Solutions Manual and Test Bank Intermediate Accounting Kieso Weygandt Warfield 14th edition
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Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment
Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment
1. What are the major characteristics of plant assets?
2. Mickelson Inc. owns land that it purchased on January 1, 2000, for $450,000. At December 31, 2012, its current value is $770,000 as determined by appraisal. At what amount should Mickelson report this asset on its December 31, 2012, balance sheet? Explain.
3. Name the items, in addition to the amount paid to the former owner or contractor, that may properly be included as part of the acquisition cost of the following plant assets. (a) Land. (b) Machinery and equipment. (c) Buildings.
4. Indicate where the following items would be shown on a balance sheet. (a) A lien that was attached to the land when purchased. (b) Landscaping costs. (c) Attorney’s fees and recording fees related to purchasing land. (d) Variable overhead related to construction of machinery. (e) A parking lot servicing employees in the building. (f) Cost of temporary building for workers during construction of building. (g) Interest expense on bonds payable incurred during construction of a building. (h) Assessments for sidewalks that are maintained by the city. (i) The cost of demolishing an old building that was on the land when purchased.
5. Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations. What are the circumstances or rationale that support or deny the application of these methods?
6. The Buildings account of Postera Inc. includes the following items that were used in determining the basis for depreciating the cost of a building. (a) Organization and promotion expenses.
(b) Architect’s fees. (c) Interest and taxes during construction. (d) Interest revenue on investments held to fund construction of a building. Do you agree with these charges? If not, how would you deal with each of the items above in the corporation’s books and in its annual financial statements?
7. Burke Company has purchased two tracts of land. One tract will be the site of its new manufacturing plant, while the other is being purchased with the hope that it will be sold in the next year at a profit. How should these two tracts of land be reported in the balance sheet?
8. One financial accounting issue encountered when a company constructs its own plant is whether the interest cost on funds borrowed to finance construction should be capitalized and then amortized over the life of the assets constructed. What is the justification for capitalizing such interest?
9. Provide examples of assets that do not qualify for interest capitalization.
10. What interest rates should be used in determining the amount of interest to be capitalized? How should the amount of interest to be capitalized be determined?
11. How should the amount of interest capitalized be disclosed in the notes to the financial statements? How should interest revenue from temporarily invested excess funds borrowed to finance the construction of assets be accounted for?
12. Discuss the basic accounting problem that arises in handling each of the following situations. (a) Assets purchased by issuance of capital stock. (b) Acquisition of plant assets by gift or donation. (c) Purchase of a plant asset subject to a cash discount. (d) Assets purchased on a long-term credit basis. (e) A group of assets acquired for a lump sum. (f) An asset traded in or exchanged for another asset.
13. Magilke Industries acquired equipment this year to be used in its operations. The equipment was delivered by the suppliers, installed by Magilke, and placed into operation. Some of it was purchased for cash with discounts available for prompt payment. Some of it was purchased under long-term payment plans for which the interest charges approximated prevailing rates. What costs should Magilke capitalize for the new equipment purchased this year? Explain.
14. Schwartzkopf Co. purchased for $2,200,000 property that included both land and a building to be used in operations. The seller’s book value was $300,000 for the land and $900,000 for the building. By appraisal, the fair value was estimated to be $500,000 for the land and $2,000,000 for the building. At what amount should Schwartzkopf report the land and the building at the end of the year?
15. Pueblo Co. acquires machinery by paying $10,000 cash and signing a $5,000, 2-year, zero-interest-bearing note payable. The note has a present value of $4,208, and Pueblo purchased a similar machine last month for $13,500. At what cost should the new equipment be recorded?
16. Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for these two situations.
17. Crowe Company purchased a heavy-duty truck on July 1, 2009, for $30,000. It was estimated that it would have a useful life of 10 years and then would have a trade-in value of $6,000. The company uses the straight-line method. It was traded on August 1, 2013, for a similar truck costing $42,000; $16,000 was allowed as trade-in value (also fair value) on the old truck and $26,000 was paid in cash. A comparison of expected cash flows for the trucks indicates the exchange lacks commercial substance. What is the entry to record the trade-in?
18. Once equipment has been installed and placed in operation, subsequent expenditures relating to this equipment are frequently thought of as repairs or general maintenance and, hence, chargeable to operations in the period in which the expenditure is made. Actually, determination of whether such an expenditure should be charged to operations or capitalized involves a much more careful analysis of the character of the expenditure. What are the factors that should be considered in making such a decision? Discuss fully.
19. What accounting treatment is normally given to the following items in accounting for plant assets? (a) Additions. (b) Major repairs. (c) Improvements and replacements.
20. New machinery, which replaced a number of employees, was installed and put in operation in the last month of the fiscal year. The employees had been dismissed after payment of an extra month’s wages, and this amount was added to the cost of the machinery. Discuss the propriety of the charge. If it was improper, describe the proper treatment.
21. To what extent do you consider the following items to be proper costs of the fixed asset? Give reasons for your opinions. (a) Overhead of a business that builds its own equipment. (b) Cash discounts on purchases of equipment. (c) Interest paid during construction of a building. (d) Cost of a safety device installed on a machine. (e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity. (f) Cost of moving machinery to a new location. (g) Cost of plywood partitions erected as part of the remodeling of the office. (h) Replastering of a section of the building. (i) Cost of a new motor for one of the trucks.
22. Neville Enterprises has a number of fully depreciated assets that are still being used in the main operations of the business. Because the assets are fully depreciated, the president of the company decides not to show them on the balance sheet or disclose this information in the notes. Evaluate this procedure.
23. What are the general rules for how gains or losses on retirement of plant assets should be reported in income? RI E F EXERCI S
BE10-1 Previn Brothers Inc. purchased land at a price of $27,000. Closing costs were $1,400. An old building was removed at a cost of $10,200. What amount should be recorded as the cost of the land?
BE10-2 Hanson Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $1,800,000 on March 1, $1,200,000 on June 1, and $3,000,000 on December 31. Compute Hanson’s weighted-average accumulated expenditures for interest capitalization purposes.
BE10-3 Hanson Company (see BE10-2) borrowed $1,000,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 5-year, $2,000,000 note payable and an 11%, 4-year, $3,500,000 note payable. Compute the weighted-average interest rate used for interest capitalization purposes.
BE10-4 Use the information for Hanson Company from BE10-2 and BE10-3. Compute avoidable interest for Hanson Company.
BE10-5 Garcia Corporation purchased a truck by issuing an $80,000, 4-year, zero-interest-bearing note to Equinox Inc. The market rate of interest for obligations of this nature is 10%. Prepare the journal entry to record the purchase of this truck.
BE10-6 Mohave Inc. purchased land, building, and equipment from Laguna Corporation for a cash payment of $315,000. The estimated fair values of the assets are land $60,000, building $220,000, and equipment $80,000. At what amounts should each of the three assets be recorded?
BE10-7 Fielder Company obtained land by issuing 2,000 shares of its $10 par value common stock. The land was recently appraised at $85,000. The common stock is actively traded at $40 per share. Prepare the journal entry to record the acquisition of the land.
BE10-8 Navajo Corporation traded a used truck (cost $20,000, accumulated depreciation $18,000) for a small computer worth $3,300. Navajo also paid $500 in the transaction. Prepare the journal entry to record the exchange. (The exchange has commercial substance.)
BE10-9 Use the information for Navajo Corporation from
BE10-8. Prepare the journal entry to record the exchange, assuming the exchange lacks commercial substance.
BE10-10 Mehta Company traded a used welding machine (cost $9,000, accumulated depreciation $3,000) for office equipment with an estimated fair value of $5,000. Mehta also paid $3,000 cash in the transaction. Prepare the journal entry to record the exchange. (The exchange has commercial substance.)
