Chapter 10: Depreciation, Amortization, and Impairmentboliver/Ch10.pdf · Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th ... Chapter 10: Depreciation, Amortization,

© 2017 McGraw-Hill Education. All rights reserved.Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition 10-1

Chapter 10: Depreciation, Amortization, and Impairment

Suggested TimeCase 10-1 Bright Lights Limited

10-2 Rock Group Limited10-3 Road Safety Incorporated

Technical ReviewTR10-1 Depreciation Decision................................................ 5TR10-2 Depreciation............................................................... 15TR10-3 Depreciation Estimates .............................................. 15TR10-4 Component Depreciation ........................................... 10TR10-5 Fractional Deprecation............................................... 15TR10-6 Recoverable Amount ................................................. 5TR10-7 Impairment................................................................. 5TR10-8 Assigning Impairment to Assets ................................ 15TR10-9 Minimum Depreciation test ....................................... 5TR10-10 CCA ........................................................................... 10

Assignment A10-1 Depreciation Policy.................................................... 10 A10-2 Interpreting Depreciation Disclosures ...................... 5 A10-3 Valuation Models....................................................... 15 A10-4 Depreciation or Amortization Policy ......................... 15 A10-5 Amortization or Impairment ...................................... 15 A10-6 Component Depreciation ........................................... 20 A10-7 Standby Assets and Spare Parts ................................. 20 A10-8 Depreciation Computation (*W)................................ 20 A10-9 Depreciation Schedule ............................................... 25 A10-10 Analysis of Three Depreciation Methods—Maximize

Earnings (*W) ................................................... 20 A10-11 Identify and Recalculate Depreciation ...................... 20 A10-12 Depreciation and Depletion—Schedule, Entries …. . 25 A10-13 Component Depreciation .......................................… 20 A10-14 Component Depreciation ........................................... 20 A10-15 Component Depreciation ........................................... 15 A10-16 Fractional Depreciation.............................................. 20 A10-17 Fractional Depreciation (*W) .................................... 25 A10-18 Comprehensive Intangibles—Accounting and

Amortization ...................................................... 20 A10-19 Asset Impairment–Five Situations............................. 20 A10-20 Asset Impairment (*W).............................................. 15 A10-21 Asset Impairment ....................................................... 15 A10-22 Asset Impairment ....................................................... 15 A10-23 Goodwill Impairment................................................. 20

© 2017 McGraw-Hill Ryerson Ltd. All rights reserved10-2 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition

A10-24 Goodwill Impairment................................................. 20 A10-25 Statement of Cash Flows ........................................... 15 A10-26 Comprehensive Long-lived Asset Transactions and

Depreciation....................................................... 40 A10-27 CCA Calculations (Appendix 1)................................ 25 A10-28 Revaluation Model (Appendix 2)…. ......................... 25 A10-29 Asset Impairment (ASPE).......................................... 15 A10-30 Asset Impairment (ASPE).......................................... 15

*W The solution to this assignment is on the text website, Connect.This solution is marked WEB.


Cases

Case 10-1 Bright Lights Limited

Overview

Bright Lights Limited (Bright) is a relatively young company involved in manufacturing solar devices. The company is in the development stage, and must be viewed as a high risk situation because of uncertainties related to technology and the difficulties involved in establishing a viable operation.

Bright might be a possible take-over target in the future. More immediately, Bright is in discussions with potential investors and, as such, will benefit from adopting accounting policies that strengthen the financial statements. The debt-to-equity level is important to this group of potential investors, as is return on assets (in 20X7 and beyond). The company’s current cost of borrowing of 9% suggests creditors attach a moderate level of risk to Bright.

The company has adopted IFRS and should select very conservative accounting policies because of their risk profile.

Issues1. Depreciation2. Government assistance3. Decommissioning asset and asset retirement obligation4. Development costs

Analysis and recommendations

1. Depreciation

Bright is depreciating the entire building despite only using 40% of it. The building will not be fully utilized until 20X7. Assets are not depreciated before they are in use and as a result only 40% of the building should be depreciated. This will result in depreciation from 20X4 to 20X6 of $3,360 (($210,000/25)×.4) rather than $8,400($210,000/25). Starting in 20X7, depreciation expense will be $9,087 (($210,000 – ($3,360 ×3))/22).

This is an error correction that must be corrected on a retrospective basis, with restatement of 20X4 financial statements.

The building is subject to an impairment test. This is a control on charging too little deprecation. If, for example, the building were not fully used but was becoming obsolete or had no alternate use, it would have to be written down through an impairment. Accordingly, the recoverable amount of the building must be ascertained through fair value appraisal or value in use (discounted cash flow). There is no information to suggest that impairment is needed.


2. Government assistance

Government assistance received towards the purchase of the building may be accounted for using either the deferral method or the net method. Bright is currently using the deferral method in which the full amount of the government assistance is initially recorded as a liability on the SFP. The liability and depreciation expense are each reduced over the life of the building. Under the net method, the government assistance is initially offset against the cost of the building, resulting in lower amounts for assets and liabilities. There is no difference between the two methods in terms of the impact on depreciation expense. If Bright’s current creditors or potential investors evaluate the company using debt-to-equity or return on asset ratios, then it would be better for Bright to use the net method of accounting for the government assistance because the ratios would improve. This change in accounting policy can be justified because it is more relevant to users.

In addition, since only 40% of the building is being depreciated, only 40% of the annual amount of government grant should be recognized. This is $800 (($50,000/25)×.4) rather than $2,000. Later recognition will be higher, at $2,164 (($50,000 – ($800 ×3))/22) per year, assuming that commercial production starts as scheduled in 20X7

3. Decommissioning and asset retirement obligation

At the beginning of 20X4, Bright made a promise to remove waste management tanks by the end of 20X13, at an estimated cost of $90,000. This was a public commitment, and it is reasonable to suggest that the community will rely on the statement. The commitment, and the amount, is now disclosed in the notes. It will be expensed in 20X13, when the money is spent.

However, since Bright has created an expectation for outsiders there is a constructive obligation. Bright is required to set up a liability for the present value of the estimated cost associated with the future land enhancements. To calculate this liability, Bright would use a discount factor associated with the risk of the underlying liability. In the absence of that specific information, Bright’s incremental cost of borrowing of 9% will be used. The initial recording of the asset retirement obligation will also increase the cost of the related asset which will then depreciate, causing additional expense. Over the life of the obligation, the liability will be increased and finance charges recorded on the SCI. Merely disclosing this commitment in the notes to the financial statements is not adequate.

There are two views as to when this liability actually exists and should be recorded. One view is that the need to clean up waste management tanks only exists once the waste management tanks are installed and put into use in 20X6/20X7. Accordingly, the constructive obligation would be recorded in 20X6 when the tanks are installed. Installation of the tanks is the triggering event; the $90,000 commitment is therefore recorded in 20X6 and the term is seven years, assuming that the tanks are installed at the


end of 20X6. The initial present value, recorded as an increase to the asset and as a liability, is therefore $49,233.

The other view is that the obligation exists when the promise was made and an expectation created for outsiders. This occurred at the beginning of 20X4, ten years before land restoration will happen. This is two years before the waste management tanks are installed. Therefore, the costs will be associated with an intangible asset, land access rights, which provide a benefit to Bright for ten years. These rights have a finite life of ten years, which will be the depreciation and interest period. The initial present value, recorded as an increase to the asset and as a liability, is therefore $38,017. This is an error correction that must be corrected on a retrospective basis, with restatement of 20X4 financial statements to include interest and depreciation expense.

Overall, the arguments for 20X6 recognition of the asset retirement obligation appear stronger. This is because the triggering event is the commencement of commercial production; before this time, there is no environmental issue to address. This increase in liabilities and increase in expenses over the duration of the obligation will have a negative impact on the financial statements and related ratios.

4. Development costs.

From the text:The following criteria must all be met for a development asset to be capitalized:

1. The asset must be proven to be technologically feasible so it will be available for sale or use;2. Management must have the intent to complete and then produce and market, or use, the asset;3. The entity must be able to use or sell the asset;4. The probable future economic benefits for (or external market or internal

usefulness) of the product or process is clearly established; 5. Adequate resources exist, or are expected to be available, to complete the project; and 6. Costs can be reliably measured.

Up to this point, Bright fails one or more of these criteria and expenses. However, they are making progress toward commercial production and might be able to begin capitalization. Looking at the criteria, management intent is certainly clear, they intend to sell the product, adequate financing is in place, and costs should be measurable. The two remaining factors must be explored. The company should determine whether they have technological feasibility in 20X5, and adequate proof of a market. If so, capitalization of development costs, but not operating costs, is appropriate.

