M8-1 LO1, 3, 6

Classifying Long-Lived Assets and Related Cost Allocation Concepts

For each of the following long-lived assets, indicate its nature and related cost allocation
concept. Use the following symbols:
Nature Cost Allocation Concept
L Land &nbs p; DR Depreciation
B Building & nbsp; DP Depletion
E Equipment &n bsp; A Amortization
NR Natural resources NO No cost allocation
I Intangible ; O Other
O Other

Asset &nb sp; Nature Cost Allocation

1. Copy right ------- ---------------
2. Land held for use &nb sp; ------- ---------------
3. & nbsp; Warehouse ------ ---------------
4. Oil well ------- ---------------
5. New engine for old machine ------- ---------------
6. Operation license &n bsp; ------- ---------------
7. Land held for sale &nbs p; ------ ---------------
8. Delivery vans & nbsp; ------- ---------------
9. Timber tract &nb sp; ------- --------------
10. Production plant &n bsp; ------- --------------

Cost
Asset Nature Allocation Concept
(1) Copyright I A
(2) Land held for use L NO
(3) Warehouse B DR
(4) Oil well NR DP
(5) New engine for old machine E DR
(6) Operating license I A
(7) Land held for sale O (investment) NO
(8) Delivery vans E DR
(9) Timber tract NR DP
(10) Production plant B DR

M8-2 LO1
Computing and Evaluating the Fixed Asset Turnover Ratio
The following information was reported by Cutter’s Air Cargo Services for 2007:
Net fixed assets (beginning of year) $1,500,000
Net fixed assets (end of year) 2,300,000
Net sales for the year ; 3,300,000
Net income for the year 1,600,000
Compute the company’s fixed asset turnover ratio for the year. What can you say about
Cutter’s ratio when compared to Southwest’s 2007 ratio?

Cutter’s fixed asset turnover ratio is

= Net sales
[(Beginning net fixed asset balance + Ending net fixed asset balance) ÷ 2]

$3,300, 000
= $1,500, 000 + $2,300, 000
2

= 1.74

Cutter’s ratio is higher than Delta’s 2007 ratio of 0.94 indicating that Cutter may be
somewhat more efficient in its use of fixed assets.

M8-3 LO2
Indentifying Capital and Revenue Expenditures
For each of the following items, enter the correct letter to the left to show the type of
expenditure. Use the following:
Type of Expenditure Transactions
C Capital expenditure ----- (1) Paid $400 for ordinary repairs
R Revenue expenditure ----- (2) Paid $6,000 for extraordinary repairs
N Neither ----- (3) Paid $20,000, for addition to old building
----- (4) Paid for routine maintenance, $200, on credit
------ (5) Purchased a machine, $7,000; gave long-term
note
&n bsp; ----- (6) Paid three-year insurance premium, $900.
&n bsp; ----- (7) Purchased a patent, $4,300 cash.
&n bsp; ___ (8) Paid $10,000 for monthly salaries.
&nbs p; ____ (9) Paid cash dividends, $20,000

(1) R; (2) C; (3) C; (4) R ; (5) C; (6) N; (7) C; (8) R; (9) N.

M8-4 LO3
Computing Book Value (Straight-Line Depreciation) (Show your work)
Calculate the book value of a three-year-old machine that cost $21,000, has an estimated
residual value of $1,000, and has an estimated useful life of four years. The company
uses straight-line depreciation.

Machinery (original cost) $21,000

Accumulated depreciation at end of third year
Depreciation expense =
($21,000 cost – $1,000 residual value) x 1/4 years = $5,000

Accumulated depreciation = $5,000 annual depreciation expense x 3 yrs = 15,000

Net book value at the end of the third year $6,000

M8-6 L03
Computing Book Value (Units-of-Production Depreciation) (Show your work)
Calculate the book value of a four-year-old machine that cost $21,000, has an estimated
residual value of $1,000, and has an estimated useful life of 20,000 machine hours. The
company uses units-of-production depreciation and ran the machine 3,200 hours in year
1, 7,050 hours in year 2, 7,500 hours in year 3

Machinery (original cost) $21,000

Accumulated depreciation at end of third year
Depreciation expense per machine hour

$21, 000 − $1, 000

= = $1
20, 000

Accumulated depreciation Yr 1 Yr 2 Yr 3
= $1 depreciation expense per machine hr x (3,200+7,050+7,500) hrs = 17,750
Net book value at end of third year $3,250

M8-8LO5
Recording the Disposal of a Long-Lived Asset (Straight-Line Depreciation)(Show your
work)
As part of a major renovation at the beginning of the year, Mullin’s Pharmacy, Inc., sold
shelving units (store fixtures) that were 10 years old for $3,000 cash. The original cost of
the shelves was $6,000 and had been depreciated on a straight-line basis over an
estimated useful life of 13 years with an estimated residual value of $800. Record the sale
of the shelving units.

Store fixtures (original cost) $6,000

Accumulated depreciation at end of tenth year
Depreciation expense =
($6,000 cost – $800 residual value) x 1/13 years = $400
Accumulated depreciation = $400 annual depreciation expense x 10 yrs = 4,000
Net book value at end of tenth year (i.e., NBV immediately prior to sale) $2,000

Journal entry to record the disposal is as follows.

