CHAPTER 8

LONG-TERM ASSETS
SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE,
BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES,
AND CPA CODES
Ite L BT LO AACS CP Ite L BT LO AACS CP LO LO AACS CP
Item BT
m O D B A m O D B A D B A
True-False Statements
1. 1 K M AN F 6. 3 K M AN F 11. 8 K E AN F
2. 2 K M AN F 7. 4 K E AN F 12. 8 K E AN F
3. 2 K H AN F 8. 6 C M AN F 13. 9 K E AN F
4. 2 K E AN F 9. 6 C E AN F
5. 3 K E AN F 10. 7 C E AN F
Multiple Choice Questions
1 AN F 4 K AN F 5 A AN F
14. K E 37. E 60. H
P
1 AN F 4 A AN F 6 AN F
15. K E 38. E 61. C E
P
16. 9 K E AN,C C,F 39. 4 K E AN F 62. 6 C M AN,C F
1 AN,C C,F 4 AN F 6 A AN,C F
17. K E 40. C E 63. M
P
2 AN F 4 AN F 7 A AN F
18. K M 41. C M 64. M
P
2 AN F 4 AN F 7 A AN F
19. K M 42. C E 65. H
P
2 A AN F 4 A AN F 7 A AN F
20. E 43. E 66. E
P P P
2 A AN F 4 AN F 7 AN F
21. M 44. K E 67. C E
P
2 A AN F 4 A AN F 7 AN F
22. H 45. H 68. C M
P P
2 AN F 4 A AN F 4 AN,C F
23. K E 46. M 69. C M
P
2 A AN F 4 A AN F 4 AN,C F
24. M 47. M 70. C M
P P
2 AN F 4 A AN F 8 AN F
25. C M 48. M 71. K E
P
2 AN F 4 A AN F 8 AN F
26. K M 49. M 72. C M
P
2 AN F 4 A AN F 8 AN F
27. C M 50. M 73. C H
P
3 AN F 4 A AN F 8 A AN F
28. C E 51. M 74. H
P P
3 AN F 4 A AN F 8 A AN F
29. K E 52. H 75. H
P P

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8-2 Test Bank for Understanding Financial Accounting, Second Canadian Edition

3 AN F 4 A AN F 8 AN F
30. K E 53. M 76. C H
P
3 AN,C F 4 A AN F 89 AN F
31. C M 54. H 77. C M
P
4 AN F 4 A AN F M AN,C F
32. C E 55. M 78. 9 C
P
33. 4 K M AN F 56. 5 C E AN F 79. 9 C M AN,C F
34. 4 C E AN F 57. 5 C E AN F 80. 10 C M AN,C F
4 AN F 5 A AN F
35. K E 58. M
P
4 AN F 5 A AN F
36. C E 59. H
P

Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge

LOD: E = Easy M = Medium H = Hard
AACSB: AN = Analytic C = Communication
CPA: C = Communication F = Financial Reporting

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 Long-Term Assets 8-3

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE,

BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES,
AND CPA CODES (CONT’D)
BT LO AACS CP L BT LO AACS CP L LO AACS CP
Item LO Item Item BT
D B A O D B A O D B A
Exercises
2 AN F 4, A M AN F 10 A M AN F
81. AP M 85. 89.
7 P N
24 AN F 4, A M AN F 10 A M AN F
82. AP M 86. 90.
7 P N
4 M AN F 4, A AN F
83. AP 87. M
5 P
4,5 AN F 9 A H AN F
84. AP M 88.
P
Matching
2,8,9 4
91. C H AN F 92. C M AN F
,
Short-Answer Essay
1 K E AN,C C, 4 A M AN,C C, 9 M AN,C C,
93. 96. 99. C
F N F F
2 A M AN,C C, 4 M AN,C C, 100 10 A M AN F
94. 97. C
N F F . N
3 C, M AN,C F 9 M AN F
95. 98. C
K
Essay
101 2 A M AN F 102 4 M AN F 103 4, E AN F
C C
. N . . 8

Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge

LOD: E = Easy M = Medium H = Hard
AACSB: AN = Analytic C = Communication
CPA: C = Communication F = Financial Reporting

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8-4 Test Bank for Understanding Financial Accounting, Second Canadian Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Learning Objective 1
1. TF 14. MC 15. MC 16. MC 17. MC 93. SAE
Learning Objective 2
2. TF 18. MC 21. MC 24. MC 27. MC 91. Ma
3. TF 19. MC 22. MC 25. MC 81. Ex 94. SAE
4. TF 20. MC 23. MC 26. MC 82. Ex 101. Es
Learning Objective 3
5. TF 28. MC 30. MC 82. Ex
6. TF 29. MC 31. MC 95. SAE
Learning Objective 4
7. TF 36. MC 41. MC 46. MC 51. MC 82. Ex 92. Ma
32. MC 37. MC 42. MC 47. MC 52. MC 83. Ex 102. Es
33. MC 38. MC 43. MC 48. MC 53. MC 84. Ex 103. Es
34. MC 39. MC 44. MC 49. MC 54. MC 85. Ex
35. MC 40. MC 45. MC 50. MC 55. MC 86. Ex
Learning Objective 5
56. MC 57. MC 58. MC 59. MC 60. MC 84. Ex 87. Ex
Learning Objective 6
8. TF 9. TF 61. MC 62. MC 63. MC
Learning Objective 7
10. TF 65. MC 67. MC 85. Ex
64. MC 66. MC 68. MC 86. Ex
Learning Objective 8
69. MC 70. MC 92. Ma 96. SAE 97. SAE
Learning Objective 9
11. TF 71. MC 73. MC 75. MC 91. Ma
12. TF 72. MC 74. MC 76. MC 103. Es
Learning Objective 10
13. TF 76. MC 78. MC 80. MC 89. Ex 91. Ma 99. SAE
75. MC 77. MC 79. MC 88. Ex 90. Ex 98. SAE 100. SAE

Note: TF = True-False Ex = Exercise SAE = Short-Answer Essay

MC = Multiple Choice Ma = Matching Es = Essay

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 Long-Term Assets 8-5

CHAPTER LEARNING OBJECTIVES

1. Identify and distinguish between the various types of long-term assets.

Property, plant, and equipment (PP&E) items: have physical substance and provide
economic benefits to a company because they are used to generate revenues, usually in
combination with other assets.
Intangible assets: have no physical substance, but provide economic benefits as a result
of the rights they bestow on the company that owns them.
Goodwill: results from a business combination, has no physical substance, and cannot
be separated from the business it is a part of. Provides economic benefits through the
average earnings that are expected as a result of the acquisition.

