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CRT 8

Chapter 8 covers operating assets, including property, plant, equipment, and intangibles, focusing on their balance sheet disclosures, acquisition costs, and depreciation methods. It explains how to determine capital expenditures versus revenue expenditures and the impact of asset disposals on financial statements. Additionally, the chapter discusses the treatment of intangible assets and the importance of accurate asset valuation for investors.

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0% found this document useful (0 votes)

19 views46 pages

CRT 8

Uploaded by

Jihane Qadadri

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

CHAPTER 8

Operating Assets: Property, Plant,

and Equipment, and Intangibles
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Understand balance sheet disclosures for 11* 30 Mod
operating assets.

2. Determine the acquisition cost of an operating asset. 1 10 Easy

3. Explain how to calculate the acquisition cost of assets 2 20 Mod

purchased for a lump sum.

4. Describe the impact of capitalizing interest as part of the 12* 5 Easy

acquisition cost of an asset.

5. Compare depreciation methods and understand the factors 3 20 Mod

affecting the choice of method. 4 15 Mod
12* 5 Easy

6. Understand the impact of a change in the estimate of the asset 5 15 Mod

life or residual value.

7. Determine which expenditures should be capitalized as asset costs 11* 30 Mod

and which should be treated as expenses.

8. Analyze the effect of the disposal of an asset at a gain or loss. 6 15 Mod

7 15 Mod

9. Understand the balance sheet presentation of intangible assets. 13* 10 Mod

10. Understand the proper amortization of intangible assets. 8 15 Easy

13* 10 Mod

11. Explain the impact that long-term assets have on the statement 9 5 Mod
of cash flows. 10 5 Mod

12. Understand how investors can analyze a company’s

operating assets.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

8-1
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-2 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Understand balance sheet disclosures for
operating assets. 6* 30 Mod

2. Determine the acquisition cost of an operating asset. 7* 15 Diff

3. Explain how to calculate the acquisition cost of assets 1 20 Mod

purchased for a lump sum. 6# 30 Mod

4. Describe the impact of capitalizing interest as part of the

acquisition cost of an asset.

5. Compare depreciation methods and understand the factors 2 10 Easy

affecting the choice of method. 3 15 Mod
6* 30 Mod
7* 15 Diff
8# 20 Mod

6. Understand the impact of a change in the estimate of the asset 9* 10 Mod

life or residual value.

7. Determine which expenditures should be capitalized as asset costs 6# 20 Mod

and which should be treated as expenses. 8* 20 Mod

8. Analyze the effect of the disposal of an asset at a gain or loss. 6* 30 Mod

8* 20 Mod
10* 35 Mod

9. Understand the balance sheet presentation of intangible assets. 6** 30 Mod

11* 20 Diff

10. Understand the proper amortization of intangible assets. 6** 30 Mod

9* 10 Mod
11* 20 Mod

11. Explain the impact that long-term assets have on the statement 4 15 Mod
of cash flows. 5 40 Diff
10* 35 Mod
11* 20 Diff
12. Understand how investors can analyze a company’s
operating assets.

*Exercise, problem, or case covers two or more learning outcomes

**Alternate problem only
#Original problem only
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES 8-3

Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Understand balance sheet disclosures for 1* 20 Mod
operating assets. 2* 20 Mod
3* 20 Mod

2. Determine the acquisition cost of an operating asset.

3. Explain how to calculate the acquisition cost of assets 5 25 Mod

purchased for a lump sum.

4. Describe the impact of capitalizing interest as part of the

acquisition cost of an asset.

5. Compare depreciation methods and understand the factors 3* 20 Mod

affecting the choice of method. 4 25 Mod
6 15 Mod

6. Understand the impact of a change in the estimate of the asset

life or residual value.

7. Determine which expenditures should be capitalized as asset costs

and which should be treated as expenses.

8. Analyze the effect of the disposal of an asset at a gain or loss.

9. Understand the balance sheet presentation of intangible assets. 1* 20 Mod

2* 20 Mod

10. Understand the proper amortization of intangible assets.

11. Explain the impact that long-term assets have on the statement
of cash flows.

12. Understand how investors can analyze a company’s

operating assets.

*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-4 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

QUESTIONS

1. Operating assets include property, plant, and equipment, and intangibles. They are
generally presented in two categories on the balance sheet: (1) Property, Plant, and
Equipment and (2) Intangible Assets. Examples of assets considered operating as-
sets are buildings, equipment, land, land improvements, patents, copyrights, and
goodwill. Operating assets are important to the long-term future of the company be-
cause they are the assets used to produce a product or service sold to customers.
The operating assets allow a company to produce a product efficiently and remain
competitive with other firms.
2. The acquisition cost of an operating asset includes all the costs normally necessary
to acquire the asset and prepare it for its intended use. Acquisition costs include the
purchase price, freight costs, installation costs, taxes paid at the time of purchase,
and repairs made to prepare the asset for use.
3. The acquisition cost of assets purchased as a group should be determined by allo-
cating the purchase price on the basis of the proportion of the fair market value to
the total fair market value. Market value is best established by an independent ap-
praisal of the property. If such appraisal is not possible, the accountant must rely on
the market value of other similar assets, on the value of the assets in tax records, or
on other available evidence.
4. It is important to separately account for the cost of land and building because the
amount allocated to a building represents a depreciable amount, while the amount
allocated to land does not. Land is not a depreciable asset.
5. Generally, interest on borrowed money should be treated as an expense of the
period. If a company buys an asset and borrows money to finance the purchase, the
interest on the borrowed money is not considered part of the asset’s cost. Therefore,
interest is treated as a period cost and should appear on the income statement as
interest expense in the period incurred. There is one exception to this general guide-
line. If a company constructs an asset over a period of time and borrows money to
finance the construction, the interest incurred during the construction period is not
treated as interest expense. Instead, the interest must be included as part of the ac-
quisition cost of the asset.
6. The decline in usefulness of an operating asset is related to physical deterioration
factors, such as wear and tear. It is also related to obsolescence and technological
factors and to the repair and maintenance of the asset. A company should use a de-
preciation method that allocates the original cost of the asset to the periods bene-
fited and that allows the company to accurately match the expense to the revenue
generated by the asset. However, the company is not required to use the same
method for all depreciable assets. Actually, it is not unusual for a company to use
two different depreciation methods for the same asset, one for financial reporting
purposes and another one for tax purposes.

7. The straight-line method is the most popular method of depreciation for several rea-
sons, including its simplicity and ease of application. It is most appropriate for assets
that experience a decline in usefulness related to the passage of time. It may also be
used by companies that wish to report a stable income over time.
8. When the straight-line method or units-of-production method is used, the residual
value should be deducted from the acquisition cost to determine the depreciable
amount to be allocated over the useful life of the asset. When the double-declining-
balance method is used, the residual value is not deducted. However, the asset
should not be depreciated to an amount that is lower than the residual value.
9. Companies may use one method of depreciation for financial reporting and another
method for tax purposes because the objectives are different. The accountant’s
purpose in recording depreciation for financial reporting purposes is to allocate the
original cost of the asset to the periods benefited in a manner that matches the de-
cline in usefulness of the asset. The accountant’s purpose in recording depreciation
for tax purposes is to minimize the amount of income tax that must be paid.
10. If an estimate must be changed, the change in estimate should be recorded pros-
pectively over the remaining life of the asset. Past amounts recorded for deprecia-
tion are not changed or altered. The remaining depreciable amount should be
recorded over the remaining life of the asset, using the revised estimate or estimates
of residual value and asset life.
11. A capital expenditure is an amount that must be capitalized or added to the value of
the asset. A revenue expenditure is an outlay that should be recorded as an ex-
pense in the year incurred. An item should be treated as a capital expenditure if it in-
creases the life or productivity of the asset. Otherwise, the amount should be treated
as a revenue expenditure.
12. The gain or loss on the sale of an asset should be calculated as the difference be-
tween the selling price and the book value of the asset as of the date of sale. In or-
der to calculate the correct gain or loss on the sale of the asset, depreciation must
be recorded up to the date of the sale. A gain occurs when the selling price of the
asset exceeds its book value. A loss occurs when the selling price of the asset is
less than its book value. The account Gain on Sale of Asset or Loss on Sale of As-
set should appear on the income statement in the Other Income/Expense category.
13. Patents, copyrights, trademarks, and goodwill are examples of intangible assets.
Some companies have a separate category on the balance sheet titled Intangibles
for such assets. Other companies include intangibles in a category titled Long-Term
Assets or in the Other Assets category of the balance sheet.
14. Goodwill represents the difference between the acquisition price paid to acquire a
business and the total of the fair market values of the identifiable net assets ac-
quired. Goodwill can be recorded as an asset only when one company acquires
another. It cannot be recorded on the basis of internally generated factors that some
may refer to as goodwill.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-6 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

