Friedlan4e SM Ch08

8/10/2019 Friedlan4e SM Ch08

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John Friedlan, Financial Accounting: A Critical Approach , 4 th edition Page 8-1Solutions Manual Copyright © 2013 McGraw-Hill Ryerson Ltd.

CHAPTER 8Capital Assets

QUESTIONS

Q8-1.(The list of assets isn’t comprehensive. Students could identify other reasonable choices). a. A gas station has gas pumps, a cash register, reservoirs (for gas) and other fixtures, signs,

racks, and potentially a building and land.

b. A university has student residences, various buildings with classrooms and offices forfaculty, desks and other furniture, library books, computers, land, trucks and equipmentfor maintaining the grounds.

c. A convenience store has a cash register, counters, display shelves for merchandise, signs,and refrigeration units for dairy products and ice cream.

d. A hotel has the hotel building, beds and furnishings for the rooms, carpeting, elevators,office equipment, decorations and furnishings for the lobby, cleaning equipment.

e. A dairy farm has pasture, fencing, a barn, tractors, storage buildings, milking machines,tanks to store milk, a loader to handle manure and feed, a silo to store feed, cows.

f. An electric utility has generating stations, office furniture and wiring, transmission wires,computer equipment.

g. A golf course has land, a clubhouse building, golf carts, lawnmowers, irrigation systems,and other maintenance equipment.

Q8-2.An intangible asset is an asset t hat doesn’t have physical substance. Intangible assets differ fromtangible assets in that tangible assets can be touched and seen; they have physical substance.Examples of intangible assets are patents, trademarks, taxi licences, copyrights, and franchises.Tangible assets include buildings, furniture, machinery, and motor vehicles.

Q8-3.In accounting, goodwill is the amount a purchaser of an entity pays for an entity over and abovethe fair value of the purchased entity’s identifiable assets and liabilities on the date the entity is

purchased. Goodwill can represent many things: reputation, earning power, synergies,efficiencies, management, and other difficult to identify and measure intangible assets of acompany that the acquired company has built up by carrying on business — assets that are realand valuable but that traditional accounti ng doesn’t attempt to measure. It isn’t possible to knowwhat goodwill is because it’s calculated as a residual. Goodwill could also representoverpayment for an acquired entity. Conceptually, an entity doesn’t have to be purchased for it tohave goodwill. However, under IFRS/ASPE an entity must be purchased if the goodwill is toappear on the financial statements.




Q8-4.Capital assets are depreciated because they contribute to the earning of revenue over more thanone period and are used up in the process. Depreciation represents the using up of capital assetsover their useful lives. Capital assets are used up by the passage of time and obsolescence. To

properly measure income under accrual accounting, it’s necessary to allocate the cost of capitalassets to expense over time to match the cost of the assets to the revenues in the periods when theasset contributed to earning revenues.

Q8-5.Inventories are held for sale or to be included in the production of goods that will be sold whilecapital assets are purchased for use in providing or producing goods and services to customers. Acompany could have identical assets, some of which are inventory and some of which are capitalassets. For example, a truck dealer could have one truck that is used for parts delivery and is acapital asset. The company could also have many identical trucks that are for sale and areincluded in inventory. The difference is the purpose for which the asset is being held.

Q8-6.Depreciation has no effect on an entity’s cash flow. It’s just the allocation of the cost of a capitalasset to expense over its useful life. Depreciation is added back to net income under the indirectmethod of determining cash from operations because it has been deducted from revenues whencalculating ne t income. Since depreciation doesn’t represent a cash flow, the amount is added

back to net income. The idea is that we are trying to adjust net income for non-cash items. Sincedepreciation is a non-cash amount that was deducted when calculating net incom e, it’seliminated by adding it back when determining cash from operations.

Q8-7.The stock price of a company isn’t affected by the depreciation method used because the marketunderstands that different methods of depreciating capital have no economic impact on theentity, its performance, or its cash flows. However, stock price is only one consideration inassessing whether or not the depreciation method of the firm matters. The depreciation methodwill affect net income and other financial statement measurements and, therefore, could affectcontracts and decisions that explicitly require the use of financial statement numbers, forexample, management bonuses, employee contract demands, compliance with covenants, etc.

Q8-8.A capital asset (or asset group) is impaired (under IFRS) when the carrying amount of the assetsexceeds the recoverable amount of the assets. The recoverable amount is the greater of the fairvalue less selling cost of the asset and the present value of the asset ’s future cash flows (value inuse). If an asset is impaired it’s written down to the recoverable amount. Two examples ofimpairment includes 1) change in property value due to neighbourhood conditions translating tolower earning potential from future rentals. 2) A particular drug patent that has reduced earning

potential due to the release of a new drug that is more effective. Under ASPE an asset isimpaired if the carrying amount is greater than the undiscounted cash flow the asset is expectedto generate over its useful life.




Q8-9.When tax minimization is the main objective of financial reporting the selection of a depreciationmethod is never an issue because the Canada Revenue Agency specifies its own method, calledCapital Cost Allowance (CCA), for calculating depreciation of capital assets for tax purposes.

No matter what method of depreciation is used for financial reporting purposes the method

prescribed by the Income Tax Act must be used for tax purposes. As a result, an entity can pursue whatever objective it wants for financial reporting.

Q8-10.The problem with knowledge assets is that their future benefit’s difficult to assess. Manyintangible assets develop over time — for example, brand names, trademarks, patents, humanresources —and it’s difficult to know as the investments in these assets are being made whetherthey will lead to resources that provide benefits to the entity. The problem is uncertainty. Thereis a great deal of uncertainty about the future benefits of expenditures that may lead to intangibleassets so accounting takes a conservative approach and expenses these costs. Tangible assets areless problematic because even for an asset that is being constructed, the entity knows that it will

have an asset that can be used (a building, machine, etc.). It isn’t as clear with intangibles. Q8-11.The $32,000 initial cost of knocking down the wall should be considered part of the cost ofinstalling the new equipment and should be capitalized. The $44,000 cost of replacing the secondwall that was knocked down accidentally doesn’t contribute to getting the new equipment readyfor use and shouldn’t be included in the amount capitalized. Instead, the amount should beexpensed when incurred. The extra cost doesn’t make the asset better or allow it to be used so it shouldn’t be capitalized.

Q8-12.Repairs are expensed because they don’t provide any future benefits to the entity. In other words,they don’t meet the definition of an asset. Or, repairs simply help the asset perform as intended.Betterments are expenditures that provide additional future benefits to the entity — they extendthe life of the asset or make the asset more efficient or effective.

Q8-13.First, it’s important to recognize that the price a buyer will pay for a capital asset isn’t strictly amanagerial decision. The price is determined by market forces. A gain or loss on disposal of acapital asset is the difference between the proceeds of sale and the carrying amount of the asset(cost – accumulated depreciation). The carrying amount at any time depends on the useful life,residual value, and the depreciation method selected by management. If a shorter useful life anda lower residual value are selected the depreciation expense will be higher each year, whichmeans that carrying amount will be lower. In sum, the choices that affect the carrying amount ofa capital asset affect the amount of gain or loss when the asset is sold, assuming the actual selling

price isn’t affected by the amount of gain or loss.




Q8-14.A write-down of capital assets is an accrual concept and represents a decrease in the carryingamount of the asset and a decrease in net income. It has no effect on cash flow. The journal entrywould debit write down or a loss (income statement), which will reduce net income and creditaccumulated depreciation; cash isn’t involved. A write -down (off) could expense the full net

amount of an asset. As a result, what was previously classified as an asset is removed from the balance sheet and expensed. The only transactions or events related to capital assets that haveany cash flow implications are the sale or purchase of an asset.

Q8-15A writedown means that the carrying amount of a capital asset is reduced and an expense isrecorded for the amount of the writedown. A writedown is required when a capital asset becomesimpaired. The approach to determining whether a capital asset is impaired is different fromdetermining if inventory is impaired. Also, IFRS and ASPE approach determining impairmentand the amount of an impairment differently. The writedown of capital assets takes a longer-term

perspective while the write-down of inventory has a short-term focus.

Under IFRS a capital asset is impaired if its recoverable amount is less than its carrying amount.The recoverable amount is the greater of fair value less cost to sell and value-in-use (presentvalue of the cash flows the asset will generate over its remaining life). The amount of thewritedown is the difference between the carrying amount and the recoverable amount.

Under ASPE a capital asset is impaired if the carrying amount is greater than the undiscountedcash flows the asset will generate over its remaining life. If that condition is met and the fairvalue less cost to sell of the asset is less than the carrying amount the capital asset is writtendown. The amount of the writedown is the difference between the fair value less cost to sell andthe carrying amount.

Inventory is written down if its net realizable value on the balance sheet date is less than itscarrying amount. The amount of the writedown is the difference between the NRV and thecarrying amount.

Q8-16.a. The lawnmower is equipment that the lawn care company uses to provide its service to

customers.

b. The Zamboni machine prepares the ice in the arena for a hockey game or other event. Ifthe ice is in poor condition, the quality of the hockey or skating will be poor and peoplewill be less likely to pay to see a game or pay to skate on the ice.

c. The display cases in the jewellery store provide a place to show the store’s jewellery to potential customers.

d. The waiting-room furniture provides a place for patients to wait until the doctor is readyto see them. If there was no waiting room furniture, many patients might find anotherdoctor — one who provided a more comfortable environment for waiting.




e. The warehouse is necessary to store the auto parts manufacturer’s inventory so that it can be available for delivery to customers when ordered.

Q8-17.

Many decisions go into determining the amount of the depreciation expense. Managers mustchoose the depreciation method and estimate the asset’s useful life and residual value. Theseestimates must be made at the time the asset is acquired (although changes are allowed) and it’snot possible with any certainty what the ―right‖ estimates are. Different choices will result indifferent depreciation expenses.

Q8-18.Under the cost method a new calf wo uldn’t be reported on the balance sheet. The calf itself hasno cost associated with its acquisition so there is no basis for measuring it as an asset, althoughcosts are incurred as a result of birth. For example, there would be veterinarian costs, feed, andother expenses up until the point when the calf has matured and ready to produce milk. These

costs could be capitalized.Q8-19.Accounting policies may not affect an entity’s cash flows directly, but they can have secondarycash flow implications. Different accounting policies will affect accounting measurements suchas net income and cash flows may be based on these measures. For example, cash flowsassociated with bonuses, taxes, selling prices of businesses, and compliance with covenants may

be affe cted by an entity’s accounting choices.

Q8-20.a. Historical cost is the amount that was paid to acquire the asset plus any costs incurred to

ready the asset for use. Historical cost is useful for income determination — allowingusers to see the costs that were incurred to earn the reported revenue. Historical cost isalso appropriate for tax purposes.

b. Replacement cost is the amount that would have to be spent to replace a capital asset. Thereplacement cost of a capital asset allows the user to relate the current cost of the inputsof the business to current revenues for a better indication of the profitability of the

business. Replacement cost would also be helpful for predicting the future cash flowsneeded to replace the capital assets. This amount would also be useful for insurance

purposes.

c. Fair value is the amount that would be received from the sale of an asset betweenknowledgeable and willing parties within an arm’s length transaction. The fair valuewould be of interest to creditors who have the asset as collateral for a loan or if the

business was no longer a going concern.

d. Value-in-use is the net present value of the cash flow an asset will generate over its life,or the net present value of the cash flow that the asset would allow the entity to avoid




paying. Value-in-use would be useful to investors who are trying to figure out the valueof an entity and predict future profitability.

Q8-21.Only those intangibles that have been acquired in an arms-length transaction are recorded in the

accounts. It’s likely that Company A built the trademark internally by investing in advertisingand promotion to build the name whereas Company B likely purchased its trademark in atransaction with another entity.

Q8-22.a. The effect of using these conservative accounting policies on income is that income will

be lower than if less conservative estimates were made (because more depreciation will be expensed in the early years). However, if the estimated useful lives are conservativeand assets tend to be used for longer than the estimated period, net income would behigher in the years beyond the estimated life of the asset.

b. Because the cost of an asset is expensed more quickly with conservative estimates, thecarrying amount of the asset will be lower when the asset is disposed of than if lessconservative estimates are used. As a result, the gains on disposal of the asset will belarger (or the losses smaller) with more conservative accounting methods. This discussionassumes that the proceeds from the sale of an asset are not affected by how the asset’scarrying amount. A prospective buyer will consider the value of the asset withoutconsideration of the seller accounts for it, although the seller might consider theaccounting implications of the sale.

Q8-23.Capital cost allowance (CCA) is the term used in the Income Tax Act for depreciation of assetsfor tax purposes, which means for purposes of determining taxable income and the amount of taxthat must be paid. The purpose of depreciation for accounting purposes is matching and incomedetermination. The purpose of CCA is influenced by government policy, for example toencourage investment by companies. The Income Tax Act is very specific about the method andthe rate that must be used for each type of asset. There is little judgement to be exercised. Fordepreciation for accounting purposes, the managers must choose the accounting method,estimate of useful life and residual value of assets. The managers exercise considerable

judgement. Because the Income Tax Act is very specific and because the purposes ofdepreciation and C CA are different, it’s very common to see different CCA deductions anddepreciation expenses.

Q8-24.a. Amortization refers to the allocation of the cost (sometimes fair value) of intangible

assets to expense over their useful lives.

b. Depreciation refers to the allocation of the cost (sometimes fair value) of tangible assetsto expense over their useful lives.




c. Depletion is the allocation of the cost of natural resource assets to expense as theresources are extracted.

The term amortization is often used as the more general term for the allocation of cost (or fairvalue) to expense of any capital asset. In the text the term depreciation is used in the more

general sense.Q8-25.Yes, it’s possible for an entity to use a capital asset that is fully depreciated, if the asset continuesto contribute to revenues for a longer period than the original estimate of the useful life. Thissituation can occur because estimates are predictions. It isn’t possible to know with certaintyhow long an asset can or will be used. If an estimate proves to be too short or conservative, theasset will continue to be used after it’s fully depreciated. The carrying amount of such an assetwould be zero or equal to its residual value.

Q8-26.

The reason that it’s necessary t o allocate the purchase price to individual assets is that the itemsdon’t all have equal useful lives. The furniture may have a useful life as long as 20 or 25 years.It’s very unlikely that the equipment wouldn’t have as long a useful life because it wou ld havesignificantly more wear and tear and would need to be replaced. It’s also likely that the sellingcompany didn’t purchase these assets at the same time. Some assets may be nearing the end oftheir useful lives while other assets would have been rec ently purchased. For that reason, it’snecessary to determine the fair values of the individual assets so that they can be accounted for ina way that reflects the period of time over which they are likely to contribute to the revenues ofthe restaurant. Since allocating the purchase price of a bundle of assets is subjective (the exactfair value of an asset, especially a used asset, can often not be determined with precision),managers will have some flexibility in how to allocate the cost. As a result, managers can makechoices to achieve reporting objectives. For example, if the objective were to maximize incomethe managers might allocate more of the cost to assets with longer lives. If the objective is tominimize taxes, then allocating more of the cost to assets that are depreciated more quickly fortax purposes would serve to defer taxes.




EXERCISES

E8-1.

a) $100,000 would be capitalized. The HST is refundable so it isn’t capitalized.

b)

The $12,500 would be capitalized to the equipment as it’s a cost associated with gettingthe asset ready for use.c) The $6,700 would be capitalized to the asset as it’s part of the cost associated with

getting the asset ready for use.d) The $8,000 should be expensed as these costs were incurred due to the mistake by

workers . The amount wasn’t necessary to get the asset ready for use.

E8-2.Straight-line depreciation methoda.

Display cases $150,000Taxes (non-refundable) 2,500Delivery 5,000Set up 8,000Total cost $165,500

Dr. Furniture (asset +) 165,500Dr. Refundable taxes (asset +) 19,500

Cr. Cash (asset -) 185,000*It’s assumed everything was paid in cash; other assumptions are reasonable.

b.Straight line

YearEnd

AccumulatedDepreciation

CarryingAmount

DepreciationExpense

Dec. 31 Cost (AD) (CA) (DE)Purchase $165,500 $- $165,500 $-

1 165,500 16,050 149,450 16,050 2 165,500 48,150 117,350 32,100 3 165,500 80,250 85,250 32,100 4 165,500 112,350 53,150 32,100

5 165,500 144,450 21,050 32,1006 165,500 160,500 5,000 16,050 Total $160,500

Cost 165,500 purchase price + associated costsRV 5,000 residual valueUL 5 useful life

Depreciation expense {DE} = (165,500 – 5,000)/5 years = $32,100




c. Display cases are sold at the end of year 3 for $25,000. The entry for the year 3 depreciationexpense would be made before the gain or loss is calculated. The carrying amount of the cases at

the end of year 3 was $85,250.Proceeds $25,000

Carrying Amount 85,250Loss ($60,250)

There is a loss of $60,250

At the time of sale, it would be first necessary to record depreciation for the third year:

Dr. Depreciation expense 32,100Cr. Accumulated depreciation 32,100

To record the depreciation expense for year 3.Dr. Cash 25,000Dr. Accumulated depreciation 80,250Dr. Loss on disposal of furniture 60,250

Cr. Furniture 165,500To record the sale of the furniture in the third year.