2. Describe the valuation methods for property, plant, and equipment, including
identifying costs that are usually capitalized.
PP&E items are reported on the statement of financial position at their carrying amount;
that is, cost less accumulated depreciation and accumulated impairment losses.
An asset’s carrying amount is the portion of its cost that has yet to be expensed. It is not
what the asset could be sold for.
Cost includes purchase price, non-refundable taxes, legal costs, shipping costs, site
preparation, and installation costs.
When multiple PP&E assets are purchased for a single price (a basket purchase), the
cost of each is determined using the assets’ relative fair values.
Costs incurred after the purchase of a PP&E asset are capitalized (added to the cost of
the asset) if they will extend the useful life of the asset, reduce its operating costs, or
improve its output in terms of quantity or quality. Otherwise, these costs are expensed
as period costs (for example, repairs and maintenance expense).

3. Explain why property, plant, and equipment assets are depreciated.

Depreciating PP&E allocates a portion of the cost of each asset to each period in which
the asset’s economic benefits are being used up or consumed.
Only the depreciable amount (cost less estimated residual value) is expensed.
The depreciable amount is allocated or expensed over the asset’s estimated useful life.

4. Identify the factors that influence the choice of depreciation method and
implement the most common methods of depreciation.
The choice of depreciation method depends upon the pattern in which the PP&E asset’s
economic benefits are expected to be used up or consumed by the company.
Common methods of depreciation:
 straight-line: allocates the depreciable amount evenly over time (in equal amounts
each period)
 diminishing balance: allocates a greater portion of the depreciable amount early in
the asset’s life and less as time goes by (that is, there is a larger depreciation
expense early in the asset’s life, reducing over time)
 units-of-production: allocates the depreciable amount on a per-unit basis (that is,
depreciation expense varies with the asset’s use).

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8-6 Test Bank for Understanding Financial Accounting, Second Canadian Edition

Companies are expected to select the method that is most consistent with the way in
which they expect the asset’s economic benefits will be used up or consumed.
A contra-asset account, accumulated depreciation, is used to capture the portion of a
PP&E asset’s cost that has been depreciated.
Depreciation should cease when the depreciable amount has been expensed; that is,
when the asset’s carrying amount is equal to the estimated residual value.
Companies often use the “15-day rule” to determine depreciation for a partial period.
The Income Tax Act does not allow depreciation expense as a deductible expense in
calculating taxable income.
Instead, the Income Tax Act allows capital cost allowance (CCA), with specific rules
about how the maximum amount of annual CCA is calculated.

5. Describe and implement changes in depreciation estimates and methods.

Depreciation expense is an estimate because the variables that go into its calculation
are almost all estimates. Over time, if the estimates change materially, the periodic
expense must also change. This is a change in accounting estimate, and is accounted
for prospectively; in other words, in future periods, rather than going back and changing
prior periods.
Depreciation expense for future periods is based on the asset’s carrying amount at the
time of change, the revised estimate of residual value, the remaining estimated useful
life, and the pattern in which the asset’s remaining economic benefits are expected to be
used.

6. Explain what it means if property, plant, and equipment assets are impaired.
With PP&E, management expects future economic benefits to flow from the use of the
PP&E asset. These benefits should be at least equal to the asset’s carrying amount.
At year end, management must determine whether there are any internal or external
factors that might indicate that their PP&E assets are impaired. That is, the expected
future economic benefits are less than the asset’s carrying amount.
If such factors are present, the company will determine the amount of the asset’s
impairment loss, which is equal to the asset’s carrying amount less the greater of the
expected future cash flows and the asset’s fair value less selling costs.
Any impairment loss is recorded in the period in which it occurs. The asset’s carrying
amount is reduced through using accumulated impairment losses, a contra-asset
account.

7. Account for the disposal of property, plant, and equipment.

Accounted for using a two-step approach:
 Step one: The asset is depreciated to the disposal date so the correct expense from
using it in the period is recognized and the relevant accumulated depreciation
account is updated.
 Step two: the carrying amount (balances in the asset and accumulated depreciation
and impairment accounts) is removed from the records and the proceeds of sale
(cash or other assets) are recognized. If the proceeds of sale exceed the carrying
amount, a gain is recognized. If the proceeds of sale are less than the carrying
amount, a loss is reported.

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 Long-Term Assets 8-7

8. Explain the accounting treatment for intangible assets, including amortization.

Intangible assets are recorded only when purchased from a third party.
Determining cost follows the same principles as used for PP&E.
Intangible assets with a finite (limited) useful life are amortized (expensed) over this
period, usually by the straight-line method. Amortization is similar to depreciation.
The useful life of an intangible asset is often shorter than its legal life.
Intangible assets with an indefinite useful life are not amortized, but are tested annually
for impairment.

9. Explain the accounting treatment for goodwill, including impairment.

Recognition of goodwill:
 happens only as a result of the acquisition of a business
 is equal to the excess of the purchase cost over the fair values of the identifiable
assets net of liabilities acquired, because of the potential for above-average
earnings that are expected to result from the acquisition.
Internally generated goodwill cannot be recognized.
After acquisition, goodwill is carried at cost and is not amortized. It is reviewed annually
for evidence of impairment. If impaired, it is reported at cost less accumulated
impairment losses.

10. Assess the average age of property, plant, and equipment; calculate the fixed
assets turnover ratio; and assess the results.
The average age of PP&E can be determined by dividing the company’s accumulated
depreciation by the annual depreciation expense.
The average age percentage can be determined by dividing accumulated depreciation
by total PP&E assets (excluding land).
The older a company’s PP&E assets, the more likely it will need cash for investing
purposes in the near future.
The fixed asset turnover ratio is equal to sales revenue divided by average net PP&E.
Assessing results of fixed asset turnover ratio indicates how effective an entity has been
in managing its investment in PP&E.

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8-8 Test Bank for Understanding Financial Accounting, Second Canadian Edition

TRUE-FALSE STATEMENTS

1. The cash inflows generated from a long-term asset will be received over several
future periods.

2. Under ASPE, property, plant, and equipment must be recognized using the
revaluation model.

3. The total accumulated depreciation on a long-term asset is also known as the asset's
amortized cost.

4. In a basket purchase, the total purchase price is divided equally among the assets
acquired.

5. Depreciation expense is a measure of an asset's increase in value due to wear and

tear.

6. Depreciation is a cost allocation method and has nothing to do with determining an

asset’s market value.

7. Residual value directly enters into the calculation of depreciation expense under all
depreciation methods.

8. If a company determines that due to damage, the recoverable cost of its asset is
reduced, it increases accumulated depreciation.

9. An impairment loss should be recognized if the net recoverable amount of the asset
exceeds the carrying value.

10. Upon the disposal of an asset, if the carrying value is NOT equal to the proceeds, a
gain or loss must be recognized.

11. Basic research costs that occur prior to any decision to develop a product or process
are usually capitalized.

12. All patents have useful and economic lives of 20 years.

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 Long-Term Assets 8-9

13. Internally generated goodwill may be capitalized annually.

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8 - 10 Test Bank for Understanding Financial Accounting, Second Canadian Edition

ANSWERS TO TRUE-FALSE STATEMENTS

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 4. F 7. F 10. T 13. F
2. F 5. F 8. F 11. F
3. F 6. T 9. F 12. F

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 Long-Term Assets 8 - 11

MULTIPLE CHOICE QUESTIONS

14. Which of the following is not a tangible capital asset?

a) buildings
b) land
c) copyrights
d) equipment

15. Which of the following would not be classified as property, plant, and equipment?
a) buildings in current use
b) land purchased for resale
c) machinery
d) tools used in production

16. The only long-term asset that cannot be separated from the business and sold is
a) land.
b) buildings.
c) goodwill.
d) trademarks.

