Chapter 7.

Long-Lived Fixed Assets, Intangible Assets, and Natural

Resources.

Suggested Solutions to Questions, Exercises, Problems, and Corporate Analyses

Difficulty Rating for Exercises and Problems:

Easy: E7.14; E7.15; E7.16; E7.17

Medium: E7.18; E7.19; E7.20; E7.21; E7.22; E7.23
P7.25; P7.27; P7.28; P7.29; P7.34
Difficult: E7.24
P7.26; P7.30; P7.31; P7.32; P7.33

QUESTIONS
Q7.1 Brand Names. Intangible assets, like brand names, are capitalized to the
balance sheet when they are purchased that is, when there is a transaction
with an independent party. Williams-Sonoma (WS) did not acquire its brand
name in a purchase transaction; it built the brand name with advertising, quality
service and products, and by word-of-mouth. If WS is subsequently acquired by
another company, the brand would be reported on the acquiring companys
balance sheet because the brand name would have been part of the acquisition
transaction. Brand names are thus a form of unreported asset (i.e., an off-
balance-sheet asset).

The companys brand name is not reflected anywhere on the financial

statements; but, to the extent that the WS brand name generates future cash
flows, it is reflected in the market value of the companys share price even if it is
not reported on the face of the companys balance sheet.

Q7.2 Depreciation, Depletion and Amortization: The Matching Concept. The

matching principle stipulates that a business must match all of the costs of
producing its revenue with the revenue in the same period in which the revenue
is reported on the businesss income statement. Depreciation, depletion and
amortization are processes that distribute the outlay to acquire an asset to the
many future periods that the asset is expected to produce revenue for a
business. To deduct the entire cost of an asset as a lump sum in the year of
acquisition would create a significant mismatching of revenue and expenses.
Thus, the purpose of depreciation, depletion, and amortization is to prevent that
mismatching, without which a businesss profitability would in some periods be
overstated and in other periods understated.

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Solutions Manual, Chapter 7 7-1
Q7.3 Advertising Costs: Capitalize or Expense? Advertising costs and
expenditures for research and development costs are similar in terms of the
uncertainty that surrounds these cash outlays that is, the uncertainty that the
advertising is effective and will be associated with incremental future product
sales, as well as the uncertainty as to when, and in what amount, those future
incremental sales will occur. Because of this uncertainty, and the desire to
avoid guessing about the possible answers to these uncertainties, GAAP
recommends that, following the conservatism construct, all advertising costs be
expensed when incurred (i.e., expensing is best practice).

Can an argument be made to capitalize advertising costs? Yes, but it is a

tenuous argument. Most advertising firms believe that they can measure
whether advertising is effective or not; and, indeed, looking at the change in
sales following an advertising campaign can provide some ex poste evidence
as to its effectiveness. But, measuring marketing effectiveness on an ex ante
basis is not possible.

One solution for companies like AOL is to follow a successful efforts approach
to advertising, namely initially capitalizing the cost of advertising until the rate of
new subscribers can be ascertained and then expensing the portion of the cost
that was unsuccessful. This strategy would not be possible for Johnson and
Johnson, however, since consumers are notoriously fickle and there is no
guarantee of their brand loyalty.

Q7.4 Revaluation of Long-lived Assets. Restricting companies like The

Thunderbird Corporation to valuing its noncurrent assets at historical cost or
lower (e.g when an impairment in value is observed), presents a situation
wherein the balance sheets of companies holding appreciated assets are
clearly understated. To the extent that such companies are valued using a
price-to-book-value multiple, the possibility exists that such firms will also be
mis-priced (i.e., undervalued).

U.K. GAAP allows companies to annually revalue their appreciated assets like
land, by increasing the asset account to its fair market value and also
increasing a shareholders equity account called the asset revaluation
reserve. In short, the U.K. system treats the appreciation of land as an
increase in overall firm wealth, not to be realized or reported on the income
statement until the asset is sold.

Under U.S. GAAP, revaluation of investments that are available for sale is
permitted (i.e. see Chapter 8) and is basically handled the same way as U.K.
GAAP accounts for land appreciation. Thus, precedents do exist to permit the
revaluation of assets in both the U.K. and the U.S. The reason that land
revaluation has not been permitted in the U.S. is the absence of an efficiently
functioning marketplace for real estate similar to that which exists for stocks
and bonds.

