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CHAPTER 9
Plant Assets, Natural Resources, and Intangible Assets

FEATURE STORY

How Much for a Ride to the Beach?

It’s summer vacation. Your plane has landed, you’ve finally found your bags, and you’re dying to hit the Tylösand beach in Halmstad, Sweden—but first you need a “vehicular unit” to get you there. As you turn away from baggage claim, you see a long row of rental agency booths. First, you see booths for Hertz (USA) and Europcar (FRA). Then, a booth at the far end catches your eye—Rent-A-Wreck (USA). Now there’s a company making a clear statement!

Any company that relies on equipment to generate revenues must make decisions about what kind of equipment to buy, how long to keep it, and how vigorously to maintain it. Rent-A-Wreck has decided to rent used rather than new cars and trucks. While Europcar emphasizes that all its vehicles are new, Rent-A-Wreck competes on price.

Rent-A-Wreck’s message is simple: Rent a used car and save some cash. It’s not a message that appeals to everyone. If you’re a marketing executive wanting to impress a big client, you might choose Europcar instead of Rent-A-Wreck. But if you want to get from point A to point B for the minimum cash per mile, then Rent-A-Wreck is playing your tune. The company’s message seems to be getting across to the right clientele. Revenues have increased significantly.

When you rent a car from Rent-A-Wreck or from Europcar, you are renting from an independent businessperson. This owner has paid a “franchise fee” for the right to use the Rent-A-Wreck or Europcar name. In order to gain a franchise, he or she must meet financial and other criteria, and must agree to run the rental agency according to prescribed rules. Some of these rules require that each franchise maintain its cars in a reasonable fashion. This ensures that, though you won’t be cruising up to the Hotel Tylösand in a Mercedes convertible, you can be reasonably assured that you won’t be calling a towtruck.

PREVIEW OF CHAPTER 9

The accounting for non-current assets has important implications for a company’s reported results. In this chapter, we explain the application of the historical cost principle of accounting to property, plant, and equipment, such as Rent-A-Wreck or Europcar vehicles, as well as to natural resources and intangible assets, such as the “Europcar” trademark. We also describe the methods that companies may use to allocate an asset’s cost over its useful life. In addition, we discuss the accounting for expenditures incurred during the useful life of assets, such as the cost of replacing tires and brake pads on rental cars.

The content and organization of Chapter 9 are as follows.

The Navigator

Plant Assets

Learning Objective 1

Describe how the historical cost principle applies to plant assets.

Plant assets are resources that have three characteristics. They have a physical substance (a definite size and shape), are used in the operations of a business, and are not intended for sale to customers. They are also called property, plant, and equipment; plant and equipment; and fixed assets. These assets are expected to be of use to the company for a number of years. Except for land, plant assets decline in service potential over their useful lives.

Because plant assets play a key role in ongoing operations, companies keep plant assets in good operating condition. They also replace worn-out or outdated plant assets, and expand productive resources as needed. Many companies have substantial investments in plant assets. Illustration 9-1 shows the percentages of plant assets in relation to total assets of companies in a number of industries during a recent year.

Determining the Cost of Plant Assets

The historical cost principle requires that companies record plant assets at cost. Thus, Europcar (FRA) records its vehicles at cost. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, and installation costs. Once cost is established, the company generally uses that amount as the basis of accounting for the plant asset over its useful life.

In the following sections, we explain the application of the historical cost principle to each of the major classes of plant assets.

LAND

Companies often use land as a site for a manufacturing plant or office building. The cost of land includes (1) the cash purchase price, (2) closing costs such as title and attorney’s fees, (3) real estate brokers’ commissions, and (4) accrued property taxes and other liens assumed by the purchaser. For example, if the cash price is $50,000 and the purchaser agrees to pay accrued taxes of $5,000, the cost of the land is $55,000.

• HELPFUL HINT
Management’s intended use is important in applying the historical cost principle to plant assets.

Companies record as debits (increases) to the Land account all necessary costs incurred to make land ready for its intended use. When a company acquires vacant land, these costs include expenditures for clearing, draining, filling, and grading. Sometimes, the land has a building on it that must be removed before construction of a new building. In this case, the company debits to the Land account all demolition and removal costs, less any proceeds from salvaged materials.

To illustrate, assume that Lew Company Ltd. acquires real estate at a cash cost of HK$2,000,000. The property contains an old warehouse that is razed at a net cost of HK$60,000 (HK$75,000 in costs less HK$15,000 proceeds from salvaged materials). Additional expenditures are the attorney’s fee, HK$10,000, and the real estate broker’s commission, HK$80,000. The cost of the land is HK$2,150,000, as computed in Illustration 9-2.

Illustration 9-2 Computation of cost of land

Land
Cash price of property	HK$ 2,000,000
Net removal cost of warehouse $(HK $ 75,000 - HK $ 15,000)$ $(HK $ 75,000 - HK $ 15,000)$	60,000
Attorney’s fee	10,000
Real estate broker’s commission	80,000
Cost of land	HK$2,150,000

Lew makes the following entry to record the acquisition of the land.

Land	2,150,000
Cash		2,150,000
(To record purchase of land)

LAND IMPROVEMENTS

Land improvements are structural additions made to land. Examples are driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use. For example, the cost of a new parking lot for a Hero Supermarket (IDN) includes the amount paid for paving, fencing, and lighting. Thus, Hero Supermarket debits to Land Improvements the total of all of these costs.

Land improvements have limited useful lives. Even when well-maintained, they will eventually be replaced. As a result, companies expense (depreciate) the cost of land improvements over their useful lives.

BUILDINGS

Buildings are facilities used in operations, such as stores, offices, factories, warehouses, and airplane hangars. Companies debit to the Buildings account all necessary expenditures related to the purchase or construction of a building. When a building is purchased, such costs include the purchase price, closing costs (attorney’s fees, title insurance, etc.), and the real estate broker’s commission. Costs to make the building ready for its intended use include expenditures for remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing. When a new building is constructed, costs consist of the contract price plus payments for architects’ fees, building permits, and excavation costs.

In addition, companies charge certain interest costs to the Buildings account. Interest costs incurred to finance the project are included in the cost of the building when a significant period of time is required to get the building ready for use. In these circumstances, interest costs are considered as necessary as materials and labor. However, the inclusion of interest costs in the cost of a constructed building is limited to the construction period. When construction has been completed, the company records subsequent interest payments on funds borrowed to finance the construction as debits (increases) to Interest Expense.

EQUIPMENT

Equipment includes assets used in operations, such as store check-out counters, office furniture, factory machinery, delivery trucks, and airplanes. The cost of equipment, such as Europcar vehicles, consists of the cash purchase price, sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit. However, Europcar does not include motor vehicle licenses and accident insurance on company vehicles in the cost of equipment. These costs represent annual recurring expenditures and do not benefit future periods. Thus, they are treated as expenses as they are incurred.

To illustrate, assume Zhang Company Ltd. purchases factory machinery at a cash price of HK$500,000. Related expenditures are for sales taxes HK$30,000, insurance during shipping HK$5,000, and installation and testing HK$10,000. The cost of the factory machinery is HK$545,000, computed in Illustration 9-3.

Illustration 9-3 Computation of cost of factory machinery

Factory Machinery
Cash price	HK$ 500,000
Sales taxes	30,000
Insurance during shipping	5,000
Installation and testing	10,000
Cost of factory machinery	HK$545,000

Zhang makes the following summary entry to record the purchase and related expenditures.

Equipment	545,000
Cash		545,000
(To record purchase of factory machinery)

For another example, assume that Huang Company purchases a delivery truck at a cash price of HK$420,000. Related expenditures consist of sales taxes HK$13,200, painting and lettering HK$5,000, motor vehicle license HK$800, and a three-year accident insurance policy HK$16,000. The cost of the delivery truck is HK$438,200, computed as follows.

Illustration 9-4 Computation of cost of delivery truck

Delivery Truck
Cash price	HK$ 420,000
Sales taxes	13,200
Painting and lettering	5,000
Cost of delivery truck	HK$438,200

Huang treats the cost of the motor vehicle license as an expense and the cost of the insurance policy as a prepaid asset. Thus, Huang makes the following entry to record the purchase of the truck and related expenditures:

Equipment	438,200
License Expense	800
Prepaid Insurance	16,000
Cash		455,000
(To record purchase of delivery truck and related expenditures)

> DO IT!

The Navigator

Cost of Plant Assets

Assume that Jing Feng Heating and Cooling Co. purchases a delivery truck for ¥150,000 cash, plus sales taxes of ¥9,000 and delivery costs of ¥5,000. The buyer also pays ¥2,000 for painting and lettering, ¥6,000 for an annual insurance policy, and ¥800 for a motor vehicle license. Explain how each of these costs would be accounted for.

Action Plan

✓ Identify expenditures made in order to get delivery equipment ready for its intended use.
✓ Treat operating costs as expenses.

Solution

Related exercise material: BE9-1, BE9-2, E9-1, E9-2, E9-3, and DO IT! 9-1.

The Navigator

Depreciation

Learning Objective 2

Explain the concept of depreciation and how to compute it.

As explained in Chapter 3, depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Cost allocation enables companies to properly match expenses with revenues in accordance with the expense recognition principle, as shown in Illustration 9-5.

It is important to understand that depreciation is a process of cost allocation. It is not a process of asset valuation. No attempt is made to measure the change in an asset’s fair value during ownership. So, the book value (cost less accumulated depreciation) of a plant asset may be quite different from its fair value. In fact, if an asset is fully depreciated, it can have a zero book value but still have a positive fair value.

Depreciation applies to three classes of plant assets: land improvements, buildings, and equipment. Each asset in these classes is considered to be a depreciable asset. Why? Because the usefulness to the company and revenue-producing ability of each asset will decline over the asset’s useful life. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time. In fact, in many cases, the usefulness of land is greater over time because of the scarcity of good land sites. Thus, land is not a depreciable asset.

During a depreciable asset’s useful life, its revenue-producing ability declines because of wear and tear. A delivery truck that has been driven 100,000 miles will be less useful to a company than one driven only 800 miles.

Revenue-producing ability may also decline because of obsolescence. Obsolescence is the process of becoming out of date before the asset physically wears out. For example, major airlines moved from Chicago’s Midway Airport to Chicago-O’Hare International Airport because Midway’s runways were too short for jumbo jets. Similarly, many companies replace their computers long before they originally planned to do so because technological improvements make the old computers obsolete.

Recognizing depreciation on an asset does not result in an accumulation of cash for replacement of the asset. The balance in Accumulated Depreciation represents the total amount of the asset’s cost that the company has charged to expense. It is not a cash fund.

Note that the concept of depreciation is consistent with the going concern assumption. The going concern assumption states that the company will continue in operation for the foreseeable future. If a company does not use a going concern assumption, then plant assets should be stated at their fair value. In that case, depreciation of these assets is not needed.

FACTORS IN COMPUTING DEPRECIATION

Three factors affect the computation of depreciation, as shown in Illustration 9-6.

• HELPFUL HINT
Depreciation expense is reported on the income statement. Accumulated depreciation is reported on the statement of financial position as a deduction from plant assets.

Cost. Earlier, we explained the issues affecting the cost of a depreciable asset. Recall that companies record plant assets at cost, in accordance with the historical cost principle.
Useful life. Useful life is an estimate of the expected productive life, also called service life, of the asset for its owner. Useful life may be expressed in terms of time, units of activity (such as machine hours), or units of output. Useful life is an estimate. In making the estimate, management considers such factors as the intended use of the asset, its expected repair and maintenance, and its vulnerability to obsolescence. Past experience with similar assets is often helpful in deciding on expected useful life. We might reasonably expect Rent-A-Wreck and Europcar to use different estimated useful lives for their vehicles.
Residual value. Residual value is an estimate of the asset’s value at the end of its useful life. This value may be based on the asset’s worth as scrap or on its expected trade-in value. Like useful life, residual value is an estimate. In making the estimate, management considers how it plans to dispose of the asset and its experience with similar assets.

• Alternative Terminology
Another term sometimes used for residual value is salvage value.

DEPRECIATION METHODS

Depreciation is generally computed using one of the following methods:

Straight-line
Units-of-activity
Declining-balance

Each method is acceptable under IFRS. Management selects the method(s) it believes to be appropriate. The objective is to select the method that best measures an asset’s contribution to revenue over its useful life. Once a company chooses a method, it should apply it consistently over the useful life of the asset. Consistency enhances the comparability of financial statements. Depreciation affects the statement of financial position through accumulated depreciation and the income statement through depreciation expense.

We will compare the three depreciation methods using the following data for a small delivery truck purchased by Barb’s Florists on January 1, 2017.

Illustration 9-7 Delivery truck data

Cost	€ 13,000
Expected residual value	€ 1,000
Estimated useful life in years	5
Estimated useful life in miles	100,000

No matter which method is used, the total amount depreciated over the useful life of the asset is its depreciable cost. Depreciable cost is equal to the cost of the asset less its residual value.

STRAIGHT-LINE METHOD Under the straight-line method, companies expense the same amount of depreciation for each year of the asset’s useful life. It is measured solely by the passage of time.

To compute depreciation expense under the straight-line method, companies need to determine depreciable cost. As indicated above, depreciable cost is the cost of the asset less its residual value. It represents the total amount subject to depreciation. Under the straight-line method, to determine annual depreciation expense, we divide depreciable cost by the asset’s useful life. Illustration 9-8 shows the computation of the first year’s depreciation expense for Barb’s Florists.

Alternatively, we also can compute an annual rate of depreciation. In this case, the rate is $20 % (100 % \div 5 years)$ $20 % (100 % \div 5 years)$ . When a company uses an annual straight-line rate, it applies the percentage rate to the depreciable cost of the asset. Illustration 9-9 shows a depreciation schedule using an annual rate.

Note that the depreciation expense of €2,400 is the same each year. The book value (computed as cost minus accumulated depreciation) at the end of the useful life is equal to the expected €1,000 residual value.

What happens to these computations for an asset purchased during the year, rather than on January 1? In that case, it is necessary to prorate the annual depreciation on a time basis. If Barb’s Florists had purchased the delivery truck on April 1, 2017, the company would own the truck for nine months of the first year (April–December). Thus, depreciation for 2017 would be $€ 1,800 (€ 12,000 \times 20 % \times 9 / 12 of a year)$ $€ 1,800 (€ 12,000 \times 20 % \times 9 / 12 of a year)$ .

The straight-line method predominates in practice. Large companies such as Daimler (DEU), Anheuser-Busch InBev (BEL), and General Mills (USA) use the straight-line method. It is simple to apply, and it matches expenses with revenues when the use of the asset is reasonably uniform throughout the service life.

> DO IT!

The Navigator

Straight-Line Depreciation

On January 1, 2017, Iron Mountain Ski AG purchased a new snow-grooming machine for €50,000. The machine is estimated to have a 10-year life with a €2,000 residual value. What journal entry would Iron Mountain Ski make at December 31, 2017, if it uses the straight-line method of depreciation?

Action Plan

✓ Calculate depreciable cost $(Cost - Residual value)$ $(Cost - Residual value)$ .
✓ Divide the depreciable cost by the asset’s estimated useful life.

Solution

Related exercise material: BE9-3, BE9-4, E9-4, E9-6, E9-7, E9-10, and DO IT! 9-2.

The Navigator

• Alternative Terminology
Another term often used is the units-of-production method.

UNITS-OF-ACTIVITY METHOD Under the units-of-activity method, useful life is expressed in terms of the total units of production or use expected from the asset, rather than as a time period. The units-of-activity method is ideally suited to factory machinery. Manufacturing companies can measure production in units of output or in machine hours. This method can also be used for such assets as delivery equipment (miles driven) and airplanes (hours in use). The units-of-activity method is generally not suitable for buildings or furniture because depreciation for these assets is more a function of time than of use.

• HELPFUL HINT
Under any method, depreciation stops when the asset’s book value equals expected residual value.

To use this method, companies estimate the total units of activity for the entire useful life and then divide these units into depreciable cost. The resulting number represents the depreciable cost per unit. The depreciable cost per unit is then applied to the units of activity during the year to determine the annual depreciation expense.

To illustrate, assume that Barb’s Florists drives its delivery truck 15,000 miles in the first year. Illustration 9-10 shows the units-of-activity formula and the computation of the first year’s depreciation expense.

The units-of-activity depreciation schedule, using assumed mileage, is as follows.

This method is easy to apply for assets purchased mid-year. In such a case, the company computes the depreciation using the productivity of the asset for the partial year.

The units-of-activity method is not nearly as popular as the straight-line method primarily because it is often difficult for companies to reasonably estimate total activity. However, some very large companies, such as Chevron (USA), do use this method. When the productivity of an asset varies significantly from one period to another, the units-of-activity method results in the best matching of expenses with revenues.

DECLINING-BALANCE METHOD The declining-balance method produces a decreasing annual depreciation expense over the asset’s useful life. The method is so named because the periodic depreciation is based on a declining book value (cost less accumulated depreciation) of the asset. With this method, companies compute annual depreciation expense by multiplying the book value at the beginning of the year by the declining-balance depreciation rate. The depreciation rate remains constant from year to year, but the book value to which the rate is applied declines each year.

At the beginning of the first year, book value is the cost of the asset. This is because the balance in accumulated depreciation at the beginning of the asset’s useful life is zero. In subsequent years, book value is the difference between cost and accumulated depreciation to date. Unlike the other depreciation methods, the declining-balance method ignores residual value in determining the amount to which the declining-balance rate is applied. Residual value, however, does limit the total depreciation that can be taken. Depreciation stops when the asset’s book value equals expected residual value.

