9.1 Flashcards
On January 1, Year 1, Jambon purchased equipment for use in developing a new product. Jambon uses the straight-line depreciation method. The equipment could provide benefits over a 10-year period. However, the new product development is expected to take 5 years, and the equipment can be used only for this project. Jambon’s Year 1 expense equals
The total cost of the equipment.
The costs of materials, equipment, or facilities that are acquired or constructed for a particular R&D project and that have no alternative future uses and therefore no separate economic values are R&D costs when incurred. R&D costs are expensed in full when incurred.
Helsing Co. bought a franchise from Anya Co. on January 1 for $204,000. An independent consultant retained by Helsing estimated that the remaining useful life of the franchise was a finite period of 50 years and that the pattern of consumption of benefits of the franchise is not reliably determinable. Its unamortized cost on Anya’s books on January 1 was $68,000. What amount should be amortized for the year ended December 31, assuming no residual value?
$4,080.
A franchise is an intangible asset. The initial measurement of an intangible asset acquired other than in a business combination is at fair value. Thus, the “cost” to be amortized should be based on the more reliably measurable of the fair value of the consideration given or the fair value of the assets acquired. If the useful life is finite, the intangible asset is amortized over that period. Moreover, if the consumption pattern of benefits of the intangible asset is not reliably determinable, the straight-line method of amortization is used. Accordingly, given no residual value, the amortization expense is $4,080 ($204,000 consideration given ÷ 50-year finite useful life).
Which of the following should be expensed as incurred by the franchisee for a franchise with an estimated useful life of 10 years?
Periodic payments to the franchisor based on the franchisee’s revenues.
Payments under a franchise agreement made to a franchisor based on the franchisee’s revenues do not create benefits in future periods and should not be treated as an asset. These payments should be treated as operating expenses in the period in which they are incurred.
Brill Co. made the following expenditures during Year 1:
Costs to develop computer software for internal use in Brill’s general management information system: $100,000
Costs of market research activities: 75,000
What amount of these expenditures should Brill report in its Year 1 income statement as research and development expenses?
$0.
Costs of market research are not R&D costs. Furthermore, general and administrative costs not clearly related to R&D activities are not included as R&D costs. Thus, costs to develop software for the company’s own general management information system are also not R&D costs.
Yellow Co. spent $12,000,000 during the current year developing its new software package. Of this amount, $4,000,000 was spent before it was at the application development stage and the package was only to be used internally. The package was completed during the year and is expected to have a 4-year useful life. Yellow has a policy of taking a full-year’s amortization in the first year. After the development stage, $50,000 was spent on training employees to use the program. What amount should Yellow report as an expense for the current year?
$6,050,000.
Costs incurred in the preliminary project stage for computer software to be used internally are expensed as incurred. During the application development stage, costs are capitalized. However, training costs are expensed. Accordingly, $8,000,000 ($12,000,000 total – $4,000,000 spent before application development) of the development cost was capitalized. Amortization is on a straight-line basis over the 4-year useful life of the software. Thus, given that a full-year’s amortization is recognized in year one, the expense for the year is $6,050,000 [$4,000,000 preliminary project expense + ($8,000,000 ÷ 4) amortization + $50,000 training cost].
Brand Co. incurred the following research and development project costs at the beginning of the current year:
Equipment purchased for current and future projects: $100,000
Equipment purchased for current projects only: 200,000
Research and development salaries for current project: 400,000
Equipment has a 5-year life and is depreciated using the straight-line method. What amount should Brand record as depreciation for research and development projects at December 31?
$20,000.
R&D costs must be expensed as incurred. The costs of equipment acquired for a particular project and having no alternative future uses and salaries of personnel engaged in R&D are R&D costs. They are expensed when incurred. The costs of equipment acquired for R&D and having alternative future uses are not R&D costs. They are capitalized as tangible assets and depreciated accordingly. Thus, the recorded depreciation is $20,000 ($100,000 ÷ 5 years).
Under East Co.’s accounting system, all insurance premiums paid are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance. Additional information for the year ended December 31, Year 2, is as follows:
Prepaid insurance at December 31, Year 1: $105,000
Charges to insurance expense during Year 2 (including a year-end adjustment of $17,500): 437,500
Prepaid insurance at December 31, Year 2; 122,500
What was the total amount of insurance premiums paid by East during Year 2?
$455,000.
The company debits prepaid insurance for all insurance premiums paid and credits the account when it charges insurance expense. Thus, total debits equal insurance premiums paid. The asset account had total credits (charges to expense) of $437,500 but increased by $17,500 ($122,500 ending balance – $105,000 beginning balance). Consequently, total debits (premiums paid) must have been $455,000 ($437,500 total charges to insurance expense + $17,500 increase in the asset account).
Ward Company incurred research and development costs in Year 1 as follows:
Equipment acquired for use in various research and development projects: $975,000
Depreciation on the above equipment: 135,000
Materials used: 200,000
Compensation costs of personnel: 500,000
Outside consulting fees: 150,000
Indirect costs appropriately allocated: 250,000
The total research and development costs charged in Ward’s Year 1 income statement should be
$1,235,000.
Materials used in R&D ($200,000), compensation costs of personnel ($500,000), outside consulting fees ($150,000), and indirect costs appropriately allocated ($250,000) are R&D costs that should be expensed immediately. The cost of equipment having an alternative future use should be capitalized and depreciated. Alternative use includes other R&D projects as well as non-R&D use. The depreciation, in this case $135,000, is included in R&D cost. Total R&D expense was thus $1,235,000 ($200,000 + $500,000 + $150,000 + $250,000 + $135,000).
