Investment

Chapter 12—Investments in Noncurrent Operating Assets-Acquisition MULTIPLE CHOICE 1. Kramer Service Corporation bought a building lot to construct a new corporate office building. An older home on the building lot was razed immediately so that the office building could be constructed. The cost of purchasing the older home should be a. recorded as part of the cost of the land. b. written off as a loss in the year of purchase. c. written off as an extraordinary item in the year of purchase. d. recorded as part of the cost of the new building. ANS: A

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2. The term "intangible assets" is used in accounting to denote a. current or noncurrent property items without physical characteristics. b. assets with lesser economic significance because of the nature of such assets. c. properties without physical characteristics that have long-term effects on a business enterprise. d. such items as patents, copyrights, and claims against customers which can be valued on a monetary basis. ANS: C

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

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4. In a business combination, goodwill is defined as the excess of cost over the a. fair value of assets acquired. b. fair value of assets acquired less the liabilities assumed. c. book value of assets acquired less the liabilities assumed. d. net book value of assets acquired. ANS: B

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

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6.

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

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

b. Land.............................. Gain from Receipt of Donated Land Land.............................. c. Unrealized Gain from Receipt of Donated Land.................. d. Land.............................. Retained Earnings................

ANS: B

200,000 200,000 200,000 200,000 200,000 200,000 200,000

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Five Years a. b. c. d.

No No Yes Yes

ANS: D

Ten Years No Yes No Yes

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22. An expenditure subsequent to acquisition of assembly-line manufacturing equipment benefits future periods. The expenditure should be capitalized if it is a Betterment a. b. c. d.

Yes Yes No No

ANS: A

Rearrangement Yes No Yes No

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

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

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25. On February 12, Laker Company purchased a tract of land as a factory site for $175,000. An existing building on the property was razed and construction was begun on a new factory building in March of the same year. Additional data are available as follows: Cost of razing old building .......................... Title insurance and legal fees to purchase land ...... Architect's fees ..................................... New building construction cost .......................

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$ 35,000 12,500 42,500 875,000

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

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

$120,000 80,000 40,000

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

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27. Carter Company acquired three machines for $200,000 in a package deal. The three assets together had a book value of $160,000 on the seller's books. An appraisal costing the purchaser $2,000 indicated that the three machines had the following market values (book values are given in parentheses): Machine 1: $60,000 ($40,000) Machine 2: $80,000 ($50,000) Machine 3: $100,000 ($70,000) The three assets should be individually recorded at a cost of (rounded to the nearest dollar) Machine 1 a. b. c. d.

$40,000 $50,000 $40,000 $50,500

ANS: D

Machine 2

Machine 3

$53,333 $62,500 $50,000 $67,333

$66,667 $87,500 $70,000 $84,167

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

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

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

$1,200 700 550

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

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

$ 20,000 32,000 60,000 280,000 48,000

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

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

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

Book Value

Fair Value

$5,000,000 500,000 3,000,000

$5,750,000 0 2,800,000

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

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

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

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

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

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

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39. Jazz company started construction on a building on January 1 of this year and completed construction on December 31 of the same year. Jazz had only two interest notes outstanding during the year, and both of these notes were outstanding for all 12 months of the year. The following information is available: Average accumulated expenditures ..................... Ending balance in construction in progress before capitalization of interest .................. 6 percent note incurred specifically for the project . 9 percent long-term note .............................

$250,000 360,000 150,000 500,000

What amount of interest should Jazz capitalize for the current year? a. $15,000 b. $18,000 c. $22,500 d. $27,900 ANS: B

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

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

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$50,000 60,000 90,000

41. During 2005, Krieger, Inc. incurred the following costs: Research and development services performed by Dell Company for Krieger ................................ Testing for evaluation of new products ............... Laboratory research aimed at discovery of new knowledge

$125,000 150,000 187,500

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

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42. Richard Co. incurred research and development costs in 2005 as follows: Equipment acquired for use in various research and development projects ............................... Depreciation on the above equipment .................. Materials used ....................................... Compensation costs of personnel ...................... Outside consulting fees .............................. Indirect costs appropriately allocated ...............

$500,000 67,500 100,000 250,000 75,000 125,000

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

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43. During the year just ended, Morton Company made the following expenditures relating to its plant building: Continuing and frequent repairs ..................... Repainted the plant building ........................ Major improvements to the electrical wiring system .. Partial replacement of roof tiles ...................