A common declining-balance rate is double the straight-line rate. The method is often called the double-declining-balance method. If Barb’s Florists uses the double-declining-balance method, it uses a depreciation rate of $40 % (2 \times the straight-line rate of 20 %)$ $40 % (2 \times the straight-line rate of 20 %)$ . Illustration 9-12 shows the declining-balance formula and the computation of the first year’s depreciation on the delivery truck.¹

Book Value at Beginning of Year	$\times$ $\times$	Declining-Balance Rate	$=$ $=$	Annual Depreciation Expense
$€ 13,000$ $€ 13,000$	$\times$ $\times$	$40 %$ $40 %$	$=$ $=$	$€ 5,200$ $€ 5,200$

The depreciation schedule under this method is as follows.

• HELPFUL HINT
The method recommended for an asset that is expected to be significantly more productive in the first half of its useful life is the declining-balance method.

The delivery equipment is 69% depreciated $(€ 8,320 \div € 12,000)$ $(€ 8,320 \div € 12,000)$ at the end of the second year. Under the straight-line method, the truck would be depreciated $40 % (€ 4,800 \div € 12,000)$ $40 % (€ 4,800 \div € 12,000)$ at that time. Because the declining-balance method produces higher depreciation expense in the early years than in the later years, it is considered an accelerated-depreciation method. The declining-balance method is compatible with the expense recognition principle. It matches the higher depreciation expense in early years with the higher benefits received in these years. It also recognizes lower depreciation expense in later years, when the asset’s contribution to revenue is less. Some assets lose usefulness rapidly because of obsolescence. In these cases, the declining-balance method provides the most appropriate depreciation amount.

When a company purchases an asset during the year, it must prorate the first year’s declining-balance depreciation on a time basis. For example, if Barb’s Florists had purchased the truck on April 1, 2017, depreciation for 2017 would become $€ 3,900 (€ 13,000 \times 40 % \times 9 / 12)$ $€ 3,900 (€ 13,000 \times 40 % \times 9 / 12)$ . The book value at the beginning of 2018 is then $€ 9,100 (€ 13,000 - € 3,900)$ $€ 9,100 (€ 13,000 - € 3,900)$ , and the 2018 depreciation is $€ 3,640 (€ 9,100 \times 40 %)$ $€ 3,640 (€ 9,100 \times 40 %)$ . Subsequent computations would follow from those amounts.

COMPARISON OF METHODS Illustration 9-14 compares annual and total depreciation expense under each of the three methods for Barb’s Florists.

Illustration 9-14 Comparison of depreciation methods

Year	Straight-Line	Units-of-Activity	Declining-Balance
2017	€ 2,400	€ 1,800	€ 5,200
2018	2,400	3,600	3,120
2019	2,400	2,400	1,872
2020	2,400	3,000	1,123
2021	2,400	1,200	685
	€12,000	€12,000	€12,000

Annual depreciation varies considerably among the methods, but total depreciation expense is the same (€12,000) for the five-year period under all three methods. Each method is acceptable in accounting because each recognizes in a rational and systematic manner the decline in service potential of the asset. Illustration 9-15 graphs the depreciation expense pattern under each method.

COMPONENT DEPRECIATION

Thus far, we have assumed that plant assets use a single depreciation rate. However, IFRS requires component depreciation for plant assets. Component depreciation requires that any significant parts of a plant asset that have significantly different estimated useful lives should be separately depreciated.

To illustrate component depreciation, assume that Lexure Construction builds an office building for HK$4,000,000, not including the cost of the land. If the HK$4,000,000 is allocated over the 40-year useful life of the building, Lexure reports $HK $ 100,000 (HK $ 4,000,000 \div 40)$ $HK $ 100,000 (HK $ 4,000,000 \div 40)$ of depreciation per year, assuming straight-line depreciation and no residual value. However, assume that HK$320,000 of the cost of the building relates to personal property and HK$600,000 relates to land improvements. Because the personal property has a depreciable life of five years and the land improvements have a depreciable life of 10 years, Lexure must use component depreciation. It must reclassify HK$320,000 of the cost of the building to personal property and HK$600,000 to the cost of land improvements. Assuming that Lexure uses straight-line depreciation, component depreciation for the first year of the office building is computed as follows.

Illustration 9-16 Component depreciation computation

Building cost adjusted $(HK $ 4,000,000 - HK $ 320,000 - HK $ 600,000)$ $(HK $ 4,000,000 - HK $ 320,000 - HK $ 600,000)$	HK$3,080,000
Building cost depreciation per year $(HK $ 3,080,000 \div 40)$ $(HK $ 3,080,000 \div 40)$	HK$ 77,000
Personal property depreciation $(HK $ 320,000 \div 5)$ $(HK $ 320,000 \div 5)$	64,000
Land improvements depreciation $(HK $ 600,000 \div 10)$ $(HK $ 600,000 \div 10)$	60,000
Total component depreciation in first year	HK$ 201,000

DEPRECIATION AND INCOME TAXES

Tax laws allow corporate taxpayers to deduct depreciation expense when they compute taxable income. However, tax laws often do not require taxpayers to use the same depreciation method on the tax return that is used in preparing financial statements.

Many corporations use straight-line in their financial statements to maximize net income. At the same time, they use an accelerated-depreciation method on their tax returns to minimize their income taxes.

REVISING PERIODIC DEPRECIATION

Depreciation is one example of the use of estimation in the accounting process. Management should periodically review annual depreciation expense. If wear and tear or obsolescence indicate that annual depreciation estimates are inadequate or excessive, the company should change the amount of depreciation expense.

When a change in an estimate is required, the company makes the change in current and future years. It does not change depreciation in prior periods. The rationale is that continual restatement of prior periods would adversely affect confidence in financial statements.

• HELPFUL HINT
Use a step-by-step approach: (1) determine new depreciable cost; (2) divide by remaining useful life.

To determine the new annual depreciation expense, the company first computes the asset’s depreciable cost at the time of the revision. It then allocates the revised depreciable cost to the remaining useful life.

To illustrate, assume that Barb’s Florists decides on January 1, 2020, to extend the useful life of the truck by one year (a total life of six years) and increase its residual value to €2,200. The company has used the straight-line method to depreciate the asset to date. Depreciation per year was $€ 2,400 [(€ 13,000 - € 1,000) \div 5]$ $€ 2,400 [(€ 13,000 - € 1,000) \div 5]$ . Accumulated depreciation after three years (2017–2019) is $€ 7,200 (€ 2,400 \times 3)$ $€ 7,200 (€ 2,400 \times 3)$ , and book value is $€ 5,800 (€ 13,000 - € 7,200)$ $€ 5,800 (€ 13,000 - € 7,200)$ . The new annual depreciation is €1,200, as shown in Illustration 9-17.

Book value, 1/1/20	€ 5,800
Less: Residual value	2,200
Depreciable cost	€ 3,600
Remaining useful life	3 years	(2020–2022)
Revised annual depreciation $(€ 3,600 \div 3)$ $(€ 3,600 \div 3)$	€ 1,200

Barb’s Florists makes no entry for the change in estimate. On December 31, 2020, during the preparation of adjusting entries, it records depreciation expense of €1,200. Companies must describe in the financial statements significant changes in estimates.

> DO IT!

The Navigator

Revised Depreciation

Chambers plc purchased a piece of equipment for £36,000. It estimated a 6-year life and £6,000 residual value. Thus, straight-line depreciation was £5,000 per year $[(£ 36,000 - £ 6,000) \div 6]$ $[(£ 36,000 - £ 6,000) \div 6]$ . At the end of year three (before the depreciation adjustment), it estimated the new total life to be 10 years and the new residual value to be £2,000. Compute the revised depreciation.

Action Plan

✓ Calculate depreciable cost.
✓ Divide depreciable cost by new remaining life.

Solution

Related exercise material: BE9-8, E9-9, and DO IT! 9-3.

The Navigator

Revaluation of Plant Assets

IFRS allows companies to revalue plant assets to fair value at the reporting date. Companies that choose to use the revaluation framework must follow revaluation procedures. If revaluation is used, it must be applied to all assets in a class of assets. Assets that are experiencing rapid price changes must be revalued on an annual basis. Otherwise, less frequent revaluation is acceptable.

GAIN SITUATION

To illustrate asset revaluation accounting, assume that Pernice Ltd. applies revaluation to equipment purchased on January 1, 2017, for HK$1,000,000. The equipment has a useful life of five years and no residual value. On December 31, 2017, Pernice makes the following journal entry to record depreciation expense, assuming straight-line depreciation.

Dec. 31	Depreciation Expense	200,000
	Accumulated Depreciation—Equipment		200,000
	(To record depreciation expense in 2017)

After this entry, Pernice’s equipment has a carrying amount of $HK $ 800,000 (HK $ 1,000,000 - HK $ 200,000)$ $HK $ 800,000 (HK $ 1,000,000 - HK $ 200,000)$ . At the end of 2017, independent appraisers determine that the asset has a fair value of HK$850,000. To report the equipment at its fair value of HK$850,000 on December 31, 2017, Pernice eliminates the Accumulated Depreciation—Equipment account, reduces Equipment to its fair value of HK$850,000, and records Revaluation Surplus of HK$50,000. The entry to record the revaluation is as follows.

Dec. 31	Accumulated Depreciation—Equipment	200,000
	Equipment		150,000
	Revaluation Surplus		50,000
	(To adjust the equipment to its fair value)

Thus, Pernice follows a two-step process. First, Pernice records depreciation based on the cost basis of HK$1,000,000. As a result, it reports depreciation expense of HK$200,000 on the income statement. Second, it records the revaluation. It does this by eliminating any accumulated depreciation, adjusting the recorded value of the equipment to its fair value, and debiting or crediting the revaluation surplus account. In this example, the revaluation surplus is HK$50,000, which is the difference between the fair value of HK$850,000 and the book value of HK$800,000. Revaluation surplus is an example of an item reported as other comprehensive income, as discussed in Chapter 5. Pernice now reports the following information in its statement of financial position at the end of 2017.

Illustration 9-18 Statement presentation of plant assets (equipment) and revaluation surplus

Equipment $(HK $ 1,000,000 - HK $ 150,000)$ $(HK $ 1,000,000 - HK $ 150,000)$	HK$850,000
Accumulated depreciation—equipment	0
	HK$850,000
Revaluation surplus (equity)	HK$ 50,000

Pernice reports depreciation expense of HK$200,000 in the income statement and HK$50,000 in other comprehensive income. As indicated, HK$850,000 is the new basis of the asset. Assuming no change in the total useful life, depreciation in 2018 will be $HK $ 212,500 (HK $ 850,000 \div 4)$ $HK $ 212,500 (HK $ 850,000 \div 4)$ .

LOSS SITUATION

Assume again that Pernice’s equipment has a carrying amount of $HK $ 800,000 (HK $ 1,000,000 - HK $ 200,000)$ $HK $ 800,000 (HK $ 1,000,000 - HK $ 200,000)$ . However, at the end of 2017, independent appraisers determine that the asset has a fair value of HK$775,000, which results in an impairment loss of $HK $ 25,000 (HK $ 800,000 - HK $ 775,000)$ $HK $ 25,000 (HK $ 800,000 - HK $ 775,000)$ . To record the equipment at fair value and to record this loss, Pernice first eliminates the balance in the Accumulated Depreciation—Equipment account of HK$200,000. Next, it reduces the Equipment account by HK$225,000 to report the equipment at $HK $ 775,000 (HK $ 1,000,000 - HK $ 225,000)$ $HK $ 775,000 (HK $ 1,000,000 - HK $ 225,000)$ . The entry to record the equipment and report the impairment loss is as follows

Dec. 31	Accumulated Depreciation—Equipment	200,000
	Impairment Loss	25,000
	Equipment		225,000
	(To record impairment loss of equipment)

The impairment loss of HK$25,000 reduces net income.

Comparison of this loss situation with the previous gain situation illustrates an important point. Losses are reported in net income, whereas gains are reported in other comprehensive income. The accounting for gains and losses continues this practice in subsequent periods with additional complications. As a result, the treatment of accounting for revaluation gains and losses in subsequent periods is addressed in advanced accounting classes.

Expenditures During Useful Life

Learning Objective 3

Distinguish between revenue and capital expenditures, and explain the entries for each.

During the useful life of a plant asset, a company may incur costs for ordinary repairs, additions, or improvements. Ordinary repairs are expenditures to maintain the operating efficiency and productive life of the unit. They usually are fairly small amounts that occur frequently. Examples are motor tune-ups and oil changes, the painting of buildings, and the replacing of worn-out gears on machinery. Companies record such repairs as debits to Maintenance and Repairs Expense as they are incurred. Because they are immediately charged as an expense against revenues, these costs are often referred to as revenue expenditures.

In contrast, additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset. They are usually material in amount and occur infrequently. Additions and improvements increase the company’s investment in productive facilities. Companies generally debit these amounts to the plant asset affected. They are often referred to as capital expenditures.

Companies must use good judgment in deciding between a revenue expenditure and capital expenditure. For example, assume that Rodriguez Co. purchases a number of wastepaper baskets. Although the proper accounting would appear to be to capitalize and then depreciate these wastepaper baskets over their useful lives, it would be more usual for Rodriguez to expense them immediately. This practice is justified on the basis of materiality. Materiality refers to the impact of an item’s size on a company’s financial operations. The materiality concept states that if an item would not make a difference in decision-making, the company does not have to follow IFRS in reporting that item.

Bernie Ebbers was the founder and CEO of the phone company WorldCom (USA). The company engaged in a series of increasingly large, debt-financed acquisitions of other companies. These acquisitions made the company grow quickly, which made the share price increase dramatically. However, because the acquired companies all had different accounting systems, WorldCom’s financial records were a mess. When WorldCom’s performance started to flatten out, Bernie coerced WorldCom’s accountants to engage in a number of fraudulent activities to make net income look better than it really was and thus prop up the share price. One of these frauds involved treating $7 billion of line costs as capital expenditures. The line costs, which were rental fees paid to other phone companies to use their phone lines, had always been properly expensed in previous years. Capitalization delayed expense recognition to future periods and thus boosted current-period profits.

THE MISSING CONTROLS

Documentation procedures. The company’s accounting system was a disorganized collection of non-integrated systems, which resulted from a series of corporate acquisitions. Top management took advantage of this disorganization to conceal its fraudulent activities.

Independent internal verification. A fraud of this size should have been detected by a routine comparison of the actual physical assets with the list of physical assets shown in the accounting records.

Learning Objective 4

Explain how to account for the disposal of a plant asset.

Plant Asset Disposals

Companies dispose of plant assets that are no longer useful to them. Illustration 9-19 (page 442) shows the three ways in which companies make plant asset disposals.

Whatever the disposal method, the company must determine the book value of the plant asset at the disposal date to determine the gain or loss. Recall that the book value is the difference between the cost of the plant asset and the accumulated depreciation to date. If the disposal does not occur on the first day of the year, the company must record depreciation for the fraction of the year to the date of disposal. The company then eliminates the book value by reducing (debiting) Accumulated Depreciation for the total depreciation associated with that asset to the date of disposal and reducing (crediting) the asset account for the cost of the asset.

In this chapter, we examine the accounting for the retirement and sale of plant assets. In the appendix to the chapter, we discuss and illustrate the accounting for exchanges of plant assets.

RETIREMENT OF PLANT ASSETS

To illustrate the retirement of plant assets, assume that Hobart ASA retires its computer printers, which cost €32,000. The accumulated depreciation on these printers is €32,000. The equipment, therefore, is fully depreciated (zero book value). The entry to record this retirement is as follows.

Accumulated Depreciation—Equipment	32,000
Equipment		32,000
(To record retirement of fully depreciated equipment)

• HELPFUL HINT
When disposing of a plant asset, the company removes all amounts related to the asset. This includes the original cost and the total depreciation to date in the accumulated depreciation account.

What happens if a fully depreciated plant asset is still useful to the company? In this case, the asset and its accumulated depreciation continue to be reported on the statement of financial position, without further depreciation adjustment, until the company retires the asset. Reporting the asset and related accumulated depreciation on the statement of financial position informs the financial statement reader that the asset is still in use. Once fully depreciated, no additional depreciation should be taken, even if an asset is still being used. In no situation can the accumulated depreciation on a plant asset exceed its cost.

If a company retires a plant asset before it is fully depreciated, and no cash is received for scrap or residual value, a loss on disposal occurs. For example, assume that Sunset A/S discards delivery equipment that cost €18,000 and has accumulated depreciation of €14,000. The entry is as follows.

Accumulated Depreciation—Equipment	14,000
Loss on Disposal of Plant Assets	4,000
Equipment		18,000
(To record retirement of delivery equipment at a loss)

Companies report a loss on disposal of plant assets in the “Other income and expense” section of the income statement.

SALE OF PLANT ASSETS

In a disposal by sale, the company compares the book value of the asset with the proceeds received from the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.

Only by coincidence will the book value and the fair value of the asset be the same when the asset is sold. Gains and losses on sales of plant assets are therefore quite common. For example, Delta Airlines (USA) reported a $94,343,000 gain on the sale of 10 aircraft.

GAIN ON SALE To illustrate a gain on sale of plant assets, assume that on July 1, 2017, Wright Company sells office furniture for €16,000 cash. The office furniture originally cost €60,000. As of January 1, 2017, it had accumulated depreciation of €41,000. Depreciation for the first six months of 2017 is €8,000. Wright records depreciation expense and updates accumulated depreciation to July 1 with the following entry.

July 1	Depreciation Expense	8,000
	Accumulated Depreciation—Equipment		8,000
	(To record depreciation expense for the first 6 months of 2017)

After the accumulated depreciation balance is updated, the company computes the gain or loss. The gain or loss is the difference between the proceeds from the sale and the book value at the date of disposal. Illustration 9-20 shows this computation for Wright Company, which has a gain on disposal of €5,000.