15. An argument in favor of expensing R&D is that it allows comparability among firms,
since all firms must record the item as an expense. Also, it is argued that R&D
should be expensed because it is very difficult to determine whether an asset exists
and, if it does exist, what periods are benefited by the asset. On the other hand,
many argue that R&D is an asset and should be recorded on the balance sheet.
They believe that if R&D is not recorded, the balance sheet is seriously understated.
16. The current view of the FASB is that some intangible assets have a limited life and
should be amortized over their legal life or useful life, whichever is shorter. However,
some intangible assets are thought to have an “indefinite life” and should not be
amortized. This treatment of intangibles has been debated extensively, and many
disagree with the current view. Some would argue that the value of almost all intang-
ible assets eventually becomes diminished and therefore amortization should be
recognized.
17. Amortization should occur over the shorter of the legal life or useful life. For exam-
ple, a patent has a legal life of 20 years. But if the invention under patent will be
useful over only ten years, then the patent should be amortized over the shorter ten-
year period.
18. If an intangible becomes worthless, the asset should be written off as an expense in
the period when the decline in value occurs. If the intangible continues to have value
but will provide benefit over a period shorter than was originally estimated, the event
should be treated as a change in estimate. The portion of the intangible that is un-
amortized should be amortized over the remaining life of the asset.

BRIEF EXERCISES

LO 1 BRIEF EXERCISE 8-1 PROPERTY, PLANT, AND EQUIPMENT CLASSIFICATION

All of these accounts would be in the Property, Plant, and Equipment category except
for Patent, which would be in the Intangibles category.

LO 2 BRIEF EXERCISE 8-2 DETERMINE ACQUISITION COST

Transportation costs—yes
Installation costs—yes
Repair costs incurred at time of purchase—yes, if it was known at the time of purchase
that the item needed repair
Repair costs incurred after the asset has been installed and used—no
Interest on loan to purchase the asset—no

LO 3 BRIEF EXERCISE 8-3 LUMP-SUM PURCHASE

Land $ 700,000
Building 300,000
Total $1,000,000

Land: $800,000 × ($700,000/$1,000,000) = $560,000

Building: $800,000 × ($300,000/$1,000,000) = $240,000

LO 4 BRIEF EXERCISE 8-4 CAPITALIZATION OF INTEREST

$1,000,000 × 12/12 $1,000,000

$2,000,000 × 6/12 1,000,000
$1,000,000 × 1/12 83,333
Average accumulated expenditures $2,083,333

LO 5 BRIEF EXERCISE 8-5 DEPRECIATION METHODS

1. Straight-line rate of 1/10 × 2 = 20%*

2. First-year depreciation: $40,000 × 20%* = $8,000
Second-year depreciation: ($40,000 – $8,000) × 20%* = $6,400
3. The maximum amount that can be treated as depreciation over ten years is $36,000.
(*$40,000 – $4,000** residual value = $36,000).
*This rate, 1/10 × 2= 20%, will be applied in all years to the asset’s book value at the
beginning of each year. As depreciation is recorded, the book value declines. Thus,
a constant rate is applied to a declining amount. This constant rate is applied to the
full cost or initial book value, not to cost minus residual value as in the other
methods. However, the machine cannot be depreciated below its residual value of
$4,000.**

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-8 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 6 BRIEF EXERCISE 8-6 CHANGE IN DEPRECIATION ESTIMATE

Depreciation for 2012 and 2013:

($10,000 – $1,000)/10 years = $900 per year × 2 years = $1,800
Depreciation for 2014:
Remaining depreciable amount $8,200 – $1,000 = $ 7,200
Divided by remaining life ÷ 5 years
Depreciation $ 1,440
Acquisition cost, January 1, 2012 $ 10,000
Less: Accumulated depreciation (2 years at $900 per year) 1,800
Book value, January 1, 2014 $ 8,200
Less: Residual value 1,000
Remaining depreciable amount $ 7,200
Depreciation = Remaining Depreciable Amount/Remaining Life
Depreciation = $7,200/5 years
= $1,440

LO 7 BRIEF EXERCISE 8-7 CAPITAL EXPENDITURE

Original cost, January 1, 2012 ........................................................... $ 10,000

Less: Accumulated depreciation (2 years at $900 per year) ............. 1,800
Book value, January 1, 2014 ............................................................. $ 8,200
Plus: Major overhaul.......................................................................... 5,000
Less: Residual value ......................................................................... (1,000)
Remaining depreciable amount ......................................................... $ 12,200
Depreciation = Remaining Depreciable Amount/Remaining Life
Depreciation per Year = $12,200/10 years
= $1,220

LO 8 BRIEF EXERCISE 8-8 SALE OF ASSET

Loss = Book Value – Sales Price

$6,000 = $20,000 – X
Solving for X indicates sales price, and cash received was $14,000.

Hint: This machine had to be sold for $20,000, which is the book value at the time of the
sale in order to have no loss or gain on the sale.

LO 9 BRIEF EXERCISE 8-9 CLASSIFICATION OF INTANGIBLE ASSETS

Patents—intangible asset and amortized*

Copyrights—intangible asset and amortized*
Research and development—not an intangible asset
Goodwill—intangible asset and not amortized
The company’s advantageous location—not an intangible asset that is recognized on
the balance sheet
Broadcast rights—intangible asset and may be amortized if it has a finite life*
Hint: Intangible assets are long-lived and have no physical properties but provide rights
or privileges. An intangible asset with a limited life should be amortized over the shorter
of its legal life or useful life. Intangibles with an indefinite life should not be amortized.
Research and development costs are not considered to be an intangible asset and are
treated as an expense instead. Goodwill is an intangible asset. It is not amortized but
must be evaluated every year to determine any impairment in value.
*Since these intangibles have a limited life, they should be amortized.

LO 10 BRIEF EXERCISE 8-10 AMORTIZATION OF INTANGIBLE

Amortization for 2012 and 2013: $12,000/12 years = $1,000 per year
Amortization for 2014: $10,000*/5 years = $2,000
*In 2014 patent = $12,000 – $2,000 = $10,000

LO 11 BRIEF EXERCISE 8-11 OPERATING ASSETS AND CASH FLOWS

Depreciation of an operating asset—Operating category

Gain on the sale of an asset—Operating category
Amortization of an intangible—Operating category
Loss on the sale of an asset—Operating category
Amount paid to purchase an asset—Investing category
Amount received upon sale of an asset—Investing category

LO 12 BRIEF EXERCISE 8-12 ANALYSIS OF OPERATING ASSETS

Average Life of the Assets = Property, Plant, and Equipment/Depreciation Expense

= $10,000/$1,000 = 10 years
Average Age of the Assets = Accumulated Depreciation/Depreciation Expense
= $5,000/$1,000 = 5 years
Asset Turnover = Sales/Average Total Assets
Average Total Assets = ($30,000 + $40,000)/2 = $35,000
Asset Turnover = $62,000/$35,000 = 1.77

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-10 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISES

LO 2 EXERCISE 8-1 ACQUISITION COST

The acquisition cost of the asset should be computed as follows:

List price ...................................................................................... $60,000
Less: Discount of 2% ................................................................... (1,200)
Freight.......................................................................................... 1,000
Pollution control device ................................................................ 2,500
Architect’s fee .............................................................................. 6,000
Total acquisition cost ................................................................... $68,300
Note: Repair costs of $4,000 are not included because they are not normal or neces-
sary to the acquisition.
Insurance cost of $8,000 should be treated as prepaid insurance.
Interest cost of $3,000 is not included unless an asset is constructed over time.

LO 3 EXERCISE 8-2 LUMP-SUM PURCHASE

1. The total market value is calculated as follows:

Land ............................................................................................. $200,000
Building ........................................................................................ 150,000
Equipment .................................................................................... 250,000
Total ............................................................................................. $600,000
Amount allocated to each account should be as follows:
Land $520,000 × $200,000/$600,000 = $173,333
Building $520,000 × $150,000/$600,000 = $130,000
Equipment $520,000 × $250,000/$600,000 = $216,667

EXERCISE 8-2 (Concluded)

The journal entry would be as follows:

Journal Jan. 1 Land ............................................................. 173,333

Entry Building ........................................................ 130,000
Analysis Equipment .................................................... 216,667
Cash ....................................................... 520,000
To record the purchase of assets for a
lump-sum amount.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Land 173,333
Build-
ing 130,000
Equip-
ment
216,667
Cash
(520,000)

2. The amount of depreciation expense that should be recorded for 2014 is as follows:
Land = $0
Building $130,000/20 years = $6,500
Equipment $216,667/20 years = $10,833

3. The assets would appear on the balance sheet as follows:

Long-term assets:
Land .................................................................. $173,333
Building .............................................................. $130,000
Less: Accumulated depreciation .................. 6,500 123,500
Equipment ......................................................... $216,667
Less: Accumulated depreciation .................. 10,833 205,834
Total long-term assets ....................................... $502,667

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-12 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 5 EXERCISE 8-3 STRAIGHT-LINE AND UNITS-OF-PRODUCTION METHODS

Depreciation, accumulated depreciation, and book value for the straight-line method
should be as follows:
Annual Accumulated Book
Year Depreciation Depreciation Value
2014 $10,800* $10,800 $49,200
2015 10,800 21,600 38,400
2016 10,800 32,400 27,600
2017 10,800 43,200 16,800
2018 10,800 54,000 6,000
*($60,000 – $6,000)/5 years = $10,800 per year

The estimated total number of units to be produced is

10,000 + 20,000 + 30,000 + 40,000 + 50,000 = 150,000 units.

