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Accounting Principles 7Th Canadian Edition Volume 2 By Jerry J. Weygandt

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Accounting Principles 7Th Canadian Edition Volume 2 By Jerry J. Weygandt

CHAPTER 9 LONG-LIVED ASSETS CHAPTER STUDY OBJECTIVES 1. Calculate the cost of property, plant, and equipment. The cost of property, plant, and equipment includes all costs that are necessary to acquire the asset and make it ready for its intended use. All costs that benefit future periods (that is, capital expenditures) are included in the cost of the asset. When applicable, cost also includes asset retirement costs. When multiple assets are purchased in one transaction, or when an asset has significant components, the cost is allocated to each individual asset or component using their relative fair values. 2. Apply depreciation methods to property, plant, and equipment. After acquisition, assets are accounted for using the cost model or the revaluation model. Depreciation is recorded and assets are carried at cost less accumulated depreciation. Depreciation is the allocation of the cost of a long-lived asset to expense over its useful life (its service life) in a rational and systematic way. Depreciation is not a process of valuation and it does not result in an accumulation of cash. There are three commonly used depreciation methods: Effect on Annual Method Depreciation Calculation Straight-line Constant amount (Cost − residual value) ÷ estimated useful life (in years) Diminishing- Diminishing Carrying amount at balance amount beginning of year × diminishing-balance rate Units-of- Varying (Cost − residual value) ÷ production amount total estimated units-of- production × actual activity during the year Each method results in the same amount of depreciation over the asset’s useful life. Depreciation expense for income tax purposes is called capital cost allowance (CCA). 3. Explain the factors that cause changes in periodic depreciation and calculate revised depreciation for property, plant, and equipment. A revision to depreciation will be required if there are (a) capital expenditures during the asset’s useful life; (b) impairments in the asset’s fair value; (c) changes in the asset’s fair value when using the revaluation model; and/or (d) changes in the appropriate depreciation method, estimated useful life, or residual value. An impairment loss must be recorded if the recoverable amount is less than the carrying amount. Revisions of periodic depreciation are made in present and future periods, not retroactively. The new annual depreciation is determined by using the depreciable amount (carrying amount less the revised residual value), and the remaining useful life, at the time of the revision. 4. Demonstrate how to account for property, plant, and equipment disposals. The accounting for the disposal of a piece of property, plant, or equipment through retirement or sale is as follows: (a) Update any unrecorded depreciation for partial periods since depreciation was last recorded. (b) Calculate the carrying amount (cost – accumulated depreciation). (c) Calculate any gain (proceeds > carrying amount) or loss (proceeds < carrying amount) on disposal. (d) Remove the asset and accumulated depreciation accounts at the date of disposal. Record the proceeds received and the gain or loss, if any. An exchange of assets is recorded as the purchase of a new asset and the sale of an old asset. The new asset is recorded at the fair value of the asset given up plus any cash paid (or less any cash received). The fair value of the asset given up is compared with its carrying amount to calculate the gain or loss. If the fair value of the new asset or the asset given up cannot be determined, the new long-lived asset is recorded at the carrying amount of the old asset that was given up, plus any cash paid (or less any cash received). 5. Record natural resource transactions and calculate depletion. The units-of-production method of depreciation is generally used for natural resources. The depreciable amount per unit is calculated by dividing the total depreciable amount by the number of units estimated to be in the resource. The depreciable amount per unit is multiplied by the number of units that have been extracted to determine the annual depreciation. The depreciation and any other costs to extract the resource are recorded as inventory until the resource is sold. At that time, the costs are transferred to cost of resource sold on the income statement. Revisions to depreciation will be required for capital expenditures during the asset’s useful life, for impairments, and for changes in the total estimated units of the resource. 6. Identify the basic accounting issues for intangible assets and goodwill. The accounting for tangible and intangible assets is much the same. Intangible assets are reported at cost, which includes all expenditures necessary to prepare the asset for its intended use. An intangible asset with a finite life is amortized over the shorter of its useful life and legal life, usually on a straight-line basis. The extent of the annual impairment tests depends on whether IFRS or ASPE is followed and whether the intangible asset had a finite or indefinite life. Intangible assets with indefinite lives and goodwill are not amortized and are tested at least annually for impairment. Impairment losses on goodwill are never reversed under both IFRS and ASPE. 7. Illustrate the reporting and analysis of long-lived assets. It is common for property, plant, and equipment, and natural resources to be combined in financial statements under the heading “property, plant, and equipment.” Intangible