SB-BMGT310-sess22 and 23_ch10

SB-BMGT310-sess22 and 23_ch10 - Acquisition and Disposition...

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Unformatted text preview: Acquisition and Disposition of Acquisition and Disposition of Property, Plant, and Equipment Property, Plant, and Equipment Chapter 10 Chapter 10-1 Initially Prepared by Coby Harmon, University of California, Santa Barbara modified by Stephen Brown Learning Objectives Learning Objectives 1. 2. 3. 4. 5. 6. 7. Describe property, plant, and equipment. Identify the costs to include in initial valuation of property, plant, and equipment. Describe the accounting problems associated with selfconstructed assets. Describe the accounting problems associated with interest capitalization. Understand accounting issues related to acquiring and valuing plant assets. Describe the accounting treatment for costs subsequent to acquisition. Describe the accounting treatment for the disposal of property, plant, and equipment. Chapter 10-2 Property, Plant, and Equipment 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. Longterm in nature and usually depreciated. Possess physical substance. Chapter 10-3 LO 1 Describe property, plant, and equipment. Acquisition and Valuation of PP&E 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, APB Opinion No. 6 states, "property, plant, and equipment "property, plant, and equipment should not be written up to reflect should not be written up to reflect appraisal, market, or current values appraisal, market, or current values which are above cost." which are above cost." Chapter 10-4 LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Cost of Land Includes all costs to acquire land and ready it for use. Costs typically include: (1) (2) (3) (4) (5) Chapter 10-5 the purchase price; closing costs, such as title to the land, attorney's fees, and recording fees; costs of grading, filling, draining, and clearing; assumption of any liens, mortgages, or encumbrances on the property; and Additional land improvements that have an indefinite life. LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Cost of Buildings Includes all costs related directly to acquisition or construction. Costs typically include: (1) (2) materials, labor, and overhead costs incurred during construction and professional fees and building permits. Chapter 10-6 LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition and Valuation of PP&E 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) (2) (3) (4) (5) (6) Chapter 10-7 purchase price, freight and handling charges insurance on the equipment while in transit, cost of special foundations if required, assembling and installation costs, and costs of conducting trial runs. LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Do Example 10-1 on Doc Cam Chapter 10-8 LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Self-Constructed Assets Costs typically include: (1) (2) Materials and direct labor Overhead 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 10-9 LO 3 Describe the accounting problems associated with self-constructed assets. Acquisition and Valuation of PP&E 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 interest during construction Capitalize actual costs incurred during construction (with modification) Capitalize all costs of funds Illustration 10-1 GAAP Chapter 10-10 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Interest Costs During Construction GAAP requires -- capitalizing actual interest (with modification). Consistent with historical cost -- all costs incurred to bring the asset to the condition for its intended use. Capitalization considers three items: 1. Qualifying assets. 2. Capitalization period. 3. Amount to capitalize. Chapter 10-11 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E 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 10-12 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E 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 10-13 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E 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 10-14 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Interest Capitalization Illustration: Delmar Corporation borrowed $200,000 at 12% interest from State Bank on Jan. 1, 20x5, for specific purposes of constructing special purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 20x5, and the following expenditures were made prior to the project's completion on Dec. 31, 20x5: Actual Expenditures: January 1, 20x5 $ 100,000 April 30, 20x5 150,000 November 1, 20x5 300,000 December 31, 20x5 100,000 Total expenditures $ 650,000 Other general debt existing on Jan. 1, 20x5: $500,000, 14%, 10year bonds payable $300,000, 10%, 5year note payable Chapter 10-15 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E 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 10-16 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Step 3 - Compute weightedaverage accumulated expenditures. A c t ua l Ex pe nd it ur e s $ 0 ,0 0 0 10 0 ,0 0 0 15 0 0 ,0 0 0 3 0 ,0 0 0 10 $ 5 0 ,0 0 0 6 Ca pit a liza t io n Pe r io d 12 / 12 8 / 12 2 / 12 0 / 12 W e ig h t e d A ve r a g e A c c um ula t e d Ex pe nd it ur e s $ 0 ,0 0 0 10 0 ,0 0 0 10 0 ,0 0 0 5 $ 5 0 ,0 0 0 2 Da t e J a n. 1 A pr . 