BE10-11 Cheng Company traded a used truck for a new truck. The used truck cost $30,000 and has accumulated depreciation of $27,000. The new truck is worth $37,000. Cheng also made a cash payment of $36,000. Prepare Cheng’s entry to record the exchange. (The exchange lacks commercial substance.)
BE10-12 Slaton Corporation traded a used truck for a new truck. The used truck cost $20,000 and has accumulated depreciation of $17,000. The new truck is worth $35,000. Slaton also made a cash payment of $33,000. Prepare Slaton’s entry to record the exchange. (The exchange has commercial substance.)
BE10-13 Indicate which of the following costs should be expensed when incurred. (a) $13,000 paid to rearrange and reinstall machinery. (b) $200,000 paid for addition to building. (c) $200 paid for tune-up and oil change on delivery truck. (d) $7,000 paid to replace a wooden floor with a concrete floor. (e) $2,000 paid for a major overhaul on a truck, which extends the useful life.
BE10-14 Ottawa Corporation owns machinery that cost $20,000 when purchased on July 1, 2009. Depreciation has been recorded at a rate of $2,400 per year, resulting in a balance in accumulated depreciation of $8,400 at December 31, 2012. The machinery is sold on September 1, 2013, for $10,500. Prepare journal entries to (a) update depreciation for 2013 and (b) record the sale.
BE10-15 Use the information presented for Ottawa Corporation in
BE10-14, but assume the machinery is sold for $5,200 instead of $10,500. Prepare journal entries to (a) update depreciation for 2013 and (b) record the sale. 2 4 4 5 4 5 5 5 5 5 5 5 6 7 7 EXERCI S E S
E10-1 (Acquisition Costs of Realty) The expenditures and receipts below are related to land, land improvements, and buildings acquired for use in a business enterprise. The receipts are enclosed in parentheses. (a) Money borrowed to pay building contractor (signed a note) $(275,000) (b) Payment for construction from note proceeds 275,000 (c) Cost of land fill and clearing 10,000 (d) Delinquent real estate taxes on property assumed by purchaser 7,000 (e) Premium on 6-month insurance policy during construction 6,000 (f) Refund of 1-month insurance premium because construction completed early (1,000) (g) Architect’s fee on building 25,000 (h) Cost of real estate purchased as a plant site (land $200,000 and building $50,000) 250,000 (i) Commission fee paid to real estate agency 9,000 (j) Installation of fences around property 4,000 (k) Cost of razing and removing building 11,000 (l) Proceeds from salvage of demolished building (5,000) (m) Interest paid during construction on money borrowed for construction 13,000 (n) Cost of parking lots and driveways 19,000 (o) Cost of trees and shrubbery planted (permanent in nature) 14,000 (p) Excavation costs for new building 3,000
Instructions Identify each item by letter and list the items in columnar form, using the headings shown below. All receipt amounts should be reported in parentheses. For any amounts entered in the Other Accounts column, also indicate the account title. Other Item Land Land Improvements Buildings Accounts
E10-2 (Acquisition Costs of Realty) Pollachek Co. purchased land as a factory site for $450,000. The process of tearing down two old buildings on the site and constructing the factory required 6 months. The company paid $42,000 to raze the old buildings and sold salvaged lumber and brick for $6,300. Legal fees of $1,850 were paid for title investigation and drawing the purchase contract. Pollachek paid $2,200 to an engineering firm for a land survey, and $65,000 for drawing the factory plans. The land survey had to be made before definitive plans could be drawn. Title insurance on the property cost $1,500, and a liability insurance premium paid during construction was $900. The contractor’s charge for construction was $2,740,000. The company paid the contractor in two installments: $1,200,000 at the end of 3 months and $1,540,000 upon completion. Interest costs of $170,000 were incurred to finance the construction.
Instructions Determine the cost of the land and the cost of the building as they should be recorded on the books of Pollachek Co. Assume that the land survey was for the building.
E10-3 (Acquisition Costs of Trucks) Shabbona Corporation operates a retail computer store. To improve delivery services to customers, the company purchases four new trucks on April 1, 2012. The terms of acquisition for each truck are described below. 1. Truck #1 has a list price of $15,000 and is acquired for a cash payment of $13,900. 2. Truck #2 has a list price of $20,000 and is acquired for a down payment of $2,000 cash and a zerointerest- bearing note with a face amount of $18,000. The note is due April 1, 2013. Shabbona would normally have to pay interest at a rate of 10% for such a borrowing, and the dealership has an incremental borrowing rate of 8%. 3. Truck #3 has a list price of $16,000. It is acquired in exchange for a computer system that Shabbona carries in inventory. The computer system cost $12,000 and is normally sold by Shabbona for $15,200. Shabbona uses a perpetual inventory system. 4. Truck #4 has a list price of $14,000. It is acquired in exchange for 1,000 shares of common stock in Shabbona Corporation. The stock has a par value per share of $10 and a market price of $13 per share.
Instructions Prepare the appropriate journal entries for the foregoing transactions for Shabbona Corporation. (Round computations to the nearest dollar.) 2
E10-4 (Purchase and Self-Constructed Cost of Assets) Dane Co. both purchases and constructs various equipment it uses in its operations. The following items for two different types of equipment were recorded in random order during the calendar year 2013. Purchase Cash paid for equipment, including sales tax of $5,000 $105,000 Freight and insurance cost while in transit 2,000 Cost of moving equipment into place at factory 3,100 Wage cost for technicians to test equipment 6,000 Insurance premium paid during fi rst year of operation on this equipment 1,500 Special plumbing fi xtures required for new equipment 8,000 Repair cost incurred in fi rst year of operations related to this equipment 1,300 Construction Material and purchased parts (gross cost $200,000; failed to take 1% cash discount) $200,000 Imputed interest on funds used during construction (stock fi nancing) 14,000 Labor costs 190,000 Allocated overhead costs (fi xed—$20,000; variable—$30,000) 50,000 Profi t on self-construction 30,000 Cost of installing equipment 4,400
Instructions Compute the total cost for each of these two pieces of equipment. If an item is not capitalized as a cost of the equipment, indicate how it should be reported.
E10-5 (Treatment of Various Costs) Allegro Supply Company, a newly formed corporation, incurred the following expenditures related to Land, to Buildings, and to Machinery and Equipment. Abstract company’s fee for title search $ 520 Architect’s fees 3,170 Cash paid for land and dilapidated building thereon 92,000 Removal of old building $20,000 Less: Salvage 5,500 14,500 Interest on short-term loans during construction 7,400 Excavation before construction for basement 19,000 Machinery purchased (subject to 2% cash discount, which was not taken) 65,000 Freight on machinery purchased 1,340 Storage charges on machinery, necessitated by noncompletion of building when machinery was delivered 2,180 New building constructed (building construction took 6 months from date of purchase of land and old building) 485,000 Assessment by city for drainage project 1,600 Hauling charges for delivery of machinery from storage to new building 620 Installation of machinery 2,000 Trees, shrubs, and other landscaping after completion of building (permanent in nature) 5,400
Instructions Determine the amounts that should be debited to Land, to Buildings, and to Machinery and Equipment. Assume the benefits of capitalizing interest during construction exceed the cost of implementation. Indicate how any costs not debited to these accounts should be recorded.