assets with finite and indefinite lives are sometimes combined under the heading “intangible assets” or are listed separately. Goodwill must be presented separately. Either on the balance sheet or in the notes, the cost of the major classes of long-lived assets is presented. Accumulated depreciation (if the asset is depreciable) and carrying amount must be disclosed either in the balance sheet or in the notes. The depreciation and amortization methods and rates, as well as the annual depreciation expense, must also be indicated. The company’s impairment policy and any impairment losses should be described and reported. Under IFRS, companies must include a reconciliation of the carrying amount at the beginning and end of the period for each class of long-lived assets and state whether the cost or revaluation model is used. The asset turnover ratio (net sales ÷ average total assets) is one measure that is used by companies to show how efficiently they are using their assets to generate sales revenue. A second ratio, return on assets (profit ÷ average total assets), calculates how profitable the company is in terms of using its assets to generate profit.   EXERCISES Exercise 1 Rust Company was organized on January 1. During the first year of operations, the following expenditures and receipts were recorded in random order in the account, Land: Debits 1. Cost of real estate purchased as a plant site (land and building). $ 320,000 2. Legal fees paid at the time of the purchase of the real estate. 6,500 3. Cost of demolishing building to make land suitable for construction of a new building 12,000 4. Architect’s fees on building plans. 14,000 5. Excavation costs for new building. 24,000 6. Cost of filling and grading the land. 5,000 7. Insurance and taxes during construction of building. 6,000 8. Cost of repairs to building under construction caused by a small fire. 14,000 9. Interest paid during the year, of which $52,000 pertains to the construction period 64,000 10. Full payment to building contractor. 760,000 11. Cost of parking lots and driveways. 36,000 12. Property taxes paid for the current year on the land. 4,000 Total Debits $1,265,500 Credits 13. Insurance proceeds for fire damage. $10,000 14. Proceeds from residual of demolished building. 3,500 Total Credits $13,500 Instructions Analyze the above transactions using the columns below. Insert the number of each transaction in the item space and insert the amounts in the appropriate columns. Land Item Land Improvements Building Other Account Title Solution 1 (15 min.) Land Item Land Improvements Building Other Account Title 1. $320,000 2. 6,500 3. 12,000 4. $ 14,000 5. 24,000 6. 5,000 7. 6,000 8. $ 14,000 Fire Loss 9. 52,000 12,000 Interest Expense 10. 760,000 11. $36,000 Land Improvements 12. 4,000 Property Tax Expense 13. (10,000) Fire Loss 14. (3,500) Totals $340,000 $36,000 $856,000 $20,000 Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment CPA: Financial Reporting Exercise 2 Identify the following expenditures as capital expenditures or operating expenditures: 1. Replacement of worn out gears on factory machinery 2. Construction of a new wing on an office building 3. Painting the exterior of a building 4. Oil change on a company truck 5. Replacing a network server’s hard drive, this increases data storage capacity by ten times. No extension of useful life expected 6. Overhaul of a truck motor. One year extension in useful life is expected 7. Purchased a wastebasket, with an expected useful life of five years, at a cost of $10 8. Painting and lettering of a used truck upon acquisition of the truck Solution 2 (5 min.) 1. operating 2. capital 3. operating 4. operating 5. capital 6. capital 7. operating 8. capital Bloomcode: Comprehension Difficulty: Easy Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment CPA: Financial Reporting Exercise 3 Below are selected entries for Econi Co.: 1. The $60 cost of repairing a printer was charged to Computer Equipment. 2. The $5,000 cost of a major engine overhaul was debited to Repair Expense. The overhaul is expected to increase the operating efficiency of the truck. 3. The $6,000 closing costs associated with the acquisition of land were debited to Legal Expense. 4. A $600 charge for transportation costs on new equipment purchased was debited to Delivery Expense. 5. Freight cost incurred bringing a new piece of machinery to the plant site was charged to Machinery. Instructions For each entry below make a correcting entry if necessary. If the entry given is correct, then state “No entry required.” Solution 3 (10 min.) 1. Repair Expense 60 Computer Equipment 60 2. Truck 5,000 Repair Expense 5,000 3. Land 6,000 Legal Expense 6,000 4. Equipment 600 Delivery Expense 600 5. No entry required. Bloomcode: Analysis Difficulty: Easy Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment CPA: Financial Reporting Exercise 4 Below are transactions for Oriel Company: 1. Purchased land for $900,000. 2. Paid $20,000 to demolish building located on land. 3. Paid $3,000 for building permit. 4. Paid $2,000 for architect fees. 5. Paid $3,000 for excavation costs. 6. Paid interest of $22,000 during construction of new building. 7. Paid $960,000 to complete the building. 8. Paid $30,000 to pave the parking lot. 9. Paid $4,000 for underground sprinkler. 10. Ordered new equipment, paid $30,000. 11. Paid $1,500 to install and test new equipment. 12. Paid $250 to insure equipment for one year. 13. P aid $2,500 to paint office walls in the new building. 14. Paid $2,000 to repair equipment. 15. Purchased a truck for $25,000. 16. Paid $250 for truck license. 17. Paid $60 for oil change on new truck. 18. Paid $15,000 for fences around the new building. 