Solutions to Chap 10 problems

EXERCISE 10-8 (a) Computation of Weighted-Average Accumulated Expenditures Expenditures Date Amount X Capitalization Period = Weighted-Average Accumulated Expenditures March 1 $ 360,000 10/12 $ 300,000 June 1 600,000 7/12 350,000 July 1 1,500,000 6/12 750,000 December 1 1,500,000 1/12 125,000 $3,960,000 $1,525,000 Weighted-Average Accumulated Expenditures X Interest Rate = Avoidable Interest $1,525,000 .12 (Construction loan) $183,000 Actual interest $3,000,000 X 12% $ 360,000 $4,000,000 X 13% 520,000 $1,600,000 X 10% 160,000 $1,040,000 Note: Use avoidable interest for capitalization purposes because it is lower than actual. (b) Building ................................................................ 183,000 Interest Expense*............................................................857,000 Cash ($360,000 + $520,000 + $160,000) ................ 1,040,000 *Actual interest for year $1,040,000 Less: Amount capitalized (183,000) Interest expense debit $ 857,000 EXERCISE 10-15 (a) Equipment ................................................................86,861.85* Discount on Notes Payable ............................................18,138.15 Cash................................................................ 30,000.00 Notes Payable ........................................................ 75,000.00 *PV of $15,000 annuity @ 10% for 5 years ($15,000 X 3.79079) $56,861.85 Down payment 30,000.00 Capitalized value of equipment $86,861.85 (b) Notes Payable ................................................................15,000.00 Interest Expense (see schedule)................................5,686.19 Cash................................................................ 15,000.00 Discount on Notes Payable................................ 5,686.19 Year Note Payment 10% Interest Reduction of Principal Balance 12/31/06 $56,861.85 12/31/07 $15,000.00 $5,686.19 $ 9,313.81 47,548.04 12/31/08 15,000.00 4,754.80 10,245.20 37,302.84 (c) Notes Payable ................................................................15,000.00 Interest Expense .............................................................4,754.80 Cash................................................................ 15,000.00 Discount on Notes Payable................................ 4,754.80 PROBLEM 10-9 (a) Exchange has commercial substance: Arna Inc.?s Books Asset B 75,000 Accumulated Depreciation?Asset A 45,000 Asset A 96,000 Gain on Disposal of Plant Assets ($60,000 ? [$96,000 ? $45,000]) 9,000 Cash 15,000 Bontemps Inc.?s Books Cash 15,000 Asset A 60,000 Accumulated Depreciation?Asset B 52,000 Asset B 110,000 Gain on Disposal of Plant Assets ($75,000 ? [$110,000 ? $52,000]) 17,000 (b) Exchange lacks commercial substance: Arna Inc.?s Books Asset B ($75,000 ? $9,000) 66,000 Accumulated Depreciation?Asset A 45,000 Asset A 96,000 Cash 15,000 Fair value of asset $75,000 acquired Less: gain deferred ($9,000) 9,000 Basis of Asset B $66,000 Bontemps Inc.?s Books Cash 15,000 Asset A 46,400* Accumulated Depreciation?Asset B 52,000 Asset B 110,000 Gain on Disposal of Plant Assets 3,400** *Fair value of asset $60,000 acquired Less gain deferred ($17,000 ? $3,400) 13,600 Basis of Asset A $46,400 $15,000 **Gain recognized = $15,000 + $60,000 X $17,000 = $3,400 CASE 10-6 In general, the inclusion of the $7,500 as part of the cost of the machine is justified because the primary purpose in accounting for plant asset costs is to secure an equitable allocation of incurred costs over the period of time when the benefits are being received from the use of the assets. These costs?both the $40,000 and the $7,500?are much like prepaid expenses, to be matched against the revenue emerging through their use. The purpose of accounting for plant assets then is not primarily aimed at securing sound valuation of the asset for balance sheet purposes, but proper determination of net income through matching of incurred costs with revenue resulting from use of the assets. 1. It may be true that these installation costs could not be recovered if the machine were to be sold. This is not important, however, because presumably the machine was acquired to be used, not to be sold. Assuming approximately equal utilization of the machine in each of the ten years, the owner properly could allocate $4,750 (10% of $47,500) against each year?s operations. If the owner?s suggestion was followed, the first year would be charged with $11,500 ($7,500 plus 10% of $40,000), and the following nine years with $4,000 per year, hence overstating expenses by $6,750 the first year and understating expenses by $750 per year for the succeeding nine years. This could hardly be defended as proper matching of costs and revenue. 2. Again, the purpose of accounting for plant assets is not to arrive at an approximation of current value of the assets each year over the life of the assets. However, even if this were an objective, the question of which method would come closer to stating current market value at some later date would revolve around the general trend of the price level over the years involved. 3. Two factors are involved here. First, the $7,500 is not a proper deduction under federal income tax regulations. If it were deducted in the year of acquisition, and a correction were made in a later year on review of the return, additional tax plus interest would have to be paid. In the second place, even if the $7,500 could properly be deducted, there would be no total tax saving over the years unless the tax rates applicable to the business were reduced during the following years. There is some value to taking the $7,500 deduction right now because of the present value of money. If the rates increased, there would be an increase in total taxes, due to higher rates applicable during the period when depreciation deductions would be reduced. However, generally accepted accounting principles are not determined by income tax effects. In many instances, GAAP requires different accounting treatment of an item than the IRS Revenue Code does. PROFESSIONAL SIMULATION Measurement Historical cost is measured by the cash or cash-equivalent price of obtaining the asset and bringing it to the location and condition for its intended use. For Norwel, this is: Price $12,000 Tax ($12,000 X .05) 600 Platform 1,400 Total $14,000 Journal Entry Machine 14,000 Cash 14,000 Depreciation Expense 1,500 Accumulated Depreciation 1,500* *Depreciable base: ($14,000 ? $2,000) = $12,000 Depreciation expense: $12,000 ÷ 4 = $3,000 per year 2003: 1/2 year = $3,000 X .50 = $1,500 Financial Statements The amount reported on the balance sheet is the cost of the asset less accumulated depreciation: Machine $14,000 Accumulated depreciation (4,500) Book value $ 9,500 Analysis The income effect is a gain or loss, determined by comparing the book value of the asset to the disposal value: Book value Cost $14,000 Accumulated depreciation 6,000 Book value 8,000 Cash received for machine and platform 7,000 Pretax loss $ 1,000 poonw 30210-sol