CHAPTER 9

Long-Lived assets

CHAPTER STUDY OBJECTIVES

1. Calculate the cost of property, plant, and equipment. The cost of property, plant, and equipment includes all costs that are necessary to acquire the asset and make it ready for its intended use. All costs that benefit future periods (that is, capital expenditures) are included in the cost of the asset. When applicable, cost also includes asset retirement costs. When multiple assets are purchased in one transaction, or when an asset has significant components, the cost is allocated to each individual asset or component using their relative fair values.

2. Apply depreciation methods to property, plant, and equipment. After acquisition, assets are accounted for using the cost model or the revaluation model. Depreciation is recorded and assets are carried at cost less accumulated depreciation. Depreciation is the allocation of the cost of a long-lived asset to expense over its useful life (its service life) in a rational and systematic way. Depreciation is not a process of valuation and it does not result in an accumulation of cash. There are three commonly used depreciation methods:

Effect on Annual

Method Depreciation Calculation

Straight-line Constant amount (Cost − residual value) ÷

estimated useful life

(in years)

Diminishing- Diminishing Carrying amount at

balance amount beginning of year ×

diminishing-balance rate

Units-of- Varying (Cost − residual value) ÷

production amount total estimated units-of-

production × actual

activity during the year

Each method results in the same amount of depreciation over the asset’s useful life. Depreciation expense for income tax purposes is called capital cost allowance (CCA).

3. Explain the factors that cause changes in periodic depreciation and calculate revised depreciation for property, plant, and equipment. A revision to depreciation will be required if there are (a) capital expenditures during the asset’s useful life; (b) impairments in the asset’s fair value; (c) changes in the asset’s fair value when using the revaluation model; and/or (d) changes in the appropriate depreciation method, estimated useful life, or residual value. An impairment loss must be recorded if the recoverable amount is less than the carrying amount. Revisions of periodic depreciation are made in present and future periods, not retroactively. The new annual depreciation is determined by using the depreciable amount (carrying amount less the revised residual value), and the remaining useful life, at the time of the revision.

4. Demonstrate how to account for property, plant, and equipment disposals. The accounting for the disposal of a piece of property, plant, or equipment through retirement or sale is as follows:

(a) Update any unrecorded depreciation for partial periods since depreciation was last recorded.

(b) Calculate the carrying amount (cost – accumulated depreciation).

(c) Calculate any gain (proceeds > carrying amount) or loss (proceeds < carrying amount) on disposal.

(d) Remove the asset and accumulated depreciation accounts at the date of disposal. Record the proceeds received and the gain or loss, if any.

An exchange of assets is recorded as the purchase of a new asset and the sale of an old asset. The new asset is recorded at the fair value of the asset given up plus any cash paid (or less any cash received). The fair value of the asset given up is compared with its carrying amount to calculate the gain or loss. If the fair value of the new asset or the asset given up cannot be determined, the new long-lived asset is recorded at the carrying amount of the old asset that was given up, plus any cash paid (or less any cash received).

5. Record natural resource transactions and calculate depletion. The units-of-production method of depreciation is generally used for natural resources. The depreciable amount per unit is calculated by dividing the total depreciable amount by the number of units estimated to be in the resource. The depreciable amount per unit is multiplied by the number of units that have been extracted to determine the annual depreciation. The depreciation and any other costs to extract the resource are recorded as inventory until the resource is sold. At that time, the costs are transferred to cost of resource sold on the income statement. Revisions to depreciation will be required for capital expenditures during the asset’s useful life, for impairments, and for changes in the total estimated units of the resource.

6. Identify the basic accounting issues for intangible assets and goodwill. The accounting for tangible and intangible assets is much the same. Intangible assets are reported at cost, which includes all expenditures necessary to prepare the asset for its intended use. An intangible asset with a finite life is amortized over the shorter of its useful life and legal life, usually on a straight-line basis. The extent of the annual impairment tests depends on whether IFRS or ASPE is followed and whether the intangible asset had a finite or indefinite life. Intangible assets with indefinite lives and goodwill are not amortized and are tested at least annually for impairment. Impairment losses on goodwill are never reversed under both IFRS and ASPE.

