Long Term Operating Assets

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Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.

1. When recording the purchase of a building, the asset should include all of the following except

a. real estate commission
b. remodel prior to moving into the building
c. current year property insurance costs
d. attorney’s fees related to the purchase

Answer
C. When purchasing property, plant and equipment, the cost of the asset should include all costs that must be paid to get the asset to the point of producing revenues. You do not expense costs before producing revenues (matching principle). Current year property insurance costs will be incurred this year and do not give future benefit. Costs incurred this year must be expensed this year.

2. The amount of capitalized interest is computed as

a. all interest costs incurred by the company
b. average construction costs multiplied by the cost of capital
c. average construction costs multiplied by the cost of capital limited to actual interest expense incurred
d. average construction cost divided by the average cost of capital

Answer
C. A company can capitalize interest cost incurred on the cost of a self constructed asset up to the amount of actual interest cost incurred. The amount of time costs are tied up in the asset is considered when computing the interest to be capitalized.
3. An asset that is acquired in a transaction for other than cash is recorded at the fair market value

a. of the asset received
b. of the asset given up
c. of the asset received or the asset given up, whichever is more reliable
d. historical cost of the asset received

Answer
C. An asset acquired in a non cash exchange (a trade) is recorded at the fair market value of the asset received or the asset given up, whichever is considered to be more reliable. Fair market value is considered historical cost on the transaction date.

4. Which of the following is recorded as an expense in the period incurred?

a. research aimed at discovering new knowledge
b. research searching for new applications
c. design, construction, testing before production
d. all of the above

Answer
D. All of the above are considered research and development and are expensed in the period incurred. 
5. Long term assets used in the business to produce revenues typically fall in one of which of the following categories?

a. tangible or intangible
b. property, plant, equipment or intangible
c. property, plant, equipment or tangible
d. equipment or building

Answer
B. The two most common categories reported on the balance sheet for long term assets are P/P/E (for tangible assets) and Intangible assets. Equipment and building are types of assets, not categories.

6. Technological feasibility means

a. the company believes the idea for a new product will sell
b. the company believes the idea for a new product can be economically produced
c. the new software product works and will produce future revenues
d. the new idea is feasible

Answer
C. The term “technological feasibility” means the product has been proven to work and provide value to customers. The company has tested the product and believes that probable future benefit will occur. 
7. Research and development that is purchased in an acquisition must be

a. expensed
b. capitalized and amortized
c. partially expensed and partially capitalized depending on where in the product cycle the research and develop is at the time of purchase
d. expensed or capitalized at the discretion of management

Answer
C. Purchased R & D must be allocated to in-process research and development and developed technology. In process R & D must be expensed and developed technology is capitalized and amortized.

8. Natural resources are reported on the balance sheet as

a. inventory
b. property
c. either a. and b.
d. they are not reported until extracted from the ground

Answer
C. Natural resources are reported on the balance sheet as inventory if they have been extracted from the ground or harvested to be sold and as property if they remain in the ground. Natural resources bring future benefit and are reported as an asset at historical cost.
9. Goodwill is reported as

a. an asset only when it is internally developed
b. an asset only for the difference between appraised value and historical cost of the assets purchased
c. an asset only for the difference between the price paid and the fair market value of the net assets purchased
d. an expense as incurred

Answer
C. Goodwill is reported as an asset only when the company purchases the entire company. The amount of goodwill recorded is the difference in the price paid for the entire company and the fair market value of net assets purchased. 

10. An intangible asset is recorded when

a. a payment is made outside the company that gives probable future benefit
b. employees work on developing an intangible asset
c. a cost paid outside the company to extend the life of the intangible asset
d. both a. and c.

Answer
D. Expenditures related to intangibles are capitalized (asset) when paid outside the company and there is probable future benefit. Costs paid to employees are expensed because the future value can not be reliably estimated.

11. A company purchased land and incurred the following related expenditures:

a. purchase price of the land $100,000
b. real estate commission fees $    6,000
c. clearing and permanent landscaping fees $    3,000
d. costs to bulldoze an old building on the land $    1,500
e. payment of prior year’s property taxes $    4,400
f. survey fees   $       800
g. payment of current year property taxes $   1,200

Make the journal entry to record all expenditures related to the land.

