Land, Building and Equipment

Question 1

Assets owned by an entity may create a liability to be satisfied at the time of the asset’s retirement. Assume a certain asset is acquired that will necessitate a $400,000 payment in 18 years when the asset is retired. How should the entity account for obligation?

Answer 1

The current FV is determined. If that value cannot be ascertained, the PV of the future cash flow is computed. This amount is added to the capitalized cost of the asset and is also recognized by the entity as a liability. Thus, if the pv of $400,000 retirement obligation is $76,000, that figure is added to the reported cost of the capitalized asset, and the same amount is shown as a liability of the entity.

Question 2

An entity buys an offshore oil drilling unit for $2 million. At the end of its life, the entity must spent $600,000 to remove the asset. The $600,000 has a PV of $120,000 @ 10%. What does this entity report on its balance sheet?

Answer 2

the asset is initially reported at $2,120,000

the liability is reported at $120,000

Question 3

An entity buys an offshore oil drilling unit for $4 million. At the end of its life, the entity must spend $700,000 to remove it. The $700,000 has a PV of $100,000. The unit has a 20 year expected life and a $400,000 salvage value.

Using the SL method for depreciation and the effective rate method for interest expense, what total expense does this entity report for the first year of operations?

Answer 3

The asset is reported at $4.1 million. because the expected salvage value is $400,000 the annual depreciation is $4.1 million less $400,000 divided by 20 years or $185,000.

The liability is initially reported at $100,000. using an effective interest for the first year is $10,000. Thus the total expenses is $185,000 + $10,000 or $195,000

Question 4

An entity buys an electric power plant and becomes responsible for $3 million retirement obligation. The entity cannot determine the current value of this obligation, so it must compute the PV of the future cash flow. What interest rate is used for this purpose?

Answer 4

When the PV of a retirement obligation is to be determined, the entity uses an interest rate known as the credit-adjusted risk-free rate. The entity starts with the US bond interest rate for the length of time of the cash flows. That rate is then increased, based on the credit rating of the entity. A strong entity would use a rate slightly higher than the US government rate. A weaker, more risky entity would use a significantly higher rate.

Question 5

What are some of the events that should lead an entity to test one or more of its assets for possible impairment?

Answer 5

significant decline in market price of an asset

the entity has indicated its intention to sell the asset before the end of its expected life

a significant change in the use of an asset

a current negative cash flow from the asset or a history of negative cash flows

a significant change in the physical condition of the asset

a significant change in the business climate

the asset has a cost that was greater than expected

Question 6

An entity has a building and equipment that produce widgets. The question has been raised as to whether the value of these assets has been impaired. Should the building and equipment be tested separately or together?

Answer 6

In testing for impairment, assets should be grouped at the lowest possible level for which there are identifiable cash flows. Hence, if cash flows can be separately determined for the building and equipment, two impairment tests are necessary. If cash flows can only be determined for the building and equipment together, one impairment test must be performed for this group of assets.

Question 7

A number of assets are being tested together for impairment. One of these assets must be identified as the primary asset. What is a primary asset when testing for impairment?

Answer 7

The primary asset is the most significant one in the group for generating cash flows.

Question 8

Two assets are being tested together for impairment of value. The primary asset has a remaining life of 10 years, while the other asset has a remaining life of 16 years. For what period of time must the cash flows be determined for this group of assets?

Answer 8

In testing a group of assets for impairment, total cash flows are determined for these assets for the life of the primary asset. Thus, in this case, the cash flows from this group for the next 10 years must be anticipated. For any asset with a longer life, the assumption is made that the asset will be sold for cash at the end of the life of the primary asset at expected FV.

Question 9

3 assets are grouped together and tested for an impairment of value. The assets have book values of $600,000, $300,000 and $100,000. An impairment loss of $90,000 is determined for the group. How is this loss allocated to the individual assets?

Answer 9

An impairment loss for a group of assets is assigned proportionately to the individual assets based on their book values. However, no asset’s book value can be reduced below its FV, if that figure is known.

Question 10

An entity has decided to sell one of its fixed assets in the future. When several criteria have been met, the entity should reclassify the asset into a held-for-sale category. What are some of these criteria?

