EXERCISE 9.6

Revision of Depreciation Estimates

Swindall Industries uses straight-line depreciation on all of its depreciable assets. The company records annual depreciation expense at the end of each calendar year. On January 11, 2011, the company purchased a machine costing $90,000. The machines useful life was estimated to be 12 years with an estimated residual value of $18,000. Depreciation for partial years is recorded to the nearest full month.

In 2015, after almost five years of experience with the machine, management decided to revise its estimated life from 12 years to 20 years. No change was made in the estimated residual value. The revised estimate of the useful life was decidedpriorto recording annual depreciation expense for the year ended December 31, 2015.

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a.Prepare journal entries in chronological order for the above events, beginning with the purchase of the machinery on January 11, 2011. Show separately the recording of depreciation expense in 2011 through 2015.

b.What factors may have caused the company to revise its estimate of the machines useful life?

LO9-5

EXERCISE9.7

Accounting for Trade-ins

Willis Bus Service traded in a used bus for a new one. The original cost of the old bus was $52,000. Accumulated depreciation at the time of the trade-in amounted to $34,000. The new bus cost $67,000, but Mathews was given a trade-in allowance of $10,000.

a.What amount of cash did Mathews have to pay to acquire the new bus?

b.Compute the gain or loss on the disposal for financial reporting purposes.

c.Explain how the gain or loss would be reported in the companys income statement.

LO9-6

EXERCISE9.8

Estimating Goodwill

During the past several years the annual net income of Avery Company has averaged $540,000. At the present time the company is being offered for sale. Its accounting records show the book value of net assets (total assets minus all liabilities) to be $2,800,000. The fair value of Averys net identifiable assets, however, is $3,000,000.

An investor negotiating to buy the company offers to pay an amount equal to the fair value for the net identifiable assets and to assume all liabilities. In addition, the investor is willing to pay for goodwill an amount equal to the above-average earnings for three years.

On the basis of this agreement, what price should the investor offer? A normal return on the fair value of net assets in this industry is 15 percent.

LO9-5, LO9-8

EXERCISE9.9

The Write-Down of Impaired Assets

For several years, a number ofFood Lion, Inc., grocery stores were unprofitable. The company closed some of these locations. It was apparent that the company would not be able to recover the cost of the assets associated with the closed stores. Thus, the current value of these impaired assets had to be written down.

A note in the financial statements indicated that the company tests assets for impairment when circumstances indicate that an impairment may exist. For impairment testing, each store is considered a cash-generating unit. Stores with potential impairments are tested by comparing their carrying value with their recoverable amounts.

a.Explain whyFood Lionwrote down the current carrying value of its unprofitable stores.

b.Explain why the write-down of impaired assets is considered a noncash expense.

LO9-1, LO9-6

EXERCISE9.10

Ethics: Let the Buyer Beware

Bill Gladstone has owned and operated Gladstones Service Station for over 30 years. The business, which is currently the towns only service station, has always been extremely profitable. Gladstone recently decided that he wanted to sell the business and retire. His asking price exceeds the fair market value of its net identifiable assets by nearly $100,000. Gladstone attributes this premium to the above-normal returns that the service station has always generated.

Gladstone recently found out about two issues that could have a profound effect upon the future of the business: (1) A well-known service station franchise will be built across the street from his station in approximately 18 months, and (2) one of his underground fuel tanksmayhave developed a very slow leak.

a.How might these issues affect the $100,000 in goodwill that Gladstone included in his selling price?

b.Assume that Gladstone isnotdisclosing this information to potential buyers. Does he have an ethical obligation to do so? Defend your answer.

LO9-7