Book and Answer Ch10

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Chapter 10 Operational Assets: Acquisition and Disposition
QUESTIONS FOR REVIEW OF KEY TOPICS

Question 10-1
The term operational asset is used to describe the broad category of long-lived assets that are
used in the production of goods and services. The difference between tangible and intangible assets
is that intangible assets lack physical substance and they primarily refer to the ownership of rights.
Question 10-2
The cost of an operational asset includes the purchase price (less any discounts received from
the seller), transportation costs paid by the buyer to transport the asset to the location in which it will
be used, expenditures for installation, testing, legal fees to establish title, and any other costs of
bringing the asset to its condition and location for use.
Question 10-3
The cost of a developed natural resource includes the acquisition costs for the use of land, the
exploration and development costs incurred before production begins, and the restoration costs
incurred during or at the end of extraction.
Question 10-4
Purchased intangibles are valued at their original cost to include the purchase price and all
other necessary costs to bring the asset to condition and location for use. Research and development
costs incurred to internally develop an intangible asset are expensed in the period incurred. Filing
and legal costs for both purchased and developed intangibles are capitalized.
Question 10-5
Goodwill represents the unique value of the company as a whole over and above all
identifiable tangible and intangible assets. This value results from a companys clientele and
reputation, its trained employees and management team, its unique business location, and any other
unique features of the company that cant be associated with a specific asset.
Because goodwill cant be separated from a company, it is not possible for a buyer to acquire it
without also acquiring the whole company or a substantial portion of it. Goodwill will appear as an
asset in a balance sheet only when it was paid for in connection with the acquisition of another
company. The capitalized cost of goodwill equals the purchase price of the acquired company less
the market value of the net assets acquired. The market value of the net assets equals the market
value of all identifiable tangible and intangible assets less the market value of any liabilities of the
selling company assumed by the buyer.
The McGraw-Hill Companies, Inc., 2007

Solutions Manual, Vol.1, Chapter 10 10-1
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Answers to Questions (continued)

Question 10-6
A lump-sum purchase price generally is allocated based on the relative market values of the
individual assets. The relative market value percentages are multiplied by the lump-sum purchase
price to arrive at the initial valuation of each of the separate assets.
Question 10-7
Assets acquired in exchange for deferred payment contracts are valued at their fair value or the
present value of payments using a realistic interest rate. Theoretically, both alternatives should lead
to the same valuation.
Question 10-8
Assets acquired through the issuance of equity securities are valued at the fair value of the
securities if known; if not known, the fair value of the assets received is used.
Question 10-9
Donated assets are valued at their fair values.
Question 10-10
When an operational asset is sold, a gain or loss is recognized for the difference between the
consideration received and the assets book value. Retirements and abandonments are handled in a
similar fashion. The only difference is that there will be no monetary consideration received. A loss
is recorded for the remaining book value of the asset.
Question 10-11
The basic principle used to value assets acquired in a nonmonetary exchange is to use the fair
value of asset(s) given up plus (minus) monetary consideration - cash - paid (received).
Question 10-12
The two exceptions are (1) when fair value is not determinable, and (2) when the exchange
lacks commercial substance.
Question 10-13
GAAP require the capitalization of interest incurred during the construction of assets for a
companys own use as well as for assets constructed for sale or lease. Assets qualifying for
capitalization exclude inventories that are routinely manufactured in large quantities on a repetitive
basis and assets that are in use or ready for their intended purpose. Only assets that are constructed
as discrete projects qualify for interest capitalization.

10-2 Intermediate Accounting, 4/e
Answers to Questions (continued)

Question 10-14
Average accumulated expenditures for a period is an approximation of the average amount of
debt the company would have had outstanding if it borrowed all of the funds necessary for
construction. If construction expenditures are incurred equally throughout the period, the average
accumulated expenditures for the period can be estimated by adding the accumulated expenditures at
the beginning of the period to the accumulated expenditures at the end of the period and dividing by
two. If expenditures on the project are unequal throughout the period, individual expenditures,
perhaps expenditures grouped by month, should be weighted by the amount of time outstanding until
the end of the construction period or the end of the companys fiscal year, whichever comes first.
Question 10-15
Applying the specific interest method, the interest rate on any construction related debt is used
up to the amount of the construction debt and any excess average accumulated expenditures is
multiplied by a weighted-average interest rate of all other debt. The weighted-average method
multiplies average accumulated expenditures by the weighted-average interest rate of all debt,
including any construction-related debt.
Question 10-16
SFAS 2 defines research and development as follows:
Research is planned search or critical investigation aimed at discovery of new knowledge with
the hope that such knowledge will be useful in developing a new product or service or a new process
or technique or in bringing about a significant improvement to an existing product or process.
Development is the translation of research findings or other knowledge into a plan or design for
a new product or process or for a significant improvement to an existing product or process whether
intended for sale or use.
Question 10-17
SFAS 2 specifically excludes from current R&D expense the cost of operational assets that
have alternative future uses beyond the current R&D project. However, the depreciation or
amortization of these assets will be included as R&D expenses in the future periods the assets are
used for R&D activities. If the equipment has no alternative future use, its cost is expensed as R&D
immediately.
Question 10-18
GAAP require the capitalization of software development costs incurred after technological
feasibility is established. Technological feasibility is established when the enterprise has completed
all planning, designing, coding, and testing activities that are necessary to establish that the product
can be produced to meet its design specifications including functions, features, and technical
performance requirements. Costs incurred after technological feasibility but before the product is
available for general release to customers are capitalized as an intangible asset. These costs include
coding and testing costs and the production of product masters. Similar to SFAS 2, costs incurred
after commercial production begins usually are not R&D expenditures.

Answers to Questions (concluded)

Question 10-19
The cost of developed technology is capitalized and expensed over its expected useful life.
The cost of in-process R&D is expensed in the period of the acquisition. Developed technology
relates to those projects that have reached technological feasibility.
Question 10-20
The successful efforts method allows companies to capitalize only exploration costs resulting
in successful wells. The full-cost method allows companies to capitalize all exploration costs
incurred within a geographical area.

BRIEF EXERCISES
Brief Exercise 10-1
Capitalized cost of the machine:
Purchase price $35,000

Freight 1,500
Installation 3,000
Testing 2,000
Total cost $41,500
Note: Personal property taxes on the machine for the period after acquisition are
not part of acquisition cost. They are expensed in the period incurred.
Brief Exercise 10-2

Capitalized cost of land:

Brokers commission 30,000
Title insurance 3,000
Miscellaneous closing costs 6,000
Demolition of old building 18,000
Total cost $657,000
All of the expenditures, including the costs to demolish the old building, are
included in the initial cost of the land.

