Vous êtes sur la page 1sur 38

Chapter 10 Operational Assets: Acquisition and Disposition

True/False Questions

1. Operational assets is a term used to describe assets created by the normal operation of the
business, including inventories and receivables.

Answer: False Learning Objective: 1 Level of Learning: 1

2. Sales tax paid on equipment used in the business is not capitalized or depreciated.

Answer: False Learning Objective: 1 Level of Learning: 1

3. Demolition costs to remove an old building from land purchased as a site for a new building
are considered part of the cost of the new building.

Answer: False Learning Objective: 1 Level of Learning: 1

4. The initial cost of an operational asset includes all the identifiable expenditures necessary to
bring the asset to its desired condition and location for use.

Answer: True Learning Objective: 1 Level of Learning: 1

5. A distinguishing characteristic of intangible assets is the degree of uncertainty about when or


if they will provide future benefits.

Answer: True Learning Objective: 1 Level of Learning: 1

6. Costs incurred after discovery of a natural resource but before production begins are reported
as expenses of the period in which the expenditures are made.

Answer: False Learning Objective: 1 Level of Learning: 2

7. The relative fair market values are used to determine the valuation of individual assets
acquired in a lump-sum purchase.

Answer: True Learning Objective: 2 Level of Learning: 1

8. The fair value of the asset, debt or equity securities given in a noncash acquisition should
determine the value of the consideration received.

Answer: True Learning Objective: 6 Level of Learning: 1

9. Under current GAAP, fair value is used to measure the components of all nonmonetary
exchanges.

Answer: False Learning Objective: 6 Level of Learning: 2

10. When nonmonetary exchanges lack commercial substance, the asset(s) acquired are valued at
the book value of the asset(s) given up plus (or minus) any cash exchanged.

Answer: True Learning Objective: 6 Level of Learning: 1

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 119


Chapter 10 Operational Assets: Acquisition and Disposition

11. The capitalization period for a self-constructed asset ends either when the asset is substantially
complete and ready for use or when interest costs no longer are being incurred.

Answer: True Learning Objective: 7 Level of Learning: 1

12. The FASB's required accounting treatment for research and development costs often
understates both net income and assets.

Answer: True Learning Objective: 8 Level of Learning: 1

Matching Pair Questions

Use the following to answer questions 13-17:

13-17. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
a. Average accumulated expenditures
b. Exchange of operational assets
c. Expected cash flow approach
d. Franchise
e. Interest cost
f. Land
g. Noninterest-bearing note
h. R&D performed for others
i. Revenue-donation of asset
j. Trademark
Phrases:
13. _____ Account credited when assets are donated to a corporation.
14. _____ Approximation of average outstanding debt if all construction funds were borrowed.
15. _____ Both the total amount and the amount capitalized should be disclosed.
16. _____ Asset received is measured at fair value.
17. _____ Right granted to use a trademark or tradename within a geographic area.

Answer: 13-I; 14-A; 15-E; 16-B; 17-D

120 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 18-22:

18-22. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
a. Average accumulated expenditures
b. Exchange of operational assets
c. Expected cash flow approach
d. Franchise
e. Interest cost
f. Land
g. Noninterest-bearing note
h. R&D performed for others
i. Revenue-donation of asset
j. Trademark
Phrases:
18. _____ Exclusive right to display a word, symbol, or emblem.
19. _____ Generates inventoriable costs.
20. _____ Incorporates specific probabilities of cash flows.
21. _____ Its cost includes filling, draining, and removal of old structures.
22. _____ May require determination of implicit interest.

Answer: 18-J; 19-H; 20-C; 21-F; 22-G

Use the following to answer questions 23-27:

23-27. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term by placing the letter designating the best
term in the space provided by the phrase.

Terms:
a. Amortization
b. Asset retirement obligations
c. Fixed asset turnover ratio
d. Implicit rate of interest
e. Land improvements
f. Natural resources
g. Nonmonetary exchange
h. Research and development costs
i. Similar assets exchange
j. Technological feasibility
Phrases:
23. _____ Point in time to begin capitalization of software development costs.
24. _____ Expensed in the period incurred.
25. _____ The allocation of cost for intangible assets.
26. _____ The basic principle is to value assets acquired using fair value of consideration given.
27. _____ Wasting assets.

Answer: 23-J; 24-H; 25-A; 26-G; 27-F

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 121


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 28-32:

28-32. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term by placing the letter designating the best
term in the space provided by the phrase.

Terms:
a. Amortization
b. Asset retirement obligations
c. Fixed asset turnover ratio
d. Implicit rate of interest
e. Land improvements
f. Natural resources
g. Nonmonetary exchange
h. Research and development costs
i. Similar assets exchange
j. Technological feasibility
Phrases:
28. _____ A measurement of efficiency in using depreciable assets.
29. _____ Used when recording a noninterest-bearing note.
30. _____ Associated with the disposition of an operational asset.
31. _____ Recorded like dissimilar asset exchanges.
32. _____ Includes parking lots, fences, and driveways, lighting and sprinkler systems.

Answer: 28-C; 29-D; 30-B; 31-I; 32-E

Use the following to answer questions 33-37:

33-37. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
a. Copyright
b. Depletion
c. Depreciation
d. Donated assets
e. Effective interest
f. Goodwill
g. Intangible assets
h. Lump-sum purchase
i. Patents
j. Software development costs
Phrases:
33. _____ Operational assets that generally represent various types of rights.
34. _____ Purchase price less fair value of net identifiable assets.
35. _____ The cost allocation of equipment.
36. _____ The allocation of cost of natural resources.
37. _____ Protects against infringements on manufactured products.

Answer: 33-G; 34-F; 35-C; 36-B; 37-I

122 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 38-42:

38-42. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
a. Copyright
b. Depletion
c. Depreciation
d. Donated assets
e. Effective interest
f. Goodwill
g. Intangible assets
h. Lump-sum purchase
i. Patents
j. Software development costs
Phrases:
38. _____ Market rate times outstanding debt.
39. _____ Revenue recorded upon receipt from unrelated parties.
40. _____ Exclusive right to benefit from a creative work.
41. _____ Capitalized between points of technological feasibility and start of production.
42. _____ Price allocated in proportion to relative market values.

Answer: 38-E; 39-D; 40-A; 41-J; 42-H

Multiple Choice Questions

43. Operational assets are:


A) Created by the normal operation of the business and include accounts receivable.
B) All assets except cash and cash equivalents.
C) Current and long-term assets used in the production of either goods or services.
D) Long-term revenue-producing assets.

Answer: D Learning Objective: 1 Level of Learning: 1

44. The acquisition costs of tangible operational assets do not include:


A) The ordinary and necessary costs to bring the asset to its desired condition and location
for use.
B) The net invoice price.
C) Legal fees, delivery charges, installation, and any applicable sales tax.
D) Maintenance costs during the first 30 days of use.

Answer: D Learning Objective: 1 Level of Learning: 1

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 123


Chapter 10 Operational Assets: Acquisition and Disposition

45. Goodwill is:


A) Amortized over the greater of its estimated life or forty years.
B) Only recorded by the seller of a business.
C) The excess of the fair market value of a business over the fair market value of all net
identifiable assets.
D) Not subject to amortization for purposes of income taxes.