$160,000 40,000 128,000 56,000

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

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44. On September 10, Sandy Company incurred the following costs for one of its printing presses: Purchase of stapling attachment ..................... Installation of attachment .......................... Replacement parts for renovation of press ........... Labor and overhead in connection with renovation of press ..........................................

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$90,000 20,000 60,000 28,000

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

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

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46. Selected information from the 2005 and 2004 financial statements of Bowen Corporation is presented below. (in thousands) As of Dec.31 2005 2004 Cash ...................................... Marketable Securities ..................... Accounts Receivable (net) ................. Inventory ................................. Prepaid Expenses .......................... Land and Building (net) ................... Accounts Payable .......................... Accrued Expenses .......................... Notes Payable (short-term) ................ Bond Payable ..............................

$ 21 27 60 105 5 247 57 10 8 52

$ 35 22 98 142 3 315 75 14 4 66

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

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

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

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

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

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

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51. Acquired in-process research and development should be a. capitalized when acquired but not amortized. b. capitalized when acquired and amortized over a period not to exceed 40 years. c. capitalized when acquired and amortized based on the number of units of product or services sold each period. d. expensed when acquired. ANS: D

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

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

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

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

OBJ: LO 4

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

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

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

OBJ: LO 4

PROBLEMS 1. On February 1, 2004, Reardon Corporation purchased a parcel of land as a factory site for $320,000. An old building on the property was demolished and construction begun on a new warehouse that was completed April 15, 2005. Costs incurred on the construction project are listed below. Demolition of old building ........................... Architect's fees ..................................... Legal fees--title investigation ...................... Construction costs ................................... Imputed interest based on stock financing ............ Landfill for building site ........................... Clearing of trees from building site ................. Temporary buildings used for construction activities . Land survey .......................................... Excavation for basement .............................. (Salvage materials from demolition sold for $1,800) (Timber sold for $3,300)

$ 21,000 31,700 4,100 950,000 14,000 19,300 9,600 29,000 4,000 13,200

Determine the cost of the land and new building. ANS: Land Cost ................................................. Demolition ........................................... Legal fees--title investigation ...................... Landfill ............................................. Clearing of trees .................................... Land survey .......................................... Salvage .............................................. Sale of timber ....................................... Total .............................................

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$ 320,000 21,000 4,100 19,300 9,600 4,000 (1,800) (3,300) $ 372,900

Building Construction costs ................................... Architect's fees ..................................... Temporary buildings .................................. Excavation ........................................... Total..............................................

Note:

OBJ:

$

950,000 31,700 29,000 13,200 $1,023,900

Interest charges would not be recorded. Under FASB Statement No. 34, only interest charges incurred may be recognized. LO 1

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

Land ............................. Warehouse ........................ Office Building ..................

Current Assessed Valuation

Vendor's Original Cost

$280,000 320,000 200,000 $800,000

$180,000 315,000 129,000 $624,000

Determine the appropriate amounts that Lenny should record for the land, warehouse, and office building. ANS: Land .................... Warehouse ............... Office Building ......... Allocation: .35  $690,000 = .40  $690,000 = .25  $690,000 =

OBJ:

$280,000/$800,000 = $320,000/$800,000 = $200,000/$800,000 = $800,000

$241,500 276,000 172,500 $690,000

35% 40% 25% 100%

Land Warehouse Office Building

LO 2

3. The Callister Company exchanged 25,000 shares of its own $50 par value common stock for a turret lathe from Payne Company. The market value of the Callister Company stock was $68 per share at the date of exchange. The equipment had a carrying value of $1,625,000. Record the exchange on the books of Callister Company in general journal form. ANS: Machinery ............................................. Common Stock (25,000  $50) ......................... Paid-In Capital in Excess of Par ....................

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1,700,000 1,250,000 450,000

OBJ:

LO 2

4. One of the most critical steps in recording the acquisition of assets is the determination of the cost assigned to the asset. Data related to assets acquired by Mentor Manufacturing Company are as follows: (1)

Machine A was purchased at a list price of $92,000; terms 1/10, net 30. The machine invoice was paid after the discount period. Transportation charges were $1,270; installation costs were $920; and the cost of a trial run was $960. Normal repairs and maintenance for the first year were $410.

(2)

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

(3)

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

(4)

The company purchased equipment under a deferred payment contract-- $40,000 down payment and 30 semiannual payments of $5,000. (Assume a 12 percent interest rate.)

