Interest to Purchase Machinery

							                Intermediate Accounting II
                    ACCTG 302 Section A
Spring 2005                                Instructor J.B. Paperman


                          Midterm Exam 2
                           May 12, 2005


Name:   ____________________________


INSTRUCTIONS:



  1. This exam is closed book. You may use one double-sided
     sheet of notes. You may use a calculator to assist in
     computations.

  2. You must complete this exam on your own. No assistance is
     allowed except that provided by the instructor.

  3. If you feel there is ambiguity in a problem, state your
     assumptions clearly.

  4. The exam has 9 pages in total and 14 questions with 100
     points.




                              1
Multiple Choice (5pts each) – Circle the MOST correct answer


1. Cotton Hotel Corporation recently purchased Holiday Hotel and
   the land on which it is located with the plan to tear down
   the Holiday Hotel and build a new luxury hotel on the site.
   The cost of the Holiday Hotel should be
     a. depreciated over the period from acquisition to the date
        the hotel is scheduled to be torn down.
     b. written off as an extraordinary loss in the year the
        hotel is torn down.
     c. capitalized as part of the cost of the land.
     d. capitalized as part of the cost of the new hotel.

C - because it is always intended to tear down the building it
is part of the land cost.

2. The debit for a sales tax properly levied and paid on the
   purchase of machinery preferably would be a charge to
     a. the machinery account.
     b. a separate deferred charge account.
     c. miscellaneous tax expense (which includes all taxes
        other than those on income).
     d. accumulated depreciation——machinery.

A – considered one of the cost of buying and added to value.

3. Assets that qualify for interest cost capitalization include
     a. assets under construction for a company's own use.
     b. assets that are ready for their intended use in the
        earnings of the company.
     c. assets that are not currently being used because of
        excess capacity.
     d. All of these assets qualify for interest cost
        capitalization.

A – only capitalize during the period from when construction
starts until ready for use. Also only while undergoing
construction.

4. Use of the double-declining-balance method
     a. results in a decreasing charge to depreciation expense.
     b. means salvage value is not deducted in computing the
        depreciation base.
     c. means the book value should not be reduced below salvage
        value.
     d. all of these.


                             2
D – all apply.

5. Economic factors that shorten the service life of an asset
   include
     a. obsolescence.
     b. supersession.
     c. inadequacy.
     d. all of these.

D – all result in a life shorter than the physical life.

6. Which of the following intangible assets should not be
   amortized?
     a. Copyrights
     b. Customer lists
     c. Perpetual franchises
     d. All of these intangible assets should be amortized.

C – indefinite lived assets – perpetual franchise has no limit
on it’s life.

7. The intangible asset goodwill may be
     a. capitalized only when purchased.
     b. capitalized either when purchased or created internally.
     c. capitalized only when created internally.
     d. written off directly to retained earnings.

A – goodwill is only recognized when purchased and is not
written off immediately (could be impaired but this is through
net income, not directly to RE).

8. Which of the following principles best describes the current
   method of accounting for research and development costs?
     a. Associating cause and effect
     b. Systematic and rational allocation
     c. Income tax minimization
     d. Immediate recognition as an expense

D – expense R&D immediately.




                               3
9.   (10 points) On March 1, Gatt Co. began construction of a
small building. The following expenditures were incurred for
construction:

           March 1    $ 90,000           April 1    $ 84,000
           May 1       210,000           June 1      300,000
           July 1      100,000

     The building was completed and occupied on July 1. To help
     pay for construction, $60,000 was borrowed on March 1 on a
     12%, three-year note payable. The only other debt
     outstanding during the year was a $500,000, 10% note issued
     two years ago.