Brief Exercise 10-3

Cost of land and building:

Brokers commission 30,000
Miscellaneous closing costs 6,000
Total cost $639,000
The total must be allocated to the land and building based on their relative market
values:
Initial
Percent of Total Valuation
Market Value (Percent x
Asset Market Value $639,000)
Land $420,000 60% $383,400
Building 280,000 40 255,600
$700,000 100% $639,000
Brief Exercise 10-4

Cost of silver mine:
Acquisition, exploration, and development $5,600,000
Restoration costs 429,675
$6,029,675
$500,000 x 20% = $100,000

550,000 x 45% = 247,500
650,000 x 35% = 227,500
$575,000 x .74726* = $429,675
*Present value of $1, n = 5, i = 6% (from Table 2)

Brief Exercise 10-5

After one year, the liability will increase to $455,456.
($429,675 + ($429,675 x 6%) = $455,456)
$500,000 x 20% = $100,000

550,000 x 45% = 247,500
650,000 x 35% = 227,500
$575,000 x .74726* = $429,675
*Present value of $1, n = 5, i = 6% (from Table 2)
Actual restoration costs $596,000

Less: Asset retirement liability (575,000)
Loss on retirement $ (21,000)
Brief Exercise 10-6

Calculation of goodwill:
Purchase price $14,000,000

Less fair value of net assets:
Book value of assets $8,300,000
Plus: Excess of fair value over book value
of intangible assets 2,500,000 (10,800,000)
Goodwill $ 3,200,000

Brief Exercise 10-7

The initial value of machinery and note will be the present value of the note
payment:
PV = $60,000 (.85734* ) = $51,440

* Present value of $1: n = 2, i = 8% (from Table 2)
Interest expense for 2006:
$51,440 x 8% x 6/12 = $2,058
Brief Exercise 10-8

The cost of the patent equals the market value of the stock given in exchange:
50,000 x $22 = $1,100,000
Brief Exercise 10-9

Average PP&E for 2006 = ($740,000 + 940,000) 2 = $840,000
Net sales Average PP&E = Fixed-asset turnover ratio

? $840,000 = 3.25
Average PP&E x Fixed-asset turnover ratio = Net sales
$840,000 x 3.25 = $2,730,000

Brief Exercise 10-10

Proceeds $16,000
Less book value: $80,000
(71,000) 9,000
Gain on sale of equipment $ 7,000
Journal entry (not required):
Cash .............................................................................. 16,000

Accumulated depreciation (account balance) .................... 71,000
Gain (difference) .......................................................... 7,000
Equipment (account balance) ......................................... 80,000

Pickup trucks = Fair value of machinery less cash received
$17,000 8,000 = $9,000
Loss on exchange = $20,000 (book value) 17,000 (fair value) = $3,000
Cash .............................................................................. 8,000

Pickup trucks (determined above) ..................................... 9,000
Loss (difference) .............................................................. 3,000
Machinery (account balance) ......................................... 65,000


Pickup trucks = Fair value of machinery less cash received
$24,000 8,000 = $16,000
Gain on exchange = $24,000 (fair value) 20,000 (book value ) = $4,000
Cash .............................................................................. 8,000

Gain (difference) .......................................................... 4,000

Pickup trucks = Book value of machinery less cash received
$20,000 8,000 = $12,000
No gain is recognized in this situation.
Cash .............................................................................. 8,000



Average accumulated expenditures:
January 2, 2006 $500,000 x 12/12 = $ 500,000

March 31, 2006 600,000 x 9/12 = 450,000
June 30, 2006 400,000 x 6/12 = 200,000
October 30, 2006 600,000 x 2/12 = 100,000
$1,250,000
Interest capitalized:
$1,250,000
- 700,000 x 7% = $49,000
$ 550,000 x 6.75%* = 37,125
$ 86,125 = interest capitalized
* Weighted-average rate of all other debt:
$3,000,000 x 8% = $240,000
5,000,000 x 6% = 300,000
$8,000,000 $540,000
$540,000
= 6.75% weighted average
$8,000,000


January 2, 2006 $500,000 x 12/12 = $ 500,000
March 31, 2006 600,000 x 9/12 = 450,000
June 30, 2006 400,000 x 6/12 = 200,000
October 30, 2006 600,000 x 2/12 = 100,000
$1,250,000
$1,250,000 x 6.77%* = $84,625
$ 700,000 x 7% = $ 49,000
3,000,000 x 8% = 240,000
5,000,000 x 6% = 300,000
$8,700,000 $589,000
$589,000
= 6.77% weighted average
$8,700,000

Research and development:
Salaries $220,000
Depreciation on R & D facilities and equipment 125,000
Utilities and other direct costs 66,000
Payment to another company 120,000
Total R & D expense $531,000

Note: The patent filing and related legal costs and the costs of adapting the
product to a particular customers needs are not included as research and development
expense.

EXERCISES
Exercise 10-1
Capitalized cost of land:

Demolition of old building $4,000
Less: Sale of materials (2,000) 2,000
Legal fees for title investigation 2,000
Total cost of land $64,000
Capitalized cost of building:
Construction costs $500,000

Architect's fees 12,000
Interest on construction loan 5,000
Total cost of building $517,000
Note: Property taxes on the land for the period after acquisition are not part of
acquisition cost. They are expensed in the period incurred.
Exercise 10-2
To record the purchase of a machine.
Machine ($45,000 + + 2,200 + 700 + 1,000) ......................... 48,900

Accounts payable ...................................................... 47,200
Cash .......................................................................... 1,700
To record prepaid insurance for the machine.
Prepaid insurance .......................................................... 900

Cash .......................................................................... 900

Exercise 10-3
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% = $ 75,000

400,000 x 40% = 160,000
600,000 x 35% = 210,000
$445,000 x .68301* = $303,939
*Present value of $1, n = 4, i = 10%
Requirement 2
Copper mine (determined above) .................................... 1,903,939

Cash ($1,000,000 + 600,000)....................................... 1,600,000
Asset retirement liability (determined above) ............ 303,939
Equipment (cost) ......................................................... 120,000

Cash ....................................................................... 120,000

Exercise 10-4
Organization cost expense ($12,000 + 3,000) .................... 15,000
Patent ($20,000 + 2,000) ................................................... 22,000
Pre-opening expenses ................................................... 40,000
Furniture ....................................................................... 30,000
Cash .......................................................................... 107,000
Exercise 10-5

Assets $23,000,000
Less: Liabilities assumed (9,500,000) (13,500,000)
Exercise 10-6

Book value of net assets $7,800,000
Plus: Fair value in excess of book value:
Property, plant, and equipment 1,400,000
Intangible assets 1,000,000
Less: Book value in excess of fair value:
Receivables (200,000) 10,000,000

