Chapter 12—Investments in Noncurrent Operating Assets-Acquisition

MULTIPLE CHOICE

1. Kramer Service Corporation bought a building lot to construct a new corporate office building.
An older home on the building lot was razed immediately so that the office building could be
constructed. The cost of purchasing the older home should be
a. recorded as part of the cost of the land.
b. written off as a loss in the year of purchase.
c. written off as an extraordinary item in the year of purchase.
d. recorded as part of the cost of the new building.
ANS: A OBJ: LO 1

2. The term "intangible assets" is used in accounting to denote

a. current or noncurrent property items without physical characteristics.
b. assets with lesser economic significance because of the nature of such assets.
c. properties without physical characteristics that have long-term effects on a business
enterprise.
d. such items as patents, copyrights, and claims against customers which can be valued on a
monetary basis.
ANS: C OBJ: LO 1

3. Which of the following intangible assets does not have the characteristic of exchangeability?
a. Patent
b. Copyright
c. Goodwill
d. Franchise
ANS: C OBJ: LO 1

4. In a business combination, goodwill is defined as the excess of cost over the

a. fair value of assets acquired.
b. fair value of assets acquired less the liabilities assumed.
c. book value of assets acquired less the liabilities assumed.
d. net book value of assets acquired.
ANS: B OBJ: LO 1

5. Goodwill should be recorded in the accounting records only when

a. it is purchased from another company.
b. it can be established that a definite benefit or advantage has resulted to a firm from some
item such as a good name, capable staff, or reputation.
c. it is acquired through the purchase of another business entity.
d. a firm reports above normal earnings for five or more consecutive years.
ANS: C OBJ: LO 1

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6. Donated equipment for which the fair value has been determined should be recorded as a debit to
the appropriate equipment account and a credit to
a. Other Income.
b. Retained Earnings.
c. Capital Stock.
d. Revenue or gain.
ANS: D OBJ: LO 2

7. Lakepoint Company recently accepted a donation of land with a fair value of $200,000 from the
city of Dale in return for a promise to build a plant in Dale.
The entry that Lakepoint should use to record this land is:
a. Land.............................. 200,000
Gain from Receipt of Donated Land 200,000
b. Land.............................. 200,000
Gain from Receipt of Donated Land 200,000
c. Land.............................. 200,000
Unrealized Gain from Receipt of
Donated Land.................. 200,000
d. Land.............................. 200,000
Retained Earnings................ 200,000

ANS: B OBJ: LO 2

8. Nimbus Inc. purchased certain plant assets under a deferred payment contract. The agreement
was to pay $30,000 per year for ten years. The plant assets should be valued at
a. $300,000.
b. $300,000 plus imputed interest.
c. present value of $30,000 annuity for ten years at an imputed interest rate.
d. future value of $30,000 annuity for ten years at an imputed interest rate.
ANS: C OBJ: LO 2

9. An asset is being constructed for an enterprise's own use. The asset has been financed with a
specific new borrowing. The interest cost incurred during the construction period as a result of
expenditures for the asset is
a. a part of the historical cost of acquiring the asset to be written off over the estimated useful
life of the asset.
b. interest expense in the construction period.
c. recorded as a deferred charge and amortized over the term of the borrowing.
d. a part of the historical cost of acquiring the asset to be written off over the term of the
borrowing used to finance the construction of the asset.
ANS: A OBJ: LO 2

10. If the cost of ordinary repairs is capitalized as an addition to the building account during the
current year,
a. net income for the current year will be understated.
b. stockholders' equity at the end of the current year will be understated.
c. total assets at the end of the current year will not be affected.
d. total liabilities at the end of the current year will not be affected.
ANS: D OBJ: LO 3

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11. A company purchased land to be used as the site for the construction of a plant. Timber was cut
from the building site so that construction of the plant could begin. The proceeds from the sale of
the timber should be
a. classified as other income.
b. netted against the costs to clear the land and expensed as incurred.
c. deducted from the cost of the plant.
d. deducted from the cost of the land.
ANS: D OBJ: LO 1

12. When a company purchases land with a building on it and immediately tears down the building
so that the land can be used for the construction of a plant, the costs incurred to tear down the
building should be
a. amortized over the estimated time period between the tearing down of the building and the
completion of the plant.
b. expensed as incurred.
c. added to the cost of the plant.
d. added to the cost of the land.
ANS: D OBJ: LO 1

13. A donated plant asset for which the fair value has been determined, and for which incidental costs
were incurred in acceptance of the asset, should be recorded at an amount equal to its
a. incidental costs incurred.
b. fair value and incidental costs incurred.
c. book value on books of donor and incidental costs incurred.
d. book value on books of donor.
ANS: B OBJ: LO 2

14. According to SFAS No. 34, "Capitalization of Interest Cost," interest should be capitalized for
assets that are
a. in use or ready for their intended use in the earnings activities of the enterprise.
b. being constructed or otherwise being produced as discrete projects for an enterprise's own
use.
c. not being used in the earnings activities of the enterprise and that are not undergoing the
activities necessary to get them ready for use.
d. routinely produced but require an extended period of time and are used in the earnings
activities of the enterprise.
ANS: B OBJ: LO 2

15. A company is constructing an asset for its own use. Construction began in 2004. The asset is
being financed entirely with a specific new borrowing. Construction expenditures were made in
2004 and 2005 at the end of each quarter. The total amount of interest cost capitalized in 2005
should be determined by applying the interest rate on the specific new borrowing to the
a. total accumulated expenditures for the asset in 2005.
b. average accumulated expenditures for the asset in 2005.
c. average expenditures for the asset in 2005.
d. total expenditures for the asset in 2005.
ANS: B OBJ: LO 2