7. Illustrate the reporting and analysis of long-lived assets. It is common for property, plant, and equipment, and natural resources to be combined in financial statements under the heading “property, plant, and equipment.” Intangible assets with finite and indefinite lives are sometimes combined under the heading “intangible assets” or are listed separately. Goodwill must be presented separately. Either on the balance sheet or in the notes, the cost of the major classes of long-lived assets is presented. Accumulated depreciation (if the asset is depreciable) and carrying amount must be disclosed either in the balance sheet or in the notes. The depreciation and amortization methods and rates, as well as the annual depreciation expense, must also be indicated. The company’s impairment policy and any impairment losses should be described and reported. Under IFRS, companies must include a reconciliation of the carrying amount at the beginning and end of the period for each class of long-lived assets and state whether the cost or revaluation model is used.

The asset turnover ratio (net sales ÷ average total assets) is one measure that is used by companies to show how efficiently they are using their assets to generate sales revenue. A second ratio, return on assets (profit ÷ average total assets), calculates how profitable the company is in terms of using its assets to generate profit.

Exercises

Exercise 1

Ed Harris Company was organized on January 1. During the first year of operations, the following expenditures and receipts were recorded in random order in the account, Land:

Debits

1. Cost of real estate purchased as a plant site (land and building). $ 320,000

2. Legal fees paid at the time of the purchase of the real estate. 6,500

3. Cost of demolishing building to make land suitable for construction

of a new building 12,000

4. Architect's fees on building plans. 14,000

5. Excavation costs for new building. 24,000

6. Cost of filling and grading the land. 5,000

7. Insurance and taxes during construction of building. 6,000

8. Cost of repairs to building under construction caused by a small fire. 14,000

9. Interest paid during the year, of which $ 52,000 pertains to the

construction period 64,000

10. Full payment to building contractor. 760,000

11. Cost of parking lots and driveways. 36,000

12. Property taxes paid for the current year on the land. 4,000

Total Debits $ 1,265,500

Credits

13. Insurance proceeds for fire damage. $ 10,000

14. Proceeds from residual of demolished building. 3,500

Total Credits $ 13,500

Instructions

Analyze the above transactions using the columns below. Insert the number of each transaction in the item space and insert the amounts in the appropriate columns.

Land

Item Land Improvements Building Other Account Title

Exercise 2

Rainbow Logistics purchased land with the intention of building an office. Rainbow also engaged other contractors for fencing, paving, lighting, landscaping, and to remove a dilapidated building to make room for new office building. The following information relates to these transactions:

• Purchased land for $ 350,000.
• Paid $ 4,000 for seller's back property taxes.
• Paid $ 22,000 to have the dilapidated building removed.
• Paid a builder $ 400,000 to design and build the office building.
• Paid an excavation company $ 20,000 to grade and clear the land to make it suitable for building purposes.
• Paid a landscaping company $ 10,000 for trees and shrubs.
• Paid a contractor $ 16,000 for outside lighting around the parking area and sidewalks.
• Paid $ 26,000 to have the parking lot paved.
• Paid a fence builder $ 15,000 to construct a security fence around the property.

Instructions

Determine the cost of the land, the building, and the land improvements.

Exercise 3

Identify the following expenditures as capital expenditures or operating expenditures:

1. Replacement of worn out gears on factory machinery

2. Construction of a new wing on an office building

3. Painting the exterior of a building

4. Oil change on a company truck

5. Replacing a network server’s hard drive, this increases data storage capacity by ten times. No extension of useful life expected

6. Overhaul of a truck motor. One year extension in useful life is expected

7. Purchased a wastebasket, with an expected useful life of five years, at a cost of $ 10

8. Painting and lettering of a used truck upon acquisition of the truck

Exercise 4

Below are selected entries for Joanna Co.:

1. The $ 60 cost of repairing a printer was charged to Equipment.

2. The $ 5,000 cost of a major engine overhaul was debited to Repairs Expense. The overhaul is expected to increase the operating efficiency of the truck.

3. The $ 6,000 closing costs associated with the acquisition of land were debited to Legal Fees Expense.

4. A $ 600 charge for transportation costs on new equipment purchased was debited to Delivery Expense.

5. Freight cost incurred bringing a new piece of equipment to the plant site was charged to Equpment.

Instructions

For each entry below make a correcting entry if necessary. If the entry given is correct, then state "No entry required."

