Chapter 9: Long-lived Assets

Chapter 9: Long-lived Assets

Case

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Glowworm Inc. Winery Incorporated Penguins in Paradise

Suggested Time

Technical Review TR9-1 Lump-sum Purchase................................................ 10 TR9-2 Capital versus Expense ........................................... 5 TR9-3 Elements of Cost ..................................................... 10 TR9-4 Self-constructed Asset............................................. 10 TR9-5 Low-interest Loan........ ......................................... 15 TR9-6 Decommissioning Obligation ................................. 15 TR9-7 Research and Development..................................... 10 TR9-8 Website.................................................................... 10 TR9-9 Goodwill.................................................................. 10 TR9-10 Disposal of Long-lived Assets........ ...................... 15

Assignment A9-1 Valuation Model ..................................................... 10 A9-2 Component Accounting .......................................... 15 A9-3 Lump-sum Purchase (*W) ...................................... 10 A9-4 Repairs and Other Expenditures ............................. 20 A9-5 Acquisition Cost.................................................... 15 A9-6 Acquisition Cost...................................................... 25 A9-7 Expenditure Classification ...................................... 15 A9-8 Asset Acquisition (*W) .......................................... 40 A9-9 Self-Constructed Asset ........................................... 10 A9-10 Self-Constructed Asset............................................ 30 A9-11 Donated Assets ....................................................... 15 A9-12 Long-lived Asset Accounting ................................. 30 A9-13 Decommissioning Obligation ................................. 15 A9-14 Costs in Research and Development Phases (*W) . 15 A9-15 Costs in Research and Development Phases........... 15 A9-16 Costs in Research and Development Phases........... 20 A9-17 Costs of Software Development ............................ 20 A9-18 Intangible Assets ..................................................... 30 A9-19 Website Development ............................................. 30 A9-20 Intangible Assets (*W)............................................ 15 A9-21 Goodwill.................................................................. 15 A9-22 Goodwill ................................................................ 20 A9-23 Disposal of Long-lived Assets ................................ 20 A9-24 Disposals ................................................................. 20 A9-25 Investment Property (Appendix)............................. 20

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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition

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A9-26 Investment Property (Appendix)............................. 30 A9-27 Government Assistance (Appendix) ...................... 30 A9-28 Government Assistance (Appendix) ..................... 25 A9-29 Self-constructed Asset (ASPE) ............................... 15 A9-30 Expenditure Classification (ASPE)......................... 15

*W

The solution to this assignment is on the text website, Connect.

The solution is marked WEB.

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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition

Cases

Case 9-1 Glowworm Inc.

Overview

GI is a large, privately owned manufacturing firm that reports its financial results in accordance with ASPE (ASPE). There is currently a disagreement between Jessica Simpson, senior accountant at GI, and GI's Chief Financial Officer (CFO). The dispute is in relation to whether employee bonuses will be paid for the 20x6 fiscal year-end. At GI, bonuses are paid when income before tax exceeds $1,000,000. The CFO made adjustments to Jessica's draft financials that resulted in income before taxes of $925,000.

In analyzing the contentious issues, we must be mindful of a potential bias on the part of Jessica. She may be inclined to select policies that maximize earnings for purposes of a bonus. The needs of external users relying on GI's financial statements to make resource allocation decisions must be kept in mind in analyzing these issues.

Issues

1. Depreciation 2. Grant 3. Asset retirement 4. Restated net income

Analysis and Conclusions

1. Depreciation

Jessica reversed the journal entry that has been recorded to reflect depreciation expense on GI's office building. Her reasoning is that the building has increased in value, based on a recent appraisal.

ASPE requires use of the historical cost model for long-lived assets. This means the asset is reported at its cost on the date of acquisition, plus any subsequent betterments/additions, less accumulated depreciation. The historical cost model is not meant to reflect the fair value of the asset. The depreciation method selected by GI must be applied on a consistent basis to allocate the cost of the asset to the period of use. It was not appropriate for Jessica to reverse the depreciation entry. The adjustment made by the CFO was correct: $200,000 in depreciation expense should be reported in the financial statements.

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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition

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2. Grant

The grant received from the Federal Government to upgrade manufacturing equipment was reported as revenue by Jessica in the 20x6 financial statements. As discussed in the appendix to the chapter, ASPE provides the following guidance with respect to government assistance:

"Accounting standards require that government grants toward the acquisition of property, plant, and equipment in any form should be either: 1. Deducted from the related assets with any depreciation calculated on the net amount; or 2. Recorded as deferred income that is recognized over the life of the asset. The deferred income would

be amortized to income on the same basis as the related depreciable assets are depreciated."

Based on the above guidance, it is clear that the $50,000 grant should not have been reported as revenue in 20x6. Given users of the financial statements may find relevance in seeing the government assistance reported as a separate line item on the balance sheet, GI should select option 2 and report the unamortized portion of the grant as deferred income on the balance sheet. The amount that can be taken into income in 20x6 is 1/7 of $50,000: $7,143. This takes the grant into income on the same basis as the depreciation on the related assets (assuming a straight line method is used).

The special platform, which cost $13,000, was correctly capitalized with the equipment as all costs associated with readying an asset for use are to be reported as part of the asset's cost. Using this principle, we can conclude that the $6,000 spent to remove and reinstall other equipment to make room for the new equipment was incorrectly expensed. The $6,000 should have been capitalized with the equipment and amortized over the 7 year useful life of the equipment. The income impact of the adjustment that should have been made to Jessica's financial statements with respect to this new equipment can be summarized as follows:

Grant Revenue (reverse): Deferred revenue into income in 20X6: Reverse expense re: installation: Depreciation on $6,000: Net change to income:

($50,000) 7,143 6,000 (857)

($37,714)

3. Asset retirement obligation

Jessica recorded a liability in the financial statements to reflect a promise made by GI to restore a piece of land in order to maintain the peace in the community and meet community bylaws. The restoration is planned for fiscal 20x17 and is estimated to cost $40,000. The issue is whether this liability needs to be recorded or not. Under ASPE, such obligations are only to be recorded if the result of a legal obligation. Constructive liabilities (based on past actions of the firm or promises made to the public) are not recorded in accordance with ASPE.

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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition

In this case, since GI was advised by a lawyer to clean up the land, it seems as though a legal obligation does exist in fiscal 20x6. Further clarification with the lawyer as to the basis of this advice is needed. Assuming that there is some legal liability, the following entry is needed:

Land improvement .......................................................................... 28,983 Provision for site restoration ................................................

$40,000 ? (P/F, 4%, 11) = $40,000 ? 0.64958= $28,983

28,983

This assumes a 4% interest rate. Other assumptions are valid. Interest of $1,040 and some asset amortization must be recorded.

4. Restated net income

Based on the analysis above, the net income before tax for the year ending Dec 31 20x6 should be:

$1,220,000 - $200,000 - $37,714 - $1,040 and amortization = $981,246, less amortization,

Although this is higher than the CFO's calculation, it is still below the threshold for employee bonuses.

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Solutions Manual to accompany Intermediate Accounting, Volume 1, 7th edition

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