Exercise 10-7
1. a
2. d
3. c
Exercise 10-8
Initial
Land ................ $ 300,000 30% $270,000
Building A ....... 450,000 45 405,000
Building B ....... 250,000 25 225,000
$1,000,000 100% $900,000

Exercise 10-9
Requirement 1
Tractor ($5,000 cash + 18,783 present value of note) ............. 23,783

Discount on note payable (difference) ............................. 6,217
Cash .......................................................................... 5,000
Note payable (face amount) .......................................... 25,000

Present value of note payment:
PV = $25,000 (.75131* ) = $18,783

* Present value of $1: n = 3, i = 10% (from Table 2)
Requirement 2
2006: Interest expense ($18,783 x 10%) = $1,878

2007: Interest expense [($18,783 + 1,878) x 10%] = 2,066
Requirement 3
2006: $25,000 ($6,217 1,878) = $20,661
2007: $25,000 ($6,217 1,878 2,066) = 22,727

Exercise 10-10
To record the acquisition of land in exchange for common stock.
February 1, 2006
Land ............................................................................. 90,000
Common stock (5,000 shares x $18) .............................. 90,000
To record the acquisition of a building through purchase and donation.
November 2, 2006
Building ........................................................................ 600,000
Cash ......................................................................... 400,000
Revenue - donation of asset (difference) ...................... 200,000
Exercise 10-11
Requirement 1
($ in millions)
Average PP&E for 2004 = ($15,768 + 16,661) 2 = $16,214.5
Net sales Average PP&E = Fixed-asset turnover ratio

$34,209 $16,214.5 = 2.11
Requirement 2
The fixed-asset turnover ratio indicates the level of sales generated by the
companys investment in fixed assets. Intel is able to generate $2.11 in sales for every
$1 invested in property, plant, and equipment.

Exercise 10-12
Requirement 1
Cash .............................................................................. 3,000

Accumulated depreciation - tractor (balance) .................. 26,000
Loss on sale of tractor (difference)................................... 1,000
Tractor (balance) ......................................................... 30,000
Requirement 2
Cash .............................................................................. 10,000

Accumulated depreciation - tractor (balance) .................. 26,000
Tractor (balance) ......................................................... 30,000
Gain on sale of tractor (difference)............................... 6,000
Exercise 10-13
Equipment - new ($200,000 + 60,000) .............................. 260,000

Accumulated depreciation (balance)................................ 220,000
Cash .......................................................................... 60,000
Equipment - old (balance) ........................................... 400,000
Gain ($200,000 - 180,000) ............................................. 20,000

Exercise 10-14
Equipment - new ($170,000 + 60,000) ............................... 230,000

Loss ($180,000 - 170,000) ................................................. 10,000
Accumulated depreciation (balance)................................ 220,000
Cash .......................................................................... 60,000
Equipment - old (balance) ........................................... 400,000

Exercise 10-15
Requirement 1
Fair value of land + Cash given = Fair value of patent
$150,000 + 10,000 = $160,000
Requirement 2
Patent ($150,000 + 10,000) ................................................ 160,000

Cash .......................................................................... 10,000
Land (book value) ........................................................ 120,000
Gain ($150,000 - 120,000) ............................................. 30,000
Exercise 10-16
Requirement 1
Fair value of land - Cash received = Fair value of patent
$150,000 - 10,000 = $140,000
Requirement 2
Patent ($150,000 - 10,000) ................................................. 140,000

Cash .............................................................................. 10,000
Land (book value) ........................................................ 120,000
Gain ($150,000 - 120,000) ............................................. 30,000

Exercise 10-17
Requirement 1
Fair value of old land + Cash given = Fair value of new land
$72,000 + 14,000 = $86,000
Requirement 2
Landnew ($72,000 + 14,000) ........................................... 86,000

Cash .......................................................................... 14,000
Land - old (book value) ................................................ 30,000
Gain ($72,000 30,000) ................................................ 42,000
Requirement 3
Landnew ($30,000 + 14,000) ........................................... 44,000

Cash .......................................................................... 14,000
Land - old (book value) ................................................ 30,000

Exercise 10-18
1. To record the purchase of equipment on account.
Equipment ($25,000 x 98%) ............................................. 24,500

Accounts payable ...................................................... 24,500
2. To record the acquisition of equipment in exchange for a note.
Equipment (determined below).......................................... 24,545

Discount on note payable (difference).............................. 2,455
PV = $27,000 (.90909* ) = $24,545

* Present value of $1: n=1, i=10% (from Table 2)
3. To record the exchange of old equipment for new equipment.
Equipment - new ($2,500 + 22,000) .................................. 24,500

Loss ($6,000 - 2,500) ........................................................ 3,500
Accumulated depreciation ............................................ 8,000
Cash .......................................................................... 22,000
Equipment - old......................................................... 14,000
4. To record the acquisition of equipment by the issuance of stock.
Equipment..................................................................... 24,000
Common stock .......................................................... 24,000

Exercise 10-19
$6,000,000
= $3,000,000
2
$3,000,000
- 1,500,000 x 10% = $150,000
1,500,000 x 7%* = 105,000
$255,000 = interest capitalized
$2,000,000 x 9% = $180,000
4,000,000 x 6% = 240,000
$6,000,000 $420,000
$420,000
= 7%
$6,000,000
Exercise 10-20
Average accumulated expenditures for 2006:
January 2, 2006 $500,000 x 12/12 = $ 500,000

March 1, 2006 600,000 x 10/12 = 500,000
July 31, 2006 480,000 x 5/12 = 200,000
September 30, 2006 600,000 x 3/12 = 150,000
December 31, 2006 300,000 x 0/12 = -0-
$1,350,000
$1,350,000 x 8% = $108,000
Exercise 10-21
Average accumulated expenditures for 2006:
January 2, 2006 $ 600,000 x 12/12 = $ 600,000

March 31, 2006 1,200,000 x 9/12 = 900,000
June 30, 2006 800,000 x 6/12 = 400,000
September 30, 2006 600,000 x 3/12 = 150,000
December 31, 2006 400,000 x 0/12 = -0-
$2,050,000
$2,050,000
- 1,500,000 x 8.0% = $120,000
550,000 x 10.5%* = 57,750
$177,750 = interest capitalized
$5,000,000 x 12% = $600,000

3,000,000 x 8% = 240,000
$8,000,000 $840,000
$840,000
= 10.5%
$8,000,000

Exercise 10-22
To expense R&D costs incorrectly capitalized.
Research and development expense (below) ...................3,180,000

Patent ........................................................................ 3,180,000
Research and development expenditures:
Basic research to develop the technology $2,000,000

