you can conclude that Harrington is accounting for this transaction as a(n): a) operating lease. b) capital lease. c) purchase. d) None of the above. Ans: a Response A: Correct! Response B: If the leased assets were accounted for as a capital lease, they would be reported on the balance sheet. Response C: If the assets were purchased, they would be reported on the balance sheet. Response D: Since a is the correct answer, this answer cannot be correct.

3. Depreciation is a process of: a) valuation. b) cost allocation. c) cash accumulation. d) appraisal. Ans: b Response A: Depreciation is not a process of valuing an asset. Rather, it is a process of allocating the cost of a long-term asset over its useful service life. Response B: Correct! Response C: Depreciation is not a process of cash accumulation. Rather, it is a process of allocating the cost of a long-term asset over its useful service life. Response D: Depreciation is not a process of appraisal. Rather, it is a process of allocating the cost of a long-term asset over the its useful service life.

4. Cuso Company purchased equipment on January 1, 2006, at a total invoice cost of $400,000. The equipment has an estimated salvage value of $10,000 and an estimated useful life of 5 years. What is the amount of accumulated depreciation at December 31, 2007, if the straight-line method of depreciation is used? a) $80,000. b) $160,000. c) $78,000. d) $156,000. Ans: d Response A: This answer reflects the annual depreciation expense and the amount of accumulated depreciation after one year if the salvage value is not subtracted. Since the asset has been in use for two years, the accumulated depreciation at December 31, 2007, is equal to two times the annual depreciation expense. This is computed as follows: ($400,000 - $10,000)/ 5 = $78,000 per year. Then, $78,000 per year X 2 years = $156,000. Response B: This answer reflects the amount of accumulated depreciation after two years if the salvage value is not subtracted. Since the asset has been in use for two years, the accumulated depreciation at December 31, 2007, is equal to two times the annual depreciation expense. This is computed as follows: ($400,000 - $10,000)/ 5 = $78,000 per year. Then, $78,000 per year X 2 years = $156,000. Response C: This answer represents the annual depreciation expense and the accumulated depreciation at the end of the first year, or at December 31, 2006. Since the asset has been in use for two years, the accumulated depreciation at December 31, 2007, is equal to two times the annual depreciation expense. This is computed as follows: ($400,000 - $10,000)/ 5 = $78,000 per year. Then, $78,000 per year X 2 years = $156,000. Response D: Correct!

5. A company would minimize its depreciation expense in the first year of owning an asset if it used:

a) b) c) d)

a high estimated life, a high salvage value, and declining-balance depreciation. a low estimated life, a high salvage value, and straight-line depreciation. a high estimated life, a high salvage value, and straight-line depreciation. a low estimated life, a low salvage value, and declining-balance depreciation.

Ans: c Response A: This combination of factors would not result in the lowest depreciation expense in the first year. This is because this answer contains two of the factors that would minimize depreciation expense, namely high estimated life and high salvage value. However, the straight-line depreciation method would yield a smaller depreciation charge in the first year than the declining balance method. Response B: This combination of factors would not result in the lowest depreciation expense in the first year. This is because this answer contains two of the factors that would minimize depreciation expense, namely a high salvage value and straight-line depreciation. However, a low estimated life would spread the amount to be depreciated over a shorter period of time and cause depreciation expense to be higher. Response C: Correct! Response D: This combination of factors would result in the HIGHEST depreciation expense in the first year. This is because a low estimated life would spread the amount to be depreciated over a shorter period of time, a low salvage value would result in a larger amount to be depreciated, and the declining balance method would result in a larger depreciation charge in the first year than the straight-line depreciation method.

6. When there is a change in estimated depreciation: a) previous depreciation should be corrected. b) current and future years depreciation should be revised. c) only future years depreciation should be revised. d) None of the above. Ans: b Response A: When estimated depreciation changes, the changes should be reflected in the current and future years, not in prior years. Response B: Correct! Response C: When estimated depreciation changes, the changes should be reflected in the current and future years, not only in future years. Response D: Since answer b is correct, this answer cannot be correct.

7. Additions to plant assets: a) are revenue expenditures. b) increase a Repair Expense account. c) increase a Purchases account. d) are capital expenditures. Ans: d Response A: Additions to plant assets are capital expenditures, not revenue expenditures because they increase either the operating efficiency, productive capacity, or useful life of the asset.

