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Chapter 11
Operational Assets: Utilization and

Impairment
QUESTIONS FOR REVIEW OF KEY TOPICS

Question 11-1
The terms depreciation, depletion, and amortization all refer to the process of allocating the
cost of an operational asset to periods of use. The only difference between the terms is that they
refer to different types of operational assets; depreciation for plant and equipment, depletion for
natural resources, and amortization for intangibles.
Question 11-2
The term depreciation often is confused with a decline in value or worth of an asset.
Depreciation is not measured as decline in value from one period to the next. Instead, it involves the
distribution of the cost of an asset, less any anticipated residual value, over the asset's estimated
useful life in a systematic and rational manner that attempts to match revenues with the use of the
asset.
Question 11-3
The process of cost allocation for operational assets requires that three factors be established at
the time the asset is put into use. These factors are:
1. Service (useful) life The estimated use that the company expects to receive from the asset.
2. Allocation base The value of the usefulness that is expected to be consumed.
3. Allocation method The pattern in which the usefulness is expected to be consumed.
Question 11-4
Physical life provides the upper bound for service life. Physical life will vary according to the
purpose for which the asset is acquired and the environment in which it is operated. Service life may
be less than physical life for several reasons. For example, the expected rate of technological
changes may shorten service life. Management intent also may shorten the period of an assets
usefulness below its physical life. For instance, a company may have a policy of using its delivery
trucks for a three-year period before trading the trucks for new models.
Question 11-5
The total amount of depreciation to be recorded during an assets service life is called its
depreciable base. This amount is the difference between the initial value of the asset at its
acquisition (its cost) and its residual value. Residual or salvage value is the amount the company
expects to receive for the asset at the end of its service life less any anticipated disposal costs.
Solutions Manual, Vol.1, Chapter 11
The McGraw-Hill Companies, Inc., 2007

11-1
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Answers to Questions (continued)

Question 11-6
Activity-based allocation methods estimate service life in terms of some measure of
productivity. Periodic depreciation or depletion is then determined based on the actual productivity
generated by the asset during the period. Time-based allocation methods estimate service life in
years. Periodic depreciation or amortization is then determined based on the passage of time.
Question 11-7
The straight-line depreciation method allocates an equal amount of depreciable base to each
year of an assets service life.
Accelerated depreciation methods allocate higher portions of
depreciable base to the early years of the assets life and lower amounts of depreciable base to later
years. Total depreciation is the same by either approach.
Question 11-8
Theoretically, the use of activity-based depreciation methods would provide a better matching
of revenues and expenses. Clearly, the productivity of a plant asset is more closely associated with
the benefits provided by that asset than the mere passage of time. However, activity-based methods
quite often are either infeasible or too costly to use. For example, buildings do not have an
identifiable measure of productivity. For assets such as machinery, there may be an identifiable
measure of productivity, such as machine hours or units produced, but it is more costly to determine
the amount each period than it is to simply measure the passage of time. For these reasons, most
companies use time-based depreciation methods.
Question 11-9
Companies might use the straight-line method because they consider that the benefits derived
from the majority of plant assets are realized approximately evenly over these assets useful lives. It
also is the easiest method to understand and apply. The effect on net income also could explain why
so many companies prefer the straight-line method to the accelerated methods. Straight line
produces a higher net income in the early years of an assets life. Net income can affect bonuses
paid to management, or debt agreements with lenders. Income taxes are not a factor in determining
the depreciation method because a company is not required to use the same depreciation method for
both financial reporting and income tax purposes.
Question 11-10
The group approach to aggregation is applied to a collection of depreciable assets that share
similar service lives and other attributes. For example, group depreciation could be used for fleets of
vehicles or collections of machinery. The composite approach to aggregation is applied to dissimilar
operating assets, such as all of the depreciable assets in one manufacturing plant. Individual assets
in the composite may have diverse service lives. Both approaches are similar in that they involve
applying a single straight-line rate based on the average service lives of the assets in the group or
composite.

11-2
Intermediate Accounting, 4/e
Answers to Questions (continued)

Question 11-11
The allocation of the cost of a natural resource to periods of use is called depletion. The
process otherwise is identical to depreciation. The activity-based units-of-production method is the
predominant method used to calculate depletion, not the time-based straight-line method.
Question 11-12
The amortization of intangible assets is based on the same concepts as depreciation and
depletion. The capitalized cost of an intangible asset that has a finite useful life must be allocated to
the periods the company expects the asset to contribute to its revenue generating activities.
Intangibles, though, generally have no residual values, so the amortizable base is simply cost. Also,
intangibles possess no physical life to provide an upper bound to service life. However, most
intangibles have a legal or contractual life that limits useful life. Intangible assets that have indefinite
useful lives, including goodwill, are not amortized.
Question 11-13
A company can calculate depreciation based on the actual number of days or months the asset
was used during the year. A common simplifying convention is to record one-half of a full years
expense in the years of acquisition and disposal. This is known as the half-year convention. The
modified half-year convention records a full years expense when the asset is acquired in the first
half of the year or sold in the second half. No expense is recorded when the asset is acquired in the
second half of the year or sold in the first half.
Question 11-14
A change in the service life of an operational asset is accounted for as a change in an estimate.
The change is accounted for prospectively by simply depreciating the remaining depreciable base of
the asset (book value at date of change less estimated residual value) over the revised remaining
service life.
Question 11-15
A change in depreciation method is accounted for prospectively by simply depreciating the
remaining depreciable base of the asset (book value at date of change less estimated residual value)
over the revised remaining service life using the new depreciation method, exactly as we would
account for a change in estimate. One difference is that most changes in estimate do not require a
company to justify the change. However, this change in estimate is a result of changing an
accounting principle and therefore requires a clear justification as to why the new method is
preferable. A disclosure note reports the effect of the change on net income and earnings per share
along with clear justification for changing depreciation methods.

11-3
Answers to Questions (concluded)

Question 11-16
If a material error is discovered in an accounting period subsequent to the period in which the
error is made, previous years financial statements that were incorrect as a result of the error are
retrospectively restated to reflect the correction. Any account balances that are incorrect as a result
of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the
correction is reported as a prior period adjustment to the beginning balance in the statement of
shareholders equity. In addition, a disclosure note is needed to describe the nature of the error and
the impact of its correction on net income, income before extraordinary item, and earnings per share.
Question 11-17
An impairment in the value of an operational asset results when there has been a significant
decline in value below carrying value (book value). For tangible operational assets and intangibles
with finite useful lives, GAAP require an entity to recognize an impairment loss only when the
undiscounted sum of estimated future cash flows from an asset is less than the assets book value.
The loss recognized is the amount by which the book value exceeds the fair value of the asset or
group of assets when the fair value is readily determinable. If fair value is not determinable, it must
be estimated. One method of estimating fair value is to compute the present value of estimated
future cash flows from the asset or group of assets.
For intangible operational assets other than goodwill, if book value exceeds fair value, an
impairment loss is recognized for the differences. For goodwill, an impairment loss is indicated if
the fair value of the reporting unit is less than its book value. A goodwill impairment loss is
measured as the excess of book value of goodwill over its implied fair value.
For operational assets held for sale, if book value exceeds fair value, an impairment loss is
recognized for the difference.
Question 11-18
Repairs and maintenance are expenditures made to maintain a given level of benefits provided
by the asset and do not increase future benefits. Expenditures for these activities should be
expensed in the period incurred.
Additions involve adding a new major component to an existing asset. These expenditures
usually are capitalized.
Improvements are expenditures for the replacement of a major component of an operational
asset. The costs of improvements usually are capitalized.
Rearrangements are expenditures to restructure an operational asset without addition,
replacement, or improvement. The objective is to create a new capability for the asset and not
necessarily to extend useful life. The costs of material rearrangements should be capitalized if they
clearly increase future benefits.

11-4
BRIEF EXERCISES
Brief Exercise 11-1
Depreciation is a process of cost allocation, not valuation. Koeplin should not
record depreciation expense of $18,000 for year one of the machines life. Instead, it
should distribute the cost of the asset, less any anticipated residual value, over the
estimated useful life in a systematic and rational manner that attempts to match
revenues with the use of the asset, not the periodic decline in its value.

