Question & Answer

Workman Company purchased a machine on January 2, 2014, for $800,000. The machine has an estimated useful life of 5 years and a salvage value of $100,000. Depreciation was computed by the 150% declining-balance method. What is the amount of accumulated depreciation at the end of December 31, 2015?

What basic questions must be answered before the amount of the depreciation charge can be computed?

For what reasons are plant assets retired? Define inadequacy, supersession, and obsolescence.

The plant manager of a manufacturing firm suggested in a conference of the company’s executives that accountants should speed up depreciation on the machinery in the finishing department because improvements were rapidly making those machines obsolete, and a depreciation fund big enough to cover their replacement is needed.

Discuss the accounting concept of depreciation and the effect on a business concern of the depreciation recorded for plant assets, paying particular attention to the issues raised by the plant manager.

Explain how estimation of service lives can result in unrealistically high carrying values for fixed assets.

Some believe that accounting depreciation measures the decline in the value of fixed assets. Do you agree? Explain.

Identify the factors that are relevant in determining the annual depreciation charge, and explain whether these factors are determined objectively or whether they are based on judgment.

Distinguish among depreciation, depletion, and amortization.

Your client is in the planning phase for a major plant expansion, which will involve the construction of a new warehouse. The assistant controller does not believe that interest cost can be included in the cost of the warehouse, because it is a financing expense. Others on the planning team believe that some interest cost can be included in the cost of the warehouse, but no one could identify the specific authoritative guidance for this issue. Your supervisor asks you to research this issue.

Instructions

If your school has a subscription to the FASB Codification, go to http://aaahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

(a) Is it permissible to capitalize interest into the cost of assets? Provide authoritative support for your answer.

(b) What are the objectives for capitalizing interest?

(c) Discuss which assets qualify for interest capitalization.

(d) Is there a limit to the amount of interest that may be capitalized in a period?

(e) If interest capitalization is allowed, what disclosures are required?

Johnson & Johnson, the world’s leading and most diversified health-care 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 2011 annual report is shown in the notes to the financial statements below.

Instructions

(a) What was the cost of buildings and building equipment at the end of 2011?

(b) Does Johnson & Johnson use a conservative or liberal method to depreciate its property, plant, and equipment?

(c) What was the actual interest expense paid by the company in 2011?

(d) What is Johnson & Johnson’s free cash flow? From the information provided, comment on Johnson & Johnson’s financial flexibility.

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?

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 salvage 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.

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.

Vania Magazine Company started construction of a warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2013, and completed the building on December 31, 2013. During the construction period, Vania has the following debt obligations outstanding.

Construction loan—12% interest, payable semiannually, issued December 31, 2012 $2,000,000 Short-term loan—10% interest, payable monthly, and principal payable at maturity, on May 30, 2014 1,400,000

Long-term loan—11% interest, payable on January 1 of each year; principal payable on January 1, 2016 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

(Round the weighted-average interest rate to two decimal places.)

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.

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 2014, 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.

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.

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, 2014, 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 forthe 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, 2014, 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.

During its fiscal year ended May 31, 2015, Klamath incurred $8,000 for interest expense in connection with the financing of these assets.

Transaction 3: On March 1, 2015, 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 usthe land for a parking lot. The trucks had a combined book value of $35,000, as Klamath had recorded $20,000

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

Yakima Book Value Fair Value

Inventory $ 60,000 $ 50,000

Land 40,000 80,000

Buildings 70,000 120,000$170,000 $250,000 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, 2015.

(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.

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.

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

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.

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.

Date Amount

July 30, 2014 $ 900,000

January 30, 2015 1,500,000

May 30, 2015 1,600,000

Total payments $4,000,000

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.

Laserwords Inc. is a book distributor that had been operating in its original facility since 1987. The increase in certification programs and continuing education requirements in several professions has contributed to an annual growth rate of 15% for Laserwords since 2009. Laserwords’ original facility became obsolete by early 2014 because of the increased sales volume and the fact that Laserwords now carries CDs in addition to books.

On June 1, 2014, 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, 2014 $ 900,000

January 30, 2015 1,500,000

May 30, 2015 1,600,000

Total payments $4,000,000

Construction was completed and the building was ready for occupancy on May 27, 2015. Laserwords had no new borrowings directly associated with the new building but had the following debt outstanding at May 31, 2015, the end of its fiscal year.

10%, 5-year note payable of $2,000,000, dated April 1, 2011, with interest payable annually on April 1.

12%, 10-year bond issue of $3,000,000 sold at par on June 30, 2007, with interest payable annually on June 30.

Instructions

For each of the four independent situations, prepare the journal entries to record the exchange on the booksof each company.

Grieg Landscaping began construction of a new plant on December

1  2014. 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, 2014, 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, 2015.

To finance construction of this plant, Grieg borrowed $600,000 from the bank on December 1, 2014.

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, 2014, and December 31, 2015. (Round amounts to the nearest dollar.)

(a) Land.

(b) Buildings.

(c) Interest Expense.

On January 1, 2014, 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, 2014, for the construction of an office building on land site number 101. The building was completed and occupied on

September 30, 2015. 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, 2014. The loan is payable in 10 annual installments of $300,000 starting on March 1, 2015, 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, 2014 $1,300,000

For the period January 1 to September 30, 2015 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, 2015.

(b) Prepare a schedule that discloses the individual costs that should be capitalized in the office building account as of September 30, 2015 Show supporting computations in good form.

Presented below is a schedule of property dispositions for Hollerith Co.

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, 2011, 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.

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.

Spitfire Company was incorporated on January 2,

2015, but was unable to begin manufacturing activities until July 1, 2015, because new factory facilities were not completed until that date.

The Land and Buildings account reported the following items during 2015.

January 31 Land and buildings $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—2015 at 1% (4,000)

December 31, 2015 Account balance $395,950

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, 2015.

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, 2015, to June 30, 2015.

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 2015—1% of asset value (1% of $400,000, or $4,000).

Instructions

(a) Prepare entries to reflect correct land, buildings, and depreciation accounts at December 31, 2015.

(b) Show the proper presentation of land, buildings, and depreciation on the balance sheet at December 31, 2015.