Module 10Noncurrent Assets – Acquisition

Introduction

Noncurrent assets are those assets which are not expected to be sold within the next year or operating cycle. Thus, it is possible that land may be classified as noncurrent one year but may be reclassified as a current asset in the following year if management intends to sell it within the next year.

The cost of a noncurrent asset includes the purchase price plus all other expenditures required to acquire and prepare the asset for its intended use. Thus the cost of a machine will include, apart from the invoice price, any reasonable expenditures related to: taxes, freight, installation, and costs of trial runs on the machine.

Land

Land is an asset which is not depreciated. The costs assigned to land include the price paid for the land as well all other expenditures incurred to prepare the land for the intended use. This means land costs include: commissions and legal fees paid in the transaction, assumption of any liens or mortagages on the property, costs incurred in grading and clearing, and drainage, costs related to demolishing any existing structure, and government assessments for sewer, water, roads and other such items.

Note that if an existing building has to be demolished, the cost of demolition is added to the cost of land. However, if any salvage items from the demolished building are sold then revenue from such sales are subtracted from the cost of demolition.

Land improvements with limited lives are capitalized in a separate account. This Land Improvement accout is depreciated, just like any other noncurrent asset. Some examples of items classified as land improvement are: parking lots, sidewalks and fences, and private lighting.

Basket purchase

In a basket purchase, more than one item is purchased by payment of one lump sum amount. For example, a single price may be paid for land and building together. In such lump sum purchases, the total purchase price must be allocated between the separate items in a fair manner (this is because the different assets may have different estimated useful lives for depreciation, or may not depreciate at all – like land).

Assume that in a basket purchase involving land, land improvements, and building, the total purchase price was $440,000. Assume that an appraiser gives the following fair market values for the items separately: land, $200,000; building, $300,000; land improvements, $50,000. The allocation for the basket purchase will be as follows:

Total fair market value of purchased assets = $550,000.Proportional value of land = $200,000/$550,000.Total basket purchase price = $440,000Value assigned to land = $440,000 x ($200,000/$550,000) = $160,000.

The value assigned to building will be $240,000 ($440,000 x [$300,000/$550,000]) and the value of land improvements will be $40,000 ($440,000 x [$50,000/$550,000])

Self construction

A company may construct buildings or equipments for its own use. During such construction, the company will incur costs related to material, labor, and overhead. While there is no controversy around capitalizing the cost of material and labor used in such self-construction, there is a difference of opinion about overhead costs related to construction. Some companies allocate only the extra overhead costs which arise because of the project. Others allocate both variable overhead and a proportionate share of fixed overhead.

If the cost of self-constructed assets is less than the cost of purchasing the asset from someone else, the difference is simply cost savings – the difference cannot be reported as a profit. Similarly, if the cost of the self-constructed asset is more than the cost of purchasing the asset from someone else, the difference is not recorded as a loss.

Interest Capitalization

When a company constructs assets such as buildings for its own use (or, are constructed as discrete projects for sale or lease to others), interest incurred is capitalized. Interest cannot be capitalized for: inventories manufactured on a routine basis, for assets currently in use, or for assets that are idle (that is, if there is no progress towards completion).

The amount of interest to be capitalized is calculated using the following rules: Interest charges start with the initial expenditure and continue until the asset is

completed, except when the project is idle. The expenditures (note: cash payments, not accurals) must be weighted based on

when the payments were made during the year. This gives the average accumulated expenditure (AAE) for a year.

If specific loans have been incurred for the project, the rate on such specific loans must be used first to calculate the interest. If the AAE is greater than such specific borrowing, then the weighted average rate of all other company borrowings must be used for such excess (over the AAE) expenditures.

When the construction activity is more than one year, accumulated expenditures (at the start of a given year) will include interest capitalized in prior years.

The interest capitalized in any period cannot exceed the actual interest expense for the period.

Example: Gordon Company constructed a new building for its internal use. The project was started on January 1, 2002 and was completed on June 30, 2003. The company borrowed $600,000 at 10% per year for the project on January 1, 2002. Details about the expenditures are as follows:

Date AmountJanuary 1, 2002 $ 500,000September 1, 2002 900,000April 1, 2003 400,000The interest rates on other debt of Gordon Company are as follows:

Debt Amount Interest rate Notes payable $ 900,000 12% Bonds payable 450,000 9%What is the amount of interest that can be capitalized in 2002?