11-5
Brief Exercise 11-2

a. Straight-line:
$30,000 - 2,000
= $7,000 per year
4 years
b. Sum-of-the-years digits:
Sum-of-the-digits is ([4 (4 + 1)] 2) = 10
2006
2007
$28,000 x 4/10
$28,000 x 3/10
= $11,200
= $ 8,400
c. Double-declining balance:
Straight-line rate is 25% (1 4 years) x 2
= 50% DDB rate
2006
2007
= $15,000
= $ 7,500
$30,000 x 50%
($30,000 - 15,000) x 50%
d. Units-of-production:
$30,000 - 2,000
= $2.80 per unit depreciation rate
10,000 hours
2006
2007
2,200 hours x $2.80 = $6,160

3,000 hours x $2.80 = $8,400

11-6
Brief Exercise 11-3

a. Straight-line:
$30,000 - 2,000
= $7,000 per year
4 years
2006
2007
$7,000 x 9/12
$7,000 x 12/12
=
=
$5,250
$7,000
b. Sum-of-the-years digits:
2006
$28,000 x 4/10 x 9/12
$8,400
2007
$28,000 x 4/10 x 3/12

+ $28,000 x 3/10 x 9/12
=
=
$2,800
6,300
$9,100
c. Double-declining balance:
= 50% DDB rate
2006
= $11,250
2007
or,
2007
$30,000 x 50% x 9/12

$30,000 x 50% x 3/12
+ ($30,000 15,000) x 50% x 9/12
= $ 3,750
=
5,625
$ 9,375
($30,000 11,250) x 50%
= $ 9,375

11-7
Brief Exercise 11-4

Annual depreciation will equal the group rate multiplied by the depreciable base
of the group:
($425,000 40,000) x 18% = $69,300
Since depreciation records are not kept on an individual asset basis, dispositions
are recorded under the assumption that the book value of the disposed item exactly
equals any proceeds received and no gain or loss is recorded. Any actual gain or loss
is implicitly included in the accumulated depreciation account.
Journal entry (not required):
Cash ..............................................................................
Accumulated depreciation (difference) ...........................
Equipment (account balance) .........................................
35,000
7,000
42,000
Brief Exercise 11-5

$8,250,000
Depletion per ton
= $2.75 per foot

3,000,000 cubic feet
2006 depletion
2007 depletion
= $2.75 x 700,000 feet

= $2.75 x 800,000 feet

11-8
= $1,925,000
= $2,200,000
Brief Exercise 11-6

Expenses for 2006 include:
In-process R & D
=
Amortization of the patent

=
*
Amortization of the developed technology =
Total
$2,000,000
400,000
300,000
$2,700,000
Goodwill is not amortized.
Amortization of the patent:

($4,000,000 5) x 6/12
$400,000
*Amortization of the developed technology:

($3,000,000 5) x 6/12
=
$300,000
Brief Exercise 11-7

Calculation of annual depreciation after the estimate change:
$9,000,000
$320,000
x 2 years
640,000
8,360,000
500,000
7,860,000
18
$ 436,667
Cost
Old annual depreciation ($8 million 25 years)
Depreciation to date (2004-2005)
Undepreciated cost
Revised residual value
Revised depreciable base
Estimated remaining life - 18 years (20-2)
2006 depreciation

11-9
Brief Exercise 11-8

In general, we report voluntary changes in accounting principles retrospectively.
However, a change in depreciation method is considered a change in accounting
estimate resulting from a change in accounting principle. In other words, a change in
the depreciation method reflects a change in the (a) estimated future benefits from the
asset, (b) the pattern of receiving those benefits, or (c) the companys knowledge
about those benefits, and therefore the two events should be reported the same way.
Accordingly, Robotics reports the change prospectively; previous financial statements
are not revised. Instead, the company simply employs the double-declining balance
method from now on. The undepreciated cost remaining at the time of the change
would be depreciated DDB over the remaining useful life. A disclosure note should
justify that the change is preferable and describe the effect of the change on any
financial statement line items and per share amounts affected for all periods reported.
Assets cost
Accumulated depreciation to date*
Undepreciated cost, Jan. 1, 2006
Double-declining balance depreciation for 2006
$9,000,000
(640,000)
$8,360,000
x 2/23
$ 726,957
*$8,000,000 25 = $320,000 x 2 years = $640,000
Remaining life is 23 years. Twice the straight-line rate is 2/23.

11-10
Brief Exercise 11-9

If a material error is discovered in an accounting period subsequent to the period
in which the error is made, previous years financial statements that were incorrect as
a result of the error are retrospectively restated to reflect the correction. Any account
balances that are incorrect as a result of the error are corrected by journal entry. If
retained earnings is one of the incorrect accounts, the correction is reported as a prior
period adjustment to the beginning balance in the statement of shareholders equity.
In addition, a disclosure note is needed to describe the nature of the error and the
impact of its correction on net income, income before extraordinary item, and earnings
per share.
In this case, depreciation of $32,000 should have been $320,000 ($8,000,000
25 years). Therefore, 2004 income before tax is overstated by $288,000 ($320,000
32,000) and accumulated depreciation is understated by the same amount. The
following journal entry is needed to record the error correction (ignoring income tax):
Retained earnings .......................................................... 288,000
Accumulated depreciation ........................................
288,000
Depreciation for 2006 would be $320,000.
Brief Exercise 11-10

Because the undiscounted sum of future cash flows of $28 million exceeds book
value of $26.5 million, there is no impairment loss.

11-11

Because the undiscounted sum of future cash flows of $24 million is less than
book value of $26.5 million, there is an impairment loss. The impairment loss is
calculated as follows:
Book value
Fair value
Impairment loss
$26.5 million
21.0 million
$ 5.5 million

Recoverability: Because the book value of SCCs net assets of $42 million
exceeds fair value of $40 million, an impairment loss is indicated.
Determination of implied value of goodwill:
Fair value of SCC
Less: Fair value of SCCs assets (excluding goodwill)
Implied goodwill
$40 million
31 million
$ 9 million
Measurement of impairment loss:

Book value of goodwill
Less: Implied value of goodwill
Impairment loss
$15 million
9 million
$ 6 million

Recoverability: Because the book value of SCCs net assets of $42 million is less
than the fair value of $44 million, an impairment loss is not indicated.

11-12

Annual maintenance on machinery, $5,400 - This is an example of normal
repairs and maintenance. Future benefits are not increased; therefore the
expenditure should be expensed in the period incurred.
Remodeling of offices, $22,000 - This is an example of an improvement. The
cost of the remodeling should be capitalized and depreciated, either by (1)
substitution, (2) direct capitalization of the cost, or (3) a reduction of accumulated
depreciation.
Rearrangement of the shipping and receiving area, $35,000 - This is an
example of a rearrangement. Because the rearrangement increased productivity,
the cost should be capitalized and depreciated.
Addition of a security system, $25,000 - This is an example of an addition.
The cost of the security system should be capitalized and depreciated.

11-13
EXERCISES
Exercise 11-1
1. Straight-line:
$33,000 - 3,000
= $6,000 per year
5 years
2. Sum-of-the-years digits:
Year
2006
Depreciable
Base
$30,000
2007
30,000
2008
30,000
2009
30,000
2010
30,000
Total

11-14
Depreciation
X Rate per Year =
5
15
4
15
3
15
2
15
1
15
Depreciation
$10,000
8,000
6,000
4,000
2,000
$30,000
Exercise 11-1 (concluded)

3. Double-declining balance:
Straight-line rate of 20% (1 5 years) x 2 = 40% DDB rate.
Year
2006
2007
2008
2009
2010
Total
Book Value
Beginning
of Year X
$33,000
19,800
11,880
7,128
4,277
Depreciation
Rate per
Year =
40%
40%
40%
40%
*
Depreciation
$ 13,200
7,920
4,752
2,851
1,277 *
$30,000
Book Value
End of Year
$19,800
11,880
7,128
4,277
3,000
* Amount necessary to reduce book value to residual value
4. Units-of-production:
$33,000 - 3,000
= $.30 per mile depreciation rate
100,000 miles
Year
2006
2007
2008
2009
2010
Totals
Actual
Miles
Driven X
22,000
24,000
15,000
20,000
21,000
102,000
Depreciation
Rate per
Mile =
$.30
.30
.30
.30
*
Depreciation
$6,600
7,200
4,500
6,000
5,700 *
$30,000
Book Value
End of
Year
$26,400
19,200
14,700
8,700
3,000
* Amount necessary to reduce book value to residual value

11-15
Exercise 11-2
1. Straight-line:
$115,000 - 5,000
= $11,000 per year
10 years
2006
2007
$110,000 x 10/55
$110,000 x 9/55
= $20,000
= $18,000
= 20% DDB rate
2006
2007
= $23,000
= $18,400
$115,000 x 20%
($115,000 - 23,000) x 20%
4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 10 years) x 1.5
= 15% rate
2006
2007
= $17,250
= $14,663
$115,000 x 15%
($115,000 - 17,250) x 15%
$115,000 - 5,000
= $.50 per unit depreciation rate
220,000 units
2006
2007
30,000 units x $.50 = $15,000

25,000 units x $.50 = $12,500

11-16
Exercise 11-3
1. Straight-line:
$115,000 - 5,000
= $11,000 per year
10 years
2006
2007
$11,000 x 3/12
$11,000 x 12/12
=
=
$ 2,750
$11,000
Sum-of-the-digits is {[10 (10 + 1)]/2} = 55
2006
$110,000 x 10/55 x 3/12
= $ 5,000
2007
$110,000 x 10/55 x 9/12

