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Intermediate Accounting (Kieso)
Found in: Page 606

Short Answer

Francisco Corporation is constructing a new building at a total initial cost of $10,000,000. The building is expected to have a useful life of 50 years with no residual value. The building’s finished surfaces (e.g., roof cover and floor cover) are 5% of this cost and have a useful life of 20 years. Building services systems (e.g., electric, heating, and plumbing) are 20% of the cost and have a useful life of 25 years. The depreciation in the first year using component depreciation, assuming straight-line depreciation with no residual value, is:

  1. $200,000.
  2. $215,000.
  3. $255,000.
  4. None of the above.

The correct option is option (c) $255,000.

See the step by step solution

Step by Step Solution

Step 1: Meaning of Depreciation

In accounting, depreciation refers to an expense incurred on an intangible asset due to corrosion and abrasion. A firm may adopt various methods for computing depreciation to reflect the true and accurate value of the asset.

Step 2: Explaining the correct option

Computation of depreciation of finished surfaces:

Cost of asset = Initial cost x Rate covering building surfaces

= $10,000.00 x 5%

= $500,00

Depreciation =

=

= $25,000

Computation of depreciation of service systems:

Cost of asset = Initial cost x Rate covering building service system

= $10,000,000 x 20%

= $2,000, 000

Depreciation =

=

= $80,000

Computation of depreciation for the remaining cost of building:

Cost = Initial building cost - Cost of asset of surfaces and service system

= $10,000,000 - $500,000 - $2,000,000

= $7,500,000

Depreciation =

=

$150,000

So, the total depreciation is $255,000 ($25,000+80,000+$150,000).

Step 3: Explaining the incorrect options

Option (a): Depreciation expense of $200,000 only includes the depreciation of the finished surfaces ($25,000) and the depreciation of the remaining cost of the building ($150,000). The depreciation of the service system is omitted.

Option (b): The service system's depreciation expense may be undervalued because the actual depreciation is $80,000 and the incorrect depreciation is $15,000.

Option (d): The depreciation expense for the asset is $255,000, and it is also mentioned in option (c), so options (a), (b), and (d) are incorrect.

Most popular questions for Business-studies Textbooks

(Depreciation—Strike, Units-of-Production, Obsolescence) The following are three different and unrelated situations involving depreciation accounting. Answer the question(s) at the end of each situation.

Situation I: Recently, Broderick Company experienced a strike that affected a number of its operating plants. The controller of this company indicated that it was not appropriate to report depreciation expense during this period because the equipment did not depreciate and an improper matching of costs and revenues would result. She based her position on the following points.

1. It is inappropriate to charge the period with costs for which there are no related revenues arising from production.

2. The basic factor of depreciation in this instance is wear and tear. Because equipment was idle, no wear and tear occurred.

Instructions

Comment on the appropriateness of the controller’s comments.

Situation II: Etheridge Company manufactures electrical appliances, most of which are used in homes. Company engineers have designed a new type of blender which, through the use of a few attachments, will perform more functions than any blender currently on the market. Demand for the new blender can be projected with reasonable probability. In order to make the blenders, Etheridge needs a specialized machine that is not available from outside sources. It has been decided to make such a machine in Etheridge’s own plant.

Instructions

  1. Discuss the effect of projected demand in units for the new blenders (which may be steady, decreasing, or increasing) on the determination of a depreciation method for the machine.
  2. What other matters should be considered in determining the depreciation method? (Ignore income tax considerations.)

Situation III: Haley Paper Company operates a 300-ton-per-day kraft pulp mill and four sawmills in Wisconsin. The company is in the process of expanding its pulp mill facilities to a capacity of 1,000 tons per day and plans to replace three of its older, less efficient sawmills with an expanded facility. One of the mills to be replaced did not operate for most of 2017 (current year), and there are no plans to reopen it before the new sawmill facility becomes operational.

In reviewing the depreciation rates and discussing the salvage values of the sawmills that were to be replaced, it was noted that if present depreciation rates were not adjusted, substantial amounts of plant costs on these three mills would not be depreciated by the time the new mill came on stream.

Instructions

What is the proper accounting for the four sawmills at the end of 2017?

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