Answer: C Learning Objective: 1 Level of Learning: 1

46. Assets acquired in a lump-sum purchase are valued based on:


A) Their assessed valuation.
B) Their relative fair market values.
C) The present value of their future cash flows.
D) Their cost plus the difference between their cost and fair market values.

Answer: B Learning Objective: 2 Level of Learning: 1

47. Assets acquired under multi-year deferred payment contracts are:


A) Valued at their fair value on the date of the final payment.
B) Valued at the present value of the payments required by the contract.
C) Valued at the sum of the payments required by the contract.
D) None of the above.

Answer: B Learning Objective: 3 Level of Learning: 1

48. Assets acquired by the issuance of equity securities are valued based on:
A) Their fair market values.
B) The fair market value of the equity securities.
C) Whichever of A. or B. above is more reasonably determinable.
D) Whichever of A. or B. above is smaller.

Answer: C Learning Objective: 4 Level of Learning: 1

49. The basic principle used to value the asset acquired in a nonmonetary exchange is to value it
at:
A) Fair value of the asset(s) given up.
B) The book value of the asset given plus any cash or other monetary consideration received.
C) Fair value or book value, whichever is smaller.
D) Book value of the asset given.

Answer: A Learning Objective: 6 Level of Learning: 1

50. In nonmonetary exchanges, the asset received is not valued based on the fair value of the asset
given up when:
A) When the fair value of the asset given is not determinable.
B) When there is an exchange of similar assets with no cash received and a gain is indicated.
C) When the exchange lacks commercial substance.
D) All of the above are correct.

Answer: C Learning Objective: 6 Level of Learning: 2

124 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

51. Interest is not capitalized for:


A) Assets that are constructed as discrete projects.
B) Assets constructed for sale or lease.
C) Inventories routinely and repetitively produced in large quantities.
D) Interest is capitalized for all of these items.

Answer: C Learning Objective: 7 Level of Learning: 2

52. Average accumulated expenditures:


A) Is an approximation of the average debt a firm would have outstanding if it financed all
construction through debt.
B) May be computed as a simple average if all construction expenditures are made at the end
of the period.
C) Are irrelevant if the company's total outstanding debt is less than total costs of
construction.
D) All of the above are true statements.

Answer: A Learning Objective: 7 Level of Learning: 2

53. Research and development (R&D) costs:


A) Are always expensed in the period incurred.
B) May be expensed or capitalized, at the option of the reporting entity.
C) Must be capitalized and amortized.
D) Generally pertain to activities that occur prior to the start of production.

Answer: D Learning Objective: 8 Level of Learning: 2

54. Productive assets that are physically consumed in operations are:


A) Equipment.
B) Land.
C) Land improvements.
D) Natural resources.

Answer: D Learning Objective: 1 Level of Learning: 1

55. An exclusive 20-year right to manufacture a product or use a product is a:


A) Patent.
B) Copyright.
C) Trademark.
D) Franchise.

Answer: A Learning Objective: 1 Level of Learning: 1

56. The exclusive right to benefit from a creative work, such as a film, is a:
A) Patent.
B) Copyright.
C) Trademark.
D) Franchise.

Answer: B Learning Objective: 1 Level of Learning: 1

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 125


Chapter 10 Operational Assets: Acquisition and Disposition

57. The exclusive right to display a symbol of product identification is a:


A) Patent.
B) Copyright.
C) Trademark.
D) Franchise.

Answer: C Learning Objective: 1 Level of Learning: 1

58. The capitalized cost of equipment excludes:


A) Maintenance.
B) Sales tax.
C) Shipping.
D) Installation.

Answer: A Learning Objective: 1 Level of Learning: 1

59. Donated assets are recorded at:


A) Zero (memo entry only).
B) The donor's book value.
C) The donee's stated value.
D) Market value.

Answer: D Learning Objective: 4 Level of Learning: 2

60. Until recently, the accounting treatment of nonmonetary asset exchanges depended on
A) Whether the assets exchanged were similar or dissimilar.
B) Whether a gain or loss was indicated in the exchange.
C) Whether cash was given or received.
D) All of the above factors.

Answer: D Learning Objective: 6 Level of Learning: 2

61. If a company incurs disposition obligations as a result of acquiring an asset,:


A) the company recognizes the obligation at fair value when the asset is acquired.
B) the company recognizes the obligation at fair value when the asset is disposed.
C) the company records the difference between the fair value of the asset and the obligation
when the asset is acquired.
D) None of the above.

Answer: A Learning Objective: 1 Level of Learning: 2

62. In a nonmonetary exchange of equipment, a gain is recognized if:


A) The fair value of the equipment received exceeds the book value of the equipment
surrendered.
B) The fair value of the equipment received exceeds the fair value of the equipment
surrendered.
C) The fair value of the equipment surrendered exceeds the book value of the equipment
surrendered.
D) None of the above is correct.

Answer: A Learning Objective: 6 Level of Learning: 2

126 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

63. In accounting for oil and gas exploration costs, companies:


A) May not use the full-cost method.
B) May use the successful efforts method.
C) May use the slippery slope method.
D) All of the above are correct.

Answer: B Learning Objective: 1 Level of Learning: 2

64. The fixed-asset turnover ratio provides:


A) The rate of decline in asset lives.
B) The rate of replacement of fixed assets.
C) The amount of sales generated per dollar of fixed assets.
D) The decline in book value of fixed assets compared to capital expenditures.

Answer: C Learning Objective: 5 Level of Learning: 2

65. The cost of self-constructed fixed assets should:


A) Include indirect costs allocated just as they are for production.
B) Include only incremental indirect costs.
C) Include only specifically identifiable indirect costs.
D) Not include indirect costs.

Answer: A Learning Objective: 7 Level of Learning: 2

66. Interest may be capitalized:


A) On routinely manufactured goods as well as self-constructed assets.
B) On self-constructed assets from the date an entity formally adopts a plan to build a
discrete project.
C) Whether or not there is specific borrowing for the construction.
D) Whether or not there are actual interest costs.

Answer: C Learning Objective: 7 Level of Learning: 1

67. Research and development costs for projects other than software development should be:
A) Expensed in the period incurred.
B) Expensed in the period they are determined to be unsuccessful.
C) Deferred pending determination of success.
D) Expensed if unsuccessful, capitalized if successful.

Answer: A Learning Objective: 8 Level of Learning: 1

68. Research and development expense for a given period includes:


A) The full cost of a newly acquired operational asset that has an alternative future use.
B) Depreciation on a research and development facility.
C) Research and development conducted on a contract basis for another entity.
D) Patent filing and legal costs.

Answer: B Learning Objective: 8 Level of Learning: 2

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 127


Chapter 10 Operational Assets: Acquisition and Disposition

69. Software development costs are capitalized if they are incurred:


A) Prior to point at which technological feasibility has been established.
B) After commercial production has begun.
C) After technological feasibility has been established but prior to the product availability
date.
D) None of the above is correct.