+ $110,000 x 9/55 x 3/12
= $15,000
=
4,500
$19,500
= 20% DDB rate
2006
$5,750
=
=
$17,250
4,600
$21,850
$21,850
2007
or,
2007
$115,000 x 20% x 3/12

$115,000 x 20% x 9/12
+ ($115,000 - 23,000) x 20% x 3/12
($115,000 - 5,750) x 20%
4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 10 years) x 1.5
= 15% rate
2006
$ 4,313
=
=
$12,937
3,666
$16,603
2007
$115,000 x 15% x 3/12

$115,000 x 15% x 9/12
+ ($115,000 - 17,250) x 15% x 3/12
Or,

11-17
2007
($115,000 - 4,313) x 15%

11-18
$16,603

$115,000 - 5,000
= $.50 per unit depreciation rate
220,000 units
2006
2007
10,000 units x $.50 =

25,000 units x $.50 =
$ 5,000
$12,500
Exercise 11-4
Building depreciation:
$5,000,000 - 200,000
= $160,000 per year
30 years
Building addition depreciation:
Remaining useful life from June 30, 2006 is 27.5 years.
$1,650,000
= $60,000 per year
27.5 years
2006 $60,000 x 6/12 = $30,000
2007 $60,000 x 12/12 = $60,000

11-19
Exercise 11-5
Asset A:
Straight-line rate is 20% (1 5 years) x 2 = 40% DDB rate
$24,000
= $60,000 = Book value at the beginning of year 2
.40
Cost - (Cost x 40%) = $60,000
.60Cost = $60,000
Cost = $100,000
Asset B:
Sum-of-the-digits is 36 {[8 (8 + 1)]2}
($40,000 - residual) x 7/36 = $7,000
$280,000 - 7residual = $252,000
7residual = $28,000
Residual =
$4,000
Asset C:
$65,000 - 5,000
= $6,000
Life
Life = 10 years
Asset D:
$230,000 - $10,000 = $220,000 depreciable base
$220,000 10 years = $22,000 per year
Method used is straight-line.
Asset E:
Straight-line rate is 12.5% (1 8 years) x 1.5 = 18.75% rate
Year 1 $200,000 x 18.75% = $37,500
Year 2 ($200,000 - 37,500) x 18.75% =
11-20
$30,469
Exercise 11-6
1.
2.
3.
4.
b
b
b
a
Exercise 11-7
Requirement 1
Asset
Stoves
Refrigerators
Dishwashers
Totals
Cost
$15,000
10,000
8,000
$33,000
Residual
Value
$3,000
1,000
500
$4,500
Depreciable
Base
$12,000
9,000
7,500
$28,500
Estimated
Life(yrs.)
6
5
4
Depreciation
per Year
(straight line)
$2,000
1,800
1,875
$5,675
$5,675
Group depreciation rate =
= 17.2% (rounded)
$33,000
Group life
$28,500
= 5.02 years (rounded)
$5,675
Requirement 2
To record the purchase of new refrigerators.
Refrigerators .................................................................
Cash ..........................................................................
2,700
2,700
To record the sale of old refrigerators.

Cash ..............................................................................
Accumulated depreciation (difference) ............................
Refrigerators .............................................................
200
1,300
1,500

11-21
Exercise 11-8
Requirement 1
Cost of the equipment:
Purchase price
Freight charges
Installation charges
$154,000
2,000
4,000
$160,000
Straight-line rate of 12.5% (1 8 years) x 2 = 25% DDB rate.
Year
2006
2007
2008
2009
2010
2011
2012
2013
Total
Book Value
Beginning
Depreciation
of Year
X Rate per Year =
$160,000
25%
120,000
25%
90,000
25%
67,500
25%
50,625
*
45,625
*
40,625
*
35,625
*
Depreciation
$ 40,000
30,000
22,500
16,875
5,000
5,000
5,000
5,000
$129,375
Book Value
End of Year
$120,000
90,000
67,500
50,625
45,625
40,625
35,625
30,625
* Switch to straight-line in 2010:

Straight-line depreciation:
$50,625 - 30,625
= $5,000 per year
4 years
Requirement 2
For plant and equipment used in the manufacture of a product, depreciation is a
product cost and is included in the cost of inventory. Eventually, when the product is
sold, depreciation will be included in cost of goods sold.
11-22
Exercise 11-9
Requirement 1
$4,500,000
Depletion per ton
= $5.00 per ton

900,000 tons
2006 depletion
= $5.00 x 240,000 tons
= $1,200,000
Requirement 2
Depletion is part of product cost and is included in the cost of the inventory of
coal, just as the depreciation on manufacturing equipment is included in inventory
cost. The depletion is then included in cost of goods sold in the income statement
when the coal is sold.

11-23
Exercise 11-10
Requirement 1
Cost of copper mine:
Mining site
$1,000,000
Development costs
600,000
Restoration costs
303,939
$1,903,939
$300,000 x 25% =
400,000 x 40% =
600,000 x 35% =
$ 75,000
160,000
210,000
$445,000 x .68301* = $303,939
*Present value of $1, n = 4, i = 10%
Depletion:
$1,903,939
Depletion per pound =
= $.1904 per pound

10,000,000 pounds
2006 depletion
2007 depletion
= $.1904 x 1,600,000 pounds = $304,640

= $.1904 x 3,000,000 pounds = $571,200
Depreciation:
$120,000 - 20,000
Depreciation per pound =
= $.01 per pound

10,000,000 pounds
2006 depreciation
2007 depreciation
= $.01 x 1,600,000 pounds

= $.01 x 3,000,000 pounds
=
=
$16,000
$30,000
Requirement 2
Depletion of natural resources and depreciation of assets used in the extraction of
natural resources are part of product cost and are included in the cost of the inventory
of copper, just as the depreciation on manufacturing equipment is included in
inventory cost. The depletion and depreciation are then included in cost of goods sold
in the income statement when the copper is sold.
11-24
Exercise 11-11
Requirement 1
a. To record the purchase of a patent.
January 1, 2004
Patent ............................................................................ 700,000
Cash ..........................................................................
700,000
To record amortization on the patent.
December 31, 2004 and 2005
Amortization expense ($700,000 10 years) .....................
Patent ........................................................................
70,000
70,000
b. To record the purchase of a franchise.

2006
Franchise....................................................................... 500,000
Cash ..........................................................................
500,000
c. To record research and development expenses.
2006
Research and development expense .............................. 380,000
Cash ..........................................................................
380,000

11-25

Year-end adjusting entries
Patent: To record amortization on the patent.
December 31, 2006
Amortization expense (determined below) ........................ 112,000
Patent ........................................................................
112,000
Calculation of annual amortization after the estimate change:
($ in thousands)
$700
$70
x 2 years
140
560
5
$112
Cost
Old annual amortization ($700 10 years)
Amortization to date (2004-2005)
Unamortized cost (balance in the patent account)
Estimated remaining life
New annual amortization
Franchise: To record amortization of franchise.

December 31, 2006
Amortization expense ($500,000 10 years)......................
Franchise ...................................................................
50,000
50,000
Requirement 2
Intangible assets:
Patent
Franchise
Total intangibles
$448,000 [1]
450,000 [2]
$898,000
[1] $560,000 - 112,000

11-26
[2] $500,000 - 50,000
Exercise 11-12
To record the purchase of a patent.
January 2, 2006
Patent ............................................................................ 500,000
Cash ..........................................................................
500,000
To record amortization of a patent for the year 2006.
Amortization expense ($500,000 8 years) .......................
Patent ........................................................................
62,500
62,500
To record amortization of the patent for the year 2007.

Amortization expense ($500,000 8 years) .......................
Patent ........................................................................
62,500
62,500
To record costs of successfully defending a patent infringement suit.

January, 2008
Patent ............................................................................
Cash ..........................................................................
45,000
45,000

11-27

To record amortization of patent for the year 2008.
Amortization expense (determined below) ........................
Patent ........................................................................
70,000
70,000
Calculation of revised annual amortization:

($ in thousands)
$500
$62.5
x 2 years
125
375
45
420
6
$ 70
Cost
Add
New unamortized cost
Estimated remaining life (8 years 2 years)
Exercise 11-13
($ in millions)
Amortization expense (determined below) ........................