19. Purchased two cash registers for $1,100 each. 20. Paid $2,200 for annual yard maintenance. Instructions a) Determine if each item should be capitalized (C) or expensed (E). b) Determine the balance in the land account and the building account. Solution 4 a) 1. C 2. C 3. C 4. C 5. C 6. C 7. C 8. C 9. C 10. C 11. C 12. E 13. E 14. E 15. C 16. E 17. E 18. C 19. C 20. E b) Land Account = $900,000 + $20,000 = $920,000. Building Account = $3,000 + $2,000 + $3,000 + $22,000 + $960,000 = $990,000. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment CPA: Financial Reporting Exercise 5 Baril Company purchased land for $115,000 with the intentions of constructing a new operating facility. The land purchase included a dilapidated building that was removed at a cost of $16,000. The only salvage value from this old building was some materials which were sold for proceeds of $4,000. Baril had paid surveying costs of $1,800 and legal fees related to land transfer of $6,700. The new building was quickly constructed at a total cost of $422,000. Architectural drawings and permits on the construction of this new facility totaled $18,000 and $10,650 respectively. Insurance premiums of $9,200 are paid annually. The production manager is currently on-site facilitating the production start-up. This manager is an annual salary of $85,000. Instructions a) Calculate the acquisition cost of the land. Identify each element of cost clearly. b) Calculate the acquisition cost of the new building. Identify each element of cost clearly. Solution 5 (10 min.) a) Purchase price $115,000 Demolition costs 16,000 Proceeds on demolition (4,000) Surveying costs 1,800 Legal and Land transfer costs 6,700 Acquisition cost of land $135,500 b) Construction costs $422,000 Architectural drawings 18,000 Building permits 10,650 Acquisition cost of land $450,650 Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment CPA: Financial Reporting Exercise 6 Shen Athletics purchased factory equipment with an invoice price of $92,000. Other costs incurred were freight costs, $2,500; installation of wiring and foundation, $2,200; material and labour costs in testing equipment, $700; oil lubricants and supplies to be used with equipment, $500; one-year fire insurance policy covering equipment, $1,400. The equipment is estimated to have an $8,000 residual value at the end of its 5-year useful service life. Instructions a) Calculate the acquisition cost of the equipment. Identify each element of cost clearly. b) If the double diminishing-balance method of depreciation was used, the constant percentage applied to a diminishing carrying amount would be ______. Solution 6 (10 min.) a) Invoice cost $92,000 Freight costs 2,500 Installation of wiring and foundation 2,200 Material and labour costs in testing 700 Acquisition cost $97,400 b) If the diminishing-balance method of depreciation was used, the constant percentage applied to a diminishing carrying amount would be 40% (100% ÷ 5 years = 20% ×2). Bloomcode: Application Difficulty: Easy Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment Learning Objective: Apply depreciation methods to property, plant, and equipment. Section Reference: Depreciation CPA: Financial Reporting Exercise 7 Kelso Word Processing Service uses the straight-line method of depreciation. The company’s fiscal year end is December 31. The following transactions and events occurred during the first three years. 2016 Jul 1 Purchased a new computer system from the Computer Centre for $37,000 cash and shipping costs of $250. Nov 3 Incurred ordinary repairs on computer of $3,280. Dec 31 Recorded 2016 depreciation on the basis of an estimated five-year life and residual value of $1,250. 2017 Dec 31 Recorded 2017 depreciation. 2018 Jan 1 Paid $9,800 for a major upgrade of the computer. This expenditure is expected to increase the operating efficiency and capacity of the computer. Instructions Prepare the necessary entries. (Show calculations.) Solution 7 (15 min.) 2016 Jul 1 Computer Equipment 37,250 Cash 37,250 Nov 3 Repairs Expense 3,280 Cash 3,280 Dec 31 Depreciation Expense 3,600 Accumulated Depreciation 3,600 [($37,250 – $1,250) ÷ 5 × 1 ÷ 2] 2017 Dec 31 Depreciation Expense 7,200 Accumulated Depreciation [($37,250 – $1,250) ÷ 5] 7,200 2018 Jan 1 Computer Equipment 9,800 Cash 9,800 Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the cost of property, plant, and equipment. Section Reference: Property, Plant, and Equipment Learning Objective: Apply depreciation methods to property, plant, and equipment. Section Reference: Depreciation CPA: Financial Reporting Exercise 8 On March 31, 2017 Delhon Industries purchased a new property for $2,500,000 cash. Before completing the purchase, Delhon had obtained valuations to determine the relative value of the different components of the property purchased. The valuation indicated that the fair value of the land, if purchased separately, would be $375,000, the building’s value is $1,900,000, the manufacturing equipment $192,500, and the office and computer equipment $55,000. In addition to the land, building and equipment, the purchase price includes inventory with a net realizable value of $27,500. The anticipated life of the building is 25 years, the manufacturing equipment 10 years, and the office and computer equipment 5 years, with no residual value for any of them. Delhon has a December 31 year end. Instructions a) Record the purchase on March 31, 2017. b) Record the depreciation expense for 2017 using the straight-line method assuming the company chooses to prorate depreciation based on the number of months the asset has been in use.

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