3 0 No v. 1 De c . 3 1 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 10-17 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Step 4 - Compute the Actual and Avoidable Interest. Selecting Appropriate Interest Rate: 1. For the portion of weightedaverage 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 weightedaverage 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 10-18 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Step 4 - Compute the Actual and Avoidable Interest. Actual Interest Debt Specif ic Debt General Debt $ 200, 000 500, 000 300, 000 $ 1, 000, 000 I nt erest Rat e 12% 14% 10% $ Act ual I nt erest 24, 000 70, 000 30, 000 $ 124, 000 Accumulat ed I nt erest Rat e 12% 12. 5% $ Weightedaverage interest rate on general debt $100,000 $800,000 = 12.5% Avoidable I nt erest $ 24, 000 6, 250 30, 250 Avoidable Interest Expendit ures $ 200, 000 50, 000 $ 250, 000 Chapter 10-19 LO 4 Describe the accounting problems associated with interest capitalization. Acquisition and Valuation of PP&E Acquisition and Valuation of PP&E Step 5 Capitalize the lesser of Avoidable interest or Actual interest. Avoidable int erest Act ual int erest Journal entry to Capitalize Interest: Equipment Interest expense 30,250 30,250 $ 30, 250 124, 000 Chapter 10-20 LO 4 Describe the accounting problems associated with interest capitalization. Valuation Valuation Class Do example of interest Capitalization Chapter 10-21 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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 10-22 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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, are recorded at the present value of the consideration exchanged. assets on the basis of their fair market values. Lump-Sum Purchases -- Allocate the total cost among the various Issuance of Stock -- The market value of the stock issued is a fair indication of the cost of the property acquired. Chapter 10-23 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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. 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 10-24 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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. Chapter 10-25 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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 10-26 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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. Equip m e nt ( c os t ) Ac c um ulat e d De p r e c iat ion Fair value of e quip m e nt Cas h g ive n up Ar r uz a $ 2 8 ,0 0 0 19 ,0 0 0 15 ,5 0 0 LoBianc o $ 2 8 ,0 0 0 10 ,0 0 0 12 ,5 0 0 3 ,0 0 0 Instructions: Prepare the journal entries to record the exchange on the books of both companies. Chapter 10-27 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Valuation Calculation of Gain or Loss Fair value of e quip m e nt r e c e ive d Cas h r e c e ive d / p aid Le s s : Boo k value of e quip m e nt ( $ 2 8 ,0 0 0 19 ,0 0 0 ) ( $ 2 8 ,0 0 0 10 ,0 0 0 ) Gain or ( Los s ) on Ex c hang e A r r uz a LoBianc o $ 12 ,5 0 0 $ 15 ,5 0 0 3 ,0 0 0 ( 3 ,0 0 0 ) ( 9 ,0 0 0 ) ( 18 ,0 0 0 ) $ 6 ,5 0 0 ( $ 5 ,5 0 0 ) 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 10-28 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Valuation Has Commercial Substance Arruza: Equipment Cash Accumulated depreciation Equipment Gain on exchange 12,500 3,000 19,000 28,000 6,500 LoBianco: Equipment Accumulated depreciation Equipment Cash Loss on exchange Chapter 10-29 15,500 10,000 5,500 28,000 3,000 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation 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 10-30 7,258 3,000 19,000 28,000 1,258 = Recognized Gain = $1,258 x x Total Gain $6,500 Deferred gain = $6,500 1,258 = $5,242 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Valuation Lacks Commercial Substance LoBianco (no change): Equipment Accumulated depreciation Equipment Cash Loss on exchange 15,500 10,000 5,500 28,000 3,000 Companies recognize a loss immediately whether the exchange has commercial substance or not. Chapter 10-31 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Valuation Summary of Gain and Loss Recognition on Exchanges of Nonmonetary Assets Lacks Commercial Substance Illustration 10-20 Chapter 10-32 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Valuation Valuation Accounting for Contributions 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. Chapter 10-33 LO 5 Understand accounting issues related to acquiring and valuing plant assets. Costs Subsequent to Acquisition 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 10-34 LO 6 Describe the accounting treatment for costs subsequent to acquisition. ...
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This note was uploaded on 02/07/2012 for the course BMGT 310 taught by Professor Mckinney during the Fall '08 term at Maryland.

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