Answer: C Learning Objective: 8 Level of Learning: 1

70. Amortization of capitalized computer software costs is:


A) Either the percentage-of-revenue method or the straight-line method at the company's
option.
B) The greater of the percentage-of-revenue method or the straight-line method.
C) The lesser of the percentage-of-revenue method or the straight-line method.
D) Based on neither the percentage-of-revenue nor the straight-line method.

Answer: B Learning Objective: 8 Level of Learning: 2

71. When selling operational assets for cash:


A) The seller recognizes a gain or loss for the difference between the cash received and the
fair value of the asset sold.
B) The seller recognizes a gain or loss for the difference between the cash received and the
book value of the asset sold.
C) The seller recognizes losses, but not gains.
D) None of the above.

Answer: B Learning Objective: 1 Level of Learning: 2

72. Interest is eligible to be capitalized as part of an asset's cost, rather than being expensed
immediately when:
A) The interest is incurred during the construction period of the asset.
B) The asset is a discrete construction project for sale or lease.
C) The asset is self-constructed, rather than acquired.
D) All of the above are correct.

Answer: D Learning Objective: 7 Level of Learning: 1

73. In computing capitalized interest, average accumulated expenditures


A) Are the simple arithmetic mean of all construction expenditures.
B) Are determined by time-weighting individual expenditures made during the asset
construction period.
C) Are multiplied by the company's most recent financing rates.
D) All of the above are correct.

Answer: B Learning Objective: 7 Level of Learning: 1

128 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

74. Asset retirement obligations:


A) Increase the balance in the related asset account.
B) Is measured at fair value in the balance sheet.
C) Are liabilities associated with disposition of an operational asset.
D) All of the above are correct.

Answer: D Learning Objective: 1 Level of Learning: 1

75. Asset retirement obligations are recognized:


A) When the related asset is retired or sold.
B) In the period they are incurred.
C) Gradually over the useful life of the related asset.
D) When the related asset is acquired.

Answer: B Learning Objective: 1 Level of Learning: 1

76. Which of the following does not pertain to accounting for asset retirement obligations?
A) They accrete (increase over time) at the company's cost of capital.
B) They must be recognized, according to SFAS 143.
C) Statement of Financial Accounting Concepts No. 7 is used to adjust cash flow obligations
for uncertainty.
D) All of the above pertain to accounting for asset retirement obligations.

Answer: A Learning Objective: 1 Level of Learning: 2


Rationale: Actually, the obligations accrete at the credit-adjusted risk free rate.

Use the following to answer questions 77-78:

Montana Mining Co. (MMC) paid $200 million for the right to explore and extract rare metals from
land owned by the state of Montana. To obtain the rights, MMC agreed to restore the land to a
suitable condition for other uses after its exploration and extraction activities. MMC incurred
exploration and development costs of $60 million on the project.

MMC has a credit-adjusted risk free interest rate is 7%. It estimates the possible cash flows for
restoring the land, three years after completion of its extraction activities, as follows:

Cash Outflow Probability


$10 million 60%
$30 million 40%

77. The asset retirement obligation (rounded) that should be recognized by MMC upon
completion of the extraction activities is:
A) $8.2 million
B) $14.7 million
C) $18 million
D) $30 million

Answer: B Learning Objective: 1 Level of Learning: 3


Rationale: The present value of the expected cash flows, that is, 0.81630 x [(.60 x $10 million)
+ (.40 x $30 million)], which is $14,693,400 or $14.7 million (rounded).

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 129


Chapter 10 Operational Assets: Acquisition and Disposition

78. The asset retirement obligation (rounded) that should be recognized by MMC one year after
completion of the extraction activities is:
A) $0
B) $14.7 million
C) $15.7 million
D) $19.3 million

Answer: C Learning Objective: 1 Level of Learning: 3


Rationale: $14.7 million x 1.07 = $15.7 million (rounded).

Use the following to answer questions 79-81:

On June 1, 2005, the Crocus Company began construction of a new manufacturing plant. The plant
was completed on October 31, 2006. Expenditures on the project were as follows (in $ millions):

July 1, 2005 54
October 1, 2005 22
February 1, 2006 30
April 1, 2006 21
September 1, 2006 20
October 1, 2006 6

On July 1, 2005, Crocus obtained a $60 million construction loan with a 6% interest rate. The loan was
outstanding through the end of October, 2006. The company's other interest-bearing debt was a long-
term note for $100 million with an interest rate of 8%. This note was outstanding during all of 2005
and 2006. The company's fiscal year-end is December 31.

79. What is the amount of interest that Crocus should capitalize in 2005, using the specific interest
method?
A) $1.90 million
B) $1.95 million
C) $2.96 million
D) None of the above is correct.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
Average expenditures for 2005: ($54 million x 6/6) + $22 million x 3/6) = $65 million. The
interest is $65 million x .06 x 6/12 = $1.95 million.

80. In computing the capitalized interest for 2006, Crocus' average accumulated expenditures
total:
A) $46.30 million
B) $103.54 million
C) $122.30 million
D) $124.25 million

Answer: D Learning Objective: 7 Level of Learning: 3


Rationale: The correct answer is: [from 2005 ($77.95 million x 10/10) + ($30 million x
9/10) + ($21 million x 7/10) + ($20 million x 2/10) + ($6 million x 1/10) = $124.25 million.

130 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

81. What is the amount of interest that Crocus should capitalize in 2006, using the specific interest
method (rounded to the nearest thousand dollars)?
A) $7,248,000 (rounded)
B) $7,283,000 (rounded)
C) $8,740,000 (rounded)
D) None of the above is correct.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale: Of the average accumulated expenditures ($124.25 million from question 80), $60
million was financed at 6% for 10 months in 2006, and the remainder of $64.25 million was
financed at 8% for that period. The total interest cost was $7,283,000 (rounded).

82. Grab Manufacturing Co. purchased a ten-ton draw press at a cost of $180,000 with terms of
5/15 n/45. Payment was made within the discount period. Shipping costs were $4,600, which
included $200 for insurance in transit. Installation costs totaled $12,000, which included
$4,000 for taking out a section of a wall and rebuilding it because the press was too large for
the doorway. The capitalized cost of the ten-ton draw press is:
A) $171,000.
B) $183,600.
C) $187,600.
D) $185,760.

Answer: C Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price ($180,000 x 95%) $171,000
Shipping Costs 4,600
Installation costs 12,000
Total cost of equipment $187,600

83. Holiday Laboratories purchased a high speed industrial centrifuge at a cost of $420,000.
Shipping costs totaled $15,000. Foundation work to house the centrifuge cost $8,000. An
additional water line had to be run to the equipment at a cost of $3,000. Labor and testing
costs totaled $6,000. Materials used up in testing cost $3,000. The capitalized cost is:
A) $455,000.
B) $446,000.
C) $437,000.
D) $435,000.

Answer: A Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price $420,000
Shipping Costs 15,000
Foundation work 8,000
Water line 3,000
Labor and testing 6,000
Materials used in testing 3,000
Total cost of equipment $455,000

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 131


Chapter 10 Operational Assets: Acquisition and Disposition

84. Vijay Inc. purchased a 3-acre tract of land for a building site for $320,000. On the land was a
building with an appraised value of $120,000. The company demolished the old building at a
cost of $12,000, but was able to sell scrap from the building for $1,500. The cost of title
insurance was $900 and attorney fees for reviewing the contract was $500. Property taxes paid
were $3,000, of which $250 covered the period subsequent to the purchase date. The
capitalized cost of the land is:
A) $336,400.
B) $336,150.
C) $334,650.
D) $201,150.

