Long Term Operating Assets
Medium Test
Medium Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. Which of the following expenditures should be expensed in the period incurred?
a. oil changes every 5,000 miles on the company’s autos
b. engine overhaul on one of the company’s autos
c. new tires that are expected to last 3 years
d. both a. & c.
Answer
A. Routine maintenance and repairs are always expensed. It does not give future benefit since it will have to be done again in less than one year. Costs that are capitalized give future benefit for more than one year: 1) extend the useful life (b), 2) improve efficiencies 3) increase output.
2. The asset trademark should include all of the following except
a. employee salaries working on the design of the trademark
b. fees paid to the external law firm that filed for the trademark
c. legal filing fees paid to the government associated with the trademark
d. all of the above should be capitalized as part of the asset
Answer
A. Costs related to intangible assets are expensed if they are incurred inside the company. Costs paid outside the company are capitalized if they provide probable future benefit. Employee salaries are always expensed because they are internal to the company.
3. A cost of an improvement to a machine that increases output of product is
a. expensed
b. capitalized
c. expensed over the subsequent life of the asset
d. both b. & c.
Answer
D. This is a subsequent expenditure and subsequent expenditures are capitalized when they extend the useful life or increase productivity, efficiency, output. All long term assets that have a useful life are expensed over the life of the asset. This cost is added to the cost of the asset and expensed through depreciation.
4. Which of the following could be an intangible asset with an indefinite life?
a. patent
b. goodwill
c. leasehold improvements
d. either b. or c.
Answer
B. Goodwill most often has indefinite life. Patents are granted for a definite length of time and leasehold improvements last for the life of the lease.
5. Assets acquired using long term financing that includes interest are valued
a. at the future value
b. at the company’s assessed valuation
c. the present value of the payments required
d. none of the above
Answer
C. The asset must be valued at the historical cost, not including interest. This is the present value of future payments over the time the note is repaid.
6. Research and development expenditures are
a. expensed or capitalized at the discretion of the company
b. always capitalized and amortized
c. always expensed
d. expensed if incurred prior to producing a marketable product
Answer
D. Research and development costs are incurred prior to producing a product. They are expensed or capitalized depending on if costs are incurred in support of trying to develop a product (expensed) or in support of a marketable product (capitalized).
7. The exclusive right to receive benefit from a creative work is a
a. patent
b. form of goodwill
c. trademark
d. copyright
Answer
D. A copyright gives the holder the right to receive benefit from a creative work such as a book or a film.
8. Software development costs are reported as an asset and amortized periodically when they are incurred
a. prior to technological feasibility
b. after technological feasibility
c. when paid outside the company
d. before technological feasibility and before commercial production
Answer
B. Software costs are capitalized when incurred after technological feasibility. Technological feasibility means the product has been tested and proven to work and is marketable.
9. Interest expense may be capitalized when constructing an asset and
a. the company has long term debt borrowed specifically for the construction
b. the weighted average cost of interest exceeds actual interest expense
c. the company has interest expense greater than the cost of capital on the self constructed asset.
d. none of the above
Answer
C. Interest expense may be capitalized when the company has actual borrowings and interest expense that is equal to or exceeds the weighted average cost of financing the constructed asset. The debt does not have to be incurred specifically to finance the self constructed asset.
10. A gain on the sale of an asset for cash will occur when
a. the book value of assets sold is greater than the cash received
b. the fair market value of assets is less than cash received
c. the book value of assets sold is less than total cash received
d. all of the above can generate a gain depending on the fair market value of the assets sold
Answer
C. A gain occurs when the company receives more cash than book value of assets sold.
11. State the accounting rules, very briefly and simply, for recording expenditures as an asset or an expense for:
a. property, plant, equipment
b. intangible assets
c. research and development
d. software development costs
Answer
a. Property/plant/equipment:
Capitalize all costs to get the asset ready to use (prior to use) or subsequent expenditures that extends the life or improves efficiency/output
Expense when the cost benefits one year or less and does not give future benefit
b. Intangible assets:
Capitalize costs that are paid outside the company and give future benefit
Expense costs that are paid inside the company (salaries) and costs that do not give probable future benefit
c. Research and development:
Expense all costs before commercial production (expect future economic benefit)
Capitalize all costs after the start of (expected start of) commercial production
d. Software development costs
Expense all costs incurred before technological feasibility (it works and can be sold)
Capitalize all costs incurred after technological feasibility, amortize
12. A company is constructing a retail store. The company currently has long term bank financing totaling $3,000,000, consisting of $1,000,000 at 8% and $2,000,000 at 11%. No loans were taken out to finance the construction. Construction began on June 1st of the current year and ended on November 30th of the current year. Payments made to the contractor were as follows:
| May 1st | $ 200,000 |
| July 1st | $ 600,000 |
| October 1st | $ 400,000 |
| Total Cost | $1,200,000 |
Make all the required entries for the current year related to the construction of the retail store.
