Accounting-Chapter 7 Flashcard Example #21869

WorldCom committed the largest fraud in the US history. What was the primary method WorldCom’s management used to carry out the fraud?
WorldCom recorded assets on the balance sheet that should have been recorded as expenses on the income statement. When WorldCom uses the telecommunication lines of another company, it pays a fee. This fee is part of normal operating costs, and should be recorded as an expense of the current period to properly match the expense with the revenues it helped to generate. Instead, WorldCom recorded these operating expenses as long-term assets on the balance sheet.
What are the two major categories of long-term assets? how do tees two categories differ?
The two major categories for long-term assets are (1) property, plant, and equipment and (2) intangible assets. Property, plant, and equipment include land, land improvements, buildings, equipment, and natural resources. Intangible assets include patents, trademarks, copyrights, franchises, and goodwill. The two categories differ by their physical substance. Property, plant, and equipment consist of items that you can actually see, while intangible assets lack physical substance. The existence of intangible assets is often based on a legal contract.
Explain how we initially record a long-term asset
We initially record a long-term asset at its cost plus all expenditures necessary to get the asset ready for use. Thus, the initial cost of a long-term asset might be more than just its purchase price; it also will include any additional amounts the firm paid to bring the asset to its desired condition and location for use.
If University Hero initially records an expense incorrectly as an asset, how does this mistake affect the income statement and the balance sheet?
Recording an expense incorrectly as an asset will overstate net income on the income statement. If University Hero initially records an expense incorrectly as an asset, expenses are understated or too small. Since expenses are subtracted from revenues in arriving at net income, understating expenses will overstate net income reported on the income statement. Similarly, recording an expense as an asset will overstate assets on the balance sheet. Retained earnings on the balance sheet will also be overstated due to the overstatement of net income
Little King acquires land and an old building across the street from Northwestern State University. Little Kind intends to remove the old building and build a new sandwich shop on the land. What costs might the firm incur to make the land ready for its intended use?
Costs Little King might incur to make the land ready for its intended use include the purchase price plus closing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording. Little King also includes the cost of removing the old building as an additional cost in making the land ready for its intended use. If any cash is received from selling salvaged materials from the old building, the cost of land is reduced by that amount. If the property is subject to back taxes or other obligations, these amounts are included as well. In fact, any additional expenditure such as clearing, filling, and draining the land, to prepare the land for its intended use, becomes part of the land’s capitalized cost.
Why don’t we depreciate land? What are land improvements? Why do we record land and land improvements separately?
We don’t depreciate land because its service life never ends. Land improvements are additional amounts spent to improve the land such as a parking lot, paving, temporary landscaping, lighting systems, fences, sprinkler systems, and similar additions. We record land improvements separately from land because, unlike land, these assets are subject to depreciation.
Equipment includes machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures. What costs might we incur to get equipment ready for use?
Costs we might incur to get equipment ready for use include sales tax, shipping, delivery, insurance, assembly, installation, testing, and even legal fees incurred to establish title
Where in the balance sheet do we report natural resources? Provide at least three examples of natural resource assets
We report natural resources on the balance sheet as part of property, plant, and equipment. Examples of natural resources include oil, natural gas, and timber.
Explain how the accounting treatment differs between purchased and internally developed intangible assets
We value purchased intangible assets at their original cost plus all other costs, such as legal and filing fees, necessary to get the asset ready for use. Reporting intangible assets developed internally is quite different. Rather than recording these as an intangible asset on the balance sheet, we expense most of the costs for internally developed intangible assets to the income statement as we incur them.
What are the differences among a patient, a copyright, and a trademark?
A patent is an exclusive right to manufacture a product or to use a process. A copyright is an exclusive right of protection given to the creator of a published work, such as a song, film, painting, photograph, book, or computer software. A trademark, is a word, slogan, or symbol that distinctively identifies a company, product, or service.
What is goodwill and how do we measure it? Can we sell goodwill separately from the business?
Goodwill represents the value of a company as a whole, over and above the value of its identifiable assets. We record goodwill as an intangible asset on the balance sheet only when we purchase it as part of the acquisition of another company. In this case, the acquiring company records goodwill equal to the purchase price less the fair value of the net assets acquired. The fair value of the net assets is the fair value of all identifiable assets acquired, minus the fair value of all liabilities assumed. We cannot sell goodwill separately. While most long-term assets can be separated from the company and individually sold, goodwill cannot.
How do we decide whether to capitalize (record as an asset) or expense a particular cost?
We capitalize a particular cost as an asset if it increases future benefits, whereas we expense a cost if it benefits only the current period.
Explain the usual accounting treatment for repairs and maintenance, additions, and improvements
We expense repairs and maintenance expenditures which maintain a given level of benefits, in the period incurred. We capitalize as assets more extensive repairs that increase the future benefits of the delivery truck, such as a new transmission or an engine overhaul. An addition occurs when we add a new major component to an existing asset. An improvement is the cost of replacing a major component of an asset. We should capitalize the cost of additions and improvements because they increase the future benefits from the expenditure.
Are litigation costs to defend an intangible asset capitalized or expensed? Explain your answer
If a firm successfully defends an intangible right, it should capitalize the litigation costs and amortize them over the remaining useful life of the related intangible. If the defense of an intangible right is unsuccessful, then the firm should expense the litigation costs as incurred because they provide no future benefit
How is the dictionary definition different from the accounting definition of depreciation?
The dictionary definition of depreciation is a decrease in value of an asset, whereas the accounting definition of depreciation is an allocation of an asset’s cost to an expense over time.
What factors must we estimate in allocating the cost of a long-term asset over its service life?
We must estimate the service life (also called useful life) of the asset as well as its residual value (also called salvage value) at the end of that life.
What is the service life of an asset? How do we determine service life under the straight-line and the activity-based depreciation methods?
The service life tells how long the company expects to obtain benefits from the asset before disposing of it. Under the straight-line method we determine service life in units of time. Under the activity-based method we determine service life in units of activity. For example, the estimated service life of a delivery truck might be either five years or 100,000 miles.
What is residual value? How do we use residual value in calculating depreciation under the straight-line method?
Residual value, also referred to as salvage value, is the amount the company expects to receive from selling the asset at the end of its service life. The allocation base is the asset’s cost minus its estimated residual value. In calculating depreciation under the straight-line method, we simply divide the allocation base by the number of years in the asset’s life.
Contrast the effects of the straight-line, declining-balance, and activity-based methods on annual depreciation

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