This will increase assets and reduce the reported losses, improving the debt-to-equity ratio. Since the capitalized development expenses would be amortized once operations begins, 20X7 earnings would be lower than if the current policy is continued. With capitalization, assets are higher and earnings with amortization are lower, so return on assets will be lower. Bright may prefer to expense.


Conclusion

Bright will be dealing with many new issues as the nature of their operation changes from a development company to an operating company. Bright must carefully manage its accounting policies to avoid misstatement. They must also understand the effect of their financial statements on their user groups, including both lenders and equity investors. They would be wise to have a clear understanding of the expectations and success measures that will be used to judge their progress.


Case 10-2 Rock Group Limited

TO: Wendy Wonders, CFO of Rock Group Limited (“RGL”)FROM: Accounting Advisor RE: Scrulox Screws Inc. (“SSI”) Transactions

Prior to analyzing the accounting of the significant transactions of SSI, I considered the users of their financial statements and their objectives, as well as the reporting constraints. These considerations provide a context to frame the accounting analysis.

SSI’s fiscal 20X2 financial statements will be primarily used by the management of RGL and the owners of SSI, as the basis for determining the sale price of SSI.

As the seller, SSI will seek to obtain a high selling price and therefore may attempt to overstate net income – the basis upon which the selling price is calculated. Specifically, Wally, as the primary shareholder of SSI, has a vested interest in increasing net income to maximize the amount he personally receives from the sale. As the bookkeeper, Wally has the ability to increase net income through the selection of accounting policies, choices, and estimates and may be biased towards his objective. In analyzing the various transactions, I have remained cognizant of this potential bias.

As the purchaser, you have an interest in paying the lowest price possible, and therefore have an objective to lower SSI net income.

A secondary user of their financial statements is the Canada Revenue Agency, who will use the financial statements to determine if the appropriate amount of tax has been paid by SSI.

Based on the information provided, there is no evidence that the Government of Ontario will be using SSI’s financial statements to make any decisions based on the financial statements, and therefore the Government is not considered a financial statement user.

As a professional, I have an ethical obligation to ensure that my analysis is supportable and complies with the identified reporting constraints (discussed below). As I have been engaged to analyze the SSI transactions on behalf of RGL, I will consider RGL as the primary user and as such will ensure to identify accounting opportunities (when facts allow or alternatives exist) that will enable your company to ethically reduce SSI net income, supporting a lower purchase price. However, due to the conflicting financial reporting objectives, the final determination of the appropriate accounting for each SSI transaction may need to be negotiated as part of the final purchase price negotiation. To support your negotiation efforts, I have supported all conclusions with a detailed analysis.


As SSI is a private company reporting under Accounting Standards for Private Enterprises (“ASPE”), my analysis will comply with ASPE. However, as RGL, a public company, must report under International Financial Reporting Standards (“IFRS”), and will need to consolidate the results of SSI in the future (refer to control analysis below); the accounting implications under IFRS are also addressed.

ANALYSIS:

Controller Contract

Issue: How to account for the Controller contract commitment.

Analysis:As of year-end, the commitment is viewed as an executory contract – a contract wherein neither party has yet fulfilled the requirements of the contract.

A commitment to make payments in the future is only recognized if the commitment meets the definition of a liability, is measureable, and probable to occur. One element within the definition of a liability considers if “the transaction or event obligating the entity has already occurred”. As the Controller will only start work on February 1, 20X3 (i.e. the next fiscal year), and as of year-end has not rendered any services, no transaction or obligating event has occurred.

Conclusion:As of year-end, the Controller contract commitment does not meet the definition of a liability. It does not appear that Wally has recorded a liability and therefore no adjustment is required, resulting in no implications to the financial statements.

In the next fiscal year, once the Controller starts working, her salary would be considered a cost of the period and recorded as an expense. Any unpaid salary as of period-end would be recorded as an accrued liability.

IFRSThe accounting under IFRS is consistent with ASPE.

Barrie Plant

Issue: Is the Barrie plant impaired as a result of the new plant opening? If so, what is the impairment?

Analysis: Under ASPE, long-lived assets are tested for impairment whenever events or changes in circumstances indicate that the assets carrying amount may not be recoverable.

Indicators of Impairment Indicators of impairment exist for the Barrie plant. The opening of the new plant in Hamilton is projected to reduce the cash-flows of the existing Barrie plant by about two times – a significant decline in cash flows, likely resulting from lower production and/or selling prices. As the plant is


scheduled to be shut-down in five years, the current carrying amount of the plant of $25 million may not be recoverable through use and eventual disposition.

Grouping of Assets The Barrie plant (plant and all equipment) is assumed to be an asset group because the entire plant is presumed to function together to generate independent cash flows.

Impairment Testing Even though indicators of impairment exist, the carrying amount of the Barrie plant is deemed to be recoverable because the sum of the undiscounted cash-flows expected from the plants use are 25 million (5 years x 5 million /year) an amount equal to the carrying amount.

Conclusion:The Barrie plant is not impaired.

However, I suggest that the useful life and the residual value of the plant and all corresponding assets be adjusted to reflect the expected shut-down in five years. Revising the useful life of the assets to a maximum of five years (i.e. the maximum period over which the assets are expected to contribute to the future cash flows of the plant) will increase depreciation expense and therefore lower net income, lowering the selling price of SSI, consistent with your objective.

IFRSUnder IFRS, the Barrie plant would be considered impaired because the IFRS value-in-use model considers discounted cash flows not undiscounted cash flows. An impairment loss of about $5.036 million [25 million - $5 million x (P/A, 8%, 5)] would need to be recorded. The bank borrowing rate of 8% is assumed to reflect the risks inherent in the Barrie plant assets and the time value of money.

However, on acquisition of SSI, RGL will record the plant (including its assets) at fair value of $19 million. Since the carrying value to RGL, established on acquisition, will reflect fair value, no impairment will be present.

Government Grant

Issue: How to present the receipt of the government assistance?

Analysis:Wally has recorded the entire $10 million in revenue, which is incorrect because the Government of Ontario assistance was provided for a variety of purposes, including:

1. Capital – Acquisition of new manufacturing equipment. 2. Capital – Payroll costs of those individuals directly involved in the construction of the

new Hamilton plant, such as architects and construction workers, for which the salary costs would be capitalized to the cost of the new plant as they are costs directly incurred to build the plant and thus comprise part of its cost.

3. Non-Capital - Individuals indirectly involved in the project such as the marketing personnel, for which the salary costs would be considered a cost of the period (because such costs would not qualify as an asset) and expensed as incurred.


The presentation of such assistance should reflect the purpose for which the assistance is meant to provide. As such, the $10 million must be allocated to the various purposes, as noted above, and presented accordingly.

Capital As a policy choice, government assistance towards the acquisition of the manufacturing equipment and capital related payroll costs can be either: deducted from the related fixed assets with any depreciation calculated on the net amount; or deferred and amortized to income on the same basis as the related depreciable fixed assets are

depreciated.

If the amount allocated to capital related payroll costs (#2 above) has not yet been incurred, an appropriate amount should be deferred and recognized in line with the policy choice above only when incurred. For example, if $1 million of the total assistance is deemed to relate to capital related payroll costs and as of year-end only $200,000 of such payroll have been incurred, $200,000 should be recognized in line with the policy choice above and $800,000 of the assistance should be recorded as a liability to be recognized once related costs are incurred.

Non-Capital Government assistance toward current or previously incurred payroll expenses should be included in the determination of net income for the period. However, if a portion of the non-capital payroll expenses has not yet been incurred, an appropriate amount should be deferred and amortized to income as the related expenses are incurred.

Conclusion:The recognition of the entire $10 million of government assistance in revenue is incorrect because only a portion of the assistance may relate to current year non-capital expenditures.

I recommend that further investigation is conducted regarding intent of the government assistance and appropriate estimates made to allocate and present the assistance in line with its purposes. Any adjustment will decrease net income, in line with your objective.

For preliminary analysis purposes, I have excluded the entire $10 million from net income.


Catalogues

Issue: Is it appropriate to defer expense recognition for the cost of the catalogue until 20X3?

Analysis:Under ASPE, services are received when they are performed by a supplier in accordance with a contract to deliver them to the entity and not when the entity uses them to deliver another service (for example, to deliver an advertisement to customers) [S.3064.53A]. ASPE however does not preclude an entity from recognizing a prepayment as an asset when payment for services has been made in advance of the entity receiving those services.

