Jones Corporation purchased $1,000,000 of 10-year term-to-maturity IBM bonds at par

value. Jones intends to hold the bonds for approximately five years and then sell the
bonds. The bonds are appropriately classified in which of the following categories?

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A. Trading securities.
B. Held-to-maturity securities.
C. Available-for-sale securities.
D. Trading securities for the first year, then re-classified to held-to-maturity securities.
Explanation

Choice "C" is correct. The bonds are not for sale in the next 12 months. There is no
intent by Jones to hold the bonds to maturity. The bonds should be classified as
available-for-sale securities.

Choice "A" is incorrect. Trading securities are intended for near-term sale. These bonds
are not expected to be sold for about five years

Choice "B" is incorrect. There is no stated intent to hold the bonds to maturity.

Choice "D" is incorrect. There is no stated intent to sell the bonds in the next 12 months.
The bonds should not be classified as trading securities.
Unrealized holding gains/losses would be included in earnings for which of the following
debt securities?

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Trading Held-to-maturity

A. Yes No

B. Yes Yes

C. No No

D. No Yes
Explanation

Choice "A" is correct. Trading debt securities are reported at fair value with unrealized
gains and losses included in earnings. Held-to-maturity debt securities are reported at
their amortized costs.
Which of the following statements regarding the accounting for held-to-maturity
securities is incorrect?

I. To classify an investment as held-to-maturity, the company must have either the intent or
the ability to hold the security until maturity.
II. If a debt security is purchased at par value, it will be valued and reported at the purchase
price until it matures.
III. A held-to-maturity security can be reported as either a current or a non-current liability.
CalculatorTime Value Tables
A. I only.
B. III only.
C. I and III.
D. I, II, and III.
Explanation

Choice "C" is correct.

Statement I is incorrect because the company must have both the intent AND the ability
to hold the security until maturity. Statement III is incorrect as a held-to-maturity can be
reported as either a current or a non-current asset. Statement II is a correct statement.

Choices "A", "B", and "D" are incorrect, based on the above explanation.
The following securities were purchased by Dawson Enterprises during Year 1 of
operations. The investments were appropriately classified as trading securities. The
Year 1 income statement reflected a net unrealized holding gain of $18,500. The
following data related to the investments for Year 2 are indicated below.

Fair Value Cost

GWD investments $75,000 $67,000
HCD investments $79,000 $55,000

What is the amount of the unrealized holding gain/(loss) reported on the income
statement for Year 2?

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A. $32,000
B. $13,500
C. $18,500
D. No unrealized gain or loss reported on the income statement.
Explanation

Choice “B” is correct. Debt investments classified as trading securities are reported at
fair value at the end of each reporting period. Any fluctuations in value are reported as
unrealized gains and losses on the income statement. These investments are adjusted
to fair value on the balance sheet, and unrealized holding gains and losses are included
in the net income calculation on the income statement.

Fair Value Cost

GWD investments $ 75,000 $ 67,000
HCD investments 79,000 55,000
Total $154,000 $122,000
Change in fair value $32,000 ($154,000 less $122,000)
Previously recorded gain in Year 1 18,500
Year 2 gain $13,500

Choice “A” is incorrect. The $32,000 gain represents the total change in fair value of the
investments since purchase. The gain related to Year 1 was recorded and reported in
the determination of the Year 1 net income. The increase in value from Year 1 to Year 2
is the only amount to be recorded in Year 2.

Choice “C” is incorrect. The $18,500 gain represents the unrealized gain associated
with Year 1. The question specifically asks for unrealized gain associated with Year 2.

Choice “D” is incorrect. Changes in value of trading securities are reported on the
income statement.
Merlin Enterprises sold the following debt investment on September 30, Year 2:

Market Value
Cost 12/31/Y1 9/30/Y2
Beard Inc. 67,000 59,000 71,000

What is the amount of the realized gain or loss on Merlin's Year 2 income statement,
assuming that the investment in Beard Inc. is classified as an available-for-sale debt
security?

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A. $0
B. $(8,000)
C. $4,000
D. $12,000
Explanation

Choice "C" is correct. The realized gain on the sale of the Beard Inc. available-for-sale
security is equal to the difference between the cash received from the sale and the
original cost of the security, calculated as follows

Cash received 71,000

Cost (67,000)
Gain on sale 4,000

The following JE would be recorded at the time of the sale:

Debit (Dr) Credit (Cr)

Cash 71,000
Unrealized loss - OCI 8,000
Available-for-sale security 59,000
Realized gain 4,000

Choice "A" is incorrect. Because this security was sold for an amount different than its
original cost, a gain or loss must be reported on the income statement.
Money for Nothing Enterprises ("MNE") held the following available-for-sale debt
securities during Year 2:

Market Value Market Value

Cost 12/31/Y1 Sales Price 12/31/Y2
Alpha Corp. $50,000 $53,000 $57,000 --
Beta Corp. $35,000 $30,000 $38,000
Omega Corp. $21,000 $27,000 $24,000

There are no expected credit losses. What will MNE report as unrealized gain on
available-for-sale securities on its Year 2 statement of comprehensive income (ignore
taxes)?

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A. $2,000
B. $3,000
C. $6,000
D. $8,000
Explanation

Choice "A" is correct. The unrealized gain to be recorded on MNE's Year 2 statement of
comprehensive income is calculated as follows:

Sale of Alpha Corp. debt (3,000) Write-off unrealized gain (see JE)
Unrealized gain—Beta Corp. 8,000 ($38,000 − 30,000)
Unrealized loss—Omega Corp. (3,000) ($24,000 − 27,000)
Net change in AFS securities 2,000

JE to record sale of investment in Alpha Corp.:

Debit (Dr) Credit (Cr)

Cash 57,000
Unrealized gain—OCI 3,000
Investment in Alpha Corp. debt 53,000
Realized gain 7,000
Sykes Company, which was formed on January 1, Year 1, owned the following
marketable debt securities in its available-for-sale portfolio at December 31, Year 1:

Cost Market Value

A Company 100,000 130,000
B Company 70,000 20,000
C Company 210,000 180,000
Total 380,000 330,000

The decline in value of C Company is due to expected credit losses. The present value
of the expected payments (interest and principal) on the C Company security equals the
market value ($180,000). How much loss, if any, should Sykes include in its Year 1
earnings?

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A. $0
B. $30,000
C. $80,000
D. $50,000
Explanation

Choice "B" is correct.

These particular securities are all in the available-for-sale portfolio. Unrealized gains or
losses in the available-for-sale portfolio normally are reported in other comprehensive
income and not earnings (net income).

However, in this case, one of the securities has suffered a credit loss. Credit losses are
recognized in earnings even in the available-for-sale portfolio. For C Company, the loss
is $30,000 ($210,000 − $180,000).
Harris Co. purchased several new investments during its first year of business.
Information related to each investment is presented below.

Fair Value Fair Value

Dec. 31, Year Dec. 31, Year
Cost 1 2
Available-for-Sale
Securities
XYZ bonds $217,000 $215,000 $225,000
BGSE bonds $65,000 $70,000 $75,000
Trading Securities
ESGB bonds $112,000 $105,000 $107,000
Dawson investments $97,000 $93,000 $118,000
Amortized Amortized
Cost Cost Fair Value Fair Value
Dec. 31, Year Dec. 31, Year Dec. 31, Year Dec. 31, Year
1 2 1 2
Held-to-Maturity
Securities
BK bonds $425,000 $415,000 $432,000 $427,000
GHHKG bonds $318,000 $314,000 $305,000 $303,000

What amount will be reported as total investments in bonds on the balance sheet at
Dec. 31, Year 2?