Determine the acquisition cost for each of the assets. ANS: (1) Cost of machine ($92,000  .99) ....................... Transportation costs .................................. Installation costs .................................... Trial run ............................................. Cost basis for Machine A ..............................

$91,080 1,270 920 960 $94,230

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

$29,400 175 $29,575

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

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

(4) Down payment .......................................... Semiannual payments ($5,000 x 13.7648)* ...............

300

$ 40,000 68,824 $108,824

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

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

10 percent, five-year note to finance construction of the manufacturing facility, dated January 1, 2005, $3,600,000. 12 percent, 20-year bonds issued at par on April 30, 2001, $8,400,000. 8 percent, six-year note payable, dated March 1, 2004, $1,800,000.

Determine the amount of interest to be capitalized by Grant Industries for 2005. ANS: Average Accumulated Expenditures $3,600,000 1,800,000 $5,400,000

Applicable Interest Rate 10% 11.29% *

Avoidable Interest $360,000 203,220 $563,220

* Calculation of weighted average interest rate: 12% bonds 8% note payable

Principal $ 8,400,000 1,800,000 $10,200,000

Interest $1,008,000 144,000 $1,152,000

$1,152,000/$10,200,000 = 11.29% (rounded) Actual interest cost incurred during 2005: Construction loan ($3,600,000 x 10%)..... 12% bonds ($8,400,000 x 12%)............. 8% notes ($1,800,000 x 8%)...............

$

360,000 1,008,000 144,000 $1,512,000

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

LO 2

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

Purchases of special equipment to be used solely for development of the new machine ...................... Research salaries and fringe benefits for engineers and scientists ...................................... Cost of testing prototype ........................... Legal costs for filing for patent ................... Fees paid to government patent office ............... Drawings required by patent office to be filed with patent application ..................................

301

$182,000 17,100 23,600 12,700 2,500 4,700

Gooden elected to amortize the patent over its legal life. At the beginning of the second year, Gooden Enterprises paid $24,000 to successfully defend the patent in an infringement suit. At the beginning of the fourth year Gooden determined that the remaining estimated useful life of the patent was five years. Record the above transactions in general journal form for Gooden Enterprises Inc. for the first five years of the life of the patent. Include any amortization or depreciation for each period. ANS: Year 1

Year 1

Year 2 Year 2

Year 3 Year 4

Year 5

OBJ:

Research and Development Expense [$182,000 + $17,100 + $23,600 = $222,700] ........................... Patents [$12,700 + $2,500 + $4,700 = $19,900] Cash ................................ Amortization of Patents [$19,900/17 = $1,171] ............... Patents ............................. Patents ............................... Cash ................................ Amortization of Patents [($19,900 + $24,000 - $1,171)/16] .... Patents .............................

222,700 19,900 242,600

1,171 1,171 24,000 24,000 2,671 2,671

Amortization of Patents ............... Patents .............................

2,671

Amortization of Patents [($19,900 + $24,000 - $1,171 - $2,671 - $2,671)/5] Patents .............................

7,477

Amortization of Patents ............... Patents .............................

7,477

2,671

7,477 7,477

LO 3

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

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

302

$ 10,000 120,000 330,000 80,000 (20,000)

ANS: Cash ...................................... Accounts Receivable ....................... Inventory ................................. Liabilities ............................. Negative Goodwill ....................... Cash ....................................

10,000 120,000 330,000

Cash purchase price ....................... Market value of net assets ................ Excess of market value over purchase price Reduction of property and equipment (noncurrent assets) ..................... Remainder (negative goodwill) .............

$400,000 520,000 $120,000 80,000

OBJ:

20,000 40,000 400,000

$ 40,000

LO 2

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

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

(b)

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

(c)

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

(d)

Paid $400,000 to acquire new machinery.

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

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

(b)

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

(c)

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

(d)

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

OBJ:

LO 2, LO 3

303

9.Delb Company is an oil and gas exploration firm. During 2005, Delb engaged in five different exploration projects. The costs associated with these projects are as follows: Project 1 ............................................ Project 2 ............................................ Project 3 ............................................ Project 4 ............................................ Project 5 ............................................ Total ..............................................

$

325,000 178,000 423,000 240,000 96,000 $1,262,000

Only Projects 2 and 5 were successful. As of the end of the year, production had not yet started at either of these two sites. Assuming that all exploration costs were paid for in cash, make the journal entry to record the expenditures for the year using (1) (2)

the successful efforts method. the full cost method.