The future benefit of the $80,000 payment is realized on October 5, 20X2, when the services of printing the catalogues are received by SSI (i.e. when they are performed by Print Inc. and delivered to SSI) and not when SSI uses them to deliver the catalogues to their customers. Once


the catalogues have been printed and delivered to SSI, no measurable future benefit remains because the catalogues are a form of advertisement for which the future benefit cannot be reliably measured. As such, the payment should be expensed on October 5, 20X2.

Wally may argue that the future benefit of the $80,000 payment is realized when the catalogues are delivered to the end customer. At this point, the company relinquishes control of the catalogues in order to receive the benefit of delivered advertising to its end customer. Prior to this point, the cost qualifies as an asset, as much as any cost incurred prior to the receipt of benefit, such as prepaid insurance and prepaid rent. However, such an argument, though persuasive, would be contrary to ASPE guidance.

Conclusion:The $80,000 cost of catalogues should be recognized as an expense in fiscal 20X2, lowering net income and therefore lowering the selling price of SSI, consistent with your objective.


Inventory Theft

Issue: What is the amount of the inventory loss?

Analysis:On March 24, 20X2, SSI’s Estevan, Saskatchewan plant was the victim of theft. The amount of inventory stolen can be estimated using the Gross Margin Method as follows:

Beginning Inventory + Purchases – Cost of Goods Sold = Ending Inventory 1.8 + 1.3 - 0.592 = 2.508

As of the last inventory count on December 31, 20X1, the plant had $1.8 million worth of products. Purchases during the period are noted to be $1.3 million. SSI’s records indicate that sales from January 1 to March 24th were $1.48 million. As the company has a consistent gross margin of 60% on all sales, the cost of goods sold is estimated to have been $0.592 million.

SSI needs to establish the amount of inventory left. If it was all stolen, their loss is $2.508 million. They would record an inventory write-off of $2.508 million in fiscal 20X2, increasing expenses and lowering net income.

At the same time, SSI should file an insurance claim for the same amount.

SSI may reasonably argue that the loss on the income statement should be reduced as a result of the proceeds to be received from the insurance company. However, RGL can argue that recognition of the insurance proceeds should not occur until the insurance company has assessed the claim and the claim proceeds can be reasonably measurable, which will likely be in fiscal 20X3.

Conclusion:SSI must record the $2.508 million write-down to inventory as the inventory no longer exists, due to theft. The write-down will decrease net income, lowering the selling price of SSI, consistent with your objective.

http://en.wikipedia.org/wiki/Estevan


The amount of loss to be recorded on the income statement is debatable. If we argue that no recognition of the insurance proceeds should occur until the insurance company assesses the claim, we should then be willing to reimburse SSI accordingly for any future proceeds that are received.

IFRSUnder IFRS, SSI may be able to recognize the insurance reimbursement sooner than under ASPE. Under IFRS, a reimbursement right is recognized as a separate asset when recovery is “virtually certain”.

Unlike IFRS, under ASPE reimbursements generally are not recognized in the balance sheet until actually realized. However, as an exception, if a reimbursement is in respect of a recognized loss, then it is recognized when recovery is “likely”. Under ASPE, a likely loss to an enterprise may be reduced or avoided by a counterclaim or a claim against a third party. In such a case, the amount of the likely recovery is an element of the likely loss and, therefore, would be taken into account in determining the amount to be recognized in the income statement. However, if the probability of success in the related action is less than likely, a potential recovery would not be taken into account. Contingent gains are not recorded until realized.

Like IFRS, the recovery is recognized as a separate asset and is not offset against the related liability in the balance sheet.

Vacant Land

Issue: Is the revaluation of land, to fair value, appropriate?

Analysis: Wally has recorded land at fair value at the balance sheet date, contrary to the cost measurement principle of ASPE.

Under ASPE, property, plant and equipment is recorded at cost and subsequently amortized and tested for impairment (when indicators of impairment exist). Revaluation of land to fair value is not permitted (unless the land is part of a comprehensive revaluation of all assets and liabilities – which is not the case).

Due to appreciation of the land over the years, the current year revaluation has resulted in a $5 million gain, which has increased net income.

Conclusion: The revaluation of the land to fair value is not appropriate and the $5 million unrealized gain must be reversed, lowering the land carrying value back to its original cost amount and reducing net income (i.e. gain reversed), lowering the selling price of SSI, consistent with your objective.

IFRSUnder IFRS, the vacant land would likely meet the definition of “investment property” - property (land or a building or part of a building or both) held to earn rentals or for capital appreciation or both. Land held for undetermined future use is an explicit example of investment property within the standard. As such, the land would be eligible to be fair valued, with gains/losses recorded in net income.


Even if the land did not qualify as investment property, SSI could elect to revalue the land asset class (in its entirety) using the revaluation model of IAS 16. However, unlike the above treatment for investment property, the gain would be recorded outside of net income, in other comprehensive income.

Business Combination – Purchase of SSI

Issue: What is the initial and subsequent accounting for SSI?

Analysis:

Initial Accounting After considering the various accounting adjustments discussed above, SSI net income is adjusted to about $8.4 million, resulting in a purchase price of $16.8 million (refer to Appendix 1), which is significantly lower than the preliminary purchase price of $52 million. This is a material difference. It is questionable whether the deal would continue on this basis, since this amount is less than the book value of assets 9see below)

If after negotiation, the selling price is agreed to be $16.8, negative goodwill of $33.97 million will arise (refer to Appendix 2). Again, a purchase at this price seems unlikely.

Prior to recording any negative goodwill as a gain in the income statement, I suggest a reassessment be conducted of the calculated fair values of net assets, including the patent.

Subsequent Accounting By purchasing 100% of the common share of SSI (presumed to be fully voting and participating shares), RGL will be a controlling shareholder with the unilateral power to direct the significant activities of the company, including the operating and financing policies. As a controlled investee, SSI will become a subsidiary of RGL. Under ASPE, RGL must develop a policy to either i) consolidate subsidiaries or account for them using ii) the Equity Method or iii) Cost Method. This policy would need to be applied consistently – to SSI and any other future subsidiaries.

IFRSUnlike ASPE, subsidiaries must be consolidated under IFRS – no policy choice exists.

Conclusion:Refer to Appendix 1 and Appendix 2 for detailed calculation on the purchase price and negative goodwill.

I recommend you contact SSI to commence negotiation regarding the identified accounting issues and the proposed resolution to those issues. SSI and particularly Wally may not be receptive to our feedback as many of our conclusions will result in lowering net income and therefore the selling price of SSI. Please use this report as a basis to commence discussions.

If you have any questions regarding my analysis, please contact me at your convenience.


Appendix 1: Purchase Price Calculation Purpose: To determine SSI adjusted net income based on accounting analysis conducted and calculate the purchase price of SSI. Net Income: $ 26,000,000 Adjustments Government Grant (preliminary): $ (10,000,000) Catalogues $ (80,000) Inventory Theft $ (2,508,000) Vacant Land: $ (5,000,000) Adjusted Net Income: $ 8,412,000 Purchase Price Formula ( 2 x Net Income) 2 Purchase Price $ 16,824,000 Conclusion: The purchase price of SSI is $16,824,000 which is significantly lower than the preliminary suggested price of $52,000,000.

Appendix 2: Purchase Price Allocation

Purpose: To allocate the purchase price and determine the amount of goodwill or negative goodwill. Consideration Paid $ 16,824,000 Net Assets Received Recognized Fair Value of Net Assets $50,000,000 Patent $ 800,000 $ 50,800,000 Negative Goodwill $ 33,976,000 Conclusion: Negative goodwill of $33,976,000 arises. Prior to recording the gain in net income (of RGL), an analysis should be conducted to reassess the fair value of net assets (including the patent).

The basis of negotiation may have to be adjusted.


Case 10-3 Road Safety Incorporated

Overview

This case identifies accounting policies that were selected by a new employee that has a motivation to maximize net income to maximize the amount of the bonus he will receive. In addition, the bank has a covenant with a maximum debt to equity ratio so there is the motivation to minimize debt and maximize equity. It must be considered whether the accounting policies selected are in accordance with GAAP first using IFRS and secondly as a private company using ASPE. Ethics are critical to consider in the evaluation of the accounting policy.