Answer: C Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price $320,000
Demolition costs 12,000
Scrap sold (1,500 )
Title insurance 900
Legal fees 500
Property taxes ($3,000 250) 2,750
Total cost of land $334,650

85. Juliana Corporation purchased all of the outstanding stock of Caldwell Inc., paying
$2,700,000 cash. Juliana assumed all of the liabilities. Book values and fair values of acquired
assets and liabilities were:

Book value Fair Value


Current assets (net) $420,000 $450,000
Property, plant, & equip. (net) 1,600,000 2,250,000
Liabilities 500,000 600,000

Juliana would record goodwill of:


A) $1,180,000.
B) $600,000.
C) $880,000.
D) $100,000.

Answer: B Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price $2,700,000
Less: Fair value of net assets
Assets ($450,000 + 2,250,000) $2,700,000
Less: Liabilities assumed (600,000 ) (2,100,000 )
Goodwill $ 600,000

132 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

86. Lake Incorporated purchased all of the outstanding stock of Huron Company paying $950,000
cash. Lake assumed all of the liabilities. Book values and fair values of acquired assets and
liabilities were:

Book Value Fair Value


Current assets (net) $130,000 $125,000
Property, plant, equip. (net) 600,000 750,000
Liabilities 150,000 175,000

Lake would record goodwill of:


A) $ 0.
B) $ 75,000.
C) $445,000.
D) $250,000

Answer: D Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price $950,000
Less: Fair value of net assets
Assets ($125,000 + 750,000) $875,000
Less: Liabilities assumed 175,000 (700,000 )
Goodwill $ 250,000

87. Alamos Co. exchanged land and $18,000 cash for equipment. The book value and the fair
value of the land were $82,000 and $90,000, respectively. Which of the following choices
would be correct?

Alamos would record equipment at and record a gain/(loss) of:


A) $ 82,000; $ 8,000
B) $108,000; $ 8,000
C) $ 82,000; $(8,000)
D) $108,000; $(8,000)

Answer: B Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment (FV of land + $18,000) 108,000
Cash 18,000
Land (book value) 82,000
Gain ($90,000 82,000) 8,000

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 133


Chapter 10 Operational Assets: Acquisition and Disposition

88. Bloomington Inc. exchanged land for equipment and $3,000 in cash. The book value and the
fair value of the land were $104,000 and $90,000, respectively. Which of the following
choices would be correct?

Bloomington would record equipment at and record a gain/(loss) of:


A) $ 87,000; $ 3,000
B) $104,000; $ (5,000)
C) $ 87,000; $(14,000)
D) None of the above is correct.

Answer: C Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment (FV of land - $3,000) 87,000
Cash 3,000
Loss ($104,000 90,000) 14,000
Land (book value) 104,000

89. P. Chang & Co. exchanged land and $9,000 cash for equipment. The book value and the fair
value of the land were $106,000 and $90,000, respectively. Which of the following choices
would be correct?

Chang would record equipment at and record a gain/(loss) of:


A) $ 99,000; $(16,000)
B) $ 90,000; $(25,000)
C) $108,000; $ 16,000
D) $106,000; $( 9,000)

Answer: A Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment (FV of land + $9,000) 99,000
Loss ($106,000 90,000) 16,000
Cash 9,000
Land (book value) 106,000

90. Horton Stores exchanged land for equipment and received $5,000 in cash. The book value and
the fair value of the land were $100,000 and $90,000, respectively. Which of the following
choices would be correct?

Horton would record equipment at and record a gain/(loss) of:


A) $90,000; $ 5,000
B) $85,000; $(10,000)
C) $95,000; $ 0
D) $90,000; $(10,000)

Answer: B Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment (FV of land $5,000) 85,000
Cash 5,000
Loss ($100,000 90,000) 10,000
Land (book value) 100,000

134 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 91-92:

Below are data relative to an exchange of similar assets by Grand Forks Corp.

Old Equipment Cash


Book Value Fair Value Paid
Case A $50,000 $60,000 $15,000
Case B $40,000 $35,000 $ 8,000

91. In Case A, Grand Forks would record the new equipment at:
A) $65,000.
B) $75,000.
C) $50,000.
D) $60,000.

Answer: B Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment ($60,000 + 15,000) 75,000
Cash 15,000
Equipment-old (book value) 50,000
Gain 10,000

92. In Case B, Grand Forks would record a gain/(loss) of:


A) $ 5,000
B) $ 3,000
C) $(5,000)
D) $(3,000)

Answer: C Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment ($35,000 + 8,000) 43,000
Loss ($40,000 35,000) 5,000
Cash 8,000
Equipment-old (book value) 40,000

Use the following to answer questions 93-94:

Below are listed data relative to an exchange of equipment by Pensacola Inc.

Old Equipment Cash


Book Value Fair Value Received
Case A $75,000 $80,000 $12,000
Case B $60,000 $56,000 $10,000

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 135


Chapter 10 Operational Assets: Acquisition and Disposition

93. In Case A, Pensacola would record the new equipment at:


A) $68,000.
B) $63,750.
C) $67,250.
D) $80,000.

Answer: A Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment- new ($80,000 12,000) 68,000
Cash 12,000
Equipment-old (book value) 75,000
Gain 5,000

94. In Case B, Pensacola would record a gain/(loss) of:


A) $ 4,000.
B) $ (4,000).
C) $ (10,000).
D) None of the above is correct.

Answer: B Learning Objective: 6 Level of Learning: 3


Rationale:
Equipment new ($56,000 10,000) 46,000
Cash 10,000
Loss 4,000
Equipment-old (book value) 60,000

Use the following to answer questions 95-98:

On January 1, 2006, Kendall Inc. began construction of an automated cattle feeder system. The system
was finished and ready for use on September 30, 2007. Expenditures on the project were as follows:

January 1, 2006 $200,000


September 1, 2006 $300,000
December 31, 2006 $300,000
March 31, 2007 $300,000
September 30, 2007 $200,000

Kendall borrowed $750,000 on a construction loan at 12% interest on January 1, 2006. These loans
were outstanding throughout the construction period. The company had $4,500,000 in 9% bonds
outstanding in 2006 and 2007.

136 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

95. Average accumulated expenditures for 2006 was:


A) $300,000.
B) $350,000.
C) $500,000.
D) $400,000.

Answer: A Learning Objective: 7 Level of Learning: 3


Rationale:
January 1, 2006 $200,000 x 12/12 = $200,000
September 1, 2006 300,000 x 4/12 = 100,000
December 31, 2006 300,000 x 0/12 = 0
$800,000 $300,000

96. Interest capitalized for 2006 was:


A) $48,000.
B) $42,000.
C) $60,000.
D) $36,000.

Answer: D Learning Objective: 7 Level of Learning: 3


Rationale:
$300,000 (determined above) x 12% = $36,000

97. Average accumulated expenditures for 2007 by the end of the construction period was:
A) $1,300,000.
B) $1,236,000.
C) $1,200,000.
D) $1,036,000.