Step 1: Calculate the average accumulated expenditure (AAE) for 2002.The AAE is the weighted average of the expenditures for any year. For 2002, the $500,000 spent on January 1 is weighted the full 12 months but the $900,000 spent on September 1 is weighted only four months (because the period from September 1 to December 31 is only four months). Thus the weighted average expenditure for 2002 is $800,000 ([$500,000 x 12/12] + [$900,000 x 4/12]).

Step 2: Applicable interest rate for 2002.The specific borrowing for the project is $600,000. So interest on the first $600,000 of the AAE will be calculated using the rate of the specific borrowing (10%). Since the AAE of $800,000 is greater than the specific borrowing of $600,000, we need to apply the weighted average rate for the difference of $200,000.

Weighted average rate for the excess borrowing: Debt Amount Interest rate Interest per year

(amount x rate) Notes payable $ 950,000 12% $ 108,000 Bonds payable $ 450,000 9% 40,500Total $ 1,350,000 $ 148,500Thus the total interest for the year would be $148,500, on total borrowings of $1,350,000. Hence the weighted average interest rate is 11% ($148,500/$1,350,000). Hence, 11% will be the interest rate applied to the amount of AAE over $600,000.

Step 3: Calculate interest on the project for the year.Interest for the first $600,000 of the AAE = $60,000 ($600,000 x 0.10).Interest for the remaining $200,000 of the AAE = $22,000 ($200,000 x 0.11)Total interest for the project = $82,000.

Step 4: Calculate the actual interest expense for the year.Debt Amount Interest rate Interest per year

(amount x rate)Construction loan $ 600,000 10% $ 60,000 Notes payable 950,000 12% 108,000

Bonds payable 450,000 9% 40,500Total $ 208,500

Since the interest related to the project is less than the actual interest expense for the period, the entire $82,000 can be capitalized in 2002.

Intangible Assets

Intangible assets lack physical substance, and usually result from legal or contractual rights. Unlike tangible assets which may be valuabe independent of the owner, intangible assets may have value only to a particular entity. The useful lives of intangible assets may be indeterminate or hard to estimate. These factors in turn lead to a greater degree of uncertainty related to the value or future benefits which can be derived from intangible assets

Intangible assets are shown on the books at cost. However, their book value is differs depending on whether they were created internally or were purchased from an external source. For example, if a company were to purchase a patent from another company the entire purchase price is capitalized. However, if a company were to develop a patent through its own research and development, only certain costs related to the filing of the patent application can be capitalized.

Intangible assets include: patents, copyrights, trademarks and tradenames, franchises, and goodwill.

A patent is an exclusive right, granted by the government, to use, manufacture, or sell a product or a process. The useful life of a patent is 20 years from the date of filing. Costs associated with a successful defense of a patent are capitalized. Of course, if a company loses a patent lawsuit all expenses are expensed and the patent itself is written-off.

A copyright grants exclusive rights to an author or artist to publish, sell, or control literary or artistic products for the life of the author plus 70 years. Entities can register their trademarks or tradenames with the U.S. Patent office and receive exclusive legal rights to the name or symbol for renewable periods of 20 years.

Goodwill

Goodwill is an intangible asset, and arises when one company buys another company in its entirety. Goodwill does not arise when only some assets are purchased from another company.

When one company buys another company, there are two ways of accounting for the transaction. In the first method, called pooling of interests, the books of the two merging companies are simply joined together. Thus, the combined entity will have the assets

and liabilities of the two companies added together. Goodwill does not arise in this method.

The second method of accounting for a business combination is called purchase accounting. Goodwill arises only when the purchase method of accounting is used.

When the pooling method is used, the first step is to revalue the assets and liabilities of the purchased company at fair value – which can be different from the book value. For example, if company A buys company B, company B may have on its books land which was purchased 10 years ago for $200,000. The current market value of the land may be $350,000. Similarly, company B may carry inventory (using the LCM rule) at $60,000 but the fair market value of the inventory may be $75,000.

The second step is to subtract the fair value of liabilities from the the fair value of assets of the purchased company. This amount is known as the market value of the net assets.

The third step is to subtract the market value of the net assets from the purchase price paid by the purchasing company. This difference, if it is positive, is known as goodwill. That is, goodwill arises only when the purchase price exceeds the fair market value of the net assets of the acquired company.

