Ch10_fixed asset I - Acquisition and Disposition of Acquisition Property Plant and Equipment Property Chapter 10 Chapter 10 ISV Intermediate

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Unformatted text preview: Acquisition and Disposition of Acquisition Property, Plant, and Equipment Property, Chapter 10 Chapter 10 ISV Intermediate Accounting 12th Edition Update Kieso, Weygandt, and Warfield Chapter 10-1 Prepared by Coby Harmon, University of California, Santa Barbara Learning Objectives 1. 2. 3. 4. 5. 6. Chapter 10-2 Identify the costs to include in initial valuation of property, Identify plant, and equipment. plant, Describe the accounting problems associated with selfDescribe selfconstructed assets. Describe the accounting problems associated with Describe interest capitalization. interest Understand accounting issues related to acquiring and Understand valuing plant assets. valuing Describe the accounting treatment for costs subsequent Describe to acquisition. to Describe the accounting treatment for the disposal of Describe property, plant, and equipment. property, Acquisition and Disposition of Acquisition Property, Plant, and Equipment Property, Acquisition Acquisition Acquisition costs: Land, buildings, equipment equipment Self-constructed Self-constructed assets assets Interest costs Observations Valuation Cash discounts Deferred Deferred contracts contracts Lump-sum Lump-sum purchases purchases Stock issuance Nonmonetary Nonmonetary exchanges exchanges Contributions Other valuation Other methods methods Cost Subsequent Cost to Acquisition to Additions Improvements Improvements and replacements replacements Rearrangement Rearrangement and reinstallation and Repairs Summary Dispositions Sale Involuntary Involuntary conversion conversion Miscellaneous Miscellaneous problems problems Chapter 10-3 Property, Plant, and Equipment Property, plant, and equipment includes land, buildings, and equipment (machinery, furniture, tools). Major characteristics include: “Used in operations” and not for resale. Long-term in nature and usually depreciated. Possess physical substance. Chapter 10-4 LO 1 Describe property, plant, and equipment. Acquisition and Valuation of PP&E Valued at Historical Cost, reasons include: At acquisition, cost reflects fair value. Historical cost is reliable. Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold. APB Opinion No. 6 states, “property, plant, and equipment should not be written up to reflect appraisal, market, or current values which are above cost.” Chapter 10-5 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E Cost of Land Includes all costs to acquire land and ready it for use. Costs typically include: (1) the purchase price; (2) closing costs, such as title to the land, attorney’s fees, and recording fees; (3) costs incurred on getting the land in condition for its intended use, such as grading, filling, draining, and clearing; (4) assumption of any liens, mortgages, or encumbrances on the property; and (5) Additional land improvements (permanent in nature) that have an indefinite life. Chapter 10-6 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E Cost of Buildings Includes all costs related directly to acquisition or construction. Costs typically include: (1) materials, labor, and overhead costs incurred during construction and (2) professional fees and building permits. Question: How should firms account for an old building that is on the site of a newly proposed building? Answer: The cost of demolition less its salvage value is a cost of getting the land ready for its intended use and related to the land rather than to the new building. Chapter 10-7 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E Cost of Equipment Include all costs incurred in acquiring the equipment and preparing it for use. Costs typically include: (1) purchase price, (2) freight and handling charges (3) insurance on the equipment while in transit, (4) cost of special foundations if required, (5) assembling and installation costs, and (6) costs of conducting trial runs. Chapter 10-8 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E E10-1 (Acquisition Costs of Realty) The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified: Classification Notes Payable (a) Money borrowed to pay building contractor (b) Payment for construction from note proceeds (c) Cost of land fill and clearing (d) Delinquent real estate taxes on property assumed (e) Premium on insurance policy during construction (f) Refund of 1-month insurance premium because construction completed early Building Land Land Building (Building) Chapter 10-9 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E E10-1 (Acquisition Costs of Realty) The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified: (g) Architect’s fee on building (h) Cost of real estate purchased as a plant site (land $200,000 and building $50,000) (i) (j) Commission fee paid to real estate agency Installation of fences around property Building Land Land Land Improvements Land (Land) Land Improvements Land Building (k) Cost of razing and removing building (a) Proceeds from salvage of demolished building (b) Cost of parking lots and driveways (c) Cost of trees and shrubbery (permanent) (d) Excavation costs for new building Chapter 10-10 LO 2 Identify the costs to include in initial valuation of LO property, plant, and equipment. property, Acquisition