CHAPTER 7 LONG-LIVED NONMONETARY ASSETS AND THEIR AMORTIZATION

1. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
CHAPTER 7
LONG-LIVED NONMONETARY ASSETS
AND THEIR AMORTIZATION
Changes from Twelfth Edition
Updated from Twelfth Edition. Two new cases – Silic and WorldCom – have been added.
Approach
Students find it difficult to accept the basic fact that deprecation is a process of writing off an asset’s cost,
rather than a process that has something to do with asset valuation. (A great many business people have the
same difficulty.) Instinctively, they think depreciation is related to some physical change in the asset, or to
changes in its market value. Basically, this point is made only after repeated emphasis of it.
Since the text summarizes APB Opinion No. 17 on goodwill, FASB Statement No. 2 on research and
development, FASB Statement No. 13 on leases, FASB Statement No. 86 on computer software, and FASB
Statement No 142 on goodwill and other intangible assets, instructors may wish to refer to this material for
additional background.
Cases
Stern Corporation (B) is a straightforward problem in analyzing fixed asset transactions.
Joan Holtz (C) describes several debatable items that might or might not be included in the asset amounts.
Stafford Press describes a series of transactions related to amounts to be capitalized. The case probably
cannot be covered in one session and, therefore, either the case should be used for two days or the instructor
should assign only about half the transactions.
Silic: Choosing Cost or Fair Value on Adoption of IFRSI requires students to decide if a French, real estate
investment firm should use the fair value or cost method to report its real estate investments.
Accounting Fraud at WorldCom describes the events leading up to WorldCom’s overstatement of income and
its subsequent bankruptcy.
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2. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Problems
Problem 7-1
With units-of-production depreciation, one finds the cost of one production unit, and then multiplies this by
the units used in a year to determine the year’s depreciation:
08$.
000,525,3
$18,000-$300,000
unitoneofCost ==
Years Units x $.08 =
Units of
Production
Depreciation
SYD
Charge
1 930,000 x $.08 = $ 74,400 $80,571 (6/21 x $282,000)
2 800,000 x .08 = 64,000 67,143 (5/21 x 282,000)
3 580,000 x .08 = 46,400 53,714 (4/21 x 282,000)
4 500,000 x .08 = 40,000 40,286 (3/21 x 282,000)
5 415,000 x .08 = 33,200 26,857 (2/21 x 282,000)
6 300,000 x .08 = 24,000 13,429 (1/21 x 282,000)
3,525,000 $282,000 282,000
Problem 7-2
Equipment ID #103
Dr. Cash.............................................................................................................................................................................14,300
Accumulated Depreciation............................................................................................................................................59,755*
Cr. Equipment..........................................................................................................................................................70,300
Gain on Sale of Equipment.................................................................................................................................3,755
*(70,300 / 10) x 8 ½ years = $59,755.
Equipment ID #415
Dr. Cash.............................................................................................................................................................................63,000
Accumulated Deprecation.............................................................................................................................................26,640*
Loss on Sale of Equipment...........................................................................................................................................6,360
Cr. Equipment..........................................................................................................................................................96,000
*Year 1, ($96,000 x 30%)(½ year) = $14,400.
*Year 2, ($81,600 x 30%)(½ year) = 12,240.
Equipment ID #573
Dr. Cash.............................................................................................................................................................................38,000
Accumulated Depreciation............................................................................................................................................49,500*
Loss on Sale of Equipment...........................................................................................................................................7,000
Cr. Equipment..........................................................................................................................................................94,500
*$94,500 x 11/21 = $49,500.
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3. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Problem 7-3
Automobile (new)....................................................................................................................................................................9,900
Accumulated Depreciation (old)..............................................................................................................................................14,500
Automobile (old)...............................................................................................................................................................16,000
Cash...................................................................................................................................................................................8,400
(No gain or loss was involved, because the two assets were of like kind.)