     INSTRUCTIONS
     (a) Calculate the weighted-average accumulated
         expenditures.
     (b) Calculate avoidable interest.
     (c) Determine interest capitalized.
a)   Date         Expenditure       Time                Weighted
     March 1      $ 90,000          4/12                $ 30,000
     April 1        84,000          3/12                  21,000
     May 1         210,000          2/12                  35,000
     June 1        300,000          1/12                  25,000
     July 1        100,000           0                       -0-
                                                        ————————
                                                        $111,000

     (b)   Weighted-Average                 Avoidable
            Accum. Expend.        Rate      Interest
           ————————————————       ————      —————————
               $ 60,000           .12        $ 7,200
                 51,000           .10        $ 5,100
               ————————                      ———————
               $111,000                      $12,300


c) first find actual interest
 60,000 * 12% * 10/12 = 6,000
500,000 * 10% * 12/12 = 50,000
Total                   56,000
Capitalize lesser of avoidable and actual = 12,300




                              4
    10. (10 points) Fenner Co. had a sheet metal cutter that
    cost $72,000 on January 1, 1999. This old cutter had an
    estimated life of ten years and a salvage value of $12,000.
    On April 1, 2004, the old cutter is exchanged for a similar
    cutter with a market value of $36,000. Fenner also
    received $9,000 cash. Assume that the last fiscal period
    ended on December 31, 2003, and that straight-line
    depreciation is used.

    INSTRUCTIONS
    (a) Prepare all entries that are necessary on April 1, 2004
        if the transaction has commercial substance.
    (b) Prepare all entries that are necessary on April 1, 2004
        if the transaction has no commercial substance.

for both a & b first do the depreciation to date. 3 months

annual depreciation = (72,000 – 12,000)/10 = 6,000
Depreciation for 1/1/04-3/31/04 = 6,000 * 3/12 = 1,500

Depreciation expense     1,500
   Accumulated Depreciation       1,500

Figure out the gain on the asset
         Cost                                         $72,000
         Accumulated depreciation (5 1/4 x $6,000)    (31,500)
                                                      ———————
        Book value                                     40,500
        Fair value ($36,000 + $9,000)                  45,000
                                                      ———————
        Gain                                          $ 4,500

a) with commercial substance we recognize gain

Cash                 9,000
Machinery – New     36,000
Accum. Depr. – old 31,500
   Machinery Old                  72,000
   Gain on Exchange                4,500

b) no commercial substance then no gain.   Still get rid of old
machine.

Cash                  9,000
Machinery – New      31,500 (plug or BV of 40,500 -9000 cash)
Accum. Depr. – old   31,500
   Machinery Old                  72,000


                              5
11.   (10 points) A machine, which cost $900,000, is acquired on
      April 1, 2004. Its estimated salvage value is $90,000 and
      its expected life is eight years.

      INSTRUCTIONS
      Calculate the depreciation expense for 2004 and 2005 by each
      of the following methods (to the nearest dollar) by each of
      the following methods, showing the figures used.

         (a) Straight-line
         (b) Double-declining-balance
         (c) Sum-of-the-years'-digits

a) depreciable base = 900,000 – 90,000 = 810,000
Asset life = 8
Annual depreciation = 810,000/8 = 101,250
2004 Depr = 101,250 * 9/12 = 75,398
2005 Depr = 101,250

b) DDB use the full cost of 900,000
SL rate is 1/8 = 12.5% so DDB rate is 12.5%*2 = 25%

First year of use Depr = 900,000 * 25% = 225,000
Second year of use Depr. = (900,000-225,000)*25% = 168,750

2004 Depr = 225,000 *9/12 = 168,750
2005 Depr = 225,000 * 3/12 + 168,750 * 9/12 =182,813

c) SYD use depreciable base of 810,000
sum of years = 8*9/2 = 36

First year of use Depr = 810,000 * 8/36 = 180,000
Second year of use Depr. = 810,000 * 7/36 = 157,500

2004 Depr = 180,000 *9/12 = 135,000
2005 Depr = 180,000 * 3/12 + 157,500 * 9/12 =163,125




                              6
12.   (10 points) Oates Company purchased for $4,400,000 a mine
      estimated to contain 2 million tons of ore. When the ore
      is completely extracted, it was expected that the land
      would be worth $200,000.
      A building and equipment costing $2,800,000 were
      constructed on the mine site, and they will be completely
      used up and have no salvage value when the ore is
      exhausted.
      During the first year, 750,000 tons of ore were mined, and
      $600,000 was spent for labor and other operating costs.