What if the purchase price is less than the fair market value of the net assets? Then we have negative goodwill (“badwill”). Negative goodwill is written-off by first proportionately reducing the fair value of the acquired noncurrent assets. For example, assume that the negative goodwill is $30,000 and the fair market value of acquired noncurrent assets are as follows: land, $50,000 and building, $100,000. Then, the $30,000 negative goodwill is written-off by reducing proportionately the value of land and building. Land will be written-down by $10,000 ($30,000 x [$50,000/$150,000]), and thus will be valued at $40,000. Similarly, building will be written-down by $20,000 and thus will be valued at $80,000.

In some instances, negative goodwill may be so much that even after noncurrent assets have been entirely write-down (that is, valued at zero) there is still some left over negative goodwill. In such instances, the left over amount is carried as negative goodwill or “excess of book value over cost.” This amount may be amortized (resulting in increasing the net income during the amortization period).

Glossary

Basket purchases involve the purchase of more than one item by payment of one lump sum amount.

Copyrights grant exclusive rights to an author or artist to publish, sell, or control literary or artistic products.

Goodwill is an intangible asset, and arises when one company buys another company in its entirety. Goodwill equals the purchase price less the fair market value of the net assets of the acquired company.

Intangible assets lack physical substance, and usually result from legal or contractual rights.

Noncurrent assets are those assets which are not expected to be sold within the next year or operating cycle.

Patent is an exclusive right, granted by the government, to use, manufacture, or sell a product or a process.

Demonstration Problem 1Thompson Company

On March1, 2002, Thompson Company purchased a parcel of land as a site for a factory building by paying $100,000 in cash and 1,000 shares of its common stock. The market price of the common stock was $150 per share on the date of purchase. An old building present on the land was demolished and construction of the new warehouse was completed by July 15, 2002. The following expenditures were incurred in connection with the warehouse construction project:Special tax assessment for water and sewer $ 50,000Demolition of old building 25,000Proceeds from sale of items from old building 6,000Legal fees for building construction 3,000Title insurance 2,000Architect’s fees 20,000Clearing and landfill for building site 15,000Factory building supervisor’s salary 14,000Construction costs 700,000Temporary facilities at construction site 16,000Imputed interest for equity financing 24,000Calculate the amount to be capitalized under the land and building accounts.

Solution to Demonstration Problem 1 – Thompson Company

Purchase price of land = cash paid + market value of stock given= $100,000 + (1,000 x $150) = $250,000

Land:Purchase price of parcel of land $ 250,000Special tax assessment for water and sewer 50,000Demolition of old building 25,000Title insurance 2,000Clearing and landfill for building site 15,000Proceeds from sale of items from old building (6,000)Total $ 336,000

Building:Architect’s fees $ 20,000Legal fees for building construction 3,000Factory building supervisor’s salary 14,000Construction costs 700,000Temporary facilities at construction site 16,000Total $ 753,000

Demonstration Problem 2Lewis Company

On July 1, 2002, Lewis Company paid $900,000 in a basket purchase, and obtained a parcel of land on which a factory building and warehouse were located. The book values of the items were reported by the seller, and the taxed values were obtained from the property tax records (which were last updated in 1998). In addition, Lewis Company obtained market values of the items from an appraiser just before the sale was completed. The book values, tax values, and market values of the items purchased were as follows:Item Book value Tax value Market valueLand $ 200,000 $ 200,000 $ 350,000Factory building 300,000 250,000 400,000Warehouse 170,000 125,000 250,000Calculate the appropriate amounts that Lewis Company should record for land, factory building, and warehouse.

Solution to Demonstration Problem 2 – Lewis Company

In a basket purchase, only the market values of the purchased items are relevant. Note that the tax values are not relevant because they have not been updated since 1998 and do not reflect market values.

Market value of the items purchased = $1,000,000 ($300,000 + $450,000 + $250,000)

The proportional share of market values are as follows: Item Market value Proportionate shareLand $ 350,000 $350,000/$1,000,000 = 0.35Factory building 400,000 $400,000/$1,000,000 = 0.40Warehouse 250,000 $250,000/$1,000,000 = 0.25

Hence, the allocation of the basket purchase price is as follows:Item Allocated valueLand $900,000 x 0.35 = $ 315,000Factory building $900,000 x 0.40 = $ 360,000Warehouse $900,000 x 0.25 = $ 225,000

Demonstration Problem 3Henry Company

Henry Company constructed a new building for its internal use. The project was started on January 1, 2002 and was completed on June 30, 2003. The company borrowed $300,000 at 10% per year for the project on January 1, 2002. Details about the expenditures are as follows:

Date AmountJanuary 1, 2002 $ 200,000October 1, 2002 600,000May 1, 2003 300,000The interest rates on other debt of Henry Company are as follows:

Debt Amount Interest rate Notes payable $ 500,000 12% Bonds payable 250,000 9%What is the amount of interest that can be capitalized in 2002 and in 2003?