Furniture..................................................................................................................................................................................8,850
Accumulated Depreciation.......................................................................................................................................................13,610
Loss on Disposal of Truck........................................................................................................................................................750
Truck.................................................................................................................................................................................19,860
Cash...................................................................................................................................................................................3,350
Problem 7-4
(1) Land...............................................................................................................................................................................80,600
Cash.........................................................................................................................................................................80,600
(2) Building.........................................................................................................................................................................138,000
Common Stock........................................................................................................................................................90,000
Notes Payable..........................................................................................................................................................16,000
Cash.........................................................................................................................................................................32,000
(3) Desks and Chairs (80% x $8,700)..................................................................................................................................6,960
Bookcases (80% x $2,200).............................................................................................................................................1,760
Filing Cabinets (80% x $1,100).....................................................................................................................................880
Cash.........................................................................................................................................................................9,600
The above does not treat the equipment purchase as a fortunate acquisition. An argument can be made to
record the equipment as a fortunate acquisition, giving rise to this entry instead:
Desks and Chairs............................................................................................................................................................8,700
Bookcases......................................................................................................................................................................2,200
Filing Cabinets...............................................................................................................................................................1,100
Cash.........................................................................................................................................................................9,600
Retained Earnings....................................................................................................................................................2,400
Problem 7-5
Depletable Assets
Land.........................................................................................................................................................................................$ 21,700,000
Tests – successful ....................................................................................................................................................................35,250
Tests – unsuccessful.................................................................................................................................................................116,250
Permits.....................................................................................................................................................................................41,000
$ 21,892,500
Salvage value...........................................................................................................................................................................(2,325,000)
Net Cost...................................................................................................................................................................................$19,567,500
Unit depletion = $19,567,500/800,000 tons = $24.46/ton.
Depreciation year 1 = $24.46 x 30,000 tons = $733,800
Depreciation year 2 = $24.46 x 70,000 tons = $1,712,200
Depreciation year 3 = $24.46 x 75,000 tons = $1,834,500
Land Improvements
$387,500/10 years = $38,750/year amortization.
Amortization year 1 = $38,750
Amortization year 2 = 38,750
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4. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Amortization year 3 = 38,750
Buildings
$271,250/10 years = $27,125/year depreciation
Deprecation year 1 = $27,125
Deprecation year 2 = 27,125
Deprecation year 3 = 27,125
Machinery
Depreciation year 1 = $1,162,500 x 10/55 = $211,364
Depreciation year 2 = $1,162,500 x 9/55 = $190,227
Depreciation year 3 = $1,162,500 x 8/55 = $169,091
Cases
Case 71: Stern Corporation (B)*
Note: This case is updated from the Twelfth Edition.
Approach
This is a straightforward problem, designed for use in connection with study of the text. I find it useful to put
T-accounts on the board or on a Vugraph and post entries to them as they are given. The account titles given
in the balance sheet should be used.
The case assumes individual unit depreciation. It may be desirable to ask at some point what the entries
would be if composite or group depreciation were used.
Comments on Questions
**
This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.
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5. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Question 1
1. Cash..................................................................................................................3,866
Accumulated
Depreciation,
Factory Machinery ..........................................................................................
27,367
Factory
Machinery ...................................................................................................
31,233
2. Tools Used
(Expense) .........................................................................................................
7,850
Tools 7,850
(Note the contrast between depreciation and a direct write-
off.)
3. (a) Depreciation
Expense............................................................................................................
278
Accumulated
Depreciation,
Automotive
Equipment...................................................................................................
278
(The additional depreciation is 1/6 x .20 x $8,354. Note that
the half-year convention is not used. Note that if the
depreciation incurred in 2006 is disregarded, the loss will be
overstated.)
(b) Cash..................................................................................................................2,336
Accumulated
Depreciation,
Automotive
Equipment........................................................................................................
5,458
Loss on Sale of
Other Assets.....................................................................................................
560
Automotive
Equipment...................................................................................................
8,354
(There can be a discussion of the proper showing of the loss
on the income statement.)
4. Patent Amortization
Expense............................................................................................................
11,250
Patent...........................................................................................................11,250
5. Cash..................................................................................................................75
Accumulated
Depreciation,
Office Machines...............................................................................................
1,027
Gain on Sale of
Other Assets.................................................................................................
75
Office Machines..........................................................................................1,027
(The gain is preferably combined with the loss on Item 3, with
entries to a “Loss or Gain” account. It is shown separately
here for clarity.)
6. (a) Depreciation
Expense.......................................................................................................
37
Accumulate
d
Depreciation..........................................................................................
37
(.75 x .10 x
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6. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
$490)
(b) Cash ............................................................................................................80
Accumulated
Depreciation,
Furniture and
Fixtures........................................................................................................
432
Furniture
and Fixtures...........................................................................................
490
Gain on Sale
of Other
Assets....................................................................................................
22
7. Depreciation
Expense.......................................................................................................
398,779
Accumulate
d
Depreciation
, Building..............................................................................................
48,105
Accumulate
d
Depreciation
, Factory
Machinery.............................................................................................
330,935
Accumulate
d
Depreciation
, Furniture
and Fixtures...........................................................................................