Cost of office furniture	€60,000
Less: Accumulated depreciation $(€ 41,000 + € 8,000)$ $(€ 41,000 + € 8,000)$	49,000
Book value at date of disposal	11,000
Proceeds from sale	16,000
Gain on disposal of plant asset	€ 5,000

Wright records the sale and the gain on disposal of the plant asset as follows.

July 1	Cash	16,000
	Accumulated Depreciation—Equipment	49,000
	Equipment		60,000
	Gain on Disposal of Plant Assets		5,000
	(To record sale of office furniture at a gain)

Companies report a gain on disposal of plant assets in the “Other income and expense” section of the income statement.

LOSS ON SALE Assume that instead of selling the office furniture for €16,000, Wright sells it for €9,000. In this case, Wright computes a loss of €2,000 as follows.

Illustration 9-21 Computation of loss on disposal

Cost of office furniture	€60,000
Less: Accumulated depreciation	49,000
Book value at date of disposal	11,000
Proceeds from sale	9,000
Loss on disposal of plant asset	€ 2,000

Wright records the sale and the loss on disposal of the plant asset as follows.

July 1	Cash	9,000
	Accumulated Depreciation—Equipment	49,000
	Loss on Disposal of Plant Assets	2,000
	Equipment		60,000
	(To record sale of office furniture at a loss)

Companies report a loss on disposal of plant assets in the “Other income and expense” section of the income statement.

> DO IT!

The Navigator

Plant Asset Disposal

Overland Trucking has an old truck that cost £30,000, and it has accumulated depreciation of £16,000 on this truck. Overland has decided to sell the truck. (a) What entry would Overland Trucking make to record the sale of the truck for £17,000 cash? (b) What entry would Overland Trucking make to record the sale of the truck for £10,000 cash?

Action Plan

✓ At the time of disposal, determine the book value of the asset.
✓ Compare the asset’s book value with the proceeds received to determine whether a gain or loss has occurred.

Solution

Related exercise material: BE9-11, BE9-12, E9-12, E9-13, and DO IT! 9-4.

The Navigator

Extractable Natural Resources

Learning Objective 5

Compute periodic depletion of extractable natural resources.

Common natural resources consist of standing timber and resources extracted from the ground, such as oil, gas, and minerals. Standing timber is considered a biological asset under IFRS. In the years before they are harvested, the recorded value of biological assets is adjusted to fair value each period. The additional details of accounting for biological assets are beyond the scope of this textbook.

IFRS defines extractive industries as those businesses involved in finding and removing natural resources located in or near the earth’s crust. The acquisition cost of an extractable natural resource is the price needed to acquire the resource and prepare it for its intended use. For an already-discovered resource, such as an existing coal mine, cost is the price paid for the property.

• HELPFUL HINT
On a statement of financial position, natural resources may be described more specifically as timberlands, mineral deposits, oil reserves, and so on.

The allocation of the cost of natural resources in a rational and systematic manner over the resource’s useful life is called depletion. (That is, depletion is to natural resources what depreciation is to plant assets.) Companies generally use the units-of-activity method (discussed earlier in the chapter) to compute depletion. The reason is that depletion generally is a function of the units extracted during the year.

Under the units-of-activity method, companies divide the total cost of the natural resource minus residual value by the number of units estimated to be in the resource. The result is a depletion cost per unit. To compute depletion, the cost per unit is then multiplied by the number of units extracted.

To illustrate, assume that Lane Coal Company invests HK$50 million in a mine estimated to have 10 million tons of coal and no residual value. Illustration 9-22 shows the computation of the depletion cost per unit.

Illustration 9-22 Computation of depletion cost per unit

$\frac{Total Cost - Residual Value}{Total Estimated Units Available}$ $\frac{Total Cost - Residual Value}{Total Estimated Units Available}$	$=$ $=$	$Depletion Cost per Unit$ $Depletion Cost per Unit$
$\frac{HK $ 50,000,000}{10,000,000}$ $\frac{HK $ 50,000,000}{10,000,000}$	$=$ $=$	$HK $ 5.00 per ton$ $HK $ 5.00 per ton$

If Lane extracts 250,000 tons in the first year, then the depletion for the year is $HK $ 1,250,000 (250,000 tons \times HK $ 5)$ $HK $ 1,250,000 (250,000 tons \times HK $ 5)$ . It records the depletion as follows.

Inventory (coal)	1,250,000
Accumulated Depletion		1,250,000

Lane debits Inventory for the total depletion for the year and credits Accumulated Depletion to reduce the carrying value of the natural resource. Accumulated Depletion is a contra asset similar to Accumulated Depreciation. Lane credits Inventory when it sells the inventory and debits Cost of Goods Sold. The amount not sold remains in inventory and is reported in the current assets section of the statement of financial position.

Some companies do not use an Accumulated Depletion account. In such cases, the company credits the amount of depletion directly to the natural resources account.

People, Planet, and Profit Insight

Sustainability Report Please

BHP Billiton (AUS)

Sustainability reports identify how the company is meeting its corporate social responsibilities. Many companies, both large and small, are now issuing these reports. For example, companies such as Microsoft (USA), Tata (IND), BP (GBR), Nestlé (CHE), and Samsung (KOR) issue these reports. Presented below is an adapted section of a recent BHP Billiton (AUS) (a global mining, oil, and gas company) sustainability report on its environmental policies. These policies are to (1) take action to address the challenges of climate change, (2) set and achieve targets that reduce pollution, and (3) enhance biodiversity by assessing and considering ecological values and land-use aspects. Here is how BHP Billiton measures the success or failure of some of these policies:

Environment	Commentary	Target Date
We will maintain total greenhouse gas emissions below FY2006 levels.	FY2013 greenhouse gas emissions were lower than the FY2006 baseline.	30 June 2017
All operations to offset impacts to biodiversity and the related benefits derived from ecosystems.	Land and Biodiversity Management Plans were developed at all our operations.	Annual
We will finance the conservation and continuing management of areas of high biodiversity and ecosystem value.	Two projects of international conservation significance were established—the Five Rivers Conservation Project, in Australia, and the Valdivian Coastal Reserve Conservation Project, in Chile.	30 June 2017

In addition to the environment, BHP Billiton has sections in its sustainability report that discuss people, safety, health, and community.

Q Why do you believe companies issue sustainability reports? (See page 476.)

Intangible Assets

Learning Objective 6

Explain the basic issues related to accounting for intangible assets.

Intangible assets are rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance. Evidence of intangibles may exist in the form of contracts or licenses. Intangibles may arise from the following sources:

Government grants, such as patents, copyrights, licenses, trademarks, and trade names.
Acquisition of another business, in which the purchase price includes a payment for goodwill.
Private monopolistic arrangements arising from contractual agreements, such as franchises and leases.

Some widely known intangibles are SAP’s (DEU) patents, Spar’s (NLD) convenience store franchises, Apple’s (USA) trade name iPod, J.K. Rowlings’ copyrights on the Harry Potter books, and the trademark Europcar in the Feature Story.

Accounting for Intangible Assets

• HELPFUL HINT
Amortization is to intangibles what depreciation is to plant assets and depletion is to extractable natural resources.

Companies record intangible assets at cost. This cost consists of all expenditures necessary for the company to acquire the right, privilege, or competitive advantage. Intangibles are categorized as having either a limited life or an indefinite life. If an intangible has a limited life, the company allocates its cost over the asset’s useful life using a process similar to depreciation. The process of allocating the cost of intangibles is referred to as amortization. The cost of intangible assets with indefinite lives should not be amortized.

To record amortization of an intangible asset, a company increases (debits) Amortization Expense and decreases (credits) the specific intangible asset. (Unlike depreciation, no contra account, such as Accumulated Amortization, is usually used.)

Intangible assets are typically amortized on a straight-line basis. For example, the legal life of a patent is 20 years in many countries. Companies amortize the cost of a patent over its 20-year life or its useful life, whichever is shorter. To illustrate the computation of patent amortization, assume that National Labs purchases a patent at a cost of NT$720,000. If National estimates the useful life of the patent to be eight years, the annual amortization expense is $NT $ 90,000 (NT $ 720,000 \div 8)$ $NT $ 90,000 (NT $ 720,000 \div 8)$ . National records the annual amortization as follows.

Dec. 31	Amortization Expense	90,000
	Patents		90,000
	(To record patent amortization)

Companies classify amortization expense as an operating expense in the income statement. Similar to property, plant, and equipment, IFRS permits revaluation of intangible assets to fair value, except for goodwill.

When intangible assets are acquired through a purchase, the determination of cost is similar to that of property, plant, and equipment. Cost includes the purchase price, as well as costs incurred to get the asset ready for use. However, special rules are used to determine cost when an intangible asset is generated internally, as a result of a company’s own research and development efforts. These rules are discussed in a later section.

PATENTS

A patent is an exclusive right issued by a patent office that enables the recipient to manufacture, sell, or otherwise control an invention for a specified number of years from the date of the grant. These “legal lives” sometimes vary across countries, but the legal life in many countries is 20 years. A patent is non-renewable. But, companies can extend the legal life of a patent by obtaining new patents for improvements or other changes in the basic design. The initial cost of a patent is the cash or cash equivalent price paid to acquire the patent.

The saying, “A patent is only as good as the money you’re prepared to spend defending it,” is very true. Many patents are subject to litigation by competitors. Any legal costs an owner incurs in successfully defending a patent in an infringement suit are considered necessary to establish the patent’s validity. The owner adds those costs to the Patents account and amortizes them over the remaining life of the patent.

The patent holder amortizes the cost of a patent over its legal life or its useful life, whichever is shorter. Companies consider obsolescence and inadequacy in determining useful life. These factors may cause a patent to become economically ineffective before the end of its legal life.

COPYRIGHTS

Governments grant copyrights, which give the owner the exclusive right to reproduce and sell an artistic or published work. Copyrights extend for the life of the creator plus a specified number of years, which can vary by country but is commonly 70 years. The cost of a copyright is the cost of acquiring and defending it. The cost may be only the small fee paid to a copyright office. Or, it may amount to much more if an infringement suit is involved.

The useful life of a copyright generally is significantly shorter than its legal life. Therefore, copyrights usually are amortized over a relatively short period of time.

TRADEMARKS AND TRADE NAMES

A trademark or trade name is a word, phrase, jingle, or symbol that identifies a particular enterprise or product. Trade names like Big Mac, Coca-Cola, and Jetta create immediate product identification. They also generally enhance the sale of the product. The creator or original user may obtain exclusive legal right to the trademark or trade name by registering it with a patent office or similar governmental agency. Such registration provides a specified number of years of protection, which can vary by country but is commonly 20 years. The registration may be renewed indefinitely as long as the trademark or trade name is in use.

If a company purchases the trademark or trade name, its cost is the purchase price. If a company develops and maintains the trademark or trade name, any costs related to these activities are expensed as incurred. Because trademarks and trade names have indefinite lives, they are not amortized.

FRANCHISES AND LICENSES

When you fill up your tank at the BP (GBR) station, eat lunch at Subway (USA), or rent a car from Europcar, you are dealing with franchises. A franchise is a contractual arrangement between a franchisor and a franchisee. The franchisor grants the franchisee the right to sell certain products, perform specific services, or use certain trademarks or trade names, usually within a designated geographic area.

Another type of franchise is that entered into between a governmental body (commonly municipalities) and a company. This franchise permits the company to use public property in performing its services. Examples are the use of city streets for a bus line or taxi service, use of public land for telephone and electric lines, and the use of airwaves for radio or TV broadcasting. Such operating rights are referred to as licenses. Franchises and licenses may by granted for a definite period of time, an indefinite period, or perpetually.

When a company incurs costs in connection with the purchase of a franchise or license, it should recognize an intangible asset. Companies should amortize the cost of a limited-life franchise (or license) over its useful life. If the life is indefinite, the cost is not amortized. Annual payments made under a franchise agreement are recorded as operating expenses in the period in which they are incurred.

GOODWILL

Usually, the largest intangible asset that appears on a company’s statement of financial position is goodwill. Goodwill represents the value of all favorable attributes that relate to a company that is not tied to any other specific asset. These attributes include exceptional management, desirable location, good customer relations, skilled employees, high-quality products, and harmonious relations with labor unions. Goodwill is unique. Unlike assets such as investments and plant assets, which can be sold individually in the marketplace, goodwill can be identified only with the business as a whole.

If goodwill can be identified only with the business as a whole, how can its amount be determined? Management could try to put a monetary value on the factors listed above (exceptional management, desirable location, and so on). But, the results would be very subjective, and such subjective valuations would not contribute to the reliability of financial statements. Therefore, companies record goodwill only when an entire business is purchased. In that case, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.

In recording the purchase of a business, the company debits (increases) the identifiable acquired assets, credits liabilities at their fair values, credits cash for the purchase price, and records the difference as goodwill. Goodwill is not amortized because it is considered to have an indefinite life, but its value should be written down if impaired. Companies report goodwill in the statement of financial position under intangible assets.

Global Insight

Should Companies Write Up Goodwill?

SoftBank Corp. (JPN)

SoftBank Corp. (JPN) at one time was the country’s largest Internet company. It boosted the profit margin of its mobile-phone unit from 3.2% to 11.2% through what appeared to some as accounting tricks. What did it do? It wrote down the value of its mobile-phone-unit assets by half. This would normally result in a huge loss. But rather than take a loss, the company wrote up goodwill by the same amount. How did this move increase earnings? The assets were being depreciated over 10 years, but the company amortizes goodwill over 20 years. (Amortization of goodwill was allowed under the accounting standards it followed at that time.) While the new treatment did not break any rules, the company was criticized by investors for not providing sufficient justification or a detailed explanation for the sudden shift in policy.

Source: Andrew Morse and Yukari Iwatani Kane, “SoftBank’s Accounting Shift Raises Eyebrows,” Wall Street Journal (August 28, 2007), p. C1.

Q Which aspects of this treatment are allowed under IFRS? (See page 476.)

Research and Development Costs

Research and development costs are expenditures that may lead to patents, copyrights, new processes, and new products. Many companies spend considerable sums of money on research and development (R&D). For example, in a recent year Bayer (DEU) spent over €2.6 billion on R&D.

Research and development costs present accounting problems as it is sometimes difficult to assign these costs to specific projects. Also, there are uncertainties in identifying the amount and timing of future benefits. Costs in the research phase are always expensed as incurred. Costs in the development phase are expensed until specific criteria are met, primarily that technological feasibility is achieved. Development costs incurred after technological feasibility has been achieved are capitalized to Development Costs, which is considered an intangible asset.

To illustrate, assume that Laser Scanner Ltd. spent NT$1 million on research and NT$2 million on development of new products. Of the NT$2 million in development costs, NT$400,000 was incurred prior to technological feasibility and NT$1,600,000 was incurred after technological feasibility had been demonstrated. The company would record these costs as follows.

Research and Development Expense	1,400,000
Development Costs	1,600,000
Cash		3,000,000
(To record research and development costs)

> DO IT!

Classification Concepts

Match the statement with the term most directly associated with it.

Copyrights
Intangible assets
Research costs
Depletion
Franchises

_______ The allocation of the cost of an extractable natural resource in a rational and systematic manner.
_______ Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.
_______ An exclusive right granted by a government to reproduce and sell an artistic or published work.
_______ A right to sell certain products or services or to use certain trademarks or trade names within a designated geographic area.
_______ Costs incurred by a company that often lead to patents or new products. These costs must be expensed as incurred.

Action Plan

✓ Know that the accounting for intangibles often depends on whether the item has a finite or indefinite life.
✓ Recognize the many similarities and differences between the accounting for natural resources, plant assets, and intangible assets.

Solution

Related exercise material: BE9-13, BE9-14, BE9-15, E9-14, E9-15, E9-16, and DO IT! 9-5.

The Navigator

Statement Presentation and Analysis

Learning Objective 7

Indicate how plant assets, natural resources, and intangible assets are reported.

Presentation

Usually, companies combine plant assets and natural resources under “Property, plant, and equipment” in the statement of financial position. They show intangibles separately. Companies disclose either in the statement of financial position or the notes to the financial statements the balances of the major classes of assets, such as land, buildings, and equipment, and accumulated depreciation by major classes or in total. In addition, they should describe the depreciation and amortization methods that were used, as well as disclose the amount of depreciation and amortization expense for the period.

Illustration 9-23 shows a typical financial statement presentation of property, plant, and equipment and intangibles. The notes to the company’s financial statements present greater details about the accounting for its non-current tangible and intangible assets.

Illustration 9-23 Presentation of property, plant, and equipment, and intangible assets

STANDARD LTD. Statement of Financial Position (partial) (in billions)
	June 30
	2017	2016
Goodwill and intangible assets
Goodwill	¥59,700	¥56,500
Trademarks and other intangible assets, net	34,300	33,600
Net goodwill and intangible assets	94,000	90,100
Property, plant, and equipment
Land	900	900
Buildings	7,000	6,300
Machinery and equipment	30,000	27,000
	37,900	34,200
Accumulated depreciation	(18,000)	(15,100)
Net property, plant, and equipment	¥19,900	¥19,100

Analysis

Using ratios, we can analyze how efficiently a company uses its assets to generate sales. The asset turnover analyzes the productivity of a company’s assets. It tells us, as shown below for LG (KOR), how many Korean won of sales the company generates for each Korean won invested in assets. This ratio is computed by dividing net sales by average total assets for the period, as shown in Illustration 9-24. LG’s net sales for a recent year were 58,140 billion. Its total ending assets were 35,528 billion, and beginning assets were 34,766 billion.