Exercise 5

Below are transactions for Oriel Company:

1. Purchased land for $ 900,000.

2. Paid $ 20,000 to demolish building located on land.

3. Paid $ 3,000 for building permit.

4. Paid $ 2,000 for architect fees.

5. Paid $ 3,000 for excavation costs.

6. Paid interest of $ 22,000 during construction of new building.

7. Paid $ 960,000 to complete the building.

8. Paid $ 30,000 to pave the parking lot.

9. Paid $ 4,000 for underground sprinkler.

10. Ordered new equipment, paid $ 30,000.

11. Paid $ 1,500 to install and test new equipment.

12. Paid $ 250 to insure equipment for one year.

13. P aid $ 2,500 to paint office walls in the new building.

14. Paid $ 2,000 to repair equipment.

15. Purchased a truck for $ 25,000.

16. Paid $ 250 for truck license.

17. Paid $ 60 for oil change on new truck.

18. Paid $ 15,000 for fences around the new building.

19. Purchased two cash registers for $ 1,100 each.

20. Paid $ 2,200 for annual yard maintenance.

Instructions

a) Determine if each item should be capitalized (C) or expensed (E).

b) Determine the balance in the land account and the building account.

Exercise 6

Extra Company purchased land for $ 115,000 with the intentions of constructing a new operating facility. The land purchase included a dilapidated building that was removed at a cost of $ 16,000. The only salvage value from this old building was some materials which were sold for proceeds of $ 4,000. Extra had paid surveying costs of $ 1,800 and legal fees related to land transfer of $ 6,700. The new building was quickly constructed at a total cost of $ 422,000. Architectural drawings and permits on the construction of this new facility totaled $ 18,000 and $ 10,650 respectively. Insurance premiums of $ 9,200 are paid annually. The production manager is currently on-site facilitating the production start-up. This manager has an annual salary of $ 85,000.

Instructions

a) Calculate the acquisition cost of the land. Identify each element of cost clearly.

b) Calculate the acquisition cost of the new building. Identify each element of cost clearly.

Exercise 7

On August 1, 2021, Mark Leamington Engineering paid $ 1,000,000 in a lump-sum purchase of land, building, and equipment. The payment consisted of $ 200,000 cash and a note payable for the balance. An appraisal revealed the following fair values at the time of the purchase:

Land $ 500,000

Building 450,000

Equipment 250,000

Instructions

Prepare the necessary journal entry to record this lump-sum purchase (round all percentage calculations to two decimal places).

Exercise 8

Shen Athletics purchased factory equipment with an invoice price of $ 92,000. Other costs incurred were freight costs, $ 2,500; installation of wiring and foundation, $ 2,200; material and labour costs in testing equipment, $ 700; oil lubricants and supplies to be used with equipment, $ 500; one-year fire insurance policy covering equipment, $ 1,400. The equipment is estimated to have an $ 8,000 residual value at the end of its 5-year useful service life.

Instructions

a) Calculate the acquisition cost of the equipment. Identify each element of cost clearly.

b) If the double diminishing-balance method of depreciation was used, the constant percentage applied to a diminishing carrying amount would be ______.

Exercise 9

Dufferin Company uses the straight-line method of depreciation. The company's fiscal year end is December 31. The following transactions and events occurred during the first three years.

2020 Jul 1 Purchased a new computer system from the Computer Centre for $ 37,000 cash and shipping costs of $ 250.

Nov 3 Incurred ordinary repairs on computer of $ 3,280.

Dec 31 Recorded 2020 depreciation on the basis of an estimated five-year life and residual value of $ 1,250.

2021 Dec 31 Recorded 2021 depreciation.

2022 Jan 1 Paid $ 9,800 for a major upgrade of the computer. This expenditure is expected to increase the operating efficiency and capacity of the computer.

Instructions

Prepare the necessary entries. (Show calculations.)

Exercise 10

On March 31, 2021 Holland Industries purchased assets for $ 2,500,000 cash. Before completing the purchase, Holland had an appraisal completed to determine the relative value of each of the assets included in the purchase price.

The appraisal indicated that the fair value of the land, if purchased separately, would be $ 375,000, the building’s value is $ 1,900,000, the manufacturing equipment $ 192,500, and the office and computer equipment $ 55,000. In addition to the land, building and equipment, the purchase price includes inventory with a net realizable value of $ 27,500.

