CH10 CACC414 Long-Lived Assets 1. Tangible Capital Assets - Property, plant, and equipment - (can also be referred as plant assets or fixed assets) 2. Intangible Assets Amortization is the allocation of the cost of any long-lived asset to different accounting periods
TANGIBLE CAPITAL ASSETS
3 MAJOR CHARACTERISTICS
1. Acquired and held for use in operations and not for sale 2. Long-term in nature and usually subject to amortization - Exception: Land is not amortized unless a material and continual decline in value occurs - Periodic amortization charges = cost of the investment in the asset assigned to the periods that benefit from using them 3. Possess physical substance
SUPPLY INVENTORY V. CAPITAL ASSET
Suppose: - Capital Asset = {substantial fleet of trucks} - Truck related asset = {spare tires, major motor parts, oil and grease, and truck cleaning equipment} Then: 1. Include in inventory any spare parts and servicing equipment that have multiple uses and are regularly used and replaced within the accounting period 2. Include in capital asset major spare parts and standby/servicing equipment that either are useful for more than one period or can be used only with a particular capital asset
ACQUISITION COSTS
HISTORICAL COST IS THE USUAL BASIS FOR VALUING PPE
Historical Cost is measured by cash or cash equivalent price of 1. obtaining the asset + 2. bringing it to the location + 3. getting it into proper condition necessary for its intended use Asset's Cost Includes: 1. purchase price 2. freight cost 3. provincial sales taxes 4. productive asset's installation costs (The cost are allocated to future periods using amortization) Cost incurred after acquisition are:
CACC414 CH10 1. added to the asset's cost IF they increase future service potential 2. expensed IF they do not add to the asset's original service potential At Acquisition Date Asset's Value = Cost of Asset Currently in Canada: 1. "write-up" of fixed assets' value is not allowed - Exception: during financial reorganization 2. Only historical cost can be used to value non-financial assets (with minor exceptions) Reasons: 1. At acquisition date, cost reflects fair value 2. Historical cost involves actual, not hypothetical, transactions, and as a result is more objective 3. Gains should not be anticipated and recognized before they are realized, that is, before the asset is converted into cash or a claim to cash
COST OF LAND
= EXPENDITURES THAT ARE MADE TO ACQUIRE LAND AND MAKE IT READY FOR USE
LAND COSTS INCLUDE 1. Purchase price 2. Closing costs - Title, legal, and recording fees 3. Cost of getting land ready for use - removal of old building, clearing, grading, filling and draining 4. Assumption of Liens 5. Additional improvements with indefinite life Land Improvements 1) Improvements with limited lives are recorded in a separate Land Improvements account These costs are separated from Land as they are amortized over their estimated useful lives Ex: driveways, walkways, fences and parking lots 2) Permanent improvements to the land such as landscaping are added to the Land account FINAL LAND COST = LAND COST (Proceeds that are obtained in the process of getting the land ready for its intended purpose) Ex: amounts received for salvaged materials from the demolition of old buildings
COST OF BUILDINGS
= EXPENDITURES THAT ARE DIRECTLY RELATED TO ACQUIRING OR CONSTRUCTING THEM
BUILDING COSTS INCLUDE 1. Cost of material, labor, and overhead 2. Professional fees and building permit FINAL BUILDING COST = All cost that are incurred, from excavation to complete
LAND COST V. BUILDING COST
CACC414 CH10
IS THE COST TO REMOVE THE OLD BUILDING A COST OF THE LAND OR OF THE NEW BUILDING?