Thus, each Korean won invested in assets produced 1.65 in sales for LG. If a company is using its assets efficiently, each investment in assets will create a high amount of sales. This ratio varies greatly among different industries—from those that are asset-intensive (utilities) to those that are not (services).

> DO IT!

Asset Turnover

Paramour Company reported net income of $180,000, net sales of $420,000, and had total assets of $460,000 on January 1, 2017, and total assets on December 31, 2017, of $540,000 billion. Determine Paramour’s asset turnover for 2017.

Action Plan

✓ Recognize that the asset turnover analyzes the productivity of a company’s assets.
✓ $Know the formula Net sales \div Average total assets equals Asset turnover$ $Know the formula Net sales \div Average total assets equals Asset turnover$ .

Solution

The asset turnover for Paramour Company is computed as follows.

$Net Sales$ $Net Sales$	$\div$ $\div$	$Average Total Assets$ $Average Total Assets$	$=$ $=$	$Asset Turnover$ $Asset Turnover$
$$ 420,000$ $$ 420,000$	$\div$ $\div$	$\frac{$ 460,000 + $ 540,000}{2}$ $\frac{$ 460,000 + $ 540,000}{2}$	$=$ $=$	$.84$ $.84$

Related exercise material: BE9-17, E9-17, and DO IT! 9-6.

The Navigator

APPENDIX 9A Exchange of Plant Assets

Learning Objective *8

Explain how to account for the exchange of plant assets.

Ordinarily, companies record a gain or loss on the exchange of plant assets. The rationale for recognizing a gain or loss is that most exchanges have commercial substance. An exchange has commercial substance if the future cash flows change as a result of the exchange.

To illustrate, Ramos Co. exchanges some of its equipment for land held by Brodhead AG. It is likely that the timing and amount of the cash flows arising from the land will differ significantly from the cash flows arising from the equipment. As a result, both Ramos and Brodhead are in different economic positions. Therefore, the exchange has commercial substance, and the companies recognize a gain or loss in the exchange. Because most exchanges have commercial substance (even when similar assets are exchanged), we illustrate only this type of situation for both a loss and a gain.

Loss Treatment

To illustrate an exchange that results in a loss, assume that Roland NV exchanged a set of used trucks plus cash for a new semi-truck. The used trucks have a combined book value of €42,000 (cost €64,000 less €22,000 accumulated depreciation). Roland’s purchasing agent, experienced in the secondhand market, indicates that the used trucks have a fair value of €26,000. In addition to the trucks, Roland must pay €17,000 for the semi-truck. Roland computes the cost of the semi-truck as follows.

Illustration 9A-1 Cost of semi-truck

Fair value of used trucks	€26,000
Cash paid	17,000
Cost of semi-truck	€43,000

Roland incurs a loss on disposal of plant assets of €16,000 on this exchange. The reason is that the book value of the used trucks is greater than the fair value of these trucks. The computation is as follows.

Illustration 9A-2 Computation of loss on disposal

Book value of used trucks $(€ 64,000 - € 22,000)$ $(€ 64,000 - € 22,000)$	€ 42,000
Fair value of used trucks	26,000
Loss on disposal of plant assets	€16,000

In recording an exchange at a loss, three steps are required: (1) eliminate the book value of the asset given up, (2) record the cost of the asset acquired, and (3) recognize the loss on disposal of plant assets. Roland thus records the exchange on the loss as follows.

Equipment (new)	43,000
Accumulated Depreciation—Equipment	22,000
Loss on Disposal of Plant Assets	16,000
Equipment (old)		64,000
Cash		17,000
(To record exchange of used trucks for semi-truck)

Gain Treatment

To illustrate a gain situation, assume that Mark Express decides to exchange its old delivery equipment plus cash of €3,000 for new delivery equipment. The book value of the old delivery equipment is €12,000 (cost €40,000 less accumulated depreciation €28,000). The fair value of the old delivery equipment is €19,000.

The cost of the new asset is the fair value of the old asset exchanged plus any cash paid (or other consideration given up). The cost of the new delivery equipment is €22,000, computed as follows.

Illustration 9A-3 Cost of new delivery equipment

Fair value of old delivery equipment	€ 19,000
Cash paid	3,000
Cost of new delivery equipment	€22,000

A gain results when the fair value of the old delivery equipment is greater than its book value. For Mark Express, there is a gain of €7,000 on disposal of plant assets, computed as follows.

Illustration 9A-4 Computation of gain on disposal

Fair value of old delivery equipment	€19,000
Book value of old delivery equipment $(€ 40,000 - € 28,000)$ $(€ 40,000 - € 28,000)$	12,000
Gain on disposal of plant assets	€ 7,000

Mark Express records the exchange as follows.

Equipment (new)	22,000
Accumulated Depreciation—Equipment (old)	28,000
Equipment (old)		40,000
Gain on Disposal of Plant Assets		7,000
Cash		3,000
(To record exchange of old delivery equipment for new delivery equipment)

In recording an exchange at a gain, the following three steps are involved: (1) eliminate the book value of the asset given up, (2) record the cost of the asset acquired, and (3) recognize the gain on disposal of plant assets. Accounting for exchanges of plant assets becomes more complex if the transaction does not have commercial substance. This issue is discussed in more advanced accounting classes.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW

The Navigator

LEARNING OBJECTIVES REVIEW

Describe how the historical cost principle applies to plant assets. The cost of plant assets includes all expenditures necessary to acquire the asset and make it ready for its intended use. Once cost is established, a company uses that amount as the basis of accounting for the plant asset over its useful life.

Explain the concept of depreciation and how to compute it. Depreciation is the allocation of the cost of a plant asset to expense over its useful (service) life in a rational and systematic manner. Depreciation is not a process of valuation, nor is it a process that results in an accumulation of cash.

Companies make revisions of periodic depreciation in present and future periods, not retroactively. They determine the new annual depreciation by dividing the depreciable cost at the time of the revision by the remaining useful life.

Three depreciation methods are:

Method	Effect on Annual Depreciation	Formula
Straight-line	Constant amount	$Depreciable cost \div Useful life (in years)$ $Depreciable cost \div Useful life (in years)$
Units-of-activity	Varying amount	$Depreciable cost per unit \times Units of activity during the year$ $Depreciable cost per unit \times Units of activity during the year$
Declining-balance	Decreasing amount	$Book value at beginning of year \times Declining - balance rate$ $Book value at beginning of year \times Declining - balance rate$

Distinguish between revenue and capital expenditures, and explain the entries for each. Companies incur revenue expenditures to maintain the operating efficiency and productive life of an asset. They debit these expenditures to Maintenance and Repairs Expense as incurred. Capital expenditures increase the operating efficiency, productive capacity, or expected useful life of the asset. Companies generally debit these expenditures to the plant asset affected.
Explain how to account for the disposal of a plant asset. The accounting for disposal of a plant asset through retirement or sale is as follows. (a) Eliminate the book value of the plant asset at the date of disposal. (b) Record cash proceeds, if any. (c) Account for the difference between the book value and the cash proceeds as a gain or loss on disposal.
Compute periodic depletion of extractable natural resources. Companies compute depletion cost per unit by dividing the total cost of the natural resource minus residual value by the number of units estimated to be in the resource. They then multiply the depletion cost per unit by the number of units extracted and sold.
Explain the basic issues related to accounting for intangible assets. The process of allocating the cost of an intangible asset is referred to as amortization. The cost of intangible assets with indefinite lives is not amortized. Companies normally use the straight-line method for amortizing intangible assets.
Indicate how plant assets, natural resources, and intangible assets are reported. Companies usually combine plant assets and natural resources under property, plant, and equipment. They show intangibles separately under intangible assets. Either within the statement of financial position or in the notes to the financial statements, companies should disclose the balances of the major classes of assets, such as land, buildings, and equipment, and accumulated depreciation by major classes or in total. They also should describe the depreciation and amortization methods used, and should disclose the amount of depreciation and amortization expense for the period. The asset turnover measures the productivity of a company’s assets in generating sales.
*Explain how to account for the exchange of plant assets.
Ordinarily, companies record a gain or loss on the exchange of plant assets. The rationale for recognizing a gain or loss is that most exchanges have commercial substance. An exchange has commercial substance if the future cash flows change as a result of the exchange.

GLOSSARY REVIEW

Accelerated-depreciation method: Depreciation method that produces higher depreciation expense in the early years than in the later years. (p. 436).
Additions and improvements: Costs incurred to increase the operating effi ciency, productive capacity, or useful life of a plant asset. (p. 441).
Amortization: The allocation of the cost of an intangible asset to expense over its useful life in a systematic and rational manner. (p. 446).
Asset turnover: A measure of how effi ciently a company uses its assets to generate sales; calculated as net sales divided by average total assets. (p. 450).
Capital expenditures: Expenditures that increase the companys investment in productive facilities. (p. 441).
Component depreciation: Depreciation method in which any signifi cant parts of a plant asset that have signifi cantly different useful lives are separately depreciated. (p. 437).
Copyrights: Exclusive grant from the government that allows the owner to reproduce and sell an artistic or published work. (p. 447).
Declining-balance method: Depreciation method that applies a constant rate to the declining book value of the asset and produces a decreasing annual depreciation expense over the useful life of the asset. (p. 436).
Depletion: The allocation of the cost of an extractable natural resource to expense in a rational and systematic manner over the resources useful life. (p. 444).
Depreciable cost: The cost of a plant asset less its residual value. (p. 433).
Depreciation: The process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. (p. 431).
Franchise (license): A contractual arrangement under which the franchisor grants the franchisee the right to sell certain products, perform specifi c services, or use certain trademarks or trade names, usually within a designated geographic area. (p. 447).
Going concern assumption: States that the company will continue in operation for the foreseeable future. (p. 432).
Goodwill: The value of all favorable attributes that relate to a company that is not attributable to any other specific asset. (p. 448).
Intangible assets: Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance. (p. 446).
Licenses: Operating rights to use public property, granted to a business by a governmental agency. (p. 447).
Materiality concept: If an item would not make a difference in decision-making, a company does not have to follow IFRS in reporting it. (p. 441).
Natural resources: Assets that consist of standing timber and underground deposits of oil, gas, or minerals. (p. 444).
Ordinary repairs: Expenditures to maintain the operating effi ciency and productive life of the plant asset. (p. 441).
Patent: An exclusive right issued by a patent offi ce that enables the recipient to manufacture, sell, or otherwise control an invention for a specifi ed number of years from the date of the grant. (p. 446).
Plant assets: Tangible resources that are used in the operations of the business and are not intended for sale to customers. (p. 428).
Research and development (R&D) costs: Expenditures that may lead to patents, copyrights, new processes, or new products. (p. 449).
Residual value: An estimate of an assets value at the end of its useful life. (p. 433).
Revenue expenditures: Expenditures that are immediately charged against revenues as an expense. (p. 441).
Straight-line method: Depreciation method in which periodic depreciation is the same for each year of the assets useful life. (p. 433).
Trademark (trade name): A word, phrase, jingle, or symbol that identifi es a particular enterprise or product. (p. 447).
Units-of-activity method: Depreciation method in which useful life is expressed in terms of the total units of production or use expected from an asset. (p. 435).
Useful life: An estimate of the expected productive life, also called service life, of an asset. (p. 432).

PRACTICE MULTIPLE-CHOICE QUESTIONS

(LO 1)

Erin Danielle Company purchased equipment and incurred the following costs.

Cash price €24,000

Sales taxes 1,200

Insurance during transit 200

Installation and testing 400

Total costs €25,800

What amount should be recorded as the cost of the equipment?
1. €24,000.
2. €25,200.
3. €25,400.
4. €25,800.

(LO 2)

Depreciation is a process of:
1. valuation.
2. cost allocation.
3. cash accumulation.
4. appraisal.

(LO 2)

Micah Bartlett Ltd. purchased equipment on January 1, 2016, at a total invoice cost of £400,000. The equipment has an estimated residual value of £10,000 and an estimated useful life of 5 years. The amount of accumulated depreciation at December 31, 2017, if the straight-line method of depreciation is used, is:
1. £80,000.
2. £160,000.
3. £78,000.
4. £156,000.

(LO 2)

Ann Torbert purchased a truck for €11,000 on January 1, 2016. The truck will have an estimated residual value of €1,000 at the end of 5 years. Using the units-of-activity method, the balance in accumulated depreciation at December 31, 2017, can be computed by the following formula:
1. $(€ 11,000 \div Total estimated activity) \times Units of activity$ $(€ 11,000 \div Total estimated activity) \times Units of activity$ for 2017.
2. $(€ 10,000 \div Total estimated activity) \times Units of activity$ $(€ 10,000 \div Total estimated activity) \times Units of activity$ for 2017.
3. $(€ 11,000 \div Total estimated activity) \times Units of activity$ $(€ 11,000 \div Total estimated activity) \times Units of activity$ for 2016 and 2017.
4. $(€ 10,000 \div Total estimated activity) \times Units of activity$ $(€ 10,000 \div Total estimated activity) \times Units of activity$ for 2016 and 2017.

(LO 2)

Chang Company purchased a piece of equipment on January 1, 2017. The equipment cost HK$600,000 and has an estimated life of 8 years and a residual value of HK$80,000. What was the depreciation expense for the asset for 2018 under the double-declining-balance method?
1. HK$65,000.
2. HK$112,500.
3. HK$150,000.
4. HK$65,620.

(LO 2)

When there is a change in estimated depreciation:
1. previous depreciation should be corrected.
2. current and future years’ depreciation should be revised.
3. only future years’ depreciation should be revised.
4. None of the above.

(LO 2)

Able Towing plc purchased a tow truck for £60,000 on January 1, 2015. It was originally depreciated on a straight-line basis over 10 years with an assumed residual value of £12,000. On December 31, 2017, before adjusting entries had been made, the company decided to change the remaining estimated life to 4 years (including 2017) and the residual value to £2,000. What was the depreciation expense for 2017?
1. £6,000.
2. £4,800.
3. £15,000.
4. £12,100.

(LO 2)

Wales plc applies revaluation accounting to equipment that is recorded on its books at €800,000, with €100,000 of accumulated depreciation after depreciation for the year recorded. It has determined that the asset is now worth €775,000. The entry to record the revaluation would include a:
1. credit to Equipment of €25,000.
2. debit to Equipment of €75,000.
3. credit to Accumulated Depreciation of €100,000.
4. debit to Revaluation Surplus of €75,000.

(LO 3)

Additions to plant assets are:
1. revenue expenditures.
2. debited to the Maintenance and Repairs Expense account.
3. debited to the Purchases account.
4. capital expenditures.

(LO 4)

Bennie Razor Company has decided to sell one of its old manufacturing machines on June 30, 2017. The machine was purchased for €80,000 on January 1, 2013, and was depreciated on a straight-line basis for 10 years assuming no residual value. If the machine was sold for €26,000, what was the amount of the gain or loss recorded at the time of the sale?
1. €18,000.
2. €54,000.
3. €22,000.
4. €46,000.

(LO 5)

Maggie Sharrer Ltd. expects to extract 20 million tons of coal from a mine that cost NT$12 million. If no residual value is expected and 2 million tons are mined in the first year, the entry to record depletion will include a:
1. debit to Accumulated Depletion of NT$2,000,000.
2. credit to Depletion Expense of NT$1,200,000.
3. debit to Inventory of NT$1,200,000.
4. credit to Accumulated Depletion of NT$2,000,000.

(LO 6)

Which of the following statements is false?
1. If an intangible asset has a finite life, it should be amortized.
2. The amortization period of an intangible asset can exceed 20 years.
3. Goodwill is recorded only when a business is purchased.
4. Development costs are always expensed when incurred.

(LO 7)

Indicate which of the following statements is true.
1. Since intangible assets lack physical substance, they need be disclosed only in the notes to the financial statements.
2. Goodwill should be reported as a contra account in the equity section.
3. Totals of major classes of assets can be shown in the statement of financial position, with asset details disclosed in the notes to the financial statements.
4. Intangible assets are typically combined with plant assets and extractable natural resources and shown in the property, plant, and equipment section.

(LO 7)

Tianzi Coffee Ltd. reported net sales of HK$1,800,000, net income of HK$540,000, beginning total assets of HK$2,000,000, and ending total assets of HK$3,000,000. What was the company’s asset turnover?
1. 0.90.
2. 0.20.
3. 0.72.
4. 1.39.

(LO 8)

*Schopenhauer NV exchanged an old machine, with a book value of €39,000 and a fair value of €35,000, and paid €10,000 cash for a similar new machine. The transaction has commercial substance. At what amount should the machine acquired in the exchange be recorded on Schopenhauer’s books?
1. €45,000.
2. €46,000.
3. €49,000.
4. €50,000.

(LO 8)

In exchanges of assets in which the exchange has commercial substance:
1. neither gains nor losses are recognized immediately.
2. gains, but not losses, are recognized immediately.
3. losses, but not gains, are recognized immediately.
4. both gains and losses are recognized immediately.

