Unit 4 Ingenuity
DEPRECIATION & IMPAIRMENT
Lesson 11
1. What is the major difference between the service life of an asset and its physical life?
A) Service life refers to total operational capacity, physical life refers to hours used.
B) Service life refers to the time an asset will be used by a company, and physical life refers to how long the asset will last.
C) Physical life is estimated for tax purposes, service life is used for GAAP.
D) Physical life is always shorter than service life.
Response: B
Reasoning: Service life is how long an asset will be used by the company.
Physical life is how long the asset will last/actually be usable. We operate under the assumption that companies do not run their assets into the ground before retiring them.
2. Dixon Company purchased a depreciable asset for $32,000. The estimated salvage value is $4,000, and the estimated useful life is 4 years. The double-declining balance method will be used for depreciation. What is the depreciation expense for the second year on this asset?
A) $16,000
B) $8,000
C) $7,000
D) $4,000
Response: B
Reasoning:
Double-Declining Balance Rate = [1/Useful Life] x 2 = ¼ = .25 x 2 = .50
Double-Declining Balance (DDB) takes the straight-line rate and doubles it, then applies that towards the full book value of the asset. It does not take away salvage value.
Double-Declining Depreciation Expense = DDB x Book Value = .50 x $32,000 = $16,000
This gives us the depreciation expense for year 2.
New Book Value at End of Year 1/Start of Year 2 = [Book Value - Depreciation Expense] = $32,000 - $16,000 = $16,000
Depreciation Expense for Year 2 = [New Book Value x DDB Rate] = $16,000 x .50 = $8,000
3. Which of the following principles best describes the conceptual rationale for the methods of matching depreciation expense with revenues?
A) Systematic and Rational Allocation
B) Immediate Recognition
C) Partial Recognition
D) Associating Cause and Effect
Response: A
Reasoning: Systematic and rational allocation means that we are making it easy to understand why an expense is associated with the revenue it’s associated with. We allocate it based on period and to weigh the expense of the asset against the revenue that it brings in.
Although the other options are principles about expense recognition, systematic and rational allocation is used when an asset provides benefits over multiple periods.
4. Which of the following is a principal objection to the straight-line method of depreciation?
A) It assumes that the asset’s economic usefulness is the same each year.
B) It tends to result in a constant rate of return on a diminishing investment base.
C) It provides for the declining productivity of an aging asset
D) It gives smaller periodic write-offs than decreasing charge methods.
Response: A
Reasoning: Straight-line method leads to depreciation expense being the same every year, regardless of how much revenue an asset is actually generating.
Assets naturally decline over time, meaning the cost of maintenance increases and the efficiency decreases, so this method fails to account for that, whereas a method like DDB accounts for lower maintenance costs early on and less efficiency later on.
5. The term "depreciable base," or "depreciation base," as it is used in accounting, refers to which of the following?
A) The total acquisition cost of the asset including shipping and setup fees.
B) The fair market value of an asset at the end of its physical life.
C) The total amount to be charged to expense over an asset's useful life.
D) The net book value minus accumulated depreciation.
Response: C
Reasoning: Depreciable base just means the total amount of depreciation expense that we expect an asset to accumulate over its useful life, down to its salvage value (if it has one).
Lesson 12
1. Chattanooga Company purchased a depreciable asset for $80,000 on January 1, 2015. The estimated salvage value is $20,000, and the estimated useful life is 5 years. The straight-line method is used for depreciation. On January 1, 2017, the company made a capital expenditure of $16,000 for an addition to the asset. This capital expenditure improved the overall efficiency of the asset during its remaining useful life. What is depreciation expense for 2017? (Assume that salvage value remains unchanged.)
A) $12,000
B) $16,000
C) $17,333
D) $19,200
Response: C
Reasoning:
Straight-Line Depreciation = [(Cost of Asset - Salvage Value)/Useful Life] = ($80,000 - $20,000)/5 = $12,000 per year
This is the formula for Straight-Line Depreciation Rate/Expense per year
Year 1 Depreciation Expense and New Book Value: $80,000 - $12,000 = $68,000
Year 2 Depreciation Expense and New Book Value: $68,000 - $12,000 = $56,000
New Book Value in 2017: $56,000 + $16,000 = $72,000
Due to 2017’s $16,000 capital expenditure, we add $16,000 to the asset’s book value.
New Depreciable Base = [(New Book Value - Salvage Value)/Useful Life] = ($72,000 - $20,000)/3 = $52,000/3 = $17,333
We depreciate the asset’s new value over the remainder of its useful life.