IF Land is purchased with an old building on it THEN Demolition cost salvage value of building = Land Cost IF Building, which was previously used, was razed (tear down) to raise a new building on the same land THEN Demolition cost salvage value of building = Loss/Gain on Disposal of old asset
LEASEHOLD IMPROVEMENTS
= CAPITAL EXPENDITURES THAT ARE MADE ON PROPERTY THAT IS BEING LEASED OR RENTED
Lessee charges the cost to a separate capital asset account "Leasehold improvements" and the cost is amortized as an operating expense over the remaining life of the MIN(remaining life of lease, useful life of improvement)
COST OF EQUIPMENT
(delivery equipment, office equipment, factory equipment, machinery and furniture)
= EXPENDITURES THAT ARE MADE IN ACQUIRING THE ASSET AND PREPARING IT FOR USE
EQUIPMENT COSTS INCLUDE 1. Purchase price 2. Freight and handling charges 3. Insurance while in transit 4. Cost of special foundation, assembly and installation 5. Cost of trial runs
ASSET RETIREMENT COST
CICA requires companies to recognize the obligation or liability that is associated with the asset's retirement - It is recognize in the period when the legal obligation is created - It is expensed through periodic amortization Recognizing asset retirement cost 1. Record as a liability 2. Increasing the carrying amount of the related long-lived asset by the same amount as the liability
PAGE 582 586 NOT IN LECTURE SLIDES OTHER COST ISSUES: CASH DISCOUNTS
WHEN cash discount are offered on purchases on plant assets, and IF discount is taken: 1) It is NOT recognized as a purchase discount (only recognize as purchase discount on inventory purchases)
CACC414 CH10 2) = reduction in capital asset's purchase price IF discount is not taken use net-of-discount approach - The asset cost is reduced by the discount amount even if discount is not taken Reason: - Asset's cost is its cash or cash equivalent price - Failure to take them indicates management error or inefficiency - Cost of not taking the discount should be recognized as a financing or interest expense
OTHER COST ISSUES: DEFERRED PAYMENT CONTRACTS
(Not part of lecture slides) Plant assets are often purchased on long-term credit contract through the use of 1. Notes 2. Mortgages 3. Bonds 4. Equipment obligations These asset, which are purchased on long-term credit contract, are accounted for at the PV of the consideration that is exchanged between the contracting parties at the transaction date
Example
Sutter Corporation purchases a specially built robot spray painter for its production line - Company issues a $100,000, 5-year, non-interest bearing not to Wrigley Robotics - Interest = 10% - Sutter is to pay off not in five $20,000 instalments made at the end of each year Suppose the fair market value of the robot = fair value of the note = PV of note PV of note = 20,000 () = 75,816 At Date of Purchase Equipment Discount on Notes Payable Notes Payable 75,816 24,814 100,000
$24,814 = discount/interest on the $75,816 borrowed At the end of the first year Under the effective interest approach, the interest = (100,000 24,184) 10% = 7,582 Interest Expense 7,582 Discount on Notes Payable 7,582 Notes Payable 20,000 Cash 20,000 At the end of the second year Interest Expense 6,340 Discount on Notes Payable
6,340
CACC414 CH10 Notes Payable Cash Interest 20,000 expense 20,000 = 10% (Outstanding amt in notes payable contra account "discount on notes payable" = 10% (100,000 (24,184 7,582) 20,000) = 10% 63, 398 =6,340
IF INTEREST WAS NOT TAKEN INTO ACCOUNT: 1. Asset will be recorded at an amount greater than its fair value 2. Interest expense amount reported in the income statement will be understated for all periods involved
OTHER COST ISSUES: LUMP SUM PURCHASE
Lump Sum Purchase = Cost of assets, acquired at a single lump sum price, is allocated to assets on the basis of their relative fair market values Example: Inventory, land and building purchased for lump sum of $80,000
Suppose: Asset 1. Inventory 2. Land 3. Building Book Value ($) 30,000 20,000 35,000 $85,000 Fair Value ($) 25,000 25,000 50,000 $100,000
BOOK VALUE IS IRRELVANT! COST ALLOCATION ARE AS FOLLOW:
OTHER COST ISSUES: ISSUANCE OF SHARES
WHEN property is acquired by issuing shares: COST OF ASSET = fair value of the shares given up OR = fair value of the asset received (It is not measured by the par, stated, or book value of the shares) IF Shares are traded actively cost of asset = fair value = market value
IF fair value of shares cannot be determined cost of asset = fair value of acquired asset (No determinable market value) EXAMPLE Instead of paying cash for land, it issues to the seller 5,000 no par value common shares with a fair market value of $12 per share The following entry must be made:
CACC414 CH10 Land (5,000 $12) $60,000 Common Shares $60,000
OTHER COST ISSUES: EXCHANGE OF ASSETS
Monetary assets are "money" or claims to future CFs that are fixed or determinable in amounts and timing by contract or other arrangements Ex: accounts and notes payable Non-Monetary Assets are assets that are not claims to fixed or determinable cash flows Ex: Inventory, PPE Non-Reciprocal Transfer is a transfer of asset with little or no monetary consideration
EXCHANGE OF ASSETS Type 1: monetary transaction Monetary exchange of assets occurs when:
1. Non-monetary assets are acquired for cash or other monetary assets Exchange For Non-Monetary Asset Monetary Asset or Cash Non-monetary assets are disposed of in exchange for monetary assets Disposed For Non-Monetary Asset Monetary Asset or Cash
OR
2.