Solutions

(d) All of the costs $(€ 1,200 + € 200 + € 400)$ $(€ 1,200 + € 200 + € 400)$ in addition to the cash price (€24,000) should be included in the cost of the equipment because they were necessary expenditures to acquire the asset and make it ready for its intended use. The other choices are therefore incorrect.
(b) Depreciation is a process of allocating the cost of an asset over its useful life, not a process of (a) valuation, (c) cash accumulation, or (d) appraisal.
(d) Accumulated depreciation will be the sum of 2 years of depreciation expense. Annual depreciation for this asset is $(£ 400,000 - £ 10,000) / 5 = £ 78,000$ $(£ 400,000 - £ 10,000) / 5 = £ 78,000$ . The sum of 2 years’ depreciation is therefore $£ 156,000 (£ 78,000 + £ 78,000)$ $£ 156,000 (£ 78,000 + £ 78,000)$ , not (a) £80,000, (b) £160,000, or (c) £78,000.
(d) The units-of-activity method takes residual value into consideration; therefore, the depreciable cost is €10,000. This amount is divided by total estimated activity. The resulting number is multiplied by the units of activity used in 2016 and 2017 to compute the accumulated depreciation at the end of 2017, the second year of the asset’s use. The other choices are therefore incorrect.
(b) For the double-declining method, the depreciation rate would be 25% or $(1 / 8 \times 2)$ $(1 / 8 \times 2)$ . For 2017, annual depreciation expense is $HK $ 150,000 (HK $ 600,000 book value \times 25 %)$ $HK $ 150,000 (HK $ 600,000 book value \times 25 %)$ ; for 2018, annual depreciation expense is $HK $ 112,500 [(HK $ 600,000 - HK $ 150,000) \times 25 %]$ $HK $ 112,500 [(HK $ 600,000 - HK $ 150,000) \times 25 %]$ , not (a) HK$65,000, (c) HK$150,000, or (d) HK$65,620.
(b) When there is a change in estimated depreciation, the current and future years’ depreciation computation should reflect the new estimates. The other choices are incorrect because (a) previous years’ depreciation should not be adjusted when new estimates are made for depreciation, and (c) when there is a change in estimated depreciation, the current and future years’ depreciation computation should reflect the new estimates. Choice (d) is wrong because there is a correct answer.
(d) First, calculate accumulated depreciation from January 1, 2015, through December 31, 2016, which is $£ 9,600 {[(£ 60,000 - £ 12,000) / 10 years] \times 2 years}$ $£ 9,600 {[(£ 60,000 - £ 12,000) / 10 years] \times 2 years}$ . Next, calculate the revised depreciable cost, which is $£ 48,400 (£ 60,000 - £ 9,600 - £ 2,000)$ $£ 48,400 (£ 60,000 - £ 9,600 - £ 2,000)$ . Thus, the depreciation expense for 2017 is £12,100 (£48,400/4), not (a) £6,000, (b) £4,800, or (c) £15,000.
(a) The entry to record the revaluation would include a credit to Equipment of €25,000, as well as a debit (not credit) to Accumulated Depreciation of €100,000 and a credit (not debit) to Revaluation Surplus of €75,000.
(d) When an addition is made to plant assets, it is intended to increase productive capacity, increase the assets’ useful life, or increase the efficiency of the assets. This is called a capital expenditure. The other choices are incorrect because (a) additions to plant assets are not revenue expenditures because the additions will have a long-term useful life whereas revenue expenditures are minor repairs and maintenance that do not prolong the life of the assets; (b) additions to plant assets are debited to Plant Assets, not Maintenance and Repairs Expense, because the Maintenance and Repairs Expense account is used to record expenditures not intended to increase the life of the assets; and (c) additions to plant assets are debited to Plant Assets, not Purchases, because the Purchases account is used to record assets intended for resale (inventory).
(a) First, the book value needs to be determined. The accumulated depreciation as of June 30, 2017, is $€ 36,000 [(€ 80,000 / 10) \times 4.5 years]$ $€ 36,000 [(€ 80,000 / 10) \times 4.5 years]$ . Thus, the cost of the machine less accumulated depreciation equals $€ 44,000 (€ 80,000 - € 36,000)$ $€ 44,000 (€ 80,000 - € 36,000)$ . The loss recorded at the time of sale is $€ 18,000 (€ 26,000 - € 44,000)$ $€ 18,000 (€ 26,000 - € 44,000)$ , not (b) €54,000, (c) €22,000, or (d) €46,000.
(c) The amount of depletion is determined by computing the depletion per unit $(NT $ 12 million / 20 million tons = NT $ 0.60 per ton)$ $(NT $ 12 million / 20 million tons = NT $ 0.60 per ton)$ and then multiplying that amount times the number of units extracted during the year $(2 million tons \times NT $ 0.60 = NT $ 1,200,000)$ $(2 million tons \times NT $ 0.60 = NT $ 1,200,000)$ . This amount is debited to Inventory and credited to Accumulated Depletion. The other choices are therefore incorrect.
(d) Development costs are expensed when incurred until technological feasibility is achieved. After that point, development costs are capitalized. The other choices are true statements.
(c) Reporting only totals of major classes of assets in the statement of financial position is appropriate. Additional details can be shown in the notes to the financial statements. The other choices are false statements.
(c) $Asset turnover = Net sales (HK $ 1,800,000) / Average total assets [(HK $ 2,000,000 + HK $ 3,000,000) / 2] = 0.72 times$ $Asset turnover = Net sales (HK $ 1,800,000) / Average total assets [(HK $ 2,000,000 + HK $ 3,000,000) / 2] = 0.72 times$ , not (a) 0.90, (b) 0.20, or (d) 1.39 times.
(a) When an exchange has commercial substance, the debit to the new asset is equal to the fair value of the old asset plus the cash paid $(€ 35,000 + € 10,000 = € 45,000)$ $(€ 35,000 + € 10,000 = € 45,000)$ , not (b) €46,000, (c) €49,000, or (d) €50,000.
(d) Both gains and losses are recognized immediately when an exchange of assets has commercial substance. The other choices are therefore incorrect.

PRACTICE EXERCISES

Determine depreciation for partial periods.

(LO 2)

Winston plc purchased a new machine on October 1, 2017, at a cost of £120,000. The company estimated that the machine will have a residual value of £12,000. The machine is expected to be used for 12,000 working hours during its 4-year life.

Instructions

Compute the depreciation expense under the following methods for the year indicated.

Straight-line for 2017.
Units-of-activity for 2017, assuming machine usage was 1,700 hours.
Declining-balance using double the straight-line rate for 2017 and 2018.

Solution

1. Straight-line method:
  
  $(\frac{£ 120,000 - £ 12,000}{4}) = £ 27,000 per year$ $(\frac{£ 120,000 - £ 12,000}{4}) = £ 27,000 per year$
  
  $2017 depreciation = £ 27,000 \times 3 / 12 = \underset{̲}{\underset{̲}{£ 6,750}}$ $2017 depreciation = £ 27,000 \times 3 / 12 = \underset{̲}{\underset{̲}{£ 6,750}}$
2. Units-of-activity method:
  
  $(\frac{£ 120,000 - £ 12,000}{12,000}) = £ 9 per hour$ $(\frac{£ 120,000 - £ 12,000}{12,000}) = £ 9 per hour$
  
  $2017 depreciation = 1,700 hours \times £ 9 = \underset{̲}{\underset{̲}{£ 15,300}}$ $2017 depreciation = 1,700 hours \times £ 9 = \underset{̲}{\underset{̲}{£ 15,300}}$
3. Declining-balance method:
  
  $2017 depreciation = £ 120,000 \times 50 % \times 3 / 12 = \underset{̲}{\underset{̲}{£ 15,000}}$ $2017 depreciation = £ 120,000 \times 50 % \times 3 / 12 = \underset{̲}{\underset{̲}{£ 15,000}}$
  
  $Book value January 1, 2018 = £ 120,000 - £ 15,000 = \underset{̲}{\underset{̲}{£ 105,000}}$ $Book value January 1, 2018 = £ 120,000 - £ 15,000 = \underset{̲}{\underset{̲}{£ 105,000}}$
  
  $2018 depreciation = £ 105,000 \times 50 % = \underset{̲}{\underset{̲}{£ 52,500}}$ $2018 depreciation = £ 105,000 \times 50 % = \underset{̲}{\underset{̲}{£ 52,500}}$

Prepare entries to set up appropriate accounts for different intangibles; amortize intangible assets.

(LO 6)

Sun Moon Lake Ltd., organized in 2017, has the following transactions related to intangible assets.

1/2/17	Purchased patent (8-year life)	NT$560,000
4/1/17	Goodwill purchased (indefinite life)	360,000
7/1/17	10-year franchise; expiration date 7/1/2027	440,000
9/1/17	Research and development costs	185,000

Instructions

Prepare the necessary entries to record these intangibles. All costs incurred were for cash. Make the adjusting entries as of December 31, 2017, recording any necessary amortization and reflecting all balances accurately as of that date. Assume all development costs were incurred prior to technological feasibility.

Solution

1/2/17	Patents	560,000
	Cash		560,000
4/1/17	Goodwill	360,000
	Cash		360,000
	(Part of the entry to record purchase of another company)
7/1/17	Franchises	440,000
	Cash		440,000
9/1/17	Research and Development Expense	185,000
	Cash		185,000
12/31/17	Amortization Expense
	$(NT $ 560,000 \div 8) + [(NT $ 440,000 \div 10) \times 1 / 2]$ $(NT $ 560,000 \div 8) + [(NT $ 440,000 \div 10) \times 1 / 2]$	92,000
	Patents		70,000
	Franchises		22,000

Ending balances, 12/31/17:

$Patents = NT $ 490,000 (NT $ 560,000 - NT $ 70,000)$ $Patents = NT $ 490,000 (NT $ 560,000 - NT $ 70,000)$
$Goodwill = NT $ 360,000$ $Goodwill = NT $ 360,000$
$Franchises = NT $ 418,000 (NT $ 440,000 - NT $ 22,000)$ $Franchises = NT $ 418,000 (NT $ 440,000 - NT $ 22,000)$
$Research and development expense = NT $ 185,000$ $Research and development expense = NT $ 185,000$

PRACTICE PROBLEMS

Compute depreciation under different methods.

(LO 2)

DuPage SA purchases a factory machine at a cost of €18,000 on January 1, 2017. DuPage expects the machine to have a residual value of €2,000 at the end of its 4-year useful life.
During its useful life, the machine is expected to be used 160,000 hours. Actual annual hourly use was 2017, 40,000; 2018, 60,000; 2019, 35,000; and 2020, 25,000.

Instructions

Prepare depreciation schedules for the following methods: (a) straight-line, (b) units-of-activity, and (c) declining-balance using double the straight-line rate.

Solution

Record disposal of plant asset.

(LO 4)

On January 1, 2017, Hong Kong International Airport Limousine Co. purchased a limo at an acquisition cost of HK$280,000. The vehicle has been depreciated by the straight-line method using a 4-year service life and a HK$40,000 residual value. The company’s fiscal year ends on December 31.

Instructions

Prepare the journal entry or entries to record the disposal of the limousine assuming that it was:

Retired and scrapped with no residual value on January 1, 2021.
Sold for HK$50,000 on July 1, 2020.

Solution

WileyPLUS

Brief Exercises, DO IT! Review, Exercises, and Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: Asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

QUESTIONS

Rick Baden is uncertain about the applicability of the historical cost principle to plant assets. Explain the principle to Rick.
What are some examples of land improvements?
Lexa Company acquires the land and building owned by Malta Company. What types of costs may be incurred to make the asset ready for its intended use if Lexa Company wants to use (a) only the land, and (b) both the land and the building?
In a recent newspaper release, the president of Wanzo OAO asserted that something has to be done about depreciation. The president said, “Depreciation does not come close to accumulating the cash needed to replace the asset at the end of its useful life.” What is your response to the president?
Jeremy is studying for the next accounting examination. He asks your help on two questions: (a) What is residual value? (b) Is residual value used in determining periodic depreciation under each depreciation method? Answer Jeremy’s questions.
Contrast the straight-line method and the units-of-activity method as to (a) useful life, and (b) the pattern of periodic depreciation over useful life.
Contrast the effects of the three depreciation methods on annual depreciation expense.
What is component depreciation, and when must it be used?
In the fourth year of an asset’s 5-year useful life, the company decides that the asset will have a 6-year service life. How should the revision of depreciation be recorded? Why?
What is revaluation of plant assets? When should revaluation be applied?
Distinguish between revenue expenditures and capital expenditures during an asset’s useful life.
How is a gain or loss on the sale of a plant asset computed?
Luis SA owns a machine that is fully depreciated but is still being used. How should Luis account for this asset and report it in the financial statements?
What are extractable natural resources, and what are their distinguishing characteristics?
Explain the concept of depletion and how it is computed.
What are the similarities and differences between the terms depreciation, depletion, and amortization?
Spectrum Company hires an accounting intern who says that intangible assets should always be amortized over their legal lives. Is the intern correct? Explain.
Goodwill has been defined as the value of all favorable attributes that relate to a business. What types of attributes could result in goodwill?
Mark Gannon, a business major, is working on a case problem for one of his classes. In the case problem, the company needs to raise cash to market a new product it developed. Sara Bates, an engineering major, takes one look at the company’s statement of financial position and says, “This company has an awful lot of goodwill. Why don’t you recommend that it sell some of it to raise cash?” How should Mark respond to Sara?
Under what conditions is goodwill recorded?
Often, research and development costs provide companies with benefits that last a number of years. (For example, these costs can lead to the development of a patent that will increase the company’s income for many years.) However, IFRS requires that many such costs be recorded as an expense when incurred. Why?
Some product development expenditures are recorded as research and development expenses, and others as development costs. Explain the difference between these accounts, and how a company decides which classification is appropriate.
McDonald’s Corporation (USA) reports total average assets of $28.9 billion and net sales of $20.5 billion. What is the company’s asset turnover?
Alpha SE and Zito SE operate in the same industry. Alpha uses the straight-line method to account for depreciation; Zito uses an accelerated method. Explain what complications might arise in trying to compare the results of these two companies.
Wanzo ASA uses straight-line depreciation for financial reporting purposes but an accelerated method for tax purposes. Is it acceptable to use different methods for the two purposes? What is Wanzo’s motivation for doing this?
You are comparing two companies in the same industry. You have determined that Lam Ltd. depreciates its plant assets over a 40-year life, whereas Shuey Ltd. depreciates its plant assets over a 20-year life. Discuss the implications this has for comparing the results of the two companies.
Zelm Company is doing significant work to revitalize its warehouses. It is not sure whether it should capitalize these costs or expense them. What are the implications for current-year net income and future net income of expensing versus capitalizing these costs?
When assets are exchanged in a transaction involving commercial substance, how is the gain or loss on disposal of plant assets computed?
Morris Refrigeration Company trades in an old machine on a new model when the fair value of the old machine is greater than its book value. The transaction has commercial substance. Should Morris recognize a gain on disposal of plant assets? If the fair value of the old machine is less than its book value, should Morris recognize a loss on disposal of plant assets?

BRIEF EXERCISES

Determine the cost of land.

(LO 1)

BE9-1 The following expenditures were incurred by Rosenberg AG in purchasing land: cash price €64,000, accrued taxes €3,000, attorneys’ fees €2,500, real estate broker’s commission €2,000, and clearing and grading €4,400. What is the cost of the land?

Determine the cost of a truck.

(LO 1)

BE9-2 Jawson plc incurs the following expenditures in purchasing a truck: cash price £30,000, accident insurance £2,000, sales taxes £1,800, motor vehicle license £160, and painting and lettering £400. What is the cost of the truck?

Compute straight-line depreciation.

(LO 2)

BE9-3 Weller Company acquires a delivery truck at a cost of €42,000. The truck is expected to have a residual value of €9,000 at the end of its 5-year useful life. Compute annual depreciation expense for the first and second years using the straight-line method.

Compute depreciation and evaluate treatment.

(LO 2)

BE9-4 Kowloon Ltd. purchased land and a building on January 1, 2017. Management’s best estimate of the value of the land was HK$1,000,000 and of the building HK$2,000,000. However, management told the accounting department to record the land at HK$2,250,000 and the building at HK$750,000. The building is being depreciated on a straight-line basis over 20 years with no residual value. Why do you suppose management requested this accounting treatment? Is it ethical?

Compute declining-balance depreciation.

(LO 2)

BE9-5 Depreciation information for Weller Company is given in BE9-3. Assuming the declining-balance depreciation rate is double the straight-line rate, compute annual depreciation for the first and second years under the declining-balance method.

Compute depreciation using the units-of-activity method.

(LO 2)

BE9-6 Freemont Taxi Service uses the units-of-activity method in computing depreciation on its taxicabs. Each cab is expected to be driven 150,000 miles. Taxi no. 10 cost €33,500 and is expected to have a residual value of €500. Taxi no. 10 is driven 36,000 miles in year 1 and 22,000 miles in year 2. Compute the depreciation for each year.

Compute depreciation using component method.

(LO 2)

BE9-7 Mandall Ltd. constructed a warehouse for £280,000. Mandall estimates that the warehouse has a useful life of 20 years and no residual value. Construction records indicate that £40,000 of the cost of the warehouse relates to its heating, ventilation, and air conditioning (HVAC) system, which has an estimated useful life of only 8 years. Compute the first year of depreciation expense using straight-line component depreciation.

Compute revised depreciation.

(LO 2)

BE9-8 On January 1, 2017, the Vasquez SA ledger shows Equipment €32,000 and Accumulated Depreciation—Equipment €9,000. The depreciation resulted from using the straight-line method with a useful life of 10 years and residual value of €2,000. On this date, the company concludes that the equipment has a remaining useful life of only 4 years with the same residual value. Compute the revised annual depreciation.

Prepare entries for revaluation of plant assets.

(LO 3)

BE9-9 At the end of its first year of operations, Brianna Company chose to use the revaluation framework allowed under IFRS. Brianna’s ledger shows Equipment £480,000 and Accumulated Depreciation—Equipment £60,000. Prepare journal entries to record the following.

Independent appraisers determine that the plant assets have a fair value of £468,000.
Independent appraisers determine that the plant assets have a fair value of £400,000.

Prepare entries for delivery truck costs.

(LO 3)

BE9-10 Tong Company had the following two transactions related to its delivery truck.

Paid €45 for an oil change.
Paid €580 to install special gear unit, which increases the operating efficiency of the truck.

Prepare Tong’s journal entries to record these two transactions.