ANS: (1) Exploration Expense .................................. Capitalized Exploration Cost ......................... Cash ...............................................

988,000 274,000 1,262,000

(2) Capitalized Exploration Cost .............. Cash ....................................

OBJ:

1,262,000 1,262,000

LO 3

10. Assets constructed for a firm's own use present the problem of whether to capitalize interest on the funds invested during the time required to prepare the assets for their intended use. Current generally accepted accounting principles as specified by the FASB in Statement No. 34 require the capitalization of interest on borrowed capital, but not to exceed the total interest paid by the firm. Evaluate the appropriateness of the approach currently required in the professional pronouncements now in effect. ANS: Capitalization of interest on borrowed capital (but not in excess of total interest paid by the enterprise) avoids the difficulty of determining how much of an investment is financed by debt and how much by equity. The entire investment is assumed to be financed by debt. Interest capitalized, however, is limited to the total interest incurred by the enterprise during the period. Interest thus represents an opportunity cost in the amount that could have been avoided by not borrowing or by using the funds to reduce outstanding debt. Limiting the amount capitalized to the total interest cost incurred during the period is consistent with the historical cost principle since only the actual interest expense incurred is capitalized.

304

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

LO 2

11. You are the auditor of Don Corporation, a newly organized company that manufactures plastic cups using an extrusion process. One of the promoters of the company was formerly involved in an enterprise that used the extrusion process and has agreed to contribute an extrusion machine to the new company in return for shares of stock of Don Corporation. What concerns would you have as the auditor of Don Corporation regarding this transaction? ANS: This transaction represents a related party transaction. Accordingly, you should be concerned about the amount recorded on the records of the company. You should determine what methods were used to establish the value on the books of the company of the asset contributed as well as the cost of the machine to the promoter and the length of ownership by the promoter. You should be concerned not only about the value of the asset for purposes of recording the asset in the property accounts, but also about attempts by the promoter and management to defraud investors in the company through attempts to inflate the value of the shares of stock by overvaluing the asset. OBJ:

LO 2

12. You have just been promoted to the position of senior accountant with the public accounting firm of Watts and Zimmerman. Your first audit client as senior accountant is to be the Delta Manufacturing Company. You have had a considerable amount of experience both in planning and conducting the audit procedures for current asset accounts such as cash, receivables, and inventory. This is your first experience, however, in planning the audit of the property, plant, and equipment accounts. Compare the nature of current assets with property, plant, and equipment, and describe how any differences might affect your audit generally. ANS: The audit work required to verify the property, plant, and equipment accounts generally is substantially less than that required for current assets. This is due to the nature of the assets included in the property accounts. A typical unit of property or equipment usually has a high dollar value, and relatively few transactions may support one large amount on the balance sheet. Current asset accounts such as cash, receivables, and inventory, on the other hand, generally have a large volume of transactions, many of which may be of lower dollar values. The property accounts typically do not show large changes in the balances of these accounts from year to year. Current asset accounts often change dramatically from year to year, again as a result of a large volume of transactions.

305

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

LO 1

13. UR Company purchased a customer database and a formula for a new fuel substitute for diesel fuel for a total of $100,000. UR Company uses the expected cash flow approach for estimating the fair value of these two intangibles. The appropriate interest rate is 5%. The potential future cash flows from the two intangibles, and their associated probabilities, are as follows: Customer Database: Outcome 1 20% probability of cash flows of $10,000 at the end of each year for 5 years. Outcome 2 30% probability of cash flows of $2,000 at the end of each year for 4 years. Outcome 3 50% probability of cash flows of $200 at the end of each year for 3 years. Formula: Outcome 1 Outcome 2 Outcome 3

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

Prepare the journal entry necessary to record the purchase of the two intangibles. ANS: Customer Database

Outcome 1 Outcome 2 Outcome 3 Total Estimated Fair Value

Present Value $43,295 7,092 545

Probability 0.20 0.30 0.50

Probability Weighted Present Value $ 8,659 2,128 273 $11,060

Formula

Outcome 1 Outcome 2 Outcome 3 Total Estimated Fair Value

Present Value $386,087 106,379 27,233

Probability 0.10 0.30 0.60

Probability Weighted Present Value $38,609 31,914 16,340 $86,863

306

Estimated Fair Value Customer Database $11,060 Formula $86,863 $97,923

Cost Allocation According to Relative Estimated Fair Values 11,060/97,923 x $100,000 86,863/97,923 x $100,000