E10-6 (Correction of Improper Cost Entries) Plant acquisitions for selected companies are presented below and on the next page. 1. Natchez Industries Inc. acquired land, buildings, and equipment from a bankrupt company, Vivace Co., for a lump-sum price of $680,000. At the time of purchase, Vivace’s assets had the following book and appraisal values. Book Values Appraisal Values Land $200,000 $150,000 Buildings 230,000 350,000 Equipment 300,000 300,000 To be conservative, the company decided to take the lower of the two values for each asset acquired. The following entry was made. Land 150,000 Buildings 230,000 Equipment 300,000 Cash 680,000 2 3 2 3 4 3 4 2. Arawak Enterprises purchased store equipment by making a $2,000 cash down payment and signing a 1-year, $23,000, 10% note payable. The purchase was recorded as follows. Equipment 27,300 Cash 2,000 Notes Payable 23,000 Interest Payable 2,300 3. Ace Company purchased office equipment for $20,000, terms 2/10, n/30. Because the company intended to take the discount, it made no entry until it paid for the acquisition. The entry was: Equipment 20,000 Cash 19,600 Purchase Discounts 400 4. Paunee Inc. recently received at zero cost land from the Village of Cardassia as an inducement to locate its business in the Village. The appraised value of the land is $27,000. The company made no entry to record the land because it had no cost basis. 5. Mohegan Company built a warehouse for $600,000. It could have purchased the building for $740,000. The controller made the following entry. Buildings 740,000 Cash 600,000 Profit on Construction 140,000
Instructions Prepare the entry that should have been made at the date of each acquisition.
E10-7 (Capitalization of Interest) McPherson Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2012. McPherson expected to complete the building by December 31, 2012. McPherson has the following debt obligations outstanding during the construction period. Construction loan—12% interest, payable semiannually, issued December 31, 2011 $2,000,000 Short-term loan—10% interest, payable monthly, and principal payable at maturity on May 30, 2013 1,600,000 Long-term loan—11% interest, payable on January 1 of each year; principal payable on January 1, 2016 1,000,000
Instructions (Carry all computations to two decimal places.) (a) Assume that McPherson completed the office and warehouse building on December 31, 2012, as planned at a total cost of $5,200,000, and the weighted average of accumulated expenditures was $3,800,000. Compute the avoidable interest on this project. (b) Compute the depreciation expense for the year ended December 31, 2013. McPherson elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of $300,000.
E10-8 (Capitalization of Interest) On December 31, 2011, Hurston Inc. borrowed $3,000,000 at 12% payable annually to finance the construction of a new building. In 2012, the company made the following expenditures related to this building: March 1, $360,000; June 1, $600,000; July 1, $1,500,000; December 1, $1,200,000. Additional information is provided as follows. 1. Other debt outstanding 10-year, 11% bond, December 31, 2005, interest payable annually $4,000,000 6-year, 10% note, dated December 31, 2009, interest payable annually $1,600,000 2. March 1, 2012, expenditure included land costs of $150,000 3. Interest revenue earned in 2012 $49,000
Instructions (a) Determine the amount of interest to be capitalized in 2012 in relation to the construction of the building. (b) Prepare the journal entry to record the capitalization of interest and the recognition of interest expense, if any, at December 31, 2012. 4 4
E10-9 (Capitalization of Interest) On July 31, 2012, Bismarck Company engaged Duval Tooling Company to construct a special-purpose piece of factory machinery. Construction began immediately and was completed on November 1, 2012. To help finance construction, on July 31 Bismarck issued a $400,000, 3-year, 12% note payable at Wellington National Bank, on which interest is payable each July 31. $300,000 of the proceeds of the note was paid to Duval on July 31. The remainder of the proceeds was temporarily invested in short-term marketable securities (debt investments) at 10% until November 1. On November 1, Bismarck made a final $100,000 payment to Duval. Other than the note to Wellington, Bismarck’s only outstanding liability at December 31, 2012, is a $30,000, 8%, 6-year note payable, dated January 1, 2009, on which interest is payable each December 31.
Instructions (a) Calculate the interest revenue, weighted-average accumulated expenditures, avoidable interest, and total interest cost to be capitalized during 2012. Round all computations to the nearest dollar. (b) Prepare the journal entries needed on the books of Bismarck Company at each of the following dates. (1) July 31, 2012. (2) November 1, 2012. (3) December 31, 2012.
E10-10 (Capitalization of Interest) The following three situations involve the capitalization of interest. Situation I On January 1, 2012, Columbia, Inc. signed a fixed-price contract to have Builder Associates construct a major plant facility at a cost of $4,000,000. It was estimated that it would take 3 years to complete the project. Also on January 1, 2012, to finance the construction cost, Columbia borrowed $4,000,000 payable in 10 annual installments of $400,000, plus interest at the rate of 10%. During 2012, Columbia made deposit and progress payments totaling $1,500,000 under the contract; the weighted-average amount of accumulated expenditures was $900,000 for the year. The excess borrowed funds were invested in short-term securities, from which Columbia realized investment income of $250,000.
Instructions What amount should Columbia report as capitalized interest at December 31, 2012? Situation II During 2012, Evander Corporation constructed and manufactured certain assets and incurred the following interest costs in connection with those activities. Interest Costs Incurred Warehouse constructed for Evander’s own use $30,000 Special-order machine for sale to unrelated customer, produced according to customer’s specifi cations 9,000 Inventories routinely manufactured, produced on a repetitive basis 8,000 All of these assets required an extended period of time for completion.
Instructions Assuming the effect of interest capitalization is material, what is the total amount of interest costs to be capitalized? Situation III Antonio, Inc. has a fiscal year ending April 30. On May 1, 2012, Antonio borrowed $10,000,000 at 11% to finance construction of its own building. Repayments of the loan are to commence the month following completion of the building. During the year ended April 30, 2013, expenditures for the partially completed structure totaled $6,000,000. These expenditures were incurred evenly throughout the year. Interest earned on the unexpended portion of the loan amounted to $650,000 for the year.
Instructions How much should be shown as capitalized interest on Antonio’s financial statements at April 30, 2013? (CPA adapted)
E10-11 (Entries for Equipment Acquisitions) Chopin Engineering Corporation purchased conveyor equipment with a list price of $15,000. Presented below are three independent cases related to the equipment. (Round to nearest dollar.) (a) Chopin paid cash for the equipment 8 days after the purchase. The vendor’s credit terms are 2/10, n/30. Assume that equipment purchases are recorded gross. 4 4 2 3 5 (b) Chopin traded in equipment with a book value of $2,000 (initial cost $8,000), and paid $14,200 in cash one month after the purchase. The old equipment could have been sold for $400 at the date of trade. (The exchange has commercial substance.) (c) Chopin gave the vendor a $16,200 zero-interest-bearing note for the equipment on the date of purchase. The note was due in one year and was paid on time. Assume that the effective-interest rate in the market was 9%.
Instructions Prepare the general journal entries required to record the acquisition and payment in each of the independent cases above. Round to the nearest dollar.
E10-12 (Entries for Asset Acquisition, Including Self-Construction) Below are transactions related to Impala Company. (a) The City of Pebble Beach gives the company 5 acres of land as a plant site. The fair value of this land is determined to be $81,000. (b) 14,000 shares of common stock with a par value of $50 per share are issued in exchange for land and buildings. The property has been appraised at a fair value of $810,000, of which $180,000 has been allocated to land and $630,000 to buildings. The stock of Impala Company is not listed on any exchange, but a block of 100 shares was sold by a stockholder 12 months ago at $65 per share, and a block of 200 shares was sold by another stockholder 18 months ago at $58 per share. (c) No entry has been made to remove from the accounts for Materials, Direct Labor, and Overhead the amounts properly chargeable to plant asset accounts for machinery constructed during the year. The following information is given relative to costs of the machinery constructed. Materials used $12,500 Factory supplies used 900 Direct labor incurred 16,000 Additional overhead (over regular) caused by construction 2,700 of machinery, excluding factory supplies used Fixed overhead rate applied to regular manufacturing operations 60% of direct labor cost Cost of similar machinery if it had been purchased from outside suppliers 44,000
Instructions Prepare journal entries on the books of Impala Company to record these transactions.