Engineering design work 680,000
Development of a prototype 300,000
Testing and modification of the prototype 200,000
Total $3,180,000
To capitalize cost of equipment incorrectly capitalized as patent.
Equipment..................................................................... 60,000
Patent ........................................................................ 60,000
To record depreciation on equipment used in R&D projects.
Research and development expense .............................. 10,000

Accumulated depreciation - equipment ..................... 10,000

Exercise 10-23
Research and development expense:
Salaries and wages for lab research $ 400,000

Materials used in R&D projects 200,000
Fees paid to outsiders for R&D projects 320,000
Depreciation on R&D equipment 120,000
Total $1,040,000
The patent filing and legal costs are capitalized as the cost of the patent. The
salaries, wages, and supplies for R&D performed for another company are included as
inventory and expensed as cost of goods sold using either the completed contract or
percentage-of-completion method.
Exercise 10-24
1. a
2. d
3. d
4. b

Exercise 10-25
List A List B
f 1. Depreciation a. Exclusive right to display a word, a symbol, or an
emblem.
d 2. Depletion b. Exclusive right to benefit from a creative work.
i 3. Amortization c. Operational assets that represent rights.
g 4. Average accumulated d. The allocation of cost for natural resources.
expenditures
h 5. Revenue - donation of asset e. Purchase price less fair market value of net
identifiable assets.
j 6. Nonmonetary exchange f. The allocation of cost for plant and equipment.
k 7. Natural resources g. Approximation of average amount of debt if all
construction funds were borrowed.
c 8. Intangible assets h. Account credited when assets are donated to a
corporation.
b 9. Copyright i. The allocation of cost for intangible assets.
a 10. Trademark j. Basic principle is to value assets acquired using fair
value of assets given.
e 11. Goodwill k. Wasting assets.

Exercise 10-26
Requirement 1
($ in millions)
Research and development expense .............................. 4
Software development costs .......................................... 2
Cash .......................................................................... 6
Requirement 2
(1) Percentage-of-revenue method:
$4,000,000
= 40% x $2,000,000 = $800,000
$10,000,000
(2) Straight-line method:

1/5 or 20 % x $2,000,000 = $400,000.
The percentage-of-revenue method is used since it produces the greater
amortization, $800,000.
Requirement 3
Software development costs $2,000,000
Less: Amortization to date (800,000)
Net $1,200,000

Exercise 10-27
1. a. The costs of fixed assets (plant and equipment) are all costs necessary to acquire
these assets and to bring them to the condition and location required for their
intended use. These costs include shipping, installation, pre-use testing, sales
taxes, interest, capitalization, etc. The original cost of the machinery to be
recorded in the books is the sum of the purchase price, installation, and delivery
charges.
2. d. SFAS No. 153, Exchanges of Nonmonetary Assets an amendment of APB

Opinion No. 29, states that the basic principle to be followed in these exchanges
is to value the asset received at fair value and to recognize gain or loss (the
difference between the fair value and the book value of the asset given up).
Harpers used machine has a book value of $64,000 ($162,500 cost - $98,500
accumulated depreciation). The fair value of the used machine is $80,000
resulting in a gain of $16,000 ($80,000 64,000). The only exceptions to using
fair value are (1) when fair value is not determinable and (2) when the exchange
lacks commercial substance. In these cases, book value is used to value the
new asset and the gain would not be recognized.
3. c. The answer is the same as question 2.

Exercise 10-28
Requirement 1
Oil wells ....................................................................... 450,000

Cash .......................................................................... 450,000
Requirement 2
Oil wells ($50,000 + 60,000 + 80,000) ................................ 190,000

Exploration expense ...................................................... 260,000
Cash .......................................................................... 450,000

PROBLEMS
Problem 10-1
1. To record the acquisition of land and building.
Land (determined below) ............................................................................ 62,500

Building (determined below) ............................................. 37,500
Cash .......................................................................... 100,000
Initial
Land $ 75,000 62.5% $ 62,500
Building 45,000 37.5 37,500
$120,000 100.0% $100,000
2. To record the acquisition of equipment for cash and a note.
Equipment (determined below).......................................... 37,037

Present value of note payments:
PV = $40,000 (.92593* ) = $37,037

* Present value of $1: n = 1, i=8% (from Table 2)
3. To record the acquisition of a truck by donation.
Truck............................................................................. 2,500
Revenue - donation of asset....................................... 2,500

Problem 10-1 (concluded)
4. To capitalize organization costs.
Organization cost expense............................................. 3,000

Cash .......................................................................... 3,000
5. To record the purchase of machinery.
Machinery ($15,000 + 500) .............................................. 15,500

Cash .......................................................................... 15,500
6. To record the acquisition of office equipment by the issuance of common

stock.
Office equipment........................................................... 5,500

Common stock .......................................................... 5,500
7. To record the acquisition of land in exchange for cash and a note.
Land .............................................................................. 20,000

Cash .......................................................................... 2,000
Note payable ............................................................. 18,000

Problem 10-2
Requirement 1
Blackstone Corporation
LAND ACCOUNT (Site Number 11)
As of September 30, 2007
Acquisition cost $600,000

Real estate brokers commission 36,000
Legal fees 6,000
Cost of razing existing building 75,000
Balance, September 30, 2007 $735,000
Requirement 2
Blackstone Corporation
CAPITALIZED COST OF OFFICE BUILDING
As of September 30, 2007
Contract cost $3,000,000

Plans, specifications, and blueprints 12,000
Architects fees for design and supervision 95,000
Capitalized interest for 2006:
$900,000 x 14% x 10/12 105,000
Capitalized interest for 2007:
$2,300,000 x 14% x 9/12 241,500
Total capitalized cost, September 30, 2007 $3,453,500

Problem 10-3
Requirement 1
Pell Corporation
ANALYSIS OF CHANGES IN PLANT ASSETS
For the Year Ended December 31, 2006
Balance Balance
12/31/05 Increase Decrease 12/31/06
Land $ 350,000 $438,000 [1] $ 788,000
Land improvements 180,000 180,000
Building 1,500,000 1,500,000
Machinery and
equipment 1,158,000 287,000 [2] $58,000 1,387,000
Automobiles 150,000 19,000 [3] 18,000 151,000
Totals $3,338,000 $744,000 $76,000 $4,006,000
Explanation of Amounts:
[1] Cost of land acquired 11/1/06:
Pell stock exchanged (10,000 shares x $38) $380,000
Legal fees and title insurance 23,000
Razing existing building 35,000
$438,000
[2] Cost of machinery and equipment purchased 1/2/06:
Invoice cost $260,000
Installation cost 27,000
$287,000
[3] Cost recorded for new automobile 12/31/06:
Market value of trade-in $ 3,750
Cash paid 15,250
$ 19,000