Issues1. Valuation basis for land and building2. Warranty3. Deferred tax4. Goodwill5. Non-monetary transaction6. Major spare parts

Analysis

For each issue the appropriate accounting policy using IFRS will be discussed then any difference if ASPE was selected.

1. Valuation basis for land and building Part AThe vacant land would qualify for investment property since it is being held for capital appreciation. The building would not qualify as investment property since it is being used in the operations of the business. The land and building could both be shown at fair value. The land could use the fair value model as investment property (IAS 40) and the building could use the revaluation model in property, plant and equipment (IAS 16). However, only changes to the land will go into net income and the land would not be depreciated. The building would still be depreciated in the revaluation model and increases in value would go into other comprehensive income and then the revaluation surplus. Any appreciation in value would not impact earnings until the building was sold.

The accounting policy suggested by Tom is incorrect for the building but correct for the land. This would have a negative impact on Tom’s bonus.

Part BIf ASPE were selected the land and building would be valued using cost. The land would not be depreciated. The building would be depreciated. Any appreciation in value would not impact the income statement until the land or building was sold.


2. WarrantyPart AThe warranty is not a separate performance obligation. It is not a stand-alone contract and is meant only to ensure that the product is working as designed. There is no need to bifurcate the revenue contract on initial recognition. The warranty would be a provision which should be recognized in the period in which the product has been purchased. The provision would be determined by estimates based on past history. The amounts may be small if there are few or any warranty costs.

The accounting policy recommended by Tom is incorrect. The estimated liability would have a negative impact on the debt to equity ratio and Tom’s bonus.

Part BIf ASPE were selected the accounting policy would be the same since warranty costs are estimated and recognized at the time the related revenue is recognized.

3. Deferred Tax**(Note to instructors students likely have little or no knowledge on deferred tax at this point in the course. It is at discretion of instructor whether this issue should or should not be included)

Part AThe liability method is required for income tax. This would mean that deferred tax liabilities must be recognized. Deferred tax assets are only recognized if it is probable that there will be sufficient taxable profit to use the benefit. However, losses would likely be recognized as a deferred tax asset since our company becomes profitable.

Tom’s recommended policy is incorrect since the recognition of deferred tax is not optional. Any deferred tax liabilities would have a negative impact on the debt to equity ratio. However, the bank often does not consider deferred taxes (in their covenant calculation). This must be clarified with the bank.

Part BIf ASPE are selected then the liability method would not have to be used. The company could elect to use the taxes payable method. However, it is only under the liability method that the tax losses could be recognized as a future tax asset if the more likely than not provision was met. If this method was selected future tax liabilities would also need to be recognized.


4. Goodwill

Part AThere are two issues with the recommended accounting policy selected by Tom. Internal goodwill cannot be recognized therefore RI should not have any existing goodwill on the books since this is the first year that a company has been purchased. Goodwill must be tested for impairment on an annual basis. Therefore, Tom’s accounting policy is incorrect. Existing goodwill must be removed from the Statement of Financial Position.

Part BThe accounting policy would be identical using ASPE in that internal goodwill would not be recognized. However, in these standards, testing goodwill for impairment does not need to occur on an annual basis only if an event or circumstance indicates impairment.

5. Non-monetary transaction

Part AThis is a non-monetary transaction. Valuation is an issue. The starting point would be to use the value of the technology received unless the value of the shares is more determinable. It would need to be determined if the fair value of either the shares or the technology could be estimated using a valuation model. If neither value is determinable which is indicated based on the information that we have the technology should be recognized at the book value of the shares.

Part BUnder ASPE, the accounting policy would be to look first at the fair value of the shares unless the fair value of the patent was more reliable.

6. Major spare parts

Part AMajor spare parts and inspections or overhauls are recognized as a separate component and depreciated over the period until the spare part will be replaced or the next overhaul. Straight line depreciation is an appropriate method as long as it reflects the pattern of consumption of benefits.

Tom is incorrect in his accounting policy. This will likely increase depreciation expense and reduce net income and Tom’s bonus.

Part BASPE would not require the use of component accounting (if not practical and when reliable estimates of useful lives of separate assets cannot be made).

Overall recommendation


It appears that Tom may have been motivated by his bonus and / or the covenant to select incorrect accounting policies. These do not appear to be ethical decisions.


Technical Review

Technical Review 10-1

a. Goodwill. Not depreciated; indefinite life

b. Trademark with a remaining life of ten years but renewable for an infinite period; expected to be used indefinitely.

Not depreciated; indefinite life

c. Customer lists. Not depreciated; indefinite life (if assumed to have a definite life, must be amortized)

d. Machinery. Depreciated; finite life

e. Land expected to be held for twenty years and then sold.


f. Site restoration costs with respect to the land in e.

Depreciated; finite life

g. Buildings, accounted for using the revaluation method.

Depreciated

h. Rental property, accounted for using the fair value method


i. Vines (winery). Biological asset but exempt and recorded at cost and depreciated (bearer plants)



Requirement 1

Depreciation Schedule – Straight-line Method

Depreciation Accumulated Net BookYear Expense Depreciation Cost Value

1 January 20x2 $500,000 $500,00031 December 20x2 $48,000 1 $ 48,000500,000 452,00031 December 20x3 48,000 96,000 500,000 404,000

1 ($500,000 – $20,000) × 1/10

Requirement 2

Depreciation Expense — Productive Output Method


1 January 20x2 $500,000 $500,00031 December 20x2 $90,000 1 $ 90,000500,000 410,00031 December 20x3 72,0002 162,000 500,000 338,000

1 ($500,000 – $20,000)/800,000 =$.6 per unit; 150,000 units x $.6 = $90,0002 ($500,000 – $20,000)/800,000 =$.6 per unit; 120,000 units x $.6 = $72,000

Requirement 3

Depreciation Schedule — Declining Balance Method


1 January 20x2 $500,000 $500,00031 December 20x2 $200,000 1 $200,000 500,000 300,00031 December 20x3 120,000 320,000 500,000 180,000

1 Net book value × .40

Note: The required only asks for depreciation expense; additional information has been provided for completeness.



Requirement 1

Year Straight-line Units of production

Declining balance

20X8($34,000 - $8,000)/10 $2,600(($34,000 - $8,000)/200,000)x 34,000

$4,420

$34,000 x 50% $17,00020X9($34,000 - $8,000)/10 $2,600(($34,000 - $8,000)/200,000)x 40,000

$5,200

($34,000 - $17,000) x .5 $8,500

Requirement 2

Year Straight-line Units of production

Declining balance

20X8($34,000 - $4,000)/15 $2,000(($34,000 - $4,000)/300,000)x 34,000

$3,400

$34,000 x 50% $17,00020X9($34,000 - $4,000)/15 $2,000(($34,000 - $4,000)/300,000)x 40,000

$4,000

($34,000 - $17,000) x .5 $8,500



Requirement 1

Component A $80,000/5 = 16,000Component B $120,000/10 = 12,000Component C $200,000/25 = 8,000Total depreciation = $36,000

Depreciation expense ................................................. 36,000 Accumulated depreciation, A................................ 16,000 Accumulated depreciation, B................................ 12,000 Accumulated depreciation, C................................ 8,000

Requirement 2

If component A was replaced at the end of year 4, the remaining value of the original part would be $16,000 (20% of cost). The replacement would trigger a loss because the component is not fully depreciated.

Component A (new part) ........................................... 100,000Accumulated depreciation (80%) .............................. 64,000Loss on replacement .................................................. 16,000 Component A (old part) .................................. 80,000 Cash................................................................ 100,000



Requirements 1 and 2

Year Month Half year Full first year Final year20X3(($90,000 - $10,000)/5) x 9/12

$12,000

(($90,000 - $10,000)/5) x 6/12

$8,000

(($90,000 - $10,000)/5) $16,000$0

20X4 $16,000 $16,000 $16,000 $16,00020X5 $16,000 $16,000 $16,000 $16,00020X6 $16,000 $16,000 $16,000 $16,00020X7 $16,000 $16,000 $16,000 $16,00020X8(($90,000 - $10,000)/5) x 3/12

$4,000$8,000 $0 $16,000

Requirement 3

Year Month Half year Full first year Final yearProceeds, 20X6 $6,000 $6,000 $6,000 $6,000

Net book value, 20X6($90,000 – ($12,000 +($16,000 x 3))

$30,000

($90,000 – ($8,000 +($16,000 x 3))

$34,000

($90,000 – ($16,000 x 4))

$26,000

($90,000 – ($16,000 x 3))

$42,000

Loss on sale $24,000 $28,000 $20,000 $36,000

The amounts are different because different amounts of depreciation have been expensed.