Patent ........................................................................
2.5
2.5
Calculation of annual amortization after the estimate change:

$ in millions)
$9
$1
x 4 years
4
5
2
$2.5
Cost
Estimated remaining life (6 years 4 years)

11-28
Exercise 11-14
Requirement 1
Depreciation expense (determined below) .........................
Accumulated depreciation - computer .......................
3,088
3,088

$40,000
$7,200
x 2 years
14,400
25,600
900
24,700
8
$ 3,088
Cost
Old annual depreciation ($36,000 5 years)
Undepreciated cost
Estimated remaining life (10 years - 2 years)
New annual depreciation
Requirement 2
Accumulated depreciation - computer .......................
3,889
3,889

$40,000
$12,000
9,600
21,600
18,400
900
17,500
x 8/36
$ 3,889
Cost
Old depreciation:
2004 - ($36,000 x 5/15)
2005 - ($36,000 x 4/15)
Undepreciated cost
Estimated remaining life - 8 years
2006 depreciation
11-29
Exercise 11-15
SYD depreciation
[10+9+8 x ($1.5 - .3) million] = $589,091
55
$1,500,000
589,091
910,909
300,000
610,909
7 yrs.
$ 87,273
Cost
Depreciation to date, SYD (2003 - 2005)
Undepreciated cost as of 1/1/06
Less residual value
Depreciable base
Remaining life (10 years - 3 years)
Adjusting entry (2006 depreciation):

Depreciation expense (calculated above) ...........................
Accumulated depreciation .........................................

11-30
87,273
87,273
Exercise 11-16
Requirement 1
In general, we report voluntary changes in accounting principles retrospectively.
However, a change in depreciation method is considered a change in accounting
estimate resulting from a change in accounting principle. In other words, a change in
the depreciation method reflects a change in the (a) estimated future benefits from the
asset, (b) the pattern of receiving those benefits, or (c) the companys knowledge
about those benefits, and therefore the two events should be reported the same way.
Accordingly, Clinton reports the change prospectively; previous financial statements
are not revised. Instead, the company simply employs the straight-line method from
now on. The undepreciated cost remaining at the time of the change would be
depreciated straight-line over the remaining useful life. A disclosure note should
justify that the change is preferable and describe the effect of the change on any
financial statement line items and per share amounts affected for all periods reported.
Requirement 2
Assets cost
Accumulated depreciation to date (given)
Estimated residual value
To be depreciated over remaining 3 years
Annual straight-line depreciation 2006-8
$2,560,000
(1,650,000)
$ 910,000
(160,000)
$ 750,000
3 years
$ 250,000
Adjusting entry:
Depreciation expense (calculated above) ............
Accumulated depreciation .............................
250,000
250,000

11-31
Exercise 11-17
Requirement 1
Analysis:
Correct
(Should Have Been Recorded)
2003 Machine
Cash
350,000
350,000
Incorrect
(As Recorded)
Expense
Cash
350,000
350,000
2003 Expense
70,000
Accum. deprec.
70,000
Depreciation entry omitted
2004 Expense
70,000
Accum. deprec.
70,000
2005 Expense
70,000
Accum. deprec.
70,000
During the three-year period, depreciation expense was understated by

$210,000, but other expenses were overstated by $350,000, so net income
during the period was understated by $140,000, which means retained
earnings is currently understated by that amount.
During the three-year period, accumulated depreciation was understated, and
continues to be understated by $210,000.
To correct incorrect accounts
Machine ...........................................................
Accumulated depreciation ($70,000 x 3 years) ..
Retained earnings ($350,000 210,000) ............
350,000
210,000
140,000
Requirement 2
Correcting entry:
Assuming that the machine had been disposed of, no correcting entry would be
required because, after five years, the accounts would show appropriate
balances.
11-32
Exercise 11-18
Requirement 1
Book value
Fair value
Impairment loss
$6.5 million
3.5 million
3.0 million
Requirement 2
Because the undiscounted sum of future cash flows of $6.8 million exceeds book
value of $6.5 million, there is no impairment loss.
Exercise 11-19
Requirement 1
Determination of implied goodwill:
Fair value of Centerpoint, Inc.
Fair value of Centerpoints net assets (excluding goodwill)
Implied value of goodwill
Impairment loss
$220 million
200 million
$ 20 million
$50 million
20 million
$30 million
Requirement 2
Because the fair value of the reporting unit, $270 million, exceeds book value,
$250 million, there is no impairment loss.

11-33
Exercise 11-20
1. To record the replacement of the heating system.
Accumulated depreciation - building............................. 250,000
Cash ..........................................................................
250,000
2. To record the addition to the building.
Building ........................................................................ 750,000
Cash ..........................................................................
750,000
3. To expense annual maintenance costs.
Maintenance expense ....................................................
Cash ..........................................................................
14,000
14,000
4. To capitalize rearrangement costs.

Machinery .....................................................................
Cash ..........................................................................

11-34
50,000
50,000
Exercise 11-21
Requirement 1
Cash ..............................................................................
Accumulated depreciation - lathe (determined below) .......
Loss on sale (difference) ..................................................
Lathe (balance) ............................................................
17,000
56,250
6,750
80,000
Accumulated depreciation:
Annual depreciation =
2002
2003
2004
2005
2006
Total
$80,000 - 5,000
= $15,000
5 years
$15,000 x 1/2 =
$15,000 x 1/4 =
$ 7,500
15,000
15,000
15,000
3,750
$56,250

11-35

Requirement 2
Cash ..............................................................................
Accumulated depreciation - lathe (determined below) .......
Gain on sale (difference) ..............................................
Lathe (balance) ............................................................
17,000
67,500
4,500
80,000
Accumulated depreciation:
Sum-of-the-digits is ([5 (5 + 1)]/2) = 15
2002
$75,000 x 5/15 x 6/12 =
2003
+
$75,000 x 5/15 x 6/12 =

$75,000 x 4/15 x 6/12 =
$12,500
10,000
22,500
$75,000 x 4/15 x 6/12 =

$75,000 x 3/15 x 6/12 =
$10,000
7,500
17,500
$75,000 x 3/15 x 6/12 =

$75,000 x 2/15 x 6/12 =
$ 7,500
5,000
12,500
2004
2005
2006
$75,000 x 2/15 x 3/12 =

Total
$12,500
2,500
$67,500
Exercise 11-22
1.
2.
3.
4.
d
b
b
a

11-36
Exercise 11-23
List A
g
d
f
1. Depreciation
2. Service life
3. Depreciable base
4.
m
h
j
k
a
5.
6.
7.
8.
9.
l
b
i
c
10.
11.
12.
13.
List B
a. Cost allocation for natural resource.

b. Accounted for prospectively.
c. When there has been a significant
decline in value.
Activity-based method
d. The amount of use expected from an operational
asset.
Time-based method
e. Estimates service life in units of output.
Double-declining balance
f. Cost less residual value.
Group method
g. Cost allocation for plant and equipment.
Composite method
h. Does not subtract residual value from cost.
Depletion
i. Accounted for the same way as a change in
estimate.
Amortization
j. Aggregates assets that are similar.
Change in useful life
k. Aggregates assets that are physically unified.
Change in depreciation method l. Cost allocation for an intangible asset.
Write-down of asset
m. Estimates service life in years.

11-37
Exercise 11-24
1. d. Because 50% of the original estimate of quality ore was recovered during the
years 1997 through 2004, recorded depletion of $250,000 [50% x ($600,000 $100,000 salvage value)]. In 2005, the earlier depletion of $250,000 is
deducted from the $600,000 cost along with the $100,000 salvage value. The
remaining depletable cost of $250,000 will be allocated over the 250,000 tons
believed to remain in the mine. The $1 per ton depletion is then multiplied
times the tons mined each year..
2. a. The cost should be amortized over the remaining legal life or useful life,
whichever is shorter. In addition to the initial costs of obtaining a patent, legal
fees incurred in the successful defense of a patent should be capitalized as part
of the cost, whether it was internally developed or purchased from an inventor.
The legal fees capitalized then should be amortized over the remaining useful
life of the patent.
3. a. Given that the company paid $6,000,000 for net assets acquired with a fair
value of $5,496,000, goodwill was $504,000. Under SFAS 142, Goodwill and
Other Intangible Assets, purchased goodwill is not amortized but is tested
annually for impairment.

11-38
Exercise 11-25
Requirement 1
To record the acquisition of small tools.
2004
Small tools ...................................................................
Cash ..........................................................................
8,000
8,000
To record additional small tool acquisitions.

2006
Small tools ....................................................................
Cash ..........................................................................
2,500
2,500
To record the sale/depreciation of small tools.

2006
Cash .............................................................................
Depreciation expense (difference) ....................................
Small tools ................................................................
250
1,750
2,000

11-39

Requirement 2
To record the acquisition of small tools.
2004
Small tools ...................................................................
Cash ..........................................................................
8,000
8,000
To record the replacement/depreciation of small tools.

2006
Depreciation expense ...................................................
Cash ..........................................................................
2,500
2,500
To record the sale of small tools.

2006
Cash .............................................................................
Depreciation expense ................................................