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16. Which of the following research and development related costs should be capitalized and
amortized over current and future periods?
a. Labor and material costs incurred in building a prototype model.
b. Cost of testing equipment that will also be used in another separate research and
development project scheduled to begin next year.
c. Administrative salaries allocated to research and development.
d. Research findings purchased from another company to aid a particular research project
currently in process.
ANS: B OBJ: LO 3

17. Which of the following principles best describes the current method of accounting for research
and development costs?
a. Associating cause and effect
b. Systematic and rational allocation
c. Income tax minimization
d. Immediate recognition as an expense
ANS: D OBJ: LO 3

18. If a company constructs a laboratory building to be used as a research and development facility,
the cost of the laboratory building is matched against earnings as
a. research and development expense in the period(s) of construction.
b. depreciation deducted as part of research and development costs.
c. depreciation or immediate write-off depending on company policy.
d. an expense at such time as productive research and development has been obtained from
the facility.
ANS: B OBJ: LO 3

19. When a company replaces an old asphalt roof on its plant with a new fiberglass insulated roof,
which of the following types of expenditure has occurred?
a. Ordinary repairs and maintenance
b. Addition
c. Rearrangement
d. Betterment
ANS: D OBJ: LO 3

20. An improvement made to a machine increased its fair market value and its production capacity by
25 percent without extending the machine's useful life. The cost of the improvement should be
a. expensed.
b. debited to Accumulated Depreciation.
c. capitalized in the machine account.
d. allocated between Accumulated Depreciation and the machine account.
ANS: C OBJ: LO 3

21. A machine with an original estimated useful life of ten years is moved to another location in the
factory after it had been in service for three years. The efficiency of the machine is increased for
its remaining useful life. The reinstallation costs should be capitalized if the remaining useful life
of the machine is

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 Five Years Ten Years

a. No No
b. No Yes
c. Yes No
d. Yes Yes

ANS: D OBJ: LO 3

22. An expenditure subsequent to acquisition of assembly-line manufacturing equipment benefits

future periods. The expenditure should be capitalized if it is a

Betterment Rearrangement

a. Yes Yes
b. Yes No
c. No Yes
d. No No

ANS: A OBJ: LO 3

23. Which of the following concepts is often given as justification not to value noncurrent operating
assets at their current values?
a. The revenue principle
b. Verifiability
c. Relevance
d. Predictive value
ANS: B OBJ: LO 5

24. Which of the following is true?

a. The Financial Accounting Standards Board has never permitted the disclosure of the fair
values of noncurrent operating assets in the notes to financial statements.
b. The SEC currently requires the disclosure of the fair values of noncurrent operating assets
in the notes to financial statements of companies that are registered with the SEC.
c. The Financial Accounting Standards Board currently requires the disclosure of the fair
values of noncurrent operating assets in the notes to the financial statements.
d. Disclosure of the fair values of noncurrent operating assets in the notes to the financial
statements is currently encouraged but not required by the Financial Accounting Standards
Board.
ANS: D OBJ: LO 5

25. On February 12, Laker Company purchased a tract of land as a factory site for $175,000. An
existing building on the property was razed and construction was begun on a new factory
building in March of the same year. Additional data are available as follows:

Cost of razing old building .......................... $ 35,000

Title insurance and legal fees to purchase land ...... 12,500
Architect's fees ..................................... 42,500
New building construction cost ....................... 875,000

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 The recorded cost of the completed factory building should be
a. $910,000.
b. $917,500.
c. $930,000.
d. $952,500.
ANS: B OBJ: LO 1

26. The Oscar Corporation acquired land, buildings, and equipment from a bankrupt company at a
lump-sum price of $180,000. At the time of acquisition, Oscar paid $12,000 to have the assets
appraised. The appraisal disclosed the following values:

Land .................................................. $120,000

Buildings ............................................. 80,000
Equipment ............................................. 40,000

What cost should be assigned to the land, buildings, and equipment, respectively?
a. $64,000, $64,000, and $64,000
b. $90,000, $60,000, and $30,000
c. $96,000, $64,000, and $32,000
d. $120,000, $80,000, and $40,000
ANS: C OBJ: LO 2

27. Carter Company acquired three machines for $200,000 in a package deal. The three assets
together had a book value of $160,000 on the seller's books. An appraisal costing the purchaser
$2,000 indicated that the three machines had the following market values (book values are given
in parentheses):

Machine 1: $60,000 ($40,000)

Machine 2: $80,000 ($50,000)
Machine 3: $100,000 ($70,000)

The three assets should be individually recorded at a cost of (rounded to the nearest dollar)

Machine 1 Machine 2 Machine 3

a. $40,000 $53,333 $66,667

b. $50,000 $62,500 $87,500
c. $40,000 $50,000 $70,000
d. $50,500 $67,333 $84,167

ANS: D OBJ: LO 2

28. Peterson, Inc. purchased a machine under a deferred payment contract on December 31, 2004.
Under the terms of the contract, Peterson is required to make eight annual payments of $140,000
each beginning December 31, 2005. The appropriate interest rate is 8 percent. The purchase price
of the machine is
a. $1,389,190.
b. $1,120,000.
c. $868,900.
d. $804,530.
ANS: D OBJ: LO 2

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29. On October 1, Takei, Inc. exchanged 8,000 shares of its $25 par value common stock for a parcel
of land to be held for a future plant site. Takei's common stock had a fair market value of $80 per
share on the exchange date. Takei received $36,000 from the sale of scrap when an existing
building on the site was razed. The land should be carried at
a. $200,000.
b. $236,000.
c. $604,000.
d. $640,000.
ANS: C OBJ: LO 2

30. Marburg Manufacturing Company purchased a machine on January 2, 2005. The invoice price of
the machine was $40,000, and the vendor offered a 2 percent discount for payment within ten
days. The following additional costs were incurred in connection with the machine:
Transportation-in .................................... $1,200
Installation cost .................................... 700
Testing costs prior to regular operation ............. 550