Requirement 1

The recoverable amount is the higher of:1. fair value less costs to sell $155,000, and2. value in use $148,000.

The recoverable amount is therefore $155,000. This value is then compared to the carrying amount of the asset $175,000.

Requirement 2

The amount of the impairment is $20,000 ($175,000-$155,000).


Requirement 1

The recent health studies would be an indication that there may be impairment. The recoverable amount is the higher of fair value less costs to sell (which cannot be determined) and value in use of $17,000.

The recoverable amount of $17,000 is then compared to the carrying amount of the asset $20,000. The amount of the impairment is $3,000.

Impairment loss...................................................................... 3,000 Machinery ....................................................... 3,000

Requirement 2

Yes, impairment can be reversed. The amount of the reversal would be the difference between the carrying amount had depreciation still been taken. Assuming no depreciation then the amount of the reversal would be $3,000.

Machinery....................................................................... 3,000 Recovery of impairment loss .......................... 3,000



Requirement 1 The impairment loss is $1,000 ($2,500 less $1,500 recoverable amount)

Carrying Value (thousands)

Proportion (equipment

and building only; $1,250

base)

Allocation of impairment

loss

Net book value

Equipment $ 600 48% 168(3) $432Building 650 52% 182(3) 468Land 700 100(2) 600Goodwill 550 550(1) --

$2,500 $1,000 $1,500

(1) Allocated first(2) Allocated only to limit of fair value less cost to sell; ($700 - $600) If land was

included in the general write-down, it would receive ($1,000 - $550) x ($700/$1,950) = $161 of write-down and this would reduce it below its individual fair value less cost to sell.

(3) Proportions based only on assets excluding land and goodwill. ($1,000 loss less $550 allocated to goodwill and $100 to land); $350 x 48% and 52%

Requirement 2

The impairment loss reversal is $300 ($1,800 less $1,500)

Carrying Value (thousands)

Proportion (E&B only; $900 base)

Allocation of impairment

lossreversal

Net book value

Equipment $432 48% 144(3) $576Building 468 52% 156(3) 624Land 600 --(2) 600Goodwill -- --(1) --

$1,500 $300 $1,8001. Not reversed2. Not reversed because fair value less cost to sell is not changed3. Proportions based only on assets excluding land and goodwill.; $300 x 48% and 52%



ASPE minimum amortization test:

Calculation 1 Calculation 2

($254,000 - $125,000)/15 years $8,600($254,000 - $2,500)/25 years $10,060

Depreciation expense is the larger amount, $10,060


CCA Class 8

20X8Acquisitions................................................................................ $100,000CCA for 20x5 ($100,000 × 20% × 1/2) ..................................... (10,000)UCC closing balance.................................................................. $90,000

20X9Disposals .................................................................................... $(6,000)Additions .................................................................................... 40,000 34,000CCA for 20x6 ($90,000 × 20%) + ($34,000 × 20% × 1/2)...... ( 21,400)UCC closing balance.................................................................. $102,600


Assignments

Assignment 10-1

This method would not be considered acceptable. A method cannot be selected just to be conservative.

Depreciation policy of external reporting should reflect the consumption of benefits. However, a declining balance approach is acceptable if it can be justified based on consumption of benefits.

Some features of the CCA model – some of the high depreciation rates, the treatment of proceeds on sale, for example - are simply not acceptable for external reporting.

In addition, for external reporting. component depreciation is required; each item of property, plant and equipment must be separated into significant components and an appropriate depreciation rate and method must be selected for each component if there are components with different life spans.


Assignment 10-2

Requirement 1

From Note 1, depreciation is recognized under the straight-line method.

Requirement 2

From Note 1,1/useful life = 2% 1/useful life = 6%useful life = 50 years useful life = 16.67 years

Requirement 3

From Note 16, at 31 December 20x2 for buildings:Book value = $194,969 – $64,545 = $130,424Percent of useful life remaining = $130,424 ÷ $194,969 = 67%

Requirement 4

From Note 16:Cost of machinery retired in 20x2 ........................................................ $16,319Accumulated depreciation .................................................................... 12,302Book value of machinery and equipment retired in 20x2.....................$ 4,017

Requirement 5

Depreciation on buildings, machinery for 20x2 was $44,507 ($7,422 + $37,085).a) $44,507 ÷ $2,079,455 = 2%b) $44,507 ÷ $187,277 = 24%


Assignment 10-3

a. Cost model – Assets are recorded at historic cost. Depreciation is accounted for each period with the exception of certain assets e.g. land, goodwill and intangible assets with indefinite lives. Impairment factors are reviewed each year for all assets and assets are be written down if impaired, and reinstated if impairment reverses.

b. Revaluation model – Assets are revalued to fair value periodically to reflect market conditions. Assets are written up, with gains recorded in accumulated OCI. If gains reverse, OCI is reversed. Impairment factors are reviewed each year for all assets. If the asset is written down, this is treated as an impairment, and the loss is recorded in earnings. Loss reversals are also in earnings. Depreciation is recorded each period before a revaluation is completed. This model is only appropriate for property, plant and equipment and intangible assets with an active market.c. Fair value model – Assets are revalued annually to fair value. Gains and losses are recorded in earnings. Depreciation is not recorded in this model. Impairment testing is automatically done since fair value is recorded every reporting date. This model is only appropriate for investment property (rental buildings).

Assignment 10-4

a) Land is not depreciated. Land improvements for site restoration costs are depreciated, probably straight-line, but based on benefits consumed.

b) Productive-output (referred to as depletion) (industry practice)c) Straight-line over lifespan of intangibled) Straight-line (or perhaps productive-output if production is volatile)e) Straight-linef) Straight-line (the most simple)g) Declining-balance (usage)h) Units-of-production (usage)i) Declining-balancej) Declining-balance using rates close to CCAk) Straight-line (same as parent for consolidation)


Assignment 10-5

Case A

The patent should be amortized since it has a limited lifespan to the company. The lifespan is 8 years unless it could be resold after Year 8. The appropriate method of amortization would be straight-line. Useful life would need to be reassessed annually.

Case B

The patent should be amortized since it has a limited lifespan to the company. The lifespan is the 10 years or until another competitor enters the market. The appropriate method of amortization would be straight-line. The useful life would be reassessed annually.

Case C

The quota would have an indefinite life since the cost to renew is minimal, the company intends to renew and quotas are difficult to obtain. The quota is not depreciated but would be tested for impairment.

Case D

The trademark at this point has an indefinite lifespan since it is for one of the top selling products. The trademark would not be amortized, but it would be tested for impairment. If, at some point, the product were to have a limited lifespan, the company would begin to amortize the trademark.


Assignment 10-6

Case A

Component depreciation would not be used for this machine. The part is $250/$25,000, or 1% of cost, which would not be considered significant. The machine would be depreciated over the 10 years. Replacements parts would be expensed.

Case B

Component depreciation would likely be used for this machine. The part is $4,000/$20,000 or 20% of cost, which would likely be considered significant. Professional judgment would need to be used. The part would be depreciated over two years and the remainder of the machine over ten years, assuming no other significant components. Replacement components would be capitalized and depreciated.

Case C

Component depreciation would be used for this machine. The major overhaul will be $12,500/$50,000 or 25% of cost, which would be considered significant. The major overhaul would be depreciated over three years and the remainder of the machine over its useful life, assuming no other significant components.


Assignment 10-7

Case A

The first transformer would be depreciated over its useful life of 50 years. The second transformer would be considered standby equipment. It would be considered an item of property, plant and equipment since it is expected to be used over the same period. The second transformer would be depreciated over its useful life of 50 years even though it may never be brought into service.

Case B

The spare parts would start to be depreciated once they were put in use. They are not depreciated before installation, because technological obsolescence is not a factor. At that point they would be depreciated over 50 years.


Assignment 10-8 (WEB)

Requirement 1

Year (a)DB 30% (b) Productive Output (c) SL

1 $10,800 $3,840 $5,6002 7,560 5,760 5,600

(a) $36,000 × 30%; ($36,000 – $10,800) × 30%(b) ($36,000 – $2,400) ÷ 210,000 = $0.16; $0.16 × 24,000; $0.16 × 36,000(c) ($36,000 – $2,400) × 1/6 = $5,600

Requirement 2

Year (a)DB 20% (b) Productive Output (c) SL

1 $7,200 $3,840 $3,3602 5,760 5,760 3,360

(a) ($36,000 × .2); (($36,000 - $7,200) × .2)(b) ($36,000 – $2,400) ÷ 210,000 = $0.16; $0.16 × 24,000; $0.16 × 36,000(c) ($36,000 – $2,400) × 1/10

Conclusions based on comparisons of 1 and 2:

When years of life enter directly into the depreciation calculation, changing the years of life has a material impact on depreciation levels. For other methods, the years of life indirectly affect the calculation (depreciation per unit of product) and may not affect initial depreciation.