The anticipated life of the building is 25 years, the manufacturing equipment 10 years, and the office and computer equipment 5 years, with no residual value for any of them. Holland has a December 31 year end.

Instructions

a) Record the purchase on March 31, 2021.

b) Record the depreciation expense for 2021 using the straight-line method assuming the company chooses to prorate depreciation based on the number of months the asset has been in use.

Exercise 11

On May 5, 2021 Vermilion River Adventures purchased a property for $ 400,000 cash. The property included the following long-lived assets:

Appraised Value

Land $ 120,000

Building 200,000

Equipment 100,000

Paved area 20,000

Outdoor Lighting 10,000

$ 450,000

Instructions

a) Give the journal entry to allocate the purchase price between the above assets. Round all amounts to the nearest dollar, if necessary.

b) Prepare a compound journal entry to record depreciation of the long-lived assets on December 31, 2021, assuming the following additional details:

Useful Life in Years Residual Value

Building 30 $ 20,000

Equipment 5 10,000

Paved area 4 -0-

Outdoor Lighting 10 -0-

Prorate depreciation based on the number of months the asset has been in use.

Exercise 12

Independent Energy depreciates all assets using the straight-line method. The company's fiscal year end is December 31. The following selected transactions and events occurred during the first three years:

2020 Jan 1 Purchased equipment from the Equipment World for $ 214,500 on account. Independent Energy also incurred freight and installation costs of $ 1,500 and $ 4,000 respectively.

Sep 30 Paid for annual insurance of $ 4,200 and routine maintenance of $ 1,700 for the machine. The insurance policy expires on September 30, 2021.

Dec 31 Recorded 2020 depreciation on the basis of an estimated 10-year useful life and residual value of $ 20,000.

2021 Dec 31 Recorded 2021 depreciation and impairment loss (if any). Independent Energy conducted an impairment assessment as indicators suggested that an impairment may be possible. It was determined that the recoverable amount of the equipment is currently $ 160,000. The estimated residual value remained unchanged.

2022 Dec 31 Independent Energy sold the equipment to Engaged Auto Company for proceeds of $ 140,000.

Instructions

Prepare the necessary entries. (Show calculations.)

Exercise 13

Das Gym purchased new equipment for $ 175,000. It is estimated that the equipment will have a $ 15,000 residual value at the end of its 5-year useful service life. The double diminishing-balance method of depreciation will be used.

Instructions

Prepare a depreciation schedule which shows the annual depreciation expense on the equipment for its 5-year life.

Exercise 14

Randy Automotive purchased equipment on October 1, 2021, at a total cost of $ 150,000. The machine has an estimated useful life of 8 years or 100,000 hours, and an estimated residual value of $ 10,000. During 2021 and 2022, the machinery was used 4,400 and 12,800 hours, respectively.

Instructions

Compute depreciation expense at December 31, 2021 and December 31, 2022, under the following depreciation methods:

2021 2022

Straight-line depreciation ________ ________

Units-of-production depreciation ________ ________

Double diminishing-balance depreciation ________ ________

Exercise 15

Equipment acquired on October 1, 2021 at a cost of $ 540,000 has an estimated useful life of 10 years. The residual value is estimated to be $ 55,000 at the end of the equipment's useful life. The company has a December 31 year end.

Instructions

Calculate the depreciation expense for December 31, 2021 and 2022 using:

a) the straight-line method.

b) the double diminishing-balance method.

Exercise 16

On October 1, 2021 Stan Auto Rentals purchases a new automobile for $ 30,000 to add to its fleet of rental cars. The automobiles are rented out on a short-term basis with rental fees calculated based on distance driven by the customer. Welch’s policy is to sell and replace a car after the earlier of 3 years, or 75,000 kilometres. The average selling price of the used cars is $ 8,000. This particular car was driven 8,000 km in 2021, 39,000 km in 2022 and 21,000 km in 2023.

Instructions

a) Calculate 2021 and 2022 depreciation expense under each of the following methods:

(i) Straight-line

(ii) Diminishing-balance using a 40% rate

(iii) Units-of-production

b) Which method will best match the estimated pattern in which the asset’s economic benefits are expected to be consumed? Explain.