Answer: D Learning Objective: 7 Level of Learning: 3


Rationale:
Accumulated expenditures at 12/31/06
(determined above) $ 836,000 x 9/9 = $836,000
March 31, 2007 300,000 x 6/9 = 200,000
September 30, 2007 200,000 x 0/9 = 0
$1,336,000 $1,036,000

98. Interest capitalized for 2007 was:


A) $104,625.
B) $86,805
C) $97,875.
D) $67,500.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
Total $1,036,000 (determined above) =
Specific borrowing 750,000 x 12% x 9/12 = $67,500
Excess 286,000 x 9% x 9/12 = 19,305
Capitalized interest $86,805

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 137


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 99-102:

On January 1, 2006, Dreamworld Co. began construction of a new warehouse. The building was
finished and ready for use on September 30, 2007. Expenditures on the project were as follows:

January 1, 2006 $300,000


September 1, 2006 $450,000
December 31, 2006 $450,000
March 31, 2007 $450,000
September 30, 2007 $300,000

Dreamworld had $5,000,000 in 12% bonds outstanding through both years.

99. Dreamworld's average accumulated expenditures for 2006 was:


A) $300,000.
B) $450,000.
C) $525,000.
D) $600,000.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
January 1, 2006 $300,000 x 12/12 = $300,000
September 1, 2006 450,000 x 4/12 = 150,000
December 31, 2006 450,000 x 0/12 = 0
$1,200,000 $450,000

100. Dreamworld's capitalized interest in 2006 was:


A) $72,000.
B) $63,000.
C) $54,000.
D) $36,000.

Answer: C Learning Objective: 7 Level of Learning: 3


Rationale:
$450,000 (determined above) x 12% = $54,000

101. The average accumulated expenditures for 2007 by the end of the construction period was:
A) $1,950,000.
B) $1,554,000.
C) $1,254,000.
D) $975,000.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
Accumulated expenditures at 12/31/06
(determined above) $ 1,254,000 x 9/9 = $1,254,000
March 31, 2007 450,000 x 6/9 = 300,000
September 30, 2007 300,000 x 0/9 = 0
$2,004,000 $1,554,000

138 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

102. What was the final cost of Dreamworld's warehouse?


A) $2,154,480.
B) $2,143,860.
C) $1,950,000.
D) $1,254,000.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
Accumulated expenditures at 9/31/07
before 2207 interest(determined above) $ 2,004,000
2007 interest capitalized $1,554,000 x 12% x 9/12 139,860
Total capitalized cost $2,143,860

103. On July 1, 2006, Larkin Co. purchased a $400,000 tract of land that is intended to be the site
of a new office complex. Larkin incurred additional costs and realized salvage proceeds
during 2006 as follows:

Demolition of existing building on site $75,000


Legal and other fees to close escrow 12,000
Proceeds from sale of demolition scrap 10,000

What would be the balance in the land account as of December 31, 2006?
A) $400,000.
B) $475,000.
C) $477,000.
D) $487,000.

Answer: C Learning Objective: 1 Level of Learning: 3


Rationale:
Purchase price $400,000
Demolition costs 75,000
Legal fees 12,000
Sale of scrap (10,000 )
Total cost of land $477,000

104. In the current year Tool Corp. purchased Patent X for $42,000 and Patent Y for $38,000.
Additional acquisition costs for X and Y were $7,000 and $5,000, respectively. Tool also paid
litigation costs for patent infringement on X and Y of $40,000 and $30,000, respectively. The
X litigation was unsuccessful. The Y litigation was successful. What amount should Tool
capitalize for patents?
A) $ 73,000.
B) $162,000.
C) $ 43,000.
D) $ 92,000.

Answer: A Learning Objective: 8 Level of Learning: 3


Rationale:
Since the defense of Patent X was unsuccessful, the patent will not provide future benefits for
the company. Only the costs associated with Patent Y should be capitalized:
$38,000 + 5,000 + 30,000 = $73,000

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 139


Chapter 10 Operational Assets: Acquisition and Disposition

105. Liddy Corp. began constructing a new warehouse for its operations during the current year. In
the year Liddy incurred interest of $30,000 on a working capital loan, and interest on a
construction loan for the warehouse of $60,000. Interest computed on the average
accumulated expenditures for the warehouse construction was $50,000. What amount of
interest should Liddy expense for the year?
A) $ 30,000.
B) $ 40,000.
C) $ 90,000.
D) $140,000.

Answer: B Learning Objective: 7 Level of Learning: 3


Rationale:
Total interest cost incurred ($30,000 + 60,000) $90,000
Interest capitalized (50,000 )
Interest expense $40,000

106. During 2006, the Longhorn Oil Company incurred $5,000,000 in exploration costs for each of
20 oil wells drilled in 2006 in west Texas. Of the 20 wells drilled, 14 were dry holes.
Longhorn uses the successful efforts method of accounting. Assuming that none of the oil
found is depleted in 2006, what oil exploration expense would Longhorn charge for this
activity in its 2006 income statement?
A) $ 0
B) $30 million
C) $70 million
D) $100 million

Answer: C Learning Objective: 1 Level of Learning: 3


Rationale: Expense the dry holes -- $100 million x (14/20) = $70 million

107. During 2006, Prospect Oil Corporation incurred $4,000,000 in exploration costs for each of 15
oil wells drilled in 2006. Of the 15 wells drilled, 10 were dry holes. Prospect uses the
successful efforts method of accounting. Assuming that Prospect depletes 30% of the oil
discovered in 2006, what amount of these exploration costs would remain on its 12/31/06
balance sheet?
A) $6 million
B) $14 million
C) $20 million
D) $42 million

Answer: B Learning Objective: 1 Level of Learning: 3


Rationale: Capitalize the wells that are not dry holes: 5 x $4 million = $20 million. Of this,
30% is depleted in 2006 and the rest remains on the balance sheet.
Therefore, 70% of $20 million remains = $14 million.

140 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

Problems

108. On July 1, 2006, Jekel & Hyde Inc. purchased land and incurred other costs relative to the
construction of a new warehouse. A summary of economic activities is listed below:

Purchase price $185,000


Title insurance $1,500
Legal fees to purchase land $1,000
Cost of razing old building on lot 8,500
Proceeds from sale of salvageable materials (1,200)
Property taxes, January 1, 2006 - June 30, 2006 3,000
Cost of grading and filling building site 9,000
Cost of building construction 620,000
Interest on construction loan 12,000
Cost of constructing driveway 8,000
Cost of parking lot and fencing 12,000

Required:
Indicate the accounts that would be affected by the above transactions and the resulting
balance in each account. Apply the interest on the construction loan to the cost of the building
only.

