SM Chapter 08

8-1

CHAPTER 8

Operating Assets: Property, Plant, and Equipment, Natural Resources,

and Intangibles

OVERVIEW OF EXERCISES, PROBLEMS, AND CASESEstimated

Time inLearning Objective Exercises Minutes Level

1. Understand the balance sheet disclosures for long-term 11* 30 Modoperating assets.

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

3. Explain how to calculate the acquisition cost of assets that are 2 20 Modpurchased as a group for a lump-sum amount.

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

acquisition cost of an asset.

5. Compare depreciation methods and understand the factors 3 20 Modaffecting the choice of methods. 4 15 Mod

12* 5Easy

6. Understand the impact of a change in the estimate of the asset 5 15 Modlife or residual value.

7. Determine which expenditures should be capitalized as asset 11 30 Modcosts and which should be treated as expenses.

8. Analyze the effect of the disposal of an asset at a gain or loss. 6 15 Mod7 15 Mod

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

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

13* 10 Mod

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

12. Understand how investors can analyze a company’s operating assets.

8-2 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

*Exercise, problem, or case covers two or more learning objectivesLevel = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

Problems Estimated and Time in

Learning Objective Alternates Minutes Level1. Understand the balance sheet disclosures for long-term 7* 30 Mod

operating assets.

2. Determine the acquisition cost of an operating asset. 8* 15 Diff

3. Explain how to calculate the acquisition cost of assets that are 1 20 Modpurchased as a group for a lump-sum amount. 7* 30 Mod

4. Describe the impact of capitalizing interest as part of theacquisition cost of an asset.

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

affecting the choice of methods. 3 15 Mod7* 30 Mod8* 15 Diff9* 20 Mod

6. Understand the impact of a change in the estimate of the 10* 10 Modasset life or residual value.

7. Determine which expenditures should be capitalized as asset 7* 20 Modcosts and which should be treated as expenses. 9* 20 Mod

8. Analyze the effect of the disposal of an asset at a gain or loss. 7* 30 Mod9* 20 Mod

11* 35 Mod

9. Understand the balance sheet presentation of intangible assets.7# 30 Mod12* 20 Diff

10. Describe the proper amortization of intangible assets. 7# 30 Mod10* 10 Mod12* 20 Mod

11 . Explain the impact that long-term assets have on the 4 15 Mod statement of cash flows. 5 40 Diff

11* 35 Mod12* 20 Diff

12. Understand how investors can analyze a company’s 6 20 Diffoperating assets

*Exercise, problem, or case covers two or more learning objectives# Alternate problem onlyLevel = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

.

CHAPTER 8 OPERATING ASSETS: PROPERTY, PLANT, AND EQUIPMENT, NATURAL RESOURCES, AND INTANGIBLES 8-3

EstimatedTime in

Learning Objective Cases Minutes Level

1. Understand the balance sheet disclosures for long-term 1* 20 Modoperating assets. 2* 20 Mod

4* 25 Mod

2. Determine the acquisition cost of an operating asset.

3. Explain how to calculate the acquisition cost of assets that are 6 15 Modpurchased as a group for a lump-sum amount.

4. Describe the impact of capitalizing interest as part of the acquisition cost of an asset.

5. Compare depreciation methods and understand the factors 4* 25 Modaffecting the choice of methods. 5 25 Mod

7 10 Mod

6. Understand the impact of a change in the estimate of the assetlife or residual value.

7. Determine which expenditures should be capitalized as asset costs and which should be treated as expenses.

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

9. Understand the balance sheet presentation of intangible 1* 20 Mod assets. 2* 20 Mod

10. Describe the proper amortization of intangible assets.

11. Explain the impact that long-term assets have on the 3 20 Modstatement of cash flows.

12. Understand how investors can analyze a company’s operatingassets of cash flows.

*Exercise, problem, or case covers two or more learning objectivesLevel = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)


Q U E S T I O N S

1. Operating assets include property, plant, and equipment and intangibles. Examples of assets considered operating assets are buildings, equipment, land, land improvements, patents, copyrights, and goodwill. Operating assets are important to the long-term future of the company because they are the assets used to produce a product or service sold to customers. The operating assets allow a company to produce a product efficiently and remain competitive with other firms.

2. The acquisition cost of an asset includes all the costs normally necessary to acquire the asset and prepare it for its intended use. Acquisition costs include the purchase price, freight costs, installation costs, taxes paid at the time of purchase, and repairs made to prepare the asset for use.

3. The acquisition cost of assets purchased as a group should be determined by allocating the purchase price on the basis of the proportions of the fair market values to the total fair market value.

4. It is important to separately account for the cost of land and building because the amount allocated to a building represents a depreciable amount, while the amount allocated to land does not.

5. Interest should be capitalized when an asset is constructed by the acquiring company over time, and the asset is not an item of inventory.

6. The decline in usefulness of an operating asset is related to physical deterioration factors, such as wear and tear. It is also related to obsolescence and technological factors and to the repair and maintenance of the asset. The depreciation method chosen should match the decline in usefulness of the asset to the periods benefited by the asset after all factors have been taken into account. However, the company is not required to use the same method for all depreciable assets.

7. The straight-line method is the most popular method of depreciation for several reasons, including its simplicity and ease of application. It is most appropriate for assets that experience a decline in usefulness related to the passage of time. It may also be used by companies that wish to report a stable income over time.

8. When the straight-line method is used, the residual value should be deducted from the acquisition cost to determine the depreciable amount to be allocated over the useful life of the asset. When the double declining balance method is used, the residual value is not deducted. However, the asset should not be depreciated to an amount that is lower than the residual value.

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9. Companies may use one method of depreciation for financial reporting and another method for tax purposes because the objectives are different. The accountant's purpose in recording depreciation for financial reporting purposes is to allocate the original cost of the asset to the periods benefited in a manner that matches the decline in usefulness of the asset. The accountant's purpose in recording depreciation for tax purposes is to minimize the amount of income tax that must be paid.