Answer
1st: Compute the weighted average expenditure: May 1st to November 30th
Current Year:
| May 1st | $ 200,000 | x | 8/12 | = | $133,333 |
| July 1st | $ 600,000 | x | 5/12 | = | $250,000 |
| October 1st | $ 400,000 | x | 2/12 | = | $ 66,667 |
| Weighted Average | $450,000 | ||||
2nd No specific borrowings. Compute the company’s average interest rate to use to compute the interest on construction.
| Borrowings Interest Expense
1,000,000 x 8% = 80,000 |
| Interest Expense 300,000 = 10% Total Borrowings 3,000,000 |
3rd: Compute the interest expense related to weighted average expenditures:
Current Year:
| Weighted Average $450,000 x Annual Interest Rate 10% = Related Interest Expense $ 45,000 |
Compute the total interest expense during the construction period and make sure the amount you computed to capitalize is not higher than the actual interest expense. Do not capitalize interest greater than actual interest expense incurred during the construction period.
$3,000,000 x 10% x 7/12 (May to Nov) = $175,000
4th: Record the payments to the contractor for each year and the interest expense:
| Retail Stores 1,200,000 Cash 1,200,000 Retail Stores 45,000 |
13. A company incurred the following costs associated with a coal mine:
| Cost of Land | $200,000 |
| Development Cost | $320,000 |
| Estimated Restoration Costs | $190,000 |
| Estimated Annual Costs of Operations | $600,000 |
The coal mine is expected to produce 20,000 tons of coal over the 10 year life of the mine. The company expects to sell the land after all coal is mined for approximately $100,000. Current year production was 880 tons.
Make the required journal entries associated with the coal mine for the current year.
Answer
| Coal Mine $710,000 Cash $520,000 Restoration liability $190,000 |
The restoration costs are paid over the life of production as necessary.
| Operating Expenses $600,000 Cash $600,000 |
Costs that are incurred each year are expensed (no future benefit)
Depletion Expense:
Cost – Residual Value / total units = cost per unit
$710,000 – $100,000 / 20,000 = $30.50 per ton
| Tons Produced current year: 880 x Cost per ton $30.50 = Depletion Expense $26,840 |
| Depletion Expense 26,840 Coal Mine 26,840 |
A. Legal fees paid to an outside attorney related to a trademark
B. Closing costs related to purchase of an office building
C. Survey costs related to purchasing a plot of land
D. The difference in fair market value of net assets and the amount paid when buying a company
E. Major overhaul to the engine of a truck to extend the life
F. Repairs and maintenance that is done monthly
G. Bulldozing a building on land purchased
H. Training employees to use a new machine
I. Salaries paid to develop a patent
J. Landscaping that will be done every 3 years
Answer
B. Building – prior to using
C. Land – prior to using
D. Goodwill
E. Truck – future benefit, subsequent expenditure, extends the life
F. Repairs & Maintenance expense – no future benefit
G. Land – building is no longer, must do to get land ready for use
H. Machine – prior to use
I. Salary expense – inside the company
J. Land improvements (asset) – future benefit.
Does not go to land because land is not depreciated
15. The company purchased the following assets for a total cost of $1,340,000. The assets were appraised at a fair market value of:
| Land | $400,000 |
| Building | $600,000 |
| Equipment | $250,000 |
Make the journal entry to record the purchase.
Answer
| Asset | FMV | % of Total |
| Land | 400,000 | .32 |
| Building | 600,000 | .48 |
| Equipment | 250,000 | .20 |
| Total | 1,250,000 | 1.00 |
2nd: Using the allocated FMV percentage to allocate the amount paid to each asset:
| Asset | Cost | % of Total | Allocated Cost |
| Land | 1,340,000 | .32 | $ 428,800 |
| Building | 1,340,000 | .48 | $ 643,200 |
| Equipment | 1,340,000 | .20 | $ 268,000 |
| Total | 1,340,000 | 1.00 | $1,340,000 |
3rd: Record the purchase using the allocated costs to each asset
| Land 428,800 Building 643,200 Equipment 268,000 Cash 1,340,000 |