2. Unless otherwise stipulated, what is depreciation normally computed on the basis of?
A) The nearest full month
B) The exact number of days
C) The nearest full year
D) The beginning of the fiscal quarter
Response: A
Reasoning: Depreciation is typically computed based on the nearest full month. For example, if I buy an asset in April and then retire it in March of next year, I find depreciation based on 11 months.
3. Cambodian Import Company purchased a depreciable asset for $160,000 on April 1, 2014. The estimated salvage value is $40,000, and the estimated useful life is 5 years. The straight-line method is used for depreciation. What is the balance in accumulated depreciation on March 1, 2017 when the asset is sold?
A) $64,000
B) $70,000
C) $72,000
D) $96,000
Response: B
Reasoning:
Straight-Line Rate = [(Cost of Asset - Salvage Value)/Useful Life] = ($160,000 - $40,000)/5 = $24,000
April 1st, 2014 - March 1st, 2017 = 35 months
This is basic math I’m not explaining that
Find Depreciation Expense per Month: $24,000/12 = $2,000 per month
Find Accumulated Depreciation: $2,000 x 35 = $70,000
4. When an asset being depreciated under the group method is disposed of, how is any resulting gain or loss recorded?
A) Recognized immediately on the income statement as a separate line item.
B) Credited directly to Retained Earnings.
C) Recorded in the Accumulated Depreciation account.
D) Deferred and amortized over the remaining group life.
Response: C
Reasoning: The difference between the asset’s original cost and the amount a company sells it for is recorded directly into the accumulated depreciation account.
5. How can the composite or group depreciation system be described?
A) A straight-line rate is computed by dividing total salvage value by useful life.
B) A straight-line rate is computed by dividing the total of the annual depreciation expense for all assets in the group by the total cost of the assets.
C) Assets are grouped and depreciated using double-declining balance based on historical cost.
D) An accelerated rate applied individually to a collection of similar assets.
Response: B
Reasoning:
Lesson 13
1. Erie Corporation owns machinery with a book value of $2,200,000. It is estimated that the machinery will generate future cash flows of $1,995,000. The machinery has a fair value of $1,915,000. To record the impairment loss, what should be included in the journal entry?
A) A credit to Gain on Impairment of $205,000.
B) A debit to Loss on Impairment of $285,000.
C) An increase in the asset's Accumulated Depreciation account by $285,000.
D) A direct credit to Machinery for $205,000.
Response: C
Reasoning:
Impairment Test:
If future cash flows < carrying value of an asset, the asset is impaired.
10. Flannery Corporation owns machinery with a book value of $520,000. It is estimated that the machinery will generate future cash flows of $465,000. The machinery has a fair value of $415,000. Which amount should Florence recognize as a loss on impairment?
A) $55,000
B) $105,000
C) $50,000
D) $0
11. When is the restoration of an impairment loss permitted?
A) On all held-and-used plant assets.
B) Never under any circumstances under US GAAP.
C) On assets being held for disposal.
D) Only when cash flows exceed carrying value in the subsequent year.
12. An asset impairment occurs when the asset's carrying amount exceeds what amount?
A) Expected future net cash flows
B) Historical cost
C) Salvage value
D) Present value of net sales
13. Usually, companies compute depletion for accounting purposes using which method?
A) Straight-line method
B) Declining balance method
C) Units-of-production method (Activity method)
D) Sum-of-the-years-digits method
14. Porter Resources Company acquired a tract of land containing an extractable natural resource. Porter is required by its purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 2,500,000 tons, and that the land will have a value of $1,000,000 after restoration. Relevant cost information includes: Land at $7,500,000 and Estimated restoration costs of $1,500,000. If Porter maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material?
A) $2.60
B) $3.20
C) $3.00
D) $3.60
15. What is true regarding a general description of the depreciation methods applicable to major classes of depreciable assets?
A) They can be changed annually without disclosure in notes.
B) It is necessary to include depreciation in corporate financial statements or notes thereto.
C) Straight-line is mandatory for financial reporting under GAAP.
D) Tax depreciation schedules must match financial reporting schedules.