E8-3.Declining balance depreciation method

a.Display cases $150,000Taxes (non-refundable) 2,500Delivery 5,000Set up 8,000Total cost $165,500








b.Declining balance

Accumulated Carrying DepreciationYear End Depreciation Amount ExpenseDec. 31 Cost (AD) (CA) (DE)

Purchase $165,500 $- $165,500 $- 1 165,500 33,100 132,400 33,100 2 165,500 86,060 79,440 52,960 3 165,500 117,836 47,664 31,776 4 165,500 136,902 28,598 19,066 5 165,500 148,341 17,159 11,439 6 165,500 160,500 5,000 12,159

Total $160,500

Cost $165,500 purchase price + associated costsRate 40%RV 5,000 residual value

UL 5 years useful life

Carrying Amount = Cost - ADDE = Rate * Previous Carrying AmountAD = Current DE + previous years AD

Note year six depreciation expense is greater than year five even though it’s only depreciationfor a half the year. This is because the asset’s useful life has ended (asset is being replaced) atthis time and the remaining amount minus the residual value must be expensed when using thedeclining balance method.

c. Display cases are sold at the end of year 3 for $25,000. The entry for the year 3 depreciationexpense would be made before the gain or loss is calculated.

Proceeds $25,000Carrying

amount 47,664Loss ($22,664)

There is a loss of $22,664.

Dr. Depreciation expense 31,776

Cr. Accumulated depreciation 31,776To record the depreciation expense for year 3.

Dr. Cash 25,000Dr. Accumulated depreciation 117,836Dr. Loss on disposal of furniture 22,664

Cr. Furniture 165,500To record the sale of the furniture in year 3




E8-4.a.

Cost 400,000

Installation 25,000Training 65,000490,000

Dr. Computer equipment 490, 000Cr. Cash 490, 000

To record the purchase of computer equipment. [The service contract and the refundable taxesaren’t included in the capitalized cost of the asset.]

b. Declining balance

Year End AccumulatedDepreciation Carrying amount DepreciationExpenseDec. 31 Cost (AD) (CA) (DE)

Purchase $490,000 $0 $490,000 $0 2017 490,000 245,000 245,000 245,000 2018 490,000 367,500 122,500 122,500 2019 490,000 428,750 61,250 61,250 2020 490,000 455,000 35,000 26,250

Total 455,000

Cost 490,000 purchase price + associated costsRate 50% RV 35,000 residual valueUL 4 useful life

CA= Cost - ADDE = Rate * Previous Carrying AmountAD = Current DE + previous years AD

The depreciation expense in 2020 would reduce the carrying amount of the asset to $35,000, itsestimated residual value. However, given that residual values are imprecise and difficult toestimate it would also be reasonable not to make an adjustment since the carrying amount would

be close to the estimated residual value. If the full 50% was expensed in 2020 the depreciationexpense would have been $30,625 and the carrying amount $30,625.




c. The new computer equipment is sold at the end of 2019 for $55,000. The entry for the 2019amortization expense would be made before the gain or loss is calculated.

Proceeds $55,000Carrying Amount 61,250

Loss (6,250)


Dr. Depreciation expense 61,250Cr. Accumulated Depreciation 61,250

To record the depreciation expense for 2019.

Dr. Cash 55,000Dr. Accumulated Depreciation 428,750Dr. Loss on disposal of computer equipment 6,250

Cr. Computer equipment 490,000To record the sale of the computer equipment in 2019.

E8-5.a.

Cost $400,000Installation 25,000Training 65,000

490,000

Dr. Computer equipment 490, 000Cr. Cash 490, 000To record the purchase of computer equipment. [The service contract and the refundable taxesaren’t included in the capitalized cost of the asset.] b. Straight Line

Year EndAccumulatedDepreciation

CarryingAmount

DepreciationExpense

Dec. 31 Cost (AD) (CA) (DE)

Purchase 490,000 0 490,000 02017 490,000 113,750 376,250 113,750

2018 490,000 227,500 262,500 113,7502019 490,000 341,250 148,750 113,750

2020 490,000 455,000 35,000 113,750

Total 455,000

Cost 490,000 purchase price + associated costsRV 35,000 residual value




UL 4 useful life

Depreciation expense {DE} =

(purchase price {Cost} - residual value{RV})

useful life {UL}

DE= 113,750

c. The new computer equipment is sold at the end of 2019for $55,000. The entry for the 2019amortization expense would be made before the gain or loss is calculated.


Loss (93,750)




Dr. Cash 55,000Dr. Accumulated Depreciation 341,250Dr. Loss on disposal of computer equipment 93,750

Cr. Computer equipment 490,000To record the sale of the computer equipment in 2019.




E8-6.a.Stamping machine $60,000Taxes (non-refundable taxes only) 2,200Delivery & installation 4,000

Total $66,200

Dr. Machinery 66,200Cr. Cash 66,200

To record the purchase of the stamping machine. (Payments are assumed to be in cash. Otherassumptions are also possible.

b.

Units of production

AccumulatedDepreciation Carrying Amount DepreciationExpense % of production units of productionYearEndDec. 31 Cost (AD) (CA) (DE) % UOP #of Units

Purchase $66,200 $0 $66,200 $02017 66,200 7,464 58,736 7,464 12.0% 60,0002018 66,200 44,784 21,416 37,320 60.0% 300,0002019 66,200 60,956 5,244 16,172 26.0% 130,0002020 66,200 62,200 4,000 1,244 2.0% 10,000

Total 62,200 100% 500,000

# of Units overlife 500,000 estimate

Cost $66,200 purchase price + associated costsRV $4,000 residual valueUL 4 useful life

DE=(#units in period/#units over life)*(Cost-RV)DE = (%UOP)*(Cost-RV)AD = Current AE + previous years ADCA = Cost - AD

c. The machine is sold at the end of 2019 for $2,000. The entry for the 2019 depreciation

expense would be made before the gain or loss is calculated. The depreciation expense for 2019,assuming 75,000 units were sold and no adjustment was made for the reduced total output:

Depreciation for 2019 = 75,000/500,000 x ($66,200 – $4,000)= $9,330

Accumulated Depreciation AD (2018) $44,784




DE (2019) 9,330 AD(2019) $54,114

Proceeds $2,000 Carrying amount 12,086 ($66,200 – $54,114) Loss $(10,086)




Dr. Cash 2,000Dr. Accumulated Depreciation 54,114Dr. Loss on disposal of machinery 10,086

Cr. Machinery 66,200To record disposal of the stamping machine.





Total $66,200


To record the purchase of the stamping machine. (Payments are assumed to be in cash. Otherassumptions are also possible.

b.Straight line

Accumulated Carrying DepreciationYear End Depreciation Amount Expense

Dec. 31 Cost (AD) (CA) (DE)Purchase $66,200 $0 $66,200 $02017 66,200 15,550 50,650 15,5502018 66,200 31,100 35,100 15,5502019 66,200 46,650 19,550 15,5502020 66,200 62,200 4,000 15,550

Total $62,200

Cost 66,200 purchase price + associated costs

RV 4,000residual

valueUL 4 years useful life

Depreciation expense {DE} =(purchase price {Cost} - residual value{RV})

useful life {UL}

DE= 15,550

AD = Current DE + previous years ADCA = Cost - AD

This assumes that the machine was purchased early in 2017.




c. The machine is sold at the end of 2019 for $2,000. The entry for the 2019 Depreciationexpense would be made before the gain or loss is calculated.Proceeds $2,000 CA 19,550 Loss $(17,550)



To record the Depreciation expense for 2019.




Total $66,200


To record the purchase of the stamping machine. (Payments are assumed to be in cash. Otherassumptions are also possible.)

b.Declining balance


Dec. 31 Cost (AD) (CA) (DE)Purchase $66,200 $0 $66,200 $02017 66,200 33,100 33,100 33,1002018 66,200 49,650 16,550 16,5502019 66,200 57,925 8,275 8,2752020 66,200 62,200 4,000 4,275

Total $62,000

Cost 66,200 purchase price + associated costsRate 50%RV 4,000 residual value




UL 4 useful lifeCA = Cost - ADDE = Rate * Previous CAAD = Current DE + previous years AD

c. The machine is sold at the end of 2019 for $2,000. The entry for the 2019 Depreciationexpense would be made before the gain or loss is calculated.Proceeds $2,000CA 8,275Loss $(6,275)

There is a loss of $6,275.


To record the Depreciation expense for 2019.



E8-9Asset Carrying

AmountValue in use Fair value

less cost tosell

RecoverableAmount

Write-down

a. Apartment building

$18,000,000 $23,000,000 $20,500,000 $23,000,000 $0

b. Patent 7,000,000 3,250,000 2,500,000 3,250,000 3,750,000c. Assembly

line25,000,000 12,750,000 18,000,000 18,000,000 7,000,000

d. Servicecentre

4,500,000 6,000,000 6,250,000 6,250,000 0

Recoverable Amount is the greater of value-in-use and the fair value less cost to sell.




E8-10.Total Purchase $175,000Equipment #1 75,000 Equipment #2 100,000

Dr. Equipment #1 75,000Dr. Equipment #2 100,000

Cr. Cash 175,000To record the purchase of 2 pieces of equipment.

Equipment #1 Annual depreciation expense = 75,000/5 = 15,000Equipment #2 Annual depreciation expense = 100,000/8 = 12,500Total depreciation expense, equipment = 27,500

Dr. Depreciation expense, equipment 27,500Cr. Accumulated depreciation, equipment 27,500

To record depreciation expense for equipment for December 31, 2018.

E8-11.

a. Purchased a new operating table for the clinic. Capitalize: This asset helps the clinic provide its services over many periods.

b. Paid for advertising on radio and in community newspapers. Expense: This is the cost ofdoing business and doesn’t provide a measurable future benefit.

c. Paid to have the clinic’s lawn cut. Expense: This is considered as maintenance rather than betterment.

d. Purchased a supply of syringes. Inventory —expensed when used: The syringes aren’t acapital asset. They are consumed when used providing services to clients.

e. Purchased original native art for the waiting room area. Capitalize: The art enhances thewaiting area. It’s a capital asset that will be enjoyed by waiting customers for many years.

f. Payment for malpractice insurance for the year for the veterinarians. Expense: This is anoperating expense; it doesn’t provide future benefit to the practice. It provides protectionover the year.

g. Payment for replacing windows broken during a storm. Expensed/Capitalize: This isnormally considered a repair. However if the windows were upgraded and as a result reducedenergy cost it may be a betterment which entitles the new windows to be capitalized.

E8-12.Dr. Cash 3,500,000

Cr. Land 2,500,000Cr. Gain on sale of land 1,000,000

To record the sale of land in 2018.




E8-13.a.

Straight lineAccumulated Carrying Depreciation

Year End Depreciation Amount ExpenseDec. 31 Cost (AD) (CA) (DE)

Purchase 100,000 0 100,000 02012 100,000 9,200 90,800 9,2002013 100,000 18,400 81,600 9,2002014 100,000 27,600 72,400 9,2002015 100,000 36,800 63,200 9,2002016 100,000 46,000 54,000 9,2002017 100,000 50,600 49,400 4,600

Total 50,600

Cost 100,000 purchase price + associated costsRV 8,000 residual valueUL 10 useful life


useful life {UL}

DE= 9,200AD = Current DE + previous years AD

CA = Cost - AD

June 30, 2017Proceeds $37,000CA 49,400Loss (12,400)

Depreciation expense in 2017 was divided in half because the asset was only used for half theyear.


To record a half year of Depreciation expense for 2017

Dr. Cash 37,000Dr. Accumulated Depreciation 50,600Dr. Loss on disposal of equipment 12,400

Cr. Equipment 100,000To record sale of the equipment in 2017




b.Straight line


Dec. 31 Cost (AD) (CA) (DE)Purchase 5,000,000 0 5,000,000 02003 5,000,000 160,000 4,840,000 160,0002004 5,000,000 320,000 4,680,000 160,0002005 5,000,000 480,000 4,520,000 160,0002006 5,000,000 640,000 4,360,000 160,0002007 5,000,000 800,000 4,200,000 160,0002008 5,000,000 960,000 4,040,000 160,0002009 5,000,000 1,120,000 3,880,000 160,0002010 5,000,000 1,280,000 3,720,000 160,0002011 5,000,000 1,440,000 3,560,000 160,0002012 5,000,000 1,600,000 3,400,000 160,0002013 5,000,000 1,760,000 3,240,000 160,0002014 5,000,000 1,920,000 3,080,000 160,0002015 5,000,000 2,080,000 2,920,000 160,0002016 5,000,000 2,240,000 2,760,000 160,0002017 5,000,000 2,280,000 2,720,000 40,000

Total 2,280,000

Cost 5,000,000 purchase price + associated costs

RV 1,000,000residual

valueUL 25 years useful life


useful life {UL}

DE= 160,000AD = Current DE + previous years ADCA = Cost - AD

March 31, 2017Proceeds $7,500,000CA 2,720,000Gain 4,780,000

In 2017 25% of a year’s depreciation was expensed because the building was sold on March 31.





To record a quarter year of Depreciation expense for 2017

Dr. Cash 7,500,000

Dr. Accumulated Depreciation 2,280,000Cr. Equipment 5,000,000Cr. Gain on sale 4,780,000

To record sale of the building in 2017

c.Straight line


Dec. 31 Cost (AD) (CA) (DE)Purchase 60,000 0 60,000 02015 60,000 10,000 50,000 10,0002016 60,000 20,000 40,000 10,0002017 60,000 30,000 30,000 10,000

Total 30,000

Cost 60,000 purchase price + associated costsRV 10,000 residual valueUL 5 years useful life


useful life {UL}

DE= 10,000AD = Current DE + previous years AD

CA = Cost - AD

December 31, 2017Proceeds $30,000CA 30,000

-There is no gain or loss on this disposal because CA =Proceeds


To record a full year of depreciation expense for 2017

Dr. Cash 30,000Dr. Accumulated Depreciation 30,000

Cr. Delivery van 60,000To record sale of the delivery van




E8-14.

a. Intangible: The design doesn’t have physical qualities. b. Tangible: Office furniture has physical substance.c. Intangible: A right doesn’t have physical substance.

d. Tangible: Land is a tangible asset, since it has physical substance.e. Intangible: A right is an intangible asset since it doesn’t have physical substance. f. Tangible: The building has physical substance.

E8-15.Fair market value of assets $25,000,000Fair market value of liabilities 6,000,000Fair market value of net assets $19,000,000

Price paid for 100% of common shares $22,000,000 – Fair market value of net assets 19,000,000

Goodwill $3,000,000Resolute would report $3,000,000 of goodwill on its consolidated balance sheet.

E8-16.a.Fair market value of assets $27,500,000Fair market value of liabilities 15,000,000Fair market value of net assets $12,500,000

Price paid for 100% of common shares $16,000,000 – Fair market value of net assets 12,500,000Goodwill $3,500,000

b.Dr. Write-down of goodwill (income statement) 1,000,000

Cr. Goodwill (balance sheet) 1,000,000

The goodwill will be reported on the balance sheet at $2,500,000 and the income statement willshow the write-down (an expense) of $1,000,000.




E8-17.a.Annual Depreciation expense = ($102,000-12,000)/5 = $18,000

Straight lineAccumulated Carrying DepreciationYear End Depreciation Amount Expense

30-Jun Cost (AD) (CA) (DE)Purchase $102,000 $0 $102,000 $0

2018 102,000 18,000 84,000 18,0002019 102,000 36,000 66,000 18,0002020 102,000 54,000 48,000 18,0002021 102,000 72,000 30,000 18,0002022 102,000 90,000 12,000 18,000

Total 90,000

Cost $102,000 purchase price + associated costsRV $12,000 residual valueUL 5 years useful life

( [ ] [ ])

[ ]

DE= 18,000





b.Declining balance

YearEnd

Cost


(AD)

Carryingamount

(CA)

DepreciationExpense

(DE) 30-Jun

Purchase $102,000 $0 $102,000 $02018 102,000 35,700 66,300 35,7002019 102,000 58,905 43,095 23,205

2020 102,000 73,988 28,012 15,0832021 102,000 83,792 18,208 9,804

2022 102,000 90,000 12,000 6,208

Total 90,000

Cost $102,000 purchase price + associated costs

Rate 35%

RV $12,000 residual valueUL 5 years useful life

CA = Cost - AD

DE = Rate * Previous CA

AD = Current DE + previous years AD

Note: The Depreciation expense in the sixth year is reduced to reflect the residual value of

$12,000.




c.i.