17. Capital assets include all of the following except for

a) goodwill.
b) franchise rights.
c) buildings.
d) inventory.

18. Which of the following would not be capitalized as part of a purchased asset's cost?
a) non-refundable taxes
b) installation cost
c) shipping costs
d) insurance costs

19. In 2020 as part of a property purchase, Melrose Ltd. incurred and paid 2019 property
taxes. These costs should be
a) recognized as an impairment loss.
b) recognized on the Statement of Income as an expense.
c) recognized as a capital cost.
d) not be taken into consideration, these costs are irrelevant.

20. Barium Corp. purchased a piece of equipment on September 30 for $27,000. It cost
$400 to ship the equipment to the company’s facilities and another $1,000 to install the
equipment. After the equipment was installed the company had to pay an additional
$1,500 for increased insurance. The capitalized cost of the equipment was

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8 - 12 Test Bank for Understanding Financial Accounting, Second Canadian Edition

a) $29,900.
b) $29,500.
c) $28,400.
d) $27,400.

21. A plot of land was purchased for $120,000 and had $10,000 of past due property
taxes on it. Non-refundable taxes on the purchase were $1,400 and the title search cost
$500. The capitalized cost of the land was
a) $120,000.
b) $121,900.
c) $130,000.
d) $131,900.

22. A machine was purchased for $125,500 during August; the cost included $750 in
supplies that would be used with the new machine. The company had to pay $6,000 for
to have the machine shipped. The capitalized cost of the equipment is
a) $125,500.
b) $126,250.
c) $131,500.
d) $132,250.

23. Assets acquired in a basket purchase are to be allocated a portion of the total price
based on their respective
a) fair market values.
b) book values.
c) present values.
d) assessed values.

24. AFM Holdings Co. purchased 15 acres of land with an office building and warehouse
on it for $2,000,000. The assets were appraised at: land $1,000,000, building $600,000,
and warehouse $900,000. The assets were carried on the seller's books at: land
$800,000, building $500,000, and warehouse $700,000. At what cost should the
purchasing company record each of the assets?
Land Building Warehouse
a) $1,000,000 $600,000 $900,000
b) $800,000 $480,000 $720,000
c) $800,000 $500,000 $700,000
d) $1,000,000 $500,000 $500,000

25. Which of the following statements is true with respect to capitalizing asset costs?
a) All additional costs related to acquiring an asset should be expensed.
b) Land cannot be depreciated so it should just be expensed when acquired.
c) When costs are capitalized, the company gets the tax deduction immediately.
d) Some small expenses related to the purchase of an asset can be expensed for
simplicity.

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 Long-Term Assets 8 - 13

26. When capitalizing the cost of a purchased asset, all of the following cost should be
included in capitalization except for
a) the full purchase price plus any discounts.
b) set up costs.
c) legal costs.
d) shipping costs.

27. When deciding whether to expense or capitalize the costs incurred after acquiring a
capital asset, which one of the following is not relevant to the decision?
a) Will these costs extend useful life?
b) Will these costs reduce asset operating costs?
c) Will these costs improve output?
d) Will these costs be incurred for more than one year?

28. The unexpensed portion of a depreciable asset is called

a) accumulated depreciation.
b) net realizable value.
c) estimated residual value.
d) net present value.

29. The ultimate sales value of a long-term asset is referred to as its

a) residual value.
b) value in use.
c) net book value.
d) historical value.

30. The depreciable amount of an asset is defined as the

a) original cost less residual value.
b) original cost less depreciation.
c) original cost less accumulated depreciation.
d) original cost.

31. A key reason that there are various acceptable depreciation methods is
a) different assets have different expected usage patterns.
b) some methods are too complicated to calculate.
c) to make it easier to calculate corporate income taxes.
d) to account for assets with indefinite lives.

32. According to accounting standards, the method of depreciation chosen should

a) measure the change in an asset's value.
b) be systematic and rational.
c) allocate the most of the asset's cost to the early periods benefiting from its use.
d) recognize the reduced usefulness of an asset.

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8 - 14 Test Bank for Understanding Financial Accounting, Second Canadian Edition

33. The depreciation method that most closely resembles what is allowable for tax
purposes under CRA is
a) the straight-line method.
b) units-of-activity method.
c) the declining-balance method.
d) depletion method.

34. Assets that produce their greatest benefits to a firm early in their useful life should be
depreciated using the
a) straight-line method.
b) declining-balance method.
c) compound interest method.
d) units-of-activity method.

35. The most commonly used method of depreciation is

a) straight-line.
b) capital cost allowance.
c) declining-balance.
d) units-of-activity.

36. The residual value is not directly used for the calculation of depreciation expense
under which method?
a) units-of-activity method
b) straight-line method
c) interest capitalization method
d) declining-balance method

37. To apply the units-of-activity method, all of the following information is needed
except the
a) original cost.
b) estimated residual value.
c) estimated useful life.
d) estimated usage.

38. A company is depreciating a $1,000,000 building using a straight-line rate of 5%.

The building has an estimated residual value of $200,000. What would the amount of
depreciation be in the first year using the straight-line method and the double-declining-
balance method?
Straight-line Double-declining-balance
a) $40,000 $80,000
b) $40,000 $100,000
c) $50,000 $80,000
d) $50,000 $100,000

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 Long-Term Assets 8 - 15

39. Which of the following depreciation methods calculates annual depreciation expense
based on an asset's cost minus its residual value?
a) deferred depreciation
b) straight-line
c) capital cost allowance
d) declining-balance

40. If an asset generates revenues evenly over its useful life, which depreciation method
should be used?
a) capital cost allowance
b) declining-balance
c) units-of-activity
d) straight-line

41. If management wanted to show an increasing income over the life of an asset which
method of depreciation should they choose?
a) capital cost allowance
b) declining-balance
c) units-of-activity
d) straight-line

42. Which of the following amortization methods ignore residual value in the calculation
of the annual depreciation expense?
a) double-declining-balance and capital cost allowance
b) straight-line and double-declining-balance
c) straight-line and capital cost allowance
d) present value and straight-line

43. The correct entry to record the annual depreciation expense for a long-term asset is
a) Dr. Accumulated depreciation.
b) Dr. Depreciation expense, Cr. Accumulated depreciation.
c) Dr. Accumulated depreciation, Cr. Long-Term asset.
d) Dr. Depreciation expense, Cr. Long-Term asset.

44. The Canada Revenue Agency allows corporations to deduct the following when
calculating taxable income:
a) declining-balance depreciation.
b) straight-line depreciation.
c) capital cost allowance.
d) one-half of the cost of the asset in the year of acquisition.