E10-13 (Entries for Acquisition of Assets) Presented below is information related to Rommel Company. 1. On July 6, Rommel Company acquired the plant assets of Studebaker Company, which had discontinued operations. The appraised value of the property is: Land $ 400,000 Buildings 1,200,000 Equipment 800,000 Total $2,400,000 Rommel Company gave 12,500 shares of its $100 par value common stock in exchange. The stock had a fair value of $180 per share on the date of the purchase of the property. 2. Rommel Company expended the following amounts in cash between July 6 and December 15, the date when it first occupied the building. Repairs to building $105,000 Construction of bases for machinery to be installed later 135,000 Driveways and parking lots 122,000 Remodeling of offi ce space in building, including new partitions and walls 161,000 Special assessment by city on land 18,000 3. On December 20, the company paid cash for machinery, $280,000, subject to a 2% cash discount, and freight on machinery of $10,500.
Instructions Prepare entries on the books of Rommel Company for these transactions.
E10-14 (Purchase of Equipment with Zero-Interest-Bearing Debt) Sterling Inc. has decided to purchase equipment from Central Michigan Industries on January 2, 2012, to expand its production capacity to meet customers’ demand for its product. Sterling issues a $900,000, 5-year, zero-interest-bearing note to Central Michigan for the new equipment when the prevailing market rate of interest for obligations of this nature is 12%. The company will pay off the note in five $180,000 installments due at the end of each year over the life of the note. 2 3 5 2 5
Instructions (a) Prepare the journal entry(ies) at the date of purchase. (Round to nearest dollar in all computations.) (b) Prepare the journal entry(ies) at the end of the first year to record the payment and interest, assuming that the company employs the effective-interest method. (c) Prepare the journal entry(ies) at the end of the second year to record the payment and interest. (d) Assuming that the equipment had a 10-year life and no salvage value, prepare the journal entry necessary to record depreciation in the first year. (Straight-line depreciation is employed.)
E10-15 (Purchase of Computer with Zero-Interest-Bearing Debt) Napoleon Corporation purchased a computer on December 31, 2011, for $130,000, paying $30,000 down and agreeing to pay the balance in five equal installments of $20,000 payable each December 31 beginning in 2012. An assumed interest rate of 10% is implicit in the purchase price.
Instructions (a) Prepare the journal entry(ies) at the date of purchase. (Round to two decimal places.) (b) Prepare the journal entry(ies) at December 31, 2012, to record the payment and interest (effectiveinterest method employed). (c) Prepare the journal entry(ies) at December 31, 2013, to record the payment and interest (effectiveinterest method employed).
E10-16 (Asset Acquisition) Logan Industries purchased the following assets and constructed a building as well. All this was done during the current year. Assets 1 and 2 These assets were purchased as a lump sum for $104,000 cash. The following information was gathered. Depreciation to Initial Cost on Date on Seller’s Book Value on Description Seller’s Books Books Seller’s Books Appraised Value Machinery $100,000 $50,000 $50,000 $90,000 Equipment 60,000 10,000 50,000 30,000 Asset 3 This machine was acquired by making a $10,000 down payment and issuing a $30,000, 2-year, zerointerest- bearing note. The note is to be paid off in two $15,000 installments made at the end of the first and second years. It was estimated that the asset could have been purchased outright for $35,900. Asset 4 This machinery was acquired by trading in used machinery. (The exchange lacks commercial substance.) Facts concerning the trade-in are as follows. Cost of machinery traded $100,000 Accumulated depreciation to date of sale 36,000 Fair value of machinery traded 80,000 Cash received 10,000 Fair value of machinery acquired 70,000 Asset 5 Office equipment was acquired by issuing 100 shares of $8 par value common stock. The stock had a market price of $11 per share. Construction of Building A building was constructed on land purchased last year at a cost of $180,000. Construction began on February 1 and was completed on November 1. The payments to the contractor were as follows. Date Payment 2/1 $120,000 6/1 360,000 9/1 480,000 11/1 100,000 To finance construction of the building, a $600,000, 12% construction loan was taken out on February 1. The loan was repaid on November 1. The firm had $200,000 of other outstanding debt during the year at a borrowing rate of 8%.
Instructions Record the acquisition of each of these assets. 5 5
E10-17 (Nonmonetary Exchange) Alatorre Corporation, which manufactures shoes, hired a recent college graduate to work in its accounting department. On the first day of work, the accountant was assigned to total a batch of invoices with the use of an adding machine. Before long, the accountant, who had never before seen such a machine, managed to break the machine. Alatorre Corporation gave the machine plus $320 to Mills Business Machine Company (dealer) in exchange for a new machine. Assume the following information about the machines. Alatorre Corp. Mills Co. (Old Machine) (New Machine) Machine cost $290 $270 Accumulated depreciation 140 –0– Fair value 85 405
Instructions For each company, prepare the necessary journal entry to record the exchange. (The exchange has commercial substance.)
E10-18 (Nonmonetary Exchange) Montgomery Company purchased an electric wax melter on April 30, 2013, by trading in its old gas model and paying the balance in cash. The following data relate to the purchase. List price of new melter $15,800 Cash paid 10,000 Cost of old melter (5-year life, $700 residual value) 12,700 Accumulated depreciation—old melter (straight-line) 7,200 Secondhand fair value of old melter 5,200
Instructions Prepare the journal entry(ies) necessary to record this exchange, assuming that the exchange (a) has commercial substance, and (b) lacks commercial substance. Montgomery’s year ends on December 31, and depreciation has been recorded through December 31, 2012.
E10-19 (Nonmonetary Exchange) Santana Company exchanged equipment used in its manufacturing operations plus $2,000 in cash for similar equipment used in the operations of Delaware Company. The following information pertains to the exchange. Santana Co. Delaware Co. Equipment (cost) $28,000 $28,000 Accumulated depreciation 19,000 10,000 Fair value of equipment 13,500 15,500 Cash given up 2,000
Instructions (a) Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange lacks commercial substance. (b) Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange has commercial substance.
E10-20 (Nonmonetary Exchange) McArthur Inc. has negotiated the purchase of a new piece of automatic equipment at a price of $7,000 plus trade-in, f.o.b. factory. McArthur Inc. paid $7,000 cash and traded in used equipment. The used equipment had originally cost $62,000; it had a book value of $42,000 and a secondhand fair value of $45,800, as indicated by recent transactions involving similar equipment. Freight and installation charges for the new equipment required a cash payment of $1,100.
Instructions (a) Prepare the general journal entry to record this transaction, assuming that the exchange has commercial substance. (b) Assuming the same facts as in (a) except that fair value information for the assets exchanged is not determinable. Prepare the general journal entry to record this transaction.
E10-21 (Analysis of Subsequent Expenditures) Accardo Resources Group has been in its plant facility for 15 years. Although the plant is quite functional, numerous repair costs are incurred to maintain it in sound working order. The company’s plant asset book value is currently $800,000, as indicated below. Original cost $1,200,000 Accumulated depreciation 400,000 Book value $ 800,000 5 5 5 During the current year, the following expenditures were made to the plant facility. (a) Because of increased demands for its product, the company increased its plant capacity by building a new addition at a cost of $270,000. (b) The entire plant was repainted at a cost of $23,000. (c) The roof was an asbestos cement slate. For safety purposes it was removed and replaced with a wood shingle roof at a cost of $61,000. Book value of the old roof was $41,000. (d) The electrical system was completely updated at a cost of $22,000. The cost of the old electrical system was not known. It is estimated that the useful life of the building will not change as a result of this updating. (e) A series of major repairs were made at a cost of $47,000, because parts of the wood structure were rotting. The cost of the old wood structure was not known. These extensive repairs are estimated to increase the useful life of the building.
Instructions Indicate how each of these transactions would be recorded in the accounting records.