Depreciation Expense per Unit = (Acquisition Cost – Residual Value)/Life in Units

= ($60,000 – $6,000)/150,000 units
= $0.36 per unit
Depreciation, accumulated depreciation, and book value for the units-of-production
method should be as follows:
Annual Accumulated Book
Year Depreciation Depreciation Value
2014 10,000 × $0.36 = $ 3,600 $ 3,600 $56,400
2015 20,000 × $0.36 = 7,200 10,800 49,200
2016 30,000 × $0.36 = 10,800 21,600 38,400
2017 40,000 × $0.36 = 14,400 36,000 24,000
2018 50,000 × $0.36 = 18,000 54,000 6,000

Students may note that the units-of-production method results in a depreciation pattern
in this exercise that is the opposite of accelerated depreciation. That is appropriate be-
cause of the pattern of usage of the asset.

LO 5 EXERCISE 8-4 ACCELERATED DEPRECIATION

1. Accumulated Book Value

Year Annual Depreciation Depreciation at end of Yr. 1 becomes
beginning Yr. 2 and so on
2014 40%* × $6,000 = $2,400 $2,400 $3,600
2015 40% × 3,600 = 1,440 3,840 2,160
2016 40% × 2,160 = 864 4,704 1,296
2017 40% × 1,296 = 518 5,222 778
2018 178** 5,400 600
*Straight-line rate: 100%/5 years = 20%; double the straight-line rate = 40%. This
40% rate will be applied in all years to the asset’s book value at the beginning of
each year. As depreciation is recorded, the book value declines. Thus, a constant
rate is applied to a declining amount. This constant rate is applied to the full cost or
initial book value, not to cost minus residual value as in the other methods. How-
ever, the machine cannot be depreciated below its residual value of $600.
**Since the asset should not be depreciated below residual value, the amount to be
recorded the last year 2018 is $6,000 – $5,222 – $600 = $178.

Journal Dec. 31 Depreciation Expense .................................. 2,400

Entry Accumulated Depreciation ...................... 2,400
Analysis To record depreciation for 2014.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accumulated
Deprecia- Depreciation
tion* (2,400) (2,400) Expense 2,400 (2,400)
*The Accumulated Depreciation account has increased. It is shown as a decrease in the equation above because it is a contra account and
causes total assets to decrease.

3. Koffman may believe that the double-declining-balance method best matches the
decline in usefulness of the asset with the revenues produced by the asset. Koffman
may also choose this method because it allows more depreciation to be taken in the
early years of the asset life and thus delays taxes until the later years.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-14 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 6 EXERCISE 8-5 CHANGE IN ESTIMATE

1. Depreciation, accumulated depreciation, and book value for the straight-line method
should be as follows:
Accumulated
Year Depreciation Depreciation Book Value
2014 $ 8,000* $ 8,000 $72,000
2015 8,000 16,000 64,000
2016 15,500** 31,500 48,500
2017 15,500 47,000 33,000
2018 15,500 62,500 17,500
2019 15,500 78,000 2,000
*($80,000 – $8,000)/9 years = $8,000
**$64,000 – $2,000 = $62,000
$62,000/4 years = $15,500

Acquisition cost, January 1, 2014 ................................................ $80,000

Less: Accumulated depreciation
(2 years at $8,000 per year) ................................................... 16,000
Book value, January 1, 2016 ....................................................... $64,000
Less: Residual value .................................................................... 2,000
Remaining depreciable amount ................................................... $62,000
Depreciation = Remaining Depreciable Amount/Remaining Life
Depreciation = $62,000/4 years
= $15,500

2. Depreciation for 2014 and 2015 was not wrong. The company used the best infor-
mation available at that time to develop its estimate of depreciation. The information
available in 2016 made it necessary to revise the estimate of depreciation. This illu-
strates the difference between a change in estimate and a correction of an error.

LO 8 EXERCISE 8-6 ASSET DISPOSAL

Journal July 1 Depreciation Expense .................................. 4,500

Entry Accumulated Depreciation—Asset ......... 4,500
Analysis To record depreciation of asset to July 1 for ½ year 2014.
($60,000 – $6,000)/6 years = $9,000 per year.
$9,000 × 6/12 = $4,500.
Note: In order to calculate the correct gain or loss on the sale of the asset,
depreciation must be recorded up to the date of the sale.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accum. Depr.
—Asset* Depreciation
(4,500) (4,500) Expense 4,500 (4,500)
*The Accumulated Depreciation account has increased. It is shown as a decrease in the equation above because it is a contra account and
causes total assets to decrease.

Journal July 1 Cash............................................................. 40,000

Entry Accumulated Depreciation—Asset ............... 22,500*
Analysis Asset ....................................................... 60,000
Gain on Sale of Asset ............................. 2,500**
To record sale of the asset.
Balance Sheet Income Statement
STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accum. Depr. Gain on Sale
—Asset of Asset
22,500* 2,500 2,500** 2,500
Cash 40,000
Asset
(60,000)
*The Accumulated Depreciation account has decreased. It is shown as an increase in the equation above because it is a contra account
and causes total assets to increase.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-16 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISE 8-6 (Concluded)

The depreciation for 2014 is calculated as follows:

($60,000 – $6,000)/6 years = $9,000 per year
$9,000 × 6/12 = $4,500 for 2014
*Accumulated depreciation at time of sale:
Depreciation for 2012 and 2013—($9,000 × 2) $18,000
Depreciation for 2014...................................... 4,500
Total ................................................................ $22,500
**Gain on sale is calculated as follows:
Asset cost ....................................................... $60,000
Less: Accumulated depreciation ..................... 22,500
Book value ...................................................... $37,500
Sale price ........................................................ 40,000
Gain on sale .................................................... $ 2,500

2. The gain or loss should appear in the Other Income category of the income state-
ment to indicate that it is not part of the normal operating activity of the company. A
gain occurs when the selling price of the asset exceeds its book value. A loss occurs
when the selling price of the asset is less than its book value. The account Gain on
Sale of Asset or Loss on Sale of Asset should appear on the income statement in
the Other Income/Expense category because it is not part of the normal operating
activity of the company.

LO 8 EXERCISE 8-7 ASSET DISPOSAL

Journal July 1 Depreciation Expense .................................. 4,500

Entry Accumulated Depreciation—Asset ......... 4,500
Analysis To record depreciation to July 1 for ½ year 2014.
($60,000 – $6,000)/6 years = $9,000 per year.
$9,000 × 6/12 = $4,500.

Balance Sheet Income Statement

EXERCISE 8-7 (Concluded)

Journal July 1 Cash............................................................. 15,000

Entry Note Receivable ........................................... 15,000
Analysis Accumulated Depreciation—Asset ............... 22,500
Loss on Sale of Asset .................................. 7,500
Asset ....................................................... 60,000
To record sale of the asset.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Cash 15,000 Loss on Sale
Note Receiv- (7,500) of Asset 7,500** (7,500)
able 15,000
Asset
(60,000)
Accum. Depr.
—Asset
22,500*
*The Accumulated Depreciation account has decreased. It is shown as an increase in the equation above because it is a contra account
and causes total assets to increase.
**The loss on sale is calculated as follows:
Asset cost $60,000
Less: Accumulated depreciation 22,500
Book value $37,500
Sale price 30,000
Loss on sale $ 7,500

LO 10 EXERCISE 8-8 AMORTIZATION OF INTANGIBLES

Trademark is not amortized because it has an indefinite life.