and Valuation of PP&E Self-Constructed Assets Costs typically include: (1) Materials and direct labor (2) Overhead (indirect costs, including utility, insurance, supervisory labor, depreciation of fixed assets and supplies, and so on) can be handled in two ways: 1. Assign no fixed overhead 2. Assign a portion of all overhead to the construction process. Companies use the second method extensively. Chapter 10-11 LO 3 Describe the accounting problems associated with self-constructed assets. Acquisition and Valuation of PP&E Interest Costs During Construction Three approaches have been suggested to account for the interest incurred in financing the construction. $0 Increase to Cost of Asset $? Capitalize no Capitalize interest during construction construction Capitalize actual Capitalize costs incurred during construction (with modification) modification) Capitalize Capitalize all costs of funds funds Illustration 10-1 GAAP Chapter 10-12 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Interest Costs During Construction GAAP requires — capitalizing actual interest (with modification). Consistent with historical cost — all costs (including interest) incurred to bring the asset to the condition and location necessary for its intended use. Rationale: a firm should defer (capitalize) interest costs during construction, since the asset is not generating revenues. Once the construction is complete, the asset is ready for its intended use and can earn revenues. At this point, firms should report interests as an expense and match it to the revenue. Capitalization considers three items: 1. 2. 3. Chapter 10-13 Qualifying assets. Capitalization period. Amount to capitalize. LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Qualifying Assets Require a period of time to get them ready for their intended use. Two types of assets: Assets under construction for a company’s own use. Assets intended for sale or lease that are constructed or produced as discrete projects. Chapter 10-14 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Capitalization Period Begins when: 1. 2. 3. Expenditures for the asset have been made. Activities for readying the asset are in progress . Interest costs are being incurred. Ends when: The asset is substantially complete and ready for use. Chapter 10-15 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Amount to Capitalize Capitalize the lesser of: 1. 2. Actual interest costs Avoidable interest - the amount of interest that could have been avoided if expenditures for the asset had not been made. Chapter 10-16 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Interest Capitalization Illustration: Delmar Corporation borrowed $200,000 at 12% interest from State Bank on Jan. 1, 2005, for specific purposes of constructing special-purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 2005, and the following expenditures were made prior to the project’s completion on Dec. 31, 2005: Actual Expenditures: January 1, 2005 April 30, 2005 November 1, 2005 December 31, 2005 Total expenditures $100,000 150,000 300,000 100,000 $650,000 Other general debt existing on Jan. 1, 2005: $500,000, 14%, 10-year bonds payable $300,000, 10%, 5-year note payable Chapter 10-17 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition Step 1 - Determine which assets qualify for capitalization of interest. Special purpose equipment qualifies because it requires a period of time to get ready and it will be used in the company’s operations. Step 2 - Determine the capitalization period. The capitalization period is from Jan. 1, 2005 through Dec. 31, 2005, because expenditures are being made and interest costs are being incurred during this period while construction is taking place. Chapter 10-18 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Step 3 - Compute weighted-average accumulated expenditures. Date Jan. 1 Apr. 30 Nov. 1 Dec. 31 Actual Expenditures $ 100,000 150,000 300,000 100,000 $ 650,000 Weighted Average Capitalization Accumulated Period Expenditures 12/12 $ 100,000 8/12 100,000 2/12 50,000 0/12 $ 250,000 A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure. Chapter 10-19 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Step 4 - Compute the Actual and Avoidable Interest. Selecting Appropriate Interest Rate: 1. For the portion of weighted-average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use the interest rate incurred on the specific borrowings. For the portion of weighted-average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a weighted average of interest rates incurred on all other outstanding debt during the period. 