Answer

First determine if the cost is capitalized (C) or expensed (E) and the account name used:

a. purchase price of the land $100,000     C    Land
b. real estate commission fees $     6,000     C    Land
c. clearing and permanent landscaping fees $     3,000     C    Land
d. costs to bulldoze an old building on the land $     1,500     C    Land
e. payment of prior year’s property taxes $     4,400     C    Land
f. survey fees $        800     C    Land
g. payment of current year property taxes $     1,200     E    Prop tax expense

All costs with “C Land” are costs that must be incurred to get the land to the point it can be used to produce revenues. For some expenditures, you can not purchase the land without incurring the cost (b, e, f). Bulldozing the building does not go to “building” because there is no building; the building must be removed to use the land. Landscaping that is permanent is an asset because it gives future benefit. Landscaping that is temporary, lasts less than a year, is an expense

Land                                                115,700
Property tax expense                       1,200
             Cash                                                              116,900
12. Indicate whether each of the following expenditures should be capitalized or expensed. State the account name that will be used to record the expenditure.

a. paid $100,000 for a new roof for a building currently used
b. paid $3,000 for repairs for damage done by a hurricane
c. pay $500 every 3 months to keep the machine in working order
d. paid $12,000 in salary to the attorney working on patents for the company
e. paid $2,200 to train employees how to operate a new machine

Answer
a. paid $100,000 for a new roof for a building currently used

Capitalize – Building
Extend the life of the building

b. paid $3,000 for repairs for damage done by a hurricane

Expense – Repairs and maintenance expense

Repairs do not extend the life, improve efficiency, or increase output

The repairs enable the company to continue use, the future benefit was already paid for before.

Could also be recorded as an unusual item; “Loss from hurricane”.

c. pay $500 every 3 months to keep the machine in working order

Expense – repairs and maintenance expense

The cost does not bring long term future benefit. 3 months is short term

d. paid $12,000 in salary to the attorney working on patents for the company

Expense – salary expense

Costs related to intangible assets are expensed if paid internally in the company.

Salary is an internal cost.
Costs are capitalized if paid outside the company

e. paid $2,200 to train employees how to operate a new machine

Capitalize – Machine

This is a necessary cost to get the machine to where it can be used to produce revenues.

This is a new machine, not yet in use.

Training after the machine is in use is expensed to match the same period revenue.

13. At the beginning of the current year, the company borrowed $1,200,000 at an interest rate of 7% to build a new warehouse. Construction began on March 1st and was completed on December 31st. Payments for the warehouse in the current year were as follows:

April 1st                              $300,000
June 1st                              $700,000
December 1st                   $400,000

Compute and record the interest that should be capitalized for the current year.

Answer
Date Months / 12 Amount      7%
Interest		 Interest
Expense
4/1     9 / 12 $300,000 .07 $15,750
6/1     7 / 12 $700,000 .07 $28,584
12/1     1 / 12 $400,000 .07 $ 2,333
$46,667
Warehouse Building                  $46,667
              Interest Expense                           $46,667

Total Interest Expense $1,200,000 x .07 = $84,000.
The amount capitalized may not exceed the total actual interest amount.
The amount is lower than total interest expense; capitalize the computed amount.

Alternative Calculation:

Date Months / 12 Amount Weighted average
4/1       9 / 12 $300,000 $225,000
6/1     7 / 12 $700,000 $408,333
12/1     1 / 12 $400,000 $ 33,333
    Total $666,666
x    Interest %          
Capitalize Interest
      .07    
$ 46,667
14. For the following costs, state the account that will be used for the debit. Give the account name, not the category on the balance sheet

A. Amounts spent to extend the life of a machine
B. Remodel of the building prior to occupancy
C. Landscaping the building that will be done each year
D. Real Estate commission paid for the purchase of the building
E. Property taxes paid on the building for periods before occupancy
F. Painting, which will be done every year
G Land survey costs prior to purchasing land
H. Demolition of a building on the land purchased
I. Installation costs related to machines
J. Outside legal costs incurred to purchase a patent

Answer
A. Machine
B. Building
C. Landscaping expense
D. Building
E. Building
F. Repairs and maintenance expense
G. Land
H. Land
I. Machine
J. Patent

Capitalized P/P/E if it is a cost to get the asset ready to use (prior to use) or it is a subsequent expenditure that extends the life or improves efficiency/output

Expense is the cost benefits one year or less and does not give future benefit

Capitalize intangible assets if paid outside the company and there is future benefit.

Expense intangible related costs if incurred inside the company. (salaries)

15. The company exchanged a machine for a different type of machine and paid cash of $6,000. Additional information:

Old Machine – Historical Cost $23,000
New Machine – Fair Market Value $18,500
Accumulated Depreciation – Old Machine $  7,200
Old Machine – Fair Market Value $13,000

Prepare the journal entry to record the exchange.

Answer
Equipment – New                                    19,000
Accumulated Depreciation                      7,200
Loss on Exchange                                      2,800
             Equipment – Old                                     23,000
             Cash                                                            6,000

Record the new asset at the fair market value of what is given up in exchange, 13,000 equipment FMV + 6,000 cash = 19,000

The fair market value of both assets is readily determinable, so use the FMV of the asset given up.

Remove the old asset from the books at historical cost and associated accumulated depreciation

Plug a gain (credit) or loss (debit) to balance the journal entry