Answer:
Land:
Purchase price $185,000
Title insurance 1,500
Legal fees 1,000
Cost of razing old building $8,500
Proceeds from sale of salvaged materials (1,200) 7,300
Property tax prior to 6/30 3,000
Cost of grading and filling building site 9,000
Total $206,800

Building:
Cost of building construction $620,000
Interest on construction loan 12,000
Total $632,000

Land improvements:
Driveway $ 8,000
Parking lot and fencing 12,000
Total $20,000

Learning Objective: 1 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 141


Chapter 10 Operational Assets: Acquisition and Disposition

109. Mad Hatter Enterprises purchased new equipment for $365,000, FOB shipping point. Other
costs connected with the purchase were as follows:

State sales tax 29,200


Freight costs 5,600
Insurance while in transit 800
Insurance after equipment placed in service 1,200
Installation costs 2,000
Testing, including $300 of spoilage 700

Required:
Determine the capitalized cost of the equipment.

Answer:
Purchase price $365,000
Sales tax 29,200
Freight 5,600
Insurance-shipping 800
Installation 2,000
Testing 700
Total cost of equipment $403,300

Learning Objective: 1 Level of Learning: 3

110. During the current year, Brewer Company purchased all of the outstanding common stock of
Miller Inc. paying $12,000,000 cash. The book values and fair values of Miller's assets and
liabilities acquired are listed below:

Book Value Fair Value


Accounts receivable $1,800,000 $ 1,625,000
Inventories 2,700,000 4,000,000
Property, plant, and equipment 9,000,000 11,625,000
Accounts payable 3,000,000 3,000,000
Bonds payable 4,500,000 4,125,000

Required:
Prepare the journal entry to record the acquisition by Brewer Company.

Answer:
Accounts receivable 1,625,000

Inventory 4,000,000
Property, plant, and equipment 11,625,000
Goodwill 1,875,000
Accounts payable 3,000,000
Bonds payable 4,125,000
Cash 12,000,000

Learning Objective: 1 Level of Learning: 3

142 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

111. On August 15, 2006, Willis Inc. purchased all of the outstanding common stock of Bork Inc.
paying $7,400,000 cash. The book values and fair values of Willis' assets and liabilities are
listed below:

Book Value Fair Value


Accounts receivable $1,080,000 $ 975,000
Inventories 1,620,000 2,400,000
Property, plant, and equipment 5,400,000 6,975,000
Accounts payable 1,800,000 1,800,000
Bonds payable 2,700,000 2,475,000

Required:
Prepare the journal entry to record the acquisition by Willis Inc.

Answer:
Accounts receivable 975,000
Inventory 2,400,000
Property, plant, and equipment 6,975,000
Goodwill 1,325,000
Accounts payable 1,800,000
Bonds payable 2,475,000
Cash 7,400,000

Learning Objective: 1 Level of Learning: 3

112. Watson Company purchased assets of Holmes Ltd. at auction for $1,300,000. An independent
appraisal of the market value of the assets acquired is listed below:

Land $214,500
Building 357,500
Equipment 572,000
Inventories 286,000

Required:
Prepare the journal entry to record the purchase of the assets.

Answer:
Appraised Allocated
Values Percent Costs
Land $ 214,500 15% $ 195,000
Building 357,500 25 325,000
Equipment 572,000 40 520,000
Inventory 286,000 20 260,000
$1,430,000 100% $1,300,000

Land 195,000
Building 325,000
Equipment 520,000
Inventory 260,000
Cash 1,300,000

Learning Objective: 2 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 143


Chapter 10 Operational Assets: Acquisition and Disposition

113. Eli Company purchased assets of Whitney Inc. at auction for $1,560,000. An independent
appraisal of the market value of the assets acquired is listed below:

Land $171,600
Building 514,800
Equipment 600,600
Inventories 429,000

Required:
Prepare the journal entry to record the purchase of the assets.

Answer:
Appraised Allocated
Values Percent Costs
Land $171,600 10% $156,000
Building 514,800 30 468,000
Equipment 600,600 35 546,000
Inventory 429,000 25 390,000
$1,716,000 100% $1,560,000
Land 156,000
Building 468,000
Equipment 546,000
Inventory 390,000
Cash 1,560,000

Learning Objective: 2 Level of Learning: 3

114. Beacon Inc. received a gift of land and building in the Twin Pines Park as an inducement to
relocate. The land and buildings have fair market values of $45,000 and $455,000.

Required: Prepare journal entries to record the above transactions.

Answer:
Land 45,000
Buildings 455,000
Revenue-donation of assets 500,000

Learning Objective: 4 Level of Learning: 3

144 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

115. Cool Globe Inc. entered into two transactions, as follows:


(a.) They purchased equipment paying $20,000 down and signed a noninterest-bearing note
requiring the balance to be paid in four annual installments of $20,000 on the anniversary
date of the contract. Based on Bright Light's 12% borrowing rate for such transactions, the
implicit interest cost is $19,253.
(b.) They purchased a tract of land in exchange for $10,000 cash down payment and a
noninterest-bearing note requiring five $10,000 annual payments, with the first annual
payment in one year. The fair market value of the land is $46,000.

Required:
Prepare the journal entries for these transactions.

Answer:
(a.) Equipment 80,747
Discount on notes payable 19,253
Notes payable 80,000
Cash 20,000

(b.) Land 46,000


Discount on notes payable 14,000
Cash 10,000
Notes payable 50,000

Learning Objective: 3 Level of Learning: 3

116. Wendell Corporation exchanged an old truck and $25,500 cash for a new truck. The old truck
had a book value of $6,000 and a market value of $7,700.

Required:
Prepare the journal entry to record the exchange.

Answer:
Truck (new) 33,200
Gain 1,700
Cash 25,500
Truck (old), net 6,000

Learning Objective: 6 Level of Learning: 3

117. Kerry, Inc. exchanged land for a front-end loader and cash of $8,000. The land had a book
value of $55,000 and a market value of $60,000.

Required:
Prepare the journal entry to record the exchange.

Answer:
Equipment 68,000
Gain 5,000
Cash 8,000
Land 55,000

Learning Objective: 6 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 145


Chapter 10 Operational Assets: Acquisition and Disposition

118. Peanut Corporation exchanged land for a front-end loader and cash of $6,500. The land had a
book value of $45,000 and a market value of $34,000.

Required:
Prepare the journal entry to record the exchange.

Answer:
Equipment 40,500
Loss 11,000
Cash 6,500
Land 45,000

Learning Objective: 6 Level of Learning: 3

119. Ford Inc. exchanged land and $7,500 cash for material handling equipment. The land had a
book value of $75,000 and a market value of $105,000.

Required:
Prepare the journal entry to record the exchange.

Answer:
Equipment 112,500
Gain 30,000
Cash 7,500
Land 75,000

Learning Objective: 6 Level of Learning: 3

120. Walker Corporation exchanged land and $4,500 cash for material handling equipment. The
land had a book value of $45,000 and a market value of $58,000.

Required:
Prepare the journal entry to record the exchange.

Answer:
Equipment 62,500
Gain 13,000
Cash 4,500
Land 45,000

Learning Objective: 6 Level of Learning: 3

146 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

121. Cheney Company sold a 20-ton mechanical draw press for $60,000. The old draw press cost
$77,000 and had a net book value of $55,000.

Required:
Prepare the journal entry to record the disposition.

Answer:
Cash 60,000
Accumulated depreciation 22,000
Equipment 77,000
Gain on disposal of equipment 5,000

Learning Objective: 6 Level of Learning: 3

122. McLean Mfg. Company sold a three-speed lathe for $24,000 cash. The lathe cost $66,200 and
had a net book value of $23,200.