16. How do you calculate the asset turnover ratio?
A) Net sales / average total assets
B) Net income / net sales
C) Gross profit / average total assets
D) Net sales / ending total assets
17. What is the book value of a plant asset equal to?
A) Market value less salvage value
B) The asset's acquisition cost less the total related depreciation recorded to date
C) Replacement cost less salvage value
D) Original cost less estimated future cash flows
18. How do you calculate the profit margin on sales?
A) Net income / average total assets
B) Net income / net sales
C) Gross profit / net sales
D) Operating income / net sales
19. How do you calculate return on assets?
A) Net income / average total assets (or Profit margin on sales x Asset turnover)
B) Net income / total stockholders' equity
C) Operating income / net sales
D) Net sales / average total assets
20. Lundy Company purchased a depreciable asset for $99,000 on January 1. The estimated salvage value is $18,000, and the estimated useful life is 9 years. The double-declining balance method will be used for depreciation. What is the depreciation expense for the second year on this asset? (Please round the double-declining balance rate to 2 decimal places, e.g. 0.35 or 35% in your intermediate calculations.)
A) $22,000
B) $16,988
C) $18,000
D) $14,400
21. For 2017, Lassiter Company reports beginning of the year total assets of $900,000, end of the year total assets of $1,100,000, net sales of $1,250,000, and net income of $250,000. What is Lassiter's 2017 asset turnover ratio?
A) 1.39 times
B) 1.25 times
C) 1.14 times
D) 0.25 times
22. Mains Corporation owns equipment with a cost of $290,000 and accumulated depreciation at December 31, 2017 of $150,000. It is estimated that the machinery will generate future cash flows of $165,000. The machinery has a fair value of $115,000. Which of the following should be recognized as a loss on impairment?
A) $0
B) $25,000
C) $125,000
D) $150,000
23. McDonald Company acquired machinery on January 1, 2015 which it depreciated under the straight-line method with an estimated life of fifteen years and no salvage value. On January 1, 2020, McDonald estimated that the remaining life of this machinery was six years with no salvage value. How should this change be accounted for by McDonald?
A) By restating prior years' financial statements retroactively.
B) By setting future annual depreciation equal to one-sixth of the book value on January 1, 2020.
C) By continuing to depreciate over the original nine remaining years.
D) By recording a cumulative effect adjustment in current income.
24. A pizza delivery chain buys several assets with varying useful lives at the start of the year (12 delivery trucks, 4 pizza ovens, 6 point-of-sale systems, 20 sets of tables and chairs). Which depreciation method allows the pizza delivery chain to use one rate to depreciate all the assets?
A) Group method
B) Composite method
C) Units-of-activity method
D) Sum-of-the-years-digits method
25. A company wants to calculate a loss on impairment on an asset. How is the loss calculated?
A) Carrying value less the fair value
B) Carrying value less future undiscounted cash flows
C) Historical cost less salvage value
D) Fair value less accumulated depreciation
26. The asset turnover for a company in the most recent accounting year is 1.50. Which statement accurately describes the meaning of this ratio?
A) The company generated $1.50 of net income for every dollar of assets.
B) The company generated net sales of $1.50 per dollar of assets in the most recent year.
C) Assets were replaced 1.50 times during the operational period.
D) The company has $1.50 in current assets for every dollar of liabilities.
27. A company purchased and placed into service a piece of machinery with an original cost of $100,000. It estimates a 10-year useful life with no salvage value. At the beginning of Year 8, when accumulated depreciation was $70,000 and the asset's book value was $30,000, the company estimates that it will use the machine for a total of 12 years. Which statement describes the proper accounting treatment beginning with Year 8?
A) Depreciate $10,000 per year for the remaining two years.
B) The company will depreciate the $30,000 book value over the next five years.
C) Restate prior financial statements to reflect a 12-year life.
D) Write off the remaining $30,000 immediately as a change in accounting estimate.
28. A company purchased a plot of land for $500,000 for the purposes of harvesting timber for resale. The company paid $10,000 to have the property boundaries marked by a land surveyor. The company also acquired a bulldozer for $100,000. The bulldozer will be used at this plot of land in addition to other locations where the company harvests trees. What will be the company's depletion base for the land?
A) $500,000
B) $510,000
C) $600,000
D) $610,000
29. A company believes a property contains natural resources and pays $80,000 for the property. The company spends $50,000 on a bulldozer to be used in multiple projects, $10,000 to dig the land to find the natural resources, and $3,000 on intangible development costs. How much is the depletion base for the natural resources?
A) $80,000
B) $90,000
C) $93,000
D) $143,000
30. An asset costs $200,000 with an expected useful life of five years. At the end of five years, the salvage value is expected to be $20,000. What is the depreciation base?
A) $200,000
B) $180,000
C) $160,000
D) $220,000