Amortization expense = $0
Accumulated amortization = $0

Patent amortization = $50,000/10 years = $5,000

Accumulated amortization = $5,000 × 6 years = $30,000

Copyright amortization = $80,000/20 years = $4,000

Accumulated amortization = $4,000 × 3 years = $12,000

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8-18 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 11 EXERCISE 8-9 IMPACT OF TRANSACTIONS INVOLVING OPERATING ASSETS ON

STATEMENT OF CASH FLOWS

Purchase of land: I
Proceeds from sale of land: I
Gain on sale of land: O
Purchase of equipment: I
Depreciation expense: O
Proceeds from sale of equipment: I
Loss on sale of equipment: O

LO 11 EXERCISE 8-10 IMPACT OF TRANSACTIONS INVOLVING INTANGIBLE ASSETS

ON STATEMENT OF CASH FLOWS

Cost incurred to acquire copyright: I

Proceeds from sale of patent: I
Gain on sale of patent: O
Research and development costs: N
(not separately reported as an operating activity)
Amortization of patent: O

MULTI-CONCEPT EXERCISES

LO 1,7 EXERCISE 8-11 CAPITAL VERSUS REVENUE EXPENDITURES

1. The following entries should be made to capitalize costs:

Jan. 1

Journal Building ................................................................. 40,000

Entry Cash ............................................................... 40,000
Analysis To record cost of new conveyor system.
Balance Sheet Income Statement
STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Build-
ing 40,000
Cash (40,000)

EXERCISE 8-11 (Continued)

Journal Delivery Truck ....................................................... 5,000

Entry Cash ............................................................... 5,000
Analysis To record cost of hydraulic lift installed on truck.
Balance Sheet Income Statement
STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Delivery
Truck 5,000
Cash (5,000)

Note: Some may choose to capitalize the engine overhaul costs of $4,000 and the
window repair costs of $10,000. However, both costs appear to keep the asset in its
normal operating condition and are more properly treated as expenses.

2. The entry to record depreciation should be as follows:

Journal Dec. 31 Depreciation Expense .................................. 14,322

Entry Accumulated Depreciation—Building ...... 9,739
Analysis Accumulated Depreciation—Truck ......... 4,583
To record 2014 depreciation.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accum. Depr. Depreciation
—Building (14,322) Expense 14,322 (14,322)
(9,739)*
Accum. Depr.
—Truck
(4,583)*
*The Accumulated Depreciation accounts have increased. They are shown as decreases in the equation above because they are contra
accounts and cause total assets to decrease.

The depreciation for 2014 should be calculated as follows:

Building Truck
Original cost ............................................................ $200,000 $20,000
Less: Depreciation for 2012 and 2013 .................... 16,000* 6,667**
Book value .............................................................. $184,000 $13,333
Plus: Capitalized costs ............................................ 40,000 5,000
Depreciable amount ................................................ $224,000 $18,333
Depreciation per year on building
($224,000/23 years left) .................................... $ 9,739
Depreciation per year on truck
($18,333/4 years left) ......................................... $ 4,583
*$200,000/25 years = $8,000 depreciation per year × 2 years = $16,000
**$20,000/6 years = $3,333 depreciation per year × 2 years = $6,667

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8-20 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISE 8-11 (Concluded)

3. The assets should appear on the 2014 balance sheet as follows:

Building ................................................................... $240,000
Less: Accumulated depreciation ............................. 25,739* $214,261
Truck ....................................................................... $ 25,000
Less: Accumulated depreciation ............................. 11,250** 13,750
Total property, plant, and equipment ...................... $228,011
*$8,000 + $8,000 + $9,739 = $25,739
**$3,333.50 + $3,333.50 + $4,583 = $11,250

LO 4,5 EXERCISE 8-12 CAPITALIZATION OF INTEREST AND DEPRECIATION

1. $200,000 + $8,000 = $208,000

2. The amount of depreciation expense for 2014 is zero because the asset was not
completed and put into use until January 1, 2015. The amount of depreciation ex-
pense for 2015 is $200,000 + $8,000 – $5,000 = $203,000/20 years = $10,150.

LO 9,10 EXERCISE 8-13 RESEARCH AND DEVELOPMENT AND PATENTS

a. All research and development costs should be treated as an expense. The 2014 in-
come statement should reflect an expense of $20,000.
b. Patent costs should be treated as an asset. The 2014 balance sheet should reflect a
Patent account of $10,000 – ($10,000/5 years) = $8,000.
c. The $8,000 cost of defending the patent should be added to the Patent account and
reflected in the 2015 balance sheet.
2014 amortization = $10,000/5 years = $2,000
2015 amortization = $10,000 – $2,000 amortization from 2014 + $8,000 infringement
= $16,000
$16,000/4 years = $4,000 amortization for 2015

PROBLEMS

LO 3 PROBLEM 8-1 LUMP-SUM PURCHASE OF ASSETS AND SUBSEQUENT EVENTS

1. Relative fair values:

Section 1 ................................................................. $ 630,000 50%
Section 2 ................................................................. 378,000 30
Section 3 ................................................................. 252,000 20
Total ........................................................................ $1,260,000 100%

Section
1 2 3
50% 30% 20%
(a) $1,260,000 $630,000 $378,000 $252,000
(b) 1,560,000 780,000 468,000 312,000
(c) 1,000,000 500,000 300,000 200,000

2. The purchase of the land has no effect on total assets. Current assets (cash) de-
clines and long-term assets (land) increases and, therefore, only the composition of
assets on the balance sheet is changed.
3. Carter would be concerned with the value assigned to each section if it intended to
sell one or two sections and keep others. Carter would want the section it intended
to sell to be assigned the highest value in order to defer a gain. The value assigned
to buildings would be depreciated; therefore, Carter would want more value as-
signed to the buildings in order to depreciate them and take advantage of the tax
shield.

LO 5 PROBLEM 8-2 DEPRECIATION AS A TAX SHIELD

If the asset is not purchased, the company must pay income tax of $50,000 × 35% =
$17,500.
If the asset is purchased, the company should record depreciation of $20,000 per
year. The amount of income tax the company must pay is $50,000 – $20,000 = $30,000
× 35% = $10,500.
The amount of the depreciation tax shield is the amount of income tax saved by pur-
chase of the asset, or $17,500 – $10,500 = $7,000. The depreciation tax shield can also
be expressed as the amount of depreciation each year times the tax rate, or $20,000 ×
35% = $7,000.

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8-22 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 5 PROBLEM 8-3 BOOK VERSUS TAX DEPRECIATION

1. Year Straight-Line – MACRS = Difference

1 $ 5,600* $ 6,720 $(1,120)
2 5,600 10,750 (5,150)
3 5,600 6,450 (850)
4 5,600 3,870 1,730
5 5,600 3,870 1,730
6 5,600 1,940 3,660
$33,600 $33,600 $ 0
*$33,600/6 years = $5,600 per year

2. The president is correct that a total of $33,600 will be deducted as depreciation un-
der either method over the six-year life. However, the memo should stress that all
other things being equal, Griffith should prefer MACRS for taxes, since it results in
the payment of less income tax during the early years in the life of the truck. Money
received earlier is preferable to money received later (time value of money).
The memo should also stress that it is important to analyze the tax position of
Griffith carefully. A variety of other factors may be important in the choice of a de-
preciation method for tax purposes.
The memo should also stress to the president that not only is it legal, but it is also
not a violation of GAAP to use one method of depreciation for the books and a dif-
ferent one for tax purposes. Using straight-line depreciation for the books will tend to
even out the income over the life of the asset and will report higher income in the
earlier years than would be reported if an accelerated method, such as MACRS, is
used.

LO 11 PROBLEM 8-4 DEPRECIATION AND CASH FLOW

1. O’HARE COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2014
Service revenue ........................................................................... $100,000
Depreciation expense .................................................................. 15,000
Net income ................................................................................... $ 85,000

2. The amount of the net cash inflow for 2014 is $100,000.

3. The amount of the net income ($85,000) does not equal the amount of the net cash
inflow ($100,000) because of depreciation expense. Depreciation is an expense on
the income statement but does not involve a cash outlay. For that reason, deprecia-
tion must be “added back” to net income to determine the amount of the net cash in-
flow.

