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Exercise for Depreciation FTMBA Core (Section-E), FTMBA Cap Market.

& Executive MBA_2010-11 Amit Shrivastava Multiple choice/ Problem /cases _Source: Stice
24. Konering Company purchased a patent for a new manufacturing process for $34,000. Because of government regulation the patent is now worth $42,500. The process is only expected to be useful for 5 years. The annual amortization expense associated with this patent is: a. $2,000 b. $6,800 c. $2,500 d. $8,500 $34,000 / 5 years = $6,800. (Konering can not recognize the increase in value of the patent; it's amortization period is the lesser of [a] the legal life or [b] the useful life.) OBJ: KP 12-5 25. TOP: Depreciation and Amortization The Acquisition of Intangible Assets

ANS: B

Which of the following is not typically a problem associated with allocating the cost of noncurrent, nonmonetary assets to future accounting periods? a. distinguishing between revenues and expenses b. determining acquisition costs c. selecting among alternative depreciation methods d. accounting for disposals of property, plant, and equipment OBJ: KP 12-5 TOP: Depreciation and Amortization Which of the following is not a factor in computing depreciation? a. acquisition cost b. residual value c. depreciable cost d. estimated useful life e. All of the choices provided in this question are factors in computing depreciation. OBJ: KP 12-5 TOP: Depreciation and Amortization Depreciation expense is recorded in order to a. ensure that the firm has adequate cash to replace the asset. b. present assets at fair market value. c. prevent the recognition of large losses at disposition. d. allocate the cost of noncurrent, nonmonetary assets to periods benefited. OBJ: KP 12-5 TOP: Depreciation and Amortization The estimate of the value of an asset at the time of disposal is the a. acquisition cost. b. residual value. c. depreciable cost. d. economic life. OBJ: KP 12-5 TOP: Depreciation and Amortization

ANS: A 26.

ANS: E 27.

ANS: D 28.

ANS: B

29.

The estimate of the length of service to be provided by an asset is the a. acquisition cost. b. residual value. c. depreciable cost. d. economic life. e. physical life. OBJ: KP 12-5 TOP: Depreciation and Amortization The difference between an asset's acquisition cost and its residual value is the a. depreciable cost. b. accumulated depreciation. c. book value. d. depreciation expense. OBJ: KP 12-5 TOP: Depreciation and Amortization The difference between an asset's acquisition cost and its accumulated depreciation is the a. depreciable cost. b. accumulated depreciation. c. book value. d. depreciation expense. OBJ: KP 12-5 TOP: Depreciation and Amortization From an accounting perspective, which of the following statements regarding depreciation is true? a. Depreciation attempts to reflect the current value of an asset. b. Depreciation is a source of cash. c. Depreciation is the allocation of an asset's cost to the periods benefited. d. All of the choices provided in this question are true. e. None of the choices provided in this question are true. OBJ: KP 12-5 TOP: Depreciation and Amortization The use of an accelerated depreciation method a. is appropriate for assets which produce more benefits in earlier years than in later years. b. results in a greater net income in early years than the straight-line method. c. recognizes more depreciation in total over the asset's useful life than the straight-line method. d. can be used for financial statement purposes only if the same method is used for tax purposes. OBJ: KP 12-5 TOP: Depreciation and Amortization

ANS: D 30.

ANS: A 31.

ANS: C 32.

ANS: C 33.

ANS: A

Wheaten On January 1, Year 1, Wheaton Corporation purchased a new machine for $68,000. The machine was expected to have a useful life of 5 years, which equates to approximately 12,000 machine hours of usage. The machine is expected to have a residual value of $8,000. 34. Refer to Wheaton. Wheaton's depreciation expense recognized in Year 2 using the straight-line method is: a. $12,000 b. $13,600 c. $24,000 d. $27,200 ($68,000 - $8,000) / 5 years = $12,000 OBJ: KP 12-5 35. TOP: Depreciation and Amortization

ANS: A

Refer to Wheaton. Wheaton's accumulated depreciation on the machine after three full years using straight-line would be: a. $36,000 b. $40,800 c. $72,000 d. $60,000 ($68,000 - $8,000) / 5 years = $12,000 3 years = $36,000

ANS: A

OBJ: KP 12-5 36.