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A. $1,237,000
B. $1,255,000
C. $1,220,000
D. $1,254,000
Explanation

Choice “D” is correct. Investment reporting on the balance sheet is determined by the
type of investment purchased by the business. Available-for-sale (AFS) investments are
reported at fair value at the end of the reporting period with unrealized gains and losses
recorded in other comprehensive income. Trading securities are reported at fair value at
the end of the reporting period with unrealized gains and losses recorded on the income
statement. Held-to-maturity (HTM) investments are reported at amortized cost at the
Jones Company purchased 1,000 shares of ABC common stock for $190,000 on
January 1, Year 1. At quarter end, the value of the investment had declined to
$182,000. Jones should reflect the stock's decline in value by:

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A. Recognizing a realized loss of $8,000 as part of income from continuing operations in its first
quarter income statement.
B. Recognizing an unrealized loss of $8,000 as part of income from continuing operations in its
first quarter income statement.
C. Recognizing an unrealized loss as part of other comprehensive income in its first quarter
income statement.
D. Recognizing a realized loss as part of other comprehensive income in its first quarter income
statement.
Explanation

Choice "B" is correct. Unrealized losses in an available-for-sale equity securities

portfolio must be included in net income in the quarterly income statement.

Choice "A" is incorrect. The loss has not been realized because the securities have not
been sold.

Choice "C" is incorrect. Unrealized losses on available-for-sale debt securities are

included in other comprehensive income. This is an equity security and is included in
net income.

Choice "D" is incorrect. The loss has not been realized because the securities have not
been sold.
A U.S.-based hospitality company owns a hotel. The building was purchased in Year 1
and capitalized for $1,250,000. At the end of Year 2, the building was appraised for
refinancing purposes at $1,350,000. In addition, $250,000 of depreciation expense was
taken on the income statement related to the building in each of Years 1 and 2. If the
company follows U.S. GAAP, which of the following is true regarding the accounting
treatment of the building?

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A. The company does not need to record depreciation expense in Year 2.
B. The building's carrying value should be increased to $1,350,000 at the end of Year 2.
C. The building's carrying value should be reported at $750,000 at the end of Year 2.
D. The building's carrying value remains at $1,250,000 at the end of Year 2.
Explanation

Choice "C" is correct. The historical cost principle is used in the reporting of assets held
for use such as property, plant, and equipment (PP&E). PP&E is capitalized and
reported on the balance sheet at historical cost less accumulated depreciation. The
asset continues to be reported at historical cost and is not adjusted to market value
unless there is a permanent impairment indicated.

Because this building is used in operations and the company follows U.S. GAAP, the
company will record the asset initially at the historical cost of $1,250,000. The asset will
be depreciated over the useful life and, as indicated in the fact pattern, $250,000 per
year will be reported as depreciation expense, resulting in a total of $500,000 in the
accumulated depreciation account at the end of Year 2. The carrying value of the asset
at the end of Year 2 will be $1,250,000 historical cost less $500,000 in accumulated
depreciation or a net carrying value of $750,000.

Choice "A" is incorrect. Depreciation would not be recorded if the asset were held for
investment purposes only. Because the asset is used in operations, depreciation is
recorded to ensure adherence to the expense recognition principle and the building
costs would be allocated over the useful life of the asset.

Choice "B" is incorrect. Under U.S. GAAP, assets are not adjusted to fair value when
being used in operations. This adjustment would take place only if the company were
following IFRS.

Choice "D" is incorrect. Depreciation is recorded for tangible fixed assets in accordance
with the expense recognition principle under U.S. GAAP; therefore, the carrying value
would fall below the historical cost of $1,250,000.
Federal Manufacturers, Inc. purchased land with the intention of building its new
administrative headquarters on the site. Which of the following costs should be charged
to "Land"?

I. Title and recording fees.

II. Clearing of trees and grading.
III. Interest on loan to purchase land.
IV. Architect's fees.
V. Installation of sewage system.
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A. I only.
B. I and II only.
C. I, II, III, and IV only.
D. I, II, III, IV, and V.
Explanation

Choice "B" is correct. Items I and II should be charged to Land. Any usual and
necessary cost to clear and grade the land is properly included in the Land account.
Interest should only be capitalized in connection with a "discrete manufacturing activity,"
so interest incurred to acquire land should be expensed when incurred. Architect's fees
should be charged to Buildings. A sewage system is a Land Improvement.

Choices "A", "C", and "D" incorrectly include one or more of the above explained items.
A firm uses the revaluation model to revalue its fixed assets under IFRS. Which of the
following is not a feature of the revaluation model?

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A. Impairment is recognized by first using the revaluation surplus and then recording the loss on
the income statement.
B. Fixed assets may be revalued separately or as an asset class.
C. Accumulated depreciation after the fair value revaluation date is considered.
D. A revaluation loss that reverses a previous recognized gain is recognized in other
comprehensive income.
Explanation

Choice “B” is correct. This is not an accurate feature of the revaluation model. The
revaluation must be applied to all assets in that particular class of fixed assets, not to
individual fixed assets.

Choice “A” is incorrect. When an impairment loss occurs, the loss is first recognized in
other comprehensive income until the revaluation surplus reaches zero, with the
remaining loss reported on the income statement.

Choice “C” is incorrect. Any accumulated depreciation for that asset class after the fair
value revaluation date must be recognized when determining the revaluation model
carrying value on the balance sheet.

Choice “D” is incorrect. Usually, revaluation losses affect the income statement, unless
the revaluation loss reverses a previous recognized gain. In this scenario, the
revaluation loss is recognized in other comprehensive income with a reduction to the
revaluation surplus.
Which of the following is the proper treatment of a revaluation surplus gain for intangible
assets and/or fixed assets in an accounting period under either U.S. GAAP or IFRS?

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A. Revaluation surplus gains on intangible assets or fixed assets are included in other
comprehensive income for U.S. GAAP reporting only.
B. Revaluation surplus gains on intangible assets or fixed assets are included in other
comprehensive income for IFRS reporting only.
C. Revaluation surplus gains on intangible assets (only) are included in other comprehensive
income under IFRS only.
D. Revaluation surplus gains on intangible assets and fixed assets are not recognized as a
component in other comprehensive income under either U.S. GAAP or IFRS.
Explanation

Choice "B" is correct. Revaluation of intangible assets or fixed assets is allowed only
under IFRS for a given reporting period. The revaluation surplus gain recognized when
either intangible assets or tangible assets are revalued is recognized in other
comprehensive income under IFRS only.

Choice "A" is incorrect. U.S. GAAP does not allow either intangible assets or fixed
assets to be revalued upward for a given accounting period. It should be noted that U.S.
GAAP does allow a downward adjustment if the given asset is deemed impaired.

Choice "C" is incorrect. Fixed assets may also be revalued upward under IFRS resulting
in the recognition of a surplus gain in other comprehensive income.

Choice "D" is incorrect. IFRS allows the revaluation of intangible assets and tangible
assets and the recognition of a surplus gain in other comprehensive income.
Superior Paint Co. is currently revaluing its fixed assets using the cost model. The
following data was assembled at year-end by the accounting department:

Accumulated
Cost Fair Value Impairment Depreciation
Land $40,000,000 $42,000,000 $0 $0
Buildings 15,000,000 11,500,000 0 2,500,000
Storage units 3,000,000 2,000,000 600,000 500,000
Equipment 6,000,000 4,500,000 0 1,000,000

Based on the above, what is the total fixed asset amount recorded on the balance
sheet at year-end if the assets were revalued using the cost model (IFRS)?