If the invoice is paid within the discount period, Marburg should record the acquisition cost of the
machine at
a. $41,650.
b. $41,100.
c. $40,400.
d. $39,200.
ANS: A OBJ: LO 1

31. The general ledger of the Flayle Corporation as of December 31 includes the following accounts:
Organization costs ................................... $ 20,000
Deposits with advertising agency (will be used to
promote goodwill) .................................. 32,000
Discount on bonds payable ............................ 60,000
Excess of cost over book value of net assets of
acquired subsidiary ................................ 280,000
Trademarks ........................................... 48,000

In the preparation of Flayle's balance sheet as of December 31, what should be reported as total
intangible assets?
a. $68,000
b. $328,000
c. $368,000
d. $380,000
ANS: B OBJ: LO 1

32. On June 30, 2005, Hi-Tech Inc. purchased for cash at $50 per share all 150,000 shares of
outstanding common stock of Skicraft Company. Skicraft's balance sheet at June 30, 2005,
showed net assets with a book value of $6,000,000. The fair value of Skicraft's property, plant,
and equipment on June 30, 2005, was $800,000 in excess of its book value. What amount, if any,
will be recorded by Hi-Tech as goodwill on the date of purchase?
a. $0
b. $700,000
c. $800,000
d. $1,500,000
ANS: B OBJ: LO 1

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33. On July 31, 2005, Cleveland Company purchased for $4,000,000 cash all of the outstanding
common stock of Gem Company when Gem's balance sheet showed net assets of $3,200,000.
Gem's assets and liabilities had fair values different from the book values as follows:

Book Value Fair Value

Property, plant, and equipment,
net ........................... $5,000,000 $5,750,000
Other assets .................... 500,000 0
Long-term debt .................. 3,000,000 2,800,000

As a result of the transaction, what amount will be shown as goodwill in the July 31, 2005,
consolidated balance sheet of Cleveland Company and its wholly owned subsidiary, Gem
Company?
a. $350,000
b. $250,000
c. $750,000
d. $800,000
ANS: A OBJ: LO 1

34. Peyton Company started construction of a new office building on January 1, 2005, and moved
into the finished building on July 1, 2006. Of the building's $5,000,000 total cost, $4,000,000 was
incurred in 2005 evenly throughout the year. Peyton's incremental borrowing rate was 12 percent
throughout 2005, and the total amount of interest incurred by Peyton during 2005 was $204,000.
What amount should Peyton report as capitalized interest at December 31, 2005?
a. $480,000
b. $300,000
c. $240,000
d. $204,000
ANS: D OBJ: LO 2

35. Mozely Company borrowed $400,000 on a 10 percent note payable to finance a new warehouse
Mozely is constructing for its own use. The only other debt on Mozely's books is a $600,000, 12
percent mortgage payable on an office building. At the end of the current year, average
accumulated expenditures on the new warehouse totaled $475,000. Mozely should capitalize
interest for the current year in the amount of
a. $40,000.
b. $47,500.
c. $49,000.
d. $52,250.
ANS: C OBJ: LO 2

36. Jazz Company acquired land and paid for it in full by issuing $600,000 of its 10 percent bonds
payable and 40,000 shares of its common stock, par $10. The stock was selling at $19 per share
and the bonds were trading at 102. What amount should Jazz record as the cost of the land?
a. $988,000
b. $1,000,000
c. $1,372,000
d. $1,387,200
ANS: C OBJ: LO 2

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37. Jazz Company purchased land with a current market value of $240,000. Its book value in the
accounts of the seller was $130,500. In exchange for the land, Jazz issued 20,000 shares of its
common stock, par $10, with an estimated market value of $14 per share. Jazz stock is not traded
on an established stock exchange. What amount should Jazz record as the cost of the land?
a. $130,500
b. $200,000
c. $240,000
d. $280,000
ANS: C OBJ: LO 2

38. The third year of a construction project began with a $30,000 balance in Construction in
Progress. Included in that figure is $6,000 of interest capitalized in the first two years.
Construction expenditures during the third year were $80,000 which were incurred evenly
throughout the entire year.
The company has had over $300,000 in interest-bearing debt outstanding the third year, at a
weighted average rate of 9 percent. How much interest for the third year is capitalized?
a. $3,600
b. $6,300
c. $9,360
d. $9,900
ANS: B OBJ: LO 2

39. Jazz company started construction on a building on January 1 of this year and completed
construction on December 31 of the same year. Jazz had only two interest notes outstanding
during the year, and both of these notes were outstanding for all 12 months of the year. The
following information is available:
Average accumulated expenditures ..................... $250,000
Ending balance in construction in progress
before capitalization of interest .................. 360,000
6 percent note incurred specifically for the project . 150,000
9 percent long-term note ............................. 500,000
What amount of interest should Jazz capitalize for the current year?
a. $15,000
b. $18,000
c. $22,500
d. $27,900
ANS: B OBJ: LO 2

40. A company made the following cash expenditures on a self-constructed building begun January 1
of the current year:
January 1 ............................................ $50,000
June 1 ............................................... 60,000
December 1 ........................................... 90,000

The building is still under construction at year-end. What is the average accumulated
expenditures for the purpose of capitalizing interest?
a. $87,500
b. $92,500
c. $100,000
d. $200,000
ANS: B OBJ: LO 2

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41. During 2005, Krieger, Inc. incurred the following costs:

Research and development services performed by Dell

Company for Krieger ................................ $125,000
Testing for evaluation of new products ............... 150,000
Laboratory research aimed at discovery of new knowledge 187,500