Gain 15,000

Dr. Cash 45,000Dr. Accumulated Depreciation 72,000Dr. Cr. Equipment 102,000

Gain on disposal of equipment 15,000To record the disposal of the equipment when straight-line depreciation is used

ii. Proceeds $45,000Carrying Amount 18,208Gain 26,792

Dr. Cash 45,000Dr. Accumulated Depreciation 83,792Cr. Equipment 102,000Cr. Gain on disposal of equipment 26,792

To record the disposal of the equipment when declining-balance depreciation is used

d.The difference in the amount of the gain between the two different methods is a result of timingand useful life of the asset. In this case using the declining balance method depreciated the assetfaster than using straight line. As a result the gain is smaller using the straight line method

because the carrying amount of the asset at the end of 2021 is greater using straight line.

Therefore the gain (or loss) depends on how the equipment is accounted for. The proceeds fromthe sale are not affected by the carrying amount of the asset. Thus, gains and losses are affected by accounting estimates.




E8-18.

a. Depreciation expense = ($200,000-10,000)/8 = $23,750


Year End Depreciation Amount Expense30-Jun Cost (AD) (CA) (DE)

Purchase $200,000 $0 $200,000 $02018 200,000 23,750 176,250 23,7502019 200,000 47,500 152,500 23,7502020 200,000 71,250 128,750 23,7502021 200,000 95,000 105,000 23,7502022 200,000 118,750 81,250 23,7502023 200,000 142,500 57,500 23,7502024 200,000 166,250 33,750 23,7502025 200,000 190,000 10,000 23,750

Total 190,000


( )( [ ] [ ])

[ ]

DE= 23,750





ii.Declining balance


30-Jun Cost (AD) (CA) (DE)Purchase $200,000 $0 $200,000 $0

2018 200,000 60,000 140,000 60,0002019 200,000 102,000 98,000 42,0002020 200,000 131,400 68,600 29,4002021 200,000 151,980 48,020 20,5802022 200,000 166,386 33,614 14,4062023 200,000 176,470 23,530 10,0842024 200,000 183,529 16,471 7,0592025 200,000 190,000 10,000 6,471

Total 190,000

Cost $200,000 purchase price + associated costsRate 30%RV $10,000 residual valueUL 8 years useful life

CA = Cost - ADDE = Rate * Previous CAAD = Current DE + previous years AD

The expense in the last year was $6,471 so that the residual value of the equipment would be$10,000 at the end of the asset’s 8 -year useful life.




iii.Units of production

Accumulated Carrying Depreciation % units ofYear End Depreciation Amount Expense production

30-Jun Cost (AD) (CA) (DE) % UOPPurchase 200,000 0 200,000 02018 200,000 19,000 181,000 19,000 10.0%2019 200,000 38,000 162,000 19,000 10.0%2020 200,000 66,500 133,500 28,500 15.0%2021 200,000 95,000 105,000 28,500 15.0%2022 200,000 123,500 76,500 28,500 15.0%2023 200,000 152,000 48,000 28,500 15.0%2024 200,000 171,000 29,000 19,000 10.0%2025 200,000 190,000 10,000 19,000 10.0%

Total 190,000 100%


DE=(#units in period/#units over life)*(Cost-RV)DE = (%UOP)*(Cost-RV)AD = Current DE + previous years ADCA = Cost - AD

b.In theory it shouldn’t matter. If the bank lender officer is sophisticated he/she would realizedthere is no difference in the economic condition of the company under the three methods. If the

banker isn’t sophisticated or it’s too difficult or costly for him/her to adjust for the different

methods then the choice the company makes could matter. If the loan amount is based on thevalue of assets for collateral then it’s likely that the company will favour the method that leavesthe highest residual value of the asset (carrying amount). If the bank is focused on the incomestatement then a lower depreciation expense will reflect a higher net income. In this case if theloan application was in the first two years then the units of production method is the best optionssince depreciation expense is lowest and the carrying amount of the asset is highest of the threemethods. Latter periods will depend on whether the choice is to have a higher carrying amountfor the asset or a lower depreciation expense.




E8-19.a. These expenditures should be expensed because they don’t extend the life of the asset or

improve performance. These costs are needed to ensure that the trucks operate asexpected and are useful for the expected life. It’s a requirement of the asset.

b. Presumably, the new colours represent promotion for the airline. This promotion provides

value for the airline by providing a unique identity. The promotional value of the paint job will last as long as the paint job does, so the cost of the paint job should becapitalized. Generally promotion costs are expensed but because the paint job providesother benefits to the plane a case can be made to capitalize.

c. Replacing the windows is a repair. There is no enhancement to the building and so thecost should be expensed.

d. The rewiring improves the service quality that can be offered to customers — it provides afuture benefit — so the expenditure should be capitalized.

e. This expenditure doesn’t increase the life or efficiency of the computers. Replacing theCPU is required to have the computers function as originally anticipated. The expenditureshould be expensed when incurred.

f.

Cleaning the carpets doesn’t make them better or improve their life. The cleaning cost isa maintenance cost that should be expensed when incurred.g. The cost of the extension should be capitalized. The extension will provide an increased

benefit to the owners of the building buy adding more useable area or more places to rentout.

h. Although this training will provide future benefit to th e business it’s difficult to measurethis benefit therefore the costs would be expensed. Human capital isn’t recorded as anasset on the balance sheet. An exception to the treatment of not recording human capitalon the balance sheet may occur when a business purchases another business and humancapital could be part of the goodwill purchased.

E8-20.If we’re sure that the building will be demolished at the end of the 45 years, there are only 13years remaining in the useful life of the building so the roof should be depreciated over 13 years.It’s unreasonable to depreciate the roof over a longer period since the roof provides no benefits ifthe building underneath it i sn’t there. The benefits from the roof will be received equally overtime, so the straight-line method is appropriate. Since the roof can’t be sold when the building isdemolished it has a zero residual value.




E8-21.The following table indicates the costs that should be included in the cost of the pool.

Item Included Excluded Reasoni. Permits $1,000 Necessary cost to construct the pool.

ii. Design 8,000 Necessary cost to construct the pool.iii. Redesign $5,000 Should be excluded if these are incrementalcosts over what would have been charged hadthe changes been originally included. In otherwords, if the design would have been say$13,000 and the changes were originally

planned, then this cost should be capitalized. Ifthe costs were incurred because the changeswere required after construction began, thenthey shouldn’t be capitalized. The latterinterpretation is used here.

iv. Clearing 12,000 Necessary cost to construct the pool.v. Pool 150,000 Necessary cost to construct the pool.vi. Damage 22,000 If the damage had to occur to build the pool

then the cost should be capitalized. If thedamage wasn’t necessary and could have beenavoided then it should be expensed. The formerinterpretation is taken here.

vii. Meals 2,000 Necessary cost to construct the pool. (Perhapsnot necessary but part of the labour cost to buildthe pool.)

viii. Penalties 9,000 If these penalties were incurred for good reason

(perhaps not to disturb guests at certain times)they should be capitalized as part of the cost ofthe pool.

ix. Damage 5,500 This damage appears to have been avoidable soit shouldn’t be capitalized.

x. Patio 45,000 Necessary cost to construct the pool. Possiblethat these should be capitalized and amortizedseparate from the pool (perhaps different usefullife).

xi. Wiring 15,000 Necessary cost to construct the pool. Possiblethat these should be capitalized and amortizedseparate from the pool (perhaps different usefullife).

xii. Plants 9,200 The plants should be capitalized but probablyseparately from the pool.

$273,200 $10,500




E8-22. Note to help ratio analysisIf the numerator of a ratio increases or the denominator decrease then the whole ratio willincrease.If the numerator of a ratio decreases or the denominator increase then the whole ratio will

decrease.If the effect on the numerator increases the ratio and the effect on decreases the ratio(conflicting) then the amount that is smallest will have the greatest impact and determine whichway the ratio is going to change. For example, if the current ratio is greater than 1 (i.e. CA islarger than CL) and CA increase by the same amount as CL (CA is showing increase ratio andCL is showing decrease in ratio, conflicting which way the ratio should go), thus CL is thesmaller amount and the determining factor on the ratio. In this case the ratio would decrease.

Return on assets = (NI + After – tax interest expense)/Average TA;PM% = NI/Sales;Current ratio = CA/CL;

D/E ratio = L/OE;Fixed Asset Turnover = Revenue/Average Fixed Asset

Note: the following table indicates the effect on the ratios in the year of the transaction. Differenteffects may occur in future periods.

Return on assets Profitmargin

percentage

Currentratio

Debt-to-equity ratio

Fixed-assetturnover

ratioa. Writedown of a machine. Decrease Decrease No Effect Increase Increase

b. Changes in fair value areincluded in net income.

Increase Increase No Effect Decrease Decrease

c. Equipment is purchased for

cash and depreciation isexpensed in the year of

purchase.

Decrease Decrease Decrease Increase Decrease

d. Capitalize development costs.Costs were incurred in cash anddepreciation will begin in afuture period.

No Effect No Effect Decrease No Effect Decrease

a.Dr. Write down (OE-)

Cr. Capital Asset (A-)

Overall, the assets, owners’ equity, and net income will decrease (conflicting ROA ratio).Average total assets decrease less than net income (the denominator is an average) so the neteffect is to decrease ROA.




b.Dr. Land (A+)

Cr. Gain (OE+)

c.

Dr. Equipment (A+)Cr. Cash (A-)

Dr. Depreciation (OE-)Cr Accumulated depreciation (A-)

Assumption is made that equipment is paid for in cash. The purchase decreases the current ratio(cash decreases). ROA decreases because net income decreases and total assets increase

d. Net income isn’t affected by capitalizing development costs. Depreciation of development costs

from previous years isn’t considered here. It’s also assumed development costs are paid in cash.Dr. Development costs (A +)

Cr. Cash (A-)Current assets would decrease but total assets would remain the same. There is no effect on netincome or owners’ equity. There is no effect on the fixed asset turnover ratio becausedevelopment costs are an intangible asset, not PPE.

E8-23. Note to help ratio analysisIf the numerator of a ratio increases or the denominator decrease then the whole ratio willincrease.If the numerator of a ratio decreases or the denominator increase then the whole ratio willdecrease.If the effect on the numerator increases the ratio and the effect on decreases the ratio(conflicting) then the amount that is smallest will have the greatest impact and determine whichway the ratio is going to change. For example, if the current ratio is greater than 1 (i.e. CA islarger than CL) and CA increase by the same amount as CL (CA is showing increase ratio andCL is showing decrease in ratio, conflicting which way the ratio should go), thus CL is thesmaller amount and the determining factor on the ratio. In this case the ratio would decrease.

Return on assets = (NI + After – tax interest expense)/Average TA;PM% = NI/Sales;Current ratio = CA/CL;D/E ratio = L/OE;Fixed Asset Turnover = Revenue/Average Fixed Asset

Note: the following table indicates the effect on the ratios in the year of the transaction. Differenteffects may occur in future periods.




Return onassets

Profit marginpercentage

Currentratio

Debt-to-equityratio

Fixed-assetturnover

ratioa. Sale of a building Ambiguous Increase No Effect Decrease Increase

b. Recoverable amount No Effect No Effect No Effect No Effect No Effectc. An intangible asset

was acquired. No Effect No Effect Decrease No Effect No Effect

d. Expense researchcosts.

Decrease Decrease Decrease Increase No Effect

a.

Dr. Notes Receivable (A+)Dr. Accumulated depreciation (A+)

Cr. Building (A-)Cr. Gain on Building (OE+)

Return on asset is ambiguous because we don’t know how large the gain on sale is and we don’tknow the proportional change in net income and average total assets. Profit margin percentageincreases because the building is sold at a gain and so net income increases.

b.

The greater of the value-in-use and the fair value less selling cost is called the recoverableamount. If this amount is less than the carrying amount then there is a write-down. Since thisdidn’t happen there is no change.

c. Since there are no factors that limit the useful life of the intangible asset there will be no needto amortize it, thus no expense and no change in net income or owners’ equity. We also canassume that cash was paid for the new asset thus a decrease in current asset but no effect to totalassets.

d.The effect of expensing research costs is compared to net income before the research costs isexpensed. Thus net income decreases as a result of expensing research . It’s also assumedresearch costs are paid in cash.

Dr. Research expenseCr. cash

Higher expense and fewer assets mean lower net income, equity, and assets. Overall, the assets,owner’s equity, and net income will decrease (conflicting ROA ratio) . Average total assetsdecrease less than net income (the denominator is an average) so the net effect is to decreaseROA.




E8-24.

Net income Gross marginTotalassets

Owners’equity

Cash fromoperations

Investingcashflows(cash

flowstatement

Total cashflow

a. Anintangibleasset nofactors limitits usefullife.

No effect No effect No effect No effect No effect Increase Decrease

b. Capitalizedevelopmentcosts.

No effect No effect No effect No effect No effect Increase Decrease

c. Purchaseequipment

Decrease* No effect Increase Decrease No effect Noeffect

No effect

d. Repairs Decrease Decrease** Decrease Decrease Decrease Noeffect

Decrease

e. BuildingFair Valueincrease

Increase No effect Increase Increase No effect Noeffect

No effect

*Assumes equipment depreciation isn’t included in COGS ** Assumes that repairs are a product cost and included in COGS

E8-25.

Fixed Asset Turnover Ratio = Revenue

Average PPE

Average Capital Asset = Beginning Fixed Assets+ Ending Fixed Assets 2

2017

Average Capital Asset = Beginning PPE + Ending PPE 2

= 5,250,000 + 6,125,000

2 Average Capital Asset = 5,687,500

Fixed Asset Turnover Ratio = Revenue Average PPE

= 12,525,000 5,687,500




Fixed Asset Turnover Ratio = 2.20

2018

Average Capital Assets = Beginning PPE + Ending PPE

2 = 6,125,000+5,925,000

2 Average Capital Asses = 6,025,000

Fixed Asset Turnover Ratio = Revenue Average PPE

= 16,750,000 6,025,000

Fixed Asset Turnover Ratio = 2.78

The increase in the fix asset turnover ratio indicates improving efficiency in the use of PPE togenerate sales. Sales increased by a larger proportion that average PPE, which means thatamount of sales per dollar of PPE has increased.




E8-26.Assumption is no depreciation was taken in the first year of acquisition.

Straight line

Accumulated Carrying Depreciation

Year End Depreciation Amount Expense

Cost (AD) (CA) (DE)Purchase 450,000 0 450,000 0

2015 450,000 56,250 393,750 56,250

2016 450,000 112,500 337,500 56,250

2017 450,000 168,750 281,250 56,250

2018 450,000 225,000 225,000 56,250

Total 225,000


RV $0 residual valueUL 8 years useful life

( )( [ ] [ ])

[ ]

DE= 56,250


Carrying Amount = Cost - AD

Proceeds 210,000

Carrying Amount 225,000

Loss (15,000)

The balance in accumulated depreciation after 4 years (assuming zero salvage) =4 x ($450,000 – 0)/8= $225,000


Cr. Equipment 450,000

To record the disposal of heavy machinery in 2018.

The $210,000 proceeds from selling the equipment will appear in the investing section of thestatement of cash flows. The loss will need to be added back in the operating section if theindirect method is used. However, the loss doesn’t affect operating cash flows. Overall there is a

positive cash flow despite the loss.




E8-27.Straight line


Year End Depreciation Amount Expense

Cost (AD) (CA) (DE)

Purchase 1,500,000 0 1,500,000 02013 1,500,000 200,000 1,300,000 200,0002014 1,500,000 400,000 1,100,000 200,000

2015 1,500,000 600,000 900,000 200,000

2016 1,500,000 800,000 700,000 200,000

2017 1,500,000 1,000,000 500,000 200,000

Total 1,000,000

Cost $1,500,000 purchase price + associated costsRV $100,000 residual value


( )( [ ] [ ])

[ ]

DE= 200,000

DA = Current DE + previous years AD

CA = Cost - AD


Loss (75,000)

Dr. Cash 425,000Dr. Accumulated Depreciation 1,000,000Dr. Loss on disposal of machinery 75,000

Cr. Equipment 1,500,000To record the disposal of machinery in 2018.