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A. $57,400,000
B. $58,000,000
C. $59,400,000
D. $60,000,000
Explanation

Choice “C” is correct. The revalued fixed assets were derived using the following cost
model formula calculation:

Original cost – accumulated depreciation – impairment

$64,000,000 – $4,000,000 – $600,000 = $59,400,000

Choice “A” is incorrect. This choice recognizes the fair value of fixed-asset classes that
are below the carrying value as well as the asset impairment. Fair values are not
recognized under the cost model.

Choice “B” is incorrect. This choice recognizes the fair value of fixed assets that are
below the carry value but not the fixed-asset impairment. Fair values are not recognized
under the cost model.

Choice “D” is incorrect. This choice subtracts accumulated depreciation from the original
cost of the fixed assets, but ignores the asset impairment.
A firm performs an IFRS revaluation on all of its fixed assets at the end of the current
year, with the following carrying values and fair values obtained:

Carrying Value Fair Value

Buildings $62,000,000 $58,400,000
Equipment 13,500,000 12,800,000
Land 94,000,000 97,100,000

If the firm recorded a $1,200,000 revaluation loss on its land during the prior year, what
is the total (net) amount from the revaluation of all fixed asset classes reported in other
comprehensive income for the current year under the revaluation model?

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A. ($4,300,000)
B. $0
C. $1,900,000
D. $3,100,000
Explanation

Choice “C” is correct. The choice is determined as follows:

Revaluation losses: $3,600,000 (buildings) + $700,000 (equipment) = $4,300,000

Revaluation gain: $3,100,000

The combined revaluation losses of $4,300,000 from the two asset classes are reported
as a loss on the income statement in the current year. Part of the revaluation gain
($1,200,000) is recognized on the income statement to the extent that it reverses a
previous recognized loss. The remaining $1,900,000 ($3,100,000 – $1,200,000) is
reported in other comprehensive income and accumulated in equity as a revaluation
surplus.

Choice “A” is incorrect. This choice recognizes the current year’s revaluation losses in
other comprehensive income, with revaluation gains reported on the income statement.

Choice “B” is incorrect. This choice assumes that all revaluation gains or losses affect
the income statement, with no effect on other comprehensive income.

Choice “D” is incorrect. This choice assumes that all of the revaluation gain affects other
comprehensive income, with no offset recognized from the prior year’s revaluation loss
from the land asset class.
On December 31, Year 1, an entity adopted the IFRS revaluation model for reporting its
long-term assets and revalued a patent with a carrying value of $85,000 and a 10 year
life to its fair value of $75,000. On December 31, Year 2, before recording any
amortization, the entity determined that the patent had a fair value of $90,000. In its
December 31, Year 2 financial statements, the entity will report a revaluation gain of:

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A. $5,000 on the income statement and $10,000 in other comprehensive income.
B. $10,000 on the income statement and $5,000 in other comprehensive income.
C. $15,000 in other comprehensive income.
D. $15,000 on the income statement.
Explanation

Choice "B" is correct. The total Year 2 revaluation gain is $15,000 ($90,000 fair value on
12/31/Y2 - $75,000 fair value on 12/31/Y1). $10,000 of the revaluation gain will be
recognized on the income statement to reverse the revaluation loss of $10,000 ($75,000
fair value - $85,000 carrying value) reported on the income statement in Year 1. The
remaining $5,000 will be recognized as a revaluation surplus in Year 2 other
comprehensive income.
A company reporting under IFRS has the following asset revaluations for one of its
asset classes:

Year 1 $300,000 revaluation loss

Year 2 $120,000 revaluation gain

The amount shown in accumulated other comprehensive income at the end of Year 2
as a result of asset revaluations is:

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A. $120,000
B. $0
C. ($180,000)
D. ($300,000)
Explanation

Choice "B" is correct. The revaluation loss for Year 1 is reported in the income
statement. For Year 2, revaluation gains are reported on the income statement to the
extent that they reverse a previously recognized revaluation loss. Therefore, no amount
is shown in AOCI.

Choice "A" is incorrect. The revaluation gain shown in Year 2 is reported in the income
statement since it is a reversal of a previously recognized revaluation loss.

Choice "C" is incorrect. The revaluation loss for Year 1 is reported in the income
statement. For Year 2, revaluation gains are reported on the income statement to the
extent that they reverse a previously recognized revaluation loss. The amount of
revaluation in AOCI will never be a negative amount. Only surpluses that do not reverse
a prior recognized loss are reported in AOCI.

Choice "D" is incorrect. The revaluation loss for Year 1 is reported in the income
statement. The amount of revaluation in AOCI will never be a negative amount. Only
surpluses that do not reverse a prior recognized loss are reported in AOCI.
McDonnell Company purchased a machine on January 1, Year 1 for $250,000. The
machine was estimated to have a useful life of 10 years, with a salvage value of
$50,000. During Year 3, it became apparent that the machine would not be usable past
December 31, Year 5 and that the salvage value at that point would be $0.

What would be the accumulated depreciation at December 31, Year 3? Assume the
company uses the straight-line method.

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A. $100,000
B. $60,000
C. $110,000
D. $70,000
Explanation

Choice "C" is correct. Note that the question could have just as easily asked for
depreciation expense or for carrying amount (book value).

In this question, they are asking about depreciation after a change in accounting
estimate. The change in accounting estimate is a change in the depreciation life of a
machine and a change in the salvage value.

The machine was originally purchased on January 1, Year 1 for $250,000. With a
salvage value of $50,000 and a useful life of 10 years, depreciation for Year 1 was
$20,000. The carrying amount at 12/31/Y1 was thus $230,000.

Depreciation for Year 2 was another $20,000, and the carrying amount at 12/31/Y2 was
$210,000. Accumulated depreciation at that date was $40,000.

During Year 3, the change in accounting estimate occurred. The useful life was reduced
from 10 years to 5 years (3 more years at 12/31/Y2) and the salvage value was reduced
from $50,000 to $0. The net result was that the full $210,000 remaining would be
depreciated over the remaining 3 years at $70,000 per year. Accumulated depreciation
at December 31, Year 3 would thus be $110,000 ($40,000 + $70,000).
Which of the following is an accurate comparison of component depreciation versus
composite depreciation?

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A. Repair and maintenance expense will be more accurate when composite depreciation is used.
B. The calculation of depreciation expense is more complex under the composite method.
C. Annual depreciation expense is more accurate under component depreciation.
D. IFRS requires firms to use composite depreciation, with footnote disclosure of component
depreciation recommended.
Explanation

Choice “C” is correct. This represents an accurate statement. A primary advantage of

using component depreciation (versus composite depreciation) is that recorded
depreciation expense would be more accurate in a given year, as each component is
depreciated separately over its useful life.

Choice “A” is incorrect. Repair and maintenance expense is more accurate under
component depreciation, as the replacements of components would be excluded.

Choice “B” is incorrect. A primary advantage of composite depreciation is the simplicity

of the depreciation expense calculation.

