Operating Assets – Expense and Disposal

Hard Test

Key Things To Know

j

Practice As You Learn

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Easy Test

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Hard Test

Hard Test

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

1. An accelerated depreciation method is

a. always used for assets with less than 3 years life
b. most appropriate for assets that produce more revenue in early years used than in later years
c. results in a higher income in early years
d. none of the above

Answer

B. Accelerated depreciation means that more is expensed in early years of use than the later years. Depreciation is recorded in order to match the expense with expected revenue produced from the asset. A higher expense results in lower income (c.) The method chosen should be based on estimated revenues.

2. Goodwill is

a. recorded by the company when profits are earned during this year
b. the difference in what was paid for the company and the fair market value of net assets purchased
c. the difference in what was paid for the company and the book value of net assets purchased
d. expensed annually as the company uses the benefits to produce revenues

Answer

B. The technical definition of goodwill is (b.). The reason the company is willing to pay more than the separate fair market value of net asset is they believe they are getting intangible assets, such as a good management team, name brand, good location, etc, which is the intangible asset goodwill. Goodwill has indefinite life and is not expensed annually (amortized).

3. A company sold an asset with a historical cost of $10,000 that was purchased and used 3 years and 6 months prior to the sale. The asset was estimated to be used for 4 years and have a residual value of $2,000. The entry to record the sale at a price of $4,000 will include

a. a $1,000 gain
b. a $1,500 gain
c. a $1,000 loss
d. a $4,000 gain

Answer
A. First compute annual depreciation expense: $10,000 – $2,000 / 4 years = $2,000 per year. 3 and ½ years x $2,000 per year gives a total of 7,000 accumulated depreciation expense recorded. The entry to record the sale is to decrease (credit) the asset for cost, decrease all associated accumulated depreciation (debit), record the cash received (debit) and plug the difference to gain or loss. The gain or loss will be the difference in cash received and book value.

 

Book value               $3,000
Cash received          $4,000
Gain                           $1,000 Received more than book value
4. An asset cost $110,000, has a residual value of $10,000 and will be used for 5 years. When will the expense using the straight-line method be higher than the expense using the double declining balance method?

a. always, every year
b. never
c. after the 2nd year
d. after the 4th year

Answer
C. Straight-line depreciation expense will be $20,000 each year. Double declining balance is computed as follows:

100% / 5 = 20% x 2 = 40% x 110,000 = 44,000 1st year
= 40% x (110,000 – 44,000) = 26,400 2nd year
= 40% x (110,000 – 44,000 – 26,400) = 15,840 3rd year

5. Which of the following is true?

a. book value is never higher than the depreciable base
b. accumulated deprecation will be the same for all depreciation methods when the asset is fully depreciated
c. useful life can be longer than legal life
d. if the estimated useful life is changed, it must be changed to a longer life

Answer

B. Useful life estimates can be changed at any time to increase or decrease the life, depending how long management intends to use the asset. Book value will be equal to cost less residual value when fully depreciated regardless of the method used. Book value is always equal to or higher than depreciable base. 

6. Which of the following regarding long term asset impairment is true?

a. the impairment loss is always recorded in the period the asset is sold
b. impairment always increases the asset’s cost
c future cash flows are higher than historical cost when impairment occurs
d. future cash flows are lower than historical cost when impairment occurs

Answer

D. Impairment occurs when projected future cash flows are lower than historical cost. An asset can not be reported at higher than expected future benefit. The loss is recorded at the time the impairment is determined (a.). Assets are never increased to the amount of future cash flows, only decreased.

7. When testing a machine for impairment, you must first compare book value to

a. future discounted cash flows
b. future undiscounted cash flows
c. the appraised fair market value of the machine
d. the depreciable base

Answer

B. The first step in testing for impairment is to compare book value to future undiscounted cash flows. When book value is more than future undiscounted cash flows it is considered impaired.

8. Which method of depreciation will most likely give the highest gain when sold after using the asset for about 20% of the 5 year useful life?

a. units of production
b. straight-line
c. double declining balance
d. the loss will be the same for all methods

Answer

C. Double declining balance will give the highest depreciation expense and the lowest book value at the time of sale. The lowest book value will give the highest gain.

9. The amortization of an intangible asset reduces

a. the fair market value of the asset
b. accumulated amortization
c. the book value of the asset
d. all of the above

Answer

C. Book value is cost less accumulated amortization. Recording amortization expense increases accumulated amortization. Book value is not an indication of fair market value. 

10. Depreciation expense must be recorded for

a. only the time the asset is used
b. a full year amount when the asset is used for part of the year
c. time from the day the expenditure is made to the end of use of the asset
d. any of the above depending on the company’s policy

Answer

A. The goal of depreciation is to match the cost of using the asset over the time used. Assets can be purchased before beginning use, and the time before use is not expensed (c.) Assets used for only part of the year incur less than one year of expense (b.)