10. If an estimate must be changed, the change in estimate should be recorded prospectively over the remaining life of the asset. Past amounts recorded for depreciation are not changed or altered. The remaining depreciable amount should be recorded over the remaining life of the asset, using the revised estimate or estimates of residual value and asset life.

11. A capital expenditure is an amount that must be capitalized or added to the value of the asset. A revenue expenditure is an outlay that should be recorded as an expense in the year incurred. An item should be treated as a capital expenditure if it increases the life or productivity of the asset. Otherwise, the amount should be treated as a revenue expenditure.

12. The gain or loss on the sale of an asset should be calculated as the difference between the selling price and the book value of the asset as of the date of sale. The account Gain on Sale of Asset should appear on the income statement in the other income/expense category.

13. Patents, copyrights, trademarks, and goodwill are examples of intangible assets. Some companies have a separate category on the balance sheet titled Intangibles for such assets. Other companies include intangibles in a category titled Long-Term Assets or in the Other Assets category of the balance sheet.

14. Goodwill represents the difference between the acquisition price paid to acquire a business and the total of the fair market values of the identifiable net assets acquired. Goodwill can be recorded as an asset only when one company acquires another. It can not be recorded on the basis of internally generated factors that some may refer to as goodwill.

15. An argument in favor of expensing R & D is that it allows comparability among firms, since all firms must record the item as an expense. Also, it is argued that R & D should be expensed because it is very difficult to determine whether an asset exists and, if it does exist, what periods are benefited by the asset. On the other hand, many argue that R & D is an asset and should be recorded on the balance sheet. They believe that if R & D is not recorded, the balance sheet is seriously understated.

16. The current view of the FASB is that some intangible assets have a limited life and should be amortized over their legal life or useful life whichever is shorter. However, some intangible assets are thought to have an


“indefinite life” and should not be amortized. This treatment of intangibles has been debated extensively and many disagree with the current view. Some would argue that the value of almost all intangible assets eventually becomes diminished and therefore amortization should be recognized.

17. Amortization should occur over the shorter of the legal life or useful life. For example, a patent has a legal life of 20 years. But if the invention under patent will be useful over only 10 years, then the patent should be amortized over the shorter 10-year period.

18. If an intangible becomes worthless, the asset should be written off as an expense in the period when the decline in value occurs. If the intangible continues to have value but will provide benefit over a period shorter than was originally estimated, the event should be treated as a change in estimate. The portion of the intangible that is unamortized should be amortized over the remaining life of the asset.

E X E R C I S E S

LO 2 EXERCISE 8-1 ACQUISITION COST

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

List price $60,000Less: Discount (1,200)Freight 1,000Pollution device 2,500Architect's fee 6,000 Total acquisition cost $ 68,300

Note: Repair costs of $4,000 are not included because they are not normal or necessary to the acquisition.

Insurance cost of $8,000 should be treated as prepaid insurance.

Interest cost of $3,000 is not included unless an asset is constructed over time.

LO 3 EXERCISE 8-2 LUMP-SUM PURCHASE

1. The total market value is

Land $ 200,000Building 150,000Equipment 250,000 Total $ 600,000

Amount allocated to each account should be

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Land $200,000/$600,000 X $520,000 = $173,333

Building $150,000/$600,000 X $520,000 = $130,000

Equipment $250,000/$600,000 X $520,000 = $216,667

The effect of the acquisition on the accounting equation is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Owners' Equity + Revenues – Expenses

Land 173,333Building 130,000Equipment 216,667Cash (520,000)

2. The amount of depreciation expense that should be recorded for 2004 is as follows:Land = $0Building $130,000/20 years = $6,500Equipment $216,667/20 years = $10,833

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

Long-term assets:Land $ 173,333Building $ 130,000

Less: Accumulated depreciation 6,500 123,500Equipment $ 216,667

Less: Accumulated depreciation 10,833 205,834 Total long-term assets $ 502,667

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

Depreciation, accumulated depreciation, and book value for the straight line method should be as follows:

AccumulatedYear Depreciation Depreciation Book Value2004 $10,800* $10,800 $49,2002005 10,800 21,600 38,4002006 10,800 32,400 27,6002007 10,800 43,200 16,8002008 10,800 54,000 6,000

* ($60,000 - $6,000)/5 years = $10,800 per yearThe estimated total number of units to be produced is

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

Depreciation expense per unit = ($60,000 – $6,000)/150,000 units


= $.36 per unit

Depreciation, accumulated depreciation, and book value for the units of production should be as follows:

AccumulatedYear Depreciation Depreciation Book Value2004 10,000 X $.36 = $ 3,600 $ 3,600 $56,4002005 20,000 X $.36 = 7,200 10,800 49,2002006 30,000 X $.36 = 10,800 21,600 38,4002007 40,000 X $.36 = 14,400 36,000 24,0002008 50,000 X $.36 = 18,000 54,000 6,000

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

LO 5 EXERCISE 8-4 ACCELERATED DEPRECIATION

1. AccumulatedYear Depreciation Depreciation Book Value2004 40%* X $6,000 = $2,400 $ 2,400 $ 3,6002005 40% X 3,600 = 1,440 3,840 2,1602006 40% X 2,160 = 864 4,704 1,2962007 40% X 1,296 = 518 5,222 7782008 178** 5,400 600

*Straight-line rate: 100%/5 years = 20%; double the straight-line rate = 40%.

**Since the asset should not be depreciated below residual value, the amount to be recorded is $6,000 – $5,222 – $600 = $178.

