Long Term Assets

Easy Practice Test

Introduction to Accounting

Easy Practice Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. When recording the purchase of a building, the asset should include all of the following except

a. real estate commission
b. remodel prior to moving into the building
c. current year property insurance costs
d. attorney’s fees related to the purchase

Check Your Answer

C. When purchasing property, plant and equipment, the cost of the asset should include all costs that must be paid to get the asset to the point of producing revenues. You do not expense costs before producing revenues (matching principle). Current year property insurance costs will be incurred this year and do not give future benefit. Costs incurred this year must be expensed this year.

2. Which of the following is not used when computing depreciation expense?

a. residual value
b. estimated years the asset will be used by the company
c. accumulated depreciation
d. the total amount of time the asset is estimated to useable

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D.  Depreciation expense is recorded over the time the asset is expected to be used by the company to produce revenues.  The expense should not exceed the time used by the company, even if the asset can still be used (by someone else)

3. Acquisition cost less accumulated depreciation of an asset is

a. book value
b. depreciable base
c. salvage value
d. depreciation expense

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A.  This is called book value.  It is the amount of the asset that has not yet been expensed.  Depreciable base is cost less salvage value (b.). Salvage value is the amount you expect to receive when you sell the asset (c.). 

4. A company that sells an asset for more than cost less accumulated depreciation will record

a. a revenue
b. an expense
c. a gain
d. a loss

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C.  A gain occurs when more is received than is recorded on the books.  Cost less accumulated depreciation (book value) is what is recorded in the company’s accounts. Selling an asset is a peripheral activity that is not part of day to day business.  Revenue is not recorded when selling an asset because a good or service is not provided to the customer. 

5.  Long term assets used in the business to produce revenue typically fall in one of which of the following categories?

a.  tangible or intangible 
b.  property, plant, equipment or intangible
c.  property, plant, equipment or tangible
d.  equipment or building

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B.  The two most common categories reported on the balance sheet for long term assets are P/P/E (for tangible assets) and Intangible assets.  Equipment and building are types of assets, not categories.

6. Which method of depreciation does not consider residual value when determining
depreciation expense?

a. straight-line method
b. double declining balance method
c. units of production method
d. all use residual value when determining depreciation expense

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D.  The maximum amount of depreciation expense that can be recorded under all methods is cost less residual value (depreciable base).  This also applies to double declining balance even though the annual expense calculation does not use residual value.

7. Which of the following could be recorded when selling an asset for more than book
value?

a. cash is recorded with a credit
b. a loss is recorded with a credit
c. an expense is recorded with a debit
d. accumulated depreciation will be reduced with a debit

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D.   The entry to record the sale of an asset is to increase cash for the amount received (debit), decrease the asset for historical cost (credit), decrease accumulated depreciation for the cumulative amount associated with the asset through the date of sale (debit) and plug the entry to balance with a gain (credit) or loss (debit).  Accumulated depreciation is a contra asset account and is decreased with a debit.

8. Which of the following methods is most appropriate to use when expensing the use
of natural resources?

a. straight-line method
b. double declining balance method
c. units of production method
d. the method that gives the lowest net income to be conservative

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C.  The most appropriate method is the method that best matches the expense with the revenues generated from the asset.  Revenues from natural resources will vary. Units of production records the expense based on the production. This method best matches the expense to the revenue. 

9. The account used to match the cost of using an intangible asset to revenues
produced with the asset is

a. depreciation
b. amortization
c. depletion
d. straight-line

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B.  Amortization expense is used to record the cost of using an intangible asset.  This works just like depreciation expense. It is acceptable to reduce the asset or record accumulated amortization when recording amortization expense.  Straight-line is the method that is most commonly used to determine the annual expense.

10. An intangible asset is recorded when

a. a payment is made outside the company that gives probable future benefit
b. employees work on developing an intangible asset
c. a cost paid outside the company to extend the life of the intangible asset
d. both a. and c.

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D.  Expenditures related to intangibles are capitalized (asset) when paid outside the company and provides probable future benefit.   Future benefit provided by employees is expensed because it is difficult to reliably value.

11. A company purchased land and incurred the following related expenditures:

a. purchase price of the land $100,000
b. real estate commission fees $6,000
c. clearing and permanent landscaping fees $3,000
d. costs to bulldoze an old building on the land $1,500
e. payment of prior year’s property taxes $4,400
f. survey fees $800
g. payment of current year property taxes $1,200

Make the journal entry to record all expenditures related to the land.

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First determine if the cost is capitalized (C) or expensed (E) and the account name
used:

a. purchase price of the land $100,000 C Land
b. real estate commission fees $6,000 C Land
c. clearing and permanent landscaping fees $3,000 C Land
d. costs to bulldoze an old building on the land $1,500 C Land
e. payment of prior year’s property taxes $4,400 C Land
f. survey fees $800 C Land
g. payment of current year property taxes $1,200 E Prop tax expense

All costs with “C Land” are costs that must be incurred to get the land to the point it can be used to produce revenues.   For some expenditures, you can not purchase the land without incurring the cost (b, e, f). Bulldozing the building does not go to “building” because there is no building; the building must be removed to use the land.  Landscaping that is permanent is an asset because it gives future benefit. Landscaping that is temporary, lasts less than a year, is an expense

Land                                           115,700
Property tax expense                  1,200
       Cash                                               116,900

12. Indicate whether each of the following expenditures should be capitalized or expensed. State the account name that will be used to record the expenditure.

a. paid $100,000 for a new roof for a building currently used
b. paid $3,000 for repairs for damage done by a hurricane
c. pay $500 every 3 months to keep the machine in working order
d. paid $12,000 in salary to the attorney working on patents for the company
e. paid $2,200 to train employees how to operate a new machine

Check Your Answer

a. paid $100,000 for a new roof for a building currently used

Capitalize – Building
Extends the life of the building

b. paid $3,000 for repairs for damage done by a hurricane

Expense – Repairs and maintenance expense

Repairs do not extend the life, improve efficiency, or increase output

The repairs enable the company to continue use, the future benefit was already paid for
before.