E10-22 (Analysis of Subsequent Expenditures) The following transactions occurred during 2013. Assume that depreciation of 10% per year is charged on all machinery and 5% per year on buildings, on a straight-line basis, with no estimated salvage value. Depreciation is charged for a full year on all fixed assets acquired during the year, and no depreciation is charged on fixed assets disposed of during the year. Jan. 30 A building that cost $112,000 in 1996 is torn down to make room for a new building. The wrecking contractor was paid $5,100 and was permitted to keep all materials salvaged. Mar. 10 Machinery that was purchased in 2006 for $16,000 is sold for $2,900 cash, f.o.b. purchaser’s plant. Freight of $300 is paid on the sale of this machinery. Mar. 20 A gear breaks on a machine that cost $9,000 in 2008. The gear is replaced at a cost of $3,000. The replacement does not extend the useful life of the machine. May 18 A special base installed for a machine in 2007 when the machine was purchased has to be replaced at a cost of $5,500 because of defective workmanship on the original base. The cost of the machinery was $14,200 in 2007. The cost of the base was $4,000, and this amount was charged to the Machinery account in 2007. June 23 One of the buildings is repainted at a cost of $6,900. It had not been painted since it was constructed in 2009.
Instructions Prepare general journal entries for the transactions. (Round to the nearest dollar.)
E10-23 (Analysis of Subsequent Expenditures) Plant assets often require expenditures subsequent to acquisition. It is important that they be accounted for properly. Any errors will affect both the balance sheets and income statements for a number of years.
Instructions For each of the following items, indicate whether the expenditure should be capitalized (C) or expensed (E) in the period incurred. (a) __________ Improvement. (b) __________ Replacement of a minor broken part on a machine. (c) __________ Expenditure that increases the useful life of an existing asset. (d) __________ Expenditure that increases the efficiency and effectiveness of a productive asset but does not increase its salvage value. (e) __________ Expenditure that increases the efficiency and effectiveness of a productive asset and increases the asset’s salvage value. (f) __________ Ordinary repairs. (g) __________ Improvement to a machine that increased its fair value and its production capacity by 30% without extending the machine’s useful life. (h) __________ Expenditure that increases the quality of the output of the productive asset.
E10-24 (Entries for Disposition of Assets) On December 31, 2012, Chrysler Inc. has a machine with a book value of $940,000. The original cost and related accumulated depreciation at this date are as follows. Machine $1,300,000 Accumulated depreciation 360,000 Book value $ 940,000 Depreciation is computed at $72,000 per year on a straight-line basis. 6 6 7
Instructions Presented below is a set of independent situations. For each independent situation, indicate the journal entry to be made to record the transaction. Make sure that depreciation entries are made to update the book value of the machine prior to its disposal. (a) A fire completely destroys the machine on August 31, 2013. An insurance settlement of $630,000 was received for this casualty. Assume the settlement was received immediately. (b) On April 1, 2013, Chrysler sold the machine for $1,040,000 to Avanti Company. (c) On July 31, 2013, the company donated this machine to the Mountain King City Council. The fair value of the machine at the time of the donation was estimated to be $1,100,000.
E10-25 (Disposition of Assets) On April 1, 2012, Pavlova Company received a condemnation award of $410,000 cash as compensation for the forced sale of the company’s land and building, which stood in the path of a new state highway. The land and building cost $60,000 and $280,000, respectively, when they were acquired. At April 1, 2012, the accumulated depreciation relating to the building amounted to $160,000. On August 1, 2012, Pavlova purchased a piece of replacement property for cash. The new land cost $90,000, and the new building cost $380,000.
Instructions Prepare the journal entries to record the transactions on April 1 and August 1, 2012. S
P10-1 (Classification of Acquisition and Other Asset Costs) At December 31, 2011, certain accounts included in the property, plant, and equipment section of Reagan Company’s balance sheet had the following balances. Land $230,000 Buildings 890,000 Leasehold improvements 660,000 Equipment 875,000 During 2012, the following transactions occurred. 1. Land site number 621 was acquired for $850,000. In addition, to acquire the land Reagan paid a $51,000 commission to a real estate agent. Costs of $35,000 were incurred to clear the land. During the course of clearing the land, timber and gravel were recovered and sold for $13,000. 2. A second tract of land (site number 622) with a building was acquired for $420,000. The closing statement indicated that the land value was $300,000 and the building value was $120,000. Shortly after acquisition, the building was demolished at a cost of $41,000. A new building was constructed for $330,000 plus the following costs. Excavation fees $38,000 Architectural design fees 11,000 Building permit fee 2,500 Imputed interest on funds used during construction (stock fi nancing) 8,500 The building was completed and occupied on September 30, 2012. 3. A third tract of land (site number 623) was acquired for $650,000 and was put on the market for resale. 4. During December 2012, costs of $89,000 were incurred to improve leased office space. The related lease will terminate on December 31, 2014, and is not expected to be renewed. (Hint: Leasehold improvements should be handled in the same manner as land improvements.) 5. A group of new machines was purchased under a royalty agreement that provides for payment of royalties based on units of production for the machines. The invoice price of the machines was $87,000, freight costs were $3,300, installation costs were $2,400, and royalty payments for 2012 were $17,500.
Instructions (a) Prepare a detailed analysis of the changes in each of the following balance sheet accounts for 2012. Land Leasehold improvements Buildings Equipment Disregard the related accumulated depreciation accounts. 2 (b) List the items in the situation that were not used to determine the answer to (a) above, and indicate where, or if, these items should be included in Reagan’s financial statements. (AICPA adapted)
P10-2 (Classification of Acquisition Costs) Selected accounts included in the property, plant, and equipment section of Lobo Corporation’s balance sheet at December 31, 2011, had the following balances. Land $ 300,000 Land improvements 140,000 Buildings 1,100,000 Equipment 960,000 During 2012, the following transactions occurred. 1. A tract of land was acquired for $150,000 as a potential future building site. 2. A plant facility consisting of land and building was acquired from Mendota Company in exchange for 20,000 shares of Lobo’s common stock. On the acquisition date, Lobo’s stock had a closing market price of $37 per share on a national stock exchange. The plant facility was carried on Mendota’s books at $110,000 for land and $320,000 for the building at the exchange date. Current appraised values for the land and building, respectively, are $230,000 and $690,000. 3. Items of machinery and equipment were purchased at a total cost of $400,000. Additional costs were incurred as follows. Freight and unloading $13,000 Sales taxes 20,000 Installation 26,000 4. Expenditures totaling $95,000 were made for new parking lots, streets, and sidewalks at the corporation’s various plant locations. These expenditures had an estimated useful life of 15 years. 5. A machine costing $80,000 on January 1, 2004, was scrapped on June 30, 2012. Double-decliningbalance depreciation has been recorded on the basis of a 10-year life. 6. A machine was sold for $20,000 on July 1, 2012. Original cost of the machine was $44,000 on January 1, 2009, and it was depreciated on the straight-line basis over an estimated useful life of 7 years and a salvage value of $2,000.
Instructions (a) Prepare a detailed analysis of the changes in each of the following balance sheet accounts for 2012. Land Land improvements Buildings Equipment (Hint: Disregard the related accumulated depreciation accounts.) (b) List the items in the fact situation that were not used to determine the answer to (a), showing the pertinent amounts and supporting computations in good form for each item. In addition, indicate where, or if, these items should be included in Lobo’s financial statements. (AICPA adapted)
P10-3 (Classification of Land and Building Costs) Spitfire Company was incorporated on January 2, 2013, but was unable to begin manufacturing activities until July 1, 2013, because new factory facilities were not completed until that date. The Land and Building account reported the following items during 2013. January 31 Land and building $160,000 February 28 Cost of removal of building 9,800 May 1 Partial payment of new construction 60,000 May 1 Legal fees paid 3,770 June 1 Second payment on new construction 40,000 June 1 Insurance premium 2,280 June 1 Special tax assessment 4,000 June 30 General expenses 36,300 July 1 Final payment on new construction 30,000 December 31 Asset write-up 53,800 399,950 December 31 Depreciation—2013 at 1% 4,000 December 31, 2013 Account balance $395,950 2 7 2 3 5 The following additional information is to be considered. 1. To acquire land and building, the company paid $80,000 cash and 800 shares of its 8% cumulative preferred stock, par value $100 per share. Fair value of the stock is $117 per share. 2. Cost of removal of old buildings amounted to $9,800, and the demolition company retained all materials of the building. 3. Legal fees covered the following. Cost of organization $ 610 Examination of title covering purchase of land 1,300 Legal work in connection with construction contract 1,860 $3,770 4. Insurance premium covered the building for a 2-year term beginning May 1, 2013. 5. The special tax assessment covered street improvements that are permanent in nature. 6. General expenses covered the following for the period from January 2, 2013, to June 30, 2013. President’s salary $32,100 Plant superintendent’s salary—supervision of new building 4,200 $36,300 7. Because of a general increase in construction costs after entering into the building contract, the board of directors increased the value of the building $53,800, believing that such an increase was justified to reflect the current market at the time the building was completed. Retained earnings was credited for this amount. 8. Estimated life of building—50 years. Depreciation for 2013—1% of asset value (1% of $400,000, or $4,000).