Prepare entries for disposal by retirement.

(LO 4)

BE9-11 Prepare journal entries to record the following.

Matterhorn AG retires its delivery equipment, which cost CHF44,000. Accumulated depreciation is also CHF44,000 on this delivery equipment. No residual value is received.
Assume the same information as (a), except that accumulated depreciation is CHF37,000, instead of CHF44,000, on the delivery equipment.

Prepare entries for disposal by sale.

(LO 4)

BE9-12 Arma Ltd. sells equipment on September 30, 2017, for £20,000 cash. The equipment originally cost £72,000 and as of January 1, 2017, had accumulated depreciation of £42,000. Depreciation for the first 9 months of 2017 is £4,800. Prepare the journal entries to (a) update depreciation to September 30, 2017, and (b) record the sale of the equipment.

Prepare depletion entry and statement of financial position presentation for natural resources.

(LO 5)

BE9-13 Jackie Chan Mining Co. purchased for ¥7 million a mine that is estimated to have 28 million tons of ore and no residual value. In the first year, 4.7 million tons of ore are extracted.

Prepare the journal entry to record depletion for the first year.
Show how this mine is reported on the statement of financial position at the end of the first year.

Prepare amortization expense entry and statement of financial position presentation for intangibles.

(LO 6)

BE9-14 Felipe SA purchases a patent for R$120,000 on January 2, 2017. Its estimated useful life is 8 years.

Prepare the journal entry to record amortization expense for the first year.
Show how this patent is reported on the statement of financial position at the end of the first year.

Prepare entry for research and development costs.

(LO 6)

BE9-15 Newell Industries spent €260,000 on research and €600,000 on development of a new product. Of the €600,000 in development costs, €400,000 was incurred prior to technological feasibility and €200,000 after technological feasibility had been demonstrated. Prepare the journal entry to record research and development costs.

Classify long-lived assets on statement of financial position.

(LO 7)

BE9-16 Information related to plant assets, extractable natural resources, and intangibles at the end of 2017 for Loomis Company is as follows: buildings £1,300,000, accumulated depreciation—buildings £650,000, goodwill £410,000, coal mine £500,000, and accumulated depletion—coal mine £122,000. Prepare a partial statement of financial position of Loomis Company, Ltd. for these items.

Analyze long-lived assets.

(LO 7)

BE9-17 In its 2013 annual report, Target (USA) reported beginning total assets of $48.2 billion; ending total assets of $44.6 billion; and net sales of $72.6 billion. Compute Target’s asset turnover.

Prepare entry for disposal by exchange.

(LO 8)

*BE9-18 Cordero Company SLU exchanges old delivery equipment for new delivery equipment. The book value of the old delivery equipment is €33,000 (cost €61,000 less accumulated depreciation €28,000). Its fair value is €19,000, and cash of €5,000 is paid. Prepare the entry to record the exchange, assuming the transaction has commercial substance.

Prepare entry for disposal by exchange.

(LO 8)

*BE9-19 Assume the same information as BE9-18, except that the fair value of the old delivery equipment is €37,200. Prepare the entry to record the exchange.

> DO IT! REVIEW

Explain accounting for cost of plant assets.

(LO 1)

DO IT! 9-1 Yockey Company Ltd. purchased a delivery truck. The total cash payment was £28,220 including the following items.

Negotiated purchase price	£24,000
Installation of special shelving	1,200
Painting and lettering	780
Motor vehicle license	140
Annual insurance policy	800
Sales tax	1,300
Total paid	£28,220

Explain how each of these costs would be accounted for.

Calculate depreciation expense and make journal entry.

(LO 2)

DO IT! 9-2 On January 1, 2017, Rolling Hills Country Club purchased a new riding mower for £18,000. The mower is expected to have an 8-year life with a £2,000 residual value. What journal entry would Rolling Hills make at December 31, 2017, if it uses straight-line depreciation?

Calculate revised depreciation.

(LO 2)

DO IT! 9-3 Savin NV purchased a piece of equipment for €50,000. It estimated a 5-year life and €2,000 residual value. At the end of year four (before the depreciation adjustment), it estimated the new total life to be 8 years and the new residual value to be €4,000. Compute the revised depreciation.

Make journal entries to record plant asset disposal.

(LO 4)

DO IT! 9-4 Forgetta Manufacturing has old equipment that cost €48,000. The equipment has accumulated depreciation of €28,000. Forgetta has decided to sell the equipment.

What entry would Forgetta make to record the sale of the equipment for €26,000 cash?
What entry would Forgetta make to record the sale of the equipment for €15,000 cash?

Match intangibles classifications concepts.

(LO 6)

DO IT! 9-5 Match the statement with the term most directly associated with it.

Goodwill
Intangible assets
Development expenses
Amortization
Franchises
Development costs

_______ Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.
_______ The allocation of the cost of an intangible asset to expense in a rational and systematic manner.
_______ A right to sell certain products or services, or use certain trademarks or trade names within a designated geographic area.
_______ Costs incurred after technological feasibility to complete the development of a new product.
_______ The excess of the cost of a company over the fair value of the net assets acquired.
_______ Costs incurred after research to bring a new product to a state of technological feasibility.

Calculate asset turnover.

(LO 7)

DO IT! 9-6 For 2017, Sale Company reported beginning total assets of $300,000 and ending total assets of $340,000. Its net income for this period was $50,000, and its net sales were $400,000. Compute the company’s asset turnover for 2017.

EXERCISES

Determine cost of plant acquisitions.

(LO 1)

E9-1 The following expenditures (in thousands) relating to plant assets were made by Lee Jung Ltd. during the first 2 months of 2017.

Paid 5,000 of accrued taxes at time plant site was acquired.
Paid 400 insurance to cover possible accident loss on new factory machinery while the machinery was in transit.
Paid 850 sales taxes on new delivery truck.
Paid 17,500 for parking lots and driveways on new plant site.
Paid 310 to have company name and advertising slogan painted on new delivery truck.
Paid 8,000 for installation of new factory machinery.
Paid 900 for one-year accident insurance policy on new delivery truck.
Paid 90 motor vehicle license fee on the new truck.

Instructions

Explain the application of the historical cost principle in determining the acquisition cost of plant assets.
List the numbers of the foregoing transactions, and opposite each indicate the account title to which each expenditure should be debited.

Determine property, plant, and equipment costs.

(LO 1)

E9-2 Bliesmer SE incurred the following costs.

1. Sales tax on factory machinery purchased	€ 5,000
2. Painting of and lettering on truck immediately upon purchase	700
3. Installation and testing of factory machinery	2,000
4. Real estate broker’s commission on land purchased	3,500
5. Insurance premium paid for first year’s insurance on new truck	1,100
6. Cost of landscaping on property purchased	7,200
7. Cost of paving parking lot for new building constructed	17,900
8. Cost of clearing, draining, and filling land	12,600
9. Architect’s fees on self-constructed building	10,000

Instructions

Indicate to which account Bliesmer would debit each of the costs.

Determine acquisition costs of land.

(LO 1)

E9-3 On March 1, 2017, Rollinger Company acquired real estate on which it planned to construct a small office building. The company paid €86,000 in cash. An old warehouse on the property was razed at a cost of €9,400; the salvaged materials were sold for €1,700. Additional expenditures before construction began included €1,100 attorney’s fee for work concerning the land purchase, €5,100 real estate broker’s fee, €7,800 architect’s fee, and €12,700 to put in driveways and a parking lot.

Instructions

Determine the amount to be reported as the cost of the land.
For each cost not used in part (a), indicate the account to be debited.

Understand depreciation concepts.

(LO 2)

E9-4 Ann Tremel has prepared the following list of statements about depreciation.

Depreciation is a process of asset valuation, not cost allocation.
Depreciation provides for the proper matching of expenses with revenues.
The book value of a plant asset should approximate its fair value.
Depreciation applies to three classes of plant assets: land, buildings, and equipment.
Depreciation does not apply to a building because its usefulness and revenue-producing ability generally remain intact over time.
The revenue-producing ability of a depreciable asset will decline due to wear and tear and to obsolescence.
Recognizing depreciation on an asset results in an accumulation of cash for replacement of the asset.
The balance in accumulated depreciation represents the total cost that has been charged to expense.
Depreciation expense and accumulated depreciation are reported on the income statement.
Three factors affect the computation of depreciation: cost, useful life, and residual value.

Instructions

Identify each statement as true or false. If false, indicate how to correct the statement.

Compute depreciation under units-of-activity method.

(LO 2)

E9-5 Copacabana Bus Lines uses the units-of-activity method in depreciating its buses. One bus was purchased on January 1, 2017, at a cost of R$145,000. Over its 4-year useful life, the bus is expected to be driven 100,000 miles. Residual value is expected to be R$15,000.

Instructions

Compute the depreciable cost per unit.
Prepare a depreciation schedule assuming actual mileage was 2017, 27,000; 2018, 32,000; 2019, 24,000; and 2020, 17,000.

Determine depreciation for partial periods.

(LO 2)

E9-6 Xanadu A/S purchased a new machine on October 1, 2017, at a cost of €96,000. The company estimated that the machine will have a residual value of €12,000. The machine is expected to be used for 10,000 working hours during its 5-year life.

Instructions

Compute the depreciation expense under the following methods for the year indicated.

Straight-line for 2017.
Units-of-activity for 2017, assuming machine usage was 1,700 hours.
Declining-balance using double the straight-line rate for 2017 and 2018.

Compute depreciation using different methods.

(LO 2)

E9-7 Tanger Company purchased a delivery truck for R$38,000 on January 1, 2017. The truck has an expected residual value of R$6,000, and is expected to be driven 100,000 miles over its estimated useful life of 8 years. Actual miles driven were 15,000 in 2017 and 12,000 in 2018.

Instructions

Compute depreciation expense for 2017 and 2018 using (1) the straight-line method, (2) the units-of-activity method, and (3) the double-declining-balance method.
Assume that Tanger uses the straight-line method.
1. Prepare the journal entry to record 2017 depreciation.
2. Show how the truck would be reported in the December 31, 2017, statement of financial position.

Compute depreciation under component method.

(LO 2)

E9-8 Mooney Ltd. completed construction of an office building for £2,400,000 on December 31, 2016. The company estimated that the building would have a residual value of £0 and a useful life of 40 years. A more detailed review of the expenditures related to the building indicates that £300,000 of the total cost was used for personal property and £180,000 for land improvements. The personal property has a depreciable life of 5 years and land improvements have a depreciable life of 10 years.

Instructions

Compute depreciation expense for 2017 using component depreciation and the straight-line method.

Compute revised annual depreciation.

(LO 2)

E9-9 Steve Grant, the new controller of Greenbriar Ltd., has reviewed the expected useful lives and residual values of selected depreciable assets at the beginning of 2017. His findings are as follows.

All assets are depreciated by the straight-line method. Greenbriar uses a calendar year in preparing annual financial statements. After discussion, management has agreed to accept Grant’s proposed changes.

Instructions

Compute the revised annual depreciation on each asset in 2017. (Show computations.)
Prepare the entry (or entries) to record depreciation on the building in 2017.

Journalize entries for straight-line depreciation and revaluation.

(LO 2)

E9-10 Barton Enterprises purchased equipment on January 1, 2017, at a cost of €350,000. Barton uses the straight-line depreciation method, a 5-year estimated useful life, and no residual value. At the end of 2017, independent appraisers determined that the assets have a fair value of €320,000.

Instructions

Prepare the journal entry to record 2017 depreciation using the straight-line method.
Prepare the journal entry to record the revaluation of the equipment.
Prepare the journal entry to record 2018 depreciation, assuming no additional revaluation.

Journalize entries for straight-line depreciation and revaluation.

(LO 2)

E9-11 At December 31, 2017, the end of its first year of operations, Franklin SA chose to use the revaluation framework allowed under IFRS. Franklin’s ledger shows Equipment €750,000 and Accumulated Depreciation—Equipment €150,000.

Instructions

Independent appraisers determine that the plant assets have a fair value of €660,000. Record the revaluation.
Using your answer from part (a), what would be the amount of Franklin’s 2018 depreciation? Assume no change in the value of Franklin’s equipment in 2018, a 4-year remaining life, and no residual value.
Independent appraisers determine that the plant assets have a fair value of €520,000. Record the revaluation. (Ignore your answers to parts (a) and (b).)
Using your answer from part (a), what would be the amount of Franklin’s 2018 depreciation? Assume no change in the value of Franklin’s equipment in 2018, a 4-year remaining life, and no residual value.

Journalize entries for disposal of plant assets.

(LO 2)

E9-12 Presented below are selected transactions at Ingles Company for 2017.

Jan. 1	Retired a piece of machinery that was purchased on January 1, 2007. The machine cost £58,000 on that date. It had a useful life of 10 years with no residual value.
June 30	Sold a computer that was purchased on January 1, 2014. The computer cost £40,000. It had a useful life of 5 years with no residual value. The computer was sold for £14,600.
Dec. 31	Discarded a delivery truck that was purchased on January 1, 2013. The truck cost £34,000. It was depreciated based on a 6-year useful life with a £4,000 residual value.

Instructions

Journalize all entries required on the above dates, including entries to update depreciation, where applicable, on assets disposed of. Ingles Company uses straight-line depreciation. (Assume depreciation is up to date as of December 31, 2016.)

Journalize entries for disposal of equipment.

(LO 4)

E9-13 Francis Company owns equipment that cost €50,000 when purchased on January 1, 2014. It has been depreciated using the straight-line method based on an estimated residual value of €8,000 and an estimated useful life of 5 years.

Instructions

Prepare Francis Company’s journal entries to record the sale of the equipment in these four independent situations.

Sold for €28,000 on January 1, 2017.
Sold for €28,000 on May 1, 2017.
Sold for €11,000 on January 1, 2017.
Sold for €11,000 on October 1, 2017.

Journalize entries for extractable natural resources depletion.

(LO 5)

E9-14 On July 1, 2017, Ticino AG invested CHF736,000 in a mine estimated to have 800,000 tons of ore of uniform grade. During the last 6 months of 2017, 124,000 tons of ore were mined.

Instructions

Prepare the journal entry to record depletion.
Assume that the 124,000 tons of ore were mined, but only 90,000 units were sold. How are the costs applicable to the 34,000 unsold units reported?

Prepare adjusting entries for amortization.

(LO 6)

E9-15 The following are selected 2017 transactions of Yosuke Ltd.

Jan. 1	Purchased a small company and recorded goodwill of €150,000. Its useful life is indefinite.
May 1	Purchased for €84,000 a patent with an estimated useful life of 5 years and a legal life of 20 years.

Instructions

Prepare necessary adjusting entries at December 31 to record amortization required by the events above.

Prepare entries to set up appropriate accounts for different intangibles; amortize intangible assets.

(LO 6)

E9-16 Nelson Company, organized in 2017, has the following transactions related to intangible assets.

1/2/17	Purchased patent (7-year life)	$560,000
4/1/17	Goodwill purchased (indefinite life)	360,000
7/1/17	8-year franchise; expiration date 7/1/2025	440,000
11/1/17	Research and development costs incurred prior to technological feasibility	448,000

Instructions

Calculate asset turnover.

(LO 7)

E9-17 During 2017, Otaki Ltd. reported net sales of €5,200,000 and net income of €1,500,000. Its statement of financial position reported average total assets of €1,600,000.

Instructions

Calculate the asset turnover.

Journalize entries for exchanges.

(LO 8)

*E9-18 Presented below are two independent transactions. Both transactions have commercial substance.

Global Co. exchanged old trucks (cost £64,000 less £22,000 accumulated depreciation) plus cash of £17,000 for new trucks. The old trucks had a fair value of £37,400.
Rijo Ltd. trades its used machine (cost £12,000 less £4,000 accumulated depreciation) for a new machine. In addition to exchanging the old machine (which had a fair value of £9,000), Rijo also paid cash of £3,200.

Instructions

Prepare the entry to record the exchange of assets by Global Co.
Prepare the entry to record the exchange of assets by Rijo Ltd.

Journalize entries for the exchange of plant assets.

(LO 8)

*P9-19 Jay’s Delivery Company and Astro’s Express Delivery exchanged delivery trucks on January 1, 2017. Jay’s truck cost €22,000. It has accumulated depreciation of €16,000 and a fair value of €4,000. Astro’s truck cost €10,000. It has accumulated depreciation of €7,000 and a fair value of €4,000. The transaction has commercial substance.

Instructions

Journalize the exchange for Jay’s Delivery Company.
Journalize the exchange for Astro’s Express Delivery.

PROBLEMS: SET A

Determine acquisition costs of land and building.

(LO 1)

P9-1A Diaz SLU was organized on January 1. During the first year of operations, the following plant asset expenditures and receipts were recorded in random order.

Debit
1. Cost of filling and grading the land	€ 6,600
2. Full payment to building contractor	780,000
3. Real estate taxes on land paid for the current year	5,000
4. Cost of real estate purchased as a plant site (land €100,000 and building €45,000)	145,000
5. Excavation costs for new building	35,000
6. Architect’s fees on building plans	10,500
7. Accrued real estate taxes paid at time of purchase of real estate	2,800
8. Cost of parking lots and driveways	14,000
9. Cost of demolishing building to make land suitable for construction of new building	15,000
	€1,013,900
Credit
10. Proceeds from salvage of demolished building	€ 3,600

Instructions

Totals

Land €165,800

Buildings €825,500

Analyze the foregoing transactions using the following column headings. Insert the number of each transaction in the Item column, and then insert the amounts in the other appropriate columns. For amounts entered in the Other Accounts column, also indicate the account titles.

Item

Land

Buildings

Other Accounts

Compute depreciation under different methods.