Choice “D” is incorrect. IFRS requires firms to use component (not composite)
depreciation.
At the beginning on the year, Aluminum Products International purchased a new
production machine for $900,400 with an expected useful life of 15 years. The cost of
the production machine includes a punching press component valued at $100,000 that
must be replaced every five years, a welding arm part valued at $30,000 that must be
replaced every three years, and an inspection cost of $2,400 that must be completed
every two years. Assuming that the company uses the component method to record
depreciation under IFRS, what amount of depreciation expense is recognized in the
current operating year?

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A. $61,040
B. $81,200
C. $82,400
D. $91,227
Explanation

Choice “C” is correct. The choice is derived under the following calculations:

Cost Useful Life Depreciation

Production machine $768,000 15 $51,200
Punching press component 100,000 5 20,000
Welding arm part 30,000 3 10,000
Inspection 2,400 2 1,200
Total depreciation $82,400

Choice “A” is incorrect. This choice did not recognize depreciation on the individual
components other than inspection cost.

Choice “B” is incorrect. This choice recognized component depreciation on the punching
press component and the welding arm part, but not the inspection cost.

Choice “D” is incorrect. This choice recognized individual component depreciation but
included the full cost as the depreciable base for the production machine.
Healthy Foods Inc. purchased a packaging machine for $785,000 at the beginning of
the year. The company estimates that the machine will have a useful life of 12 years
and includes a $25,000 master conveyer belt that must be replaced every five years, a
$40,000 engine cylinder that has a useful life of four years, and $500 in minor parts that
must be replaced every two years. If annual repairs and maintenance costs will average
$5,000 for the machine, what amount of depreciation expense will be recognized for the
year using component depreciation?

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A. $75,000
B. $75,250
C. $79,583
D. $80,417
Explanation

Choice “A” is correct. The component depreciation for the year is as follows:

Cost Useful Life Depreciation

Machine $720,000 12 $60,000
Conveyer belt 25,000 5 5,000
Engine cylinder 40,000 4 10,000
Total $75,000

Choice “B” is incorrect. This choice also includes the separate depreciation of minor
parts, which is not a significant component.

Choice “C” is incorrect. This choice includes annual repairs and maintenance costs,
which is treated as period expense and not part of component depreciation.

Choice “D” is incorrect. This choice did not adjust the depreciable base of the machine
for the separate components.
Steel and Wire Co. purchased a metal-cutting machine for $420,000 on January 1 that
is expected to have a useful life of 25 years. The machine cost includes a $16,000
motor drive that must be replaced every four years and a required state inspection that
must be performed every eight years at a cost of $4,000. Assuming that repairs and
maintenance costs will be necessary every two years at an estimated cost of $1,000,
what amount will be recognized as depreciation expense for the year if the component
depreciation method is used?

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A. $20,160
B. $20,500
C. $20,960
D. $21,300
Explanation

Choice “B” is correct. The depreciation expense is calculated as follows:

Cost Useful Life Depreciation

Cutting machine $400,000 25 $16,000
Motor drive 16,000 4 4,000
Inspection 4,000 8 500
Total $20,500

Choice “A” is incorrect. This choice did not include the inspection as a depreciation
component.

Choice “C” is incorrect. This choice included repairs and maintenance as a depreciation
component. It should be treated as a period expense when actually incurred.

Choice “D” is incorrect. This choice used the original cost of the machine instead of
reducing the depreciable base by the other components.
Cambridge Co. uses IFRS and purchases a building for $20 million. Per industry
standards, the overall building has a useful life of 40 years. Included in the cost of the
building is the roof ($1.5 million, useful life of 25 years) and HVAC system ($1.8 million,
useful life of 15 years).

Assuming the straight line method is used, annual depreciation expense will be:

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A. $500,000
B. $597,500
C. $667,000
D. $680,000
Explanation

Choice "B" is correct. IFRS requires component depreciation, which means the
individual components must be depreciated based on their own useful lives.

Cost Useful Life Depreciation

Building 16.7 million 40 417,500
HVAC 1.8 million 15 120,000
Roof 1.5 million 25 60,000
Total 20 million 597,500

Choice "A" is incorrect. This choice takes the overall cost of the building (including the
component units) and divides it by the building's useful life. Each component must be
depreciated by its own useful life.

Choice "C" is incorrect. This choice takes the overall cost of $20 million and divides it by
the average useful life of all three components (30 years).

Choice "D" is incorrect. This choice incorrectly keeps the building component at $20
million, without removing the HVAC and Roof components.
Which of the following is correct regarding the use of component or composite (group)
depreciation?

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A. Accelerated depreciation methods must be used when applying composite (group)
depreciation under U.S. GAAP.
B. MACRS and straight-line depreciation are compatible with component depreciation.
C. A firm would not recognize a gain (loss) when a single asset in a group (composite) is sold
under composite depreciation.
D. Repairs and maintenance costs are included as a separate component when calculating
depreciation expense using component depreciation.
Explanation

Choice “C” is correct. There is no gain or loss recognized when one asset in a
composite (group) is sold under the composite depreciation method. Instead, the gain or
loss is absorbed in the accumulated depreciation account when the average service life
of the group of assets has not been reached.

Choice “A” is incorrect. When applying composite (group) depreciation under U.S.
GAAP, straight-line depreciation is also acceptable.

Choice “B” is incorrect. MACRS is not compatible with component depreciation,

whereas straight-line depreciation is acceptable to use with component depreciation.

Choice “D” is incorrect. Repairs and maintenance costs are treated as period costs
(expensed in the period incurred) and are not included as a separate component under
the component depreciation method.
Sykes Corporation's comparative balance sheets at December 31, Year 2 and Year 1,
reported accumulated depreciation balances of $800,000 and $600,000 respectively.
Property with a cost of $50,000 and a carrying amount of $40,000 was the only property
sold in Year 2. Depreciation charged to operations in Year 2 was:

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A. $190,000
B. $200,000
C. $210,000
D. $220,000
Explanation

Choice "C" is correct. Depreciation is a part of operating activities and is added back
since it was subtracted to produce net income in the first place. This question is a
question on the SCF although it does not look like the question is phrased in exactly
that manner.

Looking at the facts, an accumulated depreciation account analysis format can be used.
The beginning and ending balances are available. The format is as follows:

Beginning balance 600,000

Add: depreciation charged to operations ?
Subtract: A/D on equipment sold ?
Ending balance 800,000

To obtain the accumulated depreciation of the property sold, subtract the $40,000
carrying amount from the $50,000 original cost, and the difference is the accumulated
depreciation that was eliminated when the equipment was sold.

Beginning balance 600,000

Add: depreciation charged to operations ?
Subtract: A/D on equipment sold (10,000)
Ending balance 800,000

In this account analysis format, the depreciation charged to operations is $210,000.

Or another way to look at it:

Accumulated Depreciation
Karrington Corp. purchased a delivery van that cost $40,000 with an expected service
life of 8 years and an estimated residual value of $4,000 on January 1, Year 1. What
would be the book value of the van at the end of the second year of the asset’s life
using straight-line depreciation?

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A. $40,000
B. $31,000
C. $35,500
D. $31,500
Explanation

Choice “B” is correct. Book value of an asset is determined by taking cost less
accumulated depreciation. Depreciation on tangible fixed assets is recorded by utilizing
a contra-asset account called accumulated depreciation instead of reducing the cost
basis of the asset itself. Each year an entry is made to record depreciation expenses
associated with the current period based on estimated depreciation appropriate during
the period, with a corresponding credit to accumulated depreciation. The balance in the
accumulated depreciation account increases each year as additional depreciation is
recorded on the asset.