Cost Assigned to Infividual Assets $

11,295

$ 88,705 $100,000

Journal entry to record purchase: Intangible Asset--Customer Database Intangible Asset--Formula Cash OBJ:

11,295 88,705 100,000

LO 4

14. Abacus Company purchased a customer database and in-process research and development for a total of $100,000. Abacus Company uses the expected cash flow approach for estimating the fair value of these two intangibles. The appropriate interest rate is 5%. The potential future cash flows from the two intangibles, and their associated probabilities, are as follows: Customer Database: Outcome 1 20% probability of cash flows of $10,000 at the end of each year for 5 years. Outcome 2 30% probability of cash flows of $2,000 at the end of each year for 4 years. Outcome 3 50% probability of cash flows of $200 at the end of each year for 3 years. In-process Research and Development: Outcome 1 10% probability of cash flows of $50,000 at the end of each year for 10 years. Outcome 2 30% probability of cash flows of $30,000 at the end of each year for 4 years. Outcome 3 60% probability of cash flows of $10,000 at the end of each year for 3 years. Prepare the journal entry necessary to record the purchase of the two intangibles. ANS: Customer Database

Outcome 1 Outcome 2 Outcome 3 Total Estimated Fair Value

Present Value $43,295 7,092 545

Probability 0.20 0.30 0.50

Probability Weighted Present Value $ 8,659 2,128 273 $11,060

307

In-process Research & Development

Outcome 1 Outcome 2 Outcome 3 Total Estimated Fair Value

Present Value $386,087 106,379 27,233

Probability 0.10 0.30 0.60

Probability Weighted Present Value $38,609 31,914 16,340 $86,863

Cost Allocation According to Relative Estimated Fair Values 11,060/97,923 x $100,000 86,863/97,923 x $100,000

Estimated Fair Value Customer Database $11,060 Formula $86,863 $97,923

Cost Assigned to Infividual Assets $ 11,295 $ 88,705 $100,000

Journal entry to record purchase: Intangible Asset--Customer Database Research & Development Expense Cash OBJ:

11,295 88,705 100,000

LO4

15. RGW Industries purchased the net assets of SP Company for $1,300,000. A schedule of the net assets of SP Company, as recorded on SP Company's books at the time of the acquisition, is as follows: Assets Cash ......................................................................................................................... $ 31,000 Receivables .............................................................................................................. 250,000 Inventory.................................................................................................................. 302,000 Land, buildings, and equipment (net) ...................................................................... 350,000 Total assets .............................................................................................................. $ 933,000 Liabilities Current liabilities ..................................................................................................... $ 90,000 Long-term debt ........................................................................................................ 185,000 Total liabilities ......................................................................................................... $ 275,000 Net assets (book value) ............................................................................................ $ 658,000 The following schedule shows the differences between the recorded costs and market values of the assets of SP Company at the date of the acquisition:

308

Inventory Land, buildings, & equipment Patents Purchased in-process research & development Existing work force Totals Liabilities

Cost $302,000 350,000

Market $400,000 390,000

-0-

40,000

-0-0$652,000 $275,000

300,000 90,000 $1,220,000 $275,000

Prepare the journal entry to record this purchase. ANS: The cost in excess of fair value is determined as follows: Purchase price ................................................................... $1,300,000 Book value of net assets ................................................... 658,000 Cost in excess of book value ............................................ $ 642,000 The identifiable portion of the $642,000 difference is $568,000 ($1,220,000 - $652,000) and is allocated to the appropriate assets. The remaining difference of $74,000 ($642,000 - $568,000) is recorded as part of goodwill. The total recorded amount of goodwill is $164,000 ($74,000 + $90,000) since the estimated values of intangibles such as the value of the existing work force that are not contract based or separately tradable are included in goodwill. The entry to record the purchase is as follows: Cash ........................................................ Receivables ............................................. Inventory................................................. Land, buildings, & equipment ................ Patents..................................................... Research & development expense .......... Goodwill ................................................. Current liabilities ....................... Long-term liabilities .................. Cash ........................................... OBJ:

LO 4

309

31,000 250,000 400,000 390,000 40,000 300,000 164,000 90,000 185,000 1,300,000