Answer 10

the entity has made a commitment to sell the asset

the price is reasonable

sale and conveyance will probably take place within one year

the asset is available for immediate sale

the entity is actively looking for a buyer

Question 11

An entity has a fixed asset that has been classified as held-for-sale because it meets all of the required criteria. At what figure should this asset be reported?

Answer 11

All assets being held for sale should be reported at the lower of book value or net realizable value.

Question 12

What is the half-year convention?

Answer 12

If a depreciable asset is bought or sold during the year, it is not in use for a full year. There are several ways to handle depreciation in this partial year. Some companies adopt the half-year convention so that depreciation for any partial year is simply assumed to be for a half-year. Whether an asset is bought on February 1 or November 1, a half-year of depreciation is taken for that period. The same method is used in the year of sale.

Question 13

An entity is trying to select a method to use for depreciation purposes and is looking at the straight-line method, the double-declining balance method, or the sum-of-the-years-digits method. Which method has the highest initial depreciation expense? After the first year or two, which of these methods would have the lowest book value?

Answer 13

the DDB method has the most expense in the first few years of an asset’s life.

Question 14

When is depreciation recorded by an entity?

Answer 14

on the last day of each reporting period.

however if an asset is disposed of during the year depreciation should be recorded on that date so that the correct book value is removed from the records

Question 15

An entity is using the half-year convention. In May of year 1, the entity buys an asset for $120,000 that has a salvage value of $20,000. The asset is being depreciated at $10,000 per year. During September of Year 4, the asset is sold for $87,000. What gain or loss should be recognized on the sale?

Answer 15

On the date of the sale, the entity should have recorded $30,000 in accumulated depreciation on this asset. Thus the book value is $90,000. because the entity received only $87,000 the entity should recognize a loss of $3,000.

Question 16

What accounts normally fall under the category of land, buildings and ?

Answer 16

the category is used for tangible assets with a life of over 1 year that are used to generate revenues.

Question 17

A cost is expended in connection with the cost of acquiring equipment. How is the decision made as to whether this cost should be capitalized to the asset account or expensed as incurred?

Answer 17

all costs which are normal and necessary to acquire an asset and put it into working condition are capitalized.

invoice price (less discounts)
sales taxes paid
freight-in
cost of installation
training cost reasonable and necessary to make the asset ready for its intended use

Question 18

During construction of a fixed asset, what costs are normally capitalized?

Answer 18

direct materials

direct labor

factory overhead

interest costs

Question 19

An entity is constructing an asset. Under what conditions is interest capitalized during construction?

Answer 19

Capitalization of interest is appropriate under the following 2 conditions

1. during construction of a fixed asset
2. during construction of inventory specifically built for a customer

Question 20

An entity is constructing a building. Construction begins on Jan 1 year 1 and ends on Dec 31 year 1, when the building is put into operation. Interest cost during Year 1 is $33,000 and interest during year 2 is $25,000. How are these amounts reported?

Answer 20

The $33,000 interest during year one is incurred during the construction of a fixed asset is capitalized.

The $25,000 interest incurred during year 2 is expensed.

Question 21

An entity constructs a building. How is the amount of interest be capitalized determined?

Answer 21

The average accumulated expenditures for the period are multiplied by an interest rate. The result is capitalized.

If money was borrowed for the construction, the interest rate is the actual rate. If money was not borrowed for this purpose, the weighted-average rate of all other debts is used.

The amount capitalized cannot be larger than the amount of interest incurred for the period.

Question 22

As an enticement to build a factory in a rural area, an entity receives 23 acres of land as a gift from a local resident. The property had originally cost the owner $800,000 but was worth $1.3 million when donated. How does the entity report the receipt of this donation from the local resident?

Answer 22

The land is placed on the books at the $1.3 million FV. the entity also records donated revenue of the same amount.

Question 23

An entity has equipment that has been in use for 6 years. The entity spends $2,000 on this asset. How can the entity determine whether to capitalize or expense this amount?