11-40
250
250
PROBLEMS
Problem 11-1
Requirement 1
Determine useful life:
$200,000 depreciable base
= 20-year useful life
$10,000 annual depreciation
Determine age of assets:
$40,000 accumulated depreciation
= 4 years old
Double-declining balance in 4th year of life:
Year 1 (2003) $200,000 x 10% = $20,000
Year 2 (2004) 180,000 x 10% = 18,000
Year 3 (2005) 162,000 x 10% = 16,200
Year 4 (2006) 145,800 x 10% = 14,580
Requirement 2
Depreciation expense (below) .....................
Accumulated depreciation ....................
$200,000
30,000
$170,000
20,000
20,000
Cost
Depreciation to date, SL 3 years (2003-2005)
Seventeen-year remaining life, or 1/17 x 2 = 2/17 = x $170,000 = $20,000

A disclosure note reports the effect of the change on net income and earnings
per share along with clear justification for changing depreciation methods.

11-41
Problem 11-2
Requirement 1
Cord Company
ANALYSIS OF CHANGES IN PLANT ASSETS
For the Year Ending December 31, 2006
Land
Land improvements
Buildings
Machinery and equipment
Automobiles and trucks
Leasehold improvements
Balance
12/31/05
$ 175,000
-1,500,000
1,125,000
172,000
216,000
$3,188,000
Increase
312,500 [1]
192,000
937,500 [1]
385,000 [2]
12,500
-$1,839,500
Decrease
$ ---17,000
24,000
-$41,000
Balance
12/31/06
$ 487,500
192,000
2,437,500
1,493,000
160,500
216,000
$4,986,500
Explanations of Amounts:
[1]
Plant facility acquired from King 1/6/06 allocation to Land and Building:
Fair value 25,000 shares of Cord common
stock at $50 market price
$1,250,000
Allocation in proportion to appraised values at date of exchange:
% of
Amount
Total
Land
$187,500
25
Building
562,500
75
$750,000
100
Land
Building
[2]
$1,250,000 x 25% =
$1,250,000 x 75% =
$ 312,500
937,500
$1,250,000
Machinery and equipment purchased 7/1/06:

Invoice cost
$325,000
Delivery cost
10,000
Installation cost
50,000
Total acquisition cost
$385,000

11-42
Problem 11-2 (continued)

Requirement 2
Cord Company
DEPRECIATION AND AMORTIZATION EXPENSE
For the Year Ended December 31, 2006
Land Improvements:
Cost
Straight-line rate (1 12 years)
Annual depreciation
Depreciation on land improvements for 2006:
(3/25 to 12/31/06)
Buildings:
Book value, 1/1/06 ($1,500,000 - 328,900)
Building acquired 1/6/06
Total amount subject to depreciation
150% declining balance rate:
(1 25 years = 4% x 1.5)
Machinery and equipment:

Balance, 1/1/06
$192,000
x 8 1/3%
16,000
x 3/4
$ 12,000
$1,171,100
937,500
2,108,600
x 6%
126,516
$1,125,000
x 10%
112,500
Purchased on 7/1/06
385,000
Depreciation for one-half year
x 5%
Depreciation on machinery and equipment for 2006
19,250
131,750
Automobiles and trucks:

Book value, 1/1/06 ($172,000 - 100,325)
Deduct 1/1/06 book value of truck sold
on 9/30 ($9,100 + 2,650)
Amount subject to depreciation
(1 5 years = 20% x 1.5)
Automobile purchased 8/30/06

Depreciation for 2006 (30% x 4/12)
Truck sold on 9/30/06 - depreciation (given)
Depreciation on automobiles and trucks
$71,675
(11,750)
59,925
x 30%
12,500
x 10%
17,978
1,250
2,650
21,878

11-43
Problem 11-2 (concluded)

Leasehold improvements:
Book value, 1/1/06 ($216,000 - 108,000)
$108,000
Amortization period (1/1/06 to 12/31/10)
5 years
Amortization of leasehold improvements for 2006
Total depreciation and amortization expense for 2006
21,600
$313,744
Problem 11-3
Pell Corporation
DEPRECIATION EXPENSE
For the Year Ended December 31, 2006
Land improvements:
Cost
Building:
Book value 12/31/05 ($1,500,000 - 350,000)
$1,150,000
86,250
$1,158,000
(58,000) $1,100,000
x 10%
110,000
287,000
x 10%
28,700
Purchased 1/2/06
Depreciation
Machine sold 3/31/06
Depreciation for three months
Total depreciation on machinery and equipment
Automobiles:
Book value on 12/31/05 ($150,000 - 112,000)
(1 3 years = 33.333% x 1.5)
Total depreciation expense for 2006

11-44
$ 12,000
x 7.5%
(1 20 years = 5% x 1.5)
Machinery and Equipment:

Balance, 12/31/05
Deduct machine sold
180,000
x 6 2/3%
58,000
x 2.5%
1,450
140,150
$38,000
x 50%
19,000
$257,400
Problem 11-4
1. Depreciation for 2004 and 2005.
December 31, 2004
Depreciation expense ($48,000 8 years x 9/12) .................
Accumulated depreciation - equipment .....................
4,500
December 31, 2005

Depreciation expense ($48,000 8 years) .........................
6,000
4,500
6,000
2. The year 2006 expenditure.

January 4, 2006
Repair and maintenance expense...................................
Equipment.....................................................................
Cash ..........................................................................
2,000
10,350
12,350
3. Depreciation for the year 2006.

December 31, 2006
5,800
5,800

$ 48,000
10,500
37,500
10,350
47,850
8 1/4
Cost
Depreciation to date ($4,500 + $6,000)
Undepreciated cost
Asset addition
New depreciable base
Estimated remaining life (10 years - 1 3/4 years)
11-45
$ 5,800
Problem 11-5
(1)
$65,000
Allocation in proportion to appraised values at date of exchange:
% of
Amount
Total
Land
$72,000
8
Building 828,000
92
$900,000
100
Land
$812,500 x 8% =
Building $812,500 x 92% =
$ 65,000
747,500
$812,500
(2) $747,500
(3)
50 years
$747,500 - 47,500
(4)
$ 14,000
Same as prior year, since method used is straight-line.
(5)
$ 85,400
3,000 shares x $25 per share =

Plus demolition of old building
(6)
None
(7)
$ 16,000
Fair market value.
(8)
$ 2,400
$16,000 x 15% (1.5 x Straight-line rate of 10%).
(9)
$ 2,040
($16,000 - 2,400) x 15%.
$75,000
10,400
$85,400
No depreciation before use.
(10) $ 99,000
Total cost of $110,000 - $11,000 in normal repairs.
(11) $ 17,000
($99,000 - 5,500) x 10/55.
(12) $ 5,100
($99,000 - 5,500) x 9/55 x 4/12.
(13) $ 30,840
PVAD = $4,000 (7.71008 * )

* Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)
(14) $ 2,056
$30,840

11-46
15 years
Problem 11-6
Requirement 1
Building:
$500,000
= $20,000 per year x 9/12 = $15,000
25 years
Machinery:
$240,000 - (10% x $240,000)
= $27,000 per year x 9/12 = $20,250
8 years
Equipment:
Sum-of-the-digits is ([6 (6 + 1)]2) = 21
($160,000 - 13,000) x 6/21 = $42,000 x 9/12 = $31,500
Requirement 2
(1)
June 29, 2007
Accumulated depreciation - machinery .....................
5,625
5,625
$100,000 - (10% x $100,000)

= $11,250 x 6/12 = $5,625
8 years

11-47

(2)
June 29, 2007
Cash ..............................................................................
Accumulated depreciation - machinery (below) ..............
Loss on sale of machinery (difference).............................
Machinery .................................................................
80,000
14,063
5,937
100,000
Accumulated depreciation on machinery sold:

2006 depreciation = $11,250 x 9/12 =
2007 depreciation = $11,250 x 6/12
Total
$ 8,438
5,625
$14,063
Requirement 3
Building:
$500,000
= $20,000
25 years
Machinery:
$140,000 - (10% x $140,000)
= $15,750
8 years
Equipment:
+
($160,000 - 13,000) x 6/21 = $42,000 x 3/12 =

($160,000 - 13,000) x 5/21 = $35,000 x 9/12 =

11-48
$10,500
26,250
$36,750
Problem 11-7
Requirement 1
Cost of mineral mine:
Purchase price
Development costs
$1,600,000
600,000
$2,200,000
Depletion:
$2,200,000 - 100,000
Depletion per ton =
= $5.25 per ton

400,000 tons
2006 depletion
= $5.25 x 50,000 tons = $262,500
2007 depletion:
Revised depletion rate =
($2,200,000 - 262,500) - 100,000

= $4.20
487,500 - 50,000 tons
2007 depletion
= $4.20 x 80,000 tons = $336,000
Depreciation:
Structures:
$150,000
Depreciation per ton =
= $.375 per ton

400,000 tons
2006 depreciation
= $.375 x 50,000 tons = $18,750
2007 depreciation:
Revised depreciation rate =
$150,000 - 18,750
= $.30
487,500 - 50,000 tons
2007 depreciation
= $.30 x 80,000 tons = $24,000