Solution to Demonstration Problem 3 – Henry Company:

Interest for the year 2002:Step 1: Calculate the average accumulated expenditure (AAE) for 2002.The average accumulated expenditure (AAE) is the weighted average of the expenditures for any year. For 2002, the AAE is:($200,000 x 12/12) + ($600,000 x 3/12) = $350,000.

Step 2: Applicable interest rate for 2002.The specific borrowing for the project is $300,000. So interest on the first $300,000 of the AAE will be calculated using the rate of the specific borrowing (10%). Since the AAE of $350,000 is greater than the specific borrowing of $300,000, we need to apply the weighted average rate for the difference of $50,000.

Weighted average rate for the excess borrowing: Debt Amount Interest rate Interest per year

(amount x rate) Notes payable $ 500,000 12% $ 60,000 Bonds payable 250,000 9% 22,500Total $ 750,000 $ 82,500Thus the total interest for the year would be $82,500, on total borrowings of $750,000. Hence the weighted average interest rate is 11% ($82,500/$750,000). Hence, 11% will be the interest rate applied to the amount of AAE over $300,000.

Step 3:Calculate avoidable interest on the project for the year.Interest for the first $300,000 of the AAE = $30,000 ($300,000 x 0.10).Interest for the remaining $50,000 of the AAE = $5,500 ($50,000 x 0.11)Total avoidable interest for the project = $35,500.

Step 4:Calculate the actual interest expense for the year.

Debt Amount Interest rate Interest per year(amount x rate)

Construction loan $ 300,000 10% $ 30,000 Notes payable 500,000 12% 60,000 Bonds payable 250,000 9% 22,500Total $ 112,500Since the avoidable interest of is less than the actual interest expense for the period, the entire $35,500 can be capitalized in 2002.

Total investment in the project as of the end of 2002 = $835,000 ($200,000 + $600,000 + $35,500 interest capitalized)

(Solution continued)

Interest for the year 2003:Step 1: Calculate the average accumulated expenditure (AAE) for 2003.Note: Since the project is finished as of June 30, interest can be capitalized only for 6 months (since interest capitalization must be stopped once the project is over).

AAE for 2003 is:($835,500 x 6/12) + ($300,000 x 2/12) = $467,750.

Step 2: Applicable interest rate for 2003.As before 11% is the interest rate for the construction loan of $300,000. However, the AAE for the period is $467,750 –which is $167,750 over the specific construction loan. Since there is no change in borrowing during the period, the weighted average interest rate continues to be 11% in 2003 for this $167,750 over the specific construction loan.

Step 3: Avoidable interest on the project for the year.Interest for the first $300,000 of the AAE = $30,000 ($300,000 x 0.10).Interest for the remaining $167,750 of the AAE = $18,452.50 ($167,750 x 0.11)Total avoidable interest for the project = $48,452.50.

Step 4:Calculate the actual interest expense for the year. As before, it is $112,500 for the year. Since the avoidable interest of is less than the actual interest expense for the period, the entire $48,452.50 can be capitalized in 2002.

Demonstration Problem 4Hadley Company

On July 1, 2002 Hadley Company paid $1,200,000 for all the issued and outstanding stock of Congdon Company, and accounted for the transaction as a purchase. The book values of the assets and liabilities of Congdon Company are as follows:Cash $ 40,000Accounts receivable 80,000Inventory 90,000Land 200,000Building 400,000Patents 100,000Current liabilities 30,000Noncurrent liabilities 80,000Hadley Company determined the market values of some of Congdon Company’s assets and liabilities as follows: accounts receivable, $70,000; inventory, $85,000; land, $250,000; building, $420,000; patents, $60,000; noncurrent liabilities, $75,000.Determine the goodwill resulting from the business combination, and prepare the necessary journal entries for Hadley Company.