2. The effect of the depreciation for 2004 on the accounting equation is as follows:



Accumulated DepreciationDepreciation (2,400) Expense (2,400)

3. Koffman may believe that the double-declining-balance method best matches the decline in usefulness of the asset with the revenues produced by the asset. Koffman may also choose this method because it allows more

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depreciation to be taken in the early years of the asset life and thus delays taxes until the later years.

LO 6 EXERCISE 8-5 CHANGE IN ESTIMATE

1. Depreciation, accumulated depreciation, and book value for the straight line method should be as follows:

AccumulatedYear Depreciation Depreciation Book Value2004 $ 8,000* $ 8,000 $ 72,0002005 8,000 16,000 64,0002006 15,500** 31,500 48,5002007 15,500 47,000 33,0002008 15,500 62,500 17,5002009 15,500 78,000 2,000

*($80,000 – $8,000)/9 years = $8,000.**$64,000 – $2,000 = $62,000.

$62,000/4 years = $15,500.

2. Depreciation for 2004 and 2005 was not wrong. The company used the best information available at that time to develop its estimate of depreciation. The information available in 2006 made it necessary to revise the estimate of depreciation. This illustrates the difference between a change in estimate and a correction of an error.

LO 8 EXERCISE 8-6 ASSET DISPOSAL

1. The depreciation for 2004 is calculated as follows:

($60,000 – $6,000)/6 years = $9,000 per year.$9,000 X 6/12 = $4,500 for 2004.

The effect of the sale of the asset on the accounting equation is as follows:



Cash 40,000 Gain on SaleAccumulated of Asset 2,500**

Depreciation—Asset 22,500*

Asset (60,000)


*Accumulated depreciation at time of sale:Depreciation for 2002 and 2003—($9,000 X 2) $18,000Depreciation for 2004 4,500 Total $ 22,500

**Gain on sale is calculated as follows:Asset cost $60,000Less: Accumulated depreciation 22,500 Book value $37,500Sale price 40,000 Gain on sale $ 2,500

2. The gain or loss should appear in the Other Income category of the income statement to indicate that it is not part of the normal operating activity of the company.

LO 8 EXERCISE 8-7 ASSET DISPOSAL

1. The depreciation for 2004 is calculated as follows:

($60,000 – $6,000)/6 years = $9,000 per year.$9,000 X 6/12 = $4,500 for 2004.

The effect of the sale of the asset on the accounting equation is as follows:



Cash 15,000 Loss on SaleNotes Receivable 15,000 of Asset

(7,500)**Accumulated

Depreciation—Asset 22,500*

Asset (60,000)

*Accumulated depreciation at time of sale:Depreciation for 2002 and 2003—($9,000 X 2) $18,000Depreciation for 2004 4,500 Total $ 22,500

**The loss on sale is calculated as follows:Asset cost $60,000Less: Accumulated depreciation 22,500 Book value $37,500Sale price 30,000 Loss on sale $ 7,500

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2. The gain or loss should appear in the Other Expense category of the income statement to indicate it is not part of the normal operating activity of the company.

LO 10 EXERCISE 8-8 AMORTIZATION OF INTANGIBLES

Trademark is not amortized because it has an indefinite lifeAmortization expense = $0Accumulated amortization = $0

Patent amortization = $50,000/10 years = $ 5,000Accumulated amortization = $5,000 X 6 years = $30,000

Copyright amortization = $80,000/20 years = $ 4,000Accumulated amortization = $4,000 X 3 years = $12,000

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

I—Purchase of landI—Proceeds from sale of landO—Gain on sale of landI—Purchase of equipmentO—Depreciation expenseI—Proceeds from sale of equipmentO—Loss on sale of equipment

LO 11 EXERCISE 8-10 IMPACT OF TRANSACTIONS INVOLVING INTANGIBLE ASSETS ON STATEMENT OF CASH FLOWS

I—Cost incurred to acquire copyrightI—Proceeds from sale of patentO—Gain on sale of patentN—Research and development costs

(not separately reported as an operating activity)O-Amortization of patent

MULTI-CONCEPT EXERCISES

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

1. The effect of the capitalized costs of the new conveyor system on the accounting equation is as follows:




Building 40,000Cash (40,000)

The effect of the capitalized costs of the hydraulic lift on the accounting equation is as follows:



Delivery Truck 5,000Cash (5,000)

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

2. The depreciation for 2001 should be calculated as follows:

Building Truck

Original cost $ 200,000 $20,000Less: Depreciation for 2002 and 2003 16,000 6,667 Book value $ 184,000 $13,333Plus: Capitalized costs 40,000 5,000 Depreciable amount $ 224,000 $ 18,333 Depreciation per year on building =

$224,000/23 years = $ 9,739 Depreciation per year on truck =

$18,333/4 years = $ 4,583

3. The assets should appear on the 2004 balance sheet as follows:

Building $ 240,000Less: Accumulated depreciation 25,739 $ 214,261Truck $ 25,000Less: Accumulated depreciation 11,250 13,750 Total property, plant, and equipment $ 228,011

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

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

2. The amount of depreciation expense for 2004 is zero because the asset was not completed and put into use until January 1, 2005. The amount of depreciation expense for 2005 is $200,000 + $8,000 – $5,000 = $203,000/20 years = $10,150.

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

a. All research and development costs should be treated as an expense. The 2004 income statement should reflect an expense of $20,000.

b Patent costs should be treated as an asset. The 2004 balance sheet should reflect a Patent account of $10,000 – ($10,000/5 years) = $8,000.

c. The $8,000 cost of defending the patent should be added to the patent account and reflected in the 2005 balance sheet.

2004 amortization = $10,000/5 years = $2,000

2005 amortization = $10,000 – $2,000 + $8,000 = $16,000

$16,000/4 years = $4,000

P R O B L E M S

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

1. Relative fair values:

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

Section 1 2 3

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

2. The purchase of the land has no effect on total assets. Current assets (cash) declines and long-term assets (land) increases and therefore only the composition of assets on the balance sheet is changed.