Karrington Corp.’s book value of the delivery van would be calculated as follows:

Calculation Book Value

(Cost – Salvage value) / (Cost – Acc.
Useful life Depreciation Expense Accumulated Depreciation depr.)
($40,000 – $4,000) / 8 years
$4,500 $4,500 $35,500
× 12/12 months
($40,000 – $4,000) / 8 years
$4,500 $9,000 $31,000
× 12/12 months

Choice “A” is incorrect. The $40,000 indicated represents the cost of the delivery van
purchased by Karrington. The question asks for book value of the van at the end of
Year 2, which would be calculated as the difference between cost and accumulated
depreciation.

Choice “C” is incorrect. The $35,500 indicates the book value of the delivery van at the
end of Year 1. The question asks for the book value at the end of Year 2.

Choice “D” is incorrect. The $31,500 was calculated using the depreciable base of the
asset of $36,000 less depreciation expense of $4,500. Book value is calculated as cost
less accumulated depreciation.
On July 1, Year 1, an entity that uses IFRS acquired equipment with a cost of $84,000
and an estimated life of 12 years. The cost of the machine included the $9,000 cost of a
component that must be replaced every 6 years and an initial inspection fee of $3,000.
The equipment must be re-inspected every 3 years at an additional cost of $3,000 per
inspection. The entity uses straight-line depreciation. What is depreciation expense for
the year ended December 31, Year 1?

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A. $4,250
B. $7,000
C. $8,500
D. $9,500
Explanation

Choice "A" is correct. IFRS requires component depreciation. Under component

depreciation, the equipment, component, and inspection cost are recognized and
depreciated separately:

Equipment: ($84,000 - $9,000 - $3,000) / 12 years = $72,000 / 12 years = $6,000

Component: $9,000 / 6 years = $1,500
Inspection Cost: $3,000 / 3 years = $1,000

Total annual straight line depreciation = $6,000 + $1,500 + $1,000 = $8,500

Depreciation for July 1, Year 1 - December 31, Year 1 = $8,500 x 6/12 = $4,250

Choice "B" is incorrect. Under IFRS component depreciation, the equipment,

component, and inspection costs are recognized and depreciated separately.

Choice "C" is incorrect. This is the annual depreciation under IFRS. However, the entity
only owned the asset for 6 months (July 1 - December 31) in Year 1, so only 6 months
of depreciation should be taken: $8,500 x 6/12 = $4,250.

Choice "D" is incorrect. The cost of the component and the cost of the inspection are
part of the acquisition cost of $84,000 and should be subtracted from the acquisition
cost of the equipment before depreciating the equipment.
On January 1, Year 1, Triton Tool Inc. purchased new production equipment for
$160,000. The equipment has an estimated useful life of 5 years and an expected
salvage value of $10,000. Triton has historically used sum-of-the-year’s digits
depreciation, but is considering a change to double-declining-balance depreciation. By
how much will the depreciation expense reported on the 12/31/Y1 income statement
change if the new depreciation method is used for the new equipment?

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A. $6,667
B. $10,000
C. $10,667
D. $14,000
Explanation

Choice "D" is correct. Under sum-of-the-years digits depreciation, the Year 1

depreciation of the new production equipment is calculated as follows:

Remaining life / SYD × (cost – salvage value) = 5/15 × ($160,000 – 10,000) = $50,000

Under double-declining balance depreciation, the Year 1 depreciation of the new

production equipment is calculated as follows:

Book value × 2 × (1/Useful life) = $160,000 × 2 × 1/5 = $64,000

Therefore, depreciation expense will increase by $14,000 in Year 1 if double-declining

balance depreciation is used instead of sum-of-the-years digits depreciation.

Choice "A" is incorrect. This answer is determined by incorrectly calculating the sum-of-
the-years digits depreciation using the cost of $160,000 rather than the depreciable
base of $150,000 ($160,000 cost - $10,000 salvage value) and incorrectly calculating
double-declining balance depreciation using the depreciable base (cost – salvage
value) of $150,000 rather than the $160,000 book value of the equipment.

Choice "B" is incorrect. This answer incorrectly calculates double-declining balance

depreciation using the depreciable base (cost – salvage value) of $150,000 rather than
the $160,000 book value of the equipment. When declining balance depreciation is
used, the salvage value is not included in the formula.

Choice "C" is incorrect. This answer is determined by incorrectly calculating the sum-of-
the-years digits depreciation using the cost of $160,000 rather than the depreciable
base of $150,000 ($160,000 cost – $10,000 salvage value).
Lavery Company purchased a machine that was installed and placed in service on July
1, Year 1 at a cost of $240,000. Salvage value was estimated at $40,000. The machine
is being depreciated over 10 years by the double declining balance method.

For the year ended December 31, Year 2, what amount should Lavery report as
depreciation expense?

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A. $48,000
B. $38,400
C. $32,000
D. $43,200
Explanation

Choice "D" is correct. This question is the same as Lavery Company 1 with a different
acquisition date.

Double declining balance with a 10-year life indicates that the rate is 20% (double).
Salvage value can be ignored because salvage value is not used in declining balance
computations up front. The calculation is as follows:

Cost 7/1/Y1 240,000

DDB for Year 1 first 6 months (24,000) (20% × $240,000 × 1/2)
Balance 1/1/Y2 216,000
DDB for Year 2 first 6 months (24,000) (20% × $240,000 × 1/2)
Balance 7/1/Y2 192,000
DDB for Year 2 second 6 months (19,200) (20% × $192,000 × 1/2)
Total depreciation for Year 2 is $43,200 ($24,000 + $19,200).
A fixed asset has a cost of $12,000 and a salvage value of $3,000. The asset has a
three-year life. If depreciation in the third year amounted to $1,500, which depreciation
method was used?

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A. Straight-line.
B. Double-declining-balance.
C. Units of production.
D. Sum-of-the-years-digits.
Explanation

Choice "D" is correct. Sum-of-the-years-digits: 3 + 2 + 1 = 6. Third year = 1/6 x $9,000

= $1,500.

Choice "A" is incorrect. Under the straight-line method, the calculations would be:
$12,000 - $3,000 = $9,000; $9,000 ÷ 3 = $3,000. Thus, this is not the correct answer.

Choice "B" is incorrect.

Choice "C" is incorrect. There is not enough information to calculate depreciation using
the units-of-production method.

Note: The best way to determine this answer is by process of elimination. Compute the
depreciation for the simplest methods first, and stop as soon as the correct answer is
identified. Under this elimination approach, it would not have been necessary to
compute depreciation using the double-declining balance method.
To comply with FASB ASC 730-10-25-1, Research and Development Costs,
expenditures for research and development must be:

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A. Capitalized in the period incurred and amortized over the estimated life of an asset.
B. Expensed in the period incurred, unless the costs are for testing a prototype.
C. Either capitalized or expensed depending on the amount and useful life of expected cash
receipts.
D. Expensed in the period incurred, unless the R&D services performed are for others as part of a
contractual agreement.
Explanation

Choice “D” is correct. GAAP defines research costs as the planned search or critical
investigation aimed at the discovery of new information in hopes of developing new
products, services, process, or techniques. Development costs are defined as the
translation of this new knowledge into a plan or design for new product or process to be
used for sale or use. All costs prior to the start of commercial productions associated
with research and development are expensed as incurred. Costs incurred in research
conducted on behalf of others are capitalized. Also, equipment purchased for the
purpose of the research that has an alternative use must be capitalized and depreciated
as R&D.