11-49

Equipment:
$80,000 - 4,000
Depreciation per ton =
= $.19 per ton

400,000 tons
2006 depreciation
= $.19
x 50,000 tons = $9,500
2007 depreciation:
Revised depreciation rate =
($80,000 - 9,500) - 4,000

= $.152
487,500 - 50,000 tons
2007 depreciation = $.152 x 80,000 tons = $12,160

Requirement 2
Mineral mine:
Cost
Less accumulated depletion:
2006 depletion
2007 depletion
Book value, 12/31/07
Structures:
Cost
Less accumulated depreciation:
2006 depreciation
2007 depreciation
Equipment:
Cost
2006 depreciation
2007 depreciation

11-50
$ 2,200,000
$262,500
336,000
598,500
$1,601,500
$ 150,000
$18,750
24,000
42,750
$107,250
$ 80,000
$ 9,500
12,160
21,660
$58,340

Requirement 3
Depletion of natural resources and depreciation of assets used in the extraction of
natural resources are part of product cost and are included in the cost of the inventory
of the mineral, just as the depreciation on manufacturing equipment is included in
inventory cost. The depletion and depreciation are then included in cost of goods sold
in the income statement when the mineral is sold.
In 2006, since all of the ore was sold, all of 2006s depletion and depreciation is
included in cost of goods sold. In 2007, since not all of the extracted ore was sold, a
portion of both 2007s depletion and depreciation remains in inventory.

11-51
Problem 11-8
Requirement 1
Calculation of goodwill:
Purchase price
Less: Fair market value of net identifiable assets
$2,000,000
1,700,000
$ 300,000
The cost of goodwill is not amortized.

To record amortization of patent.
Amortization ($80,000 8 years x 6/12) ..............................
Patent ........................................................................
5,000
5,000
To record amortization of franchise.

Amortization expense ($200,000 10 years x 3/12) .............
Franchise ...................................................................

11-52
5,000
5,000

Requirement 2
Intangible assets:
Goodwill
Patent
Franchise
Total intangibles
$300,000 [1]
75,000 [2]
195,000 [3]
$570,000
[1] $300,000
[2] $ 80,000 - 5,000
[3] $200,000 - 5,000

11-53
Problem 11-9
Requirement 1
Machine 101:
$70,000 - 7,000
= $6,300 per year x 3 years =
$ 18,900
= $9,000 per year x 1.5 years =
13,500
10 years
Machine 102:
$80,000 - 8,000
8 years
Machine 103:
$30,000 - 3,000
= $3,000 per year x 4/12
1,000
9 years
Accumulated depreciation, 12/31/05
$33,400
Requirement 2
To record depreciation on machine 102 through date of sale.
March 31, 2006
Depreciation expense ($9,000 per year x 3/12) ....................
2,250
2,250
To record sale of equipment.

March 31, 2006
Cash ..............................................................................
Accumulated depreciation ($13,500 + 2,250) ....................
Loss on sale of equipment (determined below) ..................
Equipment .................................................................
11-54
52,500
15,750
11,750
80,000

Loss on sale of machine 102:
Proceeds
Less book value on 3/31/06:
Cost
Depreciation through 12/31/05
Depreciation from 1/1/06 to
3/31/06 ($9,000 x 3/12)
Loss on sale
$52,500
$80,000
$13,500
2,250
15,750
64,250
$11,750
Requirement 3
Building:
Useful life of the building:
$200,000
= $40,000 in depreciation per year
5 years
(2001-2005)
$840,000 - 40,000
= 20-year useful life
$40,000
To record depreciation on the building.
Depreciation expense [($840,000 - 40,000) 20 years] ........
Accumulated depreciation - building .........................
40,000
40,000

11-55

To record depreciation on the equipment.
Equipment:
Machine 103 (determined above)
Machine 101:
Cost
Less: Accumulated depreciation
Revised remaining life (7 years - 3 years)

11-56
15,775
15,775
$ 3,000
$70,000
18,900
51,100
4 years
12,775
$15,775
Problem 11-10
a. This is a change in estimate.
No entry is needed to record the change.
2006 adjusting entry:
Depreciation expense (determined below) ........................
Accumulated depreciation ........................................
37,500
37,500

$1,000,000
Cost
$25,000
Old depreciation ($1,000,000 40 years)
x 3 yrs
(75,000) Depreciation to date (2003-2005)
925,000 Undepreciated cost
(700,000) New estimated salvage value
225,000 New depreciable base
6 yrs.
Estimated remaining life (6 years: 2006-2011)
$ 37,500 New annual depreciation
A disclosure note should describe the effect of a change in estimate on income
before extraordinary items, net income, and related per-share amounts for the current
period.

11-57

b. This is a change in accounting principle that is accounted for as a change in
estimate.
Depreciation expense (below) ..................... 21,000
Accumulated depreciation ............
21,000
SYD
2002 depreciation
2003 depreciation
2004 depreciation
2005 depreciation
$ 60,000
54,000
48,000
42,000
Accumulated depreciation $204,000
$330,000
204,000
126,000
0
126,000
6 yrs.
$ 21,000
($330,000 x 10/55)
($330,000 x 9/55)
($330,000 x 8/55)
($330,000 x 7/55)
Cost
Depreciation to date, SYD (above)
Less residual value
Depreciable base
A disclosure note reports the effect of the change on net income and earnings
per share along with clear justification for changing depreciation methods.
c. This is a change in accounting principle accounted for as a change in estimate.
Because the change will be effective only for assets placed in service after the
date of change, depreciation schedules do not require revision because the change
does not affect assets depreciated in prior periods. A disclosure note still is required
to provide justification for the change and to report the effect of the change on current
years income.

11-58
Problem 11-11
Requirement 1
Analysis:
Correct
(Should Have Been Recorded)
Incorrect
(As Recorded)
2004 Equipment 1,900,000

Expense
100,000
Cash
2,000,000
Equipment 2,000,000
Cash
2,000,000
2004 Expense
475,000 [1]
Accum. deprec.
475,000
Expense
500,000 [2]
Accum. deprec.
500,000
2005 Expense
356,250 [3]
Accum. deprec.
356,250
Expense
375,000 [4]
Accum. deprec.
375,000
[1] $1,900,000 x 25% (2 times the straight-line rate of 12.5%)

[2] $2,000,000 x 25%
[3] ($1,900,000 - 475,000) x 25%
[4] ($2,000,000 - 500,000 ) x 25%
During the two-year period, depreciation expense was overstated by $43,750,
but other expenses were understated by $100,000, so net income during the
period was overstated by $56,250, which means retained earnings is currently
overstated by that amount.
During the two-year period, accumulated depreciation was overstated, and
continues to be overstated by $43,750.
To correct incorrect accounts
Retained earnings ................................................
Accumulated depreciation ...................................................
Equipment .......................................................
56,250
43,750
100,000

11-59

Requirement 2
This is a change in accounting principle accounted for as a change in estimate.
No entry is needed to record the change.
Depreciation expense (determined below).................. 178,125
Accumulated depreciation .....................................
178,125
A change in depreciation method is considered a change in accounting estimate
resulting from a change in accounting principle. Accordingly, the Collins Corporation
reports the change prospectively; previous financial statements are not revised.
Instead, the company simply employs the straight-line method from now on. The
undepreciated cost remaining at the time of the change is depreciated straight-line
over the remaining useful life.
Assets cost (after correction)
Accumulated depreciation to date ($475,000 + 356,250)
Estimated residual value
To be depreciated over remaining 6 years
Annual straight-line depreciation 2006-2011

11-60
$1,900,000
(831,250)
1,068,750
(0)
1,068,750
6
$ 178,125
years
Problem 11-12
Requirement 1
Plant and equipment:
Depreciation to date:
$150 million 10 years = $15 million per year x 3 years = $45 million
Book value: $150 million $45 million = $105 million
Patent:
Amortization to date:
$40 million 5 years = $8 million per year x 3 years = $24 million
Book value: $40 million $24 million = $16 million
Requirement 2
Tangible operational assets and finite life intangibles are tested for impairment
only when events or changes in circumstances indicate book value may not be
recoverable.
Requirement 3
Goodwill should be tested for impairment on an annual basis and in between
annual test dates if events or circumstances indicate that the fair value of the reporting
unit is below its book value.
Requirement 4
Plant and equipment:
An impairment loss is indicated because the book value of the assets, $105
million, is greater than the $80 undiscounted sum of future cash flows. The amount of
the impairment loss is determined as follows:
Book value
Fair value
Impairment loss
$105 million
(60) million
45 million
Patent:
There is no impairment loss because the undiscounted sum of future cash flows,
$20 million, exceeds book value of $16 million.

