Chapter 11: Q11-4IFRS (page 607)
Explain how gains or losses on impaired assets should be reported in income.
Answer
Gains and losses on impaired assets are reported on “other income and expenses” in a financial statement.
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Distinguish among depreciation, depletion, and amortization.
Question: Identify and explain the three types of classifications for investments in debt securities.
Neither depreciation on replacement cost nor depreciation adjusted for changes in the purchasing power of the dollar has been recognized as generally accepted accounting principles for inclusion in the primary financial statements. Briefly present the accounting treatment that might be used to assist in the maintenance of the ability of a company to replace its productive capacity.
(Comprehensive Fixed-Asset Problem) Darby Sporting Goods Inc. has been experiencing growth in the demand for its products over the last several years. The last two Olympic Games greatly increased the popularity of basketball around the world. As a result, a European sports retailing consortium entered into an agreement with Darby’s Roundball Division to purchase basketballs and other accessories on an increasing basis over the next 5 years.
To be able to meet the quantity commitments of this agreement, Darby had to obtain additional manufacturing capacity. A real estate firm located an available factory in close proximity to Darby’s Roundball manufacturing facility, and Darby agreed to purchase the factory and used machinery from Encino Athletic Equipment Company on October 1, 2016. Renovations were necessary to convert the factory for Darby’s manufacturing use.
The terms of the agreement required Darby to pay Encino \(50,000 when renovations started on January 1, 2017, with the balance to be paid as renovations were completed. The overall purchase price for the factory and machinery was \)400,000. The building renovations were contracted to Malone Construction at \(100,000. The payments made, as renovations progressed during 2017, are shown below. The factory was placed in service on January 1, 2018.
1/1 | 4/1 | 10/1 | 12/31 | |
Encino | \)50,000 | \(90,000 | \)110,000 | \(150,000 |
Malone | 30,000 | 30,000 | 40,000 |
On January 1, 2017, Darby secured a \)500,000 line-of-credit with a 12% interest rate to finance the purchase cost of the factory and machinery, and the renovation costs. Darby drew down on the line-of-credit to meet the payment schedule shown above; this was Darby’s only outstanding loan during 2017.
Bob Sprague, Darby’s controller, will capitalize the maximum allowable interest costs for this project. Darby’s policy regarding purchases of this nature is to use the appraisal value of the land for book purposes and prorate the balance of the purchase price over the remaining items. The building had originally cost Encino \(300,000 and had a net book value of \)50,000, while the machinery originally cost \(125,000 and had a net book value of \)40,000 on the date of sale. The land was recorded on Encino’s books at \(40,000. An appraisal, conducted by independent appraisers at the time of acquisition, valued the land at \)290,000, the building at \(105,000, and the machinery at \)45,000.
Angie Justice, chief engineer, estimated that the renovated plant would be used for 15 years, with an estimated salvage value of \(30,000. Justice estimated that the productive machinery would have a remaining useful life of 5 years and a salvage value of \)3,000. Darby’s depreciation policy specifies the 200% declining-balance method for machinery and the 150% decliningbalance method for the
plant. One-half year’s depreciation is taken in the year the plant is placed in service, and one-half year is allowed when the property is disposed of or retired. Darby uses a 360-day year for calculating interest costs.
Instructions
(Depreciation Basic Concepts) Burnitz Manufacturing Company was organized on January 1, 2017. In 2017, it has used in its reports to management the straight-line method of depreciating its plant assets.
On November 8, you are having a conference with Burnitz’s officers to discuss the depreciation method to be used for income tax and stockholder reporting. James Bryant, president of Burnitz, has suggested the use of a new method, which he feels is more suitable than the straight-line method for the needs of the company during the period of rapid expansion of production and capacity that he foresees. Following is an example in which the proposed method is applied to a fixed asset with an original cost of \(248,000, an estimated useful life of 5 years, and a salvage value of approximately \)8,000.
Year | Year of life used | Fraction rate | Depreciation expense | Accumulated depreciation at the end of year | Book value at the end of Year |
1 | 1 | 1/15 | \(16,000 | \) 16,000 | $232,000 |
2 | 2 | 2/15 | 32,000 | 48,000 | 200,000 |
3 | 3 | 3/15 | 48,000 | 96,000 | 152,000 |
4 | 4 | 4/15 | 64,000 | 160,000 | 88,000 |
5 | 5 | 5/15 | 80,000 | 240,000 | 8,000 |
The president favors the new method because he has heard that:
Instructions
(2) Assume that the Internal Revenue Service accepts the proposed depreciation method in this case. If the proposed method were used for stockholder and tax reporting purposes, how would it affect the availability of cash flows generated by operations?
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