5,599
Accumulate
d
Depreciation
, Automotive
Equipment.............................................................................................9,989
Accumulate
d
Depreciation
, Office
Machines...............................................................................................
4,151
(Note that depreciation is calculated after the earlier entries have been recorded and that
depreciation on factory machinery is not calculated on the $85,000 of fully depreciated assets.)
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7. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Question 2
Gross
Accumulated
Depreciation Net
Land.................................................................................................................................................................................$ 186,563 $ 186,563
Building...........................................................................................................................................................................2,405,259 $ 711,484 1,693,775
Factory machinery ..........................................................................................................................................................3,394,352 1,945,926 1,448,426
Furniture and fixtures .....................................................................................................................................................55,994 45,604 10,390
Automotive equipment ...................................................................................................................................................49,944 41,965 7,979
Office machines ..............................................................................................................................................................41,507 31,129 10,378
Tools ...............................................................................................................................................................................53,444 53,444
Patent...............................................................................................................................................................................45,000 _________ 45,000
Total..........................................................................................................................................................................$6,232,063 $2,776,108 $3,455,955
Case 73: Strafford Press*
Note: This case is updated from the Twelfth Edition.
Approach
This case is, in effect, a series of short problems dealing with various aspects of fixed asset accounting. The
problems illustrate issues of asset valuation, disposal gains and losses, and expense versus capitalization of
certain items. In class I have students discuss the items sequentially, describing treatment of each transaction
with a journal entry. I try to keep income tax treatment out of the discussion; or, if it does enter in, to keep it
clearly distinguished from the financial reporting issues of the case.
Comments on Questions
1. The journal
entry recording
this disposal
would be:
Cash 149,860
Accumulated
Depreciation
(bldgs.)
199,056
Loss on Sale
of Fixed
Assets
35,182
Land 34,034
Buildings 350,064
The $35,182 is a “plug” figure; that is, it is determined as a result of the following
sequence: (1) the cost of the old land and building must be removed from the books
(credits); (2) the accumulated depreciation on the building must also be removed
(debit); (3) the cash consideration must be recorded (debit); (4) the balancing debit
is $35,182, representing the difference between the net book value of the assets
disposed of and the cash proceeds from the disposal. Although extraordinary items
have not yet been covered in the text, it should be made clear that such gains or
losses on disposal of fixed assets are not extraordinary items.
2. The entry for this disposal is completely analogous to the previous one, except in this
instance there is a gain instead of a loss:
Cash.......................................................................................................................................................35,200
**
This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.
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8. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
Accumulated
Depreciation
(eqpt.) ....................................................................................................................................................
40,890
Equipmen
t.........................................................................................................................................................
73,645
Gain on
Sale of
Fixed
Assets................................................................................................................................................
2,445
3. The purchase price should probably be recorded at $109,868, although the company’s
policy may be to treat all cash discounts separately, in which case the cost would be
$112,110. The $450 delivery cost should be capitalized, as should installation costs. The
question on the latter is the appropriate hourly rate; I feel the 60 hours should be costed
at $27.15, the retail billing rate less profit, for a total of $1,629. Others will argue for the
$15 rate, or $900. One possible entry therefore is:
Equipment
(109,868 +
450 + 1,629)...........................................................................................................................................
111,947
Cash
(possibly
other
items).................................................................................................................................................
111,947
4. The company paid $140,000 to purchase the land for the new plant.
Land.......................................................................................................................................................140,000
Cash ..................................................................................................................................................140,000
As stated in the text, the cost of land includes the cost of tearing down existing structures
so as to make the land ready for its intended use.
Land.......................................................................................................................................................21,235
Cash ..................................................................................................................................................21,235
In either case, the drainage installation is an additional cost that should be capitalized, as
follows:
Land.......................................................................................................................................................13,950
Cash ..................................................................................................................................................13,950
STAFFORD PRESS
Condensed Balance Sheet
(Revised to Reflect Move)
Assets Liabilities and Owner’s Equity
Current assets: Current liabilities...............................................................$ 160,223
Cash.....................................................................................................................................................................................$ 121,912 Long-term liabilities...........................................................425,000
Other current assets..............................................................................................................................................................251,790 Common stock...................................................................400,000
Total current Assets...........................................................................................................................................................373,702 Retained earnings...............................................................310,857
Plant and equipment:...............................................................................................................................................................
Land.....................................................................................................................................................................................175,185
Buildings .............................................................................................................................................................................$561,000
Less accumulated..............................................................................................................................................................