Use the following information for questions 45–46.

Maryam Co. purchased a machine on January 1, 2020 for $22,500. The machine had an
estimated useful life of 10 years and an estimated residual value of $2,500. The

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8 - 16 Test Bank for Understanding Financial Accounting, Second Canadian Edition

company uses double-declining-balance depreciation.

45. What will be the depreciation expense for 2020?

a) $4,500
b) $3,500
c) $2,250
d) $2,000

46. If Maryam Co. used the straight-line method of depreciation, what would the carrying
value of the machine be at the end of 2020?
a) $20,500
b) $20,250
c) $18,250
d) $18,000

Use the following information for questions 47–48.

Ponderosa Farms purchased some equipment on January 1, 2020 for $12,600. The
equipment has an estimated useful life of 10 years and an estimated residual value of
$1,200. The company uses double-declining-balance depreciation.

47. Depreciation expense for 2020 would be

a) $1,140.
b) $1,260.
c) $2,280.
d) $2,520.

48. The net book value on January 1, 2021 would be

a) $10,080.
b) $10,320.
c) $11,340.
d) $11,460.

Use the following information for questions 49–51.

On July 1, 2019, Bronson Co. purchased some equipment that initially cost $52,800.
Additional costs included freight costs $300, non-refundable taxes $6,400, and
installation $500. Estimated residual value is $2,000. The company uses a straight-line
rate of 10%. Bronson’s fiscal year end is June 30.

49. Depreciation expense for the 2020 fiscal year end is

a) $6,130.
b) $5,900.
c) $5,800.

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 Long-Term Assets 8 - 17

d) $5,930.

50. Accumulated depreciation at the fiscal year end of 2022 is

a) $17,400.
b) $17,700.
c) $17,790.
d) $18,390.

51. What would the depreciation expense be for 2020 if Bronson Co. used the double-
declining-balance method?
a) $12,200
b) $12,000
c) $11,600
d) $ 6,000

52. A building currently has a net book value of $650,000 after three years of straight-
line depreciation totalling $150,000. The estimated residual value is $50,000. What was
the building's original cost?
a) $900,000
b) $850,000
c) $800,000
d) $750,000

53. A depreciable asset with a cost of $42,500 has a residual value of $2,500 and a
useful life of 8 years. Total estimated units of output are 80,000 and in year 1; 5,200
units were produced. Under the straight-line method and the units-of-activity method the
depreciation expense for the first year would be
Straight-line Units-of-activity
a) $5,000.00 $2,600.00
b) $5,000.00 $2,762.50
c) $5,312.50 $2,600.00
d) $5,312.50 $2,762.50

54. An asset being depreciated with the straight-line method has a residual value of
$10,000 and accumulated depreciation of $30,000 in its second year. What was the
original cost of the asset if its useful life was 5 years?
a) $160,000
b) $140,000
c) $ 85,000
d) $75,000

55. Bombay Inc. bought new computers on January 1 for $18,000 to improve the quality
of their animation. The computers have a useful life of 8 years but Bombay Inc. thinks
that continuing technological developments will likely mean they will replace the
computers after 4 years, at which time they will be worth $2,000. If they use straight-line

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8 - 18 Test Bank for Understanding Financial Accounting, Second Canadian Edition

depreciation, the depreciation expense for the first year will be

a) $2,000.
b) $2,250.
c) $4,000.
d) $4,500.

56. Changes in the estimates for residual value or useful life result in changes in the
depreciation expense calculation. These changes are handled
a) retroactively.
b) as cumulative changes.
c) prospectively.
d) as prior period adjustments.

57. The depreciation expense of an asset can change for all of the following reasons
except
a) change in the estimated useful life.
b) change in the asset’s expected residual value.
c) increases due to additions to the asset for major repairs and improvements.
d) increase in the asset due to regular repairs and maintenance.

58. An asset that cost $16,200 with a residual value of $1,200 and a useful life of 5 years
was depreciated for two years using the straight-line method. In the third year, the useful
life was determined to be 2 years longer than initially expected. Depreciation in the third
year would be
a) $3,000.
b) $2,143.
c) $2,040.
d) $1,800.

59. Proctor Papers purchased a machine on January 1, 2020 at a cost of $380,000 with
an estimated residual value of $30,000 at the end of its estimated useful life of 8 years.
On January 1, 2022 Proctor Paper estimates that the machine only has a remaining life
of 5 years and a residual value of $20,000. Proctor Paper uses straight-line depreciation.
Depreciation expense for 2022 would be
a) $48,500.
b) $54,500.
c) $57,000.
d) $72,000.

60. Cola Company purchased a bottling machine on October 1, 2018 for $250,000. The
estimated useful life is 25 years and they are using straight-line depreciation. On
October 1, 2019, they spent $46,000 on the machine to double its capacity and $5,000
on routine cleaning. The company’s year end is September 30. What should the
depreciation expense be at September 30, 2020?
a) $10,000
b) $30,000

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 Long-Term Assets 8 - 19

c) $12,200
d) $11,9170

61. Oceanside Developments owns a piece of land it had purchased in 2019 for
$400,000. When they started to develop the land in 2020, they discovered that there
were environmental problems with the land. It is now estimated to be worth only
$150,000. Which of the following is the correct way to account for this?
a) No accounting is necessary because the land is recorded at its historical cost, not its
market value.
b) The land account should be written down to $150,000 and a loss recognized.
c) The land should be written off completely because now the company cannot use it for
the purpose they intended to.
d) The land should be depreciated at a new rate to reflect the decline in its value.

62. Factors that may contribute to, or may be assessed in relation to, the impairment of
PPE include
a) environmental spills or damage.
b) elimination of a business unit due to corporate restructuring.
c) the changing economic benefits of an asset.
d) all of the above
e) none of the above

63. Alexa Corporation has a calendar year end and owns equipment that was purchased
for $225,000 on March 1, 2020. On December 31, 2021 after the year-end adjusting
entries, the carrying amount of the asset is $155,000. Due to damage, management
determines the recoverable value to be $125,000. Alexa would make the following entry
related to this asset:
a) Dr. Depreciation Expense $30,000
Cr. Accumulated Depreciation $30,000
b) Dr. Loss on Impairment $30,000
Cr. Accumulated Impairment Losses—Equipment $30,000
c) Dr. Depreciation Expense $100,000
Cr. Equipment $30,000
d) Dr. Loss on Impairment $100,000
Cr. Accumulated Impairment Losses—Equipment $30,000

64. An asset with an original cost of $75,000, a residual value of $7,500, and a useful life
of 5 years is given away without any consideration at the end of year five. The entry to
record this is
a) Dr. Accumulated depreciation, Dr. Loss on disposal, Cr. Long-Term asset.
b) Dr. Accumulated depreciation, Cr. Gain on disposal, Cr. Long-Term asset.
c) Dr. Long-Term asset, Cr. Accumulated depreciation.
d) Dr. Accumulated depreciation, Cr. Long-Term Asset.