Answer 23

The $2,000 expenditure will be capitalized under the following situations.

it extends the life of the asset beyond what was anticipated

It make the asset more efficient in some way, either by reducing costs or by increasing the capacity or output

it actually makes the asset bigger in some way, such as adding a second floor to a building

Question 24

An entity buys land for $30,000, which will be paid as a lump sum in 3 years. What is the capitalized cost of the land?

Answer 24

Whenever cash flows are to be exchanged in a period beyond one year and a reasonable interest rate is not being paid, the cost of the asset is the PV of the future cash flows, based on a reasonable rate. In this case, there is no mention of interest. Thus, the PF of a single payment of $30,000 in 3 years is computed based on a reasonable rate. That PV is recorded as the cost of the land. The remainder of the payment is interest to be recognized over the 3-year period.

Question 25

An entity buys land for $50,000 to be paid as a lump sum in 5 years. The entity will also pay 2% cash interest at the end of each of those 5 years. What figure should the land be reported?

Answer 25

The PV of a single payment of $50,000 in 5 years is computed based on a reasonable rate, and the PV of an ordinary annuity of $1,000 for 5 years is also computed.

Question 26

What is the purpose of depreciation?

Answer 26

it assigns the costs of long-lived assets to the periods in which they generate revenue

Question 27

An asset has a cost of $100,000, salvage value of $10,000 and an estimated life of 10 years. If SL depreciation is being applied, what is the depreciation expense for each of the first 2 years? What figures appear in the financial records at the end of the second year?

Answer 27

Cost - salvage = depreciable value

100,000 - 10,000 = 90,000

90,000/10 years = 9,000 depreciation per year

at the end of 2nd year

asset carrying value of 82,000
accumulated deprecation 18,000

Question 28

An asset has a cost of $100,000, salvage value of $10,000 and an estimated life of 10 years. If DDB depreciation is being applied, what is the depreciation expense for each of the first 2 years?

Answer 28

cost / life = depreciation per year

100,000/10 = 10,000

10,000 x 2 = $20,000 first year depreciation

80,000 x 2/10 = 16,000 second year depreciation

Question 29

An asset has a cost of $80,000, salvage value of $5,000 and an estimated life of 5 years. If sum-of-the-years-digits depreciation is being applied, what is the depreciation expense for each of the first 2 years?

Answer 29

cost - salvage = depreciable value

80,000 - 5,000 = 75,000

5+4+3+2+1 = 15

first year

75,000 x (5/15) = 25,000

Second year

75,000 x (4/15) = 20,000

Question 30

What is meant by an accelerated method of depreciation?

Answer 30

accelerated methods record higher expenses in the first few years of an assets useful life

DDB 150DB and sum-of-the-years-digits are all accelerated methods

Question 31

An asset has a cost of $100,000, salvage value of $10,000 and an estimated life of 10 years. If 150% DB depreciation is being applied, what is the depreciation expense for each of the first 2 years?

Answer 31

cost / life = depreciation per year

100,000/10 = 10,000

10,000 x 1.5 = $15,000 first year depreciation

85,000 x 1.5/10 = 12,750 second year depreciation

Question 32

When could an entity use the group method of depreciation?

Answer 32

the group method is a SL method of depreciation that is applied to a large number of separate assets at one time to make the computation easier. This approach is called the group method if the assets are all similar. It is known as the composite method if the assets to be depreciated are different

Question 33

Using the group or composite method of depreciation, 3 assets are to be depreciated together. Info on these assets is as follows

A- $60,000 cost, 12 yr life, $5,000 annual depr.
B- $30,000 cost, 10 yr life, $3,000 annual depr.
C- $10,000 cost, 5 yr life, $2,000 annual depr.

total cost - $100,000
total annual depr. - $10,000

How is depreciation determined for each year?

Answer 33

The assumption is made that depreciation will simply be 10% of remaining cost each year as long as any of these assets is still held.

Question 34

Using the group or composite method of depreciation, 3 assets are to be depreciated together. Info on these assets is as follows

A- $60,000 cost, 12 yr life, $5,000 annual depr.
B- $30,000 cost, 10 yr life, $3,000 annual depr.
C- $10,000 cost, 5 yr life, $2,000 annual depr.

total cost - $100,000
total annual depr. - $10,000

How is the sale in Year 3 of C recorded, given a sales price of $7,000 cash? What is depreciation expense for year 3?