(LO 2)

P9-2A In recent years, Freeman Transportation purchased three used buses. Because of frequent turnover in the accounting department, a different accountant selected the depreciation method for each bus, and various methods were selected. Information concerning the buses is summarized below.

Bus	Acquired	Cost	Residual Value	Useful Life in Years	Depreciation Method
1	1/1/15	£ 96,000	£ 6,000	5	Straight‐line
2	1/1/15	140,000	10,000	4	Declining‐balance
3	1/1/16	92,000	8,000	5	Units‐of‐activity

For the declining‐balance method, the company uses the double‐declining rate. For the units‐of‐activity method, total miles are expected to be 120,000. Actual miles of use in the first 3 years were 2016, 24,000; 2017, 36,000; and 2018, 31,000.

Instructions

(a) Bus 2, 2016, £105,000

Compute the amount of accumulated depreciation on each bus at December 31, 2017.

If Bus 2 was purchased on April 1 instead of January 1, what is the depreciation expense for this bus in (1) 2015 and (2) 2016?

Compute depreciation under different methods.

(LO 2)

P9-3A On January 1, 2017, Pele SA purchased the following two machines for use in its production process.

Machine A:

The cash price of this machine was R$35,000. Related expenditures included: sales tax R$2,200, shipping costs R$150, insurance during shipping R$80, installation and testing costs R$70, and R$100 of oil and lubricants to be used with the machinery during its first year of operations. Pele estimates that the useful life of the machine is 5 years with a R$5,000 residual value remaining at the end of that time period. Assume that the straight‐line method of depreciation is used.

Machine B:

The recorded cost of this machine was R$80,000. Pele estimates that the useful life of the machine is 4 years with a R$5,000 residual value remaining at the end of that time period.

Instructions

(b) (2) 2017 DDB depreciation R$40,000

Prepare the following for Machine A.
1. The journal entry to record its purchase on January 1, 2017.
2. The journal entry to record annual depreciation at December 31, 2017.
Calculate the amount of depreciation expense that Pele should record for Machine B each year of its useful life under the following assumptions.
1. Pele uses the straight‐line method of depreciation.
2. Pele uses the declining‐balance method. The rate used is twice the straight‐line rate.
3. Pele uses the units‐of‐activity method and estimates that the useful life of the machine is 125,000 units. Actual usage is as follows: 2017, 42,000 units; 2018, 37,000 units; 2019, 28,000 units; and 2020, 18,000 units.
Which method used to calculate depreciation on Machine B reports the highest amount of depreciation expense in year 1 (2017)? The highest amount in year 4 (2020)? The highest total amount over the 4‐year period?

Calculate revisions to depreciation expense.

(LO 2)

P9-4A At the beginning of 2015, Mansen plc acquired equipment costing £80,000. It was estimated that this equipment would have a useful life of 6 years and a residual value of £8,000 at that time. The straight‐line method of depreciation was considered the most appropriate to use with this type of equipment. Depreciation is to be recorded at the end of each year.

During 2017 (the third year of the equipment’s life), the company’s engineers reconsidered their expectations, and estimated that the equipment’s useful life would probably be 7 years (in total) instead of 6 years. The estimated residual value was not changed at that time. However, during 2020 the estimated residual value was reduced to £4,400.

Instructions

2021 depreciation expense, £11,400

Indicate how much depreciation expense should be recorded each year for this equipment, by completing the following table.

Year	Depreciation Expense	Accumulated Depreciation
2015
2016
2017
2018
2019
2020
2021

Journalize a series of equipment transactions related to purchase, sale, retirement, and depreciation.

(LO 2, 4, 7)

P9-5A At December 31, 2016, Jimenez SA reported the following as plant assets.

Land		€ 3,000,000
Buildings	€26,500,000
Less: Accumulated depreciation—buildings	12,100,000	14,400,000
Equipment	40,000,000
Less: Accumulated depreciation—equipment	5,000,000	35,000,000
Total plant assets		€52,400,000

During 2017, the following selected cash transactions occurred.

April 1	Purchased land for €2,200,000.
May 1	Sold equipment that cost €750,000 when purchased on January 1, 2013. The equipment was sold for €466,000.
June 1	Sold land purchased on June 1, 2007 for €1,800,000. The land cost €300,000.
July 1	Purchased equipment for €2,450,000.
Dec. 31	Retired equipment that cost €500,000 when purchased on December 31, 2007. No residual value was received.

Instructions

(b) Depreciation Expense—Buildings €530,000; Equipment €3,997,500

Journalize the above transactions. The company uses straight‐line depreciation for buildings and equipment. The buildings are estimated to have a 50‐year life and no residual value. The equipment is estimated to have a 10‐year useful life and no residual value. Update depreciation on assets disposed of at the time of sale or retirement.
Record adjusting entries for depreciation for 2017.
Prepare the plant assets section of Jimenez’s statement of financial position at December 31, 2017.

Record disposals

(LO 4)

P9-6A Yount Co. has equipment that cost €50,000 and that has been depreciated €22,000.

Instructions

Record the disposal under the following assumptions.

It was scrapped as having no value.
It was sold for €25,000.
It was sold for €31,000.

Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section.

(LO 6, 7)

P9-7A The intangible assets section of Glover Ltd. at December 31, 2016, is presented below.

Patents (£60,000 cost less £6,000 amortization)	£54,000
Franchises (£48,000 cost less £19,200 amortization)	28,800
Total	£82,800

The patent was acquired in January 2016 and has a useful life of 10 years. The franchise was acquired in January 2013 and also has a useful life of 10 years. The following cash transactions may have affected intangible assets during 2017.

Jan. 2	Paid £45,000 legal costs to successfully defend the patent against infringement by another company.
Jan.–June	Developed a new product, incurring £100,000 in research costs and £68,000 in development costs prior to technological feasibility. A patent was granted for the product on July 1. Its useful life is equal to its 20‐year legal life.
Sept. 1	Paid £58,000 to an extremely large defensive lineman to appear in commercials advertising the company’s products. The commercials will air in September and October.
Oct. 1	Acquired a franchise for £100,000. The franchise has a useful life of 40 years.

Instructions

(b) Amortization Expense (patents) £11,000

Amortization Expense (franchises) £5,425

Prepare journal entries to record the transactions above.
Prepare journal entries to record the 2017 amortization expense.
Prepare the intangible assets section of the statement of financial position at December 31, 2017.

Prepare entries to correct errors made in recording and amortizing intangible assets.

(LO 6)

P9-8A Due to rapid turnover in the accounting department, a number of transactions involving intangible assets were improperly recorded by the Buek Company in 2017.

Buek developed a new manufacturing process, incurring research costs of €97,000 and development costs prior to technological feasibility of €50,000. The company also purchased a patent for €60,000. In early January, Buek capitalized €207,000 as the cost of the patents. Patent amortization expense of €10,350 was recorded based on a 20‐year useful life.
On July 1, 2017, Buek purchased a small company and as a result acquired goodwill of €80,000. Buek recorded a half‐year’s amortization in 2017, based on a 50‐year life (€800 amortization). The goodwill has an indefinite life.

Instructions

Research and Develop. Exp. €147,000

Prepare all journal entries necessary to correct any errors made during 2017. Assume the books have not yet been closed for 2017.

Calculate and comment on asset turnover.

(LO 7)

P9-9A Luó Ltd. and Zhaò Ltd., two corporations of roughly the same size, are both involved in the manufacture of in‐line skates. Each company depreciates its plant assets using the straight‐line approach. An investigation of their financial statements reveals the following information.

	Luó Ltd.	Zhào Ltd.
Net income	HK$ 400,000	HK$ 450,000
Sales revenue	1,240,000	1,110,000
Average total assets	2,000,000	1,500,000
Average plant assets	1,500,000	800,000

Instructions

For each company, calculate the asset turnover.
Based on your calculations in part (a), comment on the relative effectiveness of the two companies in using their assets to generate sales and produce net income.

PROBLEMS: SET B

Determine acquisition costs of land and building.

(LO 1)

P9-1B Foxx Ltd. was organized on January 1. During the first year of operations, the following plant asset expenditures and receipts were recorded in random order.

Debit
1. Accrued real estate taxes paid at time of purchase of real estate	£ 9,000
2. Real estate taxes on land paid for the current year	6,100
3. Full payment to building contractor	520,000
4. Excavation costs for new building	19,000
5. Cost of real estate purchased as a plant site (land £75,000 and building £25,000)	100,000
6. Cost of parking lots and driveways	18,000
7. Architect’s fees on building plans	9,000
8. Installation cost of fences around property	6,000
9. Cost of demolishing building to make land suitable for construction of new building	19,000
	£706,100
Credit
10. Proceeds from salvage of demolished building	£ 4,200

Instructions

Totals

Land £123,800

Buildings £548,000

Item

Land

Buildings

Other Accounts

Compute depreciation under different methods.

(LO 2)

P9-2B In recent years, Wáng Company purchased three machines. Because of heavy turnover in the accounting department, a different accountant was in charge of selecting the depreciation method for each machine, and each selected a different method. Information concerning the machines is summarized below.

Machine	Acquired	Cost	Residual Value	Useful Life in Years	Depreciation Method
1	1/1/14	¥105,000	¥ 5,000	8	Straight‐line
2	1/1/15	150,000	10,000	10	Declining‐balance
3	11/1/17	100,000	15,000	6	Units‐of‐activity

For the declining‐balance method, the company uses the double‐declining rate. For the units‐of‐activity method, total machine hours are expected to be 25,000. Actual hours of use in the first 3 years were 2017, 1,300; 2018, 4,100; and 2019, 5,500.

Instructions

(a) Machine 2, 2016, ¥54,000

Compute the amount of accumulated depreciation on each machine at December 31, 2017.
If Machine 2 had been purchased on May 1 instead of January 1, what would be the depreciation expense for this machine in (1) 2015 and (2) 2016?

Compute depreciation under different methods.

(LO 2)

P9-3B On January 1, 2017, Abraham SA purchased the following two machines for use in its production process.

Machine A:

The cash price of this machine was €55,000. Related expenditures included: sales tax €3,300, shipping costs €325, insurance during shipping €75, installation and testing costs €1,300, and €90 of oil and lubricants to be used with the machinery during its first year of operation. Abraham estimates that the useful life of the machine is 4 years with a €6,000 residual value remaining at the end of that time period.

Machine B:

The recorded cost of this machine was €130,000. Abraham estimates that the useful life of the machine is 5 years with a €10,000 residual value remaining at the end of that time period.

Instructions

(a) (2) €13,500

Prepare the following for Machine A.
1. The journal entry to record its purchase on January 1, 2017.
2. The journal entry to record annual depreciation at December 31, 2017, assuming the straight‐line method of depreciation is used.
Calculate the amount of depreciation expense that Abraham should record for Machine B each year of its useful life under the following assumption.
1. Abraham uses the straight‐line method of depreciation.
2. Abraham uses the declining‐balance method. The rate used is twice the straight‐line rate.
3. Abraham uses the units‐of‐activity method and estimates the useful life of the machine is 24,000 units. Actual usage is as follows: 2017, 4,700 units; 2018, 8,200 units; 2019, 6,800 units; 2020, 2,500 units; and 2021, 1,800 units.
Which method used to calculate depreciation on Machine B reports the lowest amount of depreciation expense in year 1 (2017)? The lowest amount in year 5 (2021)? The lowest total amount over the 5‐year period?

Calculate revisions to depreciation expense.

(LO 2)

P9-4B At the beginning of 2015, Bellamy Company acquired equipment costing £60,000. It was estimated that this equipment would have a useful life of 6 years and a residual value of £6,000 at that time. The straight‐line method of depreciation was considered the most appropriate to use with this type of equipment. Depreciation is to be recorded at the end of each year.

Instructions

2021 depreciation expense, £8,700

Indicate how much depreciation expense should be recorded for this equipment each year by completing the following table.

Year	Depreciation Expense	Accumulated Depreciation
2015
2016
2017
2018
2019
2020
2021

Journalize a series of equipment transactions related to purchase, sale, retirement, and depreciation.

(LO 2, 4, 7)

P9-5B At December 31, 2016, Durango Ltd. reported the following as plant assets.

Land		£ 2,000,000
Buildings	£28,500,000
Less: Accumulated depreciation—buildings	12,100,000	16,400,000
Equipment	30,000,000
Less: Accumulated depreciation—equipment	4,000,000	26,000,000
Total plant assets		£44,400,000

During 2017, the following selected cash transactions occurred.

Mar. 1	Purchased land for £1,350,000.
April 1	Sold equipment that cost £420,000 when purchased on January 1, 2013. The equipment was sold for £248,000.
June 1	Sold land purchased on June 1, 2007, for £1,000,000. The land cost £310,000.
Oct. 1	Purchased equipment for £1,260,000.
Dec. 31	Retired equipment that cost £300,000 when purchased on December 31, 2007. No residual value was received.

Instructions

(b) Depreciation Expense—Buildings £570,000; Equipment £2,959,500

Journalize the above transactions. Durango uses straight‐line depreciation for buildings and equipment. The buildings are estimated to have a 50‐year useful life and no residual value. The equipment is estimated to have a 10‐year useful life and no residual value. Update depreciation on assets disposed of at the time of sale or retirement.
Record adjusting entries for depreciation for 2017.
Prepare the plant assets section of Durango’s statement of financial position at December 31, 2017.

Record disposals.

(LO 4)

P9-6B Vermeer NV has equipment that cost €40,000 and that has been depreciated €29,000.

Instructions

Record the disposal under the following assumptions.

It was scrapped as having no value.
It was sold for €24,000.
It was sold for €10,000.

Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section.

(LO 6, 7)

P9-7B The intangible assets section of Whitley Company at December 31, 2016, is presented below.

Patents (£100,000 cost less £10,000 amortization)	£ 90,000
Copyrights (£80,000 cost less £32,000 amortization)	48,000
Total	£138,000

The patent was acquired in January 2016 and has a useful life of 10 years. The copyright was acquired in January 2013 and also has a useful life of 10 years. The following cash transactions may have affected intangible assets during 2017.

Jan. 2	Paid £48,600 legal costs to successfully defend the patent against infringement by another company.
Jan.–June	Developed a new product, incurring £110,000 in research costs and £120,000 in development costs prior to technological feasibility. A patent was granted for the product on July 1. Its useful life is equal to its legal life.
Sept. 1	Paid £125,000 to an X‐Games star to appear in commercials advertising the company’s products. The commercials will air in September and October.
Oct. 1	Acquired a copyright for £192,000. The copyright has a useful life of 40 years.

Instructions

(b) Amortization Expense (patents) £15,400; Amortization Expense (copyrights) £9,200

Prepare journal entries to record the transactions above.
Prepare journal entries to record the 2017 amortization expense for intangible assets.
Prepare the intangible assets section of the statement of financial position at December 31, 2017.
Prepare the note to the financials on Whitley’s intangibles as of December 31, 2017.

Prepare entries to correct errors made in recording and amortizing intangible assets.

(LO 6)

P9-8B Due to rapid turnover in the accounting department, a number of transactions involving intangible assets were improperly recorded by Kaya A.Ş. in 2017.

Kaya developed a new manufacturing process, incurring research and development costs of 110,000 before reaching technological feasibility. The company also purchased a patent for 70,000. In early January, Kaya capitalized 180,000 as the cost of the patents. Patent amortization expense of 9,000 was recorded based on a 20‐year useful life.
On July 1, 2017, Kaya purchased a small company and as a result acquired goodwill of 200,000. Kaya recorded a half‐year’s amortization in 2017, based on a 40‐year life (2,500 amortization). The goodwill has an indefinite life.

Instructions

Research and Develop. Exp. 110,000

Prepare all journal entries necessary to correct any errors made during 2017. Assume the books have not yet been closed for 2017.

Calculate and comment on asset turnover.

(LO 7)

P9-9B Ling Ltd. and Tseng Ltd., two corporations of roughly the same size, are both involved in the manufacture of canoes and sea kayaks. Each company depreciates its plant assets using the straight‐line approach. An investigation of their financial statements reveals the following information.

	Ling Ltd.	Tseng Ltd.
Net income	NT$ 9,000,000	NT$ 9,750,000
Sales revenue	36,000,000	27,900,000
Average total assets	30,000,000	30,600,000
Average plant assets	22,500,000	23,100,000

Instructions

For each company, calculate the asset turnover.
Based on your calculations in part (a), comment on the relative effectiveness of the two companies in using their assets to generate sales and produce net income.

COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 9

CP9 Raymond Company’s trial balance at December 31, 2017, is presented below. All 2017 transactions have been recorded except for the items described below and on page 473.