Instructions (a) Prepare entries to reflect correct land, building, and depreciation accounts at December 31, 2013. (b) Show the proper presentation of land, building, and depreciation on the balance sheet at December 31, 2013. (AICPA adapted)
P10-4 (Dispositions, Including Condemnation, Demolition, and Trade-in) Presented below is a schedule of property dispositions for Hollerith Co. Schedule of Property Dispositions Accumulated Cash Fair Nature of Cost Depreciation Proceeds Value Disposition Land $40,000 — $31,000 $31,000 Condemnation Building 15,000 — 3,600 — Demolition Warehouse 70,000 $16,000 74,000 74,000 Destruction by fi re Machine 8,000 2,800 900 7,200 Trade-in Furniture 10,000 7,850 — 3,100 Contribution Automobile 9,000 3,460 2,960 2,960 Sale The following additional information is available. Land On February 15, a condemnation award was received as consideration for unimproved land held primarily as an investment, and on March 31, another parcel of unimproved land to be held as an investment was purchased at a cost of $35,000. Building On April 2, land and building were purchased at a total cost of $75,000, of which 20% was allocated to the building on the corporate books. The real estate was acquired with the intention of demolishing the building, and this was accomplished during the month of November. Cash proceeds received in November represent the net proceeds from demolition of the building. Warehouse On June 30, the warehouse was destroyed by fire. The warehouse was purchased January 2, 2009, and had depreciated $16,000. On December 27, the insurance proceeds and other funds were used to purchase a replacement warehouse at a cost of $90,000. 2 5 7 Machine On December 26, the machine was exchanged for another machine having a fair value of $6,300 and cash of $900 was received. (The exchange lacks commercial substance.) Furniture On August 15, furniture was contributed to a qualified charitable organization. No other contributions were made or pledged during the year. Automobile On November 3, the automobile was sold to Jared Winger, a stockholder.
Instructions Indicate how these items would be reported on the income statement of Hollerith Co. (AICPA adapted)
P10-5 (Classification of Costs and Interest Capitalization) On January 1, 2012, Blair Corporation purchased for $500,000 a tract of land (site number 101) with a building. Blair paid a real estate broker’s commission of $36,000, legal fees of $6,000, and title guarantee insurance of $18,000. The closing statement indicated that the land value was $500,000 and the building value was $100,000. Shortly after acquisition, the building was razed at a cost of $54,000. Blair entered into a $3,000,000 fixed-price contract with Slatkin Builders, Inc. on March 1, 2012, for the construction of an office building on land site number 101. The building was completed and occupied on September 30, 2013. Additional construction costs were incurred as follows. Plans, specifi cations, and blueprints $21,000 Architects’ fees for design and supervision 82,000 The building is estimated to have a 40-year life from date of completion and will be depreciated using the 150% declining-balance method. To finance construction costs, Blair borrowed $3,000,000 on March 1, 2012. The loan is payable in 10 annual installments of $300,000 plus interest at the rate of 10%. Blair’s weighted-average amounts of accumulated building construction expenditures were as follows. For the period March 1 to December 31, 2012 $1,300,000 For the period January 1 to September 30, 2013 1,900,000
Instructions (a) Prepare a schedule that discloses the individual costs making up the balance in the land account in respect of land site number 101 as of September 30, 2013. (b) Prepare a schedule that discloses the individual costs that should be capitalized in the office building account as of September 30, 2013. Show supporting computations in good form. (AICPA adapted)
P10-6 (Interest During Construction) Grieg Landscaping began construction of a new plant on December 1, 2012. On this date, the company purchased a parcel of land for $139,000 in cash. In addition, it paid $2,000 in surveying costs and $4,000 for a title insurance policy. An old dwelling on the premises was demolished at a cost of $3,000, with $1,000 being received from the sale of materials. Architectural plans were also formalized on December 1, 2012, when the architect was paid $30,000. The necessary building permits costing $3,000 were obtained from the city and paid for on December 1 as well. The excavation work began during the first week in December with payments made to the contractor as follows. Date of Payment Amount of Payment March 1 $240,000 May 1 330,000 July 1 60,000 The building was completed on July 1, 2013. To finance construction of this plant, Grieg borrowed $600,000 from the bank on December 1, 2012. Grieg had no other borrowings. The $600,000 was a 10-year loan bearing interest at 8%.
Instructions Compute the balance in each of the following accounts at December 31, 2012, and December 31, 2013. (Round amounts to the nearest dollar.) (a) Land. (b) Buildings. (c) Interest Expense. 2 4 2 4
P10-7 (Capitalization of Interest) Laserwords Inc. is a book distributor that had been operating in its original facility since 1985. The increase in certification programs and continuing education requirements in several professions has contributed to an annual growth rate of 15% for Laserwords since 2007. Laserwords’ original facility became obsolete by early 2012 because of the increased sales volume and the fact that Laserwords now carries CDs in addition to books. On June 1, 2012, Laserwords contracted with Black Construction to have a new building constructed for $4,000,000 on land owned by Laserwords. The payments made by Laserwords to Black Construction are shown in the schedule below. Date Amount July 30, 2012 $ 900,000 January 30, 2013 1,500,000 May 30, 2013 1,600,000 Total payments $4,000,000 Construction was completed and the building was ready for occupancy on May 27, 2013. Laserwords had no new borrowings directly associated with the new building but had the following debt outstanding at May 31, 2013, the end of its fiscal year. 10%, 5-year note payable of $2,000,000, dated April 1, 2009, with interest payable annually on April 1. 12%, 10-year bond issue of $3,000,000 sold at par on June 30, 2005, with interest payable annually on June 30. The new building qualifies for interest capitalization. The effect of capitalizing the interest on the new building, compared with the effect of expensing the interest, is material.
Instructions (a) Compute the weighted-average accumulated expenditures on Laserwords’ new building during the capitalization period. (b) Compute the avoidable interest on Laserwords’ new building. (c) Some interest cost of Laserwords Inc. is capitalized for the year ended May 31, 2013. (1) Identify the items relating to interest costs that must be disclosed in Laserwords’ financial statements. (2) Compute the amount of each of the items that must be disclosed. (CMA adapted)
P10-8 (Nonmonetary Exchanges) Holyfield Corporation wishes to exchange a machine used in its operations. Holyfield has received the following offers from other companies in the industry. 1. Dorsett Company offered to exchange a similar machine plus $23,000. (The exchange has commercial substance for both parties.) 2. Winston Company offered to exchange a similar machine. (The exchange lacks commercial substance for both parties.) 3. Liston Company offered to exchange a similar machine, but wanted $3,000 in addition to Holyfield’s machine. (The exchange has commercial substance for both parties.) In addition, Holyfield contacted Greeley Corporation, a dealer in machines. To obtain a new machine, Holyfield must pay $93,000 in addition to trading in its old machine. Holyfield Dorsett Winston Liston Greeley Machine cost $160,000 $120,000 $152,000 $160,000 $130,000 Accumulated depreciation 60,000 45,000 71,000 75,000 –0– Fair value 92,000 69,000 92,000 95,000 185,000
Instructions For each of the four independent situations, prepare the journal entries to record the exchange on the books of each company.
