E10-3. Capitalizing costs subsequent to acquisition
Requirement 1:
The following costs are capitalized to the building:
Major improvement to the plumbing
Added a 7,000 square foot lobby
Total
$109,000
234,600
$343,600
GAAP requires a company to capitalize expenditures that
extend an asset’s useful life, increase its capacity or
efficiency, or cause any other increase in its economic
benefits. A major plumbing improvement and a building
addition meet these criteria and are capitalized costs.
The painting, carpet, and repair costs are expensed since
they do not improve efficiency or extend the productive life of
the building.
Requirement 2:
New carrying value of the building:
Historical cost
Add: Improvements
Less: Accumulated depreciation
New carrying value
$970,000
343,600
(440,000)
$873,600
Requirement 4:
Denominator = 6 x (6 + 1) ÷ 2 = 21
2011: ($125,000 − $5,000) x 6/21 x 3/4 year = $25,714
2012: ($125,000 − $5,000) x 6/21 x 1/4 year = $8,571
($125,000 − $5,000) x 5/21 x 3/4 year = $21,429
$30,000
E10-5. Determining depreciation base – straight-line
depreciation
(AICPA adapted)
First determine the book value of the machine at the
beginning of 2011. Given that the machine has been used for
10 years and has a 20 year life, Accumulated depreciation
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would be $15,000 (10/20 x $30,000). The book value at
January 1, 2011 also is $15,000 ($30,000 cost less $15,000
accumulated depreciation).
The $5,000 overhaul increases the value of the machine by
$5,000, so the new book value is $20,000 ($15,000 + $5,000).
The overhaul added 5 years onto the life of the machine, so
the remaining useful life of the machine at January 1, 2011 is
15 years (10 years + 5 years). To find the depreciation
expense for 2011, take the new book value ($20,000) divided
by the remaining useful life of the machine (15 years).
$20,000/15 years = $1,333
Depreciation expense for 2011 is $1,333.
E10-7. Determining asset cost and depreciation expense –
straight-line
(AICPA adapted)
First, we must find the total cost of the machine.
Purchase price
Freight-in
Installation
Testing
Total cost of machinery
Less: salvage value
Depreciation base
$65,000
500
2,000
300
$67,800
(5,000)
$62,800
Now we can find depreciation expense for 2009 and 2010:
$62,800/20 years = $3,140
Next, we need to determine the depreciation base of the
machine in January 2011. The machine has been depreciated
for two years, so:
Depreciation base, January 1, 2009
2009 depreciation
2010 depreciation
Depreciation base at January 1, 2011
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$62,800
(3,140)
(3,140)
$56,520
The accessories add $3,600 to the machine’s value, so the
depreciation base at January 1, 2011 is: [$56,520 + $3,600 =
$60,120].
The accessories did not add useful life or more salvage value.
The remaining useful life of the machine is 18 years (20 - 2).
To find straight-line depreciation expense, we divide the
depreciation base by the remaining useful life.
$60,120/18 years = $3,340
Samson should record $3,340 as depreciation expense for
2011.
E10-10. Capitalizing interest
(AICPA adapted)
The avoidable interest during 2010 is:
Cost incurred evenly over the year
$2,000,000
Average cost during the year
Incremental borrowing rate
Avoidable interest
$1,000,000
x .12
$ 120,000
Since the actual interest incurred ($102,000) was lower than
avoidable interest, Clay should report $102,000 as
capitalized interest at December 31, 2010.
E10-17. Accounting for R&D cost
(AICPA adapted)
Costs incurred in Ball Labs that will not be reimbursed by the
governmental unit should be expensed as research and
development. The computation follows:
Depreciation
Salaries
Indirect costs
Materials
Total
$300,000
700,000
200,000
180,000
$1,380,000
Ball should expense $1,380,000 as research and
development for 2011.
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P10-1. Computing depreciation expense – SL, DDB, SYD, and UP
(AICPA adapted)
The table below shows the amount of depreciation expense in
2011 under each method. Computations are shown below the
schedule.
Straight-line
2011
$90,000
Double-declining balance
2011
$162,000
Sum-of-years’ digits
2011
$140,000
Units of production
2011
$120,000
Total cost  Salvage value
Estimated useful life
Requirement 1 – Straight-line:
$864,000  $144,000
=
= $90,000 per year
8 years
Requirement 2 – Double-declining balance:Depreciation in
2010
Straight-line rate = 1/8 or 12.5%. Double this is
25%$864,000 x 25% = $216,000
Depreciation in 2011
[Book value = total cost - accumulated depreciation]
$648,000 = $864,000 - $216,000$648,000 x 25% =
$162,000
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P10-6. Capitalizing or expensing various costs
Requirement 1:
1) Since the new engines increase the future service potential
of the aircraft, the amount should be capitalized and
depreciated over the engines’ useful life.
2) Since there is no increase in useful life, future service
potential, or efficiency, the amount should be charged to
expense in the current year. Some might argue that this is a
bit of a gray area. For example, if the campaign is successful,
future service potential might increase. On the other hand, the
expenditure is also a bit like advertising, which is a period
expense.
3) Since the repairs are routine (i.e., recurring), the amount
should be charged to expense in the current year.
4) The noise abatement equipment is mandated and is, thus,
an unavoidable, necessary cost that allows the planes to use
runways and airports that could not be utilized otherwise.
Therefore, this cost is capitalizable.
5) Since the new systems increase the future service
potential of the aircraft, the amount should be capitalized and
depreciated over the now extended useful life of the systems.
6) Again, some might argue that this is another gray area.
Since the objective of the expenditure is to increase business,
it might warrant capitalization. On the other hand, since there
is no increase in useful life, future service potential, or
efficiency, the amount could be charged to expense in the
current year.
7) Since the overhauls increase the efficiency of the engines,
the amount should be capitalized and depreciated over the
expected useful life of the improvements.
Requirement 2:
Perhaps the easiest way for a firm like Fly-by-Night to use
some of the above expenditures to manage earnings upward
is to capitalize a portion of those that might otherwise be
treated as expenses of the period. Other ways Fly-by-Night
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could manage earnings is to defer maintenance expenditures
while keeping them just above the minimum required by the
Federal Aviation Administration. Fly-by-Night might also
consider “bunching” expenditures in a
given year to achieve a “big bath.” This would then improve
future years’ earnings.
P10-7. Determining asset impairment
Requirement 1:
Book value:
= $35,000,000 - [($35,000,000/7) x 4]
= $35,000,000 - 20,000,000
= $15,000,000
Requirement 2:
Yes, the asset is impaired.
The book value of $15,000,000 is greater than the
undiscounted future cash flows of $11,000,000.
Impairment loss to be reported in the income statement:
= $15,000,000
= $15,000,000
= $5,500,000
- Fair value of the asset
- 9,500,000
Requirement 3:
The balance sheet amount at the end of year 4 is $9,500,000,
the asset’s fair value. Omega would depreciate this amount
over the asset’s remaining useful life.
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