Declining balance


Year End Depreciation amount Expense

Cost (AD) (CA) (DE)Purchase 1,500,000 0 1,500,000 0

2013 1,500,000 375,000 1,125,000 375,0002014 1,500,000 656,250 843,750 281,250

2015 1,500,000 867,188 632,813 210,9382016 1,500,000 1,025,391 474,609 158,203

2017 1,500,000 1,144,043 355,957 118,652

Total 1,144,043

Cost $1,500,000 purchase price + associated costs

Rate 25%RV $100,000 residual value


CA = Cost - AD



Proceeds $425,000

Carrying Amount 355,957

Gain 69,043

Dr. Cash 425,000Dr. Accumulated Depreciation 1,144,043

Cr. Machinery 1,500,000Cr. Gain on disposal of machinery 69,043

To record the disposal of the machinery

Declining balance depreciates the machinery at a much faster rate than straight line in the firstfew years of the equipment ’s. It isn’t until the 7th year that straight line catch es up. As a resultthe early disposal of the equipment resulted in a loss for straight line, not enough depreciation

was expensed year over year, and a gain using declining balance, too much depreciation taken.(Of course depreciation is intended to reflect the NRV of a capital asset throughout its life.)While the choice of depreciation method affects what is reported in the financial statements, itdoesn’t affect the economic reality of the company. The economic position of the company is thesame. The representation of that reality is different. Depreciation is meant to allocate the cost ofthe equipment over the revenue it helped to earn, and not the outlay involved in acquiring theequipment. Therefore depreciation doesn’t affect cash flow as it’s a non -cash transaction.




E8-28a. No effect — would be deducted from net income in the calculation of cash from operations

using the indirect method. b. No effectc. Investing cash outflow

d. No effect — would be added back to net income in the calculation of cash from operationsusing the indirect method.e. Investing cash inflowf. Operating cash outflowg. No effect – would be added back to net income in the calculation of cash from operations

using the indirect method.h. Investing cash outflow.i. Financing cash inflow. Until the equipment is purchased there won’t be a cash outflow for

investing.

E8-29.

a. Given the half-year rule in the first year, the maximum CCA that can be claimed in 2017is [½ x 30% of $25,000] = $3,750.

b. The maximum in 2018 is [30% of ($25,000 – 3,750)] = $6,375.

c. On a 15 year straight-line basis without salvage, the annual depreciation expense would be $1,667. DE = [(25,000-0)/15]

d. Management’s estimate of useful life has no effect on CCA . The Income Tax Act clearlyspecifies how CCA is calculated for different types of assets. Importantly, for financialreporting purposes managers have choices regarding depreciation method, useful life, andresidual value. These choices don’t exist for tax purposes.

e. The amounts in a. and c. are different because the half- year rule doesn’t apply forfinancial reporting. Useful life and residual value aren’ t important for calculating CCA

but are used when calculating depreciation expense for financial reporting. Financialaccounting has a choice of method (straight line, declining balance, or units of

production) whereas declining balance with the half year rule and a prescribed rate isused for tax.




E8-30.

a. The carrying amount for land and building would be $7,500,000 and $10,500,000respectively.

b. The balance in the accumulated depreciation account would be:

Proportion of building not depreciated = 19/25 = 0.76Gross amount reported for the building = $10,500,000/0.76 = $13,815,789Accumulated depreciation = Gross amount – Net amount

= $13,815,789 – $10,500,000= $3,315,789

c. The change in the value of land and building would be reflected in the statement ofcomprehensive income under revaluation surplus, which is included in other comprehensiveincome. This revaluation surplus is included in accumulated other comprehensive income inthe equity portion of the balance sheet.

d. Benefits – Reporting assets at fair value is more relevant than reporting at cost. It terms ofland and building, in particular land, presenting the assets at fair value is a betterrepresentation of the value of the company. This is particularly true for property owning firmswhere the value of the firm maybe understated unless property owned is reflected at fairvalue. Having a more current measure is more valuable than a historical, but if the land and

building are to be used for operating purposes for their useful lives the relevance of currentfair value is limited because the land and buildings aren’t going to be sold.

Problems – The revaluation amount is only as accurate as the date the asset was revalued.Therefore unless the firm revalues the asset on a frequent basis, the value of the asset willnever be accurate. Also, estimating the value of many assets, often land and buildings, is verysubjective. It’s also costly to regularly revalue assets. Depreciation expense would increase,which would lower net income in periods there is a depreciation expense.




PROBLEMS

P8-1.*** This is a sample solution and students should look at the factors that might affect theirdecision on a depreciation policy***

The problem should be regarded from two levels. The first consideration is the actual utilizationof the cars and the second is the objectives of financial reporting. The useful life of the car woulddepend on the extent to which the vehicle would be used each year. If the vehicle were to be usedextensively, it would perhaps be appropriate to expect that the car would be replaced as quicklyas three years. This decision would be based on an estimate of when the vehicle would begin torequire frequent and substantial repairs or would become unreliable, in which case the restaurantwould need to replace the vehicle. If the restaurant was to hire casual employees who maycarelessly drive the vehicle, plans to replace the vehicle sooner might be appropriate. Theanticipated residual value could be estimated by reference to wholesale values of used cars thatare three years old with the anticipated mileage and condition that is expected at that time. That

said, an estimated useful life of between three and six years would probably be acceptable.The accountant might also consider the objectives of financial reporting. The restaurant has teninvestors who aren’t involved in management and who rely on the financial statements forinformation. The founder might be interested in showing the absentee owners higher net income,which could be achieved by choosing a longer useful life. If the absentee owners had a closerelationship with the company (getting information beyond the financial statements) financialreporting could be simplified by using the CCA rates regardless of how the car was to be usedmay be appropriate. This treatment would lower net income in the early years of the cars’ lives.




P8-2.The amounts (revenue and expenses) in the table below were arbitrarily chosen to demonstratewhat ha ppens with and without a write down. This table isn’t necessary to answer the question

but will be useful to help students understand the implications of accounting for write downs.The numbers are arbitrary and the chart is designed to show the effect.

Without write downAssets to be depreciated by 2 million for 6 more years

2017 2018 2019 2020 2021 2022 2023Revenue 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000Unusual Sales(net of expenses) 13,000,000Expenses (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000)Depreciation (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000)

Net Income 41,000,000 28,000,000 28,000,000 28,000,000 28,000,000 28,000,000 28,000,000

Effects of write down2017 2018 2019 2020 2021 2022 2023

Revenue 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000 65,000,000

Unusual Sales(net of expenses) 13,000,000Expenses (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000) (35,000,000)Depreciation (2,000,000)Write down (12,000,000)

Net Income 29,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000

In 2017, there is unusual earnings of 13 million that analysts didn’t expect would be earned. a. The write-down reduces income in the current year because of the loss and increases net

income in future years because the depreciation expense will be lower (because t here’sless to depreciate). As a result of the writedown Esterhazy only exceeded analysts’expectations by $1,000,000, instead of by $13,000,000. For example looking at the chart

the analysts have predicted they will earn $28 million in 2017 but with the write downthey will earn $29 million (instead of $41 million), $1 million more than expectations(remember analysts didn’t anticipate the $13 million extra).

b. Assuming the users accepted the write-down at face value, their expectations about future profitability would be reduced (of course the high earnings in 2017 may increaseexpectations unrealistically). The financial statements of the current year should beinterpreted with the understanding that the total write-down reduced current earnings andis a one-time occurrence. Most users would see the effect of the one-time write-down in2017. What would be less obvious is the improvement in earnings after 2017 as a resultof the lower depreciation expense. The effect of the write- down after 2018 wouldn’ t be

explicitly stated or reported separately. The effect on depreciation expense would bereflected in ordinary operations. As a result, some stakeholders could have a more

positive sense of the performance of the company than is merited.




c. The motive for the amount and timing of the write-down appears to be to avoid the prospect of dealing with analysts’ expectations of profits that could not be attained in thefuture. The managers may have been trying to show a steady income trend rather thanhaving an unusually good year followed by a weaker year, which may not be wellreceived by the market. By taking the write-off, Esterhazy managers may have been

trying to dampen stakeholders’ expectations for future profits. Another explanation is thatthe assets were actually overstated on the balance sheet and a write-down wasappropriate. This highlights the problem for users. It will rarely be clear what themotivation of the managers is making it more difficult to interpret the financialstatements.

d. It may not matter in the sense of analysts being misled if they understand exactly whatwas done. However, those who receive the financial statements of the company in thenext few years may not be aware of the write-down and believe that the firm is more

profitable than would have been the case in the absence of the write-down. The write-down could also have an effect on contracts that are based on financial statement

numbers. The underlining economic activity is the same in each period. The difference ishow the capital assets are accounted for and reported on the financial statements.




P8-3.The amounts (revenue and expenses) in the table below were arbitrarily chosen to demonstratewhat happens with and without a write down. This table isn’t necessary to answer the question

but will help students understand the implications of accounting for write downs. The numbersare arbitrary and the chart is designed to show the effect.

Without write down (000's)

Asset was to be amortized by 35 million for 10 years

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Revenue $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000

Expenses (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000)

Depreciation (35,000) (35,000) (35,000) (35,000) (35,000) (35,000) (35,000) (35,000) (35,000) (35,000)

Net Income 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000

Effects of write down (000's)

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Revenue $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000

Expenses (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000)Write down (350,000)

Net Income (300,000) 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000

Expensing reduces income in the current year by $350,000,000. In future years, income will behigher than otherwise because it won’t be necessary to amortize the cost of the technologiesunder development. For example, if the technologies under development were capitalized andamortized over 10 years (see chart) there would be $35,000,000 of depreciation charged everyyear. As a result, using Plumas ’ approach, the company takes a big hit in 2017 but then hasincome that is higher than it otherwise would have been had there been no write down. Plumas’approach creates a matching problem because if the technologies under development actually

generate revenues, some of the costs associated with those revenues won’t be matched to therevenues. Margins will be overstated as a result. Users may have a difficult time understandingwhy Plumas expensed the amount, given that IFRS permits the amount to be treated as an asset.The implication is that the technologies have no value and that the company made a mistake inacquiring them (which may or may not be true). Interpretations could be confusing becausemargins would be higher than otherwise and it may make comparisons with other entities moredifficult, depending on how those other entities account for similar acquisitions. One possiblemotive is that users may welcome the conservative accounting policy and consider the companyas credible. Another is that Plumas was willing to have low income this year to enjoy a higher

base in future years. In doing so, management might believe that stock market investors willrespond favourably to the higher income. This write down approach could have possibly been an

opportunity for management to take a big bath.




P8-4.

a. Under IFRS biological assets are valued at their fair value less cost to sell with gains andlosses reflected in the income statement for the period in which they occur. Therefore as the calfmatures its fair value less cost to sell will likely increase.

b. ASPE doesn’t provide specific guidelines as i t pertains to biological assets however,when a cow that wasn’t purchased is old enough to produce milk, the cost that could appear onthe balance sheet might include the veterinary costs and any other costs that can specifically betraced to the calf (alt hough it’s more likely that those costs would simply be expensed asincurred). The allocation of other costs would probably be difficult, although conceptually itmight seem appropriate since it may be considered as getting the asset ready for use, in this caseto produce milk.

c. Under IFRS there is a standard for accounting for biological assets and provides a morerelevant representation of the farms financial position than ASPE (ASPE essentially ignores the

existence of biological assets that aren't purchased) . It’s likely that IFRS provides more usefulinformation to stakeholders since it recognizes the existence of biological assets and recognizestheir changing value. ASPE statements may be misleading because is leaves out a significantasset (the cows). This is a much more conservative approach then under IFRS. IFRS has itsshortfalls as well as there is a great deal of uncertainty regarding valuation and the opportunityfor managers to select fair values in a way that servers their reporting objectives.




P8-5.(The assumption is the Wishart is using straight line depreciation.)a.

Revenue – The change would have no effect on current or future revenues sinceincreasing a useful life estimate doesn’t increase the amount of business the company

does. Expenses – Increasing the useful life will decrease the amount of depreciation expenserecognized in each period because the carrying amount is expensed over a longer periodof time.

Net Income – Will be higher given because expenses are lower. PP&E – A change in estimate won’t have an immediate effect on the carrying value of

PP&E. However since the depreciation is expensed over a longer period and the amountexpensed each year is reduced, the carrying value of the asset will decrease more slowly.

Total Assets – Same explanation as PP&E Shareholder’s equity – An increase in net income will increase shareholder’s equity by

the same amount with the reduction in expenses period to period.

In the later years of the PPE’s life expenses will be greater than if the useful life hadn’t been extended.

b. Profit Margin – With revenue staying the same and expenses decreasing profit margin

will go up once new estimates are implemented. ROA – ROA will increase because the numerator increases by more than the

denominator (the denominator is an average so the impact of the higher net income on thedenominator is half of the impact on the numerator.

Fixed Asset Turnover – The fixed asset turnover ratio would decrease because thedenominator will be larger since the value of fixed assets will retain its more of its valuewith lower depreciation.

Debt-to-equity – Since debt doesn’t change and equity will increase from a higher netincome, the overall ratio will decrease.

c. While not getting the capital needed to make improvements could hurt the companyeconomically, the change in useful life estimate doesn’t have a real economic impact. Theeconomic burden has already been recorded in a previous period.

d. Depreciation is an estimate; therefore it isn’t unusual for c ompanies to adjust useful lifeas more information and usage data becomes available. There are many factors that may affectthe estimate such as the efficiency of equipment, recycling programs, or population shrinkage.

e. As a prospective lender I look at the basis for the increase in useful life. While increasingthe useful life, if justified, provides more relevant information, not having the actual data to

justify the reason for the change in estimate makes it unreliable. Therefore as a prospectivelender I would have to consider all facts leading to the change in the estimate.




P8-6.a. (assuming cash was paid to buy equipment)Dr. Equipment 150,000

Cr. Cash 150,000To record the purchase of equipment.

b.The overhaul done on the equipment would b e considered a betterment because it’s extendingthe life of the equipment (2 years) thus increasing the future benefit of this equipment and thisincrease in benefit will increase the assets contribution to earnings. Accordingly, the cost of thework should be capitalized over the new remaining life of the asset (in this case the remaininglife increased from two to four years), assuming the useful life of the overhaul was longer thanthe remaining useful life of the equipment. If the useful life of the overhaul was shorter than theremaining life of the equipment it should be depreciated over the period until the next overhaul.

c. The treatment of the service done in May 2016 depends on its nature. It appears that this

expenditure is a repair expense. This servicing of the broken down equipment is expensed in this period because this expenditure provides no additional future benefit to the asset but simplyhelps the asset perform as intended.

d.In this case, capitalizing a betterment as done in part b increases the asset’s depreciation expense(see chart below in part e). An expense as done in part c doesn’t affect the depreciation expense.

e.The following assumes a full year of depreciation in fiscal 2012 of the original cost of the asset.The betterment was depreciated for a full fiscal year in 2016. An answer could incorporate theone-month difference between the January purchase and the February betterment.


Year End Depreciation Amount Expense Cost $150,000 purchase price + associated costsDec.31 Cost (AD) (CA) (DE) RV $15,000 residual valuePurchase 150,000 $0 $150,000 $0 UL 6 years useful life

2012 150,000 22,500 127,500 22,500 Depreciation expense {DE} =

2013 150,000 45,000 105,000 22,500 (purchase price {Cost} - residual value{RV})

2014 150,000 67,500 82,500 22,500 useful life {UL}2015 150,000 90,000 60,000 22,500 DE= 22,500

Total 90,000Betterment 248,000 $90,000 $158,000 $0 New CA $158,000 CA (2015) + Cost of betterment

2016 248,000 125,750 122,250 35,750 RV $15,000 residual value2017 248,000 161,500 86,500 35,750 UL 4 years extended useful life2018 248,000 197,250 50,750 35,750 DE= 35,7502019 248,000 233,000 15,000 35,750

Total 233,000 NBV-2015 $60,000Betterment 98,000

New value 158,000




P8-7.

Assets (=) Liabilities (+) Owners’ Equity

Long-term .

