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Chapter 9: Q20RQ (page 526)

What does it mean if an exchange of plant assets has commercial substance? Are gains and losses recorded on the books because of the exchange?

Short Answer

Expert verified

An exchange having commercial substancewill affect the business’s future cash flow, and the gains or losses arising from the same must be recorded in the books of accounts.

Step by step solution

01

Definition of Plant Assets

The assets employed in the business unit for the long-term purpose of producing goods or services are known as plant assets. These assets are charged with expenses known as depreciation.

02

Exchange of plant assets having commercial substance

The exchange of plant assets has commercial substance when the exchange affects the future cash flow of the business entity.

If the exchange has commercial substance, the business entity must record the gain or loss arising from such exchange.

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Most popular questions from this chapter

Whitney Plumb Associates surveys American eating habits. The company’s accounts include Land, Buildings, Office Equipment, and Communication Equipment, with a separate Accumulated Depreciation account for each asset. During 2018, Whitney Plumb completed the following transactions:

Jan. 1 Purchased office equipment, \(117,000. Paid \)77,000 cash and financed the remainder with a note payable.

Apr. 1 Acquired land and communication equipment in a lump-sum purchase. Total cost was \(350,000 paid in cash. An independent appraisal valued the land at \)275,625 and the communication equipment at \(91,875.

Sep. 1 Sold a building that cost \)520,000 (accumulated depreciation of \(285,000 through December 31 of the preceding year). Whitney Plumb received \)390,000 cash from the sale of the building. Depreciation is computed on a straight-line basis. The building has a 40-year useful life and a residual value of \(25,000.

Dec. 31 Recorded depreciation as follows:

Communication equipment is depreciated by the straight-line method over a five-year life with zero residual value. Office equipment is depreciated using the double-declining-balance method over five years with a \)2,000 residual value.

Record the transactions in the journal of Whitney Plumb Associates.

Determining the cost of assets Lawson Furniture purchased land, paying \(65,000 cash and signing a \)250,000 note payable. In addition, Lawson paid delinquent property tax of \(5,000, title insurance costing \)4,000, and \(9,000 to level the land and remove an unwanted building. The company then constructed an office building at a cost of \)400,000. It also paid \(54,000 for a fence around the property, \)12,000 for a sign near the entrance, and $8,000 for special lighting of the grounds. Requirements

  1. Determine the cost of land, land improvements, and building.
  2. Which of these assets will Lawson depreciate?

Question: Determining asset cost, preparing depreciation schedules (3 methods), and identifying depreciation results that meet management objectives

On January 3, 2018, Speedy Delivery Service purchased a truck at a cost of \(67,000. Before placing the truck in service, Speedy spent \)3,000 painting it, \(1,200 replacing tires, and \)3,500 overhauling the engine. The truck should remain in service for five years and have a residual value of $5,100. The truck’s annual mileage is expected to be 20,000 miles in each of the first four years and 12,800 miles in the fifth year—92,800 miles in total. In deciding which depreciation method to use, Alec Rivera, the general manager, requests a depreciation schedule for each of the depreciation methods (straight-line, units-of-production, and double-declining-balance).

Requirements

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value.

2. Speedy prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. Consider the first year that Speedy uses the truck. Identify the depreciation method that meets the company’s objectives.

Donahue Oil Incorporated has an account titled Oil and Gas Properties. Donahue paid \(6,400,000 for oil reserves holding an estimated 400,000 barrels of oil. Assume the company paid \)510,000 for additional geological tests of the property and $470,000 to prepare for drilling. During the first year, Donahue removed and sold 75,000 barrels of oil. Record all of Donahue’s transactions, including depletion for the first year.

Question:Western Bank & Trust purchased land and a building for the lump sum of $3,000,000. To get the maximum tax deduction, Western allocated 90% of the purchase price to the building and only 10% to the land. A more realistic allocation would have been 70% to the building and 30% to the land.

Requirements

1. Explain the tax advantage of allocating too much to the building and too little to the land.

2. Was Western’s allocation ethical? If so, state why. If not, why not? Identify who was harmed.
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