Requirement 2
Pell Corporation
GAIN OR LOSS FROM PLANT ASSET DISPOSALS
For the Year Ended December 31, 2006
Sale of machine on 3/31/06:

Selling price $36,500
Less: Book value of machine ($58,000 - 24,650) (33,350)
Gain on sale of machine $ 3,150
Trade-in of automobile on 12/31/06:

Book value of trade-in ($18,000 - 13,500) $ 4,500
Less: Market value of trade-in (3,750)
Loss on trade-in $ 750

Problem 10-4
To reclassify various expenditures incorrectly charged to the intangible asset
account.
Organization cost expense............................................. 7,000

Prepaid insurance .......................................................... 6,000
Copyright ...................................................................... 20,000
Patent ($3,000 + 12,000) ................................................... 15,000
Franchise....................................................................... 40,000
Advertising expense ...................................................... 16,000
Intangible asset.......................................................... 144,000
To reclassify amount paid for Stiltz Corp. incorrectly charged to the

intangible asset account.
Receivables ................................................................... 100,000

Equipment..................................................................... 350,000
Patent ............................................................................ 150,000
Goodwill (determined below) ............................................ 120,000
Note payable ............................................................. 220,000
Intangible asset.......................................................... 500,000

Less: Market value of net assets (380,000)
Goodwill $120,000

Problem 10-5
1. To expense R&D costs.

Cash .......................................................................... 12,000
2. To expense legal fees for unsuccessful defense of patent.
Legal fees expense ........................................................ 7,500

Cash .......................................................................... 7,500
3. To capitalize the cost of equipment.
Equipment (cash price) .................................................... 23,000

Cash (amount paid) ...................................................... 6,000
4. To capitalize cost of the sprinkler system.
Building - sprinkler system ........................................... 28,000

Cash .......................................................................... 28,000
5. To capitalize legal fees for successful defense of patent.
Patent ............................................................................ 12,000

Cash .......................................................................... 12,000


6. To record the trade-in of an old machine for a new machine.
Machine - new ($2,000* + 8,000)...................................... 10,000

Accumulated depreciation - machine ($7,400 - 3,000) ...... 4,400
Loss on trade-in ($3,000 2,000*) .................................... 1,000
Cash .......................................................................... 8,000
Machine - old ............................................................ 7,400
*Fair value of old machine (Fair value of new machine - Cash given):
$10,000 - 8,000 = $2,000

Problem 10-6
Southern Company:
Cash .............................................................................. 140,000

Building - new ($1,400,000 - 140,000) ............................... 1,260,000
Accumulated depreciation - building (balance) ............... 1,200,000
Building - old (balance) ............................................... 2,000,000
Gain ($1,400,000 800,000) .......................................... 600,000
Eastern Company:
The fair value of Easterns building is $1,260,000 ($1,400,000 fair value of

Southerns building less $140,000 cash given).
Building - new ($1,260,000 + 140,000) .............................. 1,400,000

Accumulated depreciation - building (balance) ............... 650,000
Cash .......................................................................... 140,000
Building - old (balance) ............................................... 1,600,000
Gain on exchange of buildings ($1,260,000 950,000) .. 310,000

Problem 10-7
Robers:
Cash .............................................................................. 5,000

New asset ($75,000 - 5,000) .............................................. 70,000
Accumulated depreciation - old asset (balance) ............... 55,000
Old asset (balance) ...................................................... 120,000
Gain on exchange of assets ($75,000 65,000) ............. 10,000
Phifer:
New asset ($70,000 + 5,000) ............................................. 75,000

Accumulated depreciation - old asset (balance) ............... 63,000
Loss ($77,000 70,000) ........................................................... 7,000
Cash .......................................................................... 5,000
Old asset (balance) ...................................................... 140,000

Problem 10-8
Requirement 1
2006:
Expenditures for 2006:
January 3, 2006 $1,000,000 x 12/12 = $1,000,000
March 1, 2006 600,000 x 10/12 = 500,000
June 30, 2006 800,000 x 6/12 = 400,000
October 1, 2006 600,000 x 3/12 = 150,000
Accumulated expenditures
(before interest) - $3,000,000
Average accumulated expenditures - $2,050,000
$2,050,000 x 10% = $205,000 = Interest capitalized in 2006
2007:
January 1, 2007
($3,000,000 + 205,000) $3,205,000 x 9/9 = $3,205,000
January 31, 2007 270,000 x 8/9 = 240,000
April 30, 2007 585,000 x 5/9 = 325,000
August 31, 2007 900,000 x 1/9 = 100,000
(before interest) - $4,960,000
$3,870,000
- 3,000,000 x 10.0% x 9/12 = $225,000
870,000 x 7.2%* x 9/12 = 46,980
$271,980 = Interest capitalized in 2007
$ 4,000,000 x 6% = $240,000 $720,000

6,000,000 x 8% = 480,000 = 7.2%
$10,000,000 $720,000 $10,000,000
Requirement 2
Accumulated expenditures 9/30/07
before interest capitalization (above) $4,960,000
2007 interest capitalized (above) 271,980
Total cost of building $5,231,980
Requirement 3
2006
$3,000,000 x 10% = $ 300,000
4,000,000 x 6% = 240,000
6,000,000 x 8% = 480,000
Total interest incurred 1,020,000
Less: Interest capitalized (205,000)
2006 interest expense $ 815,000
2007
Total interest incurred $1,020,000

Problem 10-9
Requirement 1
2006
Expenditures for 2006
January 3, 2006 1,000,000 x 12/12 = $1,000,000
March 1, 2006 600,000 x 10/12 = 500,000
June 30, 2006 800,000 x 6/12 = 400,000
October 1, 2006 600,000 x 3/12 = 150,000
(before interest) $3,000,000
$2,050,000 x 7.85%* = $160,925 = Interest capitalized in 2006
* Weighted-average rate of all debt:
$ 3,000,000 x 10% = $ 300,000 $1,020,000

4,000,000 x 6% = 240,000 = 7.85% (rounded)
6,000,000 x 8% = 480,000 $13,000,000
$13,000,000 $1,020,000
2007:
January 1, 2007
($3,000,000 + 160,925) $3,160,925 x 9/9 = $3,160,925
January 31, 2007 270,000 x 8/9 = 240,000
April 30, 2007 585,000 x 5/9 = 325,000
August 31, 2007 900,000 x 1/9 = 100,000
(before interest) $4,915,925
$3,825,925 x 7.85% x 9/12 =$225,251 = Interest capitalized in 2007

Requirement 2
Accumulated expenditures 9/30/07,
before interest capitalization (above) $4,915,925
2007 interest capitalized (above) 225,251
Total cost of building $5,141,176
Requirement 3
2006:
$3,000,000 x 10% = $ 300,000
4,000,000 x 6% = 240,000
6,000,000 x 8% = 480,000
Total interest incurred 1,020,000
2007:
Total interest incurred $1,020,000

Problem 10-10
To capitalize the cost of equipment to be used on future projects incorrectly
charged to R&D expense.
Equipment..................................................................... 400,000
Research and development expense........................... 400,000
To record depreciation on equipment used in R&D projects.

