ACC1002X Financial Accounting

Semester 2 of Academic Year 2015-2016

SOLUTIONS to Optional Questions
CHAPTER 8: 8-44, 8-62, 8-68, 8-71

8-44
Leasehold Improvements would be increased, and Cash would be decreased by
$120,000. The annual amortization would be based on the remaining life of the lease:
($120,000 4 years) = $30,000 per year. Note that amortization is over the remaining lease
term, not the physical life of the improvements.
8-62 Amounts are in millions of dollars.

Revenues (all cash)

Cash operating expenses
Cash provided by operations
before income taxes
Depreciation expense
Pretax income
Income tax expense
Net income
Supplementary analysis:
Cash provided by operations
before income taxes
Income tax expense
Net cash provided by operations
3.

1. Zero Income Taxes

2. 40% Income Taxes
Straight-line
Accelerated Straight-line Accelerated
Depreciation Depreciation Depreciation Depreciation
$405,607
$405,607
$405,607
$405,607
376,070
376,070
376,070
376,070
29,537
6,739
22,798

$ 22,798

29,537
8,739
20,798

$ 20,798

29,537
6,739
22,798
9,119
$ 13,679

29,537
8,739
20,798
8,319
$ 12,479

$29,537

$29,537

$29,537

$29,537

$29,537
9,119
$20,418

$29,537
8,319
$21,218

By itself, depreciation expense does not provide cash. This point is illustrated by part 1,
which compares the amounts shown with zero income taxes. Note that the cash provided
by operations (and the ending cash balances) are exactly the same. No matter what
depreciation expense is allocated to the year (whether $6,739 million, $8,739 million, or
zero), the $29,537 million cash provided by operations and the ending cash will be
unaffected.

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Examine part 2, which compares amounts after taxes. Again, by itself, depreciation does
not affect the cash inflow provided by operations. Only sales to customers can provide
more cash receipts from operations. However, depreciation does affect the cash outflow
for income taxes. The use of accelerated depreciation results in a strange combination of
showing less net income but conserving more cash. The accelerated method shows net
income of $12,479 million (compared with $13,679 million using straight-line), but
accelerated shows a net increase in cash provided by operations after considering income
taxes of $21,218 million (compared with $20,418 million using straight-line).
Accordingly, the final cash balance would be $800 million higher for accelerated than for
straight-line.
4.

Cash, increase by tax savings, (.40 $2,000 million) = $800 million

Accumulated depreciation, increase by $2,000 million
Pretax income, decrease by $2,000 million
Income tax expense, decrease by $800 million
Retained earnings, decrease by $1,200 million
New balances: cash, ($7,275 million + $800 million) = $8,075 million
Accumulated depreciation, ($32,964 million + $2,000 million) = $34,964 million
Journal entries (not required) may clarify the effects (in millions):
Dr. Depreciation expense
Cr. Accumulated depreciation

$2,000 more

Dr. Income tax expense

$800 less
Cr. Cash
Note: A smaller credit to Cash increases the balance in Cash.

$2,000 more
$800 less

The effect on Retained Earnings would be ($2,000 million $800 million) = $1,200
million. That is, net income (and hence Retained Earnings) would be $1,200 million
lower.
5.

The $2,500 million increase in depreciation would cause net income to decrease but
would have no effect on cash provided by operations (shown on the third line of the
following table).

Revenues (all cash)

Cash operating expenses
Cash provided by operations
Depreciation expense
Pretax income
Income tax expense
Net income

Straight-line
Depreciation
Before
After
$405,607
$405,607
376,070
376,070
29,537
29,537
6,739
9,239
22,798
20,298

$ 22,798
$ 20,298

Accelerated
Depreciation
Before
After
$405,607
$405,607
376,070
376,070
29,537
29,537
8,739
11,239
20,798
18,298

$ 20,798
$ 18,298

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8-68

Data are in millions.

1.

Proceeds
Less: Net book value of equipment sold is [$36 (6 $1)]
Gain on sale of equipment
A

Cash
+32

Equipment

$32
30
$ 2
=

L+

Accumulated
Depreciation,
Equipment

-36

+6 a

SE
Retained
Earnings
+2 b

a Accumulated depreciation for 6 years is (6 $1) = $6. The effect of removing the net
book value is $30, consisting of a decrease in Equipment of $36 and a decrease in
Accumulated Depreciation of $6. Thus, ($32 $30) = $2. Note that the effect of a
decrease in Accumulated Depreciation (by itself) is an increase in assets.
b The $2 is usually carried separately until the end of the year as Gain on Sale of
Equipment, or Gain on Disposal of Equipment.
Income statement effects:
Alaska would include the Gain on Sale of Equipment as a part of Other Income
(Expense).
2.

a.

b.

Dr. Cash
Dr. Accumulated depreciation
Cr. Equipment
Cr. Gain on sale of equipment

32
6

Dr. Cash
Dr. Accumulated depreciation
Dr. Loss on sale of equipment
Cr. Equipment

29
6
1

36
2

36

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8-71

Amounts are in millions. This case highlights how current values of equipment may have
little relation to book values.

1.

Sales price, (7 $25)

Book value:
Acquisition cost, (7 $25) =
Less: Accumulated depreciation
[7 8 yrs. ($25 - $3.5) 10 yrs.] =
Gain on sale

2.

Dr. Cash (or Receivables)

Dr. Accumulated depreciation
Cr. Aircraft
Cr. Gain on sale of aircraft

$175.0
175.0
120.4

54.6
$120.4
175.0
120.4
175.0
120.4

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