Answer 34

Cash 7,000
Accumulated depreciation 3,000
C 10,000

no gain or loss is recognized until all the assets in the group are sold.

Question 35

An entity buys a mine that is expected to have 100,000 tons of ore in it. The mine has a cost of $5 million, but the land will be worth $1 million after the ore has been removed. In the current year, 20,000 tons of ore are mined. What is the depletion?

Answer 35

cost - salvage = depletable value

5,000,000 - 1,000,000 = 4,000,000

4,000,000 / 100,000 tons of ore = $40 depletion per ton of ore

during the year 20,000 tons removed x $40 or $800,000 depletion recognized

Question 36

A taxicab costs $50,000 and has a salvage value of $10,000. The entity expects to drive the cab for 200,000 miles before it is sold. During the first year, the taxi is driven 30,000 miles. If the units of production method is being applied what is the depreciation for the first year?

Answer 36

cost - salvage = depreciable value

50,000 - 10,000 = 40,000

40,000/200,000 miles = .20 per mile

30,000 x .20 = $6000 depreciation expense

Question 37

When an asset is being used, the depreciation is recorded as an expense. In comparison how is depletion normally recorded?

Answer 37

Depletion comes from the use of wasting asset such as an oil well or silver mine. Therefore, a product is usually the result, the depletion is first recorded as the cost of inventory and is only expensed when the product is eventually sold.

Question 38

An entity has an asset with a cost of $400,000 and accumulated depreciation of $110,000, for a book value of $290,000. Under what condition would this asset be considered impaired?

Answer 38

impairment has occurred if the total of all expected net future cash is less than the current book value of $290,000.

Question 39

An entity has an asset with a cost of $400,000 and accumulated depreciation of $110,000 for a carrying value of $290,000. The entity believes this asset is impaired because the net future cash inflows are only expected to be $280,000. At this point in time, the asset has a fair value of $250,000. How is this impairment reported?

Answer 39

the asset is written down to the FV of $250,000 from its carrying value of $290,000 with the reduction recorded as a loss of $40,000.

Question 40

An entity has an asset with a cost of $400,000 and accumulated depreciation of $110,000 for a carrying value of $290,000. the asset is written down to the FV of $250,000 from its carrying value of $290,000 with the reduction recorded as a loss of $40,000. Later the asset increases in value to $260,000. What recognition should be made of this recovery of value?

Answer 40

there is no recognition of the increase in value so the asset is still reported at its $250,000 value

Question 41

An entity holds land A with a carrying value of $30,000 that is traded for a different plot land Z that is worth $34,000. Assuming the transaction has commercial substance, how does the entity record its new land, and what income effect is recognized?

Answer 41

Land Z is recorded at $34,000 and Land A is removed from the books at $30,000 the difference is recorded as a gain of $4,000.

Question 42

An entity holds land A with a carrying value of $30,000 and a FV of $33,000 that is traded for a new truck that is worth $34,000. Assuming the transaction has commercial substance, how does the entity record its new land, and what income effect is recognized?

Answer 42

The new asset recorded at the FV of asset being given up

Truck 33,000
Gain 3,000
Land A 30,000

Question 43

In a nonmonetary trade, the asset being received is recorded at the FV of the asset being surrendered. Under what condition does the asset being received get recorded at its own FV rather than the value of the asset given up?

Answer 43

if the FV is more readily determinable for the asset being gained and the FV of the asset surrendered is not known

Question 44

A trade is made that is said to have no commercial substance. What is meant by that?

Answer 44

A trade is viewed as having no commercial substance if the anticipated cash flows are virtually identical both before and after the exchange.

Cash flows are viewed as virtually identical if they are expected to have the same amounts, timing and risk amounts.

Question 45

An entity holds a nonmonetary asset with a carrying value of $23,000 but a FV of $316,000. This asset is exchanged for another asset. The exchange is viewed as having no commercial substances because the anticipated cash flows are virtually identical before and after it, and are expected to have the same timing and the same risk. How is the trade recorded?

Answer 45

the new asset is recorded on the balance sheet at the carrying value of the asset being surrendered.