INTCH10F03 - CHAPTER 10 ACQUISITION AND DISPOSITION OF...

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CHAPTER 10: ACQUISITION AND DISPOSITION OF PROPERTY, PLANT AND EQUIPMENT Objectives: Be able to illustrate your understanding of and record transactions related to the life cycle of a fixed asset: 1. Acquisition of fixed assets. 2. Capitalization of interest cost during construction. 3. Nonmonetary exchanges 4. Additions and Improvements. 5. Disposition of fixed assets. 1
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Objective 1: Acquisition of fixed assets: 1. Valuation : historical cost. All costs associated with getting it ready for use. 2. Components of cost Land : all costs to acquire and prepare it for use, such as removing old building, clearing, grading, parking lots, driveways? What about land improvements such as: Buildings : costs associated directly to acquisition and construction including architects' fees, building permits, attorney fees. Equipment : costs associated with getting it ready for use including freight, in transit insurance, cost of assembly. Self-constructed : all costs directly traced to fixed assets. What about indirect costs? Allocate portion of fixed overhead 2
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Objective 2, Capitalization of interest cost There are seven steps involved in the capitalization of interest. 1. Determine Which Assets Qualify for Capitalization of Interest. Qualifying assets include assets under construction for the firm's own use (such as buildings, machinery) and assets under construction for sale or lease as part of discrete projects (such as real estate projects). 2. Determine the Capitalization Period. The capitalization period begins when all three of the following conditions have been met: (i) Expenditures for the asset have been made (i.e., the firm has made cash payments or has incurred debt for construction of the asset). (ii) Necessary activities to get the asset ready for its intended use are in progress (i.e., actual construction work is taking place ). (iii) Interest cost of some kind is being incurred (i.e., the firm has some type of interest-bearing debt outstanding). This debt need not be specific debt incurred on the asset. it may be general debt such as bonds payable. Objective 2, continued 3
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Therefore a company may capitalize interest cost even though the entire construction cost of the asset was paid for in cash, continued so long as the company has some type of interest-bearing debt outstanding. The capitalization period ends when any one of these three conditions is no longer being met. 3. Compute the Expenditures Made During the Capitalization Period. An expenditure may be financed either with cash payments or with the incurrence of debt. Whenever an expenditure is made on a qualifying asset, the qualifying asset account is debited and either the cash account or a liability account is credited.
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