Required:
Prepare the journal entry to record the sale.

Answer:
Cash 24,000
Accumulated depreciation 43,000
Equipment 66,200
Gain 800

Learning Objective: 6 Level of Learning: 3

123. Champion Industries exchanged a dust-scrubbing piece of equipment for another version of
the same type of equipment and received $12,000 cash. The old dust scrubber cost $76,200
and had a net book value of $54,500. The new dust scrubber had a fair market value of
$58,500.

Required:
Prepare the journal entry to record the exchange.

Answer:
Equipment - new 58,500
Cash 12,000
Accumulated depreciation 21,700
Equipment - old 76,200
Gain 16,000

Learning Objective: 6 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 147


Chapter 10 Operational Assets: Acquisition and Disposition

124. Agasse Industries took out a $1,500,000, 8% construction loan on January 1, 2006, to build a
new production facility. Construction started on April 1. Agasse made payments to the general
contractor of $400,000 on June 30, $900,000 on August 31, and $500,000 on December 31.

Required:
Compute the amount of interest that Agasse would capitalize in 2006.

Answer:
Expenditures
6/30 $400,000 x 6/12= $200,000
8/31 900,000 x 4/12= 300,000
Average accumulated expenditures for 2006 $500,000

Interest capitalized in 2006 = $500,000 x 8% = $40,000

Learning Objective: 6 Level of Learning: 3

125. Montgomery Industries spent $600,000 in 2005 on a construction project to build a library.
Montgomery also capitalized $30,000 of interest on the project in 2005. Montgomery financed
100% of the construction with a 10% construction loan. The project was completed on
September 30, 2006. Additional expenditures in 2006 were as follows:

Feb. 28 90,000
Apr. 30 180,000
Jul. 1 36,000
Sept. 30 64,000

Required:
Determine the completed cost of the library. Show well labeled supporting computations.

Answer:
Expenditures

Accumulated expenditures 12/31/2005 $630,000 x 9/9 = $


630,000
2/28/2006 90,000 x 7/9 = 70,000
4/30/2006 180,000 x 5/9 = 100,000
7/1/2006 36,000 x 3/9 = 12,000
9/30/2006 64,000 x 0/9 = 0
Average accumulated expenditures for 2006 $812,000

Interest capitalized in 2006 ($812,000 x 10% x 9/12) 60,900


Completed cost of the library $1,060,900

Learning Objective: 6 Level of Learning: 3

148 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

126. During the current year, Peterson Data Corporation purchased all of the outstanding common
stock of Junior Jackson Inc. (JJI), paying $36 million in cash. Peterson recorded the assets
acquired as follows:

Accounts receivable $2,500,000


Inventory 9,000,000
Property, plant, and equipment 25,500,000
Goodwill 6,000,000

The book value of JJI's assets and owners' equity before the acquisition were $22 million and
$18 million, respectively.

Required: Compute the fair value of JJI's liabilities that Peterson incurred in the acquisition.

Answer:
Fair value of assets Fair value of liabilities = Cash paid
Therefore, Fair value of liabilities = Fair value of assets Cash paid = $43 million 36
million
= $7 million.

Learning Objective: 7 Level of Learning: 3

127. During the current year, Compton Crate Corporation purchased all of the outstanding common
stock of Little Lacy Ltd. (LLL), paying $60 million in cash. Compton recorded the assets
acquired as follows:

Accounts receivable $5,500,000


Inventory 18,000,000
Property, plant, and equipment 45,500,000
Goodwill 22,000,000

The book value of LLL's assets and owners' equity before the acquisition were $50 million
and $30 million, respectively.

Required: Compute the fair value of LLL's liabilities that Compton incurred in the
acquisition.

Answer:
Fair value of assets Fair value of liabilities = Cash paid
Therefore, Fair value of liabilities = Fair value of assets Cash paid = $91 million 60
million
= $31 million.

Learning Objective: 7 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 149


Chapter 10 Operational Assets: Acquisition and Disposition

Use the following to answer questions 128-129:

In its 2004 annual report to shareholders, Boston Beer Co. disclosed the following footnote:

E. Property, Plant and Equipment

Property, plant and equipment for the years ended December 25, 2004 and December 27, 2003
consisted of the following (in thousands):

2004 2003

Kegs $ 25,427 $ 23,404


Plant and 20,359 19,185
machinery
Office equipment 6,791 5,937
and furniture
Leasehold 3,861 3,604
improvements
Land 350 350
Building 1,420 1,420

$ 58,208 $ 53,900
Less accumulated 40,996 36,841
depreciation
_______ _______
$ 17,212 $ 17,059

The Company recorded depreciation expense related to these assets of $4.4 million and $4.7 million
for the years ended December 25, 2004 and December 27, 2003, respectively.

Also, Boston Beer reported the following information in the annual report (in thousands):

Years ended
12/25/04 12/27/03

Cash flows for investing


activities:
Purchases of property, (4,559) (1,729 )
plant and equipment (PPE)
Proceeds on disposal of 4 32
fixed assets (PPE)

Required:

150 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

128. Use a T- account to show the balances and changes during 2004 in Boston Beer's: Property,
Plant and Equipment account and its Accumulated depreciationProperty, Plant & equipment
account.

Answer:
Property Plant & Equipment Acc.Deprec.-- Property Plant & Equipment
Beg. Balance 53,900 36,841 Beg. Balance
Purchases 4,559 Disposals 251 Acc. Deprec. 4,400 Depreciation Exp.
On disposals 245
End. Balance 58,208 40,996 End. Balance

Learning Objective: 1 Level of Learning: 3

129. Show the journal entry to record Boston Beer's disposal of the PPE during 2004.

Answer:
Cash 4
Acc. Deprec. 245
Loss on disposal 2
PPE 251

Learning Objective: 1 Level of Learning: 3

Use the following to answer questions 130-131:

In its 2004 annual report to shareholders, Plank Breweries disclosed the following footnote:

4. Fixed Assets

Fixed assets consist of the following (in $ thousands):

December 31,
2004 2003
Brewery and retail $ 14,465 $ 14,246
equipment
Furniture and fixtures 918 772
Leasehold improvements 13,808 13,563
Construction in 584 165
progress
Assets held for sale 4
29,775 28,750
Less accumulated (9,555 ) (7,625 )
depreciation __________ __________
$ 20,220 $ 21,125

Total depreciation expense was approximately $2.121 million and $2.179 million for the years ended
December 31, 2004 and 2003, respectively.

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 151


Chapter 10 Operational Assets: Acquisition and Disposition

Also, Plank Breweries reported the following information in its annual report (in $ thousands):

Years Ended December 31,


2004 2003
Acquisition of fixed assets 1,279 808

Proceeds from sale of fixed assets 15 157

Required:

130. Use a T- account to show the balances and changes during 2004 in Plank Breweries:
Fixed assets account and Accumulated depreciationfixed assets account (in $ thousands).