Because it is difficult to predict the future benefits of these costs, FASB requires that
these costs should be expensed immediately. The requirement to expense research
and development costs does not apply to services performed for other companies under
a contract. These costs are capitalized as inventory costs, with associated revenues of
the contracts recognized either over a period of time or at a point in time.

Choice “A” is incorrect. Research and development costs are expensed as incurred and
are not capitalized. If equipment with alternative uses in research and development
projects is purchased, this cost should be capitalized, and the depreciation on the
equipment recorded as research and development expense over the life of the
equipment.

Choice “B” is incorrect. Research and development costs are expensed as incurred and
are not capitalized. The design, construction, and testing of preproduction prototypes
and models would be research and development prior to commercial production and
therefore the costs associated with such should be expensed immediately unless the
R&D costs are for services performed for other companies under a contract.

Choice “C” is incorrect. Research and development costs are not capitalized on the
basis of the amount and useful life of the expected cash receipts.
FASB ASC 730-10-25-1, Research and Development Costs, differentiates research and
development activities from activities not considered research and development. Which
one of the following is not considered a research and development activity?

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A. Laboratory research intended for the discovery of a new product
B. Testing in search for product processing alternatives
C. Modification of the design of a process
D. Periodic design changes to existing products
Explanation

Choice “D” is correct. GAAP defines research costs as the planned search or critical
investigation aimed at the discovery of new information in hopes of developing new
products, services, process, or techniques. Development costs are defined as the
translation of this new knowledge into a plan or design for new product or process to be
used for sale or use. ASC 730-10 states that routine, ongoing (periodic) efforts to refine,
enrich, or otherwise improve upon qualities of an existing product should be excluded
from research and development.

As per the definition, periodic design changes should be excluded from R&D.

Choice “A” is incorrect. Activities considered research and development within the
scope of research and development costs include laboratory research aimed at the
discovery of new knowledge.

Choice “B” is incorrect. Activities considered research and development within the
scope of research and development costs include conceptual formulation and design of
possible product or process alternatives.

Choice “C” is incorrect. Activities considered research and development within the
scope of research and development costs include modification of the formulation or
design of a product or process.
Conglomerate Inc. is in the process of valuing its limited life intangible assets.
Based on its due diligence, the company has obtained limited market data on
recent comparable intangible transactions, and cash flows pertaining to these
intangibles are difficult to estimate given the changing landscape of its
industries. Under the above circumstances, what is the best approach to use
to value the company's intangible assets?

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A. Cost approach
B. Income approach
C. Market approach
D. Combination approach
Explanation

Choice "A" is correct. In a scenario in which limited intangible asset

transactions exist and there are no reliable estimates of income/cash flows,
the cost approach should be used. Under this method, the company
determines intangible assets value using a replacement costs or a
reproduction cost methodology.

Choice "B" is incorrect. Without reliable estimates of income or cash flows

pertaining to the intangible assets, the income approach should not be used.

Choice "C" is incorrect. Because there is limited market data related to similar
intangible asset transactions, the market approach should not be used.

Choice "D" is incorrect. Although not an actual intangible asset approach,

combining valuation methods cannot be used given the lack of market
information and difficulty associated with estimating intangible asset cash
flows.
Bluebell, Inc. incurred $85,000 of research and development costs which led to the
grant of a patent. Also, Bluebell incurred $12,000 of legal and other costs to register the
patent. Additionally, Bluebell incurred $18,000 of legal fees to successfully defend the
patent. Under U.S. GAAP, Bluebell's patent should be capitalized at:

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A. $12,000
B. $30,000
C. $115,000
D. $97,000
Explanation

Choice "B" is correct. $30,000, legal fees for registration of the patent of $12,000 plus
legal fees to successfully defend the patent of $18,000 should be capitalized.

Choice "A" is incorrect. $12,000 is calculated by including in the cost of the patent only
the $12,000 to register the patent and not the $18,000 to defend the patent. The cost of
a successful defense of a patent should be capitalized.

Choice "C" is incorrect. $115,000 is calculated by including in the cost of the patent the
$85,000 of research and development for the patent, the $12,000 to register the patent,
and the $18,000 to defend the patent. Research and development cost should be
expensed.

Choice "D" is incorrect. $97,000 is calculated by including in the cost of the patent the
$85,000 of research and development for the patent and the $12,000 to register the
patent. Research and development cost should be expensed.
On December 31, Year 2, Anchor Products has a patent shown on its balance sheet for
$96,000 that has a remaining legal life of 8 years. It is expected that the patent will have
no economic value after 6 years. At the beginning of Year 3, the company incurs costs
of $50,000 which will extend the economic value of the patent for another 5 years.

What is the amount of the patent amortization expense for Anchor Products during Year
3?

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A. $13,273
B. $16,000
C. $18,250
D. $22,000
Explanation

Choice "C" is correct. A patent is amortized over the shorter of its estimated life or
remaining useful life. Expenses that increase the useful life of the patent require an
addition to the calculation of the annual amortization.

Patent Asset, January 1, Year 3 96,000

Year 3 additional costs to extend life 50,000
Costs to amortize 146,000
Shorter of legal or useful life ÷ 8 years
Amortization 18,250

Choice "A" is incorrect. The costs are amortized over the shorter of the remaining legal
life or the useful life of the patent.

Choice "B" is incorrect. The additional costs are added to the cost of the patent. After
the additional costs are incurred, the new economic life is 11 years. The patent is
amortized over the shorter of the remaining legal life or the economic life. Because the
legal life is 8 years, the patent will be amortized over 8 periods.

Choice "D" is incorrect. The additional costs incurred are added to the unamortized
amount of patent expense and are not separately amortized.
Impairments of tangible/intangible assets with a finite life occur when events indicate a
change in the total anticipated benefits associated with ownership of assets. Which of
the following events listed below indicates the book value of an asset may not be
recoverable?

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A. A significant change in the market value of the asset.
B. Significant adverse changes in the legal environment.
C. A change in the estimated utilization of the asset prior to the end of the asset's useful life.
D. All of the above are events indicating the book value of the asset may not be recoverable.
Explanation

Choice “D” is correct. GAAP requires an investigation into events that indicate
the book value (carrying value) of an asset may not be recoverable.

Indicators of impairment for finite life tangible/intangible assets:

 A decline in market value of asset which is substantial and not likely to reverse.
 A substantial adverse change in how the asset is being used or in its physical
condition.
 A significant adverse change in legal factors or in the business climate.
 Losses during the current period with projections of losses continuing in the
future.
 Decision to dispose of an asset prior to end of its estimated useful life.

Choice “A” is incorrect. A significant change in the market value of an asset is an

indicator of impairment, but the other answer choices also represent indicators of
impairment.

Choice “B” is incorrect. A significant change in the legal environment associated with an
asset is an indicator of impairment, but the other answer choices also represent
indicators of impairment.

Choice “C” is incorrect. A significant change in the estimated utilization of an asset prior
to the end of the asset's useful life is an indicator of impairment, but the other answer
choices also represent indicators of impairment.
Which of the following statements concerning the impairment of fixed assets under U.S.
GAAP is true?

I. Impairment losses are shown on the income statement net of tax.

II. The test for recoverability compares the present value of all expected future cash flows
produced by the fixed asset to its carrying value.
III. To determine the amount of any impairment loss, fair value can be used.
CalculatorTime Value Tables
A. I.
B. II.
C. III.
D. I and II.
Explanation

Choice "C" is correct. The third statement is true. The first statement is incorrect, since
impairment losses are shown as a component of income from continuing operations,
before tax. The second statement is also false. To determine whether an impairment
loss exists, undiscounted future cash flows are compared to carrying value. If an
impairment loss exists, then the fair value of the asset can be used to determine the
amount of the loss to be recognized.

