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Chapter 11: Q14Q (page 583)

Charlie Parker, president of Spinners Company, has recently noted that depreciation increases cash provided by operations and therefore depreciation is a good source of funds. Do you agree? Discuss.

Short Answer

Expert verified

Answer

No, depreciation does not provide cash; revenues do.

Step by step solution

01

Meaning of Depreciation 

Depreciation is the accounting practice of assigning the cost of tangible assets to expenses in a systematic and sensible mannerto the periods in which the asset is expected to be used.

02

Explaining the situation 

The money for asset replacement comes from revenues; without sales, no income is generated, and no cash inflow occurs. Management must make a distinct choice to set aside cash to accumulate asset replacement reserves. Because depreciation is a non-cash cost rather than a cash inflow, it is added to net income on the statement of cash flows (indirect method). So it is clear that depreciation does not generate cash; sales do.

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Most popular questions from this chapter

(Unit, Group, and Composite Depreciation) The certified public accountant is frequently called upon by management for advice regarding methods of computing depreciation. Of comparable importance, although it arises less frequently, is the question of whether the depreciation method should be based on consideration of the assets as units, as a group, or as having a composite life.

Instructions

  1. Briefly describe the depreciation methods based on treating assets as

(1) units and

(2) a group or as having a composite life.

  1. Present the arguments for and against the use of each of the two methods.
  2. Describe how retirements are recorded under each of the two methods.

Companies following international accounting standards can revalue fixed assets above the assets鈥� historical costs. Such revaluations are allowed under various countries鈥� standards and the standards issued by the IASB. Liberty International, a real estate company headquartered in the United Kingdom (U.K.), follows U.K. standards. In a recent year, Liberty disclosed the following information on revaluations of its tangible fixed assets. The revaluation reserve measures the amount by which tangible fixed assets are recorded above historical cost and is reported in Liberty鈥檚 stockholders鈥� equity.

Liberty International

Completed Investment Properties

Completed investment properties are professionally valued on a market value basis by external valuers at the balance sheet date. Surpluses and deficits arising during the year are reflected in the revalution reserve.

Liberty reported the following additional data. Amounts for Kimco Realty (which follows GAAP) in the same year are provided for comparison.

Liberty

(pounds sterling, in thousands)

Kimco

(dollars, in millions)

Total revenues

拢 741

$ 517

Average total assets

5,577

4,696

Net income

125

297

Instructions

  1. Compute the following ratios for Liberty and Kimco.
    1. Return on assets.
    2. Profit margin on sales.
    3. Asset turnover.

How do these companies compare on these performance measures?

  1. Liberty reports a revaluation surplus of 拢1,952. Assume that 拢1,550 of this amount arose from an increase in the net replacement value of investment properties during the year. Prepare the journal entry to record this increase.
  2. Under U.K. (and IASB) standards, are Liberty鈥檚 assets and equity overstated? If so, why? When comparing Liberty to U.S. companies, like Kimco, what adjustments would you need to make in order to have valid comparisons of ratios such as those computed in (a) above?

(Depreciation鈥擲YD, Act., SL, and DDB) The following data relate to the Machinery account of Eshkol, Inc. at December 31, 2017.


Machinery

A

B

C

D

Original cost

\(46,000

\)51,000

\(80,000

\)80,000

Year purchased

2012

2013

2014

2016

Useful life

10 years

15,000 hours

15 years

10 years

Salvage value

\( 3,100

\) 3,000

\( 5,000

\) 5,000

Depreciation method

Sum-of-the year digits

Activity

Straight-line

Double-declining balance

Accum. depr. through 2017

\(31,200

\)35,200

\(15,000

\)16,000

*In the year an asset is purchased, Eshkol, Inc. does not record any depreciation expense on the asset. In the year an asset is retired or traded in, Eshkol, Inc. takes a full year鈥檚 depreciation on the asset.

The following transactions occurred during 2018.

  1. On May 5, Machine A was sold for \(13,000 cash. The company鈥檚 bookkeeper recorded this retirement in the following manner in the cash receipts journal.

Cash 13,000

Machinery (Machine A) 13,000

b. On December 31, it was determined that Machine B had been used 2,100 hours during 2018.

c. On December 31, before computing depreciation expense on Machine C, the management of Eshkol, Inc. decided the useful life remaining from January 1, 2018, was 10 years.

d. On December 31, it was discovered that a machine purchased in 2017 had been expensed completely in that year. This machine cost \)28,000 and has a useful life of 10 years and no salvage value. Management has decided to use the double-declining-balance method for this machine, which can be referred to as 鈥淢achine E.鈥�

Instructions

Prepare the necessary correcting entries for the year 2018. Record the appropriate depreciation expense on the above-mentioned machines. No entry is necessary for Machine D.

(Depreciation for Fractional Periods) On March 10, 2019, Lost World Company sells equipment that it purchased for \(192,000 on August 20, 2012. It was originally estimated that the equipment would have a life of 12 years and a salvage value of \)16,800 at the end of that time, and depreciation has been computed on that basis. The company uses the straight line method of depreciation.

Instructions

  1. (a) Compute the depreciation charge on this equipment for 2012, for 2019, and the total charge for the period from 2013 to 2018, inclusive, under each of the six following assumptions with respect to partial periods.
    1. Depreciation is computed for the exact period of time during which the asset is owned. (Use 365 days for base and record depreciation through March 9, 2019.)
    2. Depreciation is computed for the full year on the January 1 balance in the asset account.
    3. Depreciation is computed for the full year on the December 31 balance in the asset account.
    4. Depreciation for one-half year is charged on plant assets acquired or disposed of during the year.
    5. Depreciation is computed on additions from the beginning of the month following acquisition and on disposals to the beginning of the month following disposal.
    6. Depreciation is computed for a full period on all assets in use for over one-half year, and no depreciation is charged on assets in use for less than one-half year. (Use 365 days for base.)
  2. (b) Briefly evaluate the methods above, considering them from the point of view of basic accounting theory as well as simplicity of application.

Lockard Company purchased machinery on January 1, 2017, for \(80,000. The machinery is estimated to have a salvage value of \)8,000 after a useful life of 8 years. (a) Compute 2017 depreciation expense using the straight-line method. (b) Compute 2017 depreciation expense using the straight-line method assuming the machinery was purchased on September 1, 2017.
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