$400,000 5 years = $80,000

Accumulated depreciation - equipment ..................... 80,000
To capitalize filing and legal fees for patent incorrectly charged to R&D expense.
Patent ............................................................................ 40,000

To reclassify the expenditures made for quality control during commercial

production.
Inventory*..................................................................... 20,000
*Quality control costs would either be treated as manufacturing overhead and

included in the cost of inventory (as in this journal entry), or expensed in the
period incurred.

CASES
Judgment Case 10-1
Requirement 1
All costs necessary to bring the land to its condition for use should be capitalized
as the cost of the land. This should include the following costs :
Purchase price.
Title insurance.
Escrow fees.
Delinquent property taxes.
Cost of removing old building.
Cost of grading and other land preparation costs.
Requirement 2
Assets acquired in exchange for deferred payment contracts are valued at their
fair market value or the present value of payments using a realistic interest rate.
Requirement 3
In general, operational assets received in exchange for other nonmonetary assets
should be valued at the fair value of the nonmonetary assets given up plus (minus)
monetary consideration given (received). There are certain exceptions when the assets
received are valued at the book value of the nonmonetary assets given up plus (minus)
monetary consideration given (received).
The new machine acquired by exchanging an older, similar machine generally
would be valued at the fair value of the old machine plus (minus) any cash given
(received). However, if fair value cannot be determined or if the exchange lacks
commercial substance, then the new machine would be valued at the book value of the
old machine plus (minus) any cash given (received).

Research Case 10-2

Requirement 1
SFAS No. 143, Accounting for Asset Retirement Obligations, requires that an
existing legal obligation associated with the retirement of a tangible, long-lived asset
be recognized as a liability and measured at fair value. When the liability is credited,
the offsetting debit is to the related operational asset. Usually, the fair value is
estimated by calculating the present value of estimated future cash outflows.
Traditionally, the way uncertainty has been considered in present value
calculations has been by discounting the best estimate of future cash flows applying
a discount rate that has been adjusted to reflect the uncertainty or risk of those cash
flows. That's not the approach taken here. Instead, we follow the approach described
in the FASBs Concept Statement No. 7 which is to adjust the cash flows, not the
discount rate, for the uncertainty or risk of those cash flows. This expected cash flow
approach incorporates specific probabilities of cash flows into the analysis. We use a
discount rate equal to the credit-adjusted risk free rate. The higher a companys
credit risk, the higher will be the discount rate.
Requirement 2
The cost of the coal mine is $24,513,419 determined as follows:
Mining site $15,000,000

Development costs 6,000,000
Restoration costs 3,513,419
$24,513,419
$3 million x 20% = $ 600,000
4 million x 30% = 1,200,000
5 million x 25% = 1,250,000
6 million x 25% = 1,500,000
$4,550,000 x .77218* = $3,513,419
*Present value of $1, n = 3, i = 9%
Requirement 3
Coal mine (determined above) ........................................ 24,513,419

Cash ($15,000,000 + 6,000,000) .................................. 21,000,000
Asset retirement liability (determined above) ............ 3,513,419

Case 10-2 (concluded)
Requirement 4
$3,513,419 x 9% = $316,208 x 6/12 = $158,104
Requirement 5
If the actual restoration costs are more (less) than the recorded liability at the
retirement date, a loss (gain) on retirement of the obligation is recognized for the
difference.
Asset retirement liability (maturity amount) ................... 4,550,000

Loss (difference) ........................................................... 150,000
Cash ...................................................................... 4,700,000
Requirement 6
An entity shall disclose the following information about its asset retirement
obligations:
a. A general description of the asset retirement obligations and the associated

long-lived assets.
b. The fair value of assets that are legally restricted for purposes of settling
asset retirement obligations.
c. A reconciliation of the beginning and ending aggregate carrying amount
(book value) of asset retirement obligations showing separately the changes
attributable to (1) liabilities incurred in the current period, (2) liabilities
settled in the current period, (3) accretion expense (interest expense), and
(4) revisions in estimated cash flows, whenever there is a significant change
in one or more of those four components during the reporting period.
If the fair value of an asset retirement obligation cannot be reasonably estimated,

that fact and the reasons therefor shall be disclosed.

Judgment Case 10-3

Requirement 1
The cost of a self-constructed asset includes identifiable materials and labor and a
portion of the company's manufacturing overhead costs.
Requirement 2
The treatment of manufacturing overhead cost and its allocation between
construction projects and normal production is a difficult issue. One alternative is to
include only the incremental overhead costs in the total cost of construction. That is,
only those additional costs that are incurred because of the decision to construct the
asset should be added to the cost of the asset. This would exclude such indirect costs
as depreciation and the salaries of supervisors that would be incurred whether or not
the construction project is undertaken. If, however, a new construction supervisor
were hired specifically to work on the project, then that salary would be included in
asset cost.
A second alternative is to assign overhead on the same basis that is used for the
regular manufacturing process. For example, all overhead costs might be allocated
both to production and to self-constructed assets based on the relative amount of labor
hours incurred. This is known as the full-cost approach and is the generally accepted
method used to determine the cost of a self-constructed asset.
Requirement 3
Generally accepted accounting principles provide specific guidelines for the
treatment of interest costs incurred during construction. These guidelines pertain to
the construction of assets for a companys own use as well as for assets constructed
for sale or lease. Assets qualifying for capitalization exclude inventories that are
routinely manufactured in large quantities on a repetitive basis and assets that are in
use or ready for their intended purpose. Only assets that are constructed as discrete
projects qualify for interest capitalization.
The construction of equipment by the Chilton Company appears to qualify for
interest capitalization. The cost of the equipment would include interest if, during the
construction period, interest costs were actually being incurred.