Depreciation..................................................................................................................................................................0 561,000
Equipment...............................................................................................................................................................................319,025
Less: accumulated
depreciation .........................................................................................................................................................................132,832 186,193 _________
Total assets..............................................................................................................................................................................$1,296,080
Total liabilities and
owners’ equity.................................................................$1,296,080
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9. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
5. The item was intentionally stated ambiguously in the case so that the issue of similar
(‘‘like-kind”) trade-ins can be discussed. If the equipment traded in was similar, then the
journal entry is constructed so that no gain or loss on disposal is recorded:
Equipment
(new)
(20,830 +
6,800).....................................................................................................................................................
27,630
Accumulate
d
Depreciation
(old).......................................................................................................................................................
5,200
Cash..................................................................................................................................................20,830
Equipme
nt (old)..............................................................................................................................................
12,000
On the other hand, if it is assumed that the tradein was not similar, the entry is as follows:
Equipment
(new)
(20,830 +
6,050).....................................................................................................................................................
26,880
Accumulate
d
Depreciation
(old).......................................................................................................................................................
5,200
Loss on Sale
of Fixed
Assets.....................................................................................................................................................
750
Cash..................................................................................................................................................20,830
Equipme
nt (old)..............................................................................................................................................
12,000
Note that in either case the nominal trade-in allowance $7,200 is irrelevant. In the second
treatment, the $750 loss is the difference between the fair value of the trade-in, $6,050,
and its $6,800 net book value.
6. This is
straightforward
as given:
Buildings................................................................................................................................................561,000
Cash..................................................................................................................................................136,000
Mortgage
Payable..............................................................................................................................................
425,000
7. Some might argue that these moving costs should be capitalized, on the grounds that
there are future benefits associated with the move (that was the owner’s motivation in
moving). In response, I ask, “How would you feel if the move had been made out of
necessity--say, the old property had been condemned or taken by eminent domain?” The
response in that case usually is that the moving costs should not be capitalized. Since the
benefits are speculative and (more importantly), since changing the location of
equipment through a move does not alter its future productive capacity or useful life, I
see no strong argument for capitalization. Thus, the entry would be (again using $27.15
per hour for the workers’ time, consistent with item 3):
Moving
Expense
(8,440 +
11,834
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10. Chapter 07 - Long-Lived Nonmonetary Assets and Their Amortization
3,394)...................................................................................................................................................
Cash..................................................................................................................................................11,834
(There would be labor, over and above this 125 hours, charged to moving expense, but
the total number of workers’ hours devoted to the move is not given.)
8. The repair of the damage during the move has not improved the equipment so as to
constitute a betterment; thus it is expensed:
Maintenance
(or Moving)
Expense..................................................................................................................................................
3,220
Cash....................................................................................................................................................3,220
The decrease in salvage value, $660, could be expensed immediately with an entry such
as:
Moving
Expense (or
Deprec.
Expense)..................................................................................................................................................
660
Equipment
(or
Accum.
Deprec.)..............................................................................................................................................
660
However, I don’t think an event that changes a fixed asset’s future salvage value is any
more relevant, in terms of the cost concept, than an event that changes its current market
value. Thus, in my view, rather than adjusting the cost of the asset, it is better to amortize
the reduction in salvage value by adjusting the depreciation charge for the rest of the
equipment’s useful life, which constitutes a change in an estimate. Since the accumulated
depreciation was $3,220, and annual depreciation was $805, the asset was 4 years old,
and thus had 6 years left of useful life. The amount of remaining depreciation is the net
book value at the end of 4 years, $6,780, less the newly estimated S1,290 salvage value,
or $5,490. Divided by 6 years, the new annual depreciation expense on this item would
be $915. (Easier, though not quite as thorough: the $660 lesser salvage value, spread over
6 years, is $110 per year, added to the current depreciation charge of $805, makes a total
of $915.)
The revised balance sheet reflecting the above transactions is shown above.
Case 74: Silic (A) and (B): Choosing Cost or Fair Value on Adoption of IFRS*
Note: This case is new with the Thirteenth Edition. Please see the printed Instructor’s Resource Manual for
the Harvard Teaching Notes.Case 75: Accounting Fraud at WorldCom*
Note: This case is new with the Thirteenth Edition. Please see the printed Instructor’s Resource Manual for
the Harvard Teaching Notes.
**
This note was prepared by Professors David F, Hawkins and Edward J. Riedl, and Vincent Dessain, and Andrew
Barron. Copyright © 2008 President Fellows of Harvard College. Harvard Business School Teaching Note 108-078.
**
This note was prepared by Professor Robert S. Kaplan. Copyright © 2005 President and Fellows of Harvard College.
Harvard Business School Teaching Note 105-083.
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