Trans Cash

Property,plant, andequipment

AccumulatedDepreciation Debt R/E Gain Loss

WriteDown

DepreciationExpense

Beg(i) 1,125,000 (337,500) 787,500

(ii) 45,000 (165,000) 90,000 (ii) (ii) (30,000)

(iii) 217,500 (157,500) (iii) (iii) 60,000

(iv) (285,000) 622,500 (iv) 337,500 (iv)

(v) (48,000) (v) (v) (48,000)

(vi) (127,500) (vi) (vi) (127,500)

(22,500) 1,425,000 (423,000) 337,500 787,500 60,000 (30,000) (48,000) (127,500)

Capital assets $1,425,000Accumulated Depreciation (423,000)

Ending carrying amount $1,002,000

The ending net book value on December 31, 2017 is $1,002,000

P8-8.

Assets (=) Liabilities (+) Owners’ Equity

Trans Cash

Property,plant, andequipment


NotesPayable R/E Gain Loss Write down

DepreciationExpense

Beg 80,000 1,070,000 (471,000) Beg (100,000) Beg 612,500 (30,000) 40,000 41,500 115,000

(ii) (237,500) 337,500 (ii) 100,000 (ii)

(iii) 50,000 (135,000) 115,000 (iii) (iii) 30,000

(iv) 107,500 (147,500) (iv) (iv) (40,000)

(v) (41,500) (v) (v) (41,500)

(vi) (115,000) (vi) (vi) (115,000)

End (i) 1,125,000 (512,500) (i) (i) 612,500

Capital asset $1,070,000Accumulated Depreciation (471,000)

Beginning carrying amount $599,000

The net book value on July 1, 2017 is $599,000




P8-9.

Net income Total assetsOwners’

equity

Currentratio[1.65] Return on assets 1

Debt-to-equity ratio

[1.25]

Fixed assetturnover

ratioa. Understated Understated Understated No

change

Understated Overstated Overstated

b. Overstated Overstated Overstated Nochange

Understated Understated No effect

c. Understated Understated Understated Nochange

Understated Overstated Overstated

d. Overstated Understated Understated Nochange

Overstated Overstated Overstated

e. Understated Understated Understated Nochange

Overstated Overstated Overstated

1 When the net income and total assets change by the same amount the impact of net income in the numerator isgreater because the denominator is an average.2 Advertising is an intangible asset and so doesn’t affect property, plant, and equipment .3 Assume straight-line depreciation and company stops taking depreciation after 10 years.

4

Since building has been completely depreciated equity is understated.5 Overstated because assets are understated because the building has been fully depreciated when there should beanother ten of life remaining and net income is overstated because there is no depreciation expense.




P8-10.a. At first glance, one might believe that Aguanish is the better investment because its net

income is considerably higher. However, upon closer inspection it becomes clear that thedifference between the two companies ’ net incomes is the depreciation expense. Therefore,

based on this information it seems that the companies are equally good investments (of

course other factors specific to each company may play a role, but these need not beconsidered here).

b. Each company may have a different reason for using a different depreciation method.Aguanish ’s management may have been trying to increase bonuses this year and thereforemade a choice that results in a higher net income during earlier periods. Lanigan may have acloser relationship with its shareholders and may have determined it was reasonable to

prepare its financial statements on a tax basis to simplify things. Also, each company mayhave felt that the method they chose for depreciation would best match expenses to revenues.There is no correct method of depreciation. Management has choice and that choice isexpressed in these financial statements.

c. Using different depreciation methods doesn’t matter in the sense that the underlyingeconomic activity isn’t impacted. However, alternate choices may result in differenteconomic outcomes such as different bonuses for managers. The use of different depreciationmethods also limits the comparability of statements from different companies. As there areno requirements that one method be used over another, lack of comparability is one of thelimitations of this choice.




P8-11.2018 2017 2016 2015

R & D expenditures $490 $270 $190 115.0Amortization (3 years) 163.3 90.0 63.3 38.33

Revenues $1,593.90 $995.50 $671.00 187.00Other Expenses 1,217.20 977.80 592.10 271.1R&D

From 2014 36.67 36.67

From 2015 38.33 38.33 38.33From 2016 63.33 63.33 63.33

From 2017 90.00 90.00From 2018 163.33

Total Amortization 316.67 191.67 138.33 75.00

Total expenses 1,533.86 1,169.47 730.43 346.1

a. Income (capitalize R&D) $60.03 $(173.97) $(59.43) (159.1)

Total assets (before) $ 2,777.50 $ 2,471.70 $ 2,321.00 715.0Add R&D capitalized 1,175.00 685.00 415.00 225.00

Less accumulated amortization 758.33 441.67 250.00 111.67

b. Adjusted total assets $3,194.17 $2,715.03 $2,486.00 $828.33

Less liabilities 1,083.20 889.80 812.40 300.30

c. Shareholders’ equity $2,110.97 $1,825.23 $1,673.60 528.03

Cash from operations (before) $137.50 $(198.00) $(90.20)

Add back R&D expenditures 490.00 270.00 190.00

d. Adjusted cash from operations $627.50 $72.00 $99.80

Cash spent on investing (before) $(220.10) $(271.70) $(1,177.00)

plus R&D (490.00) (270.00) (190.00)

Adjusted spent on investing $(710.10) $(541.70) $(1,367.00)

2018 2017 2016

Income as reported -expensed (113.3) (252.3) (111.1)

Equity as reported -expensed 1,694.3 1,581.9 1,508.7




e. 2018 2017 2016

ROA (expense R&D)* -4.32% -10.53% -7.32%

Average assets (expense) $ 2,954.60 $ 2,600.52 $ 1,657.17 Net income (expense) (113.3) (252.3) (111.1)

ROA (capitalize R&D)* 2.03% -6.69% -3.59%

Average assets (capitalize) 2,954.60 2,600.52 1,657.17 Net income (capitalize) $60.03 $(173.97) $(59.43)

*ROA = Net income/average assets

Debt/equity (expense R&D) 0.64 0.56 0.54 0.72 0.82Debt/equity(capitalize R&D) 0.51 0.49 0.49 0.57 0.57

Profit margin(expense R&D) -0.07 -0.25 -0.17 -1.06 -49.00Profit margin(capitalize R&D) 0.04 -0.17 -0.09 -0.85 -35.67

f.At face value, the company appears to be more profitable and less leveraged with the R&D costscapitalized. (That relationship would eventually reverse as the growth in R&D investmentslowed.) Given the uncertainty of future benefits from the R&D, expensing would seemappropriate. If value of R&D can’t be reliably estimated expensing is consistent withconservatism. By requiring the expensing of R&D the predictive value of net income issacrificed as is the usefulness of net income as a measure of management performance. By notcapitalizing research costs what may be a valuable asset in general is ignored and matching isundermined. Expensing also removes any information value of the accounting treatment forresearch because management doesn’t have to assess the future usefulness of the expenditure (ifmanagement had to decide whether to capitalize or not, it would be making a statement about itsassessment of the usefulness of the costs). However, development can be very hard to assess,which would open the door for management having more opportunity to pursue self-interests.The preparers of the financial statements would likely prefer to report higher income in theearlier years and would prefer to show more equity on the balance sheet (higher income mighthelp Mirror raise additional capital).




P8-12.2017 2016 2015 2014

R & D expenditures $3,487,500 $2,712,500 $1,550,000 $581,250depreciation (3 years) 1,162,500 904,167 516,667 193,750

Revenues 8,983,800 5,611,000 3,782,000 1,054,000Other Expenses 4,105,950 3,262,750 2,805,500 2,123,500R&DFrom 2013 129,167 129,167From 2014 193,750 193,750 193,750From 2015 516,667 516,667 516,667From 2016 904,167 904,167From 2017 1,162,500Total amortization 2,583,333 1,614,584 839,583 322,917Total expenses 6,689,283 4,877,334 3,645,083 2,446,417

a. Income (capitalize R&D) 2,294,517 733,666 136,917 1,392,417

Total assets (before) 9,784,375 8,707,125 8,176,250 2,518,750Add R&D capitalized 8,718,750 5,231,250 2,518,750 968,750Less accumulated amortization 5,489,583 2,906,250 1,291,667 452,084

b. Adjusted total assets 13,013,542 11,032,125 9,403,333 3,035,416Less liabilities 4,011,595 3,047,495 2,452,875 730,438

c. Shareholders’ equity 9,001,947 7,984,630 6,950,458

Cash from operations (before) 465,000 (775,000) (232,500)Add back R&D expenditures 3,487,500 2,712,500 1,550,000Adjusted cash from operations 3,952,500 1,937,500 1,317,500

Cash spent on investing (before) (1,395,000) (1,085,000) (5,425,000) plus R&D (3,487,500) (2,712,500) (1,550,000)

d. Adjusted spent on investing (4,882,500) (3,797,500) (6,975,000)

Income as reported -expensed 1,390,350 (364,250) (573,500)Equity as reported -expensed 5,772,780 5,659,630 5,723,375

e. ROA (expense R&D)* 15.04% -4.31% -10.72%Average assets (expense) 9,784,375 8,707,125 8,176,250

Net income (expense) 1,390,350 (364,250) (573,500)ROA (capitalize R&D)* 19.08% 7.18% 2.20%Average assets (capitalize) 12,022,833.50 10,217,729.00 6,219,374.50

Net income (capitalize) 2,294,517 733,666 136,917 *ROA = Net income/average assets

Debt/equity (expense R&D) 0.69 0.54 0.43Debt/equity(capitalize R&D) 0.45 0.38 0.35Profit margin(expense R&D) 0.15 (0.06) (0.15)Profit margin(capitalize R&D) 0.26 0.13 0.04




f.At face value, the company appears to be more profitable and less leveraged with the R&D costscapitalized. (That relationship would eventually reverse as the growth in R&D investmentslowed.) Given the uncertainty of future benefits from the R&D, expensing would seem

appropriate. If value of R&D can’t be reliably estimated expensing is consistent withconservatism. By requiring the expensing of R&D the predictive value of net income issacrificed as is the usefulness of net income as a measure of management performance. By notcapitalizing research costs what may be a valuable asset in general is ignored and matching isundermined. Expensing also removes any information value of the accounting treatment forresearch because management doesn’t have to assess the future usefulness of the expenditure (ifmanagement had to decide whether to capitalize or not, it would be making a statement about itsassessment of the usefulness of the costs). However, development can be very hard to assess,which would open the door for management having more opportunity to pursue self-interests.The preparers of the financial statements would likely prefer to report higher income in theearlier years and would prefer to show more equity on the balance sheet (higher income might

help Florze raise additional capital).




P8-13.Mr. Peribonka,

There are three possible methods which could be used for depreciation in your case: straight line,declining balance, and units of production. Based on the information you have provided, I have

calculated potential scenarios for depreciating the equipment over its useful life (provided inAppendix A below). Using the straight line method, depreciation expense is about $13,333 peryear. To compute declining balance I used a 30% rate which is the rate used for taxes based onthe equipment falling into CCA Class 43. For the tax method I applied the half-year rule, whichis required for tax purposes. This method yields a higher depreciation expense in the earlieryears. Under units of production, based on your sales estimates, depreciation expense is low inthe first year but higher than straight line from 2018-2020 then lower again in the last two years.

Although the depreciation method won’t change the underlying economic activity, the choicesmade will impact equity, assets, and net income as well as any financial ratios which use thesefinancial statement items. Since the primary users are yourself and the bank (I will discuss the

tax authorities below) you may be better off selecting a depreciation method that yields a lowerexpense in the early years; either straight line or units of production. Doing this will help youmeet any bank covenants which may rely on financial ratios and help your business to appearstronger in the earlier years. An additional benefit of using the units of production method is thatit will help to match expenses to the revenues they help generate and provide more usefulinformation on how the business is performing.

You should also be aware that for tax purposes, declining balance must be used at the rate prescribed in the Income Tax Act. Additionally, in 2017 only one half of the depreciationexpense can be claimed for tax purposes. Using this approach simplifies your financial reporting

because you won’t have to adjust the depreciation expense when preparing your tax return.

Should you have any additional questions, please feel free to contact me.

Kind Regards,

Accountant

Appendix A:Straight line


CarryingAmount

DepreciationExpense

Cost (AD) (CA) (DE)

Purchase $80,000 $0 $80,000 $0

2017 80,000 13,333 66,667 13,333

2018 80,000 26,667 53,333 13,3332019 80,000 40,000 40,000 13,333

2020 80,000 53,333 26,667 13,333

2021 80,000 66,667 13,333 13,333

2022 80,000 80,000 0 13,333




Total 80,000


RV - residual valueUL 6 years useful life

Depreciation expense {DE} =

(purchase price {Cost} - residual value{RV})

useful life {UL}

DE= 13,333


Carrying Amount = Cost - AD

Declining balance


Carryingamount

DepreciationExpense

Cost (AD) (CA) (DE)

Purchase $80,000 $0 $80,000 $0

2017 80,000 12,000 68,000 12,000*2018 80,000 32,400 47,600 20,400

2019 80,000 46,680 33,320 14,280

2020 80,000 56,676 23,324 9,9962021 80,000 63,673 16,327 6,997

2022 80,000 68,571 11,429 4,898Total 68,571

*Applies the half year rule for tax purposes


Rate 30%RV $0 residual value

UL 6 useful life

CA = Cost - AD






Units of production

YearEnd


CarryingAmount

DepreciationExpense

% units of production

Cost (AD) (CA) (DE) % UOP

Purchase $80,000 $0 $80,000 $0

2017 80,000 6,061 73,939 6,061 7.58%2018 80,000 20,606 59,394 14,545 18.18%

2019 80,000 44,848 35,152 24,242 30.30%2020 80,000 69,091 10,909 24,242 30.30%

2021 80,000 76,364 3,636 7,273 9.09%

2022 80,000 80,000 0 3,636 4.55%

Total 80,000 100%

Cost 80,000 purchase price + associated costsRV - residual value

UL 6 useful life

DE=(#units in period/#units over life)*(Cost-RV)

DE = (%UOP)*(Cost-RV)


CA = Cost - AD

Production %

2017 25,000 7.58%2018 60,000 18.18%

2019 100,000 30.30%2020 100,000 30.30%

2021 30,000 9.09%2022 15,000 4.55%

Total 330,000 100.00%




P8-14.July 15, 2017

Coaticook’s Management,

The first item of concern is to determine whether a write-down is required. As a publiccorporation you are required to follow IFRS. If a write-down is required it must be recordedimmediately and be recognized in your 2 nd quarter (June 30) financial statements and in thecurrent fiscal year’s annual report.

Under IFRS an asset is impaired if its recoverable amount is less than its carrying amount. Therecoverable amount is the greater of value-in-use and fair value less cost to sell. Managementestimates that the value-in-use is $42 million. The patent will have no residual value at the end ofits life. This is greater than is fair value of $7 million. Since the carrying amount of the patent is$93,750,000 (see chart provided in appendix A of this report) the patent is impaired and a writedown is required (the carrying amount > value-in-use).

For the 2 nd quarter financial statements and the current year’s financial statem ents, the patentmust be recorded on the balance sheet at its new carrying value of $42 million. A write down orloss from asset impairment must be reported in the income statement for $51,750,000 along witha depreciation expense of $6,250,000 to account for the depreciation for the first half of the year

before the impairment was discovered. The yearly depreciation expense has decreased from$12.5 million to $5.6 million, which only half is to be expensed for the remainder of 2012.

Journal entries for the end of JuneDr. Depreciation expense 6,250,000

Cr. Accumulated depreciation 6,250,000To record Depreciation for the first half of 2017

Dr. Loss due to impairment of patient 51,750,000Cr. Accumulated depreciation 51,750,000

To record the write down of the patent

I recommend that the above information be recognized and disclosed on the 2 nd quarter and year-end financial statements. As far as how the market will interpret this information, I wouldspeculate that it won’t be favourable, although the market would have already responded whenthe news of the competing product was announced and investors understood that Coaticook’srevenues and profits would be affected. The effect will be seen as a one-time event, although onethat will have a long-term effect on earnings unless the lost earnings stream can be replaced.Stock prices will take a hit this year with the poorer than expected earnings but they shouldstabilize at a lower price.

If you have any further questions or concerns please contact me at my office.