11-61

Goodwill:
An impairment loss is indicated because the book value of the assets of the
reporting unit, $470 million, is greater than the $450 million fair value of the reporting
unit. The amount of the impairment loss is determined as follows:
Determination of implied goodwill:
Fair value of Ellison Technology
Fair value of Ellisons net assets (excluding goodwill)
$450 million
(390) million
$ 60 million

Impairment loss
$100 million
(60) million
$40 million

11-62
CASES
Analysis Case 11-1
The terms depreciation, depletion, and amortization all refer to the same process
of allocating the cost of an operational asset to the periods benefited by their use.
However, each term is applied to a different type of operational asset; depreciation is
used for plant and equipment, depletion for natural resources, and amortization for
intangibles.
There are differences in determining the factors necessary to calculate
depreciation, depletion, and amortization but the concepts involved are the same. The
service life of plant and equipment and natural resources is limited to physical life,
while the service life of intangible assets is limited to the assets legal or contractual
life, or 40 years, whichever is shorter.
The majority of companies use straight-line depreciation and straight-line
amortization. Natural resources usually are depleted using the units-of-production
method.

11-63
Communication Case 11-2

Suggested Grading Concepts and Grading Scheme:
Content (70%)
______ 50 Explains the concept of depreciation as a process of
cost allocation, not valuation.
_____ Rational match versus market fluctuations.
_____ Numerical example.
______
10 Purpose of the balance sheet is to provide information about

financial position, not to directly measure company value.
______
10 Purpose of the income statement is to provide cash flow

information, not to directly measure the change in company
value.
____
______ 70 points
Writing (30%)
______ 6 Terminology and tone appropriate to the audience of
a company president.
______
12 Organization permits ease of understanding.

_____ Introduction that states purpose.
_____ Paragraphs that separate main points.
______
12 English
_____ Sentences grammatically clear and well organized,
concise.
_____ Word selection.
_____ Spelling.
_____ Grammar and punctuation.
____
______ 30 points

11-64
Judgment Case 11-3

Requirement 1
Portland should have selected the straight-line depreciation method when
approximately the same amount of an assets service potential is used up each period.
If the reasons for the decline in service potential are unclear, then the selection of the
straight-line method could be influenced by the ease of recordkeeping, its use for
similar assets, and its use by others in the industry.
Requirement 2
a. By associating depreciation with a group of machines instead of each
individual machine, Portlands bookkeeping process is greatly simplified. Also, since
actual machine lives vary from the average depreciable life, unrecognized net losses
on early dispositions are expected to be offset by continuing depreciation on machines
usable beyond the average depreciable life. Periodic income does not fluctuate as a
result of recognizing gains and losses on machine dispositions.
b. Portland should divide the depreciable base of each machine by its estimated
life to obtain its annual depreciation. The sum of the individual annual depreciation
amounts should then be divided by the sum of the individual capitalized costs to
obtain the annual composite depreciation rate.

11-65
Judgment Case 11-4

Requirement 1
a. The capitalized cost for the computer includes all costs reasonable and
necessary to prepare it for its intended use. Examples of such costs are the purchase
price, delivery, installation, testing, and setup.
b. The objective of depreciation accounting is to allocate the depreciable base of
an asset over its estimated useful life in a systematic and rational manner. This
process matches the depreciable base of the asset with revenues generated from its
use. Depreciable base is the capitalized cost less its estimated residual value.
Requirement 2
The rationale for using accelerated depreciation methods is based on the
assumption that an asset is more productive in the earlier years of its estimated useful
life. Therefore, larger depreciation charges in the earlier years would be matched
against the larger revenues generated in the earlier years. An accelerated depreciation
method also would be appropriate when benefits derived from the asset are
approximately equal over the assets life, but repair and maintenance costs increase
significantly in later years. The early years record higher depreciation expense and
lower repairs and maintenance expense, while the later years have lower depreciation
and higher repairs and maintenance.
Judgment Case 11-5

There is no necessarily correct answer to the question. The support made for the
answer given is more important than the answer itself. Materiality is the critical
consideration.
Information is material if it can have an effect on a decision made by users. One
consequence of materiality is that GAAP need be followed only if an item is material.
The threshold for materiality will depend principally on the relative dollar amount of
the transaction.
In this case, is the $70,000 material? Net-of-tax income would be $49,000 higher
if the expenditures were capitalized instead of expensed [$70,000 x (1-.30)]. This
represents a 4.45% increase in income ($49,000 $1,100,000). The effect on the
balance sheet is small. Shareholders' equity would be higher by $49,000 if the
expenditures were capitalized. This represents an increase of less than one-half of one
percent. Would these differences have an effect on decision-makers? There is no
single answer to this question. The FASB has been reluctant to establish any
quantitative materiality guidelines. The threshold for materiality has been left to
subjective judgment of the company preparing the financial statement and its auditors.
11-66
Communication Case 11-6

There is no right or wrong answer to this case. Both views, expense and
capitalize, can be defended once consideration is given to the materiality issue. The
process of developing and synthesizing the arguments will likely be more beneficial
than any single solution. Each student should benefit from participating in the
process, interacting first with his or her partner, then with the class as a whole. It is
important that each student actively participate in the process. Domination by one or
two individuals should be discouraged.
A significant benefit of this case is that it is forcing students to consider the
subjective nature of materiality when applying GAAP.

11-67
Integrating Case 11-7

Requirement 1
a.
Inventory (understatement of 2007 beginning inventory) ........
Retained earnings (understatement of 2006 income) .........
($ in millions)
10
10
Note: The 2005 error requires no adjustment because it has self-corrected by 2007.
b.
Retained earnings (2005-2006 patent amortization)..............
Patent [($18 million 6 years) x 2] .................................

Patent amortization expense ($18 million 6 years) .........
Patent ......................................................................
c.
Depreciation expense (below) ........................................
Accumulated depreciation .......................................
4
4
($ in millions)
SYD
2005 depreciation
2006 depreciation
Accumulated depreciation
$30
18
12
0
12
3 yrs.
$ 4
$10 ($30 x 5/15)

8 ($30 x 4/15)
$18
Cost
Depreciation to date, SYD (above)
Less residual value
Depreciable base

11-68
Case 11-7 (concluded)

Requirement 2
Assets
2005
2005 inventory
Patent amortization
Depreciation
2006
2005 inventory
2006 inventory
Patent amortization
Depreciation
$640
(12)
(3)
$330
$310
(12)
(3)
$210
(12)
(3)
Expenses
$150
12
3
no adjustments to prior years
____
$625
____
$330
____
$295
____
$195
____
$165
$820
$400
$420
$230
12
10
(3)
$175
(12)
(10)
3
10
(6)
10
(6)
no adjustments to prior years
____
$824
Shareholders Net
Liabilities
Equity
Income
____
____
____
____
$400
$424
$249
$156

11-69
Judgment Case 11-8

Requirement 1
A change from the sum-of-the-years digits method of depreciation to the
straight-line method for previously recorded assets is a change in accounting principle
that is accounted for as a change in estimate. Both the sum-of-the-years digits
method and the straight-line method are generally accepted. A change in accounting
principle results from the adoption of a generally accepted accounting principle
different from the generally accepted principle used previously for reporting purposes.
Requirement 2
A change in the expected service life of an asset arising because of more
experience with the asset is a change in accounting estimate. A change in accounting
estimate occurs because future events and their effects cannot be perceived with
certainty. Estimates are an inherent part of the accounting process. Therefore,
accounting and reporting for certain financial statement elements requires the exercise
of judgment, subject to revision based on experience.
Trueblood Accounting Case 11-9

A solution and extensive discussion materials accompany each case in the
Deloitte & Touche Trueblood Case Study Series.

11-70
Research Case 11-10

Requirement 1
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, and SFAS No. 142, Goodwill and Other Intangible Assets, are the two
relevant accounts standards.
Requirement 2
Tangible operational assets and finite life intangibles are tested for impairment
only when events or changes in circumstances indicate book value may not be
recoverable.
Intangible assets with indefinite useful lives, including goodwill, should be tested
for impairment on an annual basis and in between annual test dates if events or
circumstances indicate that the fair value of the reporting unit is below its book value.
Requirement 3
Tangible operational assets and finite life intangibles:
Determining whether to record an impairment loss and actually recording the loss
is a two-step process. The first step is a recoverability test - an impairment loss is
required only when the undiscounted sum of estimated future cash flows from an asset
is less than the assets book value. The measurement of impairment lossstep 2is
the difference between the assets book value and its fair value.
Intangible operational assets with indefinite useful lives (other than goodwill):
The measurement of an impairment loss for indefinite life intangibles other than
goodwill is a one-step process. We compare the fair value of the asset with its book
value. If book value exceeds fair value, an impairment loss is recognized for the
difference.
Goodwill:
Determining whether to record an impairment loss and actually recording the loss
is a two-step process. Step 1 - A goodwill impairment loss is indicated when the fair
value of the reporting unit is less than its book value. Step 2 - A goodwill impairment
loss is measured as the excess of the book value of the goodwill over its implied fair
value. The implied fair value of goodwill is calculated in the same way that goodwill
is determined in a business combination. That is, its a residual amount measured by
subtracting the fair value of all identifiable net assets from the purchase price using
the units previously determined fair value as the purchase price.