P10-9 (Nonmonetary Exchanges) On August 1, Hyde, Inc. exchanged productive assets with Wiggins, Inc. Hyde’s asset is referred to below as “Asset A,” and Wiggins’ is referred to as “Asset B.” The following facts pertain to these assets. Asset A Asset B Original cost $96,000 $110,000 Accumulated depreciation (to date of exchange) 40,000 47,000 Fair value at date of exchange 60,000 75,000 Cash paid by Hyde, Inc. 15,000 Cash received by Wiggins, Inc. 15,000 4 5
Instructions (a) Assuming that the exchange of Assets A and B has commercial substance, record the exchange for both Hyde, Inc. and Wiggins, Inc. in accordance with generally accepted accounting principles. (b) Assuming that the exchange of Assets A and B lacks commercial substance, record the exchange for both Hyde, Inc. and Wiggins, Inc. in accordance with generally accepted accounting principles.
P10-10 (Nonmonetary Exchanges) During the current year, Marshall Construction trades an old crane that has a book value of $90,000 (original cost $140,000 less accumulated depreciation $50,000) for a new crane from Brigham Manufacturing Co. The new crane cost Brigham $165,000 to manufacture and is classified as inventory. The following information is also available. Marshall Const. Brigham Mfg. Co. Fair value of old crane $ 82,000 Fair value of new crane $200,000 Cash paid 118,000 Cash received 118,000
Instructions (a) Assuming that this exchange is considered to have commercial substance, prepare the journal entries on the books of (1) Marshall Construction and (2) Brigham Manufacturing. (b) Assuming that this exchange lacks commercial substance for Marshall, prepare the journal entries on the books of Marshall Construction. (c) Assuming the same facts as those in (a), except that the fair value of the old crane is $98,000 and the cash paid is $102,000, prepare the journal entries on the books of (1) Marshall Construction and (2) Brigham Manufacturing. (d) Assuming the same facts as those in (b), except that the fair value of the old crane is $97,000 and the cash paid $103,000, prepare the journal entries on the books of (1) Marshall Construction and (2) Brigham Manufacturing.
P10-11 (Purchases by Deferred Payment, Lump-Sum, and Nonmonetary Exchanges) Klamath Company, a manufacturer of ballet shoes, is experiencing a period of sustained growth. In an effort to expand its production capacity to meet the increased demand for its product, the company recently made several acquisitions of plant and equipment. Rob Joffrey, newly hired in the position of fixed-asset accountant, requested that Danny Nolte, Klamath’s controller, review the following transactions. Transaction 1 On June 1, 2012, Klamath Company purchased equipment from Wyandot Corporation. Klamath issued a $28,000, 4-year, zero-interest-bearing note to Wyandot for the new equipment. Klamath will pay off the note in four equal installments due at the end of each of the next 4 years. At the date of the transaction, the prevailing market rate of interest for obligations of this nature was 10%. Freight costs of $425 and installation costs of $500 were incurred in completing this transaction. The appropriate factors for the time value of money at a 10% rate of interest are given below. Future value of $1 for 4 periods 1.46 Future value of an ordinary annuity for 4 periods 4.64 Present value of $1 for 4 periods 0.68 Present value of an ordinary annuity for 4 periods 3.17 Transaction 2 On December 1, 2012, Klamath Company purchased several assets of Yakima Shoes Inc., a small shoe manufacturer whose owner was retiring. The purchase amounted to $220,000 and included the assets listed below. Klamath Company engaged the services of Tennyson Appraisal Inc., an independent appraiser, to determine the fair values of the assets which are also presented below. Yakima Book Value Fair Value Inventory $ 60,000 $ 50,000 Land 40,000 80,000 Buildings 70,000 120,000 $170,000 $250,000 During its fiscal year ended May 31, 2013, Klamath incurred $8,000 for interest expense in connection with the financing of these assets. Transaction 3 On March 1, 2013, Klamath Company exchanged a number of used trucks plus cash for vacant land adjacent to its plant site. (The exchange has commercial substance.) Klamath intends to use the land for a parking lot. 5 2 5 The trucks had a combined book value of $35,000, as Klamath had recorded $20,000 of accumulated depreciation against these assets. Klamath’s purchasing agent, who has had previous dealings in the secondhand market, indicated that the trucks had a fair value of $46,000 at the time of the transaction. In addition to the trucks, Klamath Company paid $19,000 cash for the land.
Instructions (a) Plant assets such as land, buildings, and equipment receive special accounting treatment. Describe the major characteristics of these assets that differentiate them from other types of assets. (b) For each of the three transactions described above, determine the value at which Klamath Company should record the acquired assets. Support your calculations with an explanation of the underlying rationale. (c) The books of Klamath Company show the following additional transactions for the fiscal year ended May 31, 2013. (1) Acquisition of a building for speculative purposes. (2) Purchase of a 2-year insurance policy covering plant equipment. (3) Purchase of the rights for the exclusive use of a process used in the manufacture of ballet shoes. For each of these transactions, indicate whether the asset should be classified as a plant asset. If it is a plant asset, explain why it is. If it is not a plant asset, explain why not, and identify the proper classification. (CMA adapted) CONCEPTS FOR ANALYS I S
CA10-1 (Acquisition, Improvements, and Sale of Realty) Tonkawa Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down before construction of the office building began. Furthermore, a substantial amount of rock blasting and removal had to be done to the site before construction of the building foundation began. Because the office building was set back on the land far from the public road, Tonkawa Company had the contractor construct a paved road that led from the public road to the parking lot of the office building. Three years after the office building was occupied, Tonkawa Company added four stories to the office building. The four stories had an estimated useful life of 5 years more than the remaining estimated useful life of the original office building. Ten years later, the land and building were sold at an amount more than their net book value, and Tonkawa Company had a new office building constructed in another state for use as its new corporate headquarters.
Instructions (a) Which of the expenditures above should be capitalized? How should each be depreciated or amortized? Discuss the rationale for your answers. (b) How would the sale of the land and building be accounted for? Include in your answer an explanation of how to determine the net book value at the date of sale. Discuss the rationale for your answer.
CA10-2 (Accounting for Self-Constructed Assets) Troopers Medical Labs, Inc., began operations 5 years ago producing stetrics, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for stetrics far exceeded initial expectations, and the company was unable to produce enough stetrics to meet demand. The company was manufacturing its product on equipment that it built at the start of its operations. To meet demand, more efficient equipment was needed. The company decided to design and build the equipment, because the equipment currently available on the market was unsuitable for producing stetrics. In 2012, a section of the plant was devoted to development of the new equipment and a special staff was hired. Within 6 months a machine developed at a cost of $714,000 increased production dramatically and reduced labor costs substantially. Elated by the success of the new machine, the company built three more machines of the same type at a cost of $441,000 each.
Instructions (a) In general, what costs should be capitalized for self-constructed equipment? (b) Discuss the propriety of including in the capitalized cost of self-constructed assets: (1) The increase in overhead caused by the self-construction of fixed assets. (2) A proportionate share of overhead on the same basis as that applied to goods manufactured for sale. (c) Discuss the proper accounting treatment of the $273,000 ($714,000 2 $441,000) by which the cost of the first machine exceeded the cost of the subsequent machines. This additional cost should not be considered research and development costs.
CA10-3 (Capitalization of Interest) Langer Airline is converting from piston-type planes to jets. Delivery time for the jets is 3 years, during which substantial progress payments must be made. The multimilliondollar cost of the planes cannot be financed from working capital; Langer must borrow funds for the payments. Because of high interest rates and the large sum to be borrowed, management estimates that interest costs in the second year of the period will be equal to one-third of income before interest and taxes, and one-half of such income in the third year. After conversion, Langer’s passenger-carrying capacity will be doubled with no increase in the number of planes, although the investment in planes would be substantially increased. The jet planes have a 7-year service life.