In its income statement for the year ended December 31, 2005, Krieger should report research
and development expense of
a. $462,500.
b. $312,500.
c. $150,000.
d. $125,000.
ANS: A OBJ: LO 3

42. Richard Co. incurred research and development costs in 2005 as follows:

Equipment acquired for use in various research and

development projects ............................... $500,000
Depreciation on the above equipment .................. 67,500
Materials used ....................................... 100,000
Compensation costs of personnel ...................... 250,000
Outside consulting fees .............................. 75,000
Indirect costs appropriately allocated ............... 125,000

The total research and development costs charged in Richard's 2005 income statement should be
a. $425,000.
b. $542,500.
c. $617,500.
d. $925,000.
ANS: C OBJ: LO 3

43. During the year just ended, Morton Company made the following expenditures relating to its
plant building:

Continuing and frequent repairs ..................... $160,000

Repainted the plant building ........................ 40,000
Major improvements to the electrical wiring system .. 128,000
Partial replacement of roof tiles ................... 56,000

How much should be charged to repair and maintenance expense during the year just ended?
a. $160,000
b. $216,000
c. $256,000
d. $328,000
ANS: C OBJ: LO 3

44. On September 10, Sandy Company incurred the following costs for one of its printing presses:

Purchase of stapling attachment ..................... $90,000

Installation of attachment .......................... 20,000
Replacement parts for renovation of press ........... 60,000
Labor and overhead in connection with renovation
of press .......................................... 28,000

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 Neither the attachment nor the renovation increased the estimated useful life of the press.
However, the renovation resulted in significantly increased productivity. What amount of the
costs should be capitalized?
a. $198,000
b. $110,000
c. $90,000
d. $88,000
ANS: A OBJ: LO 3

45. On April 30, 2005, Sistar, Inc. purchased for $30 per share all 200,000 of Wren Corp.'s
outstanding common stock. On this date Wren's balance sheet showed net assets of $5,000,000.
Additionally, the fair value of Wren's identifiable assets on this date was $400,000 in excess of
their carrying amount. On Sistar's April 30, 2005, consolidated balance sheet, what amount
should be reported as goodwill?
a. $350,000
b. $400,000
c. $600,000
d. $1,000,000
ANS: C OBJ: LO 2

46. Selected information from the 2005 and 2004 financial statements of Bowen Corporation is
presented below.

(in thousands)
As of Dec.31
2005 2004
Cash ...................................... $ 21 $ 35
Marketable Securities ..................... 27 22
Accounts Receivable (net) ................. 60 98
Inventory ................................. 105 142
Prepaid Expenses .......................... 5 3
Land and Building (net) ................... 247 315
Accounts Payable .......................... 57 75
Accrued Expenses .......................... 10 14
Notes Payable (short-term) ................ 8 4
Bond Payable .............................. 52 66

Bowen had cash sales of $750 and credit sales of $615 during 2005. Cost of goods sold for 2005
was $819. Bowen's fixed asset turnover for 2005 is
a. 2.97.
b. 4.86.
c. 2.53.
d. 5.53.
ANS: B OBJ: LO 6

47. According to the most current FASB standards, intangible assets acquired in a basket purchase
which does not represent the acquisition of an entire business should be
a. valued by allocating the total purchase price according to the relative fair values of all
assets acquired, regardless of whether the assets are separately tradable or contract based.
b. valued by allocating the total purchase price according to the relative fair values only of
intangible assets that are separately tradable or contract based.

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 c. valued by recording separately traded and contract based intangible assets at their
individual fair values with any unallocated purchase price being recognized as goodwill.
d. valued by recording separately traded and contract based intangible assets at their
individual fair values with any unallocated purchase price being expensed in the year of
acquisition.
ANS: A OBJ: LO 4

48. According to the most current FASB standards, intangible assets acquired in a basket purchase
which represents the acquisition of an entire business should be
a. valued by allocating the total purchase price according to the relative fair values of all
assets acquired, regardless of whether the assets are separately tradeable or contract based.
b. valued by allocating the total purchase price according to the relative fair values only of
intangible assets that are separately tradable or contract based.
c. valued by recording separately traded and contract based intangible assets at their
individual fair values with any unallocated purchase price being recognized as goodwill.
d. valued by recording separately traded and contract based intangible assets at their
individual fair values with any unallocated purchase price being expensed in the year of
acquisition.
ANS: C OBJ: LO 4

49. Which of the following is correct?

a. The fair value of internally generated intangible assets should be estimated and recorded
on the books of the entity that developed the assets even in the absence of a business
acquisition.
b. The fair value of internally generated intangible assets may be estimated but should not be
recorded on the books or displayed on the financial statements of the entity.
c. Managers may value their own companies and recognize goodwill in the company
accounts even though an entity has not been acquired in a business acquisition.
d. Goodwill should be recognized in the accounts whenever the value of the firm increases
based on current market prices of the firm's common stock.
ANS: B OBJ: LO 4

50. Which of the following is true regarding the traditional approach to estimating the fair value of an
intangible asset?
a. The traditional approach requires the use of the risk-free rate of interest.
b. The traditional approach requires the use of various possible outcomes and their
probability of occurrence.
c. The traditional approach requires the use of judgment in determining a risk-adjusted rate
of interest.
d. The traditional approach requires the assumption that cash flows occur at the beginning of
each period (an annuity due).
ANS: C OBJ: LO 4

51. Acquired in-process research and development should be

a. capitalized when acquired but not amortized.
b. capitalized when acquired and amortized over a period not to exceed 40 years.
c. capitalized when acquired and amortized based on the number of units of product or
services sold each period.
d. expensed when acquired.
ANS: D