2. Chapter 10-20 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Step 4 - Compute the Actual and Avoidable Interest. Actual Interest Debt 200,000 500,000 300,000 1,000,000 Interest Rate 12% 14% 10% $ Actual Interest $ 24,000 70,000 30,000 124,000 Specific Debt Other Debt $ Weighted-average interest rate on general debt $100,000 $800,000 = 12.5% $ Avoidable Interest Avoidable Accumulated Expenditures $ 200,000 50,000 $ 250,000 Interest Rate 12% 12.5% Avoidable Interest $ 24,000 6,250 $ 30,250 Chapter 10-21 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Step 5 – Capitalize the lesser of Avoidable interest or Actual interest. Avoidable interest Actual interest Journal entry to Capitalize Interest: Equipment Interest expense $ 30,250 124,000 30,250 30,250 Chapter 10-22 LO 4 Describe the accounting problems associated with interest capitalization. Valuation Generally Companies should record property, plant, and equipment: at the fair value of what they give up or at the fair value of the asset received, whichever is more clearly evident. Chapter 10-23 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Cash Discounts — whether taken or not — generally considered a reduction in the cost of the asset. Deferred-Payment Contracts — Assets, purchased through long term credit contracts, are recorded at the present value of the consideration exchanged. Chapter 10-24 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Deferred-Payment Contracts (p. 482) Sutter Company issues a $100,000, five-year, zero-interest-bearing note to Wrigley Robotics, Inc. for the new robot spray painter for its production line. The prevailing market rate of interest for obligations of this nature is 10%. Sutter is to pay off the note in five $20,000 installments, made at the end of each year. Sutter approximate the robot’s value by estimating the present value of the note, since the robot’s market value cannot be readily determined. Entries for the date(s) of purchase and payments are as follows. Y1/1/1 Equipment (20,000*3.79079) Discount on Notes Payable Notes Payable 75,816 24,184 100,000 Y1/12/31 Interest Expense 7,582 Note payable 20,000 Cash Discount on Notes Payable 20,000 7,582 Chapter 10-25 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Lump-Sum Purchases — Allocate the total cost among the various assets on the basis of their fair market values. Issuance of Stock — The market value of the stock issued is a fair indication of the cost of the property acquired. Chapter 10-26 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Exchanges of Nonmonetary Assets Ordinarily accounted for on the basis of: the fair value of the asset given up or the fair value of the asset received, whichever is clearly more evident. (SFAS No. 153 “Exchange of Nonmonetary Assets, an Amendment of APB No. 29”, FASB 2004) Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance (future cash flows change as a result of the transaction). Chapter 10-27 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Accounting for Exchanges Illustration 10-10 * If cash is 25% or more of the fair value of the exchange, recognize entire gain because earnings process is complete. (EIFT Issue No. 86-29, Oct 1, 1987) Chapter 10-28 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Exchanges - Loss Situation Companies recognize a loss immediately whether the exchange has commercial substance or not. Rationale: Companies should not value assets at more than their cash equivalent price; if the loss were deferred, assets would be overstated. Chapter 10-29 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Exchange – Gain Situation Illustration: Carlos Arruza Company exchanged equipment used in its manufacturing operations plus $3,000 in cash for similar equipment used in the operations of Tony LoBianco Company. The following information pertains to the exchange. Equipment (cost) Accumulated Depreciation Fair value of equipment Cash given up Arruza $28,000 19,000 15,500 LoBianco $28,000 10,000 12,500 3,000 Instructions: Prepare the journal entries to record the exchange on the books of both companies. Chapter 10-30 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Calculation of Gain or Loss Fair value of equipment received Cash received / paid Less: Bookvalue of equipment ($28,000-19,000) ($28,000-10,000) Gain or (Loss) on Exchange Arruza $12,500 3,000 (9,000) $6,500 (18,000) ($5,500) LoBianco $15,500 (3,000) When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain. Chapter 10-31 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Has Commercial Substance Arruza: Equipment 12,500 Cash 3,000 Accumulated depreciation 19,000 Equipment Gain on disposal of used equip. 28,000 6,500 LoBianco: Equipment Accumulated depreciation Loss on disposal of used equip. 15,500 10,000 5,500 Equipment Cash Chapter 10-32 28,000 3,000 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Lacks Commercial Substance Arruza: Equipment (12,500 – 5,242) Cash Accumulated depreciation Equipment Gain on exchange Cash Received Cash Received + FMV of Assets Received $3,000 $3,000 + $12,500 Chapter 10-33 7,258 3,000 19,000 28,000 1,258 x Total Total Gain Gain = Recognized Recognized Gain Gain $1,258 x $6,500 = Deferred gain = $6,500 – 1,258 = $5,242 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Lacks Commercial Substance LoBianco (no change): Equipment Accumulated depreciation Loss on exchange Equipment Cash 15,500 10,000 5,500 28,000 3,000 Companies recognize a loss immediately whether the exchange has commercial substance or not. Chapter 10-34 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Summary of Gain and Loss Recognition on Exchanges of Nonmonetary Assets Lacks Commercial Substance Illustration 10-20 Chapter 10-35 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Accounting for Contributions The receiving companies should use the fair value of the asset to establish its value on the books and should recognize contributions received as revenues in the period received. The company contributing a nonmonetary asset should recognize the amount of the donation as an expense at the fair value of the donated asset. If a difference exists between the fair value