Demonstration Problem 3 – Hadley Company

Fair market value of net assets purchased = Fair value of assets – Fair value of liabilities

Fair value of assets = $40,000 + $70,000 + $85,000 + $250,000 + $420,000 + $60,000= $925,000

Fair value of liabilities = $30,000 + $75,000= $105,000

Fair market value of net assets = $925,000 – $105,000= $820,000

Goodwill = Purchase price – fair market value of net assets = $1,200,000 – $820,000= $380,000

Journal entry for the transaction:Account Debit CreditCashAccounts receivableInventoryLand BuildingsPatentGoodwill

$ 40,00070,00085,000

250,000420,000

60,000380,000

Current liabilities Noncurrent liabilities Cash

$ 30,00075,000

1,200,000

Practice Problem 1Massey Company

Massey Company purchased a parcel of land as a site for a warehouse building for $200,000 on January 15, 2002. An old building present on the land was demolished and construction of the new warehouse was completed by May 15, 2002. The following expenditures were incurred in connection with the warehouse construction project:Commission paid by buyer to real estate agent $ 5,000Demolition of old building 16,000Proceeds from sale of items from old building 4,000Surveyor’s and legal fees 3,000Architect’s fees 15,000Landfill for building site 10,000Clearing of trees from building site 6,000Excavation for basement 14,000Construction costs 600,000Temporary facilities at construction site 20,000Imputed interest for equity financing 17,000Calculate the amount to be capitalized under the land and building accounts.

Solution to Practice Problem 1 – Massey Company

Land:Purchase price of parcel of land $ 200,000Commission paid by buyer to real estate agent 5,000Demolition of old building 16,000Surveyor’s and legal fees 3,000Landfill for building site 10,000Clearing of trees from building site 6,000Proceeds from sale of items from old building (4,000)Total $ 236,000

Building:Architect’s fees $ 15,000Excavation for basement 14,000Construction costs 600,000Temporary facilities at construction site 20,000Total $ 649,000

Practice Problem 2Greig Company

Greig Company paid $360,000 in a basket purchase, and obtained a parcel of land on which a factory building and warehouse were located. The book values and market values of the items purchased were as follows:Item Book value Market valueLand $ 100,000 $ 120,000Factory building 140,000 180,000Warehouse 110,000 100,000Calculate the appropriate amounts that Greig Company should record for land, factory building, and warehouse.

Solution to Practice Problem 2 – Greig Company

In a basket purchase, only the market values of the purchased items are relevant.

Market value of the items purchased = $400,000 ($120,000 + $180,000 + $100,000)

The proportional share of market values are as follows: Item Market value Proportionate shareLand $ 120,000 $120,000/$400,000 = 0.30Factory building 180,000 $180,000/$400,000 = 0.45Warehouse 100,000 $100,000/$400,000 = 0.25

Hence, the allocation of the basket purchase price is as follows:Item Allocated valueLand $360,000 x 0.30 = $ 108,000Factory building $360,000 x 0.45 = $ 162,000Warehouse $360,000 x 0.25 = $ 90,000

Practice Problem 3Edward Company

Edward Company constructed a new building for its internal use. The project was started on January 1, 2002 and was completed on June 30, 2003. The company borrowed $500,000 at 10% per year for the project on January 1, 2002. Details about the expenditures are as follows:

Date AmountJanuary 1, 2002 $ 300,000September 1, 2002 480,000March 1, 2003 450,000The interest rates on other debt of Edward Company are as follows:

Debt Amount Interest rate Notes payable $ 400,000 8% Bonds payable 200,000 11%What is the amount of interest that can be capitalized in 2002 and in 2003?

Solution to Practice Problem 3 – Edward Company:

Interest for the year 2002:Step 1: Calculate the average accumulated expenditure (AAE) for 2002.The average accumulated expenditure (AAE) is the weighted average of the expenditures for any year. For 2002, the AAE is:($300,000 x 12/12) + ($480,000 x 4/12) = $460,000.

Step 2: Applicable interest rate for 2002.The specific borrowing for the project is $500,000. Since the AAE is less than the specific borrowing, the specific rate of 10% will be applicable for the entire AAE.

Step 3:Calculate avoidable interest on the project for the year.Interest for the AAE of $460,000 at 10% = $46,000.

Step 4:Calculate the actual interest expense for the year.

Debt Amount Interest rate Interest per year(amount x rate)

Construction loan $ 500,000 10% $ 50,000 Notes payable 400,000 8% 32,000 Bonds payable 200,000 11% 22,000Total $ 104,000Since the avoidable interest of is less than the actual interest expense for the period, the entire $46,000 can be capitalized in 2002.