Requirement 3

Factors influencing choice of depreciation policy:1. Nature and use of the asset2. Corporate reporting objectives3. Industry norms4. Parent company preferences5. Accounting information costs


Assignment 10-9

Requirement 1

a. Depreciation Schedule – Straight-line Method


1 January 20x5 $156,000 $156,00031 December 20x5 $31,500 1 $ 31,500156,000 124,50031 December 20x6 31,500 63,000 156,000 93,00031 December 20x7 31,500 94,500 156,000 61,50031 December 20x8 31,500 126,000 156,000 30,000

1 ($156,000 – $30,000) × 1/4

b. Depreciation Schedule — Declining-Balance Method


1 January 20x5 $156,000 $156,00031 December 20x5 $62,400 1 $62,400 156,000 93,60031 December 20x6 37,440 99,840 156,000 56,16031 December 20x7 22,464 122,304 156,000 33,69631 December 20x8 3,6962 126,000 156,000 30,000

1 Net book value × .402 Limited to take NBV to $30,000; $33,696 – $30,000

c. Depreciation Expense — Service Hours


1 January 20x5 $156,000 $156,00031 December 20x5 $35,910 1 $ 35,910156,000 120,09031 December 20x6 31,500 67,410 156,000 88,59031 December 20x7 30,240 97,650 156,000 58,35031 December 20x8 27,720 125,370 156,000 30,630

1 ($156,000 – $30,000)/20,000 = $6.30/hour; 5,700 × $6.30 and then × 5,000 hours, 4,800 hours and 4,400 hours.


Requirement 2

SL depreciation is 20% of cost ($31,500/$156,000) and 25% of depreciable cost ($31,500/$126,000).

Requirement 3

a) The 40% rate for DB was aggressive, as the equipment was almost fully depreciated in the first three years; the last year had minimal despite the fact that the asset was still in use.

b) The service hour estimate was quite accurate. The actual hours used were 19,900 versus the 20,000 estimate. Net book value was reduced to $30,630, very close to the $30,000 estimated net residual value.



a. DB: 50%Balance in Accumulated

Year Depreciation Expense Depreciation

20x5 ($2,000,000 × .50) = $1,000,000 $1,000,00020x6 ($1,000,000 × .50) = 500,000 1,500,00020x7 ($500,000 × .50) = 250,0001,750,000

$1,750,000b. Straight-line:

Balance in AccumulatedYear Depreciation Expense Depreciation

20x5 $ 445,000 (a)$ 445,00020x6 445,000 890,00020x7 445,0001,335,000

$1,335,000

(a) ($2,000,000 – $220,000) × 1/4 = $445,000

c. Units of production ($2,000,000 – $220,000) = $26.18 per unit:(20,000 + 18,000 + 16,000 + 14,000)

Balance in AccumulatedYear Depreciation Expense Depreciation

20x5 (20,000 × $26.18)=$ 523,600$ 523,60020x6 (18,000 × $26.18)= 471,240 994,84020x7 (16,000 × $26.18)= 418,8801,413,720

$1,413,720

The straight-line method results in maximum income for financial statement reporting for the three-year period ending December 31, 20x7, because cumulative depreciation expense is smallest for the straight-line method. (See schedules above.)


Assignment 10-11

Requirement 1

Productive output is Method 2; depreciation follows the usage pattern, slightly lower in each of the first three years but higher in the last year.

Straight-line is Method 3 – same depreciation in each year

Declining balance (50%) is Method 1; steadily and rapidly declining depreciation until the last year when the remaining balance is presumably written off.

Requirement 2

Productive output was calculated by ADDING the residual value, not subtracting it:($87,480 + $6,000) ÷ 4,800 = $19.475 × 1,400 = $27,265 etc.

Straight-line depreciation was calculated as $87,480 ÷ 4 = $21,870; residual value was not deducted.

Declining balance (50%) was done with a 25% rate: $87,480 × .25 = $21,870; in Year 4 depreciation is incorrect since the asset is written down to zero instead it should have ceased when net book value was equal to the $6,000 residual value.

Requirement 3Correct year 2 depreciation:

Productive output: ($87,480 – $6,000)/4,800 = $16.975 × 1,300 = $22,068

Straight-line: ($87,480 – $6,000) ÷ 4 = $20,370

Declining balance: 50% × ($87,480 – $43,740) = $21,870


Assignment 10-12

Depreciation DepletionBook Book

Year Unit Total Value Unit Total ValueInitial Cost $307,000a $600,000b

1 $.77c $ 9,240e297,760 $1.3d$ 15,600f 584,4002 .78 18,480 279,280 1.3 31,200 553,200

Because the sheds and machinery are economically tied to the minerals, they are depreciated on a productive-output basis.

a Sheds $ 160,000Machinery 144,000Installation 3,000Depreciable amount $307,000

b Land cost $600,000Residual value (80,000)Depletable amount $520,000

c Depreciation, Units-of-production:$307,000 ÷ 400,000 kilos = $.77 per kilo

d Depletion, Units-of-production:$520,000 ÷ 400,000 kilos. = $1.3 per kilo

e 12,000 × $.77 = $9,240. Second year is double the production.

f 12,000 × $1.3 = $15,600. Second year is double the production.


Assignment 10-13

Requirement 1

Component A ($120,000-$5,000)/12 = $9,583 x 2 = $19,166Component B $40,000/3 = $13,333Component C ($8,000-$500)/6 = $1,250 x 5 = $6,250Component D ($2,000/2)= $1,000 x 10= $10,000Total depreciation = $48,749

Requirement 2

If component B was replaced at the end of year 2,the remaining value of the original part would be $13,334 (1/3). A loss is recorded because the old component is not fully depreciated.

Component B (new part)............................................ 50,000Accumulated depreciation (2/3)................................. 26,666Loss on replacement .................................................. 13,334 Component B (old part) .................................. 40,000 Cash................................................................ 50,000


Assignment 10-14

Requirement 1

Shell ($400,000-$16,000)/10 $ 38,400Motor $360,000/3 120,000Tires $40,000/2 20,000Shovel $340,000/5 68,000Remainder $60,000/2 30,000

$276,400

Requirement 2

If the equipment was not separated into components, depreciation would be taken on the equipment as a whole: ($1,200,000 – $16,000)/10 = $118,400. The shell is assumed to dictate useful life. Other assumptions can be justified.

Requirement 3

The logic behind component depreciation is that when an asset is viewed as a whole, it does not reflect the pattern of consumption. Some parts or components will be used up faster than others. The effect of ignoring components is lower depreciation than if the asset was viewed as components.


Assignment 10-15

Requirement 1

Component Depreciation:

Original Residual Depreciable Estimated AnnualComponent Cost Value Cost Life Depreciation

A $ 200,000$20,000$ 180,000 10 $ 18,000B 90,000 0 90,000 5 18,000C 152,000 32,000 120,000 15 8,000D 24,800 800 24,0008 3,000

$466,800 $52,800 $414,000 $47,000

Depreciation expense .......................................................................... 47,000Accumulated depreciation ........................................................... 47,000

Requirement 2

Cash..................................................................................................... 24,000Accumulated depreciation................................................................... 36,000Loss………………………………………………………………….. 30,000Plant asset—Component B (new) ....................................................... 100,000

Plant asset—Component B (old) ................................................. 90,000Cash.............................................................................................. 100,000

Requirement 3

Depreciation expense ($466,800 / 15)................................................. 31,120Accumulated Depreciation........................................................... 31,120

To record depreciation for the year.


Assignment 10-16

Requirement 1

Invoice price of equipment $ 420,000Less cash discount missed (2,100)

Net purchase price $417,900

Plus additional costs to prepare for operation: Shipping 4,000Installation 3,000Testing 6,000Book value when ready for use $ 430,900

Requirement 2

a. Closest month: $430,900 ÷ 6 years × 6/12 = $35,908

b. Full first year: $430,900 ÷ 6 years = $71,816

c. Half-year convention: $430,900 ÷ 6 years × 1/2 = $35,908

Requirement 3

Depreciation by day is tedious to calculate, and not materially more accurate than depreciation by month. Since depreciation is itself an estimate, it is not rendered more precise by use of days instead of months.