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52. Which of the following most accurately describes the position taken by current generally
accepted accounting principles?
a. Both pooling of interests and the purchase method are still permitted under certain
circumstances.
b. The purchase method results in the assets of the acquired company being recognized on
the acquiring company's balance sheet at their fair value at the date of acquisition.
c. Goodwill may arise as a result of a business acquisition accounted for as a pooling of
interests.
d. The purchase method requires a business acquisition transaction to be structured to meet
twelve very specific criteria required by generally accepted accounting principles.
ANS: B OBJ: LO 4

53. Which of the following most accurately describes the position taken by generally accepted
accounting principles regarding the accounting for the costs of drilling dry wells in the oil and
gas industry?
a. Only the successful efforts method may be used.
b. Only the full cost method may be used.
c. Both the successful efforts and full-cost methods may be used.
d. Neither the successful efforts method nor the full cost method may be used pending the
development by the Securities and Exchange Commission of its own approach to
accounting for the costs of drilling dry wells.
ANS: C OBJ: LO 3

54. A trademark is an example of which general category of intangible asset that should be
recognized separately according to current generally accepted accounting principles?
a. Marketing-related
b. Customer-related
c. Artistic-related
d. Contract-based
ANS: A OBJ: LO 4

55. A copyright is an example of which general category of intangible asset that should be
recognized separately according to current generally accepted accounting principles?
a. Marketing-related
b. Customer-related
c. Artistic-related
d. Contract-based
ANS: C OBJ: LO 4

56. Broadcast rights are an example of which general category of intangible asset that should be
recognized separately according to current generally accepted accounting principles?
a. Marketing-related
b. Customer-related
c. Artistic-related
d. Contract-based
ANS: D OBJ: LO 4

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57. Order backlogs are an example of which general category of intangible asset that should be
recognized separately according to current generally accepted accounting principles?
a. Marketing-related
b. Customer-related
c. Artistic-related
d. Contract-based
ANS: B OBJ: LO 4

58. Trade secrets are an example of which general category of intangible asset that should be
recognized separately according to current generally accepted accounting principles?
a. Marketing-related
b. Customer-related
c. Artistic-related
d. Technology-based
ANS: D OBJ: LO 4

PROBLEMS

1. On February 1, 2004, Reardon Corporation purchased a parcel of land as a factory site for
$320,000. An old building on the property was demolished and construction begun on a new
warehouse that was completed April 15, 2005. Costs incurred on the construction project are
listed below.

Demolition of old building ........................... $ 21,000

Architect's fees ..................................... 31,700
Legal fees--title investigation ...................... 4,100
Construction costs ................................... 950,000
Imputed interest based on stock financing ............ 14,000
Landfill for building site ........................... 19,300
Clearing of trees from building site ................. 9,600
Temporary buildings used for construction activities . 29,000
Land survey .......................................... 4,000
Excavation for basement .............................. 13,200
(Salvage materials from demolition sold for $1,800)
(Timber sold for $3,300)

Determine the cost of the land and new building.

ANS:

Land
Cost ................................................. $ 320,000
Demolition ........................................... 21,000
Legal fees--title investigation ...................... 4,100
Landfill ............................................. 19,300
Clearing of trees .................................... 9,600
Land survey .......................................... 4,000
Salvage .............................................. (1,800)
Sale of timber ....................................... (3,300)
Total ............................................. $ 372,900

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 Building
Construction costs ................................... $ 950,000
Architect's fees ..................................... 31,700
Temporary buildings .................................. 29,000
Excavation ........................................... 13,200
Total.............................................. $1,023,900

Note: Interest charges would not be recorded. Under FASB Statement No. 34, only interest
charges incurred may be recognized.

OBJ: LO 1

2. On May 1, 2004, Lenny Corporation purchased for $690,000 a tract of land on which a
warehouse and office building were located. The following data were collected concerning the
property:

Current Assessed Vendor's

Valuation Original Cost
Land ............................. $280,000 $180,000
Warehouse ........................ 320,000 315,000
Office Building .................. 200,000 129,000
$800,000 $624,000

Determine the appropriate amounts that Lenny should record for the land, warehouse, and office
building.

ANS:

Land .................... $280,000/$800,000 = 35%

Warehouse ............... $320,000/$800,000 = 40%
Office Building ......... $200,000/$800,000 = 25%
$800,000 100%
Allocation:
.35  $690,000 = $241,500 Land
.40  $690,000 = 276,000 Warehouse
.25  $690,000 = 172,500 Office Building
$690,000

OBJ: LO 2

3. The Callister Company exchanged 25,000 shares of its own $50 par value common stock for a
turret lathe from Payne Company. The market value of the Callister Company stock was $68 per
share at the date of exchange. The equipment had a carrying value of $1,625,000.

Record the exchange on the books of Callister Company in general journal form.

ANS:

Machinery ............................................. 1,700,000

Common Stock (25,000  $50) ......................... 1,250,000
Paid-In Capital in Excess of Par .................... 450,000

299
 OBJ: LO 2

4. One of the most critical steps in recording the acquisition of assets is the determination of the cost
assigned to the asset. Data related to assets acquired by Mentor Manufacturing Company are as
follows:
(1) Machine A was purchased at a list price of $92,000; terms 1/10, net 30. The
machine invoice was paid after the discount period. Transportation charges were
$1,270; installation costs were $920; and the cost of a trial run was $960. Normal
repairs and maintenance for the first year were $410.

(2) Machine B could be purchased for five annual payments of $6,332 or $29,400 in
cash. Mentor elected to purchase Machine B under the installment plan. Other
related acquisition costs totaled $175.

(3) On May 12, 2005, Alabama Company offered to sell land to Mentor for $62,000;
the offer was rejected. On June 29, 2,125 shares of Mentor common stock were
issued in exchange for the land. The par value of the stock was $20 per share; the
market value of the stock was $32 per share at the time of purchase. Mentor's
management was confident the land would be worth at least $64,000 to the
company.