TOP: Depreciation and Amortization

Refer to Wheaton. Wheaton's depreciation expense in Year 2 using the double-declining balance method is: a. $27,200 b. $16,320 c. $24,000 d. $14,400 Yr 1: ($68,000 - 0) 40% = $27,200 Yr 2: ($68,000 - $27,200) 40% = $16,320

ANS: B

OBJ: KP 12-5

TOP: Depreciation and Amortization

Jeffries On January 1, Year 1, Jeffries Corporation purchased a new machine for $30,000. The machine was expected to have a useful life of 10 years, which equates to approximately 30,000 machine hours of usage. The machine is expected to have a residual value of $2,000. 37. Refer to Jeffries. Jeffries' accumulated depreciation on the machine after five full years using straight-line depreciation would be: a. $2,000 b. $2,800 c. $14,000 d. $28,000 [($30,000 - $2,000) / 10 years] 5 years = $14,000 OBJ: KP 12-5 38. TOP: Depreciation and Amortization

ANS: C

Refer to Jeffries. Jeffries' depreciation expense in Year 2 using double declining balance is: a. $2,800 b. $4,800 c. $5,600 d. $6,000 Yr 1: ($30,000 - 0) 20% = $6,000 Yr 2: ($30,000 - $6,000) 20% = $4,800

ANS: B

OBJ: KP 12-5 Sherman

TOP: Depreciation and Amortization

On April 3, Year 1, Sherman Company purchased a new truck for $36,000. The truck is expected to be driven 22,000 miles per year for a total of 5 years, at which time its residual value will be approximately $2,000. The fiscal year end for Sherman Company is December 31. 39. Refer to Sherman. Sherman's accumulated depreciation at the end of Year 2 using double declining balance would be: a. $4,320 b. $19,720 c. $20,880 d. $3,400 Year 1: ($36,000 - 0) 40% 9/12 Year 2: (36,000 - 10,800) 40% = = $10,800 10,080 $20,880

ANS: C

OBJ: KP 12-5

TOP: Depreciation and Amortization

40.

Refer to Sherman. Sherman's depreciation expense in Year 1 using the straight-line method would be: a. $6,800 b. $5,100 c. $7,200 d. $5,400 ($36,000 - $2,000) / 5 = $6,800 9/12 = $5,100

ANS: B

OBJ: KP 12-5 41.

TOP: Depreciation and Amortization

On September 2, Year 1, Bucyrus Company purchased a new truck for $25,000. The truck is expected to be driven 12,000 miles per year for a total of 6 years, at which time its residual value will be approximately $1,000. The fiscal year end is December 31. Accumulated depreciation at the end of Year 2 using double declining balance would be: a. $7,407 b. $7,444 c. $10,111 d. $10,185 e. $13,689

ANS: D The double-the-straight-line-rate for a 6-year asset is ( 1 6 2 = 33.3%) or 1/3. Year 1: ($25,000 - 0) (1/3) (4/12) Year 2: ($25,000 - $2,778) (1/3) = = $ 2,778 7,407 $10,185

OBJ: KP 12-5 42.

TOP: Depreciation and Amortization

At the end of its useful life, the accumulated depreciation of an asset would be a. greater under the declining-balance method than under the straight-line method. b. greater under the straight-line method than under the declining-balance method. c. the same under both methods. d. unable to determine from the information given. OBJ: KP 12-5 TOP: Depreciation and Amortization Depreciation is an indirect source of cash because a. it creates a cash fund being accumulated through accumulated depreciation. b. it is added back to net income in the computation of cash from operating activities. c. it reduces taxable income. d. none of the choices provided in this question. OBJ: KP 12-5 TOP: Depreciation and Amortization

ANS: C 43.

ANS: C

44.

Assuming that an asset has been depreciated using the straight-line method for 3 years, an increase in the assets estimated useful life from 7 years to 10 years would a. increase the annual depreciation expense. b. decrease the annual depreciation expense. c. not change the annual depreciation expense. d. unable to determine from the information given. OBJ: KP 12-5 TOP: Depreciation and Amortization Winston purchased a new machine in January, Year 1, for $12,000. The machine was expected to have a 5-year life and a residual value of $2,000; the straight-line method was adopted. At the beginning of Year 3 it was decided that the asset's total useful life would be 8 years rather than 5. No change was made to the estimation of residual value. The machine's accumulated depreciation at the end of Year 3 would be: a. $800 b. $900 c. $1,000 d. $1,200 e. $5,000 original depreciation: $10,000 / 5 years = $2,000 per year $2,000 2 years = $4,000 taken to date Original cost Less: Accumulated depreciation Book value Less: residual value New depreciable cost ($6,000 / 6 years remaining) Depreciation taken prior to the change in life estimate Total $12,000 (4,000) $ 8,000 (2,000) $ 6,000 $ 1,000/year 4,000 $ 5,000

ANS: B 45.