Campbell Accounting




Straight line


CarryingAmount

DepreciationExpense Cost $125,000,000 purchase price

Dec. 31 Cost (AD) (CA) (DE) RV - residual value

Purchase $125,000,000 $0 $125,000,000 $0 UL 10 years useful life2015 125,000,000 12,500,000 112,500,000 12,500,000 Depreciation expense {DE} =

2016 125,000,000 25,000,000 100,000,000 12,500,000 (purchase price {Cost} - residual value{RV})2017 (1st

half) 125,000,000 31,250,000 93,750,000 6,250,000 useful life {UL}

Total 31,250,000 DE= 12,500,000

New balance Writedown 51,750,0002017 - mid

year 125,000,000 83,000,000 42,000,000 0 New value 42,000,000 CA (mid-2017)2017 (2nd

half) 125,000,000 85,800,000 39,200,000 2,800,000 RV residual value

2018 125,000,000 91,400,000 33,600,000 5,600,000 UL 7.5 remaining useful life

2019 125,000,000 97,000,000 28,000,000 5,600,000 DE= 5,600,000

2020 125,000,000 102,600,000 22,400,000 5,600,000

2021 125,000,000 108,200,000 16,800,000 5,600,000 Tot dep exp 73,250,000

2022 125,000,000 113,800,000 11,200,000 5,600,000 Write down 51,750,000

2023 125,000,000 119,400,000 5,600,000 5,600,000 Cost 125,000,000

2024 125,000,000 125,000,000 0 5,600,000

Total 73,250,000

P8-15.a.The entry that was made in 2014:Dr. Delivery expense (expense +) 36,000

Cr. Cash (asset -) 36,000

The entry that should have been made in 2014:Dr. Truck (asset +) 36,000

Cr. Cash (asset -) 36,000

Mathematical assessment for questions b through d(The Amount recorded in error – The amount that should have been recorded) = Net Effect on

Account (difference because the error was recorded)If it’s negative, the account is understated; if it’s positive, the account is overstated.




Straight line


CarryingAmount

DepreciationExpense

Dec. 31 Cost (AD) (CA) (DE)

Purchase $36,000 $0 $36,000 $0

2014 36,000 6,200 29,800 6,200

2015 36,000 12,400 23,600 6,200

2016 36,000 18,600 17,400 6,200

2017 36,000 24,800 11,200 6,200

Total 24,800

AE= 6,200

Cost 36,000 Sale-2017 6,000

RV 5,000 Carrying Amount 11,200

UL 5 years G/L (5,200)

Truck Expensed

2014 2015 2016 2017

Truck expense (36,000)

Sale of truck 6,000

Net Income (36,000) 0 0 6,000

Total Assets 0 0 0 0

Cash operations (36,000)

Cash investing 6,000

Truck Capitalized & depreciated

Depreciation expense -Truck (6,200) (6,200) (6,200 (6,200)

Sale of truck- loss (5,200)

Net Income (6,200) (6,200) (6,200) (11,400)

Total Assets 29,800 23,600 17,400

cash operations

cash investing (36,000) 6,000

Effect and Error in 2014-2017 understated (-); overstated (+)

2014 2015 2016 2017

Net Income (29,800) 6,200 6,200 17,400

Total Assets (29,800) (23,600) (17,400) -

cash operations (36,000) - - -

cash investing 36,000 - - -




b. Assuming the truck was purchased January 1, 2014 and has a salvage value $5000, theannual depreciation expense would be $6,200. As a result of the error net income wouldhave been understated in 2014 by $29,800 ($36,000 - $6,200). In 2015 and 2016, incomewould be overstated by $6,200, the amount of depreciation that wasn’t expensed becauseof the error. Total assets would be understated by $29,800 in 2014, $23,600 in 2015, and

$17,400 in 2016 as a result of the error.c. Assuming the truck was sold at the end of the year, the expense would be understated by

$6,200, because no depreciation expense would have been recorded, thus overstating netincome by the same amount. The accumulated depreciation at the time of the sale shouldhave been $24,800 (4 x $6,200) and the carrying value would have been $11,200. As aresult, there should have been a loss of $5,200. However, because the truck wasexpensed in 2014, there was no asset recorded on the books so there is a gain on disposalof $6,000. Had the truck been accounted for properly, there would have been a net effecton the income statement of -$11,400 (-$5,200 - $6,200). Instead, there is a gain of$6,000, for a net difference or overstatement of $17,400. Because the truck was sold, the

asset balance will correct itself and there should be no difference at the end of 2017.d. There would be no overall effect on cash flow because of the error (assuming no tax or

other secondary effects). However, there would be classification differences. In 2014,CFO would have been understated by $36,000 (because the truck was expensed) and cashfrom investing activities would have been overstated by $36,000 because the truck shouldhave been classified as an investing cash outflow. There would be no effect on the otheryears because no cash was exchanged in the other years until 2017, when $6,000 wasreceived for the sale of the truck. This should be reported as an investing cash inflowregardless of the error.

e. The error could be very misleading for users. The income statement, balance sheet, andcash flow statement all would have material errors. As a result some stakeholders couldmake bad decisions. For example, as a result of the error a shareholder might have soldhis or her shares because of the seemingly poor performance when in fact actual

performance would have been better. There is virtually no chance that an external user ofthe financial statements would be aware of or be able to detect the error.




P8-16.Mathematical assessment for questions a through c

Net Effect on Account(difference because the error

was recorded)

= The amountrecorded in error

– The amount that shouldhave been recorded

If the difference is negative, the account is understated; if it’s positive, the account is overstated.

The way it was recorded - capitalizing extra work

Declining balance

. . 2017 2018 2019

YearAcc

Dep.CarryingAmount

DepExpense Dep. expense -Lathe (350,000) (280,000) (224,000)

Dec. 31 Cost (AD) (CA) (DE) Net Income (350,000) (280,000) (224,000)

Pur. $1,750,000 $0 $1,750,000 $0 Total Assets 1,400,000 1,120,000 896,000

2017 1,750,000 350,000 1,400,000 350,000 Cash from Operations

2018 1,750,000 630,000 1,120,000 280,000 Cash from Investing (1,750,000)

2019 1,750,000 854,000 896,000 224,000 Total cash Flow (1,750,000) - -

Cost 1,750,000 Total 854,000

Rate 20%

The way it should be recorded - expensing extra work

Declining balance Dep. expense -Lathe (310,000) (248,000) (198,400)

Extra work ( expensed (200,000)

YearAccDep

CarryingAmount

DepExpense Net Income (510,000) (248,000) (198,400)

Dec. 31 Cost (AD) (CA) (DE) Total Assets 1,240,000 992,000 793,600Pur. 1,550,000 0 1,550,000 0 Cash from Operations (200,000)

2017 1,550,000 310,000 1,240,000 310,000 Cash from Investing (1,550,000)

2018 1,550,000 558,000 992,000 248,000 Total cash Flow (1,750,000) - -

2019 1,550,000 756,400 793,600 198,400 Effect and Error in 2010 understated (-); overstated (+)

Cost 1,550,000 Total 756,400 2017 2018 2019

Rate 20% Net Income 160,000 (32,000) (25,600)

Total Assets 160,000 128,000 102,400

Cash from Operations 200,000 - -

Cash from Investing (200,000) - -

Total cash Flow - - -




a. The $200,000 of unnecessary costs shouldn’t be capitalized as part of the cost of thelathe, but should have been expensed when incurred. The cost of removing parts of thelathe line due to improper installation doesn’t provide any future benefit. The work

performed only returned the asset to a condition in which it should have been in the first place, thus the extra work could have been avoided. Therefore, the additional repair work

should be expensed and not capitalized. (The actual reinforcement of the building thatshould have been done in the first place could be capitalized, but not the cost of movingand reinstalling the line. This analysis assumes that the $200,000 in question is the cost ofmoving and reinstalling the line.)

b. In 2017, the net effect of capitalizing and depreciating the $200,000 and theresulting $40,000 increase in depreciation expense is that income was $160,000 greaterthan it would have been (overstated) had the unnecessary costs been expensed. NetIncome was understated in 2018 by $32,000 and 2019 by $25,600.

Because of the recording error assets were overstated by $160,000 in 2017, $128,000 in

2018, and $102,400 in 2019. The overstatement will continue to decreases and eventuallythe asset account will correct itself when the asset is completely depreciated.

c. The effect on the operating cash flows would be an overstatement of cash flow fromoperations in 2017 of $200,000 and an understatement of cash for investing activities of$200,000. There would be no effect on the other years and total cash flow would beunaffected.

d. The error could be very misleading for users. The income statement, balance sheet, andcash flow statement all would have material errors. As a result, some stakeholders couldmake bad decisions. For example, as a result of the error a shareholder might have soldhis or her shares because of the seemingly poor performance when in fact actual

performance would have been better. There is virtually no chance that an external user ofthe financial statements would be aware of or be able to detect the error.




P8-17.[This is a challenging problem. Students have to identify the problem and consideralternative ways that it can be dealt with. Importantly, there is no ―right‖ answer to thequestion. Students can interpret the scenario in different ways and make differentrecommendations. There are limited ways for the calculations to be done so these should be

fairly standard across student answers. What will differ is how students analyze and usethe information and the calculations. Note that the question doesn’t address the issue ofassets held for sale versus held for use, which is beyond the scope of the course.]

To: The president, Judge Ltd.

From: A. Student, Consultant

I have reviewed the information that you have provided and prepared my recommendationsregarding the appropriate accounting for the building that is no longer being used.

The first consideration is the use of the financial statements. A crucial user group is the creditorswho will be watching closely to ensure that the debt-to-equity ratio does not exceed the agreedamount of 1.5:1 at the end of any quarter. Should the covenant be violated, your loans would

become payable in full in 30 days. As far as I can tell, based on the information provided, thecompany would have significant difficulty in making alternative financing arrangements. As the

president of the company, you are expected to consider the interests of shareholders in any case.However, in this particular case, you are a shareholder yourself and you have no doubt a stronginterest in ensuring that the company continues to operate. A violation of the covenants couldresult in a loss of employment and a loss of invested funds. A third user of the financialstatements will be the Judge family who will be using the financial statements to monitor the

performance of the company and as a basis for decisions. Given that the creditors have beensufficiently astute to impose covenants, I assume that they have also insisted that the financialstatements are audited and therefore they must comply with ASPE (or IFRS).

The specific issue at hand is the accounting for the building that has not been used for four years.It is clear that the property is not very marketable in the current business climate as you have

been unable to locate a tenant or buyer for two years. The two questions that arise are whether ornot the property should be sold at the offered price of $2 million. The second question is, if the

property is not sold, should it be written down on the balance sheet to an amount below thecurrent carrying amount?

Based on my calculations, the debt to equity ratio will be 1.29 ($4,500,000/$3,500,000) if it isneither sold nor written down. If the building is sold and the full $2 million is used for operationsand no amount is used to pay back debt then the debt to equity will be 2.11 (see table below),which is above the maximum allowed. A write down to fair value (which I assume will be $2million) would also result in a debt to equity ratio of 2.11. If the land and building are sold for $2million and the proceeds used to reduce debt then the debt to equity ratio would be 1.17. A finaloption is to pay back $1.5 million in debt and use $500,000 for operations thus resulting in aratio of 1.41. This last option seems most appropriate and stays within the debt covenant and

provides the company with needed cash. This discussion assumes that the creditors would be




open to receiving partial payment of the long-term debt. In fact the loan agreement might notallow that. There does not seem to be any indication that a more favourable price could beobtained by delaying the sale of the property. The consequences of the sale on the incomestatement would be a loss of $920,000.

Should the offer be rejected, a decision remains regarding the reporting of the land and buildingon the balance sheet. It is clear that the value has been impaired, and ASPE will require that theimpairment be recognized in the current year. An auditor would likely insist that the propertyshould not be reported above the offer that has been received. The effect of a write-down even to$2,000,000 would reduce equity whereby the debt-to-equity covenant would be violated and theloans immediately repayable. However, I have to wonder why the write-down was not required

before. Perhaps there is some belief that the net recoverable amount is greater than the carryingamount. I should also note that the $2,000,000 offered is not necessarily an indicator of the realestate’s market value. The bidder may have made a low offer in the hopes of getting a good dealon the land. It is possible that the net recoverable amount is higher than $2,000,000. A writedown of less than $500,000 would be required to keep the debt-to-equity covenant below the 1.5

threshold.Based on my analysis, I recommend that the offer be accepted, and the debt be reduced by $1.5million. There is very little chance that the reporting of a loss can be avoided and the disposal ofthe property is the best advice I have. Before actions, however, I suggest that you obtain theadvice of a taxation adviser, as there may be taxation consequences of the alternatives I have

presented. The owners might also consider contributing additional equity to the company, whichwould give the firm more time to locate a more favourable offer.




30-Jun-17 R/E 1,450,000

Sell Land &

30-Jun-17 Sell Land or Sell Land & pay part of Maximum

Current Write down Pay Loan Loan Back Write down

Land - Carrying Amount $3,370,000

Offer 2,000,000

Loss or write down 1,370,000 500,000

Pay loan amount 2,000,000 1,500,000

Total Assets 8,000,000 6,630,000 4,630,000 5,130,000 7,500,000

Current liabilities $1,150,000 $1,150,000 $1,150,000 $1,150,000 $1,150,000

Long- term debt 3,350,000 3,350,000 1,350,000 1,850,000 3,350,000

4,500,000 4,500,000 2,500,000 3,000,000 4,500,000

Commons shares 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000

Retained earnings 1,900,000 530,000 530,000 530,000 1,400,000

Owner's Equity 3,500,000 2,130,000 2,130,000 2,130,000 3,000,000

Total L&OE 8,000,000 6,630,000 4,630,000 5,130,000 7,500,000

Net Income 450,000 (920,000) (920,000) (920,000) (50,000)

Debt to Equity = 1.29 2.11 1.17 1.41 1.50




P8-18.[This is another good thinking problem. The components are quite straight forward — theissue is how the purchase price should be allocated among a bundle of items — but thechallenge for students is to consider how to do it. This is a very practical problem and thetopic was covered in the text. The problem is that because a bundle of items was purchased,

the actual price of each item in the bundle isn’t known. An independent expert has onlyprovided ran ges of values so it’s safe to assume that exact values can’t be determined. Toanswer, students must consider the objectives of the managers and the facts and anyconstraints. Different approaches are possible and acceptable. What is most important isfor students to provide a cogent explanation for the choice that is made. The solution belowis an example rather than the model solution.]

To: The controller, Quabbin Corp.From: A. Student, Consultant

I have reviewed your information and have prepared my report on the appropriate accounting

treatment for the recent purchase of assets.The first consideration is the purpose for which the financial statements will be used. The two

primary groups of users of the financial statements are the silent investors and the bank. I amassuming that the five investors each own an equal share of the firm. Therefore, the silentinvestors own 60 percent and collectively reflect the controlling interest of the company. Therewill therefore be a stewardship role for the financial statements. Secondly, the company will beapplying for an increase in the line of credit, and the financial statements will provideinformation for that lending decision. The company is large enough that the bank is likely toexpect audited financial statements and the financial statements must comply with ASPE. Theneed for additional financing suggests that minimizing taxes would make sense to conserve cash.The silent shareholders can be communicated with separately to explain any accounting issuesthat might be of concern. It would seem that the bank is a key stakeholder that must be satisfied,however, so I recommend a strategy that will report higher assets and income. That said, the

bank would likely want these new assets as collateral against t he loan so the bank’s risk ismitigated, depending on the amount of additional borrowing that is required.

The issue at hand is the allocation of the total cost of a bundle of assets among the specificassets. The appraiser has provided ranges of values for the assets. The more of the cost that isallocated to land, the higher income will be currently and over time because there is less todepreciate (land is non-depreciable) and the greater the balance sheet value of total assets infuture years. Similarl y, the least amount should be allocated to the equipment because it’samortized over the shortest period of time. Assuming that Canada Revenue Agency will acceptthe full range of choices being discussed, the firm will also pay more income tax during the yearsthat the land is owned if more is allocated to the land (CCA can’t be claimed on land). This is anundesirable by-product of my strategy.

The appraisals suggest a range of $350,000 between the highest and lowest values for the land,$700,000 range for the building, and $500,000 range for the equipment. For the most favourable

presentation to the bank, land should be allocated $1,300,000, building $2,400,000, and




equipment $1,500,000. I note that if you choose to minimize taxable income, a smaller amountwould be allocated to land ($950,000), the most to the equipment ($2,000,000), and theremainder to the buildings ($2,250,000). For your information these different strategies willresult in a difference in taxable income of $72,000 for the current year (taking into account thehalf year rule). At a tax rate of 20%, this would mean that the former strategy would result in

$14,400 in extra tax that would have to be paid this year.The journal entry for the high income/high asset strategy would be:

Dr. Land 1,300,000Dr. Building 2,400,000Dr. Equipment 1,500,000

Cr. Cash 5,200,000

Mathematical support for income tax calculation with half year rule:

High Assets ValueAssigned Rate

Dep.expense

Land $1,300,000 N/A Building 2,400,000 4% $48,000 Equipment 1,500,000 30% 225,000

5,200,000 273,000

Low Assets Land $950,000 N/A

Building 2,250,000 4% $45,000 Equipment 2,000,000 30% 300,000

5,200,000 345,000

Difference 72,000 Tax rate 20% Additional Taxes 14,400




P8-19.a.Dr. Mining properties (asset +) 25,000,000Dr. Equipment (asset +) 18,000,000Dr. Buildings (asset +) 5,000,000

Cr. Cash (asset -) 48,000,000To record the purchase of equipment and buildings and the exploration and development costs.

b.Mining Properties - Straight line Mining Properties - Declining balance

. . . .