Judgment Case 10-4

Requirement 1
Only assets that are constructed as discrete projects qualify for interest
capitalization. Assets qualifying for capitalization exclude inventories that are
routinely manufactured in large quantities on a repetitive basis and assets that are in
use or ready for their intended purpose.
Requirement 2
The capitalization period for a self-constructed asset starts when (1) expenditures
(materials, labor and overhead) have been made and (2) interest cost is being incurred.
The interest cost incurred does not have to pertain to specific borrowings related to the
construction project. The capitalization period ends either when the asset is
substantially complete and ready for use or when interest costs are no longer incurred.
Requirement 3
Average accumulated expenditures is an approximation of the average amount of
debt that the company would have had outstanding during the period if every dollar
spent on the project was borrowed. If construction expenditures are incurred equally
throughout the period, the average accumulated expenditures for the period can be
estimated by adding the accumulated expenditures at the beginning of the period to
the accumulated expenditures at the end of the period and dividing by two. If
expenditures on the project are unequal throughout the period, individual
expenditures, perhaps expenditures grouped by month, should be weighted by the
amount of time outstanding until the end of the construction period or the end of the
companys fiscal year, whichever comes first.
Requirement 4
One method that could be used to determine the appropriate interest rate(s) to be
used in capitalizing interest is the specific interest method. If debt financing has
been obtained specifically for the construction project, its interest rate is applied to the
average accumulated expenditures up to the amount of the specific borrowing. Any
remaining average accumulated expenditures in excess of specific borrowings is
multiplied by the weighted-average rate on all other outstanding interest-bearing debt.
Sometimes it is difficult to associate specific borrowings with projects. In these
situations, it is easier to just use the weighted-average rate on all interest-bearing debt,
including all construction loans. This is the weighted-average method.

Case 10-4 (concluded)
Requirement 5
The three steps used to determine the amount of interest capitalized during a
period are:
1. Determine the average accumulated expenditures for the period.
2. Multiply average accumulated expenditures by the appropriate interest rate(s).
3. Compare interest capitalized with total interest cost incurred. Interest capitalized
cant exceed interest cost incurred.
Research Case 10-5

(Note: This case requires the student to reference a journal article.]
Requirement 2
The FASB has tentatively decided that purchased goodwill does meet the criteria
in Concepts Statement 5 for initial recognition as an asset. Goodwill does represent
future economic benefits that are in the control of the enterprise and that have
arisen from a past transaction or event.
Requirement 3
Some believe that goodwill is not an asset because of concerns about 1) equating
costs and assets, 2) exchangeability of goodwill, and 3) controllability.

Real World Case 10-6

($ in millions)
Decrease in property, plant and equipment, net

($6,097 6,091) $(6)
Decrease in intangible assets, net ($981 702) (279)
Net decrease (285)
Add: Depreciation and amortization for the year 893
Less: Additions to property, plant and equipment (755)
Book value of equipment sold * (147)

Proceeds from sale of equipment 341
Gain on sale of equipment $194
*OR,
Book value of property, plant and equipment and
intangibles, beginning of the year $7,078
Add: additions 755
Less: depreciation and amortization (893)
Less: book value of property, plant and equipment and
intangibles, end of the year (6,793)
Book value of equipment sold $ 147

Judgment Case 10-7

Requirement 1
Goodwill represents the unique value of a company as a whole over and above all
identifiable tangible and intangible assets. This value results from a companys
clientele and reputation, its trained employees and management team, its unique
business location, and any other unique features of the company that cant be
associated with a specific asset.
Requirement 2
The controller would be correct in her valuation of goodwill only if the total fair
value of all of the identifiable net assets (assets less liabilities) of Georgia, Inc. equals
the total book value of Georgias net assets ($2,800,000). Goodwill, by definition, is
the excess of purchase price over the fair value of net assets, not the book value of net
assets.

Judgment Case 10-8

Requirement 1
A company undertakes an R&D project because it believes the project will
eventually provide benefits that exceed the current expenditures. Unfortunately,
though, its difficult to predict which individual research and development projects
will ultimately provide benefits. In fact, only one in ten actually reach commercial
production. Moreover, even for those projects that pan out, a direct relationship
between research and development costs and specific future revenue is difficult to
establish. In other words, even if R&D costs do lead to future benefits, its difficult to
objectively determine the size of the benefits and in which periods the costs should be
expensed if they are capitalized. These are the issues that prompted the FASB to
require immediate expensing.
Requirement 2
Possible reasons include:
1. The larger a firm is, the more likely it is to prefer income-reducing accounting
methods (e.g., expense R&D). This is particularly true in politically sensitive
industries where excessive profits could trigger intervention into a firm's activities
by government, unions, and other special interest groups.
2. Large firms may tend to have more R&D activities occurring simultaneously,
creating a portfolio effect. That is, the number of successful R&D projects relative
to total projects may be fairly stable from year to year in large firms. There may
be much more variability in smaller firms creating larger variability in income if
R&D is expensed.
3. Earnings-based management compensation schemes may be more prevalent in
smaller R&D companies, thus creating a preference for accounting methods that
can be more easily manipulated (e.g., capitalize R&D).
4. Smaller companies may be more dependent on debt financing. Debt covenants
(contractual limitations on debt) could create a preference for accounting methods
that can be more easily manipulated (e.g., capitalize R&D).

Judgment Case 10-9

Requirement 1
The costs of research equipment used exclusively for Trouver would be reported
as research and development expenses in the period incurred.
The costs of research equipment used on both Trouver and future research
projects would be capitalized and shown as equipment (less accumulated depreciation)
in the balance sheet. An appropriate method of depreciation should be used.
Depreciation on capitalized research equipment should be reported as a research and
development expense.
Requirement 2
a. Matching refers to the process of expense recognition by associating costs
with revenues on a cause and effect basis.
b. Research and development costs usually are expensed in the period incurred
and may not be matched with revenues. This accounting treatment is justified by the
high degree of uncertainty regarding the amount and timing of future benefits. A
direct relationship between research and development costs and future revenues
generally cannot be demonstrated.
Requirement 3
Corporate headquarters costs allocated to research and development would be
classified as general and administrative expenses in the period incurred, because they
are not clearly related to research and development activities.
Requirement 4
The legal expenses incurred in defending the patent should be capitalized as part
of the cost of the intangible asset, patent.

Communication Case 10-10

You may wish to suggest to your students that they consult Appendix B of SFAS
2, Basis for Conclusions, which discusses factors deemed significant by members of
the FASB in reaching their conclusion, including the various alternatives considered
and reasons for accepting some and rejecting others.
While SFAS 2 does dictate GAAP in this case, both views, expense and
capitalize, can and often are convincingly defended. The process of developing and
synthesizing the arguments will likely be more beneficial than just acceptance of the
standard. Each student should benefit from participating in the process, interacting
first with his or her partner, and then witnessing or participating in a debate on the
issue. It is important that each student actively participate in the process of arriving at
a consensus argument. Domination by one individual should be discouraged.
Arguments supporting the expense view should include the reasons cited by the
FASB as factors they deemed significant in arriving at their conclusion. Arguments
supporting the capitalize view should include reference to violations to the matching
principle for successful R&D projects.
Trueblood Accounting Case 10-11

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

Communication Case 10-12

Suggested Grading Concepts and Grading Scheme:
Content (70%)
______ 20 Defines research and development according to SFAS 2.
______ 30 Explains the conceptual reasons for the conclusion

reached by the FASB on accounting for R&D.
____ High degree of uncertainty regarding the amount and
timing of future benefits.
____ Lack of direct relationship between R&D costs and future
revenues.
______ 20 Describes the treatment of equipment costs.