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7-2 Financial Accounting for Executives & MBAs, 3 rd Edition
Q7.5 Capitalization of Interest Costs and Earnings Quality. This quality-of-
earnings issue is at the heart of the difference between the accrual basis of
accounting and the cash basis of accounting. It also reflects the difference in
view between the accountant who seeks fairness in the measurement of
earnings and assets (regardless of when the related cash flow occurs) and the
finance professional who mainly focuses on the cash flow of a business.

It is important to note that capitalization of interest is only permitted during the

period in which an asset is under construction and that once the asset is placed
into service, capitalization is no longer permitted. It is also noteworthy that the
goal of interest capitalization was to establish parity between those firms that
purchase their assets from outside vendors and those firms (e.g., natural
resource companies) that are forced to self-construct their long-lived revenue-
producing assets. Clearly, an outside vendor would factor its cost of borrowing
into the purchase price of any manufactured asset.

To overcome this concern on the part of investment professionals, GAAP

requires that the amount of interest capitalized to the balance sheet be
disclosed on a period-by-period basis in the footnotes, enabling analysts to
restate earnings for the capitalized interest, should they desire to do so.

Q7.6 Changing Depreciation Methods. A change from the straight-line (SL) method
of depreciation to the declining-balance (DB) method will normally result in a
reduction in current earnings as the depreciation charges under DB are often
larger than those under SL. This financial outcome would be expected in every
circumstance except where a firms assets are relatively old in age; and, under
these circumstances, it is possible that earnings would increase following a
change from SL depreciation to DB depreciation. In the specific case of
Tomoegawa Paper, earnings declined.

Although the company made no reference as to why the accounting change

was implemented, one possible reason to adopt this income-reducing
depreciation method is income tax considerations. In Japan, the Ministry of
Finance, the equivalent of the IRS in the U.S., uses a companys GAAP-based
earnings statement as the basis to assess corporate income taxes. Thus, unlike
the U.S., where firms often try to make their GAAP-based performance look
better, in Japan the incentive is just the oppositethat is, Japanese firms are
incentivized to make firm performance look worse as a means to lower the level
of assessed income taxes.

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Solutions Manual, Chapter 7 7-3
Q7.7 Changing the Estimated Useful Life of a Long-lived Asset. Increasing
(decreasing) the expected useful life of amortizable or depreciable assets will
cause the level of current amortization/depreciation expense to decline
(increase), and consequently, cause the level of operating earnings to increase
(decrease). Given the voluntary nature of this policy change, research
concerning such changes suggests that the share price of McCormick &
Company should decline as the capital market speculates that the policy
change was intended to cover up poor future operating performance.

Q7.8 Exploration and Development Costs in the Natural Resource Industry. The
process of exploration and development (E&P) in the natural resource industry
is very similar to the process of research and development (R&D) in the biotech
industry. Thus, it does appear inconsistent to treat E&P as a capitalizable asset
under the full cost and successful efforts methods, while treating R&D only as
an expense. The treatment of E&P as an asset rather than as an expense,
appears to have some historical context, namely that early in the 20 th century,
the U.S. government made a strategic decision to prioritize the development of
U.S. natural resources. For example, by examining the IRS Code for the
allowable percentage depletion allowance, we can see that the oil and gas
industry received the highest (15 percent) percentage depletion allowance, thus
reflecting the priority for development of this resource. No doubt this same kind
of thinking was involved in the deliberations around acceptable U.S. GAAP.
Clearly, allowing natural resource companies to capitalize some or all of their
E&P avoids the managerial disincentive associated with expensing R&D.
Further, allowing natural resource firms to capitalize some or all E&P facilitates
capital development (i.e., it is easier to raise capital if earnings are higher, as
they would be if E&P were capitalized).

Q7.9 Asset Impairments. The process followed by most firms to evaluate whether
an asset impairment has occurred is usually based on the concept of
discounted cash flow. For example, Bristol-Myers Squibb (BMS) reports in its
annual report:

Impairment of Long-lived Assets

The Company periodically evaluates whether current facts or
circumstances indicate that the carrying value of its depreciable assets
may not be recoverable. If such circumstances are determined to exist, an
estimate of undiscounted future cash flow produced by the long-lived asset.
is compared to the carrying value to determine if an impairment exists. If
an asset is determined to be impaired, the loss is measured based on the
difference between the assets fair value and its carrying value. An estimate
of the asset fair value is based on quoted prices in active markets . . . or on
various valuation techniques, including a discounted value of estimated
future cash flows.