Exercise 17

Sangria Boat Lifts purchased equipment on January 1, 2021 for $ 96,000. It is estimated that the equipment will have a $ 5,000 residual value at the end of its 8-year useful life. It is also estimated that the equipment will produce 100,000 units over its 8-year life.

Instructions

Answer the following independent questions.

a) Calculate the amount of depreciation expense for the year ended December 31, 2021, using the straight-line method of depreciation.

b) If 16,000 units of product are produced in 2021 and 36,000 units are produced in 2022, what is the carrying amount of the equipment at December 31, 2022 using the units-of-production depreciation method?

c) If the company uses the double diminishing-balance method of depreciation, what will be the balance of the Accumulated Depreciation—Equipment account at December 31, 2023?

Exercise 18

The Picnic Basket, a popular pizza restaurant, has a thriving delivery business. The Picnic Basket has a fleet of three delivery automobiles. Information related to the fleet is as follows:

Accumulated

Estimated Life Depreciation Kilometres Operated

Car Cost Residual Value in Kilometres Beg. of the Year During Year

1 $ 18,000 $ 3,000 50,000 $ 2,100 20,000

2 15,000 2,400 60,000 1,890 22,000

3 20,000 2,500 70,000 2,000 19,000

Instructions

Using the units-of-production method:

a) Determine the depreciation rates per kilometre for each car.

b) Determine the depreciation expense for each car for the current year.

c) Make one compound journal entry to record the annual depreciation expense for the fleet.

Exercise 19

The Northwood Clinic purchased a new surgical laser for $ 75,000. The estimated residual value is $ 7,500. The laser has a useful life of four years and the clinic expects to use it 10,000 hours. It was used 1,600 hours in year 1; 2,100 hours in year 2; 3,400 hours in year 3; 2,900 hours in year 4.

Instructions

a) Calculate the annual depreciation for each of the four years under each of the following methods:

i) straight-line

ii) units-of-production

b) If you were the administrator of the clinic, which method would you deem as most appropriate? Justify your answer.

c) Which method would result in the lowest reported profit in the first year? Which method would result in the lowest total reported profit over the four-year period?

d) Which method would result in the lowest cash flow in Year 1? Over the life of the asset?

Exercise 20

Gordon’s Garage purchased a specialized machine on April 1, 2021 for a total cost of $ 254,000 from Scissor Manufactory. This machine is expected to become outdated and be replaced in 16 years at which time it will have a residual value of $ 25,000.

Instructions

1. What amount would be reported as depreciation expense for this machine on Gordon’s income statement for December 31, 2021 and December 31, 2022 under the following depreciation methods? (rounded to two decimals)
2. Straight-line method

ii) Double diminishing-balance method

1. What is the machine’s carrying amount at January 1, 2023 under both depreciation methods discussed in part a)?

Exercise 21

Prairie Airlines purchased a 747 aircraft on January 1, 2020, at a cost of $ 30,000,000. The estimated useful life of the aircraft is 20 years, with an estimated residual value of $ 4,000,000. On January 1, 2022 the airline revises the total estimated useful life to 15 years with a revised residual value of $ 3,000,000.

Instructions

a) Calculate the depreciation and carrying amount at December 31, 2021 using the straight-line method and the double diminishing-balance method.

b) Assuming the straight-line method is used, calculate the depreciation expense for the year ended December 31, 2022.

Exercise 22

Winningham Company sold the following two machines in 2021:

Machine A Machine B

Cost $ 92,000 $ 43,000

Purchase date July 1, 2017 Jan. 1, 2017

Useful life 8 years 8 years

Residual value $ 4,000 $ 3,000

Depreciation method Straight-line Double diminishing-balance

Date sold July 1, 2021 Aug. 1, 2021

Sales price $ 37,000 $ 12,000

Instructions

Journalize all entries required to update depreciation and record the sales of the two assets in 2021. The company has recorded depreciation on the machine to December 31, 2020.