(4) The company purchased equipment under a deferred payment contract-- $40,000
down payment and 30 semiannual payments of $5,000. (Assume a 12 percent
interest rate.)
Determine the acquisition cost for each of the assets.

ANS:

(1)
Cost of machine ($92,000  .99) ....................... $91,080
Transportation costs .................................. 1,270
Installation costs .................................... 920
Trial run ............................................. 960
Cost basis for Machine A .............................. $94,230

The $410 for normal repairs and maintenance is a period cost; the $920 ($92,000 - $91,080) is
recorded as Discounts Lost or Interest Expense.
(2)
Cash price of machine ................................. $29,400
Other acquisition costs ............................... 175
Cost basis for Machine B .............................. $29,575

The interest of ($31,660 - $29,400) = $2,260 is not included in the

asset cost.

(3)
Cost basis for land:
2,125 shares @ $32 (market) = $68,000

(4)
Down payment .......................................... $ 40,000
Semiannual payments ($5,000 x 13.7648)* ............... 68,824
$108,824

300
 * n = 30 i = 6% (Table 4--Present value of an ordinary annuity)

OBJ: LO 2
5. During 2005, Grant Industries, Inc. constructed a new manufacturing facility at a cost of
$12,000,000. The weighted average accumulated expenditures for 2005 were calculated to be
$5,400,000. The company had the following debt outstanding at December 31, 2005:

(a) 10 percent, five-year note to finance construction of the manufacturing facility,

dated January 1, 2005, $3,600,000.
(b) 12 percent, 20-year bonds issued at par on April 30, 2001, $8,400,000.
(c) 8 percent, six-year note payable, dated March 1, 2004, $1,800,000.

Determine the amount of interest to be capitalized by Grant Industries for 2005.

ANS:

Average Applicable
Accumulated Interest Avoidable
Expenditures Rate Interest
$3,600,000 10% $360,000
1,800,000 11.29% * 203,220
$5,400,000 $563,220

* Calculation of weighted average interest rate:

Principal Interest
12% bonds $ 8,400,000 $1,008,000
8% note payable 1,800,000 144,000
$10,200,000 $1,152,000

$1,152,000/$10,200,000 = 11.29% (rounded)

Actual interest cost incurred during 2005:

Construction loan ($3,600,000 x 10%)..... $ 360,000
12% bonds ($8,400,000 x 12%)............. 1,008,000
8% notes ($1,800,000 x 8%)............... 144,000
$1,512,000

The interest that should be capitalized for 2005 by Grant Industries, Inc. is $563,220 (the lesser of
the avoidable interest of $563,220 and the actual interest cost incurred of $1,512,000).

OBJ: LO 2

6. Gooden Enterprises Inc. developed a new machine for manufacturing baseballs. Because the
machine is considered very valuable, the company had it patented. The following expenditures
were incurred in developing and patenting the machine.

(a) Purchases of special equipment to be used solely for

development of the new machine ...................... $182,000
(b) Research salaries and fringe benefits for engineers
and scientists ...................................... 17,100
(c) Cost of testing prototype ........................... 23,600
(d) Legal costs for filing for patent ................... 12,700
(e) Fees paid to government patent office ............... 2,500
(f) Drawings required by patent office to be filed with
patent application .................................. 4,700

301
 Gooden elected to amortize the patent over its legal life. At the beginning of the second year,
Gooden Enterprises paid $24,000 to successfully defend the patent in an infringement suit. At the
beginning of the fourth year Gooden determined that the remaining estimated useful life of the
patent was five years.

Record the above transactions in general journal form for Gooden Enterprises Inc. for the first
five years of the life of the patent. Include any amortization or depreciation for each period.

ANS:

Year 1 Research and Development Expense

[$182,000 + $17,100 + $23,600 =
$222,700] ........................... 222,700
Patents
[$12,700 + $2,500 + $4,700 = $19,900] 19,900
Cash ................................ 242,600

Year 1 Amortization of Patents

[$19,900/17 = $1,171] ............... 1,171
Patents ............................. 1,171

Year 2 Patents ............................... 24,000

Cash ................................ 24,000

Year 2 Amortization of Patents

[($19,900 + $24,000 - $1,171)/16] .... 2,671
Patents ............................. 2,671

Year 3 Amortization of Patents ............... 2,671

Patents ............................. 2,671

Year 4 Amortization of Patents [($19,900 + 7,477

$24,000 - $1,171 - $2,671 - $2,671)/5]
Patents ............................. 7,477

Year 5 Amortization of Patents ............... 7,477

Patents ............................. 7,477

OBJ: LO 3

7. On March 1, 2005, the Sefkwak Company paid $400,000 for all the issued and outstanding stock
of Bodo Corporation in a transaction properly accounted for as a purchase. The market values of
the assets and liabilities of Bodo Corporation on March 1, 2005, are as follows:

Cash .................................................. $ 10,000

Accounts receivable ................................... 120,000
Inventory ............................................. 330,000
Property and equipment ................................ 80,000
Liabilities ........................................... (20,000)

Make the journal entry necessary for Sefkwak to record the purchase.

302
 ANS:

Cash ...................................... 10,000

Accounts Receivable ....................... 120,000
Inventory ................................. 330,000
Liabilities ............................. 20,000
Negative Goodwill ....................... 40,000
Cash .................................... 400,000

Cash purchase price ....................... $400,000

Market value of net assets ................ 520,000
Excess of market value over purchase price $120,000
Reduction of property and equipment 80,000
(noncurrent assets) .....................
Remainder (negative goodwill) ............. $ 40,000

OBJ: LO 2

8. Lurie Company made the following cash expenditures during the year:

(a) Paid $100,000 for interest capitalized as part of a self-construction project.

(b) Paid $225,000 for interest that was expensed during the year.