Year30-Jun Cost

Acc Dep.(AD)

CarryingAmount

(CA)

DepExpense

(DE)YE

30-Jun CostAcc Dep.

(AD)

CarryingAmount

(CA)Dep Expens

(DE)

Purchase $25,000,000 $0 $25,000,000 $0 Purchase $25,000,000 $0 $25,000,000 $

2018 25,000,000 2,500,000 22,500,000 2,500,000 2018 25,000,000 5,000,000 20,000,000 5,000,000

2019 25,000,000 5,000,000 20,000,000 2,500,000 2019 25,000,000 9,000,000 16,000,000 4,000,000

2020 25,000,000 7,500,000 17,500,000 2,500,000 2020 25,000,000 12,200,000 12,800,000 3,200,000

2021 25,000,000 10,000,000 15,000,000 2,500,000 2021 25,000,000 14,760,000 10,240,000 2,560,000

2022 25,000,000 12,500,000 12,500,000 2,500,000 2022 25,000,000 16,808,000 8,192,000 2,048,000

2023 25,000,000 15,000,000 10,000,000 2,500,000 2023 25,000,000 18,446,400 6,553,600 1,638,400

2024 25,000,000 17,500,000 7,500,000 2,500,000 2024 25,000,000 19,757,120 5,242,880 1,310,720

2025 25,000,000 20,000,000 5,000,000 2,500,000 2025 25,000,000 20,805,696 4,194,304 1,048,576

2026 25,000,000 22,500,000 2,500,000 2,500,000 2026 25,000,000 21,644,557 3,355,443 838,861

2027 25,000,000 25,000,000 0 2,500,000 2027 25,000,000 25,000,000 0 3,35544

Cost $25,000,000 Total 25,000,000 Cost $25,000,000 Total 25,000

RV - Rate 20%

UL 10 years DE= 2,500,000 RV -

UL 10 years




Mining Properties - Units of production

Acc.Dep.(AD)

CarryingAmount

(CA)

Dep.Expense

(DE)


% UOP

units of production

#of Units Year

30-Jun Cost

Purchase $25,000,000 $0 $25,000,000 $0

2018 25,000,000 403,226 24,596,774 403,226 1.6% 5,000

2019 25,000,000 2,419,355 22,580,645 2,016,129 8.1% 25,000

2020 25,000,000 5,645,161 19,354,839 3,225,806 12.9% 40,000

2021 25,000,000 8,870,968 16,129,032 3,225,806 12.9% 40,000

2022 25,000,000 12,096,774 12,903,226 3,225,806 12.9% 40,000

2023 25,000,000 15,322,581 9,677,419 3,225,806 12.9% 40,000

2024 25,000,000 18,548,387 6,451,613 3,225,806 12.9% 40,000

2025 25,000,000 21,774,194 3,225,806 3,225,806 12.9% 40,000

2026 25,000,000 24,193,548 806,452 2,419,355 9.7% 30,000

2027 25,000,000 25,000,000 - 806,452 3.2% 10,000

# of Units over life 310,000 Total 25,000,000 100% 310,000

Cost $25,000,000

RV -

UL 10 years

Equipment - Straight line Equipment - Declining balance

Acc. Carrying Dep. Acc. Carrying Dep.

Year Dep. Amount Expense YE Dep. Amount Expense

30-Jun Cost (AD) (CA) (DE) 30-Jun Cost (AD) (CA) (DE)Purchase

$18,000,000 $0

$18,000,000 $0

Purchase

$18,000,000 $0

$18,000,000 $0

2018 18,000,000 1,450,000 16,550,000 1,450,000 2018 18,000,000 3,600,000 14,400,000 3,600,000

2019 18,000,000 2,900,000 15,100,000 1,450,000 2019 18,000,000 6,480,000 11,520,000 2,880,000

2020 18,000,000 4,350,000 13,650,000 1,450,000 2020 18,000,000 8,784,000 9,216,000 2,304,000

2021 18,000,000 5,800,000 12,200,000 1,450,000 2021 18,000,000 10,627,200 7,372,800 1,843,200

2022 18,000,000 7,250,000 10,750,000 1,450,000 2022 18,000,000 12,101,760 5,898,240 1,474,560

2023 18,000,000 8,700,000 9,300,000 1,450,000 2023 18,000,000 13,281,408 4,718,592 1,179,648

2024 18,000,000 10,150,000 7,850,000 1,450,000 2024 18,000,000 14,225,126 3,774,874 943,718

2025 18,000,000 11,600,000 6,400,000 1,450,000 2025 18,000,000 14,500,000 3,500,000 274,874

2026 18,000,000 13,050,000 4,950,000 1,450,000 2026 18,000,000 14,500,000 3,500,000 0

2027 18,000,000 14,500,000 3,500,000 1,450,000 2027 18,000,000 14,500,000 3,500,000 0

Cost$18,000,00

0 Total14,500,00

0 Cost $18,000,000 Total 14,500,000

RV $3,500,000 Rate 20%

UL 10 years DE= 1,450,000 RV $3,500,000

UL 10 years




Equipment - Units of production

Acc.Dep.(AD)

CarryingAmount

(CA)

Dep.Expense

(DE)


% UOP

units of production

#of Units Year

30-Jun Cost

Purchase $18,000,000 $0 $18,000,000 $0

2018 18,000,000 233,871 17,766,129 233,871 1.6% 5,000

2019 18,000,000 1,403,226 16,596,774 1,169,355 8.1% 25,000

2020 18,000,000 3,274,194 14,725,806 1,870,968 12.9% 40,000

2021 18,000,000 5,145,161 12,854,839 1,870,968 12.9% 40,000

2022 18,000,000 7,016,129 10,983,871 1,870,968 12.9% 40,000

2023 18,000,000 8,887,097 9,112,903 1,870,968 12.9% 40,000

2024 18,000,000 10,758,065 7,241,935 1,870,968 12.9% 40,000

2025 18,000,000 12,629,032 5,307,968 1,870,968 12.9% 40,000

2026 18,000,000 14,032,258 3,967,742 1,403,226 9.7% 30,000

2027 18,000,000 14,500,000 3,500,000 467,742 3.2% 10,000


Cost $18,000,000

RV $3,500,000

UL 10 years

Building - Straight line Building - Declining balance

Year

30-Jun Cost

Acc.Dep.

(AD)

CarryingAmount

(CA)

Dep.Expense

(DE)

Acc.Dep.

(AD)

CarryingAmount

(CA)

Dep.Expense

(DE)

YE

30-Jun CostPurchase $5,000,000 $0 $5,000,000 $0 Purchase $5,000,000 $0 $5,000,000 $0

2018 5,000,000 500,000 4,500,000 500,000 2018 5,000,000 1,000,000 4,000,000 1,000,000

2019 5,000,000 1,000,000 4,000,000 500,000 2019 5,000,000 1,800,000 3,200,000 800,000

2020 5,000,000 1,500,000 3,500,000 500,000 2020 5,000,000 2,440,000 2,560,000 640,000

2021 5,000,000 2,000,000 3,000,000 500,000 2021 5,000,000 2,952,000 2,048,000 512,000

2022 5,000,000 2,500,000 2,500,000 500,000 2022 5,000,000 3,361,600 1,638,400 409,600

2023 5,000,000 3,000,000 2,000,000 500,000 2023 5,000,000 3,689,280 1,310,720 327,680

2024 5,000,000 3,500,000 1,500,000 500,000 2024 5,000,000 3,951,424 1,048,576 262,144

2025 5,000,000 4,000,000 1,000,000 500,000 2025 5,000,000 4,161,139 838,861 209,715

2026 5,000,000 4,500,000 500,000 500,000 2026 5,000,000 4,328,911 671,089 167,7722027 5,000,000 5,000,000 - 500,000 2027 5,000,000 5,000,000 - 671,089

Cost 5,000,000 Total 5,000,000 Cost 5,000,000 Total 5,000,000

RV - Rate 20%

UL 10 DE= 500,000 RV -

UL 10




Building - Units of production

Year30-Jun Cost

Acc.Dep.(AD)

CarryingAmount

(CA)

Dep.Expense

(DE)


% UOP

units of production

#of Units

Purchase $5,000,000 $0 $5,000,000 $0

2018 5,000,000 80,645 4,919,355 80,645 1.6% 5,000

2019 5,000,000 483,871 4,516,129 403,226 8.1% 25,000

2020 5,000,000 1,129,032 3,870,968 645,161 12.9% 40,000

2021 5,000,000 1,774,194 3,225,806 645,161 12.9% 40,000

2022 5,000,000 2,419,355 2,580,645 645,161 12.9% 40,000

2023 5,000,000 3,064,516 1,935,484 645,161 12.9% 40,000

2024 5,000,000 3,709,677 1,290,323 645,161 12.9% 40,000

2025 5,000,000 4,354,839 645,161 645,161 12.9% 40,000

2026 5,000,000 4,838,710 161,290 483,871 9.7% 30,000

2027 5,000,000 5,000,000 0 161,290 3.2% 10,000


Cost 5,000,000

RV -

UL 10

Note that for declining balance adjustments would have to be made to the amount of expense in2026 for the end of life of the asset.

c.The units-of-production method makes most sense for this company. It matches cost to revenuesin a sensible manner when output varies, and the income of the mine each year would be areasonable representation of the profitability of the company. Units-of-production fits becausethere is a reasonable estimate of output. Declining balance would result in huge losses in theearly years and large profits later, although if maintenance costs increase as the assets age,declining balance may result in smoother income (this would likely only be the case for theequipment). The straight-line method would show losses in the first two years and last two andhigher profits in years 2020 to 2025. It would be difficult to understand the rationale for straight-line in this situation. What makes the units-of-production method preferable in this situation isthat the amount of palladium in the ground can be reasonably estimated. The same depreciationmethod wouldn’t have to be used for each type of capital asset. Units -of-production is well suitedfor the mining properties because it’s good matching of the cost to find and extract the palladiumto revenue it helps earn. Declining balance or straight line might be more suitable for theequipment. The equipment has value at the end of the life of the mine and quite possibly will bemoved and used at new mining location in the future, thus all revenue earned at that mine maynot be the best matching of expenses to revenue. The building could be amortized straight line(gets used up with time) or units of production (the building is only good for the life of themine). A good argument could be made for both cases.




d.If the mine is shut down due to low selling prices and the eventual reopening is highly certain, itwould be logi cal to suspend depreciation until production resumes. However, it’s necessary toconsider the reason for depreciation before coming to a conclusion. The units of productionmethod is tied to actual production so when production ceases so should depreciation. The other

two methods are tied to the passage of time. The question is whether the consumption of theassets stops when production stops. For some assets, it does and for others it doesn’t. In normalcircumstances, the building would continue to be used up even if the mine was closed. However,in this case the building actually has a longer life than the ten-year life of the mine so the issue ismore complex. The equipment may continue to weather even if it isn’t being used during a mineclosure. Conceptually, it makes sense to continue depreciating assets when time-based methods(straight line, declining balance) are being used. In any event, all users of the financial statementsare likely to be aware of the shutdown and wouldn’t interpret the financia l statements differentlyif the depreciation was continued. The more likely consequence of continuing depreciation is onthe years following the resumption of production, when the depreciation would be lower than ifdepreciation had not been continued during the shutdown.

e.If the mine was shut permanently, the remaining account balances would have to be written off.The building and mining properties wouldn’t likely be saleable so they would be written down tozero. The equipment would generate proceeds that would be recognized in the financialstatements.

Dr. Cash (Proceeds)Dr. Accumulated Depreciation – Mining PropertiesDr. Accumulated Depreciation - EquipmentDr. Accumulated Depreciation – BuildingsDr. Loss on disposal of mining assets

Cr. Mining properties 25,000,000Cr. Equipment 18,000,000Cr. Buildings 5,000,000

The entry above assumes that the net proceeds of disposing of the capital assets will be less thantheir net book values.




P8-20.

a.i Product Development – Capitalized ii Product Development - Expensed

Net income before development costs $242,500 Net income before development costs $242,500

Development costs 0 Development costs -205,000

Net income $242,500 Net income $37,500

Barkway Inc. Barkway Inc.Cash Flow Statement Cash Flow Statement

For the Year Ended August 31, 2018 For the Year Ended August 31, 2018

Cash from operations Cash from operations

Net income $242,500 Net income $37,500

Add: Depreciation 92,500 Add: Depreciation 92,500

Add: Net decrease in non-cash working capital 52,500 Add: Net decrease in non-cash working capital 52,500

Add: Loss on sale of capital assets 87,500 Add: Loss on sale of capital assets 87,500

Cash from operations 475,000 Cash from operations 270,000

Investing activities Investing activities

Proceeds from the sale of capital assets 122,500 Proceeds from the sale of capital assets 122,500

Purchase of capital assets (245,000) Purchase of capital assets (245,000)

Cost of Product development (205,000) Cost of Product development -

Cash from (used for) investing activities (327,500) Cash from (used for) investing activities (122,500)

Financing activities Financing activities

Increase in long-term debt 187,500 Increase in long-term debt 187,500

Repayment of mortgage loan (62,500) Repayment of mortgage loan (62,500)

Dividends (25,000) Dividends (25,000)

Cash from (used for) financing activities 100,000 Cash from (used for) financing activities 100,000

Change in cash during 2018 247,500 Change in cash during 2018 247,500

Cash and equivalents, beginning of the year 55,000 Cash and equivalents, beginning of the year 55,000

Cash and equivalents, end of the year $302,500 Cash and equivalents, end of the year $302,500

b.The perception one obtains from the statements of cash flows, if the costs are expensed, is thatthe company is able to generate less cash from operating activities than if the costs arecapitalized. This makes the company appear to be more risky since cash from operations is an

important indicator of liquidity. The effect may be especially significant in this case because,when the costs are expensed, cash from operations is significantly lower than if they werecapitalized.

c.In 2018, capitalizing th e costs increases the total assets, net income and shareholders’ equity. Forfuture years, if no more product development cost are incurred, net income will be higher if the

product development costs were expensed in 2018 because depreciation is required if the product




costs are capitalized. Once product development costs are completely depreciated value of theasset accounts will be the same under both approaches.

d.Assuming this is the first year when product development costs are eligible for capitalization, the

managers would likely prefer to capitalize the costs as doing so would make income higher andtherefore result in a larger bonus. Over the life of the entity, the same amount of production costswill be expensed so the overall effect on net income will be the same. The managers ’ wouldlikely prefer to get their bonuses sooner rather than later.

P8-21.a. i.

Okotoks Ltd. Okotoks Ltd.Cash Flow Statement Cash Flow Statement

For the Year Ended April 30, 2017(Costs capitalized)

For the Year Ended April 30, 2017(Costs expenses)

Cash from operations Cash from operations

Net loss ($42,500) Net loss ($117,500)

Add: Depreciation 167,500 Add: Depreciation 137,500

Less: Gain on sale of capital assets 47,500 Less: Gain on sale of capital assets 47,500

Less: Net increase in non-cash working capital 56,000 Less: Net increase in non-cash working capital 56,000

Cash from operations 21,500 Cash from operations (83,500)

Investing activities Investing activities

Proceeds from the sale of capital assets 155,000 Proceeds from the sale of capital assets 155,000

Purchase of capital assets (662,500) Purchase of capital assets (662,500)

Costs of Betterment (105,000) Costs of Betterment -

Cash from (used for) investing activities (612,500) Cash from (used for) investing activities (507,500)

Financing activities Financing activities

Increase in long-term debt 500,000 Increase in long-term debt 500,000

Repayment of long-term loan (375,000) Repayment of long-term loan (375,000)

Sale of common stock 525,000 Sale of common stock 525,000

Cash from (used for) financing activities 650,000 Cash from (used for) financing activities 650,000

Change in cash during 2017 59,000 Change in cash during 2017 59,000

Cash and equivalents, beginning of the year 49,000 Cash and equivalents, beginning of the year 49,000

Cash and equivalents, end of the year $108,000 Cash and equivalents, end of the year $108,000

b.The perception one obtains from the statements of cash flows if the costs are expensed is that theability of the company to generate cash from operating activities is less than if the costs arecapitalized. That makes the company appear to be more risky since cash from operations is animportant indicator of liquidity. The effect may be especially significant in this case because,when the costs are expen sed, cash from operations is negative whereas it’s positive if they aretreated as betterments.




c.Capitalizing the costs as betterments increases the total assets and shareholders’ equity andincreases income in the years when additional expenditures on betterments exceeds thedepreciation of betterments and decreases income in other years. In 2018, when the costs are

treated as betterments, capital assets, total assets, shareholders’ equity, and net income are higherthan if the costs were treated as repairs and expensed. Once the betterment costs are fullyamortized all will be the same.

d.When legitimate alternatives exist managers will consider their objectives of financial reportingwhen making accounting choices. In the year the expenditures occur income will be higher if thecosts are capitalized. This will serve a short-term objective of income maximization, attractive ifsenior management has an income-based bonus plan, managers are trying to impress externalstakeholders, or if the selling price of the business is based on net income in 2017.