In the year just ended, Ball Labs incurred the following costs:
Direct costs of doing contract R&D work for the government to be reimbursed by governmental unit: $400,000 R&D costs not included above were Depreciation: $300,000 Salaries: 700,000 Indirect costs appropriately allocated: 200,000 Materials: 180,000
What was Ball’s total R&D expense for the year?
$1,380,000.
Materials used in R&D, compensation costs of personnel, and indirect costs appropriately allocated are R&D costs that should be expensed immediately. The costs of equipment and facilities that are used for R&D activities and have alternative future uses, whether for other R&D projects or otherwise, are to be capitalized as tangible assets when acquired or constructed. Thus, the depreciation is also expensed immediately. However, this guidance does not apply to R&D activities conducted for others. Hence, the reimbursable costs are not expensed. Ball’s total R&D expense is therefore $1,380,000 ($300,000 + $700,000 + $200,000 + $180,000).
Goodwill should be tested for value impairment at which of the following levels?
Each reporting unit.
The cost of an acquired entity minus the net amount assigned to assets acquired and liabilities assumed is goodwill. Goodwill is not amortized. However, goodwill is assigned to a reporting unit that benefited from the business combination for the purpose of testing impairment. Testing occurs each year at the same time, but different reporting units may be tested at different times. Furthermore, additional testing also may be indicated. Potential impairment of goodwill is deemed to exist only if the carrying amount (including goodwill) of a reporting unit is greater than its fair value. Thus, accounting for goodwill is based on the units of the combined entity into which the acquired entity was absorbed. A reporting unit is an operating segment or one of its components, that is, one level below an operating segment. A component qualifies as a reporting unit if (1) it is a business for which discrete financial information is available, and (2) segment management regularly reviews its operating results. However, similar components are aggregated. These provisions, including the determination of operating segments, apply even if the reporting entity is not required to report segment information.
Which of the following statements is correct concerning start-up costs?
Costs of start-up activities, including organization costs, should be expensed as incurred.
Start-up costs are expenses incurred to begin a business activity, e.g., costs of organization, opening a facility, or product introduction. Organization costs are those incurred in the formation of a business entity. Under the federal tax code, organization and start-up costs must be capitalized and amortized over a period of not less than 15 years. However, for financial accounting purposes, nongovernmental entities must expense all start-up and organization costs as incurred.
Freya Co. has two patents that have allegedly been infringed by competitors. After investigation, legal counsel informed Freya that it had a weak case for Patent A34 and a strong case in regard to Patent B19. Freya incurred additional legal fees to stop infringement on Patent B19. Both patents have a remaining legal life of 8 years. How should Freya account for these legal costs incurred relating to the two patents?
Expense costs for Patent A34 and capitalize costs for Patent B19.
Legal fees incurred in a successful defense of a patent should be capitalized and amortized. Legal fees incurred in an unsuccessful defense should be expensed as incurred. Hence, Freya should expense costs for Patent A34 and capitalize costs for Patent B19.
Which of the following legal fees should be capitalized?
Legal fees to obtain a franchise:
Legal fees to successfully defend a trademark:
Yes
Yes
Intangible assets acquired other than in a business combination are initially recognized and measured based on their fair value. This “cost” should be based on the more reliably measurable of the fair value of the consideration given or the fair value of the assets acquired. Thus, legal fees to obtain an intangible asset are part of its cost. Legal fees incurred in the successful defense of an intangible asset also should be capitalized as part of its cost. A franchise is a contract right and a trademark is a device, such as a word, that identifies the origin or ownership of a product and is legally reserved to the exclusive use of the owner. Both are therefore intangible assets because they are nonfinancial assets without physical substance, and both should be capitalized.
On January 2, Fafnir Co. purchased a franchise with a finite useful life of 10 years for $50,000. An additional franchise fee of 3% of franchise operation revenues must be paid each year to the franchisor. Revenues from franchise operations amounted to $400,000 during the year, and the pattern of consumption of benefits of the franchise is not reliably determinable. In its December 31 balance sheet, what amount should Fafnir report as an intangible asset-franchise?
$45,000.
Intangible assets acquired other than in a business combination are initially recognized and measured based on their fair value. This “cost” should be based on the more reliably measurable of the fair value of the consideration given or the fair value of the assets acquired. Franchise fees are capitalized and amortized over the finite useful life. Absent information about the fair value of the assets acquired, the capitalizable amount equals the consideration given, that is, the initial fee and other expenditures necessary to acquire the franchise. Future franchise fees are expensed as incurred. Given that the pattern of consumption of benefits of the franchise is not reliably determinable, the straight-line method of amortization is used. Thus, given no residual value, the amount that should be reported as an intangible asset is $45,000 [$50,000 – ($50,000 ÷ 10)].
On July 1, Kemp Company leased office space for 5 years at $15,000 a month. On that date, Kemp paid the lessor the following amounts:
Rent security deposit: $35,000
First month’s rent: 15,000
Last month’s rent: 15,000
Nonrefundable reimbursement to lessor for modifications to the leased premises: 90,000
Kemp made timely rental payments August 1 through December 1. What portion of the payments to the lessor should Kemp have recognized as deferred to years beyond the year just ended?
$131,000.
The first month’s rent ($15,000) should be recognized as an expense in the year just ended. Assuming the modifications have a life at least equal to the lease term, they should be amortized on the straight-line basis over the 5-year period. Amortization for the year just ended is therefore $9,000 [6 months × ($90,000 ÷ 60 months)]. Accordingly, the portion of the payments to the lessor recognized as deferred equals $131,000 ($35,000 deposit + $15,000 last month’s rent + $81,000 unamortized cost of leasehold improvements).