3. Carter would be concerned with the value assigned to each section if it intended to sell one or two sections and keep others. Carter would want the section it intended to sell to be assigned the highest value in order to defer a gain. The value assigned to buildings would be depreciated; therefore, Carter would want more value assigned to the buildings in order to depreciate them and take advantage of the tax shield.


LO 5 PROBLEM 8-2 DEPRECIATION AS A TAX SHIELD

If the asset is not purchased, the company must pay income tax of $50,000 X 35% = $17,500.

If the asset is purchased, the company should record depreciation of $20,000 per year. The amount of income tax the company must pay is $50,000 – $20,000 = $30,000 X 35% = $10,500.

The amount of the depreciation tax shield is the amount of income tax saved by purchase of the asset, or $17,500 – $10,500 = $7,000. The depreciation tax shield can also be expressed as the amount of depreciation each year times the tax rate, or $20,000 X 35% = $7,000.

LO 5 PROBLEM 8-3 BOOK VERSUS TAX DEPRECIATION

1. Year Straight-line – MACRS = Difference1 $ 5,600* $ 6,720 $ (1,120)2 5,600 10,750 (5,150)3 5,600 6,450 (850)4 5,600 3,870 1,7305 5,600 3,870 1,7306 5,600 1,940 3,660

$ 33,600 $33,600 $ 0

*$33,600/6 years = $5,600 per year

2. The president is correct that a total of $33,600 will be deducted as depreciation under either method over the six-year life. However, the memo should stress that all other things being equal, Griffith should prefer MACRS for taxes, since it results in the payment of less income tax during the early years in the life of the truck. Money received earlier is preferable to money received later.

The memo should also stress that it is important to analyze the tax position of Griffith carefully. A variety of other factors may be important in the choice of a depreciation method for tax purposes.

The memo should also stress to the president that not only is it legal, but also it is not a violation of GAAP, to use one method of depreciation for the books and a different one for tax purposes. Using straight-line depreciation for the books will tend to even out the income over the life of the asset and will report higher income in the earlier years than would be reported if an accelerated method, such as MACRS, is used.

LO 11 PROBLEM 8-4 DEPRECIATION AND CASH FLOW

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1. OHARE COMPANY INCOME STATEMENT

FOR THE YEAR ENDED DECEMBER 31, 2004

Service Revenue $ 100,000Depreciation Expense 15,000 Net Income $ 85,000

2. The amount of the net cash inflow for 2004 is $100,000.

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

4. If Ohare develops a cash flow statement using the indirect method, the operating category should appear as follows:

Cash Flow from Operating Activities:Net income $ 85,000Plus: Depreciation 15,000 Net cash from operations $ 100,000

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

1. Book value of equipment at time of sale:Book value $ XSales proceeds 315,000 Loss (gain) on sale $ 35,000

X – $315,000 = $ 35,000X = $ 350,000

Book value of copyright at time of sale:Book value $ XSales proceeds 75,000 Loss (gain) on sale $ (55,000)

X – $75,000 = $ (55,000)X = $ 20,000


2. Net book value of property, plant, and equipment at December 31, 2003:

Net book value at 12/31/03 $ XPlus purchases during 2004 292,000Less book value of equipment sold during 2004 (350,000)Less 2004 depreciation (672,000 )Net book value at 12/31/03 $ 4,459,000

X + $292,000 – $350,000 – $672,000 = $ 4,459,000X = $ 5,189,000

3. Net book value of intangibles at December 31, 2003:

Net book value at 12/31/03 $ XPlus payment of legal fees during 2004 15,000Less book value of copyright sold during 2004 (20,000)Less 2004 amortization (33,000 )Net book value at 12/31/04 $ 673,000

X + $15,000 – $20,000 – $33,000 = $ 673,000X = $ 711,000

LO 4 PROBLEM 8-6 BALANCE SHEET AND FOOTNOTE DISCLOSURES FOR DELTA AIR LINES

1. The amount of depreciation expense equals the change in the balance of the Accumulated Depreciation account: $6,109 – $5,730 = $379 million.

2. Average life = $20,295/$379 = 53.5 years.

3. Average age = $6,109/$379 = 16.1 years.

MULTI-CONCEPT PROBLEMS

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

1. Values assigned to each asset:

a. Value at time of purchase: $14,000 + $4,800 = $18,800

b. Allocation of purchase price:Supplies expense $200/$3,200 X $2,400 = $ 150Office furniture $600/$3,200 X $2,400 = $ 450Equipment $2,400/$3,200 X $2,400 = $ 1,800

c. Value of this Prepaid License Expense: $1,500

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d. Cost of truck $12,000Less: accumulated depreciation at time

of sale ((12,000 – 800) X 5/8) 7,000 Book value $ 5,000

2. Depreciation or other expense recorded for each asset during 2004:

a. ($18,800 – $800)/4 years = $4,500

b. Supplies expense $ 150Depreciation of office furniture $450/9 years = $ 50Depreciation of equipment $1,800/4 years = $ 450

c. $1,500/3 years = $500 X 11/12 = $458

d. Depreciation $11,200/8 years = $1,400 X 8/12 = $933 Book value at the time of sale $ 5,000Sale price 4,800 Loss on sale of truck $ (200 )

3. Balance Sheet Presentation:Current assets:

Prepaid license expense ($1,500 – $458) $ 1,042 Property, plant, and equipment:

Truck $18,800Office furniture 450Equipment 1,800

$21,050Less: accumulated depreciation

($4,500 + $50 + $450) (5,000 )Property, plant, and equipment, net $ 16,050

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

1. $165,000/10 years = $16,500 depreciation. The correct amount of depreciation is $19,700 [($150,000 + 15,000 + 4,000 + 25,000 + 3,000)/10 years].