PROBLEM 8-4 (Concluded)

4. If O’hare develops a cash flow statement using the indirect method, the Operating
category should appear as follows:
Cash Flow from Operating Activities:
Net income ................................................................................... $ 85,000
Plus: Depreciation ........................................................................ 15,000
Net cash from operations ............................................................. $100,000

LO 11 PROBLEM 8-5 RECONSTRUCT NET BOOK VALUES USING STATEMENT OF CASH

FLOWS

1. Book value of equipment at time of sale:

Book value of copyright at time of sale:

2. Net book value of property, plant, and equipment at December 31, 2013:
Net book value at 12/31/13 .......................................... $ X
Plus purchases during 2014 ........................................ 292,000
Less book value of equipment sold during 2014.......... (350,000)*
Less 2014 depreciation ............................................... (672,000)
Net book value at 12/31/14 .......................................... $4,459,000
X + $292,000 – $350,000 – $672,000 = $4,459,000
X = $5,189,000

3. Net book value of intangibles at December 31, 2013:

Net book value at 12/31/13 .......................................... $ X
Plus payment of legal fees during 2014 ....................... 15,000
Less book value of copyright sold during 2014 ............ (20,000)**
Less 2014 amortization ............................................... (33,000)
Net book value at 12/31/14 .......................................... $673,000
X + $15,000 – $20,000 – $33,000 = $673,000
X = $711,000

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8-24 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

MULTI-CONCEPT PROBLEMS

LO 1,3,5,7,8 PROBLEM 8-6 COST OF ASSETS, SUBSEQUENT BOOK VALUES, AND

BALANCE SHEET PRESENTATION

1. Values assigned to each asset:

a. Value at time of purchase: $14,000 + $4,800 = $18,800
b. Allocation of purchase price:
Supplies expense $2,400 × $200/$3,200* = $ 150
Office furniture $2,400 × $600/$3,200* = 450
Equipment $2,400 × $2,400/$3,200* = 1,800
*Market value for purchases = $200 + $600 + $2,400 = $3,200
c. Value of this prepaid license expense: .............................................. $1,500
d. Cost of truck ...................................................................................... $12,000
Less: Accumulated depreciation at time
of sale [($12,000 – $800) × 5/8] ................................................... 7,000
Book value ......................................................................................... $ 5,000
2. Depreciation or other expense recorded for each asset during 2014:
a. ($18,800 – $800)/4 years = $4,500
b. Supplies expense $150
Depreciation of office furniture $450/9 years = 50
Depreciation of equipment $1,800/4 years = 450
c. $1,500/3 years = $500 × 11/12 = $458
d. Depreciation $11,200/8 years = $1,400 × 8/12 = $933
Book value at the time of sale ...................................................... $5,000
Sale price ..................................................................................... 4,800
Loss on sale of truck .................................................................... $ (200)
3. Balance Sheet Presentation:
Current assets:
Prepaid license expense ($1,500 – $458) .............. $ 1,042
Property, plant, and equipment:
Truck ...................................................................... $18,800
Office furniture........................................................ 450
Equipment .............................................................. 1,800
$21,050
Less: Accumulated depreciation
($4,500 + $50 + $450) ...................................... (5,000)
Property, plant, and equipment, net ....................... $16,050

LO 2,5 PROBLEM 8-7 COST OF ASSETS AND THE EFFECT ON DEPRECIATION

1. $165,000/10 years = $16,500 depreciation. The correct amount of depreciation is

$19,700 [($150,000 + $15,000 + $4,000 + $25,000 + $3,000)/10 years].
2. Reported income in Year 1 is $51,500 ($100,000 – $16,500 – $25,000 – $4,000 –
$3,000). Reported income should be $80,300 ($100,000 – $19,700).
3. A cost is the amount incurred to acquire an asset or pay an expense, and an
expense is the amount of an expired asset or a cost that is incurred to generate
revenue.

LO 5,7,8 PROBLEM 8-8 CAPITAL EXPENDITURES, DEPRECIATION, AND DISPOSAL

1. The entry to record depreciation for 2013 is as follows:

Journal Dec. 31 Depreciation Expense .................................. 14,000

Entry Accumulated Depreciation—Building ...... 14,000
Analysis To record depreciation for 2013.
($364,000 – $14,000)/25 = $14,000.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accum. Depr.
—Building* Depreciation
(14,000) (14,000) Expense 14,000 (14,000)
*The Accumulated Depreciation account has increased. It is shown as a decrease in the equation above because it is a contra account and
causes total assets to decrease.

The entries for 2014 are as follows:

Journal Jan. 1 Repairs Expense .......................................... 21,000

Entry Cash, Payables, etc. ............................... 21,000
Analysis To record repairs in 2014.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Repairs
Cash (21,000) (21,000) Expense 21,000 (21,000)

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8-26 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 8-8 (Continued)

Journal Jan. 1 Building ........................................................ 42,000

Entry Cash ....................................................... 42,000
Analysis To record pollution control equipment.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Build-
ing 42,000
Cash (42,000)

The depreciation for 2013 should be calculated as follows:

($364,000 – $14,000)/25 years = $14,000 for 2013.
The depreciation for 2014 should be calculated as follows:
Original cost ........................................................... $ 364,000
Less: 2013 depreciation ......................................... (14,000)
Less: Residual value .............................................. (14,000)
Plus 2014 capitalized costs .................................... 42,000
Depreciable amount ............................................... $ 378,000
Remaining asset life ............................................... ÷ 30 years
Depreciation ........................................................... $ 12,600

Journal Dec. 31 Depreciation Expense .................................. 12,600

Entry Accumulated Depreciation—Building ...... 12,600
Analysis To record depreciation for 2014.

Balance Sheet Income Statement

STOCKHOLDERS’ NET
ASSETS = LIABILITIES + EQUITY REVENUES – EXPENSES = INCOME
Accum. Depr.
—Building* Depreciation
(12,600) (12,600) Expense 12,600 (12,600)
*The Accumulated Depreciation account has increased. It is shown as a decrease in the equation above because it is a contra account and
causes total assets to decrease.

2. The pollution control equipment extended the life of the asset and should be capita-
lized rather than expensed. It is difficult to determine whether Merton would rather
expense or capitalize the equipment. If the company can expense the equipment for
tax purposes, it would normally desire to do so.

PROBLEM 8-8 (Concluded)

3. Original cost of building................................................................ $364,000

Pollution device capitalized .......................................................... 42,000
Less: 2013 depreciation...................................................... (14,000)
2014 depreciation...................................................... (12,600)
Book value 1/1/2015 .................................................................... $379,400
Less: 2015 depreciation ($12,600 × 3/12) .......................... 3,150
Book value at sale........................................................................ $376,250
Sale proceeds .............................................................................. 392,000
Gain on sale ................................................................................. $ 15,750
If the pollution equipment had been expensed (and original life of 25 years was used
for depreciation purposes):
Original cost............................................................................ $364,000
Less: Accumulated depreciation ($14,000 × 2 1/4 years) ....... 31,500
Book value at 4/1/2015 ........................................................... $332,500
Sale proceeds......................................................................... 392,000
Gain on sale ........................................................................... $ 59,500

LO 6,10 PROBLEM 8-9 AMORTIZATION OF INTANGIBLE, REVISION OF RATE

1. The $85,000 of research and development costs should be recorded as an expense.

The $11,900 of legal costs to acquire the patent should be capitalized in a Patent
account.

2. *Reynosa should record $595 of amortization expense each fiscal year, for a total of
$2,975 ($595 per year × 5 years) = $2,975.
$11,900/20 years = $595 per year

3. Reynosa should record a loss of $8,925.

Original cost of patent .................................................................. $11,900
Less: Amortization for 5 years ................................................ 2,975*
Book value, 10/1/2014 ............................................................ $ 8,925

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8-28 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 8,11 PROBLEM 8-10 PURCHASE AND DISPOSAL OF OPERATING ASSET AND

EFFECTS ON STATEMENT OF CASH FLOWS

1. Partial statement of cash flows for 2014:

Cash flows from operating activities:
Net income ........................................................................ $ XX,XXX
Plus: Depreciation expense............................................... 12,000
Cash flows from investing activities:
Purchase of machinery ..................................................... (104,000)
Partial statement of cash flows for 2015:
Cash flows from operating activities:
Net income ........................................................................ $ XX,XXX
Plus: Depreciation expense ............................................. 12,000
Loss on sale of machinery ...................................... 5,000
Cash flows from investing activities:
Purchase of machinery ..................................................... (205,000)
Proceeds from sale of machinery (see below) .................. 75,000
Book value at time of sale ($104,000 – $12,000 – $12,000) ........ $ 80,000
Sale price ............................................................................... X
Loss on sale of machinery ...................................................... $ 5,000
$80,000 – X = $5,000
X = $75,000

2. Castlewood would replace machinery if the replacement would result in additional

net income in the future. Any additional revenues generated as a result of a possible
increase in production capacity (that is, the ability to make and thus sell more prod-
uct) and any costs that could be saved by automating the production process (for
example, lower wages) would increase net income. On the other hand, this increase
would be offset by the costs of acquiring and operating the new machinery.