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7-4 Financial Accounting for Executives & MBAs, 3 rd Edition
Q7.10 Capitalized Interest and Cash Flow. This question presents a classic straw-
man situation. The cash flow from operations should include the capitalized
interest only if one believes that the interest should not have been capitalized in
the first place, and hence, that the cost of borrowing used in the self-
construction of an asset should not be capitalized to the assets cost basis. If
you believe that it is proper and correct to capitalize the cost of borrowing on
self-constructed assets, then the cash outflows for capitalized interest should
appear as part of the cash flow from investing.

Q7.11 Depreciation, Depletion, Amortization and Cash Flow. The frequently-

mentioned statement that depreciation, depletion and amortization are sources
of operating cash flow is indeed very incorrect. This incorrect interpretation
regarding the relationship between these cost allocation processes and
operating cash flow is a direct consequence of the indirect method format of
presenting the statement of cash flows, wherein depreciation, depletion, and
amortization (DD&A) are added back to net income as if they were a source of
cash flow. The reality is, however, that the add-back is undertaken because
DD&A are noncash expenses subtracted in the measurement of accrual net
income. They are added back to adjust (i.e., avoid understating) net income to
fully reflect the positive operating cash flow of a business.

Q7.12 R & D Failure and Share Prices. Since research and development costs are
expensed when incurred, the termination of the Torcetrapib clinical trials would
have no immediate impact on Pfizers financial statements (i.e. there were no
capitalized R&D costs to expense following the news announcement). The
decline in Pfizers share price reflected the reduction in future revenues,
earnings, and cash flow that the capital market had already impounded into
Pfizers share price in anticipation of the successful completion of the
Torcetrapib clinical trials. The price decline reflects the futuristic approach
utilized by the capital market to value shares (i.e., a companys share price
today is a function of its future expected earnings and cash flow).

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Solutions Manual, Chapter 7 7-5
Q7.13 (Ethics Perspective) Depreciation Policy Choices to Manage Short-term
Profits. How one feels about utilizing techniques such as extending
depreciable lives to increase reported income likely depends on how one views
earnings management in general. It is nearly universally agreed that earnings
management for purely personal gain, especially if it involves deceit, is an
ethical breach. Does this situation fall under a similar view?

In order to alter the depreciable lives of a companys assets, assuming the

amount is material to the companys financial results, the manager will first
have to get the external auditors approval. Secondly, again assuming the
amounts to be material, this change will need to be disclosed in the financial
statement footnotes. Therefore, one can certainly argue that this change, being
fully vetted and disclosed, is not deceitful. Others may counter-argue, however,
that if the change is being undertaken purely to alter reported net income and
not to better convey a more accurate representation of financial performance,
such conduct represents an ethical breach. As with many ethical questions,
there is no clear right or wrong answer to this situation.

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7-6 Financial Accounting for Executives & MBAs, 3 rd Edition
 EXERCISES

E7.14 Determining the Cost of an Asset.

a Land: Purchase price $200,000

.
Demolition of old station 20,000
Legal fees on purchase 35,000
$255,000

b Warehouse: Construction cost $550,000

.
Architect fees 42,000
Interest on loan 18,000
$610,000

E7.15 Determining the Cost of an Asset.

Conveyor System: Purchase price $1,200,000

Installation cost 75,000
$1,275,000

The cost of an asset includes its acquisition cost ($1,200,000) and any costs
incurred to bring the asset to a revenue-producing state ($75,000).

E7.16 Calculating Repair and Maintenance Expense.

Repair and maintenance:

Broken driveshaft $30,000
Regularly scheduled repairs 75,000
Foam roof 200,000
$305,000

The cost of equipment overhaul can go either way repair or betterment.

Technically, since it improved the efficiency of the machines, it is a betterment;
but, if the cost is immaterial, many firms would simply expense it.