EXCHANGE OF ASSETS Type 2: non-monetary transaction: {Non-monetary exchanges, non-monetary non-reciprocal transfer = contribution of assets} Non-Monetary exchange of assets occurs when:
Non-monetary assets are acquired for cash or other monetary assets Exchange For Non-Monetary Asset New Non-Monetary Asset or Cash
GENERAL PRINCIPLE FAIR VALUE STANDARD - Non monetary transactions are accounted for on the same basis as monetary transactions Non-Monetary/Monetary Exchange Is Valued At
1. Fair value of the asset given up OR 2. Fair value of the asset received (Whichever is more reliably measurable)
GAIN OR LOSS ON THE EXCHANGE IS RECOGNIZED IN INCOME Exception to standard:
If one or more of the following conditions exist: 1) transaction lacks commercial substance 2) fair values are not determinable exchange cannot be recorded at fair value of asset given up or received reliably 3) exchange merely to facilitate a sale to customers see page 592 593 for example Then: 1) new asset cost = book value of assets given up, and 2) no gain is recognized
CACC414 CH10 A transaction has commercial substance ONLY IF there is a significant change in the entity's expected future cash flow. There is a significant change if one of the following occurs 2.1) change in configuration of CF underlying the assets that have been exchanged 2.2) change in the assets' value-in-use or entity-specific occurs
ACCOUNTING FOR ASSET EXCHANGE SUMMARY
YES APPLY FAIR VALUE STANDARD STANDARD Acquisition cost of asset(s) received = (Fair value of what is given up) OR =(Fair value of what is acquired) (Book value) (Fair value) = amount to be recognized in income given up
NO EXCEPTION TO FAIR VALUE acquisition cost of asset(s) received = carrying amount of asset(s) given up No gain is recognized Loss is recognized only when (fair value of asset(s) acquired) < (carrying amt of asset
DETAIL AND APPLICATION OF EXCHANGE OF ASSETS (PAGE 592 595)
OTHER COST ISSUES: CONTRIBUTED ASSETS
Contributed Assets = Non-Reciprocal Transfers = transfers of asset in one direction only = no consideration Ex: cash, securities, land, usage of facilities, forgiveness of a debt etc IF Non-reciprocal transfer is non-monetary in nature THEN 1. accounting standard is the same as the standard for non-monetary exchanges 2. cost of asset = asset's fair value of acquired asset 3. There are 2 ways to record the acquisition cost of the asset 1) Capital Approach IF donation is made by shareholder 2) Income Approach IF donation is made by non-owner CAPITAL APPROACH Example: company accepted donation of land with a fair value of $150,000 from a major shareholder Company makes the following entry: Land 150,000 Contributed Surplus Donated Capital 150,000 INCOME APPROACH Contribution is reflected in 1. Net income OR 2. Other Comprehensive Income
CACC414 CH10 Recall: Comprehensive Income includes items that causes a change in equity (net asset) from non-owner sources (PAGE 596 -597 Not included in lecture slides) IF Contribution is made by the government THEN 1. Assistance should be recognized in income, either as 1) Revenue 2) Reduction of Expense 2. Assistance should be deferred and recognized over the period when the related assets are used 1) Cost reduction method (p.596) 2) Deferral method (p.596)
OTHER COST ISSUES: INVESTMENT TAX CREDITS
The investment tax credit (ITC) allows enterprises to deduct directly from their income tax liability a specified percentage of cost of eligible new capital assets is also available for current costs, such as research and development expenditures Example company purchases asset for $100,000 asset qualifies for a 10% investment tax credit Company has tax liability of $30,000
Taxes payable prior to ITC $30,000 Less investment tax credit ($100,000 10%) $10,000 Final tax liability $20,000
COSTS SUBSEQUENT TO ACQUISITION
1. Costs that are incurred to achieve greater future benefits are capitalized
(Capital expenditure)
2. Costs that are incurred to maintain a specific level of service are expensed
(Revenue expenditure)
In order for cost to be capitalized, one of four conditions must be present 1. Asset's life or useful life is increased 2. They physical output or service capacity of the asset is increased 3. The quality of the output is improved 4. The associated operating costs are deducted
4 Major Types of Expenditures are incurred for Existing Assets
1. Addition o Increase or extension of existing asset 2. Improvement and Replacement o Substitution of an improved asset for an existing one 3. Rearrangement and Reinstallation o movement of an asset from one location to another 4. Repairs o Expenditures that maintain assets in good operating condition
CACC414 CH10
SUMMARY OF COSTS SUBSEQUENT TO ACQUISITION
See page 601 602