2. Reported income in year 1 is $51,500 ($100,000 – 16,500 – 25,000 – 4,000 – 3,000). Reported income should be $80,300 (100,000 – 19,700).

3. A cost is the amount incurred to acquire an asset or pay an expense, and an expense is the amount of an expired asset or a cost that is incurred to generate revenue.


LO 5,7,8 PROBLEM 8-9 CAPITAL EXPENDITURES, DEPRECIATION, AND DISPOSAL

1. The depreciation for 2003 should be calculated as follows:

($364,000 – $14,000)/25 years = $14,000 for 2003.

The depreciation for 2004 should be calculated as follows:

Original cost $ 364,000Less: 2003 depreciation (14,000)Less: residual value (14,000)Plus 2004 capitalized costs 42,000 Depreciable amount $ 378,000Remaining asset life 30 yearsDepreciation $378,000/30 years = $ 12,600

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

3. Original cost of building $ 364,000Pollution device capitalized 42,000

Less: 2003 depreciation (14,000)2004 depreciation (12,600 )

Book value 1/1/2005 $ 379,400Less: 2005 depreciation ($12,600 X 3/12) 3,150

Book value at sale $ 376,250Sale proceeds 392,000 Gain on sale $ 15,750

If the pollution equipment had been expensed (and original life of 25 years was used for depreciation purposes):

Original cost $ 364,000Less: Accumulated depreciation ($14,000 X 2 1/4 years) 31,500 Book value at 4/1/2005 $ 332,500Sale proceeds 392,000 Gain on sale $ 59,500

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

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1. The $85,000 should be recorded as an expense. The $11,900 should be capitalized in a patent account.

2. Reynosa should record $595 of amortization expense each fiscal year: a total of $2,975 ($595 per year X 5 years) = $2,975.

$11,900/20 years = $595.

3. Reynosa should record a loss of $8,925 the year ended September 30, 2005.

Original cost of patent $11,900Less: depreciation for 5 years 2,975 Book value, 10/1/04 $ 8,925

LO 8,11 PROBLEM 8-11 PURCHASE AND DISPOSAL OF OPERATING ASSET AND EFFECTS ON THE STATEMENT OF CASH FLOWS

1. Partial statements of cash flows for 2004:Cash flows from operating activities:

Net income $ XX,XXXPlus depreciation expense 12,000

Cash flows from investing activities:Purchase of machinery (104,000)

Partial statements of cash flows for 2005:Cash flows from operating activities:

Net income $ XX,XXXPlus: Depreciation expense 12,000

Loss on sale of machinery 5,000Cash flows from investing activities:

Purchase of machinery (205,000)Proceeds from sale of machinery (see below) 75,000

Book value at time of sale ($104,000 – $12,000 – $12,000) $ 80,000Sale price X Loss on sale of machinery $ 5,000

$80,000 – X = $ 5,000X = $ 75,000

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

LO 9,10,11 PROBLEM 8-12 AMORTIZATION OF INTANGIBLES AND EFFECTS ON


THE STATEMENT OF CASH FLOWS

1. 2004 amortization expense:Accumulated amortization at 12/31/03 $ 102,000Plus 2004 amortization expense X Accumulated amortization at 12/31/04 $ 119,000

$102,000 + X = $ 119,000X = $ 17,000

2. Acquisition cost:Cost of patent $ XLess accumulated amortization at 12/31/04 (119,000 )Carrying value at 12/31/04 $ 170,000

X – $119,000 = $ 170,000X = $ 289,000

Year acquired:Accumulated amortization at 12/31/04 $ 119,000Divided by annual amortization 17,000 Years owned 7 yearsIt was acquired in 1998

Estimated useful life:Cost of patent $ 289,000Divided by estimated useful life X years Annual amortization $ 17,000

$289,000/X = $ 17,000X = 17 years

The acquisition cost of $289,000 would have been reported as an outflow in the investing activities section of the 1998 statement of cash flows.

3. Assuming the indirect method is used, the amortization expense relating to the patent would be added back to net income in the cash flows from operating activities section of the statement of cash flows.

4. The proceeds from the sale of $200,000 would be reported as an inflow in the cash flows from investing activities section of the statement of cash flows. In addition, the gain on the sale of $30,000 ($200,000 – $170,000) would be subtracted from net income in the cash flows from operating activities section of the statement of cash flows.

A L T E R N A T E P R O B L E M S

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

1. Relative fair values:

Piece 1 $ 200,000 23.8%Piece 2 200,000 23.8 Piece 3 440,000 52 .4 Total $ 840,000 100 .0 %

Piece 1 2 3

23.8% 23.8% 52.4%(a) $ 960,000 $ 228,480 $ 228,480 $ 503,040(b) 680,000 161,840 161,840 356,320(c) 800,000 190,400 190,400 419,200

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

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

If asset is not purchased:Annual income tax is $62,000 X 30% = $18,600If asset is purchased:

Income before tax Depreciation Income Taxand depreciation expense before tax 30%

2004 $62,000 $24,000* $38,000 $11,4002005 62,000 14,400 47,600 14,2802006 62,000 8,640 53,360 16,0082007 62,000 5,184 56,816 17,0452008 62,000 7,776** 54,224 16,267

Total $ 75,000

*Straight-line rate = 1/5 or 20%; double declining-balance rate = 2 X 20% = 40%, 2004 depreciation = 40% X $60,000 = $24,000.

**To bring accumulated depreciation to $60,000.

Total tax if not purchased:$18,600 X 5 years = $93,000Total tax if purchased = 75,000 Depreciation tax shield $ 18,000


The tax shield if Rummy uses the straight-line method is $60,000 X 30%, or $18,000. Rummy would choose accelerated depreciation because the company would save tax earlier.

