Long Term Operating Assets
Hard Test
Hard Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. 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 each 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).
2. 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 lower than historical cost when impairment occurs
d. future cash flows are lower than book value when impairment occurs
Answer
D. Impairment occurs when projected future cash flows are lower than book value. An asset can not be reported at higher than the 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.
3. The cost of developing computer software is most likely
a. expensed if it is not probable the software will be sold
b. capitalized if there is a market for the software and it works
c. always expensed
d. both a. and b.
Answer
D. Costs are capitalized (intangible asset) if there is probable future benefit and expensed if there is not. When there is a market for the product and it can be sold, there is probable future benefit.
4. A productive asset that is typically consumed during operations is
a. an intangible asset
b. a natural resource
c. land
d. equipment
Answer
B. Natural resources are consumed when sold for revenue. Intangible assets have no physical substance and can not be consumed. Property, plant and equipment is not consumed, it is used and most often wears out.
5. The cost of using a long-term asset is always
a. expensed in the period incurred
b. a product cost
c. expensed in the period used or a cost of inventory depending on the type of asset
d. expensed for the amount computed for one year
Answer
C. Depreciation on assets used in support of selling or administrative are expensed in the period they are used. Depreciation on assets used to manufacture a product are capitalized as part of inventory and expensed when the inventory is sold.
6. The value of an asset acquired through a nonmonetary exchange is
a. the fair market value of the assets given up
b. the book value of the assets given up
c. the fair market value or book value, whichever is greater, of the assets given up
d. book value of the asset received
Answer
A. The cost recorded for the asset received is the fair market value of assets that were given to purchase the asset (unless FMV of what is received is clearly more readily determinable).
7. Interest expense is not included in the cost of the asset when the asset is
a. constructed in a separately distinguishable project
b. inventory produced in large quantities
c. constructed for sale or lease
d. both b. and c.
Answer
B. Interest cost incurred to finance inventory is not a capitalized cost, it is expensed in the period incurred. Construction on separately distinguishable assets under a long-term project may be capitalized whether it is held for use or to be sold later.
8. When one piece of equipment is exchanged for another piece of equipment and fair market value of the asset given up is not determinable, a gain is recorded when
a. cash is received
b. the fair market value of the equipment received is greater than the book value of the equipment that is given up
c. the fair market value of the equipment received is less than the book value of the equipment that is given up
d. both a. and b. occur together
Answer
B. The new equipment received is recorded at the fair market value of the equipment received because it is more readily determinable. A gain is recorded whenever more is received than the book value of what is given up. If the FMV for both assets can not be reliably determined than no gain or loss is recorded.
9. Research and development costs will be expensed when the cost is related to
a. an asset used in research that may also be used to produce revenues
b. research activity conducted on a long-term contract for another entity
c. legal costs for an outside law firm related to a trademark filing
d. depreciation on long term assets at the research facility
Answer
D. Depreciation expense must be recorded on any asset used long term. When used for research and development the cost is reported as research and development expense. All others describe costs that are capitalized.
10. Lump sum purchases must be recorded as separate assets because
a. assets have different fair market values
b. it is not reliable to assign the total value to one asset
c. both a. and b.
d. assets acquired have different useful lives
Answer
D. The expense of the assets acquired must be recorded over the time the assets are used. Assets acquired with different useful lives must be expensed over the time used to provide benefit. A cost must be estimated for each type of asset to properly estimate the cost of using each asset during each period.
11. A company is constructing a manufacturing facility. To finance the facility the company borrowed $800,000 from the bank at an annual interest rate of 9% on March 1st. Construction began on February 1st of the current year and ended on October 31st of the following year. Payments made to the contractor were as follows:
| February 1st | $ 200,000 |
| July 1st | $ 600,000 |
| December 1st | $ 800,000 |
| March 1st | $ 900,000 |
| July 1st | $ 700,000 |
| Total Cost | $3,200,000 |
The company has other long-term bank financing borrowed in prior years in the amount of $1,000,000 at an annual interest rate of 8% and $500,000 at an annual interest rate of 6%.
Make all the required entries related to the construction of the manufacturing facility for the year the construction of the facility was completed.
Answer
1st: Compute the average expenditures for the year the construction was completed:
| February 1st | $ 200,000 x | 10/12 = | 166,667 |
| July 1st | $ 600,000 x | 10/12 = | 500,000 |
| December 1st | $ 800,000 x | 10/12 = | 666,667 |
| March 1st | $ 900,000 x | 8/12 = | 600,000 |
| July 1st | $ 700,000 x | 4/12 = | 233,333 |
| Total Cost | $3,200,000 | 2,166,667 |
2nd Compute the weighted average borrowing rate on nonspecific borrowings:
| Borrowings | Interest Expense | |
| 1,000,000 x 8% | = | 80,000 |
| 500,000 x 6% | = | 30,000 |
| 1,500,000 | = | 110,000 |
| Interest Expense 110,000 = 7.33% Total Borrowings 1,500,000 |
3rd: Compute the interest expense related to weighted average expenditures:
| Construction Loan | $ 800,000 x 9% | $ 72,000 |
| Other borrowings | $1,366,667 x 7.33% | $100,177 |
| Total expenditures | $2,166,667 | $172,177 |
Compare the computed amount to be capitalized to the actual interest expense.
Do not capitalize more than the actual interest expense.
Second Year – through 10/31 completion:
| 800,000 x 9% x 8/12 = | 48,000 |
| 1,000,000 x 8% x 9/12 = | 60,000 |
| 500,000 x 6% x 9/12 = | 22,500 |
| Total interest expense | 130,500 |
4th: Record the payments to the contractor for each year and the interest expense:
2nd Year:
| Manufacturing Plant 1,600,000 Cash 1,600,000 Manufacturing Plant 130,500 |
Record the exchange of the machines.
Answer
| Cash 7,000 Machine (new) 42,900 Accumulated Depreciation 8,600 Machine (old) 58,200 Gain on Exchange 300 |
The new machine is recorded at the fair market value of the asset that has a more readily determinable fair market value.
Cash advertised price is readily determinable.
The amount is the fair market value less cash received.
Make the journal entry(ies) to record the above expenditures for the company.
Answer
1st Sort out the types of costs and apply the rules for those types of costs:
Software:
Before Technological Feasibility:
| Coding 56,000 Planning & Design 92,000 Testing 90,000 Expense before Technological Feasibility: 238,000 |
After Technological Feasibility:
| Producing master copies (Asset) 45,000
Production costs: (Inventory) 100,000 |
Research & Development / Hardware:
| Material used in R & D | 120,000 | |
| R & D Salaries | 250,000 | |
| Depreciation Expense on Equipment | 40,000 | (200,000 / 5 years) |
| Total Research and Development Expense | 410,000 |
Intangible Assets:
| Patent Filing Fees – Paid outside the company – capitalized 20,000 R & D for product producing revenues – “R & D Costs” 55,000 |
Property/Plant/Equipment:
| Equipment – capitalized | 200,000 |
| Marketing Expense | 25,000 |
| Salary Expense | 95,000 |
Record the Journal Entry:
| Software Expense | 238,000 | |
| Software Costs | 45,000 | |
| R & D Expense | 410,000 | |
| R & D Costs | 55,000 | |
| Patent | 20,000 | |
| Inventory | 100,000 | |
| Equipment | 200,000 | |
| Marketing Expense | 25,000 | |
| Salary Expense | 95,000 | |
| Cash | 1,188,000 |