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Chapter 7 Problem Session Exercise Long-term Assets

Problem I: Indicate whether each of the following statements is true (T) or false (F).

a. ___ The cost of an intangible asset, such as a patent or goodwill, should be capitalized
regardless of whether the intangible asset was purchased or created internally by the
company.

b. ___ When more than one operating asset is purchased at the same time for a single cost, the
cost assigned to each asset should be allocated based on the relative fair market values of
the assets.

c. ___ Land is not subject to depreciation while land improvements are subject to depreciation.

d. ___ The allocation of cost of a natural resource is called amortization.

e. ___ All purchased intangible assets are subject to amortization.

f. ___ The accounting definition of depreciation refers to the decrease in an operating assets
fair market value over its useful life.

g. ___ The process of recording depreciation is an application of the matching principle.

h. ___ The balance in the Accumulated Depreciation account should be reported on the income
statement.

i. ___ As an asset is depreciated, its book value will decrease.

j. ___ Regardless of the depreciation method used, the book value of a depreciable asset at the
end of its useful life should be equal to its residual (or salvage) value.

k. ___ Regardless of the depreciation method used, the accumulated depreciation balance at the
end of an assets useful life should be equal to its depreciable cost which is calculated by
taking the difference between its cost and residual value.

l. ___ The gain or loss on the disposal of a long-term asset can be determined by comparing the
assets book value to the fair market value received (ex. cash received).

m. ___ All else being equal, if Wolfpack Company has a higher return on assets than Tarheel
Inc., Wolfpack is using its operating assets more effectively than Tarheel.

n. ___ The return on assets ratio can be separated into two components, profit margin and asset
turnover, in order to provide a better analysis of what is driving the ratio.

o. ___ A company may use a depreciation method for tax purposes which is different than the
one it uses for financial statement purposes.

Problem II: A local company purchased an industrial machine on January 1, 20X4. The machine was placed into
service on March 1, 20X4. Below are various costs incurred related to the machine that occurred either before or after
it was placed into service. For each of these costs, indicate by using a checkmark () whether the cost should be
capitalized as part of the assets cost or expensed in the period incurred. The chart indicates when the costs were
incurred.

In addition, in the column to the far right, indicate the name of the account which should be debited when the
transaction involving this cost is incurred. The first one has been one as an example.
Capitalized Expensed Account name to be debited
Costs Incurred Between January 1, 20X4, and March 1, 20X4,
Before the Asset was Placed into Service

1. base invoice price of $10,000 Machine
2. sales taxes
3. insurance paid to cover a possible loss
while the machinery was in transit

4. shipping charges
5. installation charges
6. test run charges
Costs Incurred Between March 1, 20X4,
and the End of the Assets Useful Life

7. insurance paid to cover a loss while the
asset is being used over its useful life

8. ordinary repairs and maintenance costs
9. extraordinary repair cost
10. property taxes paid related to the
machine


Problem III: On January 1, 20X4, Woodson Distributors Inc. purchased a machine costing $48,000. The
machine is estimated to have a residual value of $2,000 and a four year life.

A. In the following chart, compare how much depreciation expense should be recorded each year of the
assets life if the company uses the straight-line versus the double-declining balance depreciation (DDB)
method.

Straight-line Method DDB Method
Year 1
Year 2
Year 3
Year 4

Total over all four years

B. What do you notice about the total amount of depreciation taken over the entire life of the asset under
both methods?


C. What do you notice about the pattern of depreciation taken over the entire life of the asset under both
methods?


D. In 20X4 (year one), all else being equal, which method would yield the highest income before income
tax, highest income tax expense, and highest net income?

E. In 20X4 (year one), all else being equal, which method would yield the lowest income before income tax,
lowest income tax expense, and lowest net income?

F. If total income tax expense over the entire four years is the same, what is the advantage of having the
most tax savings in year one versus year four?



G. Assuming a calendar year-end, the journal entry to record depreciation expense at the end of 20X4 using
the straight-line method would be as follows:
Debit Credit
12/31/X4


H. If the company uses the straight-line method. What will be the balance in the Accumulated Depreciation
account at the end of 20X7? What will be the book value at the end of 20X7?


I. If the company uses the DDB method. What will be the balance in the Accumulated Depreciation
account at the end of 20X7? What will be the book value at the end of 20X7?


J. If the asset had been placed into service on March 1, 20X4 instead, what would be the amount of
depreciation recorded for the year ending 12/31X4 under each of the methods?