65. Global Enterprises purchased a machine on January 1, 2020 for $22,500. The
machine had an estimated useful life of 10 years and an estimated residual value of

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8 - 20 Test Bank for Understanding Financial Accounting, Second Canadian Edition

$2,500. Assuming Global uses straight-line depreciation, what would be the book value
of the machine on December 31, 2024?
a) $ 0
b) $10,000
c) $11,250
d) $12,500

66. On July 1, 2020 a truck was sold for $10,000. The company originally paid $28,000
on June 30, 2013 and has recorded accumulated depreciation on it to date of $15,000.
The entry to record the sale would include a
a) credit to accumulated depreciation for $15,000.
b) debit to trucks for $28,000.
c) credit to gain on sale of truck for $3,000.
d) debit to loss on sale of truck for $3,000.

67. Upon the disposal of an asset, if the proceeds are greater than the carrying value of
the asset, the company must
a) recognize a loss.
b) recognize a gain.
c) adjust the accumulated depreciation account so the carrying value equals the
proceeds.
d) adjust the carrying value to market value.

68. Losses on the cash sale of capital assets

a) are the excess of the cash proceeds over the carrying value of the asset.
b) are the excess of the cash proceeds over the market value of the asset.
c) are the excess of the carrying value of the asset over the cash proceeds.
d) are the excess of the carrying value of the asset over the market value.

69. Depreciation Expense

a) applies to all non-current assets.
b) cannot be used for calculating income taxes.
c) is acceptable for use under GAAP and the Income Tax Act.
d) is very similar to CCA.
e) all of the above

70. The Capital Cost Allowance (CCA)

a) ignores residual value.
b) has prescribed depreciation rates.
c) is very similar to accelerated depreciation rates.
d) all of the above
e) none of the above

71. Long-term capital assets with a(n) ___ may not be depreciable.
a) finite life

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 Long-Term Assets 8 - 21

b) indefinite life
c) residual value
d) undefined value

72. Which of the following methods of amortization is a company most likely to use for
financial statement purposes if it purchases a patent?
a) capital cost allowance
b) double-declining-balance
c) units-of-activity
d) straight-line

73. Which of the following statements is true with respect to intangible assets with
indefinite lives?
a) They should be amortized over a period of 40 years.
b) They should be expensed to income in the year they are acquired.
c) They should be evaluated each year to determine if there has been any impairment in
their value.
d) They are never amortized or written down but remain on the company’s balance sheet
at their original cost forever.

74. Drugs R Us spent $25,000 on research and development to create a new product.
The product was successfully developed and launched into the market. How should the
research and development costs be treated?
a) The full $25,000 should be capitalized.
b) The research portion of the $25,000 should be capitalized.
c) The research portion of the $25,000 should be expensed.
d) The full $25,000 should be expensed.

75. Harmax Limited spent $5,000 registering an internally developed patent and then
another $20,000 defending and enforcing the patent in its first year. How should the
patent be reflected in the financial statements?
a) the full $25,000 expensed in the year
b) $5,000 capitalized as Patent asset and the $20,000 expensed
c) $20,000 capitalized as Patent asset and the $5,000 expensed
d) the full $25,000 capitalized in the year

76. Which of the following is an example of an intangible with an indefinite life?

a) a copyright on a song
b) a patent on a new technology
c) the development costs of a new drug
d) the goodwill value assigned to the excess purchase price when purchasing a
company

77. Which of the following intangibles would be capitalized?

a) research

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8 - 22 Test Bank for Understanding Financial Accounting, Second Canadian Edition

b) advertising
c) goodwill acquired in a purchase
d) internally developed patent

78. Goodwill
a) is the net value of the purchase price less the book value of the asset.
b) has economic value and can be sold to generate revenues.
c) can be generated internally.
d) only arises when businesses are combined.
e) all of the above

79. The carrying amount of goodwill is

a) not relevant, because goodwill is not amortized.
b) captures impairment losses.
c) calculated using CCA.
d) all of the above
e) none of the above

80. Companies can estimate when capital assets may need to be replaced in order to
maintain operating capacity by using the following ratio(s):
a) fixed asset turnover.
b) average age %.
c) current.
d) inventory turnover.
e) all of the above

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 Long-Term Assets 8 - 23

ANSWERS TO MULTIPLE CHOICE QUESTIONS

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
14. c 28. c 42. a 56. c 70. d
15. b 29. a 43. b 57. d 71. b
16. c 30. a 44. c 58. d 72. d
17. d 31. a 45. a 59. b 73. c
18. d 32. b 46. a 60. d 74. c
19. c 33. c 47. d 61. b 75. d
20. c 34. b 48. a 62. d 76. d
21. d 35. a 49. c 63. b 77. c
22. c 36. d 50. a 64. a 78. d
23. a 37. c 51. b 65. d 79. b
24. b 38. b 52. c 66. d 80. b
25. d 39. b 53. a 67. b
26. a 40. d 54. c 68. c
27. d 41. b 55. c 69. b

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8 - 24 Test Bank for Understanding Financial Accounting, Second Canadian Edition

EXERCISES

81. Sanitec Architecture made the following cash expenditures during its first year in
operations:
1. Cost of real estate purchased as a plant site
(land and building) $ 130,000
2. Accrued property taxes paid at the time of the
purchase of the real estate 3,000
3. Cost of demolishing building to make land
suitable for construction of a new building 9,000
4. Architect's fees on building plans 12,000
5. Excavation costs for new building 27,000
6. Cost of filling and grading the land 2,500
9. Full payment to building contractor 750,000
10. Cost of parking lots and driveways 32,000
11. Property taxes paid for the current year on the land 5,000

Instructions
Record the above transactions and determine the cost of the land, land improvements,
and building that will appear on Sanitec’s year-end statement of financial position.

Solution (15 min.)

1. Dr. Land.................................................. $130,000
Cr. Cash........................................ $130,000

2. Dr. Land.................................................. $3,000

Cr. Cash........................................ $3,000

3. Dr. Land.................................................. $9,000

Cr. Cash........................................ $9,000

4. Dr. Building............................................. $ 12,000

Cr. Cash........................................ $12,000

5. Dr. Building............................................. $27,000

Cr. Cash........................................ $12,000

6. Dr. Land.................................................. $ 2,500

Cr. Cash........................................ $2,500

9. Dr. Building............................................. $750,000

Cr. Cash........................................ $750,000

10. Dr. Land Improvements.......................... $32,000

Cr. Cash........................................ $32,000

11. Dr. Property Tax Expense....................... $5,000

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 Long-Term Assets 8 - 25

Cr. Cash........................................ $5,000

The account balances on the statement of financial position at the end of the period are
as follows:
Land $144,500
Land Improvement $32,000
Building $789,000

82. Beach Front Foods Inc. has decided to add a delivery service to its business. In
2020 the company purchased a car to use to deliver customer orders. The purchase
price of the car was $42,000, which includes non-refundable taxes of $5,800. The car
was painted with the store logo for $1,000 and an additional $750 was spent on the
annual license fee. During the year they spent $3,000 on gas and $1,000 on
maintenance costs. They expect to drive the car 200,000 kilometres and have a residual
value of $5,000. In 2020, they drove 27,500 km.