Requirement 4

Declining balance rate: 33%; given.

a. 20X7: $430,900 × 33% × 6/12 = $71,09820X8: ($430,900-$71,098) × 33% = $118,735

b. 20X7: $430,900 × 33% = $142,19720X8: ($430,900 – $142,197) × 33% = $95,272

c. 20X7: $430,900 × 33% × ½ = $71,098 20X8: ($430,900 – $71,098) × 33% = $118,735


Assignment 10-17 (WEB)Requirement 1 20x5 Machinery Accumulated

Depreciation1 January 20x5 ............................. $200,000 1 April 20x5 ................................. 80,000 Depreciation$200,000 x 1/10 × 12/12 .............. $20,000$80,000 x 1/5 × 9/12 .................... 12,000

Balance, 31 December 20x5 ........ 280,000 32,000 Expense, 20x5 20x61 December 20x6 ......................... 10,000 Depreciation$200,000 × 1/10 × 12/12.............. 20,000$80,000 × 1/5 × 12/12.................. 16,000$10,000 × 1/10 × 1/12.................. 84Disposal........................................ (28,000) 36,084 Expense, 20x6Acc’d depreciation$28,000 × 1/10 × 2 years ............. ( 5,600)Balance, 31 December 20x6 ........ $262,000 $62,484

Requirement 2 Accumulated 20x5 Machinery Depreciation1 January 20x5 ............................. $200,000 1 April 20x5 ................................. 80,000 Depreciation$200,000 × 1/10 × 1/2.................. $ 10,000$80,000 × 1/5 × 1/2...................... 8,000Balance, 31 December 20x5 ........ 280,000 18,000 Expense, 20x5 20x61 December 20x6 ......................... 10,000 Depreciation$172,000 × 1/10 (Note 1)............. 17,200$28,000 × 1/10 × ½ (Note 1) ....... 1,400$80,000 × 1/5 ............................... 16,000$10,000 × 1/10 × 1/2.................... 500Disposal........................................ (28,000) 35,100 Expense, 20x6Acc’d Depreciation$28,000 × 1/10 × (1/2 + 1/2)........ ( 2,800)

$262,000 $ 50,300

Note 1: $172,000 + $28,000; since $28,000 retired in 20x6, only ½ of depreciation taken in year of retirement.


Requirement 3The fractional year rule may result in a materially different amount of depreciation expense. This happens when acquisitions and disposals are not evenly distributed through the year.


Assignment 10-18

Requirement 1

Organization expense*............................................... 10,000Patent (intangible asset) ............................................. 5,000Operating expense...................................................... 220,000Goodwill (intangible asset) ........................................ 160,000Copyright (intangible asset) ...................................... 21,000Trademark (intangible asset)...................................... 8,000Training expense*...................................................... 27,500Research expense ($150,000 × 60%)......................... 90,000Development costs (intangible asset) ($150,000 × 40%)60,000 Intangibles...................................................... 601,500

* Neither the organizational costs nor the deferred training costs should be capitalized as intangibles because they have no reliably measurable future benefit. Research costs must be expensed.

Requirement 2

Amortization expense:

Patent ($5,000 ÷ 20 ) × 11/12 .................................. $229Copyright ($21,000 ÷ 10) × 2/12 .............................. 350

No amortization is charged for intangibles with an indefinite life (the trademark). Goodwill is also not amortized. These assets are subject to an annual impairment test. The development costs are not amortized until commercial production begins. However, development costs are considered an intangible asset (not yet available for sale/use); irrespective of whether there is any indication of impairment, these costs should be tested for impairment annually.


Assignment 10-19

Case A

One line of office furniture where agents sell all lines almost certainly will not constitute an independent cash generating unit for which the cash flows are largely independent of other cash flows. The furniture probably uses the same production facilities as other lines, and also uses the same sales force and administrative support system. An impairment test for this single line would not be feasible or appropriate.

Case B

The Northern Ontario division has both production and sales responsibilities. The company is decentralized, which implies that the division is responsible for its own cash flows. An impairment test is necessary.

Case C

As a foreign operation, the US stores are probably organized into a separate corporation. The stores, as a group, will generate their own cash inflows and outflows. Although there may be a large volume of transactions with the Canadian head office (e.g., shipping goods from Canada to the US stores), the US group can be assessed as a separate cash generating unit. An impairment test should be performed.

Case D This division clearly is separate from the main business of the corporation and has independent cash flows. An impairment test should be performed. As well, the division's net assets should be reported as "held-for-sale" on CHSC's SFP, since a plan for disposition is in place.

Case E

As a product offering, the connector is just one product in the company's product line and cannot be assessed independently for impairment. However, it appears that the patent itself cannot be defended successfully; the patent, as an intangible asset, should be subject to an impairment test.



Requirement 1

Impairment loss – PlayMark…………………………….. 960,000Accumulated amortization – PlayMark……….. 960,000

Note: This entry decreases the carrying value of PlayMark to $1,000,000 by increasing accumulated amortization. This is the customary approach. However, it also is feasible to credit the asset account directly.

Requirement 2

a. Had no impairment occurred the carrying amount at the end of 20X6 would have been $1,560,000 ($1,960,000- 20X6 annual depreciation of $400,000).

b. The impairment loss of $960,000 only would be reversed to increase the carrying amount to $1,560,000. This is a reversal of $560,000. This reversal would be reported in earnings.


Assignment 10-21

The carrying amount $14,000,000 must be compared to the recoverable amount. The recoverable amount is the higher of:

1. fair value less costs to sell = $5,400,000, and2. value in use ($3,000,000 - $200,000 = $2,800,000 x (P/A, 5, 6%; 4.21236) = $11,794,608 + ($100,000 x (P/F, 5, 6%; .74726 = $74,726) = $11,869,334. The distress price of $5,000,000 is disregarded.

The recoverable amount is $11,869,334.Since this is lower than the carrying amount of $14,000,000 there is an impairment of $2,130,666.


Assignment 10-22

Requirement 1

Impairment loss – abrasives group……………………….. 100Accumulated depreciation – equipment……….. 74Accumulated depreciation – fixtures………….. 23Accumulated amortization – patent rights…….. 3

Calculations:

AssetNet book

value ProportionAllocation of

impairment lossAdjusted

carrying valueEquipment $220 74% $ 74 $146Fixtures 70 23% 23 47Patent rights 10 3% 3 7

$ 300 100% $ 100 $ 200

Requirement 2Cost Net Book

ValueAdditional

depreciationRevised net book value

if no impairment

Equipment (10 year life)

$400 $220 $40 $180

Fixtures (10 year life)

125 70 12.5 57.5

Patent rights (40 year life)

80 10 2 8

$605 $300 $245.5

Requirement 3

The reversal would be allocated proportionally, as the write-down was. No asset may be written up higher than its individual fair value. No asset may be written up higher than the amount that would have been its net book value if it had not been impaired, but was deprecated, instead (requirement 2). This places a ceiling on impairment reversals for specific assets.


Assignment 10-23

Requirement 1

Impairment loss …………………………………. 1,640Goodwill…………………………………. 800Accumulated depreciation – equipment…. 227Accumulated depreciation – buildings….. 571Accumulated amortization – patent rights.. 42

Calculations:

AssetNet book

valueProportion

E+B+VAllocation of

impairment lossAdjusted

carrying valueGoodwill 800 800 0Equipment 1,200 27% 227** 973Buildings 3,000 68% 571 2,429Patent rights 240 5% 42 198

$ 5,240* 100% $ 1,640 $ 3,600

Total; only E+B+P $ 4,440*

*The impairment loss is first allocated to goodwill. Then any remaining amount is allocated to the remaining assets on a proportionate basis. The total net book value excludes the net book value of goodwill since this is not included for the allocation of the loss.** ($1,640 – $800) x 27%, etc.

Requirement 2

If there is a reversal of impairment the goodwill amount would not be reversed. The value of the goodwill would remain at zero. The impairment can be reversed for other assets, but they may not be written up to a value higher than their individual fair value less cost to sell, or their carrying value had the impairment not been reversed.