ANS: E

OBJ: KP 12-5

TOP: Depreciation and Amortization

14.

The process of allocating the cost of a long-term operating asset over the periods that the asset is in service is _______________________.

ANS: depreciation OBJ: KP 12-5 15.

TOP: Depreciation and Amortization

There are two major factors causing tangible assets to give up economic benefits: ____________________ and ____________________.

ANS: physical deterioration (or deterioration), obsolescence OBJ: KP 12-5 TOP: Depreciation and Amortization 16. Assets are not depreciated below their ________________________.

ANS: salvage value or residual value OBJ: KP 12-5 TOP: Depreciation and Amortization 17. Assets are not depreciated below their ________________________.

ANS: salvage value OBJ: KP 12-5 TOP: Depreciation and Amortization 18. ____________________ depreciation methods allocate a greater portion of an asset's cost to the early years of its useful life, and a smaller portion to later years.

ANS: Accelerated OBJ: KP 12-5 19.

TOP: Depreciation and Amortization

In choosing a particular method of depreciation, management is often concerned with practical issues, such as simplicity, which would explain the popularity of the ____________________ depreciation method.

ANS: straight-line OBJ: KP 12-5

TOP: Depreciation and Amortization

Problems:
11.On January 4, Year 1, Bavarian Corporation purchased factory equipment for $80,000. The equipment will be depreciated for an 4-year period (approximately 130,000 hours of use), at which time its residual value is estimated to be $5,000. Required: a. Calculate depreciation expense for the year ending December 31, Year 2, using the doubledeclining balance method. b. Calculate accumulated depreciation at the end of Year 3, using the straight-line method. c. Calculate the net book value of the equipment at the end of Year 3, assuming that Bavarian used the straight-line method. ANS: a. Depreciation Expense at the end of year 2 using the double-declining-balance method: $40,000.00 Year 1: ($80,000 - 0) 50% $20,000.00 Year 2: ($80,000 - $40,000) 50% Accumulated depreciation at the end of Year 3 using the straight-line method: ($80000 - $5,000) / 4 years = $18,750 3 years = $56,250 The net book value of the equipment at the end of Year 3 assuming the use of the straightline method: Original cost of asset $80,000 Less: Accumulated depreciation (56,250) Net book value after 3 years of use $23,750 TOP: Depreciation and Amortization

b. c.

OBJ: KP 12-5

12.

In its first year of operations, Zoom Corporation purchased a new truck for $22,000. The truck is expected to have an 8-year life and to be functional for 105,000 miles of use. A residual value of $1,000 has been estimated. Required: a. Calculate accumulated depreciation at the end of year 4 using the straight-line method. b. Calculate the accumulated depreciation at the end of year 2 using the double declining balance method.

ANS: a. b. Accumulated depreciation after 4 years using straight-line ($22,000 - $1,000) / 8 = $2,625 per year 4 years = $10,500 Accumulated depreciation after 2 years using double declining balance = = = $5,500 4,125 $9,625

Year 1: ($22,000 - 0) 25% Year 2: ($22,000 - $5,500) 25% Accumulated depreciation OBJ: KP 12-5 13. TOP: Depreciation and Amortization

A machine costing $48,000 had an estimated useful life of 5 years and a residual value of $3,000 when purchased on January 3, Year 1. Required: Supply the missing information in the table below: Depreciation Expense for Year 2 ____________ ____________ Accumulated Depreciation on 12/31/Yr 2 ____________ ____________ Book Value on 12/31/Yr 2 ____________ ____________

Method Straight-Line Double Declining Balance ANS:

Method Straight-Line Double Declining Balance

Depreciation Expense for Year 2 $ 9,000 $11,520

Accumulated Depreciation on 12/31/Yr 2 $18,000 $30,720

Book Value on 12/31/Yr 2 $30,000 $17,280

Accumulated Depreciation Calculations Straight-Line: ($48,000 - $3,000) / 5 = $9,000 2 years = $18,000 Double Declining Balance: Depreciation expense year 1: ($48,000 - 0) 40% Depreciation expense year 2: ($48,000 - $19,200) 40% Accumulated Depreciation $19,200 11,520 $30,720

Book values were computed by subtracting each asset's accumulated depreciation from its historical cost.