(c) Paid $300,000 for R&D expenditures that were immediately expensed.

(d) Paid $400,000 to acquire new machinery.

Indicate where in the statement of cash flows each of the preceding items would be reflected.
Lurie uses the indirect method of reporting cash flow from operations.

ANS:

(a) $100,000 cash outflow in the investing activities section.

(b) Nowhere. Interest expense would be included in the computation of net income and
would not be shown separately in the operating activities section of the statement
of cash flows. However, the amount of cash paid for interest must be disclosed
separately, as a supplemental part of the statement of cash flows or in the notes.

(c) Nowhere. Again, research and development expense would be included in the
computation of net income. Net income is the basis for computing cash from
operations when the indirect method is used.

(d) $400,000 cash outflow in the investing activities section.

OBJ: LO 2, LO 3

303
9.Delb Company is an oil and gas exploration firm. During 2005, Delb engaged in five different
exploration projects. The costs associated with these projects are as follows:

Project 1 ............................................ $ 325,000

Project 2 ............................................ 178,000
Project 3 ............................................ 423,000
Project 4 ............................................ 240,000
Project 5 ............................................ 96,000
Total .............................................. $1,262,000

Only Projects 2 and 5 were successful. As of the end of the year, production had not yet started at
either of these two sites.

Assuming that all exploration costs were paid for in cash, make the journal entry to record the
expenditures for the year using

(1) the successful efforts method.

(2) the full cost method.

ANS:
(1)

Exploration Expense .................................. 988,000

Capitalized Exploration Cost ......................... 274,000
Cash ............................................... 1,262,000

(2)

Capitalized Exploration Cost .............. 1,262,000

Cash .................................... 1,262,000

OBJ: LO 3

10. Assets constructed for a firm's own use present the problem of whether to capitalize interest on
the funds invested during the time required to prepare the assets for their intended use. Current
generally accepted accounting principles as specified by the FASB in Statement No. 34 require
the capitalization of interest on borrowed capital, but not to exceed the total interest paid by the
firm.

Evaluate the appropriateness of the approach currently required in the professional

pronouncements now in effect.

ANS:
Capitalization of interest on borrowed capital (but not in excess of total interest paid by the
enterprise) avoids the difficulty of determining how much of an investment is financed by debt
and how much by equity. The entire investment is assumed to be financed by debt. Interest
capitalized, however, is limited to the total interest incurred by the enterprise during the period.
Interest thus represents an opportunity cost in the amount that could have been avoided by not
borrowing or by using the funds to reduce outstanding debt. Limiting the amount capitalized to
the total interest cost incurred during the period is consistent with the historical cost principle
since only the actual interest expense incurred is capitalized.

304
 The current approach is deficient because it fails to recognize the portion of the investment
financed by equity sources. An opportunity cost exists for using funds obtained from equity
sources just as surely as for using funds obtained from debt sources. Ignoring the opportunity cost
associated with equity sources results in inconsistent and incomparable valuations. The approach
does not lead to comparable results for different firms producing similar assets but with different
capital structures. Additionally, the limitation on the capitalization of interest associated with
debt to the amount of interest actually incurred by an enterprise fails to recognize the total cost of
using money associated with an investment.

OBJ: LO 2

11. You are the auditor of Don Corporation, a newly organized company that manufactures plastic
cups using an extrusion process. One of the promoters of the company was formerly involved in
an enterprise that used the extrusion process and has agreed to contribute an extrusion machine to
the new company in return for shares of stock of Don Corporation. What concerns would you
have as the auditor of Don Corporation regarding this transaction?

ANS:
This transaction represents a related party transaction. Accordingly, you should be concerned
about the amount recorded on the records of the company. You should determine what methods
were used to establish the value on the books of the company of the asset contributed as well as
the cost of the machine to the promoter and the length of ownership by the promoter. You should
be concerned not only about the value of the asset for purposes of recording the asset in the
property accounts, but also about attempts by the promoter and management to defraud investors
in the company through attempts to inflate the value of the shares of stock by overvaluing the
asset.

OBJ: LO 2

12. You have just been promoted to the position of senior accountant with the public accounting firm
of Watts and Zimmerman. Your first audit client as senior accountant is to be the Delta
Manufacturing Company. You have had a considerable amount of experience both in planning
and conducting the audit procedures for current asset accounts such as cash, receivables, and
inventory. This is your first experience, however, in planning the audit of the property, plant, and
equipment accounts. Compare the nature of current assets with property, plant, and equipment,
and describe how any differences might affect your audit generally.

ANS:
The audit work required to verify the property, plant, and equipment accounts generally is
substantially less than that required for current assets. This is due to the nature of the assets
included in the property accounts.

A typical unit of property or equipment usually has a high dollar value, and relatively few
transactions may support one large amount on the balance sheet. Current asset accounts such as
cash, receivables, and inventory, on the other hand, generally have a large volume of transactions,
many of which may be of lower dollar values.

The property accounts typically do not show large changes in the balances of these accounts from
year to year. Current asset accounts often change dramatically from year to year, again as a result
of a large volume of transactions.

305
 The cash, receivables, and inventory accounts of the current asset section all pose significant
problems in terms of ensuring that a proper cut-off of transactions is made at the end of the
accounting period. Errors in recording purchases or sales can affect net income. The potential for
such errors is significant for the current asset accounts due to the large volume of transactions.
An error in recording the acquisition or retirement of a plant asset at year-end likely will not
affect net income for the period nearly to the extent a cut-off error in the current asset accounts.