Choices "A", "B", and "D" are incorrect. Each of these incorrectly includes one or more
of statements 1 and 2 as correct.
Sumrall Corporation owns machinery that was purchased 20 years ago. The machinery,
which originally cost $2,000,000, has been depreciated using the straight-line method
using a 40-year useful life and no salvage value and has a current carrying amount of
$1,000,000 and a current fair value of $800,000. Sumrall estimates that the machinery
has a remaining useful life of 20 years and will provide net cash inflow of $45,000 per
year.

Sumrall should record an impairment loss associated with the machinery of:

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A. $0 since there is no impairment.
B. $150,000
C. $100,000
D. $200,000
Explanation

Choice "D" is correct.

Impairment is a two-step process, the first of which is to determine if impairment exists,

and the second of which is to measure the loss.

To determine if an impairment loss exits, we compare the undiscounted cash flows from
the machine to the carrying amount of the machine. The undiscounted cash flows are
$900,000 ($45,000 × 20 years remaining life), and the carrying amount is $1,000,000 (in
this case, they provided the carrying amount; in a longer problem, it might have to be
calculated). Since the undiscounted cash flows are less than the carrying amount, there
is an impairment loss.

The amount of the impairment loss is the difference between the fair value of the
machine and its carrying amount ($800,000 − $1,000,000) or $200,000.
A company has a long-lived asset with a carrying value of $120,000, undiscounted
expected future cash flows of $130,000, present value of expected future cash flows of
$100,000, and a fair value less costs to sell of $105,000. What amount of impairment
loss should be reported under IFRS?

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A. $0
B. $10,000
C. $15,000
D. $20,000
Explanation

Choice "C" is correct. Under IFRS, impairment exists when the carrying value of a fixed
asset exceeds the fixed asset's recoverable amount. The recoverable amount is the
greater of the asset's fair value less costs to sell and the asset's value in use (present
value of future cash flows). In this problem, the fair value less costs to sell of $105,000
exceeds the value in use of $100,000, so the recoverable amount is $105,000. The
carrying value of $120,000 exceeds the recoverable amount of $105,000, so an
impairment loss must be recorded:

Impairment loss = Fair value less costs to sell - Carrying value = $105,000 - $120,000 = $15,000

Choice "A" is incorrect. The carrying value of $120,000 exceeds the $105,000
recoverable amount, so an impairment loss must be recorded.

Choice "B" is incorrect. The impairment loss is not the difference between the carrying
value and the undiscounted expected future cash flows.

Choice "D" is incorrect. Under IFRS, impairment exists when the carrying value of a
fixed asset exceeds the fixed asset's recoverable amount. The recoverable amount is
the greater of the asset's fair value less costs to sell and the asset's value in use
(present value of future cash flows). In this problem, the fair value less costs to sell of
$105,000 exceeds the value in use of $100,000, so the recoverable amount is
$105,000, not $100,000, and the impairment loss is $15,000, not $20,000.
On December 31, Year 1, an entity revalued its buildings to their fair value of
$2,700,000 and recorded a revaluation gain of $200,000. On December 31, Year 4, the
buildings had a carrying value of $2,295,000 and a recoverable amount of $2,000,000.
What amount of impairment loss will the entity report on its December 31, Year 4
income statement?

CalculatorTime Value Tables

A. $0
B. $95,000
C. $200,000
D. $295,000
Explanation

Choice "B" is correct. When the buildings were revalued in Year 1, the $200,000
revaluation gain was booked to other comprehensive income as a revaluation surplus.
Under IFRS, if a revalued asset becomes impaired, the impairment is recorded by first
reducing any revaluation surplus to zero, with further impairment losses reported on the
income statement. In this problem, the buildings were impaired on December 31, Year 4
because the $2,295,000 carrying value of the buildings exceeded the $2,000,000
recoverable amount. The $295,000 ($2,000,000 - $2,295,000) impairment loss is
recorded by first reducing to zero the $200,000 revaluation surplus from the Year 1
revaluation, and then recorded the $95,000 remaining impairment loss on the income
statement.

Choice "A" is incorrect. An impairment loss must be recorded in Year 4 because the
carrying value of the buildings exceeds the recoverable amount.

Choice "C" is incorrect. The $295,000 ($2,000,000 recoverable amount - $2,295,000

carrying value) impairment is recorded by first reducing the $200,000 revaluation
surplus in equity to zero and then recording the remaining $95,000 impairment loss on
the income statement.

Choice "D" is incorrect. When the $295,000 ($2,000,000 recoverable amount -

$2,295,000 carrying value) impairment is recognized, $200,000 of the impairment will
be recorded by reducing the $200,000 revaluation surplus in equity to zero and the
remaining $95,000 impairment will be recorded on the income statement.
On December 31, an entity analyzed a patent with a net carrying value of $500,000 for
impairment. The entity determined the following:

Fair value 495,000

Undiscounted future cash flows 515,000

What is the impairment loss that will be reported on the December 31 income statement
under U.S. GAAP?

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A. $0
B. $5,000
C. $15,000
D. $20,000
Explanation

Choice "A" is correct. Under U.S. GAAP, impairment analysis begins with a test for
recoverability in which the net carrying value of the asset is compared to the
undiscounted cash flows expected from the asset. If the net carrying value exceeds the
undiscounted cash flows, then an impairment loss is recorded equal to the difference
between the carrying value and fair value of the asset. In this situation, the carrying
value of $500,000 is less than the undiscounted future cash flows of $515,000, so no
impairment loss is recorded.
On December 31, an entity analyzed a patent with a net carrying value of $500,000 for
impairment. The entity determined the following:

Fair value 480,000

Estimated costs to sell 15,000
Value in use 475,000

What is the impairment loss that will be reported on the December 31 income statement
under IFRS?

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A. $0
B. $20,000
C. $25,000
D. $35,000
Explanation

Choice "C" is correct. Under IFRS, an impairment loss is recorded for the excess of the
carrying value of an intangible asset over its recoverable amount. The recoverable
amount is the greater of the asset's fair value less costs to sell and the asset's value in
use. In this problem, the value in use of $475,000 exceeds the fair value less costs to
sell of $465,000 ($480,000 - $15,000) and an impairment loss of $25,000 must be
reported on the income statement:

Impairment loss = $475,000 recoverable amount - $500,000 carrying value = $(25,000)

Choice "A" is incorrect. An impairment loss must be recorded under IFRS because the
carrying value of the patent exceeds the patent's recoverable amount.

Choice "B" is incorrect. Under IFRS, the impairment loss is the difference between the
carrying value and the recoverable amount. In this problem, the recoverable amount is
the patent's $475,000 value in use, which exceeds the patent's fair value less estimated
costs to sell of $465,000 ($480,000 - $15,000). The fair value of $480,000 is not used to
calculate the impairment loss.

Choice "D" is incorrect. Under IFRS, the impairment loss is the difference between the
carrying value and the recoverable amount. In this problem, the recoverable amount is
the patent's $475,000 value in use because it exceeds the $465,000 fair value less
costs to sell.
On December 31, Star Corp. had a reporting unit that had a book value of $950,000,
including goodwill of $130,000. As part of the company's annual review of goodwill
impairment, Star determined that the fair value of the reporting unit was $890,000. Star
assigned $840,000 of the reporting units fair value to its assets and liabilities other than
goodwill. What is the goodwill impairment loss to be reported on December 31 under
U.S. GAAP?