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Solutions Manual, Chapter 7 7-7
E7.17 Computing Depreciation Expense.
Cost of equipment $290,000
Less: Salvage value (30,000)
Depreciable cost $260,000

2012 2013 2014 2015 2016

Straight-line depreciation $52,000 $52,000 $52,000 $52,000 $52,000
Double-declining balance
(a) without S-L switch-over $116,000 $69,600 $41,760 $25,056 $7,584
(b) with S-L switch-over $116,000 $69,600 $41,760 $16,320 $16,320

A manager is likely to prefer the double-declining-balance method for income

tax purposes because of the rapid write-off of the asset, whereas for financial
reporting purposes, a manager is likely to prefer the straight-line method for its
expense and income-smoothing feature.

E7.18 Full Cost versus Successful Efforts Method.

Successful
Full Cost Efforts
Cost of drilling rights $500,000 $500,000
Roads and containment ponds 40,000 40,000
Exploration cost
8 wells @ $100,000 800,000
2 wells @ $100,000 200,000
Development cost
2 wells @ $120,000 240,000 240,000
Total capitalized cost $1,580,000 $980,000

The difference ($600,000) between the capitalized cost of the two methods is
the amount of expenses that will be immediately written off. Thus, for tax
purposes, the successful efforts method provides immediate tax-sheltering of
income in the amount of $600,000. Assuming a tax rate of 30%, that could
mean a current tax saving of $180,000 ($600,000 x 30%). Under full cost, these
costs are capitalized, to be depleted over time, and hence, full cost provides the
highest level of current income. So, if earnings maximization is the goal, the full
cost method achieves that goal best.

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7-8 Financial Accounting for Executives & MBAs, 3 rd Edition
E7.19 Calculating Accelerated Depreciation.
Cost $640,000
Less: Salvage value (20,000)
Depreciable cost $620,000

a. Sum-of-the-years digits

n(n + 1) 12(13)
= = 78
Sum-of-the-years = 2 2

Depreciation Depreciable Depreciation

Year Rate Cost Expense

1 12/78 $620,000 $95,385

2 11/78 620,000 87,436
3 10/78 620,000 79,487
4 9/78 620,000 71,538
5 8/78 620,000 63,590
Total $397,436

b. Double-Declining Balance (without straight-line switchover)

Depreciation Book Depreciation

Year Rate Value Expense

1 2/12 $640,000 $106,667

2 2/12 533,333 88,889
3 2/12 444,444 74,074
4 2/12 370,370 61,728
5 2/12 308,642 51,440
Total $382,798

For this set of facts, it appears that for the five-year period, the sum-of-the-
years digits method yields the largest total depreciation deduction, and thus,
would be preferred to the double-declining method for income tax purposes.
For financial reporting purposes, it appears to be a toss-up.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 7 7-9
E7.20 Calculating Units-of-Production Depreciation.

a. Units-of-production depreciation

($400,000 - $40,000)
Depreciation Charge per Mile $0.72 per mile
500,000

Mileage Depreciation
Year Driven Rate Expense

1 80,000 $0.72 $57,600

2 75,000 $0.72 54,000
3 80,000 $0.72 57,600
4 76,000 $0.72 54,720
5 60,000 $0.72 43,200
Total $267,120

The units-of-production method yields a higher total depreciation charge

($267,120) than does straight-line ($225,000).

b. Straight-line depreciation:

($400,000 - $40,000)
Depreciation Expense = = $45,000 per year
8

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7-10 Financial Accounting for Executives & MBAs, 3 rd Edition
E7.21 Analyzing Noncurrent Asset Disclosures.
Year 1 Year 2
Intangible asset turnover 1.85x 1.58x
Fixed asset turnover 3.00x 2.86x
Accumulated depreciation divided by
gross fixed assets 35.8% 31.7%

The trend of the intangible asset turnover ratio for Pfizer suggests that the
companys ability to generate revenue from its investment in intangibles is
declining. One possible explanation for this is that during Year 2, Pfizer made a
large acquisition involving a significant investment in new intangibles that have
yet to attain the expected level of revenue generation.

The trend of the fixed asset turnover ratio is negative, suggesting that the
company is generating a decreasing amount of revenue from its investment in
property, plant, and equipment.