11. JEH Trucking uses the straight-line method of depreciation and incurred the following costs.

A) At the beginning of the 1st year: Purchased a truck for $195,000, the truck had an expected useful life of 10 years and an estimated residual value of $25,000.

B) During the 1st year: Paid $19,000 on tires, oil changes, and minor parts replacements that must be done every year.

C) At the beginning of the 3rd year: Paid $25,000 to rustproof the truck, expected to increase the total life by 6 years. Residual value is not expected to change.

A. Record depreciation expense for the 2nd year.
B. Record depreciation expense for the 3rd year.
C. Determine book value at the end of the 4th year.

Answer

11.A. The $19,000 is routine maintenance and must be expensed. It is not added to the cost of the asset. Depreciation expense will be the same for the 1st and 2nd year because the company has not added costs that are capitalized or changed its estimate of useful life.

 

195,000 – 25,000 = 17,000 each year for 2007 and 2008
        10 years
Depreciation Expense             17,000
             Accumulated Depreciation    17,000

11.B. $25,000 is capitalized and added to the cost of the truck because rust proofing increases the useful life of the truck. This requires a revised depreciation expense estimate for future years.

New Cost – New residual value =
             New useful life
(195,000 + 25,000) – 25,000 = 13,929
    10        –       2      +       6
prior added
Depreciation Expense                 13,929
             Accumulated Depreciation       13,929

11.C. Determine book value at the end of the 4th year:

  Cost 195,000 + 25,000 =          220,000
– Accumulated Depreciation     (61,858)
= Book Value                               158,142

Accumulated depreciation = (17,000 x 2yrs) + (13,929 x 2 years)

12. The company purchased a new car for its salesman on May 1st of 20×1, for $34,000. The car is expected to be used for 5 years and have a life of 10 years. At the end of 5 years the company expects to sell the car for $8,000. The salesman is expected to drive the car approximately 150,000 miles. On February 1st, 20×3 the car is sold for $16,000.

A. Compute the gain or loss on the sale given the company uses the straight-line method.

B. Compute the gain or loss on the sale given the company uses the double declining balance method.

C. Compute the gain or loss on the sale given the company uses the units of production method and the car was driven 62,865 miles.

Answer

12.A. To compute the gain or loss, you must know accumulated depreciation on the date of the sale. Compute all prior year’s depreciation expense to determine this.

34,000 – 8,000 = 5,200
           5 years

20×1: 5,200 x 8/12 =      3,467
20×2:                                 5,200
20×3: 5,200 x 1/12 =          433
Total Accum. Deprec.     9,100
Loss on sale                              8,900
Cash                                         16,000
Accumulated Depreciation     9,100
               Automobile                          34,000

12.B. Compute total accumulated depreciation first:

20×1:
100% / 5 = 20% x 2 = 40%
x 34,000 = 13,600 x 8/12 = 9,067

20×2:
40% x (34,000 – 9,067) = 9,973
20×3
40% x (34,000 – 9,067 – 9,973) =
5,984 x 1/12 = 499

Total accumulated depreciation is 19,539

Cash                                          16,000
Accumulated Depreciation   19,539
                 Automobile                          34,000
                 Gain on sale                          1,539

12.C.
Compute total accumulated depreciation first:

34,000 – 8,000   = $0.173 per mile
150,000 miles

$0.173 x 62,865 = 10,876 accumulated depreciation

The expense for each year is not needed to record the sale

Loss on sale                               7,124
Cash                                          16,000
Accumulated Depreciation   10,876
            Automobile                           34,000

The gain or loss will vary with accumulated depreciation.

13. The company has purchased a new machine that is expected to have increasing maintenance costs each year the machine is used. Production during the year is expected to be relatively equal each year. State what depreciation method is most appropriate and why?
Answer

The depreciation expense and all other expense (total expense) of using the machine should be matched to the revenues produced. Double declining balance is most appropriate. Under DDB, the company will report a higher depreciation expense in the beginning years when maintenance expense is lower. As the years pass, the depreciation expense will decrease and maintenance expense will increase. The two expenses together will be relatively equal from year to year which will more accurately match the cost of using the machine to the revenues produced.

Revenues are produced equally each year. However, straight-line give an unequal total expense (depreciation plus maintenance) each year when revenues from the machine are expected to be consistent from year to year.

14. Three years ago the company acquired another company for $300 million. $25 million of the purchase price was recorded as goodwill. At the end of the current year, the company gathered the following data to test for impairment of the goodwill:

Fair market value of assets in the reporting unit acquired $320 million
Fair market value of the company $220 million
Book value of assets in the reporting unit acquired $280 million
Projected discounted cash flows from the
reporting unit acquired $195 million
Implied value of goodwill $ 65 million

Determine the amount of goodwill impairment and record the impairment if necessary.

Answer

1st Compare book value of net assets to the fair market value of net assets.
If book value is more impairment has occurred:

Book Value of assets in reporting unit $280 million
Fair Market value of assets in reporting unit $320 million

Book value is less so it is NOT considered impaired

Do not do the 2nd step of the test for impairment