	Debit	Credit
Cash	£ 28,000
Accounts Receivable	36,800
Notes Receivable	10,000
Interest Receivable	–0–
Inventory	36,200
Prepaid Insurance	4,400
Land	20,000
Buildings	160,000
Equipment	60,000
Patents	8,000
Allowance for Doubtful Accounts		£ 300
Accumulated Depreciation—Buildings		49,000
Accumulated Depreciation—Equipment		24,000
Accounts Payable		28,300
Income Taxes Payable		–0–
Salaries and Wages Payable		–0–
Unearned Rent Revenue		6,000
Notes Payable (due in 2018)		11,000
Interest Payable		–0–
Notes Payable (due after 2018)		35,000
Share Capital—Ordinary		50,000
Retained Earnings		63,600
Dividends	12,000
Sales Revenue		910,000
Interest Revenue		–0–
Rent Revenue		–0–
Gain on Disposal of Plant Assets		–0–
Bad Debt Expense	–0–
Cost of Goods Sold	630,000
Depreciation Expense	–0–
Income Tax Expense	–0–
Insurance Expense	–0–
Interest Expense	–0–
Other Operating Expenses	61,800
Amortization Expense	–0–
Salaries and Wages Expense	110,000
Total	£1,177,200	£1,177,200

Unrecorded transactions:

On May 1, 2017, Raymond purchased equipment for £13,000 plus sales taxes of £780 (all paid in cash).
On July 1, 2017, Raymond sold for £3,500 equipment which originally cost £5,000. Accumulated depreciation on this equipment at January 1, 2017, was £1,800; 2017 depreciation prior to the sale of the equipment was £450.
On December 31, 2017, Raymond sold on account £9,400 of inventory that cost £6,600.
Raymond estimates that uncollectible accounts receivable at year‐end is £4,000.
The note receivable is a one‐year, 8% note dated April 1, 2017. No interest has been recorded.
The balance in prepaid insurance represents payment of a £4,400 6‐month premium on October 1, 2017.
The building is being depreciated using the straight‐line method over 40 years. The residual value is £20,000.
The equipment owned prior to this year is being depreciated using the straight‐line method over 5 years. The residual value is 10% of cost.
The equipment purchased on May 1, 2017, is being depreciated using the straight‐line method over 5 years, with a residual value of £1,000.
The patent was acquired on January 1, 2017, and has a useful life of 10 years from that date.
Unpaid salaries and wages at December 31, 2017, total £2,200.
The unearned rent revenue of £6,000 was received on December 1, 2017, for 4 months rent.
Both the short‐term and long‐term notes payable are dated January 1, 2017, and carry a 9% interest rate. All interest is payable in the next 12 months.
Income tax expense was £17,000. It was unpaid at December 31.

Instructions

(b) Totals £1,228,294

(d) Total assets £271,996

Prepare journal entries for the transactions listed above.
Prepare a December 31, 2017, adjusted (entries 4–14 are adjustments) trial balance.
Prepare a 2017 income statement and a 2017 retained earnings statement.
Prepare a December 31, 2017, classified statement of financial position.

MATCHA CREATIONS

(Note: This is a continuation of the Matcha Creations problem from Chapters 1–8.)

MC9 Mei‐ling is also thinking of buying a van that will be used only for business. Mei‐ling is concerned about the impact of the van’s cost on her income statement and statement of financial position. She has come to you for advice on calculating the van’s depreciation.

Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this problem.

BROADENING YOUR PERSPECTIVE

Financial Reporting and Analysis

Financial Reporting Problem: TSMC, Ltd. (TWN)

BYP9-1 The financial statements of TSMC are presented in Appendix A. The notes to the financial statements appear in the 2013 annual report, which can be found in the Investors section of the company’s website, www.tsmc.com.

Instructions

Refer to TSMC’s financial statements and answer the following questions.

What was the total cost and book value of property, plant, and equipment at December 31, 2013?
What method or methods of depreciation are used by the company for financial reporting purposes?
What was the amount of depreciation expense for each of the years 2013 and 2012?
Using the statement of cash flows, what is the amount of capital spending in 2013 and 2012?
Where does the company disclose its intangible assets, and what types of intangibles did it have at December 31, 2013?

Comparative Analysis Problem: Nestlé SA (CHE) vs. Petra Foods Ltd. (SGP)

BYP9-2 Nestlés financial statements are presented in Appendix B. Financial statements of Petra Foods are presented in Appendix A.

Instructions

Compute the asset turnover for each company for the most recent fiscal year presented.
What conclusions concerning the efficiency of assets can be drawn from these data?

Real‐World Focus

BYP9-3 Purpose: Use an annual report to identify a company’s plant assets and the depreciation method used.

Address: www.annualreports.com, or go to www.wiley.com/college/weygandt

Steps

Select a particular company.
Search by company name.
Follow instructions below.

Instructions

Answer the following questions.
What is the name of the company?
What is the Internet address of the annual report?
At fiscal year‐end, what is the net amount of its plant assets?
What is the accumulated depreciation?
Which method of depreciation does the company use?

Critical Thinking

Decision‐Making Across the Organization

BYP9-4 Givens Company and Runge Company are two companies that are similar in many respects. One difference is that Givens Company uses the straight‐line method, and Runge Company uses the declining‐balance method at double the straight‐line rate. On January 2, 2015, both companies acquired the following depreciable assets.

Asset	Cost	Residual Value	Useful Life
Buildings	£320,000	£20,000	40 years
Equipment	125,000	10,000	10 years

Including the appropriate depreciation charges, annual net income for the companies in the years 2015, 2016, and 2017 and total income for the 3 years were as follows.

	2015	2016	2017	Total
Givens Company	£84,000	£88,400	£90,000	£262,400
Runge Company	68,000	76,000	85,000	229,000

At December 31, 2017, the statements of financial position of the two companies are similar except that Runge Company has more cash than Givens Company.

Linda Yanik is interested in buying one of the companies. She comes to you for advice.

Instructions

With the class divided into groups, answer the following.

Determine the annual and total depreciation recorded by each company during the 3 years.
Assuming that Runge Company also uses the straight‐line method of depreciation instead of the declining‐balance method as in (a), prepare comparative income data for the 3 years.
Which company should Linda Yanik buy? Why?

Communication Activity

BYP9-5 The following was published with the financial statements to American Exploration Company (USA).

AMERICAN EXPLORATION COMPANY
Notes to the Financial Statements

Property, Plant, and Equipment—The Company accounts for its oil and gas exploration and production activities using the successful efforts method of accounting. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. … The costs of drilling exploratory wells are capitalized pending determination of whether each well has discovered proved reserves. If proved reserves are not discovered, such drilling costs are charged to expense. … Depletion of the cost of producing oil and gas properties is computed on the units‐of‐activity method.

Instructions

Write a brief memo to your instructor discussing American Exploration Company’s note regarding property, plant, and equipment. Your memo should address what is meant by the “successful efforts method” and “units‐of‐activity method.”

Ethics Case

BYP9-6 Dieker Container AG is suffering declining sales of its principal product, non‐biodegradeable plastic cartons. The president, Edward Mohling, instructs his controller, Betty Fetters, to lengthen asset lives to reduce depreciation expense. A processing line of automated plastic extruding equipment, purchased for €3.1 million in January 2017, was originally estimated to have a useful life of 8 years and a residual value of €300,000. Depreciation has been recorded for 2 years on that basis. Edward wants the estimated life changed to 12 years total, and the straight‐line method continued. Betty is hesitant to make the change, believing it is unethical to increase net income in this manner. Edward says, “Hey, the life is only an estimate, and I’ve heard that our competition uses a 12‐year life on their production equipment.”

Instructions

Who are the stakeholders in this situation?
Is the change in asset life unethical, or is it simply a good business practice by an astute president?
What is the effect of Edward Mohling’s proposed change on income before taxes in the year of change?

Answers to Insight and Accounting Across the Organization Questions

p. 431 Many Firms Use Leases Q: Why might airline managers choose to lease rather than purchase their planes? A: The reasons for leasing include favorable tax treatment, better financing options, increased flexibility, reduced risk of obsolescence, and often less debt shown on the statement of financial position.
p. 445 Sustainability Report Please Q: Why do you believe companies issue sustainability reports? A: It is important that companies clearly describe the things they value in addition to overall profitability. Most companies recognize that the health, safety, and environmental protections of their workforce and community are important components in developing strategies for continued growth and longevity. Without a strong commitment to the principles of corporate social responsibility, it is unlikely that a company will be able to maintain long‐term stability and profitability. The development of a sustainability report helps companies to consider these issues and develop measures to assess whether they are meeting their goals in this area.
p. 448 Should Companies Write Up Goodwill? Q: Which aspects of this treatment are allowed under IFRS? A: The write‐down of assets is allowed if it could be shown that the assets had declined in value (an impairment). However, the creation of goodwill to offset the write‐down would not be allowed. Goodwill can be recorded only when it results from the acquisition of a business. It cannot be recorded as the result of being created internally. Also, goodwill is not amortized under IFRS.

A Look at U.S. GAAP

Learning Objective 9

Compare the accounting for long‐lived assets under IFRS and U.S. GAAP.

GAAP follows most of the same principles as IFRS in the accounting for property, plant, and equipment. There are, however, some significant differences in the implementation: IFRS allows the use of revaluation of property, plant, and equipment, and it also requires the use of component depreciation. In addition, there are some significant differences in the accounting for both intangible assets and impairments.

Key Points

Under both GAAP and IFRS, changes in the depreciation method used and changes in useful life are handled in current and future periods. Prior periods are not affected. GAAP recently conformed to IFRS in the accounting for changes in depreciation methods.
The accounting for plant asset disposals is essentially the same under GAAP and IFRS.
Initial costs to acquire natural resources are essentially the same under GAAP and IFRS.
The definition of intangible assets is essentially the same under GAAP and IFRS.
The accounting for exchanges of non‐monetary assets has converged between IFRS and GAAP. GAAP now requires that gains on exchanges of non‐monetary assets be recognized if the exchange has commercial substance. This is the same framework used in IFRS.
Both IFRS and GAAP follow the historical cost principle when accounting for property, plant, and equipment at date of acquisition. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use.
Under both GAAP and IFRS, interest costs incurred during construction are capitalized. Recently, IFRS converged to GAAP requirements in this area.

Similarities

The definition for plant assets for both GAAP and IFRS is essentially the same.
GAAP, like IFRS, capitalizes all direct costs in self‐constructed assets such as raw materials and labor. IFRS does not address the capitalization of fixed overhead although in practice these costs are generally capitalized.
GAAP also views depreciation as an allocation of cost over an asset’s useful life. GAAP permits the same depreciation methods (e.g., straight‐line, accelerated, and units‐of‐activity) as IFRS.
The accounting for subsequent expenditures, such as ordinary repairs and additions, are essentially the same under GAAP and IFRS.

Differences

Under GAAP, an item of property, plant, and equipment with multiple parts is generally depreciated over the useful life of the total asset. Thus, component depreciation is generally not used. However, GAAP permits companies to use component depreciation.
GAAP uses the term salvage value, rather than residual value, to refer to an owner’s estimate of an asset’s value at the end of its useful life for that owner.
IFRS allows companies to revalue plant assets to fair value at the reporting date.
As in IFRS, under GAAP the costs associated with research and development are segregated into the two components. Costs in the research phase are always expensed under both GAAP and IFRS. Under IFRS, however, costs in the development phase are capitalized as Development Costs once technological feasibility is achieved. Under GAAP, all development costs are expensed as incurred.
IFRS permits revaluation of intangible assets (except for goodwill). GAAP prohibits revaluation of intangible assets.
IFRS requires an impairment test at each reporting date for plant assets and intangibles and records an impairment if the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of the asset’s fair value less costs to sell or its value‐in‐use. Value‐in‐use is the future cash flows to be derived from the particular asset, discounted to present value. Under GAAP, impairment loss is measured as the excess of the carrying amount over the asset’s fair value.
IFRS allows reversal of impairment losses when there has been a change in economic conditions or in the expected use of the asset. Under GAAP, impairment losses cannot be reversed for assets to be held and used; the impairment loss results in a new cost basis for the asset. IFRS and GAAP are similar in the accounting for impairments of assets held for disposal.

Looking to the Future

With respect to revaluations, as part of the conceptual framework project, the Boards will examine the measurement bases used in accounting. It is too early to say whether a converged conceptual framework will recommend fair value measurement (and revaluation accounting) for plant assets and intangibles. However, this is likely to be one of the more contentious issues, given the long‐standing use of historical cost as a measurement basis in GAAP.

The IASB and FASB have identified a project that would consider expanded recognition of internally generated intangible assets. IFRS permits more recognition of intangibles compared to GAAP. Thus, it will be challenging to develop converged standards for intangible assets, given the long‐standing prohibition on capitalizing internally generated intangible assets and research and development costs in GAAP.

GAAP Practice

GAAP Self‐Test Questions

Which of the following statements is correct?
1. Both IFRS and GAAP permit revaluation of property, plant, and equipment and intangible assets (except for goodwill).
2. IFRS permits revaluation of property, plant, and equipment and intangible assets (except for goodwill).
3. Both IFRS and GAAP permit revaluation of property, plant, and equipment but not intangible assets.
4. GAAP permits revaluation of property, plant, and equipment but not intangible assets.
Rando Company has land that cost $450,000 but now has a fair value of $600,000. Rando Company follows GAAP to account for the land. Which of the following statements is correct?
1. Rando Company must continue to report the land at $450,000.
2. Rando Company would report a net income increase of $150,000 due to an increase in the value of the land.
3. Rando Company would report the land at $600,000.
4. Rando Company would credit Retained Earnings by $150,000.
Francisco Corporation is constructing a new building at a total initial cost of $10,000,000. The building is expected to have a useful life of 50 years with no salvage value. The building’s finished surfaces (e.g., roof cover and floor cover) are 5% of this cost and have a useful life of 20 years. Building services systems (e.g., electric, heating, and plumbing) are 20% of the cost and have a useful life of 25 years. The depreciation in the first year using GAAP (without component depreciation), assuming straight‐line depreciation with no salvage value, is:
1. $200,000.
2. $215,000.
3. $255,000.
4. None of the above.
Research and development costs are:
1. expensed under GAAP.
2. expensed under IFRS.
3. expensed under both GAAP and IFRS.
4. None of the above.
Value‐in‐use is defined as:
1. net realizable value.
2. fair value.
3. future cash flows discounted to present value.
4. total future undiscounted cash flows.

GAAP Exercises

GAAP9-1 Is component depreciation required under IFRS and GAAP? Explain.

GAAP9-2 What is revaluation of plant assets? Should revaluation be applied under GAAP?

GAAP9-3 Some product development expenditures are recorded as development expenses and others as development costs. Explain the difference between these accounts and how development costs are reported under GAAP.

GAAP9-4 Mandall Company constructed a warehouse for $280,000. Mandall estimates that the warehouse has a useful life of 20 years and no salvage (residual) value. Construction records indicate that $40,000 of the cost of the warehouse relates to its heating, ventilation, and air conditioning (HVAC) system, which has an estimated useful life of only 10 years. Compute the first year of depreciation expense using straight‐line component depreciation using IFRS. How might GAAP differ from IFRS?

GAAP9-5 Newell Industries spent $300,000 on research and $600,000 on development of a new product. Of the $600,000 in development costs, $400,000 was incurred prior to technological feasibility and $200,000 after technological feasibility had been demonstrated. (a) Prepare the journal entry to record research and development costs under IFRS. (b) Prepare the journal entry to record research and development costs under GAAP.

GAAP Financial Statement Analysis: Apple Inc.

GAAP9-6 The financial statements of Apple are presented in Appendix B.

Instructions

Use the company’s financial statements and notes to the financial statements, available at http://investor.apple.com, to answer the following questions.

What were the total cost and book value of property, plant, and equipment at September 28, 2013?
What method or methods of depreciation are used by Apple for financial reporting purposes?
What was the amount of depreciation and amortization expense for each of the 3 years 2011–2013? (Hint: Use the statement of cash flows.)
Using the statement of cash flows, what are the amounts of property, plant, and equipment purchased (capital expenditures) in 2013 and 2012?
Explain how Apple accounted for its intangible assets in 2013.

Answers to GAAP Self‐Test Questions

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Remember to go back to the Navigator box on the chapter opening page and check off your completed work.

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Book value after 2 years of depreciation	£26,000
Less: New residual value	2,000
Depreciable cost	£24,000
Remaining useful life $(10 - 2)$ $(10 - 2)$	8 years
Revised annual depreciation $(£ 24,000 \div 8)$ $(£ 24,000 \div 8)$	£ 3,000

Table of Contents for Chapter 9: Plant Assets, Natural Resources, and Intangible Assets

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FEATURE STORY

How Much for a Ride to the Beach?

PREVIEW OF CHAPTER 9

The Navigator

Plant Assets

Learning Objective 1

Determining the Cost of Plant Assets

LAND

LAND IMPROVEMENTS

BUILDINGS

EQUIPMENT

Depreciation

Learning Objective 2

FACTORS IN COMPUTING DEPRECIATION

DEPRECIATION METHODS

COMPONENT DEPRECIATION

DEPRECIATION AND INCOME TAXES

REVISING PERIODIC DEPRECIATION

Revaluation of Plant Assets

GAIN SITUATION

LOSS SITUATION

Expenditures During Useful Life

Learning Objective 3

Learning Objective 4

Plant Asset Disposals

RETIREMENT OF PLANT ASSETS

SALE OF PLANT ASSETS

Extractable Natural Resources

Learning Objective 5

Intangible Assets

Learning Objective 6

Accounting for Intangible Assets

PATENTS

COPYRIGHTS

TRADEMARKS AND TRADE NAMES

FRANCHISES AND LICENSES

GOODWILL

Research and Development Costs

Statement Presentation and Analysis

Learning Objective 7

Presentation

Analysis

APPENDIX 9A Exchange of Plant Assets

Learning Objective *8

Loss Treatment

Gain Treatment

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW

The Navigator

LEARNING OBJECTIVES REVIEW

GLOSSARY REVIEW

PRACTICE MULTIPLE-CHOICE QUESTIONS

Solutions

PRACTICE EXERCISES

Instructions

Solution

Instructions

Solution

PRACTICE PROBLEMS

Instructions

Solution

Instructions

Solution

WileyPLUS

QUESTIONS

BRIEF EXERCISES

EXERCISES

PROBLEMS: SET A

PROBLEMS: SET B

COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 9

MATCHA CREATIONS

BROADENING YOUR PERSPECTIVE

Financial Reporting and Analysis

Financial Reporting Problem: TSMC, Ltd. (TWN)

Comparative Analysis Problem: Nestlé SA (CHE) vs. Petra Foods Ltd. (SGP)

Real‐World Focus

Table of Contents for
Chapter 9: Plant Assets, Natural Resources, and Intangible Assets