Exercise 23

Paper Products Inc. sold two machines in 2021. The following information pertains to the two machines:

Purchase Useful Residual Depreciation Sales

Machine Cost Date Life Value Method Date Sold Price

#1 $ 86,000 7/1/17 5 yrs. $ 6,000 Straight-line 7/1/21 $ 20,000

#2 $ 50,000 7/1/20 5 yrs. $ 5,000 Double diminishing- 12/31/21 $ 32,000

balance

Instructions

a) Calculate the accumulated depreciation on each machine at the date of disposal.

b) Prepare the journal entries in 2021 to record 2021 depreciation and the sale of each machine.

Exercise 24

Mendelsohn Company purchased equipment on January 1, 2021 at a cost of $ 48,000. The equipment is expected to have an estimated residual value of $ 3,000 at the end of its 5-year life. The company’s new accountant has used the double diminishing-balance method to depreciate the equipment at December 31, 2021. However, the company has a policy of using the straight-line method to depreciate equipment. Profit for the year ended December 31, 2021 was $ 55,000 as the result of depreciating the equipment incorrectly.

Instructions

Using the method of depreciation which the company normally follows, prepare the correcting entry and determine the corrected profit. (Show calculations.)

Exercise 25

Equipment was acquired on January 1, 2019, at a cost of $ 90,000. The equipment was originally estimated to have a residual value of $ 5,000 and an estimated life of 10 years. Depreciation has been recorded through December 31, 2020, using the straight-line method. On January 1, 2021 the estimated residual value was revised to $ 6,000 and the useful life was revised to a total of 8 years.

Instructions

Determine the depreciation expense for 2021.

Exercise 26

On January 1, 2020, Katsumi Company purchased and installed a telephone system at a cost of $ 20,000. The equipment was expected to last five years with a residual value of $ 3,000. On January 1, 2021 more telephone equipment was purchased to compliment the current system for $ 8,000. The new equipment is expected to have a useful life of four years. Through an error, the new equipment was debited to Telephone Expense. Katsumi Company uses the straight-line method of depreciation.

Instructions

Prepare a schedule showing the effects of the error on Telephone Expense, Depreciation Expense, and profit for each year and in total beginning in 2021 through the useful life of the new equipment.

Telephone Expense Depreciation Expense Profit

Overstated Overstated Overstated

Year (Understated) (Understated) (Understated)

———————————————————————————————————————————

2021

2022

2023

2024

Exercise 27

Harrison Rentals purchased an apartment building in 2013. At the time, the building was expected to have a useful life of 25 years with a residual value of $ 100,000, during which time it was projected to generate annual rentals of $ 30,000). The building’s original cost was $ 500,000.

At January 1, 2021 the accumulated depreciation balance on this building was $ 128,000, and 2021 depreciation has been calculated as $ 16,000. Harrison has a December 31 year end.

During January 2021 Harrison had the following events and transactions related to the building. All transactions are for cash.

1. Painted all the walls in the common areas at a cost of $ 8,000.

2. Replaced the electrical wiring in three suites due to safety concerns at a cost of $ 4,500.

3. Replaced all of the linoleum flooring in the suites with hardwood, installed in-suite laundry facilities in each unit, and made other improvements at total cost of $ 120,000. As a result, the annual rental revenue has been doubled.

4. Completed structural repairs to the building at a cost of $ 100,000. As a result of this work the building life is expected to be 10 years longer than the original estimate. The residual value estimate has been revised to $ 134,000.

Instructions

a) Calculate the carrying amount of the building on December 31, 2021. Provide explanations for any increases to building cost.

b) Record the 2022 depreciation expense using the straight-line basis, assuming that the increased rental rates go into effect January 1, 2022.

Exercise 28

At January 1, 2021 Penner Auto Repairs owned the following assets:

Prior to recording depreciation expense for 2021, Penner undertook a review of the assets’ remaining life and value and determined that the following changes are warranted based on currently available information:

Building: No changes

Automotive: No changes

Computers: Obsolete

Furniture: Remaining life will be 10 years with $ 5,000 residual value.

Instructions

Calculate 2021 depreciation on each of these assets, taking the new information into account.

Exercise 29

Redwood Company performs an assessment annually for possible impairment losses and has gathered the following information pertaining to selected assets at December 31, 2021:

Instructions

Determine if the assets identified by Redwood are impaired and prepare any necessary adjusting entries to record the impairments.

Exercise 30

The following assets were sold by DNC Company during the 2021 fiscal year. The company’s year end is December 31.

Instructions