LO 9,10,11 PROBLEM 8-11 AMORTIZATION OF INTANGIBLES AND EFFECTS ON

STATEMENT OF CASH FLOWS

1. 2014 amortization expense:

Accumulated amortization at 12/31/13 ........................ $ 102,000
Plus 2014 amortization expense.................................. X
Accumulated amortization at 12/31/14 ........................ $ 119,000
$102,000 + X = $119,000
X = $17,000

2. Acquisition cost:
Cost of patent ................................................................... $ X
Less accumulated amortization at 12/31/14 ................ (119,000)
Carrying value at 12/31/14 .......................................... $ 170,000
X – $119,000 = $170,000
X = $289,000
Year acquired:
Accumulated amortization at 12/31/14 $ 119,000
Divided by annual amortization ÷ 17,000
Years owned 7 years
It was acquired in 2008.
Estimated useful life:
Cost of patent $ 289,000
Divided by estimated useful life ÷ X years
Annual amortization $ 17,000
$289,000/X = $17,000
X = 17 years
The acquisition cost of $289,000 would have been reported as an outflow in the In-
vesting Activities section of the 2008 statement of cash flows.

3. Assuming the indirect method is used, the amortization expense relating to the pa-
tent would be added back to net income in the Cash Flows from Operating Activities
section of the statement of cash flows.

4. The proceeds from the sale of $200,000 would be reported as an inflow in the Cash
Flows from Investing Activities section of the statement of cash flows. In addition, the
gain on the sale of $30,000 ($200,000 – $170,000) would be subtracted from net in-
come in the Cash Flows from Operating Activities section of the statement of cash
flows.

ALTERNATE PROBLEMS

LO 3 PROBLEM 8-1A LUMP-SUM PURCHASE OF ASSETS AND SUBSEQUENT EVENTS

1. Relative fair values:

Piece 1 $200,000 23.8%
Piece 2 200,000 23.8
Piece 3 440,000 52.4
Total $840,000 100.0%
Piece
1 2 3
23.8% 23.8% 52.4%
(a) $480,000 $114,240 $114,240 $251,520
(b) 680,000 161,840 161,840 356,320
(c) 800,000 190,400 190,400 419,200

2. The purchase does not affect total assets; it affects only the composition of the as-
sets. Cash is a current asset; equipment is a long-term asset.

LO 5 PROBLEM 8-2A DEPRECIATION AS A TAX SHIELD

If asset is not purchased:

Annual income tax is $62,000 × 30% = $18,600
If asset is purchased:
Income Before Tax Depreciation Income Tax
and Depreciation Expense Before Tax 30%
2014 $62,000 $24,000* $38,000 $11,400
2015 62,000 14,400 47,600 14,280
2016 62,000 8,640 53,360 16,008
2017 62,000 5,184 56,816 17,045
2018 62,000 7,776** 54,224 16,267
Total $75,000
*Straight-line rate = 1/5, or 20%; double-declining-balance rate = 2 × 20% = 40%, 2014
depreciation = 40% × $60,000 = $24,000
**To bring accumulated depreciation to $60,000.

PROBLEM 8-2A (Concluded)

Total tax if not purchased:

$18,600 × 5 years ........................................................................ $93,000
Total tax if purchased................................................................... 75,000
Depreciation tax shield................................................................. $18,000
The tax shield if Rummy uses the straight-line method is $60,000 × 30%, or $18,000.
Rummy would choose accelerated depreciation because the company would save tax
earlier.

LO 5 PROBLEM 8-3A BOOK VERSUS TAX DEPRECIATION

1. Year Straight-Line – MACRS = Difference

1 $ 4,700* $ 5,650 $ (950)
2 4,700 9,025 (4,325)
3 4,700 5,400 (700)
4 4,700 3,250 1,450
5 4,700 3,250 1,450
6 4,700 1,625 3,075
$28,200 $28,200 $ 0
*$28,200/6 years = $4,700 per year

2. The president is correct that a total of $28,200 will be deducted as depreciation

under either method over the six-year life. However, the memo should note that all
other things being equal, Payton should prefer MACRS for taxes, since it results in
lower taxes during the early years in the life of the truck. Money received earlier is
preferable to money received later (time value of money).
The memo should also stress that it is important to analyze the tax position of
Payton Delivery Service carefully. A variety of other factors may be important in the
choice of a depreciation method for tax purposes.
The memo should also stress to the president that not only is it legal, but it is also
not a violation of GAAP to use one method of depreciation for the books and a dif-
ferent one for tax purposes. Using straight-line depreciation for the books will tend to
even out the income over the life of the asset and will report higher income in the
earlier years than would be reported if an accelerated method, such as MACRS, is
used.

LO 11 PROBLEM 8-4A AMORTIZATION AND CASH FLOW

1. 2014 income = $500,000 – $62,500 – $50,000 = $387,500

2. Cash on hand, December 31, 2014 = $500,000 – $62,500 = $437,500
3. Cash increased from revenue and decreased by cash expenses. The amount is dif-
ferent than income for 2014 because amortization, like depreciation, is an expense
but not a cash outflow. The cost of long-term assets like a copyright is a cash out-
flow when it is purchased.

LO 11 PROBLEM 8-5A RECONSTRUCT NET BOOK VALUES USING STATEMENT OF

CASH FLOWS

1. Book value of land at time of sale:

Book value ................................................................... $ X
Sales proceeds ............................................................ 187,000
Loss (gain) on sale ...................................................... $ 17,000
X – $187,000 = $17,000
X = $204,000*
Book value of trademark at time of sale:
Book value ................................................................... $ X
Sales proceeds ............................................................ 121,000
Loss (gain) on sale ...................................................... $ (7,000)
X – $121,000 = $(7,000)
X = $114,000**

2. Net book value of property, plant, and equipment at December 31, 2013:
Net book value at 12/31/13 .......................................... $ X
Plus purchases during 2014 ........................................ 277,000
Less: Book value of land sold during 2014 ................. (204,000)*
2014 Depreciation ............................................. (205,000)
Net book value at 12/31/14 .......................................... $1,555,000
X + $277,000 – $204,000 – $205,000 = $1,555,000
X = $1,687,000

3. Net book value of intangibles at December 31, 2013:

Net book value at 12/31/13 .......................................... $ X
Plus payment of legal fees during 2014 ....................... 6,000
Less: Book value of trademark sold during 2014........ (114,000)**
2014 Amortization ............................................. (3,000)
Net book value at 12/31/14 .......................................... $ 34,000
X + $6,000 – $114,000 – $3,000 = $34,000
X = $145,000
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 8 • OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, AND INTANGIBLES 8-33

ALTERNATE MULTI-CONCEPT PROBLEMS

LO 1,5,8,9,10 PROBLEM 8-6A COST OF ASSETS, SUBSEQUENT BOOK VALUES, AND

BALANCE SHEET PRESENTATION

Depreciation or amortization and book values:

a. Depreciation should be calculated as follows:

Original cost................................................................. $16,000
Add: Cab/oven ............................................................. 10,900
Total cost ..................................................................... $26,900
Less: Residual value .................................................. 300
Depreciable amount .......................................... $26,600
Depreciation expense ($26,600/5 years) .......... $ 5,320
Book value:
Total cost................................................................ $26,900
Accumulated depreciation ...................................... 5,320
Book value at end of year 2014.............................. $21,580

b. Depreciation:
$2,700 × 66 2/3%* = $1,800
*Straight-line rate = 100%/3 = 33 1/3%, double-declining-balance rate = 66 2/3%
Book value:
$2,700 – $1,800 = $900 at end of year 2014

c. Depreciation:
($8,000 – $1,000)/8 × 3/12 = $219 for 3 months (January 1 to April 1, 2014)
Book value at time of sale:
Accumulated depreciation = ($8,000 – $1,000) × 5/8 = $4,375
Book value = $8,000 – $4,375 = $3,625
Book value ......................... $3,625
Sale price .......................... 1,500
Loss on sale ...................... $2,125

d. Amortization:
$14,000/4 years = $3,500
$3,500 × 6/12 = $1,750* amortization expense for 2014 (6 months)
Book value:
$14,000 – $1,750* = $12,250

LO 2,5 PROBLEM 8-7A COST OF ASSETS AND THE EFFECT ON DEPRECIATION

1. The proper cost to record for the acquisition is $190,000 ($168,000 + $16,500 +
$4,400 + $1,100). All costs, except the operating costs for the first year, should be
capitalized as part of the cost of the equipment. The operating costs of $26,400
should be expensed.
2. Depreciation erroneously reported in Year 1 was $21,640* ($216,400/10). Deprecia-
tion that should have been reported is $19,000 [($168,000 + $16,500 + $4,400 +
$1,100)/10]. Operating costs are not included in the cost of the asset.
3. Key reported income of $55,000 – $21,640*, or $33,360. The correct amount of in-
come should be as follows:
Income before equipment cost ................................ $ 55,000
Depreciation ............................................................ (19,000)
Operating expenses ................................................ (26,400)
Net income .............................................................. $ 9,600

4. Key should not include operating costs in the value of the asset recorded on the bal-
ance sheet. The effect of this error is to overstate assets on the balance sheet and
also overstate net income.