11-71

Requirement 4
Operational assets to be sold should be classified as held for sale in the period in
which all of the following criteria are met:
a. Management commits to a plan to sell.
b. The asset or asset group is available for immediate sale in its present condition.
c. An active program to locate a buyer and other actions required to complete the
plan to sell the asset or asset group have been initiated.
d. The sale is probable.
e. The asset or asset group is being actively marketed for sale at a price that is
reasonable in relation to its current fair value.
f. Actions required to complete the plan indicate that it is unlikely that significant
changes to the plan will be made or that the plan will be withdrawn.14
Requirement 5
An operational asset or group of assets classified as held for sale is measured at
the lower of its book value or fair value less cost to sell. An impairment loss is
recognized for any write-down to fair value less cost to sell.
14 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, Statement of Financial Accounting
Standards No. 144 (Norwalk, Conn.: FASB, 2001), par. 30.

11-72
Ethics Case 11-11

Requirement 1
2006 expense using CEO's approach:
$42,000,000
$4,200,000
x 2 years
8,400,000
33,600,000
3
$11,200,000
Cost
Old annual depreciation ($42,000,000 10 years)
Book value
Estimated remaining life (2006-2008)
2006 income would include only depreciation expense of $11,200,000.

2006 expense using Heather's approach:
$42,000,000
$4,200,000
x 2 years
8,400,000
33,600,000
12,900,000
20,700,000
3
$ 6,900,000
Cost
Old annual depreciation ($42,000,000 10 years)
Book value
Write-down
New depreciable base
Estimated remaining life (2006-2008)
2006 income would include depreciation expense of $6,900,000 and an asset writedown of $12,900,000 for a total income reduction of $19,800,000.
Using Heather's approach, 2006's before tax income would be lower by $8,600,000
($19,800,000 - 11,200,000).

11-73

Requirement 2
Discussion should include these elements.
Facts:
SFAS 144 provides guidance for recording impairment losses on partial writedowns of operational assets remaining in use. Assets should be written down if there
has been a significant impairment of value such as in decreased product demand and
full recovery of book value through use or resale is not expected. Although the
decision and computation to record an impairment loss often is very subjective and
difficult to measure, Heather is able to estimate an equipment impairment of
$12,900,000, presumably using the best information available. The simple revision in
service life approach is clearly an effort to enhance net income on the part of the CEO.
Ethical Dilemma:
Is Heather's obligation to challenge the questionable application of revision in
service life more important than her obligation to her boss and to the company's effort
to reflect a favorable net income?
Who is affected?
Heather
CEO and other managers
Other employees
Shareholders
Potential shareholders
Creditors
Company auditors

11-74
Judgment Case 11-12

Requirement 1
By changing its depreciation method, a company can shift reported income
between periods. For example, a shift from an accelerated method to the straight-line
method increases income in the year of the change. However, in some future period
or periods, income will be lower than it would have been if the change had not been
made.
This is not an effective way to manage earnings because the effect on income of
switching from one method to another must be disclosed.
Requirement 2
A company can manage earnings by changing the estimated useful lives of
depreciable assets. For example, reducing useful lives causes a decrease in income in
one or more years including the year of the change, and increases income in some
future years.
This is not an effective way to manage earnings because the effect on income of
changing useful lives, if material, must be disclosed.
Requirement 3
One possible approach to answering this question is to assume a company
overstates its impairment loss. For example, assume that the book value of
depreciable assets is $20 million. The fair value of these assets is estimated to be $13
million, indicating an impairment loss of $7 million. If these assets are written down
to $8 million, the company has effectively shifted $5 million in pre-tax income from
the current period to future periods. By writing down the assets to $8 million instead
of $13 million, future depreciation is $5 million less than it would have been with a
more appropriate write-down.

11-75
Judgment Case 11-13

Transaction
Disposition
1.
Transaction is correctly recorded as repairs and maintenance

expense.
2.

expense.
3.
Transaction is incorrectly recorded. The amount should be

capitalized as part of the cost of the plant.
4.

capitalized either as part of the cost of the plant or as a
reduction in the accumulated depreciation of the plant.
5.

expense.
6.

expense.
7.

capitalized as equipment.
8.

expense.

11-76
Real World Case 11-14

Requirement 1
($ in millions)
Plant, rental machines and other property (Cost):

Balance, beginning of 2004
Add: Acquisitions during 2004
Less: Balance end of 2004
Dispositions during 2004
$36,153
5,368
(36,385)
$ 5,136
Plant, rental machines and other property (Accumulated depreciation):

Balance, beginning of 2004
Add: Depreciation for 2004
Less: Balance end of 2004
Accumulated depreciation of 2004 dispositions
$21,464
3,959
(21,210)
$ 4,213
Gain (loss) on 2004 dispositions:

Cost of dispositions
Less: Accumulated depreciation of dispositions
Book value of dispositions
Proceeds from dispositions
Less: Book value of dispositions
Gain on 2004 dispositions
$ 5,136
(4,213)
$ 923
$1,311
(923)
$ 388
Requirement 2
2004 depreciable assets:
Plant, rental machines and other property
Less: Land and land improvements
Cost of depreciable assets
$36,385
(840)
$35,545
The disclosure note indicates that IBM uses the straight-line depreciation method.
$35,545 $3,959 (2004 depreciation) = 8.98 years.
The approximate average service life of IBM's depreciable assets is 9 years.

11-77
Real World Case 11-15

Requirement 3
The following was taken from the companys 2003 financial statements. Your
results could differ if the company changes any of its policies in years after 2003.
a. The company's depreciation and depletion policies, disclosed in Note 1.
Summary of Significant Account Policies, are as follows:
Depreciation and depletion of all capitalized costs of proved oil and gas
producing properties, except mineral interests, are expensed using the unit-ofproduction method by individual field as the proved developed reserves are
produced. Depletion expenses for capitalized costs of proved mineral interests
are recognized using the unit-of-production method by individual field as the
related proved reserves are produced. Periodic valuation provisions for
impairment of capitalized costs of unproved mineral interests are expensed.
Depreciation and depletion expenses for coal assets are determined using the
unit-of-production method as the proved reserves are produced. The
capitalized costs of all other plant and equipment are depreciated or amortized
over their estimated useful lives. In general, the declining-balance method is
used to depreciate plant and equipment in the United States; the straight-line
method generally is used to depreciate international plant and equipment and
to amortize all capitalized leased assets.
b. Expenditures for maintenance, repairs and minor renewals to maintain
facilities in operating condition are generally expensed as incurred. Major
replacements and renewals are capitalized. Environmental expenditures that
relate to ongoing operations or to conditions caused by past operations are
expensed. Expenditures that create future benefits or contribute to future
revenue generation are capitalized.
Maintenance and repair costs incurred, which are not significant improvements,
are expensed. Environmental expenditures are expensed or capitalized as
appropriate, depending upon their future economic benefit.

11-78
Analysis Case 11-16

Requirement 1
The statement of cash flows reports depreciation and amortization of $1,375
million.
Requirement 2
FedEx uses the straight-line depreciation method for financial reporting. Service
life ranges are as follows:
Wide-body aircraft and related equipment
15 to 22 years
Narrow-body and feeder aircraft and related equipment
5 to 15 years
Package handling and ground support equipment and vehicles 3 to 30 years
Computer and electronic equipment
3 to 10 years
Other
2 to 40 years
Substantially all property and equipment have no residual values.
For income tax purposes, depreciation is generally computed using accelerated
methods. Though not specifically indicated, presumably this is the Modified
Accelerated Cost Recovery System (MACRS).

11-79

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Operational Assets: Utilization and

QUESTIONS FOR REVIEW OF KEY TOPICS

Solutions Manual, Vol.1, Chapter 11

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Answers to Questions (continued)

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Intermediate Accounting, 4/e

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Answers to Questions (continued)

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Answers to Questions (concluded)

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Brief Exercise 11-2

= 50% DDB rate

2,200 hours x $2.80 = $6,160

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Brief Exercise 11-3

$28,000 x 4/10 x 9/12

$28,000 x 4/10 x 3/12

= 50% DDB rate

$30,000 x 50% x 9/12

($30,000 11,250) x 50%

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Brief Exercise 11-4

Brief Exercise 11-5

= $2.75 per foot

= $2.75 x 700,000 feet

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Intermediate Accounting, 4/e

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Brief Exercise 11-6

Amortization of the patent

Goodwill is not amortized.

Amortization of the patent:

*Amortization of the developed technology:

Brief Exercise 11-7

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Brief Exercise 11-8

*$8,000,000 25 = $320,000 x 2 years = $640,000

Remaining life is 23 years. Twice the straight-line rate is 2/23.

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Brief Exercise 11-9

Brief Exercise 11-10

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