Total investment in the project as of the end of 2002 = $826,000 ($300,000 + $480,000 + $46,000 interest capitalized)

Interest for the year 2003:Step 1: AAE for 2003.AAE for 2003 = ($826,000 x 6/12) + ($450,000 x 4/12) = $563,000.

Step 2: Applicable rate for 2003.For the first $500,000 of the AAE, the rate is the specific borrowing rate of 10%. For the extra $63,000, the weighted average rate of the notes payable and bonds payable is 9%.

Step 3: Calculate avoidable interest for 2003.Interest = ($500,000 x 0.10) + ($63,000 x 0.09) = $55,670

Step 4: Calculate interest expense for the period.Since the actual interest expense for the period is $104,000 the entire $55,670 of interest calculated in step 3 can be capitalized in 2003.

Practice Problem 4Arnold Company

On June 1, 2002 Arnold Company paid $600,000 for all the issued and outstanding stock of Old Company, and accounted for the transaction as a purchase. The book values of the assets and liabilities of Old Company are as follows:Cash $ 20,000Accounts receivable 50,000Inventory 60,000Land 100,000Building 240,000Patents 40,000Current liabilities 25,000Noncurrent liabilities 90,000Arnold Company determined the market values of some of Old Company’s assets and liabilities as follows: accounts receivable, $48,000; inventory, $57,000; land, $120,000; building, $225,000; patents, $35,000; noncurrent liabilities, $85,000.Determine the goodwill resulting from the business combination, and prepare the necessary journal entries for Hadley Company.

Practice Problem 4 – Arnold Company

Fair market value of net assets purchased = Fair value of assets – Fair value of liabilities

Fair value of assets = $20,000 + $48,000 + $57,000 + $120,000 + $225,000 + $35,000= $505,000

Fair value of liabilities = $25,000 + $85,000= $110,000

Fair market value of net assets = $505,000 – $110,000= $395,000

Goodwill = Purchase price – fair market value of net assets = $600,000 – $395,000= $205,000

Journal entry for the transaction:Account Debit CreditCashAccounts receivableInventoryLand BuildingsPatentGoodwill

$ 20,00048,00057,000

120,000225,000

35,000205,000

Current liabilities Noncurrent liabilities Cash

$ 25,00085,000

600,000

Homework Problem 1Mallett Company

On May 1, 2002, Mallett Company purchased a parcel of land as a site for a factory building by paying $200,000 in cash and 500 shares of its common stock. The market price of the common stock was $120 per share on the date of purchase. An old building present on the land was demolished and construction of the new warehouse was completed by August 31, 2002. The following expenditures were incurred in connection with the warehouse construction project:Special tax assessment for water and sewer $ 40,000Demolition of old building 45,000Proceeds from sale of items from old building 7,000Legal fees for building construction 3,000Title insurance 2,000Architect’s fees 25,000Landfill for building site 9,000Construction costs 600,000Temporary facilities at construction site 12,000Imputed interest for equity financing 22,000Calculate the amount to be capitalized under the land and building accounts.

Solution to Homework Problem 1 – Mallett Company

Land:Purchase price of parcel of land $ 260,000Special tax assessment for water and sewer 40,000Demolition of old building 45,000Title insurance 2,000Landfill for building site 9,000Proceeds from sale of items from old building (7,000)Total $ 349,000

Building:Architect’s fees $ 25,000Legal fees for building construction 3,000Construction costs 600,000Temporary facilities at construction site 12,000Total $ 640,000

Homework Problem 2Dennis Company

Dennis Company paid $85,000 in a basket purchase, and obtained a truck, a crane, and a car. The book values and market values of the items purchased were as follows:Item Book value Market valueTruck $ 20,000 $ 30,000Crane 45,000 55,000Car 10,000 15,000Calculate the appropriate amounts that Dennis Company should record for the truck, crane, and car.