LO 7,8 PROBLEM 8-8A CAPITAL EXPENDITURES, DEPRECIATION, AND DISPOSAL

1. 2013 Depreciation = [($612,000 – $12,000)/25 years)] = $24,000

2014 Depreciation = [($612,000 + $87,600 – $30,000 – $24,000)/24)] = $26,900
Original cost, January 1, 2013 .......................................... $612,000
Less: Accumulated depreciation (1 year, $24,000) ........... 24,000
Book value, January 1, 2014 ............................................ $588,000
Plus: Major overhaul in 2014 ............................................ 87,600
Less: New residual value .................................................. (30,000)
Remaining depreciable amount ........................................ $645,600
Depreciation = Remaining Depreciable Amount/Remaining Life
Depreciation per Year = $645,600/24 years = $26,900

2. The cost of the fire equipment increased the value of an asset that will last for more
than one year. The cost would have been expensed if it was maintenance. Wagner
would prefer to expense the cost of the fire equipment for taxes in order to take ad-
vantage of the tax shield immediately. However, Wagner would prefer to capitalize
the cost for accounting purposes in order to better match revenue with the costs in-
curred to generate that revenue.

PROBLEM 8-8A (Concluded)

3. Loss at sale = $612,000 + $87,600 – $24,000 – $26,900 – $360,000 = $288,700

Asset cost .................................................................................... $612,000
Plus: Major overhaul in 2014 ....................................................... 87,600
Less: Accumulated depreciation .................................................. 50,900*
Book value ................................................................................... $648,700
Sale price ..................................................................................... 360,000
Loss on sale of asset ................................................................... $288,700
*Depreciation for 2013 = $24,000 + Depreciation for 2014 = $26,900
Loss on sale if fire equipment is expensed = $612,000 – $24,000 (2013 Deprecia-
tion) – $24,000 (2014 Depreciation) – $360,000 = $204,000

LO 6,10 PROBLEM 8-9A AMORTIZATION OF INTANGIBLE, REVISION OF RATE

1. The $350,000 of costs that represent research and development should be treated
as an expense in the year of acquisition, 2009. The $23,800 of costs that represents
the patent should be treated as an intangible asset and amortized over the 20-year
time period.
2. Maciel should record amortization expense of $23,800/20 years, or $1,190 per year.
3. The book value of the patent after five years of amortization is:
$23,800 – (5 × $1,190) = $17,850. Since the patent is worthless, the amount of
$17,850 should be recorded as a loss.
Original cost of patent .................................................................. $23,800
Less: Amortization for 5 years ................................................ 5,950
Book value, 10/1/2014 ............................................................ $17,850

LO 8,11 PROBLEM 8-10A PURCHASE AND DISPOSAL OF OPERATING ASSET AND

EFFECTS ON STATEMENT OF CASH FLOWS

1. Partial statement of cash flows for 2014:

Cash flows from operating activities:
Net income ........................................................................ $XX,XXX
Plus: Depreciation expense............................................... 8,000
Cash flows from investing activities:
Purchase of delivery truck ................................................. (45,000)
Partial statement of cash flows for 2015:
Cash flows from operating activities:
Net income ........................................................................ $XX,XXX
Plus: Depreciation expense............................................... 8,000
Loss on sale ...................................................................... 12,000
Cash flows from investing activities:
Purchase of delivery truck ................................................. (80,000)
Proceeds from sale of machinery (see below) .................. 17,000*
Book value at time of sale ($45,000 – $8,000 – $8,000) .............. $ 29,000
Sale price ............................................................................... X
Loss on sale of machinery ...................................................... $ 12,000
$29,000 – X = $12,000
X = Sales price = $17,000*

2. Mansfield would replace the medium-sized delivery truck with a larger truck if the
replacement would result in additional net income in the future. Any additional reve-
nues generated as a result of Mansfield’s ability to deliver and sell more product
would increase net income. On the other hand, this increase would be offset by the
costs of acquiring and operating the new delivery truck.

LO 9,10,11 PROBLEM 8-11A AMORTIZATION OF INTANGIBLES AND EFFECTS ON

STATEMENT OF CASH FLOWS

1. 2014 amortization expense:

Accumulated amortization at 12/31/13 ................................... $ 1,510,000
Plus: 2014 Amortization expense ........................................... X
Accumulated amortization at 12/31/14 ................................... $ 1,661,000
$1,510,000 + X = $1,661,000
X = $151,000

2. Acquisition cost:
Cost of patent ......................................................................... $ X
Less: Accumulated amortization at 12/31/14 .......................... (1,661,000)
Carrying value at 12/31/14 ..................................................... $ 1,357,000
X – $1,661,000 = $1,357,000
X = $3,018,000
Year acquired:
Accumulated amortization at 12/31/14 ................................... $ 1,661,000
Divided by annual amortization............................................... ÷ 151,000
Years owned........................................................................... 11 years
It was acquired in 2004.
Estimated useful life:
Cost of patent ......................................................................... $ 3,018,000
Divided by estimated useful life .............................................. ÷ X years
Annual amortization ................................................................ $ 151,000
$3,018,000/X = $151,000
X = 20 years
The acquisition cost of $3,018,000 would have been reported as an outflow in the
Investing Activities section of the 2004 statement of cash flows.

3. Assuming that the indirect method is used, the amortization expense relating to the
patent would be added back to net income in the Cash Flows from Operating Activi-
ties section of the statement of cash flows.
4. The proceeds from the sale of the patent for $1,700,000 would be reported as an
inflow in the Cash Flows from Investing Activities section of the statement of cash
flows. In addition, the gain on the sale of $343,000 ($1,700,000 selling price –
$1,357,000 book value at 1/1/15) would be deducted from net income in the Cash
Flows from Operating Activities section of the statement of cash flows.

DECISION CASES

READING AND INTERPRETING FINANCIAL STATEMENTS

LO 1,9 DECISION CASE 8-1 COLUMBIA SPORTSWEAR

Property, plant, and equipment consisted of the following (in thousands):

_____December 31,______
___2011__ __ 2010__
Land and improvements $ 20,690 $ 16,898
Building and improvements 155,672 144,004
Machinery and equipment 198,387 193,104
Furniture and fixtures 50,108 46,147
Leasehold improvements 65,476 62,884
Construction in progress 36,463 9,775
526,796 472,812
Less accumulated depreciation (275,886) (250,999)
$ 250,910 $ 221,813

1. A note to the statements indicates the company has the following classes of assets
in the category: land and improvements, building and improvements, machinery and
equipment, furniture and fixtures, leasehold improvements, and construction in
progress.
2. The company uses the straight-line method of depreciation.
3. The estimated useful lives are: buildings and improvements, 15–30 years; land and
improvements, 15 years; furniture and fixtures, 3–10 years; and machinery and
equipment, 3–5 years. Leasehold improvements are depreciated over the lesser of
the estimated useful life of the improvement.
4. The company discloses the total amount of property, plant, and equipment before
depreciation of $526,796,000, accumulated depreciation of $275,886,000, and the
total net of depreciation of $250,910,000.
5. The statement of cash flows indicates purchases of $78,404,000 and cash received
from disposal of property and equipment of $168,000.

LO 1,9 DECISION CASE 8-2 COMPARING TWO COMPANIES IN THE SAME INDUSTRY:
UNDER ARMOUR AND COLUMBIA SPORTSWEAR

A. THE RATIO ANALYSIS MODEL

1. Formulate the Question

What is the average life of the assets?
What is the average age of the assets?
How productive are the assets in producing revenue for the company? This is
referred to as asset turnover.

2. Gather the Information from the Financial Statements

To calculate a company’s average life of assets and average age of assets, it is es-
sential to know its total operating assets and accumulated depreciation from the bal-
ance sheet and depreciation expense from the income statement or statement of
cash flows.
To calculate a company’s asset turnover, it is essential to know a company’s total
sales from the income statement and its average total assets from the balance
sheet.
• The balance sheet provides information about the age and composition of the
assets, the income statement regarding profitability and depreciation, and the
statement of cash flows on inflows and outflows of cash.
• The outlook for the industry, including consumer trends, foreign markets, labor
issues, and other factors.
• The outlook for the economy in general.
• Alternative uses for the money.

3. Calculate the Ratio and 4. Compare the Ratio to Others

Columbia Sportswear Under Armour__
2011 2010 2011 2010_
Average life of assets 12.09 12.30 7.54 5.20
Average age of assets 6.33 6.53 3.16 2.77
Asset turnover 1.27 1.15 1.85 1.58

DECISION CASE 8-2 (Concluded)

5. Interpret the Ratios

The average life and age of assets have been consistent from year to year and are
in line with other companies in the industry. The asset turnover ratio is a measure of
how many dollars of assets are necessary for every dollar of sales. If a company
uses its assets efficiently, each dollar of assets will create a high amount of sales.
The asset turnover ratio indicates how much each dollar of assets produced in sales.
It is an indication that the assets are productive and will be able to provide sales in
future periods. The average age and composition of the assets differs somewhat be-
tween the two companies. Under Amour seems to have assets with a shorter life but
those assets are more productive in producing sales. Additional analysis would be
necessary to determine the causes of the differences.