LO 5 PROBLEM 8-3A BOOK VERSUS TAX DEPRECIATION

Year Straight-line – MACRS = Difference1 $ 4,700* $ 5,650 $ (950)2 4,700 9,025 (4,325)3 4,700 5,400 (700)4 4,700 3,250 1,4505 4,700 3,250 1,4506 4,700 1,625 3,075

$28,200 $28,200 $ 0

* $28,200/6 years = $4,700 per year

2. The president is correct that a total of $28,200 will be deducted as depreciation under either method over the six-year life. However, the memo should note that all other things being equal, Payton should prefer MACRS for taxes, since it results in lower taxes during the early years in the life of the truck. Money received earlier is preferable to money received later.

LO 11 PROBLEM 8-4A AMORTIZATION AND CASH FLOW

1. 2004 net income = $500,000 – $62,500 – $50,000 = $387,500.

2. Cash on hand, December 31, 2004 = $500,000 – $62,500 = $437,500.

3. Cash increased from revenue and decreased by cash expenses. The amount is different than net income for 2004 because amortization, like depreciation, is an expense but not a cash outflow. The cost of long-term assets like a copyright is a cash outflow when it is purchased.

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

1. Book value of land at time of sale:Book value $ XSales proceeds 187,000 Loss (gain) on sale $ 17,000

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X – $187,000 = $ 17,000X = $ 204,000

Book value of trademark at time of sale:Book value $ XSales proceeds 121,000Loss (gain) on sale $ (7,000)

X – $121,000 = $ (7,000)X = $ 114,000

2. Net book value of property, plant, and equipment at December 31, 2003:

Net book value at 12/31/03 $ XPlus purchases during 2004 277,000Less book value of land sold during 2004 (204,000)Less 2004 depreciation (205,000 )Net book value at 12/31/04 $1,555,000

X + $277,000 – $204,000 – $205,000 = $1,555,000X = $ 1,687,000

3. Net book value of intangibles at December 31, 2003:

Net book value at 12/31/03 $ XPlus payment of legal fees during 2004 6,000Less book value of trademark sold during 2004 (114,000)Less 2004 amortization (3,000 )Net book value at 12/31/04 $ 34,000

X + $6,000 – $114,000 – $3,000 = $ 34,000X = $ 145,000

LO 1 PROBLEM 8-6A DISCLOSURES OF OPERATING ASSETS FOR TBW

1. The depreciation expense for property, plant, and equipment for 2004 was $856 million, the additions to accumulated depreciation.

Accumulated depreciation, 2003 $ 1,151Plus 2004 depreciation expense XLess accumulated depreciation on asset disposed of in 2004 (600 )Accumulated depreciation, 2004 $ 1,407


$1,151 + X – $600 = $ 1,407X = $ 856

2. Property, plant, and equipment: Average life = $3,398/$856 = 4.0 years.

3. Property, plant, and equipment: Average age = $1,407/$856 = 1.6 years.

ALTERNATE MULTI-CONCEPT PROBLEMS

LO 1,5,8,9,10 PROBLEM 8-7A COST OF ASSETS, SUBSEQUENT BOOK VALUES, AND BALANCE SHEET PRESENTATION

Depreciation or amortization and book values

a. Depreciation should be calculated as follows:

Original cost $16,000Add: cab/oven 10,900 Total cost $26,900Less: Residual value 300

Depreciable amount $26,600

Depreciation expense $26,600/5 years $ 5,320Book value:Total cost $26,900Accumulated depreciation 5,320 Book value $ 21,580

b. Depreciation:$2,700 X 66 2/3%* = $1,800

*Straight-line rate = 100%/3 = 33 1/3%, double declining-balance rate = 66 2/3%.

Book value:$2,700 – $1,800 = $900

c. Depreciation:($8,000 – $1,000)/8 X 3/12 = $219

Book value at time of sale:Accumulated depreciation = ($8,000 – $1,000) X 5/8 = $4,375Book value = $8,000 – $4,375 = $ 3,625

Book value $ 3,625Sale price 1,500 Loss on sale $ 2,125

d. Amortization:

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$14,000/4 years = $3,500$3,500 X 6/12 = $1,750

Book value:$14,000 – $1,750 = $12,250

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

1. The proper cost to record for the acquisition is $190,000 ($168,000 + $16,500 + $4,400 + $1,100). All costs, except the operating costs for the first year, should be capitalized as part of the cost of the equipment. The operating costs of $26,400 should be expensed.

2. Depreciation reported in year 1 is $21,640 ($216,400/10). Depreciation that should have been reported is $19,000 [($168,000 + $16,500 + $4,400 + $1,100)/10]. Operating costs are not included in the cost of the asset.

3. Key reported income of $55,000 – $21,640, or $33,360. The correct amount of income should be as follows:

Income before equipment cost $ 55,000Depreciation (19,000)Operating expenses (26,400 )Net income $ 9,600

4. Key should not include operating costs in the value of the asset recorded on the balance sheet. The effect of this error is to overstate assets on the balance sheet and to understate expenses on the Income Statement, thus overstating net income.

LO 7,8 PROBLEM 8-9A CAPITAL EXPENDITURES, DEPRECIATION, AND DISPOSAL

1. 2003 Depreciation = [($612,000 – $12,000)/25 years)] = $24,000

2004 Depreciation = [($612,000 + $87,600 – $30,000 – $24,000)/24)] = $26,900

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

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


Loss on sale if fire equipment is expensed = $612,000 – $24,000 – $24,000 – $360,000 = $204,000

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

1. The $350,000 of cost that represents research and development should be treated as an expense in the year of acquisition, 1999. The $23,800 of costs that represents the patent should be treated as an intangible asset and amortized over the 20-year time period.

2. Maciel should record amortization expense of $23,800/20 years or $1,190 per year.

3. The book value of the patent after 5 years of amortization is:

$23,800 – (5 x $1,190) = $17,850. Since the patent is worthless, the amount of $17,850 should be recorded as a loss.

LO 8,11 PROBLEM 8-11A PURCHASE AND DISPOSAL OF OPERATING ASSET AND EFFECTS ON THE STATEMENT OF CASH FLOWS



Cash flows from investing activities:Purchase of machinery (45,000)

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Loss on sale 12,000Cash flows from investing activities:

Purchase of machinery (80,000)Proceeds from sale of machinery (see below) 17,000

Book value at time of sale ($45,000 – $8,000 – $8,000) $ 29,000Sale price X Loss on sale of machinery $ 12,000

$29,000 – X = $ 12,000X = $ 17,000

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

LO 9,10,11 PROBLEM 8-12A AMORTIZATION OF INTANGIBLES AND EFFECTS ON STATEMENT OF CASH FLOWS

1. 2004 amortization expense:Accumulated amortization at 12/31/03 $ 1,510,000Plus 2004 amortization expense X Accumulated amortization at 12/31/04 $ 1,661,000

$1,510,000 + X = $ 1,661,000X = $ 151,000

2. Acquisition cost:Cost of patent $ XLess accumulated amortization at 12/31/04 (1,661,000 )Carrying value at 12/31/04 $ 1,357,000

X – $1,661,000 = $ 1,357,000X = $ 3,018,000

Year acquired:Accumulated amortization at 12/31/04 $ 1,661,000


Divided by annual amortization 151,000 Years owned 11 yearsIt was acquired in 1994

Estimated useful life:Cost of patent $ 3,018,000Divided by estimated useful life X years Annual amortization $ 151,000

$3,018,000/X = $ 151,000X = 20 years

The acquisition cost of $3,018,000 would have been reported as an outflow in the Investing Activities section of the 1994 statement of cash flows.

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

4. The proceeds from the sale of $1,700,000 would be reported as an inflow in the Cash Flows from Investing Activities section of the statement of cash flows. In addition, the gain on the sale of $343,000 ($1,700,000 – $1,357,000) would be deducted from net income in the Cash Flows from Operating Activities section of the statement of cash flows.

D E C I S I O N C A S E S

READING AND INTERPRETING FINANCIAL STATEMENTS

LO 1,9 CASE 8-1 WINNEBAGO INDUSTRIES

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1. Winnebago lists the following items in property and equipment: land, buildings, machinery and equipment, and transportation equipment.

2. The company uses the straight-line method.

3. The footnotes indicates the following useful lives:

Buildings 10-30 years Machinery and equipment 3-10 years

Transportation equipment 3-6 years

4. The company does not list the cost and accumulated depreciation of each line item separately but the balance sheet does indicate: (in thousands)Total cost $ 141,310Accumulated depreciation 92,383 Book value or net amount $ 48,927

5. The statement of cash flows indicates purchases of property and equipment of $10,997,000 and sales of property and equipment of $929,000.

LO 11 CASE 8-2 WINNEBAGO INDUSTRIES’ STATEMENT OF CASH FLOWS

1. The statement of cash flows indicates purchases of property and equipment of $10,997,000.

2. The statement of cash flows indicates sales of property and equipment of $929,000.

3. Depreciation and amortization is indicated in the cash flows statement as $7,879,000. Depreciation is not a cash flow. It is listed in the operating activities category of the cash flows statement when using the indirect method because it is necessary to eliminate the items that did not involve cash.

LO 1,9 CASE 8-3 COMPARING TWO COMPANIES IN THE SAME INDUSTRY: WINNEBAGO INDUSTRIES AND MONACO COACH CORPORATION

1. Monaco lists the following items in property, plant, and equipment: land, buildings, equipment, furniture and fixtures, vehicles, leasehold improvements, construction in progress. Winnebago Industries lists similar items on the balance sheet: land, buildings, machinery and equipment, and


transportation equipment. Winnebago Industries does not list leasehold improvements, perhaps because it does not lease assets. It also does not have an account titled Construction in Progress.

2. Both companies use the straight-line method of depreciation. In most cases, the straight-line method is chosen because of its simplicity and because it results in an even pattern of expense over the life of the assets.

3. Winnebago Industries does not list the cost and accumulated depreciation of each line item separately but the balance sheet does indicate: (in thousands)

Total cost $ 141,310 Accumulated depreciation 92,383 Book value or net amount $

48,927

Monaco Coach only provides the book value of property, plant, and equipment net of accumulated depreciation and the amount is $135,350. Monaco Coach has a larger amount of property, plant, and equipment. It may indicate that the assets of Winnebago Industries are older and more fully depreciated.

4. The life of buildings is given as 39 years and equipment is 3-10 years.

Winnebago Industries indicates a range of useful life of each type of assets: buildings at 10-30 years, machinery and equipment at 3-10 years and transportation equipment at 3-6 years.

5. Monaco Coach purchased property, plant, and equipment of $18,735,000 and had proceeds from the sale of asset of $387,000. The company also had a major business acquisition of $24,320,000. Winnebago Industries had purchases of property and equipment of $10,997,000 and sales of property and equipment of $929,000. For both companies, information about whether a gain or loss occurred from the sale of assets is provided in the operating activities section of the statement of cash flows.

6. Both companies are struggling to invest in long-term operating assets during very difficult economic times. Monaco invested in the future with a major acquisition and hopes to expand its business as a result. Winnebago spent more than $9 million on purchases of property and equipment. The company must invest heavily in property, plant, and equipment to constant update to modern, more efficient assets. While the operating assets are adding value to both companies, even more value could be created if the companies could afford to invest more in long-term assets.

MAKING FINANCIAL DECISIONS

LO 1,5 CASE 8-4 COMPARING COMPANIES

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ACCELERATED COMPANYINCOME STATEMENT


Sales $ 720,000Cost of goods sold 360,000 Gross profit $ 360,000Administrative costs $ 96,000Depreciation expense 144,000 Operating expenses 240,000 Income before tax $ 120,000Tax expense (40%) 48,000 Net income $ 72,000

Since the balance of the Accumulated Depreciation account for Straight Company is $240,000 and the depreciation expense is $120,000 per year, the assets must be two years old. The amount of depreciation expense for Accelerated Company on the double declining-balance method is as follows:

2003: $600,000 X 40% = $240,000.

2004: $600,000 – $240,000 = $360,000 X 40% = $144,000.

The analyst should consider the difference in the cash flows of the two companies. Accelerated Company has a lower net income but actually has a higher cash inflow. This occurs because the depreciation expense results in a tax savings. It is not entirely accurate to say that depreciation is a "non-cash" expense because it results in a real cash savings in the form of lower income tax.

LO 5 CASE 8-5 DEPRECIATION ALTERNATIVES

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

ACCOUNTING AND ETHICS: WHAT WOULD YOU DO?

LO 3 CASE 8-6 VALUING ASSETS

Students should be asked to determine the impact of using the first appraisal versus the second appraisal. Both appraisals result in a total increase in assets of $20,000 ($220,000 – $200,000), but they differ in the amount allocated to the


land account. Students should see that a second opinion may have been necessary to accurately appraise the property, but, on the other hand, the appraisal may have been requested to maximize the amount allocated to the depreciable asset, the building.

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

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

LO 5 CASE 8-7 DEPRECIATION ESTIMATES

According to GAAP, the equipment should be depreciated over 3 years (the length of time that the equipment will generate revenue). There is an ethical dilemma in this decision because if the manager chooses 10 years over 3 years, outsiders receive different information about the company. If the manager chooses 3 years, outsiders receive useful information about the company. They can see the revenue generated by the equipment matched to the cost of owning the equipment. If the manager uses a 10-year life for the equipment, outsiders do not receive useful information. In this case, outsiders see revenue for the equipment matched to only a portion of the expense of generating the revenue. This provides outsiders with inaccurate information to predict future cash flows. It should be stressed that the accountant’s role is to present neutral information that accurately reflects the useful life of the asset. The accountant’s role is not to present information that will present a lower depreciation expense amount in order to make the company look more profitable.

FROM CONCEPT TO PRACTICE 8.1Depreciation and amortization is indicated in the Winnebago statement of cash flows as $7,879,000. The footnotes indicate the company uses the straight-line method.

Depreciation and amortization is indicated in the Monaco Coach statement of cash flows as $8,585,000. The footnotes indicate the company uses the straight-line method.

FROM CONCEPT TO PRACTICE 8.2Walt Disney does not provide details about its intangible assets on the balance sheet. The company lists two lines for intangible assets: intangible assets, net at $2,776,000 and Goodwill at $17,083,000. Together the two intangible asset accounts constitute nearly 40% of the company’s assets.

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SOLUTIONS TO INTEGRATIVE PROBLEMS

Part 2

1. PEK COMPANYINCOME STATEMENT


Sales $ 1,250,000Cost of goods sold 636,500

Gross profit $ 613,500Depreciation on plant equipment $85,400*Depreciation on buildings 12,000Interest expense 55,400**Other expenses 83,800 236,600

Income before taxes $ 376,900Income tax expense (30% rate) 113,070 Net income $ 263,830

*$58,400 + ($270,000/10 years).**$33,800 + ($270,000 X 8%).

PEK COMPANYSTATEMENT OF CASH FLOWS


Cash flows from operating activities:Net income $ 263,830Adjustments to reconcile net income to net

cash provided by operating activities (in-cludes depreciation expense) 110,200 *

Net cash provided by operating activities $ 374,030Cash flows from financing activities:

Dividends (35,000 )Net increase in cash $ 339,030

*$83,200 + $27,000 additional depreciation.

Supplemental Schedule of Noncash Investing and Financing Activities:Acquisition of equipment in exchange for a note of $270,000.

2. PEK COMPANYINCOME STATEMENT


Sales $ 1,250,000Cost of goods sold 636,500

Gross profit $ 613,500Depreciation on plant equipment $ 107,491*


Depreciation on buildings 12,000Interest expense 55,400Other expenses 83,800 258,691

Income before taxes $ 354,809Income tax expense (30% rate) 106,443 Net income $ 248,366

*$58,400 + $49,091.

PEK COMPANYSTATEMENT OF CASH FLOWS

FOR THE YEAR ENDED DECEMBER 31, 2004Cash flows from operating activities:

Net income $ 248,366Adjustments to reconcile net income to net

cash provided by operating activities (in-cludes depreciation expense) 132,291 *

Net cash provided by operating activities $ 380,657Cash flows from financing activities:

Dividends (35,000 )Net increase in cash $ 345,657

*$83,200 + $49,091 additional depreciation.

Supplemental Schedule of Noncash Investing and Financing Activities:Acquisition of equipment in exchange for a note of $270,000.

3. a. LIFO cost of goods sold:40,000($3.25) = $ 130,00060,000($3.10) = 186,00075,000($3.00) = 225,00040,000($2.50) = 100,00030,000($2.20) = 66,000

5,000($2.10) = 10,500 Total LIFO cost of goods sold $ 717,500Total FIFO cost of goods sold 636,500

Increase in cost of goods sold $ 81,000

b. Additional cost of goods sold $ 81,000Times the tax rate 30%

Decrease in income tax expense $ 24,300

c. Additional cost of goods sold $ 81,000Decrease in income taxes 24,300

Decrease in net income $ 56,700

4. a. Sales on account $ 800,000Times estimated uncollectibles 3%

Increase in other expenses $ 24,000 b. Increase in other expenses $ 24,000

Times the tax rate 30%

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Decrease in income tax expense $ 7,200 c. Increase in other expenses $ 24,000

Decrease in income taxes 7,200Decrease in net income $ 16,800

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