Cash (+A).............................................................................. 3,000
Accumulated depreciation, store fixtures (−XA, +A)........ 4,000
Store fixtures (−A) ................................................... 6,000
Gain on sale of store fixtures (+Gain, +SE) .......... 1,000
E8-11 LO3, 7
Computing Depreciation and Book Value for Two Years Using Alternative Depreciation
Methods and Interpreting the Impact on Cash Flows
Daisy Company brought a machine for $66,000 cash. The estimated useful life was four
years, and the estimated residual value was $6,000. Assume that the estimated useful life
in productive units is 120,000. Units actually produced were 43,000 in year 1 and 45,000
in year 2
Required:
1. Determine the appropriate amounts to complete the following schedule. Show
computations, and round to the nearest dollar.
Depreciation Expense for Net Book Value at the End of
Method of Depreciation Year 1 Year 2 Year 1 Year 2
Straight-line
Units –of-production
Double-declining-balance

Depreciation Expense Book Value at End of

Method of Depreciation Year 1 Year 2 Year 1 Year 2
Straight-line.............................. $15,000 $15,000 $51,000 $36,000
Units-of-production................. 21,500 22,500 44,500 22,000
Double-declining-balance........ 33,000 16,500 33,000 16,500

Computations:

Amount to be depreciated: $66,000 – $6,000 = $60,000:

Straight-line: $60,000 ÷ 4 years = $15,000 per year

Units-of-production: $60,000 ÷ 120,000 units = $.50 per unit

Year 1: 43,000 x $.50 = $21,500
Year 2: 45,000 x $.50 = $22,500

Double-declining-balance (Rate: 2 x the straight line rate of 25% (2/4) =

50%):
Year 1: $66,000 x 50% = $33,000
Year 2: ($66,000 – $33,000) x 50% = $16,500

2. Which method would result in the lowest EPS for year 1? For year 2?

The double-declining balance method would result in the lowest EPS for Year 1
because it produced the highest depreciation expense and therefore the lowest
income (from Requirement 1 above). In Year 2, the units-of-production method
would result in the lowest EPS because it produced the highest depreciation expense
and therefore the lowest income in that year.

3. Which method would result in the highest amount of cash outflows in year 1? Why?

Depreciation is a noncash expense; that is, no cash is paid when depreciation is

recognized. Ignoring income tax implications, all methods have the same impact on
cash flows in year 1. Assuming a method is applied for tax determination, the
straight-line method will result in the lowest expense, highest net income, highest tax
liability, and therefore the highest amount of cash outflows in year 1. Companies
will select methods for tax purposes that reduce tax obligations.

4. Indicate the effects of (a) acquiring the machine and (b) recording annual depreciation
on the operating and investing activities sections of the statement of cash flows (indirect
method) for year 1 (assume the straight-line method).

The machine acquisition would decrease cash provided by investing activities by the
purchase cost of $66,000. As a noncash expense, the annual depreciation should
have no overall effect on cash provided by operating activities—however, because it
is originally subtracted to arrive at net income, an adjustment needs to be made to
reverse this effect for cash flows. Hence, $15,000 (the annual straight-line
depreciation) must be added back to net income in the operating section of the
statement of cash flows.

E8-12 LO4, 5
Inferring Asset Impairment and Recording Disposal of an Asset
United Parcel Service state in a recent 10-K report, “We are the world’s largest package
delivery company and a leading global provider of specialized transportation and
logistics services,” The following note and data were reported:
Note 1-Summary of Accounting Policies
Impairment of Long-Lived Assets
We review long-lived assets for impairment when circumstances indicate the carrying
amount of an asset may not be recoverable based on the undiscounted future cash flows
of the asset….In December (of a recent year), we permanently removed from service a
number of Boeing 727 and DC-8 aircraft. As a result, we conducted an impairment
evaluation, which result in…

&nb sp; Dollars in Million

Cost of property and equipment (beginning of Year) $25,361
Cost of property and equipment (ending of year) 26,915
Capital expenditures during the year 1,947
Accumulated depreciation (beginning of year) 11, 749
Accumulated depreciation (ending of year) 13,007
Depreciation expense during the year 1,549
Cost of property and equipment sold during the year 318
Accumulated depreciation on property sold 291
Cash received on property sold 118
Required:
1. Reconstruct the journal entry for the disposal of property and equipment during the
year.

Property, Plant, and Equipment

Beg. Bal 25,361 318 Property sold
Capital expenditures 1,947 75 Write-offs
End. Bal. 26,915

Accumulated Depreciation
Property sold 291 11,749 Beg. bal.
1,549 Depreciation expense
13,007 End. bal.

Disposal of property and equipment:

Cash (+A) ................................................................................... 118
Accumulated depreciation (−XA, +A)...................................... 291
  Property and equipment (−A)............................................. 318
Gain on sale of property and equipment (+Gain, +SE) 91

2. Compute the amount of property and equipment that United Parcel wrote off as
impaired during the year. (Hint: Set up T-accounts)

Amount of property and equipment written off as impaired during the year:

Beginning balance $25,361

+ Capital expenditures during year 1,947
- Cost of property sold during year (318)
- Impairment loss during year (?)
Ending balance $26,915

Impairment loss = $75