Answer:
Fixed assets Acc.Deprec.-- Fixed assets
Beg. Balance 28,750 7,625 Beg. Balance
Purchases 1,279 Disposals 254 Acc. Deprec. 2,121 Depreciation Exp.
on disposals 191
End. Balance 29,775 9,555 End. Balance

Learning Objective: 1 Level of Learning: 3

131. Show the journal entry to record Plank's disposal of the fixed assets during 2004.

Answer:
Cash 15
Acc. Deprec. 191
Loss on disposal 47
Fixed assets 253

Learning Objective: 1 Level of Learning: 3

152 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

132. In its 2004 annual report to shareholders, Custard Cup Inc. disclosed the following footnote:
Note 4 Property, Plant and Equipment

Property, plant and equipment (PPE) at December 31, 2004, and December 31, 2003,
consisted of the following:

2001 2000
(In millions)
Machinery and equipment $244 $237
Buildings and 90 89
improvements
Office furniture and 6 6
fixtures _______ _______
340 332
Less: Accumulated 183 165
depreciation and
amortization _______ _______
157 167
Land 15 15
Construction in progress 24 6
$196 $188

Depreciation expense for property, plant and equipment was $26 million in 2004.

Required: Compute the Accumulated depreciation on PPE disposed of by Custard Cup during
2004.

Answer:
Acc.Deprec.-- Property Plant & Equipment (in millions)
165 Beg. Balance
Acc. Deprec. 26 Depreciation Exp.
On disposals 8
183 End. Balance

Learning Objective: 1 Level of Learning: 3

Essay

Instructions:

The following answers point out the key phrases that should appear in students' answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.

133. How are donated assets recorded?

Answer: Debit the asset account for FMV based on available market price data or appraisal.
Credit a revenue from donation account.

Learning Objective: 4 Level of Learning: 2

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 153


Chapter 10 Operational Assets: Acquisition and Disposition

134. How are assets valued when they are acquired by issuing stock?

Answer: Record the asset at FMV of the asset or the security, whichever is more clearly
evident.

Learning Objective: 2 Level of Learning: 2

135. Why are software development costs treated differently than other types of R&D?

Answer: The problem with attempting to capitalize R&D in most situations is the
determination of a future benefit. With software development, a point of technological
feasibility can be determined and a reasonable future benefit estimated.

Learning Objective: 8 Level of Learning: 2

136. Explain the appropriate accounting method used to account for lump sum purchases of a group
of operational assets?

Answer: Such purchases require that the lump sum price be allocated among the assets
acquired so that each may be accounted for individually in subsequent periods. To do so, the
relative values of the assets acquired form a pro rated allocation of the lump sum cost. The
rationale is that there is an implicit discount for the lump sum purchase that is divided among
the individual items as a proportion of their own values.

Learning Objective: 3 Level of Learning: 2

137. What disclosures are required relative to interest costs incurred during the year?

Answer: Disclose the total amount of interest costs incurred and the amount of interest
capitalized. Interest expense is reported in the income statement.

Learning Objective: 7 Level of Learning: 2

138. When is interest capitalized? Briefly describe how the amount to be capitalized is computed.

Answer: Interest is capitalized during the construction period for self-constructed assets and
for assets constructed as discrete projects for sale or lease, but not for items that are routinely
manufactured. The amount of interest capitalized is equal to the average accumulated
expenditures multiplied by the appropriate interest rates, not to exceed the actual interest cost
incurred.

Learning Objective: 7 Level of Learning: 2

139. Briefly explain how R & D is reported in financial statements.

Answer:
Most R & D costs are expensed in the periods incurred, and GAAP requires that total R&D
expense incurred must be disclosed in a note or as a separate line item. R&D performed for
others would be recorded as inventory and eventually would be included in cost of goods sold.

Learning Objective: 8 Level of Learning: 2

154 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 10 Operational Assets: Acquisition and Disposition

140. Kellogg Company and its subsidiaries are engaged in the manufacture and marketing of ready-
to-eat cereal and convenience foods. In its annual report to shareholders, Kellogg disclosed
the following:

DISPOSITIONS
Last year, the Company sold certain assets and liabilities of the Lender's Bagels business to
Aurora Foods Inc. for $275 million in cash. As a result of this transaction, the Company
recorded a pretax charge of $178.9 million ($119.3 million after tax or $.29 per share). This
charge included approximately $57 million for disposal of other assets associated with the
Lender's business, which were not purchased by Aurora. Disposal of these other assets was
completed during the current year. The original reserve of $57 million exceeded actual losses
from asset sales and related disposal costs by approximately $9 million. This amount was
recorded as a credit to other income (expense), net during the current year.

Required:

Explain how the Kellogg transactions described could be interpreted as an example of


earnings management.

Answer: The disposal of assets required Kellogg to anticipate (and create an allowance for) a
loss on the disposition. Last year, Kellogg's recorded loss was greater than ultimately
required. As a result, they reversed the loss by increasing income in the current year. This is
an example of a cookie jar reserve, much like that described for allowances for uncollectible
accounts in Chapter 7.

Learning Objective: 1 Level of Learning: 3

141. Why would an oil company argue to use the full-cost method of accounting for oil and gas
exploration costs?

Answer:
Under the full-cost method, oil and gas exploration costs are capitalized, whether or not the
specific well explored is successful in finding reserves. The basis for this is that the
exploration program is the unit of investment, a portfolio of exploration efforts, and the
success of the program, not individual wells is the relevant basis for developing assets
(reserves). The full-cost method tends to be favored by smaller companies, whose smaller
numbers of explorations naturally give it less diversification that a large company can generate
by its exploration program. These companies argue that they are disadvantaged in the capital
market by having to use the same accounting as the larger, more diversified companies.

Learning Objective: 1 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 155


Chapter 10 Operational Assets: Acquisition and Disposition

142. Peoplesoft recorded capitalized software amortization, included in Cost of license fees in the
accompanying consolidated statements of operations, of $36.8 million in 2003, $14.4 million
in 2002 and $6.5 million in 2001.

Peoplesoft accounts for the development cost of software intended for sale in accordance with
Statement of Financial Accounting Standards No. 86, Accounting for Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed, (SFAS 86). SFAS 86 requires product
development costs to be charged to expense as incurred until technological feasibility is
attained. Technological feasibility is attained when the Company s software has completed
system testing and has been determined viable for its intended use. The time between the
attainment of technological feasibility and completion of software development has been short
with immaterial amounts of development costs incurred during this period. Accordingly, the
Company did not capitalize material amounts of development costs in 2003 or 2002, other
than product development costs acquired through business combinations or purchased from
third parties. The Company capitalizes software acquired through technology purchases and
business combinations if the related software under development has reached technological
feasibility or if there are alternative future uses for the software.

Required:
Describe how software companies like Peoplesoft treat software development costs differently
from the typical GAAP treatment of research and development costs in other industries. Why
is this the case?

Answer: SFAS 86 calls for software developers to capitalize costs associated with developing
products after technological feasibility is established. This is an exception to the general rule
in GAAP that research and development expenditures be expensed when incurred. This is due
in part to the political clout of the software industry and to the unique nature of the software
business in which the product's future earnings potential passes the critical juncture of
technological feasibility.

Learning Objective: 8 Level of Learning: 3

156 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition