Accounting Theory and Analysis

11th Edition

Test Bank

By

Richard G. Schroeder
University of North Carolina at Charlotte

Myrtle W. Clark
University of Kentucky

Jack M. Cathey
University of North Carolina at Charlotte

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 1
 Chapter 9

Multiple Choice

1. When a closely held corporation issues preferred stock for land, the land should be
recorded at the
a. Total par value of the stock issued
b. Total book value of the stock issued
c. Appraised value of the land
d. Total liquidating value of the stock issued

Answer c

2. A principal objection to the straight-line method of depreciation is that it

a. Provides for the declining productivity of an aging asset
b. Ignores variations in the rate of asset use
c. Tends to result in a constant rate of return on a diminishing investment base
d. Gives smaller periodic write-offs than decreasing charge methods

Answer b

3. Property, plant, and equipment are conventionally presented n the balance sheet at
a. Replacement cost less accumulated depreciation
b. Historical cost less salvage value
c. Original cost adjusted for general price level changes
d. Acquisition cost less depreciated portion thereof

Answer d

4. As generally used in accounting, depreciation

a. Is a process of asset valuation for balance sheet purposes
b. Applies only to long-lived intangible assets
c. Is used to indicate a decline in market value of a long-lived asset
d. Is an accounting process that allocates long-lived asset cost to accounting periods

Answer d

5. Lyle, Inc., purchased certain plant assets under a deferred payment contract on
December 31, 2014. The agreement was to pay $20,000 at the time of purchase and
$20,000 at the end of each of the next five years. The plant assets should be valued at
a. The present value of a $20,000 ordinary annuity for five years
b. $120,000
c. $120,000 less imputed interest
d. $120,000 plus imputed interest

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 2
 Answer c

6. For income statement purposes, depreciation is a variable expense if the depreciation

method used for book purposes is
a. Units of production
b. Straight line
c. Sum-of-the-year’s-digits
d. Declining balance

Answer a

7. A method that excludes salvage value from the base for the depreciation calculation is
a. Straight line
b. Sum-of-the-year’s digits
c. Double-declining balance
d. Productive output

Answer c

8. When a company purchases land with a building on it and immediately tears down the
building so that the land can be used for the construction of a plant, the cost incurred to
tear down the building should be
a. Expensed as incurred
b. Added to the cost of the plant
c. Added to the cost of the land
d. Amortized over the estimated time period between the tearing down of the building
and the completion of the plant

Answer c

9. A machine with a four-year estimated useful life and an estimated 15 percent salvage
value was acquired on January 1, 2012. On December 31, 2014, the accumulated
depreciation using the sum-of-year’s digits method would be
a. (Original cost less salvage value) multiplied by 9/10
b. Original cost multiplied by 9/10
c. Original cost multiplied by 9/10 less total salvage value
d. (Original cost less salvage value) multiplied by 1/10

Answer a

10. The theoretical justification for reporting depreciation expense is

a. Depreciation expense represents a decrease in the value of the asset that has
occurred during the accounting period.

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 3
 b. Depreciation expense represents the impairment of the asset that has occurred
during the accounting period.
c. Depreciation expense represents the unrealized loss that has been incurred by using
the asset during the accounting period.
d. Depreciation expense represents the allocation of the historical cost of the asset that
has been applied to the accounting period.

Answer d

11. A company using the group depreciation method for its delivery trucks retired one of its
delivery trucks due to damage before the average service life of the group was reached.
An insurance recovery was received. The net book value of these group asset accounts
would be decreased by the
a. Original cost of the truck
b. Original cost of the truck less the insurance recovery received
c. Original cost of the truck less depreciation on the truck to the date of retirement
d. Insurance recovery received

Answer b

12. When equipment is retired, accumulated depreciation is debited for the original cost less
any residual recovery under which of the following depreciation methods?

Composite Group
Depreciation Depreciation
a. No No
b. No Yes
c. Yes No
d. Yes Yes

Answer d

13. Recognizing depletion expense is an example of the accounting process of

Allocation Amortization
a. No No
b. No Yes
c. Yes Yes
d. Yes No

Answer c

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 4
 14. A donated plant asset for which the fair value has been determined, and for which
incidental costs were incurred in acceptance of the asset, should be recorded at an
amount equal to its
a. Incidental costs incurred
b. Fair value and incidental costs incurred
c. Book value on books of donor and incidental costs incurred
d. Book value on books of donor

Answer b

Essay

1. List the objectives of accounting for property, plant and equipment.

The objectives of plant and equipment accounting are:

1. Reporting to investors on stewardship.

2. Accounting for the use and deterioration of plant and equipment.
3. Planning for new acquisitions, through budgeting.
4. Supplying information for taxing authorities.
5. Supplying rate-making information for regulated industries

2. Describe how cost is assigned to individual assets when they are acquired in a lump-
sum group purchase.

When a group of assets is acquired for a lump-sum purchase price, such as the
purchase of land, buildings, and equipment for a single purchase price, the total
acquisition cost must be allocated to the individual assets so that an appropriate amount
of cost can be charged to expense as the service potential of the individual assets
expires. The most frequent, though arbitrary, solution to this allocation problem has been
to assign the acquisition cost to the various assets on the basis of the weighted average
of their respective appraisal values. Where appraisal values are not available, the cost
assignment may be based on the relative carrying values on the seller’s books.

3. Discuss the three approaches to allocating fixed overhead to a self-construction project.

The three approaches are:
a. Allocate no fixed overhead to the self-construction project. Some accountants favor
the first approach. They argue that the allocation of fixed overhead is arbitrary and
therefore only direct costs should be considered.
b. Allocate only incremental fixed overhead to the project. When operations are at less
than full capacity, this approach is the most logical. The decision to build the asset
was probably connected with the availability of idle facilities. Increasing the profit
margin on existing products by allocating a portion of the fixed overhead to the self-
construction project will distort reported profits.
c. Allocate fixed overhead to the project on the same basis as it is allocated to other
products. When the production of other products has been discontinued to produce a

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 5
 self-constructed asset, allocation of the entire amount of fixed overhead to the
remaining products will cause reported profits on these products to decrease. (The
same amount of overhead is allocated to fewer products.)

4. Discuss the issue of allocating interest to self-construction projects. That is, when should
interest be allocated and how much interest should be allocated?
During the construction period, extra financing for materials and supplies will
undoubtedly be required, and these funds will frequently be obtained from external
sources. The central question is the advisability of capitalizing the cost associated with
the use of these funds. Some accountants have argued that interest is a financing rather
than an operating charge and should not be charged against the asset. Others have
noted that if the asset were acquired from outsiders, interest charges would undoubtedly
be part of the cost basis to the seller and would be included in the sales price. In
addition, public utilities normally capitalize both actual and implicit interest (when their
own funds are used) on construction projects because future rates are based on the
costs of services. Charging existing products for the expenses associated with a
separate decision results in an improper matching of costs and revenues. Therefore, a
more logical approach is to capitalize incremental interest charges during the
construction period. Once the new asset is placed in service, interest is charged against
operations. The FASB ASC 835-20-30 guidance indicates that the amount of interest to
be capitalized is the amount that could have been avoided if the asset had not been
constructed. Two interest rates may be used: the weighted average rate of interest
charges during the period and the interest charge on a specific debt instrument issued to
finance the project. The amount of avoidable interest is determined by applying the
appropriate interest rate to the average amount of accumulated expenditures for the
asset during the construction period.

5. Explain the concept of commercial substance originally outlined in SFAS No. 158.

A nonmonetary exchange has commercial substance if the future cash flows of the entity
are expected to change significantly as a result of the exchange. For these exchanges,
the book value of the asset exchanged is to be used to measure the asset acquired in
the exchange. Thus, no gains are to be recognized; however, a loss should be
recognized if the fair value of the asset exchanged is less than its book value (i.e., an
impairment is evident).

6. How did SFAS No. 116, now FASB ASC 605-10-15-3, change the accounting for
donated assets?
Previous practice required donated assets to be recorded at their fair market values, with
a corresponding increase in an equity account termed donated capital. Recording
donated assets at fair market values is defended on the grounds that if the donation had
been in cash, the amount received would have been recorded as donated capital, and
the cash could have been used to purchase the asset at its fair market value. SFAS No.
116 (See 605-10-15-3), requires that the inflow of assets from a donation be considered
revenue (not donated capital).

7. Discuss the factors comprising the depreciation process.

The depreciation process for long-term assets comprises three separate factors:

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 6
 1. Establishing the depreciation base.
2. Estimating the useful service life.
3. Choosing a cost apportionment method.

8. Discuss the distinction between capital and revenue expenditures for long-term assets.

In most cases, the decision to expense or capitalize plant and equipment expenditures
subsequent to acquisition is fairly simple and is based on whether the cost incurred is
“ordinary and necessary” or “prolongs future life.” Expenditures in the first category are
expensed while those in the second category are capitalized.

9. Discuss accounting for asset impairments originally outlined in SFAS No’s 121 and 144.
The FASB, noting divergent practices in the recognition of impairment of long-lived
assets, originally issued SFAS No. 121, now superseded, which addressed the matter of
when to recognize the impairment of long-lived assets and how to measure the loss.
This release ignored current value as a determinant of impairment. Rather, it stated that
impairment occurs when the carrying amount of the asset is not recoverable. The
recoverable amount is defined as the sum of the future cash flows expected to result
from use of the asset and its eventual disposal. Under this standard, companies were
required to review long-lived assets (including intangibles) for impairment whenever
events or changes in circumstances indicate that book value may not be recoverable.
The FASB, noting divergent practices in the recognition of impairment of long-lived
assets, originally issued SFAS No. 121, now superseded, which addressed the matter of
when to recognize the impairment of long-lived assets and how to measure the loss.
This release ignored current value as a determinant of impairment. Rather, it stated that
impairment occurs when the carrying amount of the asset is not recoverable. The
recoverable amount is defined as the sum of the future cash flows expected to result
from use of the asset and its eventual disposal. Under this standard, companies were
required to review long-lived assets (including intangibles) for impairment whenever
events or changes in circumstances indicate that book value may not be recoverable.
The guidance from SFAS No. 144now contained at at FASB ASC 360-10-40 applies to
all dispositions of long-term assets; however, it excludes current assets, intangibles, and
financial instruments because they are covered in other releases. According to its
provisions, assets are to be classified as:

1. Long-term assets held and used.

2. Long-lived assets to be disposed of other than by sale.
3. Long-lived assets to be disposed of by sale.

Long-term assets held and used are to be tested for impairment using the original SFAS
No. 121 criteria if events suggest there may have been impairment. The impairment is to
be measured at fair value by using the present value procedures outlined in SFAC No. 7
(see Chapter 2).
Long-lived assets to be disposed of other than by sale, such as those to be abandoned,
exchanged for a similar productive asset, or distributed to owners in a spin-off, are to be
considered held and used until disposed of. Additionally, in order to resolve
implementation issues, the depreciable life of a long-lived asset to be abandoned was to
be revised in accordance with the criteria originally established in APB Opinion No. 20,
“Accounting Changes.”

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 7
 The accounting treatment for long-lived assets to be disposed of by sale is used for all
long-lived assets, whether previously held and used or newly acquired (FASB ASC 360-
10-35). That treatment retains the requirement originally outlined in SFAS No. 121 to
measure a long-lived asset classified as held for sale at the lower of its carrying amount
or fair value less cost to sell and to cease depreciation (amortization). As a result,
discontinued operations are no longer measured on a net realizable value basis, and
future operating losses are no longer recognized before they occur.
In summary, SFAS No. 144 retained the requirements of SFAS No. 121 to recognize an
impairment loss only if the carrying amount of a long-lived asset is not recoverable from
its undiscounted cash flows. This loss is measured as the difference between the
carrying amount and fair value of the asset (FASB ASC 360-10-35-17).

10. Define and discuss accounting for asset retirement obligations under SFAS No. 143
(FASB ASC 410-20)
At the time SFAS No. 143 was issued, the FASB noted that existing practice regarding
asset retirement obligations was inconsistent; consequently, the objective of this release
was to provide accounting requirements for all obligations associated with the removal of
long-lived assets. FASB ASC 410-20 applies to all entities that face existing legal
obligations associated with the retirement of tangible long-lived assets.
FASB ASC 410-20 provides the following definitions associated with the issue:
1. Asset retirement obligation. —the liability associated with the ultimate disposal of a
long-term asset.
2. Asset retirement cost. —the increase in the capitalized cost of a long-term asset that
occurs when the liability for an asset retirement obligation is recognized.
3. Retirement. —an other than temporary removal of a long-term asset from service by
sale, abandonment, or other disposal.
4. Promissory estoppel. —a legal concept that holds that a promise made without
consideration may be enforced to prevent injustice.
For each asset retirement obligation a company is required to initially record the fair
value (present value) of the liability to dispose of the asset when a reasonable
estimate of its fair value is available. Companies are required to use SFAC No. 7
criteria for recognition of the liability, which is the present value of the asset at the
credit adjusted rate. This amount is defined as the amount a third party with a
comparable credit standing would charge to assume the obligation.
Subsequently, the capitalized asset retirement cost is allocated in a systematic and
rational manner as depreciation expense over the estimated useful life of the asset.
Additionally, the initial carrying value of the liability is increased each year by use of
the interest method using the credit adjusted rate and classified as accretion
expense and not interest expense. In the event any of the original assumptions
change, a recalculation of the obligation and the subsequent associated expenses is
to be recorded as a change in accounting estimate.

11. Discuss the guidelines for accounting for property, plant and equipment outlined in IAS
No. 16.
IAS No. 16 indicates that items of property, plant, and equipment should be recognized
as assets when it is probable that the future economic benefit associated with these
assets will flow to the enterprise and that their cost can be reliably measured. Under
these circumstances, the initial measurement of the value of the asset is defined as its

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 8
 cost. Subsequently, the stated preferred treatment is to depreciate the asset’s historical
cost; however, an allowed alternative treatment is to periodically revalue the asset to its
fair market value. When such revaluations occur, increases in value are to be recorded
in stockholders’ equity, unless a previously existing reevaluation surplus exists, whereas
decreases are recorded as current-period expenses. In the event a revaluation is
undertaken, the statement requires that the entire group of assets to which the revalued
asset belongs also be revalued. Examples of groups of property, plant, and equipment
assets are land, buildings, and machinery. Finally, the required disclosures for items of
property, plant, and equipment include the measurement bases used for the assets, as
well as a reconciliation of the beginning and ending balances to include disposals and
acquisitions and any revaluation adjustments.
IAS No. 16 also requires companies to periodically review the carrying amounts of items
of property, plant, and equipment to determine whether the recoverable amount of the
asset has declined below its carrying amount. When such a decline has occurred, the
carrying amount of the asset must be reduced to the recoverable amount, and this
reduction is recognized as an expense in the current period. IAS No. 16 also requires
write-ups when the circumstances or events that led to write-downs cease to exist. This
treatment contrasts to the requirements of SFAS No. 144 (See FASB ASC 360-10),
which prohibits recognition of subsequent recoveries.

12. How does IAS no. 23 define borrowing costs?

IAS No. 23 defines borrowing costs as interest on bank overdrafts and borrowings,
amortization of discounts or premiums on borrowings, amortization of ancillary costs
incurred in the arrangement of borrowings, finance charges on finance leases and
exchange differences on foreign currency borrowings where they are regarded as an
adjustment to interest costs.

13. Discuss accounting for the impairment of assets as outlined in IAS No. 36.
The purpose of IAS No. 36 is to make sure that assets are carried at no more than their
recoverable amount, and to define how the recoverable amount is calculated. IAS No. 36
requires an impairment loss to be recognized whenever the recoverable amount of an
asset is less than its carrying amount (its book value). The recoverable amount of an
asset is the higher of its net selling price and its value in use. Both are based on present-
value calculations.

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 9 Page 9