Instructions
a) Calculate the cost of the asset to Beach Front. Provide brief support for all items
included in the cost and the reason any costs are not included.
b) Record the depreciation expense for 2020 using the units-of-activity method.

Solution (10 min.)

a) Purchase cost $42,000 original cost has future benefit
non-refundable taxes
(included in purchase price)
paint 1,000 necessary to get asset ready to use
Total capital cost $43,000

Costs not included:

License $750 an annual cost, expense each year
Gas 3,000 an annual operating cost, expense
Maintenance 1,000 did not increase the future benefits
therefore expensed

b) Depreciable cost $43,000 – $5,000 = $38,000

estimated kilometres 200,000
rate per km $0.19

# km driven 27,500
Depreciation expense $5,225

83. On September 1, 2020, Muzeen Machine Co. purchased a piece of equipment which
cost $68,900, has a $4,900 residual value, and an 8-year useful life. The company has a
fiscal year end of August 31.

Instructions
Calculate the depreciation expense for year one under
a) Straight-line,

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8 - 26 Test Bank for Understanding Financial Accounting, Second Canadian Edition

b) Double-declining-balance.

Solution (5 min.)
a) ($68,900 – $4,900) ÷ 8 years = $8,000

b) $68,900 × 25% = $17,225

84. Wilma’s Wicker Furniture purchased a laser-guided mitre saw on September 1, 2018
at a cost of $20,000. Depreciation for 2018 and 2019 was based on an estimated 8-year
useful life and $4,000 estimated residual value. In 2020, Wilma’s revised its estimates
and now believes the laser mitre saw will have a total service life of an additional three
years but the residual value will be only $2,000. Wilma’s uses the straight-line method to
depreciate all assets. Wilma’s Wicker Furniture has a December 31 year end.

Instructions
Calculate depreciation expense for 2018, 2019, and 2020.

Solution (10 min.)

2018 and 2019
Cost $20,000
Residual value 4,000
Depreciable cost 16,000
Estimated life (years) ÷8
Annual depreciation (for 2019) $2,000
Depreciation expense for 2018 ($2,000 x 4/12) $ 677

2020
Cost $20,000
Less: depreciation 2018 and 2019 2,667
Book value at December 31, 2019 17,333
Less: revised residual value 2,000
Depreciable cost 15,333
Remaining life (years) (6 years 4 months + 3 years) ÷ 9.67
Annual depreciation $ 1,586 (rounded to the nearest $).

85. Lucky Lure Co. purchased a machine on October 1, 2018 for $125,000. It has a
$15,000 residual value and a 10-year useful life. On July 1, 2020 the machine sold for
$79,500. The company uses the double-declining-balance method of depreciation. The
company fiscal year end is December 31.

Instructions
Prepare the journal entries for 2018 through 2020.

Solution (12 min.)

2018
Oct 1 Machinery............................................................. 125,000
Cash.............................................................. 125,000

Dec 31 Depreciation expense—machinery....................... 6,250

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 Long-Term Assets 8 - 27

Accumulated depreciation—machinery.......... 6,250

(125,000 x .2) x 3/12
2019
Dec 31 Depreciation expense—machinery....................... 23,750
Accumulated depreciation—machinery.......... 23,750
([$125,000 – $6,250] x .2)
2020
Jul 1 Depreciation expense—machinery....................... 9,500
Accumulated depreciation—machinery.......... 9,500
([$125,000 – $6,250 – $23,750] x.2 x 6/12)
Cash..................................................................... 79,500
Accumulated depreciation—machinery................ 39,500
Loss on sale of machinery.................................... 6,000
Machinery...................................................... 125,000

86. Acker Limited sold a piece of equipment August 1, 2020 for proceeds of $22,000.
The equipment had an original value of $60,000 and was purchased on January 1, 2017.
It was estimated to have a residual value of $3,000 and 5-year useful life. Acker uses the
straight-line method. Acker has a December 31 year end.

Instructions
Journalize all entries required to update depreciation and record the sale of the asset in
2020.

Solution (10 min.)

Aug. 1 Depreciation Expense........................ 6,650
Accumulated depreciation 6,650
($60,000 – $3,000) ÷ 5 years x 7/12 = $6,650

Cash................................................... 22,000
Accumulated depreciation**............... 40,850
Equipment................................... 60,000
Gain on Disposal ($22,000 – $19,150) 2,850

**2017, 2018 and 2019: ($60,000 – $3,000) ÷ 5 years = $11,400 x 3

= $34,200 + $11,400 x 7/12 = $6,650
Total accumulated depreciation at date of disposal = $40,850

87. Duval Industries purchases $110,000 of machinery on January 1, 2020. The

machinery is expected to have a 5 year useful life and a residual value of $10,000. On
January 1, 2023, management determines that the equipment will last for an additional 2
years and the new residual value is $6,000. Duval uses straight-line depreciation and
has a calendar year end.

Instructions
Calculate the depreciation expense related to this piece of machinery and determine the
carrying value of the machinery on December 31, 2023.

Solution (10 min.)

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8 - 28 Test Bank for Understanding Financial Accounting, Second Canadian Edition

Initial Depreciation Expense: ($110,000-$10,000) / 5 years = $20,000

Carrying amount of the machinery @ December 31, 2022
(($110,000 – (3 x $20,000)) = $50,000

Changes in Estimates:
Remaining Useful Life: 4 years
Estimated Residual Value: $6,000

2023 Depreciation Expense: ($50,000 – $6,000) / 4 years = $11,000

2023 Carrying Value: $110,000 – $71,000 = $39,000

88. Othello Corporation purchases Shakespeare Inc. for $3.5 M. Shakespeare has the
following assets all recorded at cost:
Accounts Receivable $ 125,000
Inventory $ 350,000
Land $ 500,000
Building (net) $ 350,000
Equipment (net) $ 50,000
Total Assets $1,375,000

The fair value of the assets is $2,350,000 and Othello also assumes $600,000 of debt
from Shakespeare.

Instructions
Determine if there is any goodwill related to Othello’s purchase of Shakespeare and if so
what is the value of the goodwill. Show your work. Where is goodwill captured on the
financial statements?

Solution (7 min.)
Purchase Price $3,500,000
Less: Fair value of the assets: $2,350,000
Less: Assumed Debt $ 600,000
Goodwill $ 550,000

Goodwill is captured on the Statement of Financial Position under Long-Term Assets.

89. The following Comparative Information has been provided by Bolero Corporation and
Canway Enterprises:

in '000's $ Bolero Canway

2020 2019 2020 2019
Sales 11,535 10,432 21,375 20,439
Cash 450 110 175 159
Inventory 625 575 872 903
Land 1,050 1,050 3,533 2,990
Building (net) 750 825 2,520 2,100

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 Long-Term Assets 8 - 29

Machinery
(net) 825 905 1,250 1,010

Instructions
Calculate the fixed asset turnover in 2020 for both companies. Which company is using
its assets more effectively?