Assignment 10-24

Requirement 1

Impairment loss ………………………………………. 10,000Goodwill…………………………………….. 4,000Accumulated depreciation – equipment…….. 1,240Land…………………………………………. 2,000Accumulated amortization – property……….. 2,760

Calculations:

AssetNet book

value

ProportionE and P only

(rounded)Allocation of

impairment loss

Adjusted carrying

valueGoodwill $ 4,000 $ 4,000 0Land 16,000 2,000 14,000Equipment 22,000 31% 1,240** 20,760

Property 50,000 69% 2,760 47,420$ 92,000* 100% $ 10,000 $ 82,000

E+P only $72,000

*The impairment loss is first allocated to goodwill. Land would have been assigned a loss of 18% of the remaining $6,000 loss, but this would have been $1,080, reducing land to $14,920. Land has an individual fair value less cost to sell of $14,000, and must be written down to this number. It absorbs $2,000 of the loss. This leaves an impairment loss of $4,000 to be allocated to equipment and property.

** ($10,000 - $4,000 - $2,000) x 31%, etc.

Requirement 2

If there is a reversal of impairment the goodwill amount would not be reversed. The value of the goodwill would remain at $0. The impairment can be reversed for other assets, but they may not be written up to a value higher than their individual fair value less cost to sell (eg, land), or their depreciated net book value had the impairment not been reversed.


Assignment 10-25

Operating ActivitiesAdd back:

Depreciation………………………………………….. $1,200,000Amortization................................................................... 240,000Loss on sale of machinery .............................................. 100,000

Less:Gain on sale of land ........................................................ (120,000)

Investing ActivitiesProceeds on disposition of land .......................................... 1,720,000Proceeds on disposal of machinery1................................... 524,000Acquisition of patent2......................................................... (500,000)

1 ($1,824,000 – $1,200,000) = $624,000. $624,000 – $100,000 = $524,0002 ($240,000 + $260,000) The increase in the patent account was assumed to be because of an acquisition.


Assignment 10-26

a) Land [455,000 × $175 ÷ ($175 + $375)] rounded.............. 144,800Warehouse [$455,000 × $375 ÷ ($175 + $375)] ................ 310,200 Cash ............................................................................ 455,000The appraisal values are assumed to provide an objective basis for allocating the purchase price.

b) Warehouse .......................................................................... 53,200 Cash ............................................................................ 53,200Total warehouse cost, $310,200 + $53,200 = $363,400

c) Depreciation expense, warehouse, 20X2 ($363,400 × 10%) 36,340 Accumulated depreciation, warehouse ...................... 36,340

Depreciation expense, warehouse, 20X3............................ 32,706 Accumulated depreciation, warehouse ...................... 32,706($363,400 – $36,340) × 10% = $32,706$36,340 + $32,706 = $69,046

Depreciation expense, warehouse, 20X4............................ 29,435 Accumulated depreciation, warehouse ...................... 29,435($363,400 – $69,046) × 10% = $29,435$69,046 + $29,435= $98,481

Depreciation expense, warehouse, 20X5............................ 26,492 Accumulated depreciation, warehouse ...................... 26,492($363,400 – $98,481) × 10% = $26,492$98,481 + $26,492 = $124,973

Depreciation expense, warehouse, 20X6............................ 23,843 Accumulated depreciation, warehouse ...................... 23,843($363,400 – $124,973) × 10% = $23,843$124,973 + $23,843 = $148,816Net book value of warehouse, $214,584 ($363,400 – $148,816)

d) Warehouse ($214,584 + ( $53,550 × 425/605; 70%) ......... 252,202Land ($144,800 + ( $53,550 × 180/605; 30%)................... 160,752Accumulated depreciation, warehouse ............................... 148,816 Cash ($33,750 + $19,800) ......................................... 53,550 Warehouse .................................................................. 363,400 Land............................................................................ 144,800Note: New appraisal amounts of warehouse and land are $425,000 and $180,000 respectively.

This is the exchange of similar assets. The exchange is recorded at carrying values adjusted for any additional consideration since the transaction lacks commercial


substance. The value of the transaction is the fair value of the new assets, or a total of $605,000. The cash exchanged is not material in this transaction. The new relative fair values are used to allocate the cash payments, but the old fractions may be just as well justified.

e) Depreciation expense, warehouse, 20X7 ($252,202 × 10%) 25,220 Accumulated depreciation, warehouse ........................ 25,220

Depreciation expense, warehouse, 20X8.............................. 22,698 Accumulated depreciation, warehouse ........................ 22,698($252,202 – $25,220) × 10% = $22,698$25,220 + $22,698 = $47,918

Cash ...................................................................................... 356,800Accumulated depreciation, warehouse ............................... 47,918 Warehouse ................................................................ 252,202 Gain on insurance proceeds, warehouse................... 152,516

f) Warehouse ($80,000 + $245,800 + $199,600 + $24,800 + $34,100)........................................................... 584,300Loss on insurance proceeds, warehouse ............................. 13,400Parking lot........................................................................... 45,200 Cash .............................................................................. 642,900Warehouse cost: all expenses except the parking lot cost and clean-up. If the cost of cleaning up the debris is assumed to be already recorded, it will be omitted from this entry. This is acceptable. It is a cost of the fire, and reduces the gain on insurance proceeds. Some would capitalize it as part of the new warehouse, but it is hard to see how fire debris adds to the value of a facility.

g) Income tax payable............................................................... 100,000 Deferred credit, warehouse tax credit........................... 100,000Alternatively, the warehouse facility might be credited directly.

h) Depreciation expense, warehouse, 20X9............................ 58,430 Accumulated depreciation, warehouse ($584,300 × 10%) 58,430Deferred credit, warehouse tax credit ($100,000 × 10%)... 10,000 Depreciation expense.................................................... 10,000

If the deferred credit were not separately recorded, the depreciation expense would be recorded net.

Depreciation expense, parking lot, 20X9 ........................... 2,260 Accumulated depreciation, parking lot....................... 2,260 ($45,200 × 5%)


Assignment 10-27 (Appendix 1)

CCA Class 8

20X5Acquisitions................................................................................ $300,000CCA for 20x5 ($300,000 × 20% × 1/2) ..................................... (30,000)UCC closing balance.................................................................. $270,000

20X6Disposals .................................................................................... $ (11,200)CCA for 20x6 ($270,000 – $11,200) × 20%.............................. ( 51,760)UCC closing balance.................................................................. $207,040

20X7Disposal......................................................................................($19,800)Acquisition ................................................................................. 25,000 5,200CCA for 20x7 ($207,040 × 20%) + ($5,200 × 20% × 1/2)........ ( 41,928)UCC closing balance.................................................................. $170,312

20X8Acquisition ................................................................................. 36,000CCA for 20x8 ($170,312 × 20%) + ($36,000 × 20% × 1/2)...... (37,662)UCC closing balance.................................................................. $168,650


A10-28 Revaluation Model (Appendix 2):

Requirement 1

In OCI In OCI In earnings In earnings

Gain Gain reversal

Loss Loss reversal

Case A $30

Case B

Year 1 30

Year 2 20 30

Case C

Year 1 50

Year 2 50 10

Requirement 2

Case A

If fair value model was used the $30 million would be a fair value increase in net income.

Case B

If fair value method was used in year one no difference, in year two the entire increase $50 million would be in statement profit and loss.

Case C

If fair value method was used the $50 million in year one would be a gain in statement of profit or loss and the $60 million would be a loss in the statement of profit or loss in year 2.


Assignment 10-29

Under ASPE, the first step in an impairment test is to compare the carrying value to undiscounted cash flow.

Carrying amount = $14,000,000

Undiscounted cash flow =

($3,000,000 - $200,000) x 5 = $14,000,000 + $100,000 = $14,100,000

Since this is (barely) higher than the carrying amount there would be no impairment.

Note that IFRS uses discounted cash flows and an impairment would be triggered under IFRS.


Assignment 10-30 Asset Impairment (ASPE)

Requirement 1

Under ASPE, the first step in an impairment test is to compare the carrying value to undiscounted cash flow.

Carrying amount = $595,000

Undiscounted cash flow =

$50,000 x 5 = $250,000 + $180,000 = $430,000

Since this is lower than carrying value, impairment testing moves to the second step. Fair value is now determined:

Fair value = $500,000 - $50,000 = $450,000

The impairment loss is $145,000 ($595,000 - $450,000)

Requirement 2

The undiscounted cash flows are now:

$100,000 x 5 = $500,000 + $200,000 = $700,000

Since this is higher than carrying value, impairment testing stops. The fact that the fair value is less than carrying value is not relevant.

Documents

Chapter 10: Depreciation, Amortization, and Impairmentboliver/Ch10.pdf · Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th ... Chapter 10: Depreciation, Amortization,