of the asset and its book value, the firm recognize a gain or loss. Chapter 10-36 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Costs Subsequent to Acquisition In general, costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed. To capitalize costs, one of three conditions must be present: Useful life of the asset must be increased. Quantity of units produced from asset must be increased. Quality of units produced must be enhanced. Chapter 10-37 LO 6 Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Major Types of Expenditures Additions Improvements and Replacements Rearrangement and Reinstallation Repairs (Illustration 10-21, p495) Chapter 10-38 LO 6 Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Additions Improvement & replacement Capitalize cost of addition to asset account. (a) Carrying value known: Remove cost of and accumulated depreciation on old asset, recognizing any gain or loss. Capitalize cost of improvement /replacement. (b) Carrying value unknown: 1. If the asset’s useful life is extended, debit accumulated depreciation for cost of improvement/replacement. 2. If the quality or quantity of the asset’s productivity is increased, capitalize cost of improvement/replacement to asset. Chapter 10-39 LO 6 Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Improvement and replacement (P. 493 ) Instinct Enterprise decides to use plastic in place of the copper tubing in its plumbing system. The old tubing and pipe have a book value of $15,000 (cost of $150,000 less accumulated depreciation of $135,000), and a scrap value of $1,000. The plastic tubing system costs $125,000. Instinct Enterprise makes the following entry: Plumbing System Accumulated Depreciation Loss on Disposal of Plant Assets Plumbing System Cash Chapter 10-40 125,000 135,000 14,000 150,000 124,000 LO 6 Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Rearrangement and reinstallation (a) If carrying value of the original installation is known, treat the cost as a replacement. (b) If carrying value of the original installation is unknown, and rearrangement/reinstallation cost is material and benefits future periods, capitalize as an asset. If the expenditure is immaterial or future benefit is questionable, then expense the cost when incurred. (a) Ordinary: Expense cost of repairs when incurred. Repairs (b) Major: Treat as an addition or improvement/replacement. Chapter 10-41 LO 6 Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Allowance for Repairs To provide comparability to interim report, a company may use “Allowance for Repair” account to better match the repair costs with the benefits. (P. 494) Cricket Tractor Company estimated its annual repair expense is $720,000. The actual repairs happened in the second ($344,000) and fourth ($380,800) quarters. The entries are as follows: Q1 Repair Exp 180,000 Allowance for Repair Allowance for Repair Cash, Wages Payable Chapter 10-42 Q2 180,000 180,000 344,000 - Q3 184,800 180,000 Q4 180,000 180,000 - 184,800 380,800 - 344,000 380,800 LO 7 Describe the accounting treatment for the disposal of property, plant, LO and equipment. and Disposition of Plant Assets Sale of Plant Assets BE10-14 Sim City Corporation owns machinery that cost $20,000 when purchased on January 1, 2004. Depreciation has been recorded at a rate of $3,000 per year, resulting in a balance in accumulated depreciation of $9,000 at December 31, 2006. The machinery is sold on September 1, 2007, for $10,500. Prepare journal entries to (a) update depreciation for 2007 and (b) record the sale. Chapter 10-43 LO 7 Describe the accounting treatment for the disposal of property, plant, LO and equipment. and Disposition of Plant Assets (a) update depreciation for 2007 Depreciation expense ($3,000 x 8/12) Accumulated depreciation 2,000 2,000 (b) record the sale Cash Accumulated depreciation Machinery Gain on sale 10,500 11,000 20,000 1,500 Chapter 10-44 LO 7 Describe the accounting treatment for the disposal of LO property, plant, and equipment. property, Disposition of Plant Assets Involuntary Conversion Sometimes an asset’s service is terminated through some type of involuntary conversion such as fire, flood, theft, or condemnation. Companies report the difference between the amount recovered (e.g., from a condemnation award or insurance recovery), if any, and the asset’s book value as a gain or loss. They treat these gains or losses like any other type of disposition. Chapter 10-45 LO 7 Describe the accounting treatment for the disposal of LO property, plant, and equipment. property, Disposition of Plant Assets Miscellaneous Problems If a company scraps or abandons an asset without any cash recovery, it recognizes a loss equal to the asset’s book value. If scrap value exists, the gain or loss that occurs is the difference between the asset’s scrap value and its book value. If an asset still can be used even though it is fully depreciated, it may be kept on the books at historical cost less depreciation. Chapter 10-46 LO 7 Describe the accounting treatment for the disposal of LO property, plant, and equipment. property, The end Questions? Chapter 10-47 ...
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This note was uploaded on 03/29/2010 for the course FINANCE 0011100110 taught by Professor Shentingchun during the Spring '10 term at Nashville State Community College.

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