      INSTRUCTIONS
      Compute the total cost per ton of ore mined in the first
      year. Assume depreciation is based on units of production.
      (Show computations by setting up a schedule giving cost per
      ton. Don’t forget the labor.)

       Item                        Base         Tons       Per Ton
       ————                     ——————————    —————————    ———————
       Ore                       $4,200,000    2,000,000     $2.10
       Building and Equipment     2,800,000    2,000,000      1.40
       Labor and Operating Expenses 600,000      750,000       .80
                                                             —————
       Total Cost                                           $4.30




                              7
 13. (10 points) In early January 2003, Kenner Corporation
     applied for a patent, incurring legal costs of $30,000.   In
     January 2004, Kenner incurred $9,000 of legal fees in a
     successful defense of its patent.

    INSTRUCTIONS
    (a) Compute 2003 amortization, 12/31/03 carrying value,
        2004 amortization, and 12/31/04 carrying value if the
        company amortizes the patent over 10 years.
    (b) Compute the 2005 amortization and the 12/31/05 carrying
        value, assuming that at the beginning of 2005, based on
        new market research, Kenner determines that the fair
        value of the patent is $27,500. Estimated future cash
        flows from the patent are $30,000 on January 3, 2005.

(a) 2003 amortization: $30,000 ÷ 10 yrs. = $3,000
    12/31/03 carrying value: $30,000 - $3,000 = $27,000

    For 2004 we can capitalize the defense (successful)
    2004 amortization: ($27,000 + $9,000) ÷ 9 yrs. = $4,000
    12/31/04 carrying value: ($27,000 + $9,000) - $4,000 =
                                                      $32,000
(b) Since the expected future cash flows ($30,000) are less than
the carrying value ($32,000), an impairment loss must be
computed.

Loss on impairment:
   $32,000 carrying value - $27,500 fair value = $4,500.

Value is written down to fair value at start of 2005
    2005 amortization: $27,500 ÷ 8 yrs. = $3,438.
    12/31/05 carrying value: $27,500 - $3,438 = $24,062.




                             8
14.   (10 points) Radio One Inc. purchased a broadcasting license
      in Philadelphia for $1,500,000 on January 1, 2001. The
      license is renewable every 3 years for a fee of $1,500 and
      Radio One pays their first fee to the FCC on January 1,
      2003. Due to changes in demographics during 2004 on
      December 31, 2004 Radio One re-evaluates their expected
      future cash flows and determines the license is expected to
      produce cash flows of $100,000 per year indefinitely.
      Appraisers also determine that the license could be sold for
      $1,300,000.

      Required
      Prepare the journal entries required for the acquisition of
      the license and payment of the fee. Prepare any journal
      entries required for 12/31/04 (don’t forget that fee).

1/1/01 Acquisition
Intangible Assets – License     1,500,000
   Cash                                       1,500,000

Indefinite life because of renewal so no amortization

1/1/03 Renewal fee
Prepaid License Renewal           1,500
   Cash                                           1,500
12/31/03 – 12/31/05 as we use the renewal

Licensing expense                       500
   Prepaid License Renewal                          500

On 12/31/04 test for impairment.
Because it is indefinite life we test directly against fair
value.

Carrying value (1,500,000) exceeds fair value (1,300,000) so it
is impaired.
Reduce to fair value with a loss of 1,500,000-1,300,000= 200,000

Loss on impairment of License       200,000
   Intangible Asset – License                   200,000




                                9