Solution (15 min.)

Boler Canwa
Average Net PPE o y
2,02
0 2,019 2,020 2,019
1,05
Land 0 1,050 3,533 2,990
Building (net) 750 825 2,520 2,100
Machinery (net) 825 905 1,250 1,010
2,62
5 2,780 7,303 6,100

Bolero: (2,625 + 2,780)/2 = 2,703

Canway:(7,303 + 6,100)/ 2 = 6,702

Fixed Asset Turnover:

Bolero: 11,535 / 2703 = 4.3 times
Canway: 21,375/6702 = 3.2 times

Bolero is using its assets more effectively. It is generating $4.30 in sales for every $1 in
long-term assets versus Canway, where it is generating $3.20 in sales for every $1 in
long-term assets.

90. The following information has been provided by Bolero Corporation and Canway
Enterprises:

in '000's $ Bolero Canway

2020 2020
Cash 450 175
Inventory 625 872
Land 1,050 3,533
Building 1,000 3,100
Accum
Depreciation 250 580
Machinery 1,225 2,550
Accum
Depreciation 400 1,250

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8 - 30 Test Bank for Understanding Financial Accounting, Second Canadian Edition

Additional Information:
Both Companies use straight-line depreciation, buildings are estimated to have no
residual value and a 40 year useful life, while machinery is estimated to have no residual
value and a 10 year useful life.

Instructions
Calculate the average age of PPE for 2020 using both the average age % and average
age ratios. Assess the age of Bolero and Canway’s assets. Which company is likely to
begin to replace its assets first?

Solution (10 min.)

Average Age
%
Bolero: (250 + 400) / (1,000 + 1,225) = 29.21%
Canway: (580 + 1,250) / (3,100 + 2,550)
= 32.39%

Average Age
Bolero: (250 + 400) / 147.5 = 4.41 years
Canway: (580 + 1,250) / 332.5 = 5.50 years

Depreciation Expense
Bolero: (1,000/40) + (1,225/10) = 147.5
Canway: (3,100/40) + (2,550 / 10) = 332.5

Based on the above analysis, Canway is likely to need to start replacing its assets first.
The % usage of its assets is 32.39% of the useful life versus 29.21% of Bolero’s assets.
The average age of Canway’s assets is 5.5 years versus 4.41 years for Bolero’s.
Canway’s assets are obviously older.

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 Long-Term Assets 8 - 31

MATCHING

91. Listed below are various methods of allocating the cost of certain long-term assets
over their useful lives, followed by a series of descriptive statements. Match the methods
to the statements by placing the appropriate letter in the space provided.

METHODS
A. Capitalized and depreciated/amortized
B. Capitalized and depleted
C. Evaluated for impairment
D. Expensed
E. None of these

STATEMENTS
____ 1. research costs incurred internally

____ 2. cost of timber

____ 3. five-acre parcel of land where a firm's headquarters is located

____ 4. purchased tools

____ 5. goodwill

____ 6. non-refundable taxes included in purchase price of land

____ 7. development costs for a new product

____ 8. purchased patent

____ 9. basket purchase of vehicles and equipment

____ 10. advertising costs

____ 11. intangible assets with indefinite live

____ 13. development costs that do not assist in creating a new product

Solution (3 min.)

1. D

2. B

3. E

4. A

5. C

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8 - 32 Test Bank for Understanding Financial Accounting, Second Canadian Edition

6. E

7. A

8. A

9. A

10. D

11. C

13. D

92. Listed below are various depreciation methods followed by a series of descriptive
statements. Match the depreciation method to the statements by placing the appropriate
letter in the space provided. In some cases, more than one method is appropriate.

DEPRECIATION METHODS
A. Straight-line
B. Units-of-activity
C. Double-declining-balance
D. Capital cost allowance
E. None of these

STATEMENTS
____ 1. results in the measurement of the asset at its fair market value

____ 2. sometimes used for financial reporting by small businesses

____ 3. the simplest method to apply

____ 4. produces decreasing amounts of depreciation each year

____ 5. appropriate when related assets generate revenue evenly over their useful
lives

____ 6. required for Canadian tax purposes

____ 7. provides the largest annual depreciation expense for financial reporting in
the related asset's first year

____ 8. residual value is not used in annual depreciation expense calculation

____ 9. annual depreciation is calculated using a per-unit cost

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 Long-Term Assets 8 - 33

Solution (4 min.)
1. E

2. D

3. A

4. C and D

5. A

6. D

7. C

8. C and D

9. B

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8 - 34 Test Bank for Understanding Financial Accounting, Second Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS

93. Explain the significance and importance of long-term assets to its users.

Solution (5 min.)
Companies invest in long-term assets to contribute to the generation of future revenues.
These assets generally have significant costs and impact company operations for many
years to come. These assets are often critical to future success of the company. Users
will want to monitor the age of the company’s long-term assets. Users will want to
understand the average age of these assets and anticipate when future cash flows will
be required to replace them. They will also want to understand the company’s
depreciation and amortization polices related to these assets. Users will also want to
know if a long-term asset’s expected use has been negatively effected or if these assets
have been pledged to creditors for security.

94. Langford Company bought a piece of land with a building on it for a total of
$4,400,000. They hired two companies to estimate the fair values of the land and
building. The first estimate was: Land $1,200,000, Building $3,600,000. The second
appraisal was: Land $1,000,000 and Building $4,000,000.

Instructions
a) If management’s objectives are to minimize the amount of income tax they pay,
which of the two appraisals should they use to allocate the purchase price? Support
your answer.
b) Based on your answer in part a, calculate the amount to be allocated to the Land
and the Building account.
c) Under what circumstances might management use the other appraisal value?

Solution (10 min.)

a) If they want to minimize taxable income and hence taxes payable, they want the
maximum amount allocated to the building, which is deductible (over time through capital
cost allowance) for tax purposes. Therefore they would select the second appraisal:
Land $1,000,000 and Building $4,000,000.

b) Total appraised value = $5,000,000

Allocated to Land: 1,000,000/5,000,000 = 20% x 4,400,000 = $880,000
Allocated to Building: 4,000,000/5,000,000 = 80% x 4,400,000 = $3,520,000

c) If management’s objectives were to maximize income in order to increase bonuses or

share price, they would want the maximum amount allocated to Land, because that
amount would never be expensed as land is not amortized. So they would select the first
appraisal that allocates 25% of the purchase price to Land.

95. What is depreciation? Explain how and why it is used in relation to PP&E.

Solution (5 min.)
PP&E is depreciated in order to allocate a portion of the asset’s cost to each of the

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 Long-Term Assets 8 - 35

periods that the future economic benefits are being captured as the asset is being used
up or consumed. Depreciation expense on an asset is captured in the same time period
as the revenues that the asset has helped generate. PP&E assets other than land have
a finite life. In order to depreciate an asset, we must know the cost of the asset, its
estimated residual value and estimated life. The depreciable amount of the asset = Cost
– Estimated Residual Value. If costs are capitalized, those costs are expenses in future
years through the depreciation process.