P8-22.a.Disposals

Proceeds Gain(Loss) CarryingAmount

Building $780,000 ($110,000) $890,000 Land 225,000 75,000 150,000 Equipment 100,000 32,000 68,000

Total $1,108,000

b.Purchases Price

Building/Land $487,000 Equipment 315,000

$802,000

Opening: Dec 31, 2017 PPE $4,750,000 Less: Depreciation 310,000 Less: Carrying Amount of Disposals (part a) 1,108,000 Plus: Purchases 802,000 Closing: Dec 31, 2018 PPE $4,134,000




P8-23.a.The following response assumes that the change will have no effect on income tax expense.

2017Reported net income (169,000,000)Adjustment (add) 175,000,000

Net income before adjustment 6,000,000

2018 2019 2020Revised forecasts 11,000,000 35,000,000 71,000,000Less: Adjustment for depreciation 16,500,000 16,500,000 16,500,000Previous forecasts (5,500,000) 18,500,000 54,500,000

b.There are a number of explanations. The first is that the assets are actually impaired. That is, asmanagement explains, because of the competitive environment and poor performance, theseassets are overvalued at cost. In this situation, a write down is appropriate because the future

benefits associated with the assets are less than the carrying amount. Another possibility isearnings management. Operating income is negative in 2017 and management may feel thatgiven the loss it might take a big bath now and enjoy higher income in the future. The questionsays that the CEO is new so the bath gives her a better chance of improving future earnings byeliminating some expenses. The new CEO can point to the old management to ―blame‖ for the

problems. Also, if management receives a bonus on profits in excess of some target amount andwouldn’t have received a bonus in 2017 in any event, by writing down the assets future profitswill be higher and larger bonuses may be obtained.

c.Write-downs can be a tricky business for people analyzing financial statements. They tend todistort the historical trends that exist in the numbers and make it difficult to interpret. InMildmay’s case the write-down was classified as non-recurring, which should be interpreted tomean that it won’t occur with any regularity in the future. However, the write-down does have animpact on future earnings that may not be clear to some stakeholders because future earningswill be higher than if the write-down had not occurred. In addition, the effect of the write-downwill be felt for eight years, yet comparative information is typically provided for two years. Thatmeans that in the third year from the write-down there will be no information about thewritedown in the financial statements. Also, investors who base their projection of futureearnings on the current year’s may understate their estimates and be positively surprised aboutfuture income if they don’t take into consideration the effect of the write -down.




P8-24.

(This is a very challenging question. It requires students to think carefully about the entity beingreported on and the impact of non- arm’s length transactions on financial reporting. The questionalso has broader business applications. That is, students have to think about what the business

being purchased represents before focussing on the financial statements. In this case there maybe very little to the business that the client is considering buying.)

Dear Wolfgang:

Thank you for the opportunity to advise you on your prospective purchase of Wanda’s Fashions.There are a number of challenges in assessing the attractiveness of purchasing this business.

Before considering any financial information that might be provided, I first want to address the

business itself. The information you provided indicates that Wanda has been in business formany years and has many loyal customers. A key question is if you buy the business what is itthat you are buying? The tangible assets you will acquire include inventory, and some capitalassets (sewing machines, mannequins, pressing equipment, furniture and fixtures, and signage).It would seem that these would have a relatively modest value and if you chose to start up a

business you could acquire these easily on your own, probably at relatively low cost. What trulycreates the value for Wanda’s business is Wanda herself and her loyal customers. The keyquestion is will Wanda’s customers come to you in large numbers for their tailoring needs? Thecustomer list is a valuable asset, but if the customers are loyal to Wanda as opposed to thelocation of the business, you may lose many customers. Indeed, the customers may simplycontinue to go to Wanda for their tailoring needs. As part of the contract to purchase Wanda’sFashions, will Wanda be prohibited from returning to the tailoring business? If not, many of thecustomers on her list may simply stay with her in a new location. In that case, you will have paidmoney for nothing. (Note that there are legal issues associated with non-competition clauses incontracts. You should consult a lawyer with respect to this matter.) Also, will you be able to

provide the services that Wanda provides her customers? Wanda carries a line of clothing thatshe designs herself. If many customers are attracted to her designs, will you be able to satisfytheir fashion needs? The standard tailoring and alterations services should be no problem to

provide but except for the location of Wanda’s store, is it necessary to buy a business to providethose service s? In addition, one of Wanda’s customers is her brother’s business. Can you expectto get this business? Will the terms of the arrangement with Wendel be the same as with Wanda?If not, a significant chunk of business may be lost or renegotiation may make it less profitable.

The financial performance of Wanda’s Fashions is included in the financial statements of a groupof businesses operated by Wanda and her husband. From a financial standpoint, the financialstatements that Wanda can provide will be very difficult to interpret. This is because of theextensive inter-relationships among these various businesses and the existence of many non-arm’s length transactions (transactions between relatives that cannot be assumed to take place atmarket value). It is very important that you segregate the revenues and costs associated with the




business activities that you are interested in acquiring and determine the impact of these non-arm’s length activities on the statements.

Among the concerns, you should discuss with Wanda are:a. How much revenue did Wanda’s Fashions itself earn in each of the last few years. The

financial statements will contain revenues for many other activities that Wanda and herhusband are involved in. You must ensure that you have the revenue s of Wanda’s Fashionsalone.

b. Expenses; More challenging will be segregating the expenses of Wanda’s Fashions. Whilesome expenses will be easily associated with the business, others will not For example,utilities costs may be difficult to attribute to Wan da’s Fashions alone.

c. The value of free labour provided by Wanda’s children will have to be determined. You willnot have Wanda’s children to work for no money. You will have to pay employees to theextent necessary. As a result, the statements for Wanda’s Fashions will understate the actualcost of labour. I assume that the university tuition and the cost of the car were not deductedas expenses of the businesses; if they were, this has to be clarified. The statements will also

not include a charge for Wand a herself (because Wanda’s Fashions is an unincorporated business, wages paid to the proprietor do not appear in the statements).d. Wanda’s Fashions does not pay rent. Again because Wanda’s Fashions is one of a group of

unincorporated businesses, paying rent to another business in the group is not meaningful. Asa result, the financial statements will not reflect occupancy costs. You will have to find outfrom Wanda how much rent you will have to pay for the space the business will occupy. Todetermine whether this amount is reasonable, you should ask other tenants in the buildingand other businesses in the area how much rent they pay. I assume you will not be buying the

building itself.e. What is the fair value of the assets in Wanda’s Fashions? It will be us eful to know the value

of the tangible assets you will be obtaining. In particular, is the entire inventory in stockusable? Are some of the fabrics out of style or damaged? You should only purchase theinventory that you believe will be appropriate for the business you will operate.

f. Financial statements prepared for tax purposes may not provide a good indication of the performance of a business. For tax purposes, the main goal is to reduce taxes, which meansthat revenues may be deferred and expenses advanced to the extent allowable by the IncomeTax Act.

In sum, opening your own business can be exciting and challenging. Acquiring an existing business can make starting out in business easier. However, I encourage you to proceed verycarefully. As I discus sed, it at all clear what you will be getting if you buy Wanda’s Fashions.The financial statements will be very difficult to interpret as discussed above. As well, there mayin fact be very little to Wanda’s Fashions itself. It may make more sense for you to simply startup a tailoring business on your own and tough it out.

Please contact me if you need further advice.




USING FINANCIAL STATEMENTS

TELUS

FS8-1.a. What amount of property, plant, and equipment does TELUS report on its December 31,

2011 balance sheet: $7,964,000,000 b. What amount of goodwill does TELUS report on its December 31, 2011 balance sheet:

$3,661,000c. What amount of property, plant and equipment was disposed of or retired during fiscal

2011: $264,000,000What amount of accumulated depreciation was associated with the property, plant, andequipment that was disposed of or retired? $253,000,000

d. What amount did TELUS expense for depreciation and amortization during 2011:$1,331,000,000 + $479,000,000 = $1,810,000,000

e. What is the cost of TELUS ’ netw ork assets on December 31, 2011: $23,766,000,000What is carrying amount (net book value) of TELUS ’ netw ork assets on December 31,2011: $6,338,000,000What is the amount of accumulated depreciation associ ated with TELUS’ netwo rk assets:$17,428,000,000

f. Over what period is TELUS depreciating its wireless site equipment: 6.5 to 8 yearsg. How much cash did TELUS spend on the purchase of capital assets in 2011:

$1,847,000,000h. How much was TELUS ’ amortizati on expense for software in 2011: $431,000,000

FS8-2.TELUS ’ net income for 2011 was $1,21 5,000,000. Its CFO was $2,550,000,000. The large

difference is caused by non-cash items such as depreciation and amortization and deferredincome taxes that are deducted in the calculation of net income, but have no effect on cash fromoperations. These were offset by the employer contribution to employee defined benefit plansand the net change in non-cash operating working capital (these were the largest ones).

It seems that TELUS had a good year. It was able to increase net income over 2010 levels,although cash from operations was lower. From this information the liquidity position seems ok.CFO is positive and adequate to cover capital expenditures and dividends (though just barely).The amount of cash on hand increased over the year.

FS8-3.The carrying amount of property, plant, and equipment TELUS reports on its December 31, 2011

balance sheet is $7,964,000,000 . The balance sheet represents a snapshot of TELUS’ assets andliabilities on the date of December 31, 2011 this value represents the net value PP&E taking intoaccount what was paid for the asset less any impairment (loss in value) and depreciation (usage).TELUS’ net PP&E makes up approximately 40% of TELUS’ total a sset base. This high

proportion makes sense given TELUS’ business as the company drives revenues from PP&Eintensive telephone and communication services. This means TELUS must make largeinvestments in PP&E to provide its service to customers. The net realizable value of PP&E isunknown since these assets are recorded at historical cost.




FS8-4.TELUS is contractually committed to purchase $188,000,000 of PP&E through 2013. These

purchase commitments are not reflected on the balance sheet, but are disclosed in the notes to thefinancial statements. IFRS doesn’t allow reporting these purchase commitments (executor

contracts) as liabilities on the balance sheet because the business transaction (i.e. purchase) hasyet to occur (what asset would be reported — does the asset meet the definition of an asset?). Onthe other hand a case can be made that the amount owing, if the arrangements can’t be cancelled,should be reported as a liability since it represents an amount the entity will have to pay.Disclosure is appropriate because the future cash outlay is needed which is of relevance andinterest to readers of the financial statements.

FS8-5.The value of TELUS’ fully depreciated PP&E is $3,000,000 ,000 with a carrying value of $0, onDecember 31 2011. It is possible for TELUS to be using assets that are fully depreciated the

period of which an asset is depreciated is an estimate. As a result assets may last longer than

their estimated useful lives.

FS8-6.Goodwill is an intangible asset where the value assigned is the amount paid for an acquisition ofanother entity that is over and above the fair value of the entity’s identifiable net assets.Goodwill only arises when TELUS purchases an entity for a price higher than the fair value ofthe entity’s identifiable net assets. TELUS reported goodwill of $3,661,000,000 on December 312011. Goodwill isn’t amortized but must be assessed for impairment which compares therecoverable amount to the cash generating units to the carrying amount of its cash generatingunit. TELUS added $110,000,000 of goodwill in 2011. It is very possible and likely that TELUShas developed and created valuable business intangibles like strategic synergies, competitiveadvantages, customer loyalty, brand recognition and other items that are highly valuable, but notreported on the balance sheet. Because this goodwill is internally generated and not throughacquisitions it can’t be reported on the balance sheet .

FS8-7.Intangible assets are separate identifiable assets that are non-physical, mean ing they can’t beseen or touched. TELUS reported $6,153,000,000 in intangible assets on its December 31, 2011

balance sheet. TELUS categorizes its intangible assets into two categories: intangible assetssubject to amortization and intangible assets with an indefinite life. The largest single intangibleasset is the spectrum licences with a carrying amount of $4,867,000,000. The intangible assetswith an estimated useful life are amortized using the straight-line method over the estimated

useful life. The intangible assets with indefinite lives aren’t amortized because it isn’t possible todetermine if or when the asset will be used up. These assets are periodically assessed forimpairment to ensure the reported value does not exceed the recoverable amounts.

FS8-8.The TELUS brand is valuable, but because it is internally developed intangible asset soaccording to IFRS and ASPE it is not reported on the balance sheet as an intangible asset. Thevalue of a brand name develops from advertising, promotion, and other investments that develop




the product or company name. At the time that money is spent it is difficult to know whetherthere will be a future benefit associated with the expenditure and therefore the definition of anasset isn’t met. It might be pos sible to determine a fair value of a brand, but brands are unique someasuring them is very imprecise and not permitted under IFRS. Brand names can appear asassets when they are purchased. In such instances, a business transaction can be attributed to the

direct creation of the brand while an accurate fair value can easily be obtained and verified, as itrepresents the purchase price.

FS8-9.Some of the estimates and judgement that TELUS must make with respect to its capital assetsinclude useful life, residual values, the type of depreciation method (i.e. straight line oraccelerated method), future cash flow generation attributable to the individual asset, and anyimpairment tests. Some of the challenges that TELUS’ managers can face when making theseestimates and judgements include accuracy of the estimates, classification of the assets as towhether to expense or capitalize or which category does the asset fall under. TELUS has assetsthat have very long lives and so estimates of the lives can be imprecise, as can estimates of

residual values. Determining whether an asset is impaired when the life is long can also bedifficult because discounted future cash flows have to be estimated. One of the IFRS objectivesis fair presentation of the financial statements as managers achieving this objective can bedifficult when estimates are needed. Judgement required can be reduced by bringing in experts tovalue the assets or determine amortization and depreciation when the assets are sold. The latteroption would generate more reliable value however waiting to the end of the assets life will notmake the financial statements relevant to the users. An overly conservative estimate (take moredepreciation) would make the entity appear to not be performing as well while a lenient estimatewould have the opposite effect.

FS8-10.

TELUS capitalizes its PP&E on the balance sheet as long term assets and sets up a contra assetaccount to record depreciation. PP&E is initially recorded at the transaction value — the amount

paid for the asset. PP&E is depreciated using the straight-line method. In 2011 TELUS reporteda depreciation expense of $1,331,000,000 for PP&E. As of December 31 2011, TELUS reporteda total accumulated depreciation of $20,347,000,000. TELUS depreciates its PP&E expenses fora few reasons: it matches the cost of earning revenue to the revenue it helped earn, it reflects the

physical use of the asset, and it reflects obsolescence. The carrying amount is a rather poorindicator of what an asset can be sold for. Carrying amount when using historical cost is simplythe capitalized amount that hasn’t be depreciated. It’s not intended to be an indication of marketvalue.

FS8-11.In millions of dollars 2011 2010 2009Total assets $19,931 $19,624 $19,525

Net income 1,215 1,052Finance costs 377 522Tax rate (income taxes/income before taxes) 23.6% 24.2%



ROA(net income + Finance costs*(1 – tax rate)/average assets)

7.60% 7.40%

TELUS’ has increased its ROA from 2010 to 2011 which is an indication that its assets are being better managed to generate the improved return. TELUS’ improved ROA was a result ofincreasing net income rather than reducing assets which indicates better utilization of assets.

FS8-12.It would be very difficult to get into TELUS’ business because of the huge investment in capitalassets that’s required. From the balance sheet the company has a net investment in PPE of almost$8 billion, which is after accumulated depreciation. Generally, capital intensive businesses aredifficult to get into because

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Friedlan4e SM Ch08