The accumulated depreciation divided by gross fixed assets ratio indicates the
relative age of Pfizers fixed assets. Not surprisingly, the approximate age of the
companys fixed assets decreased by four percent. Pfizers fixed assets are
relatively young in that they have over 60 percent of their remaining useful
lives.

E7.22 Calculating the Depletion Expense. Capitalized cost of reserves:

Drilling rights $10,000,000

Exploratory wells 400,000
Development wells 800,000
Total cost $11,200,000

Depletion charge per barrel = $11,200,000 500,000 = $22.40 per barrel

Year 1: Depletion expense = 100,000 x $22.40 = $2,240,000

Year 2: Depletion expense = 150,000 x $22.40 = $3,360,000

Cost basis of reserves at end of Year 2:

Total cost $11,200,000

Less: Depletion
Year 1 (2,240,000)
Year 2 (3,360,000)
Net book value $5,600,000

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Solutions Manual, Chapter 7 7-11
E7.23 Intangible Assets.
1. Organization costs of $125,000 capitalize to the balance sheet and
amortize over five years.
2. Research costs of $450,000expense. Patent filing fees of $30,000
capitalize to the balance sheet and amortize over the patents expected
useful life but not to exceed its legal life.
3. Legal defense fees of $200,000 capitalize to the patent account on the
balance sheet and amortize over the patents useful life but not to exceed its
remaining legal life.
4. Patent purchased at a cost of $700,000 initially capitalize as an asset, but
upon losing the court case, expense the full amount as an impairment.
Regarding the legal fees of $175,000, this is expensed on the income
statement as it is a cost of doing business.

E7.24 Changing the Estimated Life of a Depreciable Asset.

Years 1-8:
Straight-line depreciation = ($750,000 - $30,000) 10 years = $72,000 per year

Year 9:
Remaining book value = ($750,000 - $576,000) = $174,000
Straight-line depreciation = ($174,000 - $30,000) 6 years = $24,000 per year

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7-12 Financial Accounting for Executives & MBAs, 3 rd Edition
 PROBLEMS

P7.25 Calculating Depreciation.

Year 1 Year 2 Year 3
1 Straight-line $1.75 million $1.75 million $1.75 million
.

2 Double-declining balance $4.0 million $3.6 million $3.24 million

.

The choice of depreciation method does not impact a firms cash flow from
operations because under the indirect method, the amount of depreciation
subtracted from accrual net income is added back to net income, creating a
wash. The choice of method also does not affect a companys income taxes
because all U.S. firms are required to use the MACRS system; in short, there is
no method choice for income tax purposes.

P7.26 Capitalize versus Expense.

1. Increase
2. Decrease
3. No effect
4. No effect
5. No effect

P7.27 Intangible Assets.

1. May be capitalized
2. Expense as incurred
3. Capitalize and amortize
4. Expense
5. Expense

P7.28 Betterment versus Maintenance Expenditures.

Classification
Regularly scheduled repairs Expense as maintenance

Overhaul stamping machines Capitalize as betterment

Replace pump Expense as maintenance

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Solutions Manual, Chapter 7 7-13
Cambridge Business Publishers, 2014
7-14 Financial Accounting for Executives & MBAs, 3 rd Edition
 P7.29 Depletion Expense.
1. Depletion charge per barrel = $40 $8 = $5.00 per barrel.

2. 2012 depletion expense = 2,000,000 barrels x $5 = $10,000,000.

3. Under U.S. Department of Treasury Publication 535, oil and gas companies
must use the higher of cost depletion or statutory percentage depletion. Cost depletion
is demonstrated in Questions 1 and 2 of this exercise. Under statutory percentage
depletion, an oil and gas company may deduct depletion expense equal to 15 percent of
annual gross revenue.

P7.30 Estimating Depreciation Expense and Book Value.