____ $200,000 should be expensed as R&D.
____ $300,000 should be capitalized and depreciated.
_____
______ 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

Ethics Case 10-13

Requirement 1
If the equipment is to be used only in the single R&D project (as is likely) the
correct treatment is to expense the entire $30 million. If capitalized, only $6 million
would be expensed ($30 million divided by 5 years). Therefore, Alice's treatment will
increase before tax earnings by $24 million ($30 million - 6 million).
Requirement 2
Discussion should include these elements.
Ethical Dilemma:
Is Alice's responsibility to follow GAAP by expensing the equipment purchase
greater than her responsibility to assist the company in seeking new financing?
Who is affected?
Alice
President and other managers
Other employees
Shareholders
Potential shareholders
Creditors
Company auditors

International Case 10-14

Heineken's disclosures indicate significant differences between the Netherlands
and the U.S.A. in the valuation of operational assets. The cost of goodwill is
capitalized, but, unlike the U.S., it is amortized.
In the area of tangible fixed assets, Heineken values these assets at replacement
cost. In the U.S.A., operational assets are valued at historical cost.
Analysis Case 10-15

Requirement 1
The fixed-asset turnover ratio is computed by dividing net sales by average fixed
assets. A ratio of 2.87 for National indicates that they are able to generate $2.87 in net
sales for each dollar invested in fixed assets (property, plant, and equipment).
Requirement 2
($ in millions)
Book value of PP&E, beginning of 2004 $681
Add: purchases during 2004 215
Deduct: depreciation for 2004 (196)
Book value of PP&E, end of 2004 $700
Average PP&E for 2004 = ($681 + 700) 2 = $690.5
Turnover ratio = Net sales Average PP&E
2.87 = Net sales $690.5
Net sales = $1,982

Judgment Case 10-16

Requirement 1
Elegant was not correct in its treatment of the software development costs.
Generally accepted accounting principles require companies to expense costs incurred
to develop computer software to be sold, leased or otherwise marketed as R&D costs
until technological feasibility of the product or process has been established. Only
those costs incurred after technological feasibility has been attained and before the
product is available for general release to customers can be capitalized.
Requirement 2
The amortization of capitalized computer software development costs begins
with the start of commercial production. The periodic amortization percentage is the
greater of (1) the ratio of current revenues to current and anticipated revenues
(percentage of revenue method), or (2) the straight-line percentage over the useful life
of the asset.
Real World Case 10-17

Requirement 3
The following is based on Home Depot's 2004 (year ending January 30, 2004)
financial statements. Answers will vary depending on the financial statement dates
chosen.
a. The company lists land, buildings, furniture, fixtures and equipment,
leasehold improvements, construction in progress, and capital leases under
Property and equipment. Goodwill (cost in excess of fair value of net assets
acquired) is listed as a separate noncurrent asset.
b. $3,948 million.
c. Note 2 indicates that $40 million of interest was capitalized in fiscal 2004.
d. Fixed-asset turnover ratio = Net sales Average PP&E
($ in millions)
= $73,094 = 3.42
$21,394.5*
* Average PP&E for 2004 = ($22,726 + 20,063) 2 = $21,394.5

Analysis Case 10-18

Requirement 1
Under the Property and equipment classification, the company lists aircraft and
related equipment, package handling and ground support equipment and vehicles,
computer and electronic equipment, and other. The intangible asset goodwill is
included with Other assets as is a separate category of intangible assets.
Requirement 2
Note 1 indicates that the company capitalized interest of $11 million in 2004.
Requirement 3
The statement of cash flows reports that $1,271 million cash was used for capital
expenditures in 2004. This compares with capital expenditures of $1,511 million in
2003 and $1,615 million in 2002.
Requirement 4
The fixed-asset turnover ratio is computed by dividing net sales (revenues) by
average fixed assets. Using 2004 data, the ratio for FedEx is 2.79, which is 15%
higher than that of United Parcel Service.
($ in millions)
$24,710 = 2.79
$8,868.5*
* Average plant and equipment for 2004 = ($9,037 + 8,700) 2 = $8,868.5
The ratio is intended to measure a company's effectiveness in managing property,

plant, and equipment. It indicates the level of sales generated by the company's
investment in these assets. Like any ratio, it is but one piece of a larger puzzle and
should not be interpreted in isolation.


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Chapter 10 Operational Assets: Acquisition and Disposition

QUESTIONS FOR REVIEW OF KEY TOPICS

The McGraw-Hill Companies, Inc., 2007

Answers to Questions (continued)

The McGraw-Hill Companies, Inc., 2007

Answers to Questions (continued)

The McGraw-Hill Companies, Inc., 2007

Answers to Questions (concluded)

The McGraw-Hill Companies, Inc., 2007

Purchase price $35,000

Brief Exercise 10-2

Purchase price $600,000

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-3

Purchase price $600,000

Brief Exercise 10-4

$500,000 x 20% = $100,000

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-5

$500,000 x 20% = $100,000

Actual restoration costs $596,000

Brief Exercise 10-6

Purchase price $14,000,000

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-7

PV = $60,000 (.85734* ) = $51,440

Interest expense for 2006:

$51,440 x 8% x 6/12 = $2,058

Brief Exercise 10-8

50,000 x $22 = $1,100,000

Brief Exercise 10-9

Net sales Average PP&E = Fixed-asset turnover ratio

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-10

Journal entry (not required):

Cash .............................................................................. 16,000

Brief Exercise 10-11

Loss on exchange = $20,000 (book value) 17,000 (fair value) = $3,000

Journal entry (not required):

Cash .............................................................................. 8,000

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-12

Gain on exchange = $24,000 (fair value) 20,000 (book value ) = $4,000

Journal entry (not required):

Cash .............................................................................. 8,000

Brief Exercise 10-13

No gain is recognized in this situation.

Journal entry (not required):

Cash .............................................................................. 8,000

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-14

January 2, 2006 $500,000 x 12/12 = $ 500,000

* Weighted-average rate of all other debt:

The McGraw-Hill Companies, Inc., 2007

Brief Exercise 10-15

$1,250,000 x 6.77%* = $84,625

* Weighted-average rate of all other debt:

Brief Exercise 10-16

The McGraw-Hill Companies, Inc., 2007

The McGraw-Hill Companies, Inc., 2007

Purchase price $60,000

Capitalized cost of building:

Construction costs $500,000