Response B: Additions to plant assets are capital expenditures because they increase either the operating efficiency, productive capacity, or useful life of the asset. These expenditures should be debited to an asset account, not a Repair Expense account. Response C: Additions to plant assets are capital expenditures because they increase either the operating efficiency, productive capacity, or useful life of the asset. These expenditures should be debited to an asset account, not a Purchases account. Response D: Correct!

8. Which of the following measures provides an indication of how efficient a company is in employing its assets? a) Current ratio. b) Profit margin ratio. c) Debt to total assets ratio. d) Asset turnover ratio. Ans: d Response A: The asset turnover ratio, not the current ratio is an indication of how efficiently a company is employing its assets. Response B: The asset turnover ratio, not the profit margin ratio is an indication of how efficiently a company is employing its assets. Response C: The asset turnover ratio, not the debt to total assets ratio is an indication of how efficiently a company is employing its assets. Response D: Correct!

9. Pierce Company incurred $150,000 of research and development costs in its laboratory to develop a new product. It spent $20,000 in legal fees for a patent granted on January 2, 2007. On July 31, 2007, Pierce paid $15,000 for legal fees in a successful defense of the patent. What is the total amount that should be debited to Patents through July 31, 2007? a) $150,000. b) $35,000. c) $185,000. d) Some other amount. Ans: b Response A: Only the $20,000 in legal fees and the $15,000 of successful defense costs should be debited to the Patents account through July 31, 2007. The research and development costs spent to develop the new product must be expensed in the year they were incurred. Response B: Correct! Response C: Only the $20,000 in legal fees and the $15,000 of successful defense costs should be debited to the Patents account through July 31, 2007. The research and development costs spent to develop the new product must be expensed in the year they were incurred. Response D: Only the $20,000 in legal fees and the $15,000 of successful defense costs should be debited to the Patents account through July 31, 2007. The research and development costs spent to develop the new product must be expensed in the year they were incurred.

10. Indicate which one of these statements is true. a) Since intangible assets lack physical substance, they need to be disclosed only in the notes to the financial statements. b) Goodwill should be reported as a contra account in the stockholders equity section. c) Totals of major classes of assets can be shown in the balance sheet, with asset details disclosed in the notes to the financial statements. d) Intangible assets are typically combined with plant assets and natural resources and then shown in the property, plant, and equipment section. Ans: c Response A: This statement is not true because even though intangible assets lack substance, they should still be reported in the balance sheet. Response B: This statement is not true because goodwill should be reported as an intangible asset, not as a contra account in the stockholders equity section. Response C: Correct! Response D: This statement is not true because intangible assets are not combined with plant assets and natural resources and then reported in the property, plant, and equipment section.

11. If a company reports goodwill as an intangible asset on its books, what is the one thing you know with certainty? a) The company is a valuable company worth investing in. b) The company has a well-established brand name. c) The company purchased another company. d) The goodwill will generate a lot of positive business for the company for many years to come. Ans: c Response A: If a firm reports goodwill on its books, you do not know for sure if the company is a valuable firm in which to invest. However, you can be certain that in the past, it has purchased another company. Response B: If a firm reports goodwill on its books, you do not know for sure if the company has a wellestablished brand name. However, you can be certain that in the past, it has purchased another company. Response C: Correct! Response D: If a firm reports goodwill on its books, you do not know for sure if the goodwill will generate a lot of positive business for the company for many years to come. However, you can be certain that in the past, it has purchased another company.

12. Kant Enterprises purchased a truck for $11,000 on January 1, 2006. The truck will have an estimated salvage value of $1,000 at the end of 5 years. If you use the units-of-activity method, the balance in accumulated depreciation at December 31, 2007, can be computed by the following formula: a) ($11,000/Total estimated activity) x Units of activity for 2007. b) ($10,000/Total estimated activity) x Units of activity for 2007. c) ($11,000/Total estimated activity) x Units of activity for 2006 and 2007. d) ($10,000/Total estimated activity) x Units of activity for 2006 and 2007.

Ans: d Response A: This is not the correct formula for computing the balance in accumulated depreciation at December 31, 2007. This is because the salvage value has not been subtracted from the cost ($11,000 $1,000) and because the units of activity for BOTH 2006 and 2007 need to be included. Response B: This is not the correct formula for computing the balance in accumulated depreciation at December 31, 2007. This is because the units of activity for both 2006 and 2007 need to be included. Response C: This is not the correct formula for computing the balance in accumulated depreciation at December 31, 2007. This is because the salvage value has not been subtracted from the cost ($11,000 $1,000). Response D: Correct!