OBJ: LO 1

13. UR Company purchased a customer database and a formula for a new fuel substitute for diesel
fuel for a total of $100,000. UR Company uses the expected cash flow approach for estimating
the fair value of these two intangibles. The appropriate interest rate is 5%. The potential future
cash flows from the two intangibles, and their associated probabilities, are as follows:

Customer Database:
Outcome 1 20% probability of cash flows of $10,000 at the end of each year for 5 years.
Outcome 2 30% probability of cash flows of $2,000 at the end of each year for 4 years.
Outcome 3 50% probability of cash flows of $200 at the end of each year for 3 years.

Formula:
Outcome 1 10% probability of cash flows of $50,000 at the end of each year for 10
years.
Outcome 2 30% probability of cash flows of $30,000 at the end of each year for 4 years.
Outcome 3 60% probability of cash flows of $10,000 at the end of each year for 3 years.

Prepare the journal entry necessary to record the purchase of the two intangibles.

ANS:

Customer Database
Probability
Weighted Present
Present Value Probability Value
Outcome 1 $43,295 0.20 $ 8,659
Outcome 2 7,092 0.30 2,128
Outcome 3 545 0.50 273
Total Estimated
Fair Value $11,060

Formula
Probability
Weighted Present
Present Value Probability Value
Outcome 1 $386,087 0.10 $38,609
Outcome 2 106,379 0.30 31,914
Outcome 3 27,233 0.60 16,340
Total Estimated
Fair Value $86,863

306
 Cost Allocation
According to
Estimated Fair Relative Estimated Cost Assigned to
Value Fair Values Infividual Assets
Customer Database 11,060/97,923 x
$11,060 $100,000 $ 11,295
Formula 86,863/97,923 x
$86,863 $100,000 $ 88,705
$97,923 $100,000

Journal entry to record purchase:

Intangible Asset--Customer Database 11,295

Intangible Asset--Formula 88,705
Cash 100,000

OBJ: LO 4

14. Abacus Company purchased a customer database and in-process research and development for a
total of $100,000. Abacus Company uses the expected cash flow approach for estimating the fair
value of these two intangibles. The appropriate interest rate is 5%. The potential future cash
flows from the two intangibles, and their associated probabilities, are as follows:

Customer Database:
Outcome 1 20% probability of cash flows of $10,000 at the end of each year for 5 years.
Outcome 2 30% probability of cash flows of $2,000 at the end of each year for 4 years.
Outcome 3 50% probability of cash flows of $200 at the end of each year for 3 years.

In-process Research and Development:

Outcome 1 10% probability of cash flows of $50,000 at the end of each year for 10
years.
Outcome 2 30% probability of cash flows of $30,000 at the end of each year for 4 years.
Outcome 3 60% probability of cash flows of $10,000 at the end of each year for 3 years.

Prepare the journal entry necessary to record the purchase of the two intangibles.

ANS:
Customer Database
Probability
Weighted Present
Present Value Probability Value
Outcome 1 $43,295 0.20 $ 8,659
Outcome 2 7,092 0.30 2,128
Outcome 3 545 0.50 273
Total Estimated
Fair Value $11,060

307
 In-process Research & Development
Probability
Weighted Present
Present Value Probability Value
Outcome 1 $386,087 0.10 $38,609
Outcome 2 106,379 0.30 31,914
Outcome 3 27,233 0.60 16,340
Total Estimated
Fair Value $86,863

Cost Allocation
According to
Estimated Fair Relative Estimated Cost Assigned to
Value Fair Values Infividual Assets
Customer Database 11,060/97,923 x
$11,060 $100,000 $ 11,295
Formula 86,863/97,923 x
$86,863 $100,000 $ 88,705
$97,923 $100,000

Journal entry to record purchase:

Intangible Asset--Customer Database 11,295

Research & Development Expense 88,705
Cash 100,000

OBJ: LO4

15. RGW Industries purchased the net assets of SP Company for $1,300,000. A schedule of the net
assets of SP Company, as recorded on SP Company's books at the time of the acquisition, is as
follows:

Assets

Cash ......................................................................................................................... $ 31,000

Receivables .............................................................................................................. 250,000
Inventory.................................................................................................................. 302,000
Land, buildings, and equipment (net) ...................................................................... 350,000
Total assets .............................................................................................................. $ 933,000

Liabilities

Current liabilities ..................................................................................................... $ 90,000

Long-term debt ........................................................................................................ 185,000
Total liabilities ......................................................................................................... $ 275,000
Net assets (book value) ............................................................................................ $ 658,000

The following schedule shows the differences between the recorded costs and market values of
the assets of SP Company at the date of the acquisition:

308
 Cost Market
Inventory $302,000 $400,000
Land, buildings, & 350,000 390,000
equipment
Patents -0- 40,000
Purchased in-process
research & development -0- 300,000
Existing work force -0- 90,000
Totals $652,000 $1,220,000
Liabilities $275,000 $275,000

Prepare the journal entry to record this purchase.

ANS:
The cost in excess of fair value is determined as follows:

Purchase price ................................................................... $1,300,000

Book value of net assets ................................................... 658,000
Cost in excess of book value ............................................ $ 642,000

The identifiable portion of the $642,000 difference is $568,000 ($1,220,000 - $652,000) and is
allocated to the appropriate assets. The remaining difference of $74,000 ($642,000 - $568,000) is
recorded as part of goodwill. The total recorded amount of goodwill is $164,000 ($74,000 +
$90,000) since the estimated values of intangibles such as the value of the existing work force
that are not contract based or separately tradable are included in goodwill.

The entry to record the purchase is as follows:

Cash ........................................................ 31,000

Receivables ............................................. 250,000
Inventory................................................. 400,000
Land, buildings, & equipment ................ 390,000
Patents..................................................... 40,000
Research & development expense .......... 300,000
Goodwill ................................................. 164,000
Current liabilities ....................... 90,000
Long-term liabilities .................. 185,000
Cash ........................................... 1,300,000

OBJ: LO 4

309