Depreciation Expense Net Book Value
Year 1 Year 2
Year 1 Year 2 (year-end) (year-end)
Straight-line $6,000 $6,000 $23,000 $17,000

Double-declining balance 14,500 7,250 14,500 7,250

Units-of-production 4,200 6,000 24,800 18,800

A companys choice of depreciation method should be independent of its asset

replacement policy. Thus, even though double-declining balance depreciation
may depreciate an asset faster than the straight-line method, a company may
continue to use a fully depreciated asset, assuming that the asset still has
productive capacity.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 7 7-15
P7.31 Successful Efforts versus Full Cost Method.
Financial statements under successful efforts:
Income Statement (in millions)
2011 2012 2013 2014 2015 Total
Revenues $30.0 $45.0 $52.5 $100.0 $157.5 $385.0
Less:
Lifting Costs (5.0) (7.5) (9.0) (17.5) (28.0) (67.0)
Exploration Costs (16.0) -0- -0- -0- -0- (16.0)
Interest Expense (4.0) (4.0) (3.0) (2.0) (1.0) (14.0)
Depletion Expense (2.4) (3.6) (3.6) (6.0) (8.4) (24.0)
Income Before Tax $ 2.6 $29.9 $36.9 $ 74.5 $120.1 $264.0

*Exploration costs = $40 x 20/50 = $16; (20/50 = ratio of unsuccessful to total wells).

**Depletion schedule:

2011 2012 2013 2014 2015

Production ratio =
Actual Production
Total Production .1 .15 .15 .25 .35

Successful efforts .1($24) .15($24) .15($24) .25($24) .35($24)

Full cost .1($40) 15($40) .15($40) .25($40) .35($40)

Balance Sheet (in millions)

2011 2012 2013 2014 2015
Assets
Cash $ 21.0 $ 44.5 $ 75.0 $ 145.5 $ 264.0
Oil reserves 24.0 24.0 24.0 24.0 24.0
Less:
Accumulated depletion (2.4) (6.0) (9.6) (15.6) (24.0)
Total $ 42.6 $ 62.5 $ 89.4 $ 153.9 $ 264.0

Liabilities &
Shareholders Equity
Bank loan $ 40.0 $ 30.0 $ 20.0 $ 10.0 $-0-
Retained earnings 2.6 32.5 69.4 143.9 264.0
Total $ 42.6 $ 62.5 $ 89.4 $ 153.9 $ 264.0

Continued next page

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7-16 Financial Accounting for Executives & MBAs, 3 rd Edition
 Continued

Financial statements under full cost

Income Statement (in millions)
2011 2012 2013 2014 2015 Total
Revenues $30.0 $45.0 $52.5 $100.0 $157.5 $385.0
Less:
Lifting Costs (5.0) (7.5) (9.0) (17.5) (28.0) (67.0)
Exploration Costs -0- -0- -0- -0- -0- -0-
Interest Expense (4.0) (4.0) (3.0) (2.0) (1.0) (14.0)
Depletion Expense (4.0) (6.0) (6.0) (10.0) (14.0) (40.0)
Income Before Tax $17.0 $27.5 $34.5 $ 70.5 $114.5 $264.0

*See depletion schedule above under successful efforts.

Balance Sheet (in millions)

2011 2012 2013 2014 2015
Assets
Cash $ 21.0 $ 44.5 $ 75.0 $ 145.5 $ 264.0
Oil reserves 40.0 40.0 40.0 40.0 40.0
Less:
Accumulated depletion (4.0) (10.0) (16.0) (26.0) (40.0)
Total $ 57.0 $ 74.5 $ 99.0 $ 159.5 $ 264.0

Liabilities &
Shareholders Equity
Bank loan $ 40.0 $ 30.0 $ 20.0 $ 10.0 $-0-
Retained earnings 17.0 44.5 79.0 149.5 264.0
Total $ 57.0 $ 74.5 $ 99.0 $ 159.5 $ 264.0

P7.32 Impairment of Long-Lived Assets: Goodwill.

1. Financial Impact.
Income Statement: The write-off would be reported as a special loss.

Balance Sheet: 2011 Goodwill, attributable to Fresh Dairy Direct, declined

by $2.1 billion to $87 million.

Statement of Cash Flow: A $2.1 billion add-back to net income under the
operating activities section.

2. Debt Covenants. Dean Foods claims the impairment had no

adverse effect on its ability to meet its debt covenants; however the
impairment will make the company closer to a violation.

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Solutions Manual, Chapter 7 7-17
P7.33 Intangible Assets: Deferred Subscriber Acquisition Costs.
1. $147 million

2. $8,796 million ($9,260 - $464)

3. The amounts would be the same. Under either scenario the cash has been
expended, but it is how and when those payments become expenses on the
income statement that will differ.