This could also be recorded as a unusual item, “Loss from hurricane”.

c. pay $500 every 3 months to keep the machine in working order

Expense – Repairs and maintenance expense

The cost does not bring long term future benefit.
3 months is short term

d. paid $12,000 in salary to the attorney working on patents for the company

Expense – salary expense

Costs related to intangible assets are expensed if paid internally in the company.
Salary is an internal cost. Costs are capitalized if paid outside the company

e. paid $2,200 to train employees how to operate a new machine

Capitalize – Machine

This is a necessary cost to get the machine to where it can be used to produce
revenues. This is a new machine, not yet in use. Training after the machine is in use is
expensed to match the same period revenue.

13. A machine cost $48,000 and is expected to be used for 5 years. After 5 years the machine is expected to be sold for $12,000. Total units produced is expected to be 100,000, beginning with 20,000 in year 1 and increasing in increments of 5,000 for years 2 and 3 before producing the same amount of units in years 4 and 5.

A. Compute the depreciable base
B. Compute depreciation expense for the first 3 years using the straight-line method
C. Compute depreciation expense for the first 3 years using the double declining balance method.
D. Compute depreciation expense for years 2 and 3 using the units of production method.
E. Which method gives a higher net income for year 2.
F. What is the book value of the machine at the end of year 2 using the straight-line method of depreciation

Check Your Answer

A.  Depreciable base =  Cost less residual value =  $48,000 – 12,000 = $36,000

 

B. 

Cost – Residual Value $48,000 – $12,000 = $7,200 each year
Useful Life 5 years

Straight-line is the same for all years
$7,200 for each of the first 3 years

 

C.  Double declining balance      100% / Useful Life x 2 x Book Value

 100% / 5 = 20% x 2 = 40% x (48,000 – 0) = $19,200 depreciation expense year 1

100% / 5 = 20% x 2 = 40% x (48,000 – 19,200) = $11,520 deprec. expense year 2

100% / 5 = 20% x 2 = 40% x (48,000 – 19,200 – 11,520) = $6,912 expense year 3

Notice:  the 40% is the same for all years

Book value is = cost less all prior year’s depreciation expense

Depreciation expense is for one year only, it is not cumulative

Accumulated depreciation is the total of all prior year’s depreciation expense and is cumulative

 

D.  Units of Production:     

Total cost – RV
Total units

= cost per unit x units produced

$48,000 – $12,000 / 100,000 = $0.36 per unit produced

Year 2 = 25,000 units produced x $0.36 = $9,000 depreciation expense

Year 3 = 30,000 units produced x $0.36 = $10,800 depreciation expense

 

E.  The method that will give the higher net income for year 2 is the one that gives the lowest expense in year 2.  Straight-line gives the lowest depreciation expense in year 2.

 

F.  Book value is Cost less Accumulated depreciation:

$48,000 – $14,400 = $33,600

Accumulated depreciation is the total depreciation expense for all years at the end of the period (7,200 yr. 1 + 7,200 yr. 2).

14. For the following costs, state the account that will be used for the debit. Give the account name, not the category on the balance sheet

A. Amounts spent to extend the life of a machine
B. Remodel of the building prior to occupancy
C. Landscaping the building that will be done each year
D. Real Estate commission paid for the purchase of the building
E. Property taxes paid on the building for periods before occupancy
F. Painting, which will be done every year
G Land survey costs prior to purchasing land
H. Demolition of a building on the land purchased
I. Installation costs related to machines
J. Outside legal costs incurred to purchase a patent

Check Your Answer

A.  Machine
B.  Building
C.  Landscaping expense
D.  Building
E.  Building
F.  Repairs and maintenance expense
G.  Land
H.  Land
I.   Machine
J.  Patent

Capitalized P/P/E if it is a cost to get the asset ready to use (prior to use) or it is a subsequent expenditure that extends the life or improves efficiency/output

Expense is the cost benefits one year or less and does not give future benefit

Capitalize intangible assets if paid outside the company and there is future benefit.

Expense intangible related costs if incurred inside the company (salaries).

15. A building with acquisition cost of $100,000 was sold for $200,000. The building had an estimated useful life of 10 years and has been used for the past 8 years. Depreciation was recorded using the straight-line method.

A. Determine the book value of the building at the time of sale.
B. Determine the gain or loss on sale of the building
C. Record the sale of the building

Check Your Answer

Book value is Cost less “Accumulated Depreciation”.  To determine this, you must first determine depreciation expense for each year:

$100,000 – $0
     10 years

= $10,000 per year x 8 years
=$80,000 accumulated depreciation

Book Value is $100,000 – $80,000 = $20,000  

A gain occurs when the amount of cash received is higher than book value.
A loss occurs when the amount of cash received is lower than book value.

Cash received        $200,000
Book value              ($20,000)
  Gain on sale         $180,000

The sale would be recorded:

Cash                                              200,000
Accumulated Depreciation         80,000
       Building                                          100,000
       Gain on sale of building              180,000

Cash – increases – debit
Accumulated depreciation – decreases – debit
Building – decreases – credit – at historical cost
Gain = difference in cash received and book value