Chapter 3
Long-Term Assets
146
Critical Thinking
CT-1 (
2
3
6
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Grain Eagle Company manufactures and sells pet food. The company has adopted a partial-
year depreciation policy, where depreciation is taken on a monthly basis. The company’s
accounting intern treated the following events that occurred in 2016 as follows.
1) On March 31, 2016, Grain Eagle spent $16 million to purchase land that already
comes with a building, which the company will use as a warehouse. The land has a
fair value of $12 million and the building has a fair value of $8 million on the date
of the purchase. The building has a residual value of $2 million and is expected to
bring future economic benefits to the company evenly over its expected useful life
of 20 years. Because land and building are acquired together as a bulk purchase and
because the building is attached to the land, the intern recorded the $16 million
purchase simply as a debit to building and credit to cash.
2) On July 1, 2016, the company purchased a patent at a cost of $500,000. The patent has
a legal life of 20 years even though its useful life is expected to be only 10 years. The
intern recorded the purchase as a debit to patent and credit to cash of $500,000.
3) On November 30, 2016, the company spent $30,000 on different ingredients as part
of research and development. These ingredients will be tested to potentially develop
a new pet food formula. The intern capitalized this cost by debiting inventory and
crediting cash at $30,000.
4) On December 31, 2016, the company spent $100,000 in legal fees to successfully
defend a patent lawsuit. The intern capitalized the $100,000 by debiting patent and
crediting cash.
5) On December 31, 2016, the intern recorded depreciation and amortization for all
long-term assets, including the building and the patent listed above, and a machine
that Grain Eagle acquired on December 31, 2015. The machine costs $200,000, has
no residual value, and is expected to produce 2 million kilograms of pet food over its
10 years of useful life. The future economic benefit of the machine depends on the
number of kilograms of food it produces, which is expected to vary substantially from
year to year. The machine produced 250,000 kilograms of pet food in 2016. Since the
intern was not sure which depreciation method she should use, she decided to use the
straight-line method for all assets because that is easiest. She recorded depreciation
expenses of $20,000 for the machine and $600,000 for the building in 2016. She
amortized the patent over the patent’s legal life of 20 years. The patent’s amortization
expense from her calculation is $12,500. The intern recorded depreciation and
amortization expenses separately for each asset by debiting depreciation/amortization
expenses and crediting accumulated depreciation/amortization.