B. THE BUSINESS DECISION MODEL

1. Formulate the Question:

If you were a lender, would you be willing to lend money to either company and use
the operating assets as collateral for the loan?

2. Gather Information from the Financial Statements and Other Sources:

This information will come from a variety of sources, not limited to but including:
• The balance sheet provides information about the age and composition of the
assets, the income statement regarding profitability and depreciation, and the
statement of cash flows on inflows and outflows of cash.
• The outlook for the industry, including consumer trends, foreign markets,
labor issues, and other factors.
• The outlook for the economy in general.
• Alternative uses for the money.

3. Analyze the Information Gathered:

• Compare the ratios in (A) above as well as with industry averages.
• Look at trends over time in the age, composition, and productivity of assets.
• Review projections for the economy and the industry.

4. Make the Decision:

Taking into account all of the various sources of information, decide either to
• Lend money to the company, or
• Find an alternative use for the money

5. Monitor Your Decision:

If you decide to lend the money, you will need to monitor your investment periodically.
During the time of the loan, you will want to assess the company’s operating assets
as well as other factors you considered before making the investment.

MAKING FINANCIAL DECISIONS

LO 1,5 DECISION CASE 8-3 COMPARING COMPANIES

ACCELERATED COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2014
Sales ...................................................................................... $720,000
Cost of goods sold ................................................................. 360,000
Gross profit ............................................................................. $360,000
Administrative costs ............................................................... $ 96,000
Depreciation expense............................................................. 144,000*
Operating expenses ............................................................... 240,000
Income before tax................................................................... $120,000
Tax expense (40%) ................................................................ 48,000
Net income ........................................................................ $ 72,000
Since the balance of the Accumulated Depreciation account for Straight Company is
$240,000 and the depreciation expense is $120,000 per year, the assets must be two
years old. The amount of depreciation expense for Accelerated Company using the
double-declining-balance method is as follows:
2013: $600,000 × 40% = $240,000
*2014: $600,000 – $240,000 = $360,000 × 40% = $144,000
The analyst should consider the difference in the cash flows of the two companies.
Accelerated Company has a lower net income but actually has a higher cash inflow.
This occurs because the depreciation expense results in a tax savings. It is not entirely
accurate to say that depreciation is a “noncash” expense because it results in a real
cash savings in the form of lower income tax.

LO 5 DECISION CASE 8-4 DEPRECIATION ALTERNATIVES

For accounting purposes, the company should use straight-line depreciation because it
will better match the cost of using the asset with the equal production levels. For taxes,
the company should also use the straight-line method because the increasing tax rates
will yield a higher cash savings from the tax shield. Depreciation is not a cash outflow,
but the tax savings result in a cash inflow because of reduced tax liability.

ETHICAL DECISION MAKING

LO 3 DECISION CASE 8-5 VALUING ASSETS

1. Recognize an Ethical Dilemma:

Students should be asked to determine the impact of using the first appraisal versus
the second appraisal. The appraisals differ in the amount of the purchase cost that
will be allocated to the Land account. Students should see that a second opinion
may have been necessary to accurately appraise the property, but, on the other
hand, the appraisal may have been requested to maximize the amount allocated to
the depreciable asset, the building.

2. Analyze the Key Elements in the Situation:

Students should be asked about the nature of the appraisal process. Is it possible for
two appraisers to have different estimates of the fair market value? Should the ac-
countant always accept the first appraisal? When is it acceptable to seek another
opinion? Are Terry and Tammy unethical simply because they sought a separate
opinion? The instructor may wish to draw a parallel to “opinion-shopping” on the part
of clients who seek an opinion of auditors or public accountants.

3. List Alternatives and Evaluate the Impact of Each on Those Affected:

The proper amount to record for operating assets can have a potential effect on
anyone who uses the financial statements, including investors and lenders. Financial
statement readers must be able to rely on the accuracy of the appraisal information.
This may also affect the amount of depreciation that is recorded, since land is not a
depreciable asset.

4. Select the Best Alternative:

It appears that the concept of neutrality has been violated in this case. It is not wrong
for Terry and Tammy to seek a second appraisal if their motive was to develop
an accurate, unbiased measure of the land and building. However, if their motive
was to minimize the amount allocated to the Land account, their actions must be
questioned.

LO 5 DECISION CASE 8-6 DEPRECIATION ESTIMATES

Both methods will result in the total cost of the asset being recorded on the income
statement over the life of the asset. However, depreciating the asset is preferable be-
cause it matches the cost evenly over the asset’s life. You should try to convince the
manager that it is not correct to depreciate the asset over a longer life and then record a
large loss in the third year. If the manager is not convinced, you may have to consider
whether the matter should be discussed with his/her superior and/or the company’s
auditors.

REAL WORLD PRACTICE 8.1

Nike had property, plant, and equipment, net of depreciation, of $2,279 million as of
May 31, 2012. The company does not show the amount of accumulated depreciation on
the balance sheet, but that amount is disclosed in the notes to the financial statements.
The amount of depreciation expense for the current year is not shown on the balance
sheet. It is shown on the income statement.

SOLUTION TO INTEGRATIVE PROBLEM

1. PEK COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2014
Sales revenue ......................................................... $1,250,000
Cost of goods sold .................................................. 636,500
Gross profit ........................................................ $ 613,500
Depreciation on plant equipment ............................ $85,400*
Depreciation on buildings ........................................ 12,000
Interest expense ..................................................... 55,400**
Other expenses....................................................... 83,800 236,600
Income before taxes .......................................... $ 376,900
Income tax expense (30% rate) .............................. 113,070
Net income ........................................................ $ 263,830
*$58,400 + ($270,000/10 years)
**$33,800 + ($270,000 × 8%)

PEK COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2014
Cash flows from operating activities:
Net income .................................................................................. $263,830
Adjustments to reconcile net income to net cash provided by
operating activities (includes depreciation expense) .............. 110,200*
Net cash provided by operating activities.......................................... $374,030
Cash flows from financing activities:
Dividends ..................................................................................... (35,000)
Net increase in cash ......................................................................... $339,030
*$83,200 + $27,000 additional depreciation
Supplemental Schedule of Noncash Investing and Financing Activities:
Acquisition of equipment in exchange for a note of $270,000.

2. PEK COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2014
Sales ....................................................................... $1,250,000
Cost of goods sold .................................................. 636,500
Gross profit ........................................................ $ 613,500
Depreciation on plant equipment ............................ $107,491*
Depreciation on buildings ........................................ 12,000
Interest expense ..................................................... 55,400
Other expenses....................................................... 83,800 258,691
Income before taxes .......................................... $ 354,809
Income tax expense (30% rate) .............................. 106,443
Net income .............................................................. $ 248,366
*$58,400 + $49,091

PEK COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2014
Cash flows from operating activities:
Net income .................................................................................. $248,366
Adjustments to reconcile net income to net
cash provided by operating activities
(includes depreciation expense)............................................. 132,291*
Net cash provided by operating activities.......................................... $380,657
Cash flows from financing activities:
Dividends ..................................................................................... (35,000)
Net increase in cash ......................................................................... $345,657
*$83,200 + $49,091 additional depreciation
Supplemental Schedule of Noncash Investing and Financing Activities:
Acquisition of equipment in exchange for a note of $270,000.

3. a. LIFO cost of goods sold:

40,000($3.25) = $130,000
60,000($3.10) = 186,000
75,000($3.00) = 225,000
40,000($2.50) = 100,000
30,000($2.20) = 66,000
5,000($2.10) = 10,500
Total LIFO cost of goods sold ................................................. $717,500
Total FIFO cost of goods sold................................................. 636,500
Increase in cost of goods sold ........................................... $ 81,000
b. Additional cost of goods sold .................................................. $ 81,000
Times the tax rate ................................................................... 30%
Decrease in income tax expense ...................................... $ 24,300
c. Additional cost of goods sold .................................................. $ 81,000
Decrease in income taxes ...................................................... 24,300
Decrease in net income .................................................... $ 56,700

4. a. Sales on account .................................................................... $800,000

Times estimated uncollectibles ............................................... 3%
Increase in other expenses ............................................... $ 24,000
b. Increase in other expenses .................................................... $ 24,000
Times the tax rate ................................................................... 30%
Decrease in income tax expense ...................................... $ 7,200
c. Increase in other expenses .................................................... $ 24,000
Decrease in income taxes ...................................................... 7,200
Decrease in net income .................................................... $ 16,800

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