4. 594 million = 630+111-147. If the amounts had always been expensed, then
there would be no need for the amortization (thus the add-back). However,
the cash expended would be expensed during the year, thus the subtraction
of $147.

Note: A full reconciliation of the balance sheet account with the statement
of cash flow data reveals the following:

Deferred subscriber acquisition costs, net

Beginning balance $ 417
Purchased with operating cash 147
Not reconcilable* 9
Amortized during 2012 (111)
Ending balance $ 464

* Changes in account balances that do not reconcile to the changes

reported on the statement of cash flow are not unusual. This amount likely
represents increases in the asset arising from activities that are non-cash.
The most common cause of these would be acquisitions of other
companies. Corporate acquisitions are not operating expenditures, but
rather investment activities. Another cause would be the reclassification of
amounts from other accounts. A review of ADTs 2012 annual report does
not reveal the source.

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7-18 Financial Accounting for Executives & MBAs, 3 rd Edition
 CORPORATE ANALYSIS

CA7.34 The Procter and Gamble Company.

a. Capital Intensity Ratio 2012 2011
Net property, plant and equipment total assets 15.4% 15.4%
Net goodwill and other intangible assets total
assets 64.1% 65.2%
Capital intensity ratio 79.5% 80.6%
Goodwill and other intangible assets are the largest asset group for P&G
representing over 64 and 65 percent of the companys assets, for 2012 and
2011, respectively. Since approximately 80 percent of P&Gs assets are
represented by these two asset groups, P&G would qualify as a capital-
intensive company.

b. Noncurrent Asset Ratios 2012 2011

Fixed asset turnover ratio 4.11x 3.81x
Intangible asset turnover ratio 0.99x 0.90x

The turnover ratios for both fixed assets and intangible assets improved
from 2011 to 2012. In short, P&G used its noncurrent assets more
effectively in terms of generating incremental sales in 2012.

c. Depreciation and Amortization Expense 2012 2011

Depreciation expense1) $2,704 $2,292
Amortization expense2) 500 546
Total $3,204 $2,838
1)
See statement of cash flow for the total of depreciation expense and amortization
expense.
2)
See footnote 2.

P&G uses straight-line depreciation for all of its depreciable assets.

(Estimated useful lives are periodically reviewed and, when appropriate,
changes are made prospectively.)
2012 2011
Age of fixed assets
Accumulated depreciation gross P,P&E 49.4% 48.7%

P&Gs fixed assets are nearly 50 percent used up, with approximately 50
percent of their expected life still remaining.

d. Impairment Charges:

P&G incurred impairment charges of $1,576 million in 2012 and none in

2011.
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Cambridge Business Publishers, 2014
7-20 Financial Accounting for Executives & MBAs, 3 rd Edition
CA7.35.Internet-based Analysis. No solution is provided as any solution would be
unique to the company selected.

CA7.36 IFRS Financial Statements. LVMH Moet Hennessey-Louis Vuitton S.A.

a. Purchased brand names are capitalized and amortized over their useful
lives. Internally-developed developed brand names are not capitalized and
instead are expensed. This policy is essentially consistent with U.S. GAAP.

b. Determining the expected useful life of a brand name involves an

assessment of expected future sales and the development of pro forma
income statements to identify the economic viability of a product-line. LVMH
has considerable experience in the luxury goods business, and thus, is
likely to be able to forecast with considerable accuracy future sales. The
company also probably follows an operating policy of regularly introducing
new product-lines and removing older ones. Thus, the company has access
to a number of indicators of exactly how long a brand name is likely to exist
(i.e. its expected useful life). The companys annual report states in Note 1.8
to the Condensed Consolidated Financial Statements that the classification
of a brand or trade name as an asset of definite or indefinite useful life is
generally based on the following criteria:
The brand or trade names positioning in its market expressed in terms
of volume of activity, international presence and notoriety;
Its expected long term profitability;
Its degree of exposure to changes in the economic environment;
Any major event within its business segment liable to compromise its
future development;
Its age. Amortizable lives of brands and trade names with definite
useful lives range from 15 to 40 years, depending on their estimated
period of utilization.

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Solutions Manual, Chapter 7 7-21