96. You are advising a client who has just gone into business, in selecting accounting
policies. The client wants to use capital cost allowance (CCA) for her financial
statements. Discuss the pros and cons of her choice.

Solution (8 min.)
Pros:
 simplifies record keeping
 only have to maintain one set of books (not one set for taxes and another set using
a different method of amortization for financial statement purposes)
 tax return preparation will be easier

Cons:
 CCA is based on government objectives and may not result in a useful measure of
net income for financial statement purposes
 in general CCA rates are initially higher than depreciation rates, so net income will
be understated. May affect ability to attract more investment, pay dividends, etc.

97. Explain the four differences between depreciation and CCA (capital cost allowance)
that have been highlighted in your text. What is CRA’s motivation behind the CCA
system?

Solution (12 min.)

The four differences are as follows:
1. Under GAAP, a company may choose the deprecation method most suitable for the
deprecation of long-term assets, whereas the Income Tax Act specifies the use of
CCA.

2. Company management is able to estimate the asset’s useful life which is then used
to determine the depreciation rate; whereas, the Income Tax Act specifies the CCA
rate that must be used.

3. Company management is able to estimate the asset’s residual value which has an
impact on the annual depreciation expense. Under the Income Tax Act residual
values are ignored.

4. Depreciation expense must be recorded annually on the Income Statement, while

the amount of CCA determined under the income tax only represents the MAXIMUM
that can be claimed on the income tax return.

CRA rules remove all management judgement from the CCA system, limiting bias.

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8 - 36 Test Bank for Understanding Financial Accounting, Second Canadian Edition

98. Explain what goodwill is and when / how it can be recognized and reflected on the
financial statements.

Solution (10 min.)

Goodwill is a long-term asset that arises when two businesses are combined. It
represents the expected future economic benefits that will arise from the combination
that cannot be separately identified as either PP&E or an intangible asset. It is the
purchase price less the fair value of the PP&E and identifiable tangible assets being
acquired plus the fair value of any liabilities being assumed as part of the purchase.
Goodwill is only recorded when a business combination has taken place, it cannot be
internally generated. Goodwill is captured on the Statement of Financial Position under
long-term or non-current assets. It is considered to have an indefinite useful life and is
not amortized, but it is tested for impairment annually.

99. A friend has come to you with the following question, "What is this goodwill account
that I see on the statement of financial position of a company that I own stock in?"

Instructions
Write a reply to your friend. Include in your explanation three factors that contribute to
goodwill, under what circumstances goodwill is recorded, and how it is accounted for.

Solution (8 min.)
Goodwill stems from a number of factors, including: above-average management skills,
excellent location, excellent customer relations, and above-average earnings. Goodwill
is recorded as an asset only when it is acquired in the purchase of another company.
When the purchasing company pays more than the fair market value of the selling
company's net assets, goodwill is acquired and is represented by the difference.
Goodwill is reported as an intangible asset on the balance sheet and is not amortized.
Management is required to periodically review the carrying value of the goodwill to
determine if any impairment in value has occurred. If impairment has occurred the
goodwill should be written down and an impairment loss recognized.

100. Explain the importance for a company to be able to assess the average age of
capital assets. What metrics are available to assist in this analysis and what do they
measure?

Solution (12 min.)

Understanding the age of the long-term assets is useful to financial statement users. The
newer the long-term asset base the longer the company will be able to go without
replacing these assets. Companies with older asset bases will need to reinvest in order
to replace these assets and maintain their operating capacity.

The basic measures that can be used to assess the relative age of a company’s long-
term assets include:

Average Age % = Total Accumulated Depreciation / (Total PP&E – Land)

This measures the extent to which the company’s assets have been depreciated.

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 Long-Term Assets 8 - 37

Average Age = Total Accumulated Depreciation / Depreciation Expense

This provides information on how long a company has been using its PP&E. Measured
in years.

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8 - 38 Test Bank for Understanding Financial Accounting, Second Canadian Edition

ESSAY QUESTIONS

101. Cringan George Advertising is relocating its operations. In doing so it purchases a

new plant, land, and printing equipment for $1,500,000. The fair value of these assets
had they been purchased separately is as follows: Equipment $800,000, Plant $500,000,
and Land $750,000. Explain how these assets should be reflected on the books and
why? What values should be assigned to these assets?

Solution (10 min.)

The price paid for the assets must be divided over the land, building, and equipment
based on the relative fair values at the time of acquisition. This must be done for three
reasons: full disclosure requires that each asset must be reflected separately on the
statement of financial position, assets have different depreciation rates that must be
recorded separately, and some assets are not depreciable at all.
The value these assets should be reflected at are as follows:
Equipment: $1,500,000 x 39% = $585,000
Plant: $1,500,000 x 24% = $360,000
Land: $1,500,000 x 37% = $555,000

102. Depreciation is the allocation of an asset's cost over its useful life. As a result,
depreciation affects each of the financial statements. Explain how depreciation affects
the statement of income, statement of financial position, and cash flow statement.

Solution (8 min.)
Statement of Income
Depreciation expense is reported on the Statement of Income as selling and/or
administrative expense (for retail companies) and a part of the cost of goods sold (for
manufacturing companies). As an expense, it reduces net income.

Statement of Financial Position

Depreciation is accumulated in a contra-asset account, Accumulated Depreciation. This
account is deducted from the cost of the related asset to reflect the asset's net book
value. It reflects the portion of the asset’s original cost that has been allocated to net
income to date.

Cash Flow Statement

Depreciation is not a cash expense. However, it does impact the cash flow statement in
two ways: (1) if the indirect method is used, depreciation is added back to net income to
determine cash flows from operating activities; (2) under the direct method, depreciation
(as a proxy for Capital Cost Allowance) affects the cash outflow for income taxes
because depreciation expense reduces a firm's tax liability.

103. Capital assets can be classified as tangible or intangible assets and generally
benefit a number of accounting periods. Identify the different processes used to allocate
the cost of each of those types of long-term assets over the periods that they benefit.
Match each process with the type of asset it relates to and explain how the process is
implemented.

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 Long-Term Assets 8 - 39

Solution (10 min.)

Depreciation is the process of allocating the cost of plant and equipment. It involves
allocating the depreciable cost (cost minus residual value) over the asset's useful life
using one of the generally accepted depreciation methods—straight-line, units-of-
production or double-declining-balance.
Amortization is the process of allocating the cost of an intangible asset over its economic
life. It involves allocating the capitalized cost to each year based on the asset's
economic life. The most commonly used method is straight-line. Some intangible assets
have an unlimited economic life and hence are not amortized, but must be tested
annually for impairment. If the value of the asset has decreased, it needs to be written
down to that new value and a loss recognized.

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8 - 40 Test Bank for Understanding Financial Accounting, Second Canadian Edition

LEGAL NOTICE

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written permission of John Wiley & Sons Canada, Ltd.

MMXVIII iii F2

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