Instructions Give your recommendation concerning the proper accounting for interest during the conversion period. Support your recommendation with reasons and suggested accounting treatment. (Disregard income tax implications.) (AICPA adapted)
CA10-4 (Capitalization of Interest) Vania Magazine Company started construction of a warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2011, and completed the building on December 31, 2011. During the construction period, Vania has the following debt obligations outstanding. Construction loan—12% interest, payable semiannually, issued December 31, 2010 $2,000,000 Short-term loan—10% interest, payable monthly, and principal payable at maturity, on May 30, 2012 1,400,000 Long-term loan—11% interest, payable on January 1 of each year. Principal payable on January 1, 2014 1,000,000 Total cost amounted to $5,200,000, and the weighted average of accumulated expenditures was $3,500,000. Jane Esplanade, the president of the company, has been shown the costs associated with this construction project and capitalized on the balance sheet. She is bothered by the “avoidable interest” included in the cost. She argues that, first, all the interest is unavoidable—no one lends money without expecting to be compensated for it. Second, why can’t the company use all the interest on all the loans when computing this avoidable interest? Finally, why can’t her company capitalize all the annual interest that accrued over the period of construction?
Instructions You are the manager of accounting for the company. In a memo, explain what avoidable interest is, how you computed it (being especially careful to explain why you used the interest rates that you did), and why the company cannot capitalize all its interest for the year. Attach a schedule supporting any computations that you use.
CA10-5 (Nonmonetary Exchanges) You have two clients that are considering trading machinery with each other. Although the machines are different from each other, you believe that an assessment of expected cash flows on the exchanged assets will indicate the exchange lacks commercial substance. Your clients would prefer that the exchange be deemed to have commercial substance, to allow them to record gains. Here are the facts: Client A Client B Original cost $100,000 $150,000 Accumulated depreciation 40,000 80,000 Fair value 80,000 100,000 Cash received (paid) (20,000) 20,000
Instructions (a) Record the trade-in on Client A’s books assuming the exchange has commercial substance. (b) Record the trade-in on Client A’s books assuming the exchange lacks commercial substance. (c) Write a memo to the controller of Company A indicating and explaining the dollar impact on current and future statements of treating the exchange as having versus lacking commercial substance. (d) Record the entry on Client B’s books assuming the exchange has commercial substance. (e) Record the entry on Client B’s books assuming the exchange lacks commercial substance. (f) Write a memo to the controller of Company B indicating and explaining the dollar impact on current and future statements of treating the exchange as having versus lacking commercial substance.
CA10-6 (Costs of Acquisition) The invoice price of a machine is $50,000. Various other costs relating to the acquisition and installation of the machine including transportation, electrical wiring, special base, and so on amount to $7,500. The machine has an estimated life of 10 years, with no residual value at the end of that period. The owner of the business suggests that the incidental costs of $7,500 be charged to expense immediately for the following reasons. 1. If the machine should be sold, these costs cannot be recovered in the sales price. 2. The inclusion of the $7,500 in the machinery account on the books will not necessarily result in a closer approximation of the market price of this asset over the years, because of the possibility of changing demand and supply levels. 3. Charging the $7,500 to expense immediately will reduce federal income taxes.
Instructions Discuss each of the points raised by the owner of the business. (AICPA adapted)
CA10-7 (Cost of Land vs. Building—Ethics) Tones Company purchased a warehouse in a downtown district where land values are rapidly increasing. Gerald Carter, controller, and Wilma Ankara, financial vice president, are trying to allocate the cost of the purchase between the land and the building. Noting that depreciation can be taken only on the building, Carter favors placing a very high proportion of the cost on the warehouse itself, thus reducing taxable income and income taxes. Ankara, his supervisor, argues that the allocation should recognize the increasing value of the land, regardless of the depreciation potential of the warehouse. Besides, she says, net income is negatively impacted by additional depreciation and will cause the company’s stock price to go down.
Instructions Answer the following questions. (a) What stakeholder interests are in conflict? (b) What ethical issues does Carter face? (c) How should these costs be allocated? USING YOUR JUDGMENT
Financial Statement Analysis Case Johnson & Johnson Johnson & Johnson, the world’s leading and most diversified healthcare corporation, serves its customers through specialized worldwide franchises. Each of its franchises consists of a number of companies throughout the world that focus on a particular health care market, such as surgical sutures, consumer pharmaceuticals, or contact lenses. Information related to its property, plant, and equipment in its 2009 annual report is shown in the notes to the financial statements below and on the next page. Using Your Judgment 601 1. Property, Plant and Equipment and Depreciation Property, plant and equipment are stated at cost. The Company utilizes the straight-line method of depreciation over the estimated useful lives of the assets: Building and building equipment 20–40 years Land and leasehold improvements 10–20 years Machinery and equipment 2–13 years 4. Property, Plant and Equipment At the end of 2009 and 2008, property, plant and equipment at cost and accumulated depreciation were: (dollars in millions) 2009 2008 Land and land improvements $ 714 $ 886 Buildings and building equipment 8,863 7,720 Machinery and equipment 17,153 15,234 Construction in progress 2,521 3,552 29,251 27,392 Less accumulated depreciation 14,492 13,027 $14,759 $14,365
Instructions (a) What was the cost of buildings and building equipment at the end of 2009? (b) Does Johnson & Johnson use a conservative or liberal method to depreciate its property, plant, and equipment? (c) What was the actual interest expense incurred by the company in 2009? (d) What is Johnson & Johnson’s free cash fl ow? From the information provided, comment on Johnson & Johnson’s fi nancial fl exibility.
Accounting, Analysis, and Principles Durler Company purchased equipment on January 2, 2008, for $112,000. The equipment had an estimated useful life of 5 years with an estimated salvage value of $12,000. Durler uses straight-line depreciation on all assets. On January 2, 2012, Durler exchanged this equipment plus $12,000 in cash for newer equipment. The old equipment has a fair value of $50,000.
Accounting Prepare the journal entry to record the exchange on the books of Durler Company. Assume that the exchange has commercial substance.
Analysis How will this exchange affect comparisons of the return on asset ratio for Durler in the year of the exchange compared to prior years? Johnson & Johnson’s provided the following selected information in its 2009 cash flow statement. The Company capitalizes interest expense as part of the cost of construction of facilities and equipment. Interest expense capitalized in 2009, 2008 and 2007 was $101 million, $147 million and $130 million, respectively. Depreciation expense, including the amortization of capitalized interest in 2009, 2008 and 2007 was $2.1 billion, $2.0 billion and $1.9 billion, respectively. Johnson & Johnson 2009 Annual Report Consolidated Financial Statements (excerpts) Net cash flows from operating activities $ 16,571 Cash flows from investing activities Additions to property, plant and equipment (2,365) Proceeds from the disposal of assets 154 Acquisitions, net of cash acquired (2,470) Purchases of investments (10,040) Sales of investments 7,232 Other (primarily intangibles) (109) Net cash used by investing activities (7,598) Cash flows from financing activities Dividends to shareholders (5,327) Repurchase of common stock (2,130) Proceeds from short-term debt 9,484 Retirement of short-term debt (6,791) Proceeds from long-term debt 9 Retirement of long-term debt (219) Proceeds from the exercise of stock options/excess tax benefits 882 Net cash used by financing activities (4,092) Effect of exchange rate changes on cash and cash equivalents 161 Increase in cash and cash equivalents 5,042 Cash and cash equivalents, beginning of year (Note 1) 10,768 Cash and cash equivalents, end of year (Note 1) $ 15,810 Supplemental cash flow data Cash paid during the year for: Interest $ 533 Income taxes 2,363 Using Your Judgment 603
Principles How does the concept of commercial substance affect the accounting and analysis of this exchange?
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