OBJ: KP 12-5 14.

TOP: Depreciation and Amortization

A machine with an estimated useful life of 6 years and an expected residual value of $15,000 was purchased on July 3, Year 1, for $120,000. The fiscal year end is December 31. Required: a. Calculate depreciation expense for Year 1 using the double declining balance method. b. Calculate accumulated depreciation at the end of Year 4 using the straight-line method.

ANS: a. Depreciation Expense in Year 1 using double declining balance: ($120,000 - 0) 1/3 = $40,000 6/12 = $20,000 (DDB rate for a 6 year asset = 1 / 6 2 = 33.3% or 1/3) b. Accumulated Depreciation at the end of Year 4 using straight-line: ($120,000 - $15,000) / 6 = $17,500 per year Depreciation expense Year 1: $17,500 6/12 = Depreciation expense Years 2-4: $17,500 3 = Accumulated Depreciation TOP: Depreciation and Amortization

$ 8,750 52,500 $61,250

OBJ: KP 12-5

16.

Indigo, Inc. purchased computer equipment costing $65,000. The equipment is expected to have a useful life of 6 years with a $5,000 residual value. For financial reporting purposes, the company uses straight-line depreciation. Computer equipment is classified as five-year property for tax purposes and the percentages for calculating depreciation for tax purposes are as follows: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 20% 32% 19.2% 11.52% 11.52% 5.76%

Required: a. Calculate depreciation expense for years 1 through 6 for financial reporting purposes. b. Calculate depreciation for years 1 through 6 for tax purposes. ANS: a. b. Straight-line depreciation for financial reporting purposes ($65,000 - $5,000) 6 = $10,000 per year for Years 1 through 6 For tax purposes Year 1 $65,000 20% Year 2 $65,000 32% Year 3 $65,000 19.2% Year 4 $65,000 11.52% Year 5 $65,000 11.52%

$13,000 $20,800 $12,480 $ 7,488 $ 7,488

Year 6 $65,000 5.76% OBJ: KP 12-5 TOP: Depreciation and Amortization

$ 3,744

Question A colleague makes the observation that depreciation is a "valuation" technique and that "accumulated depreciation" is analogous to an asset replacement fund. Critique this statement. ANS: Depreciation is the process of allocating the cost of tangible long-term assets (except land) to the period in which the company receives the benefits from these assets. Depreciation is not a way to compute the current value of long-lived assets. Rather, depreciation is the systematic allocation of the cost of an asset to the periods benefited by the use of the asset. Accumulated depreciation is the sum of the previously recorded deprecation on the asset. The book value of the asset is not representative of the asset's market value, but rather the value of the asset that will be allocated to future benefit periods. If the asset has a stipulated residual value, the book value minus the residual value represents the remaining depreciable base of the asset. OBJ: KP 12-5 TOP: Depreciation and Amortization

MATCHING Match as many of the descriptions as possible with one of the terms in a-n below. If no match is possible, answer "o." n. straight-line depreciation a. accounting rate of return o. no match b. amortization c. capitalized interest d. declining-balance depreciation e. depreciable cost f. depreciation g. fixed asset turnover h. goodwill i. impairment j. long-term operating assets k. net present value method l. payback period m. residual value

1.

2.

3.

4. 5.

6.

All the special competitive advantages enjoyed by a company The time required to recover the initial cost of an operating asset. Property, plant, and equipment and intangible assets Sales divided by average fixed assets Reduction in the value of an asset due to events subsequent to its acquisition Income earned by an asset divided by the initial investment in the asset ANS: H ANS: L ANS: J ANS: G ANS: I ANS: A ANS: K ANS: O ANS: C ANS: E

7. 8. 9. 10. 11.

12. 13. 14. 15.

Compares the present value of cash outflows with the present value of cash inflows. Net income from operations divided by average fixed assets Interest that is recorded as part of the cost of a selfconstructed asset Acquisition cost less estimated residual value. The process of allocating the cost of assets such as plant and equipment to the period in which the company receives the benefits from the assets Depreciation expense is calculated by dividing depreciable cost by useful life. Estimate of what an asset will be worth at disposal. Allocates a greater portion of an asset's cost to the early years of its useful life. The process of allocating the cost of assets such as patents and copyrights to the period in which the company receives the benefits from the assets

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

11. 12. 13. 14.

ANS: F ANS: N ANS: M ANS: D