CalculatorTime Value Tables

A. $50,000
B. $60,000
C. $80,000
D. $110,000
Explanation

Choice "B" is correct.

Under U.S. GAAP, goodwill impairment exists because the $890,000 fair value of the
reporting unit is less than the $950,000 carrying value. The goodwill impairment loss will
be equal to $60,000, which is the $950,000 carrying value less the $890,000 fair value..

Choice "A" is incorrect. This is the implied fair value of the goodwill, not the goodwill
impairment loss.

Choice "C" is incorrect. This is the difference between the implied fair value of the
goodwill ($50,000) and the current value of the goodwill line item on the balance sheet
($130,000).

Choice "D" is incorrect. The goodwill impairment loss is not equal to the difference
between the book value of the reporting unit less the fair market value assigned to the
assets and liabilities of the reporting unit.
On December 31, an entity tested its goodwill for impairment and determined the
following for one of its reporting units:

Carrying value $1,015,000

Fair value 935,000

The entity also estimated at the beginning of the year that the present value of the
future cash flows expected from its reporting unit was $940,000. The reporting unit
reports goodwill of $110,000 at year-end. What is the goodwill impairment loss that will
be reported on the December 31 income statement under GAAP?

CalculatorTime Value Tables

A. $0
B. $30,000
C. $75,000
D. $80,000
Explanation

Choice "D" is correct. To calculate goodwill impairment under GAAP, the carrying
amount of the reporting unit is compared with the fair value of the reporting unit. If the
carrying amount exceeds the fair value, there is an impairment loss. The loss will be
equal to the difference between the carrying amount and the fair value, not to exceed
the amount of goodwill currently reflected on the balance sheet. The carrying amount of
$1,015,000 exceeds the fair value of $935,000 by $80,000. Because this amount is less
than the goodwill amount of $110,000, the entire $80,000 will be recognized as an
impairment loss.

Choice "A" is incorrect. Because the carrying value exceeds the fair value of the
reporting unit, an impairment loss must be recognized.

Choice "B" is incorrect. $30,000 is the amount of goodwill that will be reflected on the
balance sheet after the impairment loss of $80,000 is recognized.

Choice "C" is incorrect. The present value of future cash flows estimated at the
beginning of the year is irrelevant to the impairment loss calculation at year-end.
Goodwill should be tested for impairment at which of the following levels under IFRS?

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A. Each reporting unit.
B. Each acquisition unit.
C. Each cash-generating unit.
D. Entire business as a whole.
Explanation

Choice "C" is correct. Under IFRS, goodwill impairment is analyzed at the cash-
generating unit level.

Choice "A" is incorrect. Goodwill is analyzed for impairment at the reporting unit level
under U.S. GAAP.

Choice "B" is incorrect. Goodwill is not analyzed for impairment at the acquisition unit
level under IFRS (or U.S. GAAP).

Choice "D" is incorrect. Under IFRS, goodwill impairment is analyzed at the cash-
generating unit level, rather than for the entire business as a whole.
On December 31, an entity tested its goodwill for impairment and determined the
following for one of its cash-generating units:

Carrying value 2,425,000

Fair value 2,600,000

The entity estimated that if it were to sell the cash-generating unit, it would incur costs of
$250,000. The entity also determined that the present value of the future cash flows
expected from the cash-generating unit is $2,400,000. The cash-generating unit reports
goodwill of $65,000. What is the goodwill impairment loss that will be reported on the
December 31 income statement under IFRS?

CalculatorTime Value Tables

A. $0
B. $25,000
C. $65,000
D. $75,000
Explanation

Choice "B" is correct. Under IFRS, the goodwill impairment test is a one-step test in
which the carrying value of a cash-generating unit (CGU) is compared to the CGU's
recoverable amount, which is the greater of the CGU's fair value less costs to sell and
its value in use (PV of future cash flows expected from the CGU). For this CGU, the
value in use of $2,400,000 is the recoverable amount because it exceeds the fair value
less costs to sell of $2,350,000 ($2,600,000 fair value - $250,000 costs to sell) and the
impairment loss is:

Impairment loss = Recoverable amount - Carrying value

Impairment loss = $2,400,000 - $2,425,000 = $(25,000)

Under IFRS, the CGU impairment loss is applied first to the goodwill of the CGU.

Choice "A" is incorrect. An impairment loss must be recorded under IFRS because the
carrying value of the cash-generating unit exceeds the cash-generating unit's
recoverable amount.

Choice "C" is incorrect. The goodwill impairment loss is not equal to the carrying value
of the CGU's goodwill. Under IFRS, the goodwill impairment test is a one-step test in
which the carrying value of a cash-generating unit (CGU) is compared to the CGU's
recoverable amount, which is the greater of the CGU's fair value less costs to sell and
its value in use (PV of future cash flows expected from the CGU). For this CGU, the
value in use of $2,400,000 is the recoverable amount because it exceeds the fair value
Wizard Co. purchased two machines for $250,000 each on January 2 of the current
year. The machines were put into use immediately. Machine A has a useful life of five
years and can only be used in one research project. Machine B will be used for two
years on a research and development project and then used by the production division
for an additional eight years. Wizard uses the straight-line method of depreciation. What
amount should Wizard include in the current year research and development expense
under U.S. GAAP?

CalculatorTime Value Tables

A. $275,000
B. $50,000
C. $375,000
D. $500,000
Explanation

Choice "A" is correct. $275,000 is computed as follows:

Machine A (no alternate use) 250,000

Machine B (alternate use)
($250,000 ÷ 10 years) 25,000
Total 275,000

Choice "B" is incorrect. $50,000 is calculated by including the depreciation of both

Machine A and Machine B in research and development expense. Since Machine A had
no alternative future uses, its full cost should have been included in research and
development expense in the period of acquisition.

Choice "C" is incorrect. $375,000 is the full cost of Machine A and ½ the cost of
Machine B. It ignores the use of Machine B by the production division for the additional
eight years.

Choice "D" is incorrect. $500,000 is the full cost of both of the machines. Since Machine
B had alternative future uses, only its depreciation should have been included in
research and development expense.
Discovery Industries has been engaged to perform preproduction testing on jet
propulsion equipment manufactured by Soaring Skies Aviation. Discovery has built a
specially designed facility for $60,000,000 that the company anticipates will have
alternative uses. The building was placed on service on December 1, Year 1 and has a
10 year useful live. What was the amount of U.S. GAAP research and development
costs incurred by Discovery Industries during Year 1?

CalculatorTime Value Tables

A. $60,000,000
B. $6,000,000
C. $500,000
D. $0
Explanation

Choice "D" is correct. Discovery Industries has incurred no research and development
costs under U.S. GAAP. The purchaser of the research and development services
(Soaring Skies Aviation) will expense as research and development the amount paid
and the provider performing the research and development for the purchaser (Discovery
Industries) will expense costs incurred as cost of sales.

Choice "A" is incorrect. The cost of the building is not considered a research and
development expense to the provider of R&D services sold to others.

Choice "B" is incorrect. The annual deprecation on the building is not considered a
research and development expense to the provider of R&D services sold to others.

Choice "C" is incorrect. One month of deprecation on the building is not considered a
research and development expense to the provider of R&D services sold to others.