Solution to Homework Problem 2 – Dennis Company

Market value of the items purchased = $100,000 ($30,000 + $55,000 + $15,000)

The proportional share of market values are as follows: Item Market value Proportionate shareTruck $ 30,000 $30,000/$100,000 = 0.30Crane 55,000 $55,000/$100,000 = 0.55Car 15,000 $15,000/$100,000 = 0.15

Hence, the allocation of the basket purchase price is as follows:Item Allocated valueTruck $85,000 x 0.30 = $ 25,500Crane $85,000 x 0.55 = $ 46,750Car $85,000 x 0.15 = $ 12,750

Homework Problem 3Hunt Company

On July 1, 2002 Hunt Company paid $ 700,000 for all the issued and outstanding stock of Wolcott Company, and accounted for the transaction as a purchase. The book values of the assets and liabilities of Congdon Company are as follows:Cash $ 20,000Accounts receivable 60,000Inventory 90,000Land 130,000Building 300,000Patents 60,000Current liabilities 15,000Noncurrent liabilities 65,000Hunt Company determined the market values of some of Wolcott Company’s assets and liabilities as follows: accounts receivable, $56,000; inventory, $84,000; land, $150,000; building, $280,000; patents, $65,000; noncurrent liabilities, $60,000.Determine the goodwill resulting from the business combination, and prepare the necessary journal entries for Hunt Company.

Homework Problem 3 – Hunt Company

Fair market value of net assets purchased = Fair value of assets – Fair value of liabilities

Fair value of assets = $20,000 + $56,000 + $84,000 + $150,000 + $280,000 + $65,000= $655,000

Fair value of liabilities = $15,000 + $60,000= $75,000

Fair market value of net assets = $655,000 – $75,000= $580,000

Goodwill = Purchase price – fair market value of net assets = $700,000 – $580,000= $120,000

Journal entry for the transaction:Account Debit CreditCashAccounts receivableInventoryLand BuildingsPatentGoodwill

$ 20,00056,00084,000

150,000280,000

65,000120,000

Current liabilities Noncurrent liabilities Cash

$ 15,00060,000

700,000

Homework Problem 4

1. Garcia Company purchased a parcel of land with the intention of constructing a factory building. The cost of land will include all of the following except:a. drainage and clearing costs.b. driveways and parking lots.c. assumption of any liens or mortagages on the propertyd. cost of demolishing an existing building.

2. The cost of land does not include:a. commissions and legal fees paid in the transactionb. costs of grading and clearing.c. costs of improvements with limited livesd. special assessments for sewer.

3. Jones Company purchased a parcel of land and a building. The purchase price of the package of land and building was $200,000. The book values of land and building were $70,000 and $90,000, respectively. The market values of land and building were $100,000 and $150,000, respectively. The value assigned to building should be:a. $150,000.b. $112,500.c. $80,000.d. $120,000.

4. Interest can be capitalized for:a. inventories manufactured on a routine basis.b. self constructed assets to be used in the future. c. self constructed assets currently in use.d. self constructed assets that are idle.

5. Intangible assets include all of the following except:a. land improvements.b. copyrights.c. patents.d. trademarks.

6. Goodwill equals:a. Purchase price minus book value of assets of purchased company.b. Fair market value of net assets of purchased company.c. Book value of net assets of purchased company.d. Purchase price minus fair market value of net assets of purchased company.

7. Wallace Company purchased a parcel of land with the intention of constructing a factory building. An old warehouse on the parcel of land was demolished. The cost of demolishing the land must be:a. recorded as a part of the cost of the new building.b. recorded as a part of the cost of the land.c. written off as a loss.d. written off as an unusual loss.

8. Faber Company purchased a new machine. The capitalized cost of the machine will include, apart from the invoice price:a. sales tax.b. freight.c. installation of the machine on the factory floor.d. repairs and maintenance during the first year.

9. Some examples of items which will be classified as land improvements include all of the following except:a. parking lots.b. sidewalks and fences.c. drainage and clearing.d. private lighting.

10. Veras Company purchased a truck and car, and paid $36,000. The book values of truck and car were $20,000 and $12,000, respectively. The market values of the truck and car were $28,000 and $14,000, respectively. The value assigned to building should be:a. $24,000.b. $22,500.c. $28,000.d. $20,000.

11. Which of the following assets do not qualify for capitalization of interest incurred during the construction period?a. assets being constructed for the company’s own use.b. assets being constructed for sale that are accounted as discrete projects.c. assets being constructed with financing from long term bonds.d. assets being constructed on which no progress is being made towards completion.

12. Goodwill arises when a company purchases:a. another company and uses the purchase method of accounting.b. another company and uses the pooling method of accounting.c. another company and uses the pooling or purchase method of accounting.d. some of the assets of another company and uses the pooling method of accounting.